Ladies and gentlemen, thank you for standing by, and welcome to the iRhythm update on Q3 2019 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I'd now like to hand the conference over to Lee Savo, investor relations. Please go ahead.
Thank you, Sharon, thank you all for participating in today's call. We appreciate all of you waiting a few extra minutes while we let a few more people join the call this morning. Joining me on the call today are Kevin King, CEO, and Matt Garrett, CFO. Earlier today, iRhythm released revised financial results and issued the quarterly report on Form 10-Q for the third quarter ended September 30, 2019. A copy of the press release is available on the company's website. Before we begin, I'd like to remind you that management will make statements during this call that include forward-looking statements within the meaning of federal securities laws, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements contained in this call that are not statements of historical fact should be deemed to be forward-looking statements.
All forward-looking statements, including without limitation, our examination of operating trends and our future financial expectations, which include expectations for hiring, growth in our organization and reimbursement, and guidance for revenue, gross margins, and operating expenses in 2019, are based upon our current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements. Accordingly, you should not place undue reliance on these statements. For a list and description of the risks and uncertainties associated with our business, please refer to the risk factors section of our most recent quarterly report on Form 10-Q and annual report on Form 10-K with the SEC. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, December 23rd, 2019.
iRhythm disclaims any intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information, future events, or otherwise. With that, I'd like to turn the call over to Kevin.
Thank you, Lee. Good morning, and thank you for joining us. This morning, we filed our 10-Q for the third quarter ended September 30th, 2019, and issued a press release detailing revised quarterly financials for certain prior periods. On the call today, I will provide background on the reason for our delayed filing and a summary of the net impact of the revisions. I will also provide updated guidance before opening the call for questions. Due in large part to our efforts over the past couple of quarters to remediate our accounting controls surrounding contractual allowance and doubtful accounts, we uncovered immaterial timing and classification errors that affected prior periods. While those errors and adjustments were immaterial for any given quarter, the cumulative amounts for the years were approaching the levels of materiality requiring further investigation.
Upon the completion of that investigation, the company ultimately determined that the cumulative impact required revision. As is the normal course when revising financials, we moved all out-of-period adjustments to the appropriate quarter, including a number of small other operating expense items. We've provided a detailed bridge of each and every quarter in the press release as well as in our 10-Q filing. While the magnitude of the revisions were small and were determined shortly after the announced filing delay, the process took considerably longer than we originally anticipated as our auditors performed rigorous testing, analysis, and reviews that exceeded our expectations. As noted previously, the revisions are primarily timing and classification related. It's important to note there are no changes to any Zio Service volumes, patient registration figures, or any other data the company typically shares within any of the periods reviewed.
In summary, the net impact of the revisions on revenue and total operating expenses are as follows. For the nine months ended September 30th, 2019, revenues decreased by approximately $1.1 million, while revenue for the full year 2018 saw no material change. For the full year 2017, revenue increased by approximately $600,000. For the nine months ended September 30th, 2019, total operating expenses decreased by $1.6 million and increased by $400,000 and $1.8 million for 2017 and 2018 respectively. Given that these revisions are taking place near the end of the year, we felt it was important to update our full-year revenue guidance to reflect the revision changes described here as well as two other items. We now expect full-year 2019 revenue to be in the range of $213 million-$214 million, representing a total revenue growth of 45%.
This compares to our previous revenue range of $215 million-$217 million. We now expect full-year gross margins to be in a range of 75%-76%, compared to 75.5%-76.5% previously. There are no other changes to guidance at this time. The three items reflected in our updated guidance include: First, the revision changes related to the contracted portion of our revenue described in our financial tables of our earnings release, which represents $1.1 million. Secondly, as a final step in the remediation efforts for reserves, we are forecasting a change in estimates in the quarter for prior periods' non-contracted average collection rates. This change is directly related to the changes of implementing Topic 606 with non-contracted claims in a rapidly changing payer and payment environment. This additional reserve covers periods from 2018 through 3Q 2019.
Due to our remediation efforts and the fact that non-contracted revenue mix continues to decline, we believe this is a one-time adjustment. Lastly, while December patient registration volumes are in line with our expectations for the month, we are tracking about one day behind our historical device return rates for the month. We track daily, weekly, and monthly returns, and they are quite predictable, including the fourth quarter months of October and November. December, however, is lagging by about one day compared to our expected returns. This is roughly $1 million. Because of our service level agreements, we operate with very little backlog or queue, and a delay at the end of the quarter pushes out revenue generation and revenue recognition for us.
Certainly, we expect to receive these units, and it's possible this resolves itself by the end of the month, but we wanted to call this out given the risk. Importantly, we see no reason why this could become a new normal, and minimally expect to see all of the devices show up in our January numbers. In conclusion, we're deeply disappointed that our 3Q filing took considerably longer than we expected at the outset. The revision changes described in our filing are immaterial to any period and in total but needed revision. Likewise, for the non-contracted ACR change in the fourth quarter described here. Importantly, none are forward-looking, and there is no change in our business confidence or outlook. We plan to provide guidance for 2020 during our Q4 earnings call and hope also at that time to have important milestone updates on our much-anticipated CPT classes by then.
Thank you for your time this morning. I'll now open the call up for questions.
If you'd like to ask a question at this time, please press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Your first question comes from Robbie Marcus with JPMorgan.
Great. Thanks, good morning.
Good morning.
Hey, Kevin, or I don't know if Matt's on.
Yep.
Maybe you could just run through what caused the problems in the first place. What are some of the actions you've taken since you first realized there was a need for improvement? What does this change do to the financials going forward?
Sure.
Yeah, Kevin, this is Matt. Let me take it, and I'm sure there'll be follow-up questions, but thanks for calling in, Robbie. I apologize to have to put you guys through this morning. Look, when we announced the delay, we were very open and transparent in the fact that we had some numbers that had moved on us related to the remediation efforts that the organization has gone through. We also acknowledged that these efforts were directly correlated with the material weaknesses that we identified at the beginning of the year. Every company has audit adjustments that get booked in later periods. Only when they raise to the level of materiality, do you actually do a situation like this, a revision, or in worst case, a restatement. Again, these numbers are not material in any given quarter.
They rose to the level of materiality on a year-to-date basis. That happened directly because of our remediation efforts. Specifically, what I'm referring to is our, for lack of a better word, cleanup efforts around our reserves for both contractual allowances as well as our doubtful account reserves. Those are the bad debt expense related to the co-pay portion of our book of business. Those amounts rose to a level that made us look into whether or not a revision was necessary. As Kevin pointed out, that's exactly what we did. Specifically, what has happened is by improving our close and reserve processes, we've identified a significant amount of reserves from prior periods that needed to be released. We also identified that we were under-reserve related to the bad debt expense portion of our business.
We identified both and called out both of those on the Q3 call. It was because of that, on accumulated basis, after the call, that we unfortunately had to make the determination that a revision was necessary, and that's the reason for the delay in our filing. Let me stop there and see if that helps you understand at the high level what happened, or if you have follow-up questions.
Yeah. Is it really just an issue of getting more people in place or better systems in place? What is it that you actually do to prevent this from happening again?
Right. Great follow-up. Thanks. Look, Robbie, from February till now, we now have a full functioning revenue team. I've got a team of four. I have a director, I have a manager, and I have two analysts. We now have the ability within our systems to track claims down to the specific month by revenue stream. We've also implemented a 12-month roll forward on all adjudicated claims, again, by revenue stream. This roll forward is reviewed monthly, and if any estimate changes are required, we book those. What's most important here, and this is all related to the contractual allowance piece, is we no longer keep payer claims open in our books for longer than that 12-month period of time. It eliminates the risk of any over or under reserving for periods older than one year.
What has happened here is this was an effort to get the books cleaned up related to all of these outstanding claims from adjudicated or otherwise from prior periods. We identified that we indeed had over-reserved over a couple periods, and we released those reserves. That's the emphasis. The same goes through on the doubtful account side. We now review those. That roll forward is a little bit longer because we're dealing with the patient portion. Overall, it's the same sort of thing, and we're now in position to be able to track those in a way that we no longer believe that there would be any sort of material amounts that we would have to adjust moving forward.
Great. Last from me, the amount of orders that might slip into January, is there any way you could quantify that for us?
Yeah, we're talking about one day of receipts, Robbie, which we, as I said in the prepared remarks, is roughly $1 million.
Okay.
In a given quarter, we're talking about 60 to 62 days. We're going to do $58 million in the quarter. It's $960,000. As I said, it could get better. We have seven more days of mail receipts. As I look at it right now, for some strange reason, December is tracking slightly behind the metrics that we use for the month of December. We've not seen any other delays in any other quarters or any months. I just wanted to call it out as a risk here.
Got it. Other than that, you shouldn't really see any change to forward numbers, think 2020 or beyond, from the impact we saw resolved.
Totally right. Yeah. There's nothing associated with any volume, any patient registrations, any contracts, any contract pricing. This is the mechanics of financial healthcare services.
Sure.
Our business is a little bit different than, say, a med device where you'd have a price and a static invoice. Our invoices come in the form of claims. We have four different payment streams, we have 2 different types of claims. We have patient claims and payer claims. It can take anywhere from 12 to 18 months to fully adjudicate any given claim. Each claim can change up to half a dozen to three-quarters of a dozen times. This sort of real-time nature of tracking our claim status is what Matt is referring to when we're talking about our AR allowances and bad debt expense, that these things are changing constantly, and we need automated systems and the resources Matt was describing to track them.
It's not as simple for us as an invoice with a price, and you either paid it or you didn't pay it. It's changing constantly.
Great.
Robbie, I would add, as it relates to the plumbing here moving forward, as we called out on the Q3 call, and I'll reiterate here, we are seeing improvements overall in our collection efforts, right? Obviously, we find ourselves slightly over-reserved on the top line. I do anticipate continued improvement on our contractual allowance percentages of our overall revenue as we continue to get better. This isn't just a back-office accounting and finance exercise. This is part of this revenue cycle management investment that we've been talking about, the support for the field. When we get better at submitting claims, get better at adjudicating claims, and we get paid more, obviously our ASP per claim goes up, and I do anticipate us continuing to see that in the future.
We also mentioned, unfortunately, on the bad debt side, where the deductibles and the amount of copays for the patients are going up. That has led for a slightly higher % of bad debt expense. We do anticipate that moving forward, at least for the near term. I do believe that a lot of what we have implemented on the contractual allowance side with payers can also be implemented on the copay side as well. That's going to take just a little bit longer. For the foreseeable future, and at least from a guidance for 2020, again, we'll be talking about a slightly higher % for bad debt expense. Other than that, it's exactly the same.
All right. Great. Thanks a lot. Happy holidays.
Thank you. You too.
Next question comes from David Lewis with Morgan Stanley.
Good morning. A couple accounting questions for me, I want to dive into this demand issue here in the fourth quarter. The first issue, Kevin or Matt, you quantified the impact from the extra day for receipts as $1 million. Matt, what was the non-contracted impact year to date or reflected in guidance reduction?
David, I'll give you that answer. Let me make sure everyone understands exactly what we're talking about here and why there's this change of estimate. This is specifically related to Topic 606 implementation in Q1 of 2018. Prior to 2018, iRhythm booked non-contracted revenue only when cash came in the door, cash receipts. When we transitioned to 606, that required us to no longer book cash receipts, but to have an accrued average collection rate based upon historical collections. That is a tricky thing for us to be able to do given the fact that we have such a transient claim mix that has changed rapidly over the last two years.
In other words, on January 1st, 2018, we are required to come up with an ACR rate based on historical claims in which a period that between basically Q1 of 2018 to Q2 of this year, we had a massive shift from non-contracted to contracted. Each and every time, we have to then adjust our average collection rate moving forward. It is not subjective at all. It's an objective number. I have to look at what data we have to be able to identify what that number is. Unfortunately, throughout 2018 and 2019, we find ourselves with an ACR that was slightly higher in any given period than what we are now collecting from a historical perspective. While once again, in any given month, there's no material amount, it's $50,000 here, $75,000 there.
What we have identified from 2018 and 2019 is about expectation, as we sit here on the 23rd of December, is just under $1 million of change of estimate around our ACR number. In other words, we are going to take a reserve hit, a one-time reserve hit for overbooking of ACR in 2018 and earlier in 2019.
Okay. Said another way, adjusted for the third quarter, you're lowering guidance about $two and a half million at the midpoint. Roughly $1 million is coming from the non-contracted piece. One to $one and a half million seems to be coming from this day rate dynamic. Is that pretty close?
About $1 million, David. Yeah.
About one.
If you think of the walk from the guidance on the high end to the guidance on the previous high end to the current high end, we're at $217. We have a revision estimate of $1.1 million. That brings the net for nine months down to $215.9. We're saying in the fourth quarter, there's an ACR adjustment of $1 million. There's the possible delay in receipts of $1 million. That gets us down to $214.
Okay. Then Matt, one more chronic question, then I'll get back into the fundamentals. The adjustments, was there any pattern to the adjustments? I noticed the third quarter of 2019 and the fourth quarter of 2018 were the only period where there was a material overstatement of revenue. Any pattern, any reason why those particular quarters there was the overstatement? If not, if it's just randomness, we can leave it at that.
No, I think it's a fair question. I know it looks messy, but again, unfortunately, as Kevin pointed out, when you have a revision, you have to book everything. Again, I don't think any of these are material, but I do think it's important for investors to understand the key buckets. I would bucket them into three categories. The bucket, the adjustments for revenue for Q2 and Q3, those are contractual allowance reserve releases for prior periods. That's the 2016, 2017, and 2018 that I was referring to in my answer to Robbie's question. Those are all cleaned up. There's nothing that lingers, so we do not believe that that can happen again. The second bucket is related to out-of-period adjustments for Topic 606.
That's the number you see going favorably for us from a revenue perspective in Q1 of this year, and the number that I believe goes favorably for us in Q1 of 2018. That's number two. The third bucket is what you're seeing mostly related, again, in Q2 and Q3 of 2019, the lowering of Opex. Those, again, are specifically related to under-reserves of prior period doubtful account or bad debt expense reserves. Those are the three key buckets out of all of those immaterial changes. Once again, because this is partly a cleanup effort for prior periods, and because of our tightening ability to track this, we clearly do not anticipate seeing something of this nature happen again. I will follow up one other comment to the non-contracted ACR question, David.
The good news here, in addition to the fact that we've implemented this change of approach, is we're now at a point where the non-contracted portion of our business is much smaller than it was. I believe that Q3 2018 is now down. It's broken out in the Q, $2.7 million, or it's now 5% of revenue. A year ago, we were at 10%. That number going down obviously helps us from a perspective of managing this moving forward, because we just don't believe it can be material.
Once again, if you'd like to ask a question, please press star one on your telephone keypad. We have a question from Suraj Kalia with Oppenheimer.
Sure. Good morning, everyone. Can you hear me all right?
Yes. Sorry, Suraj.
All right. Kevin or Matt, just one question. Most have been asked. For ASC 606, is my understanding correct that even moving forward, you are looking at historical patterns, and this is a bucket analysis, whether by payer, whether by contracted or non-contracted. The % collectability is going to be defined on a bucket basis rather than a claims-by-claims basis. Is that a fair assessment on my part?
Suraj, that's exactly right. We now literally break out all four of our key revenue streams by bucket. We track claims at a monthly rate, or excuse me, on a monthly period. We have waterfalls to track how we are collecting against adjudicated claims totals. Now for the first time in Q2 and Q3, we're in position to either write off or change of estimate for each and every one of those buckets, with a couple of exceptions I'll get to in a minute, in real time. The only exceptions are on the doubtful accounts that still takes a little bit longer than 12 months because of the copay portion. Believe it or not, people are still paying their copays past the 12-month period. Then the other one is the ACR, the Topic 606 adjustments.
That can take a little bit longer as well, again, for the same reason. The majority of non-contracted claims, if they do get adjudicated, a significant portion of ownership of that payment goes to the patient. That takes a little bit longer as well. That's exactly how we're managing it moving forward.
Great. Thank you.
Okay. We do have a question from David Lewis with Morgan Stanley. Please go ahead.
Hi, guys. Can you hear me okay?
Yes.
Oh, sorry about that. Not sure what happened. Kevin, I want to go back to the fundamentals. Matt, thanks for the commentary on accounting. Kevin, I think no one cares as much about when receipts come through, they obviously care very much about the demand signal. Just a couple of questions here. First, how predictive has the invoicing been to revenue historically at the company? Has anything changed on the invoicing front over the last several quarters?
By invoicing, you mean our ability to predict reports posted, or do you mean the collection of cash against it?
Yeah. Kevin, what I think you're saying is, you believe that the timing of receipts has broken trend. The question is, it's trend relative to what? People want to get a sense of based on underlying business trends, what you thought has been the patches that have been placed on patients should have converted into receipts received by this time of the quarter. That hasn't happened. The question is, what is your predictive ability on patches placed, the demand signal, relative to receipts received? If you could help us out with that'd be, I think, important for investors to hear.
Absolutely. I'll answer it in three time periods for patients. Our predictability for patient registrations or patient prescriptions or prescriptions written by physicians for Zio Patch is extremely accurate. We're seeing no demand change, and we're not reporting any demand change here in the fourth quarter, nor for the entire year. End user demand for Zio is exactly where we think it should be. Once a patient has one device and they take it off and they mail it back to us, we're at the mercy of the post office as well as the patient returning the device to us. Our customer service and customer experience teams are in constant contact with patients to remove their device and return it, and that's where we're currently seeing this one-day lag.
Each and every month, each and every week, and each and every day, we have metrics that are ratios. You might think about as a book-to-bill ratio. The number of patients registered in a given period and the number of expected receipts returned back to us. That's what's wiggling in the month of December by one day. It has nothing to do with demand. It has to do with timing in the mail system. As far as recognizing revenue and cash collections or invoicing, those are all downstream of the receipt and the report posted, and that's what we've been talking about here as well on the invoicing cycle cash. Fundamentally, no demand change from the perspective of physician prescribing patterns. This is a one-day relative to historical averages.
Our business is quite predictable, and our analytics are quite strong that when we see a one-day delay, we scratch our head and say, "Well, why is that?" Is it because Christmas is falling on a Wednesday when last year it fell on a Friday? Is it because Thanksgiving was late this year? Is it because of weather? We don't quite know. We're trying to figure it out, but it does end up becoming relatively sizable, about $1 million a day, because that's about what we're booking. I would also comment, as I said in the prepared remarks, that we really don't have a backlog in our business. Our service level agreements with our customers require us to do essentially same-day reporting. We're a flow business.
Devices are being returned to us, devices are being reported out, or patient reports are being posted, revenue recognition, and physicians are getting their answers. We don't really have anything to draw on at the end of a week or a month or a quarter, say like a backlog business might have, CT or MRI or any other type of medical device where you would draw from. We're sort of a real-time business from that standpoint. Slowdowns can have an impact on us. It's really the first time we've ever seen it.
Okay.
It's quite odd for us. Is that helpful?
Okay, Kevin. Very specific. That's perfect. We'll leave it at that. Thanks so much.
You're welcome.
At this time, I'll turn the call over to Mr. Kevin King.
Okay. Thank you everyone for getting on this call. I know for many of you, it's very early in the morning, and it's also the holiday season. We also appreciate your patience as we worked our way through this delay in our filing. As I said earlier in our prepared remarks, the fundamentals of our business are strong. Our outlook remains the same, and we appreciate your patience. I wish you all a very happy holiday season. Thank you very much for calling in. Bye-bye.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.