(XGN)
Q2 2023 Earnings-Transcript
Exagen Inc. misses on earnings expectations. Reported EPS is $-0.28 EPS, expectations were $0.48.
Operator: Greetings. Welcome to the Exagen Inc. Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. At this time, I would like to hand the call over to Ryan Douglas of Investor Relations. Thank you. You may begin.
Ryan Douglas: Good morning and thank you for joining us. Earlier today, Exagen Inc. released financial results for the quarter ended June 30, 2023. The release is currently available on the company’s website at www.exagen.com. John Aballi, President and Chief Executive Officer; Kamal Adawi, Chief Financial Officer, will host this morning’s call. Before we get started, I would like to remind everyone that management will be making 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 facts should be deemed to be forward-looking statements.
All forward-looking statements, including, without limitation, statements regarding our business strategy and future financial and operating performance, including guidance for the quarter, potential profitability, our current and future product offerings, and reimbursement and coverage are based upon current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results to differ materially 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 risks and uncertainties associated with our business, please see our filings with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2022 and any subsequent filings.
The information provided in this conference call speaks only to the live broadcast today, August 7, 2023. Exagen disclaims any intention or obligation, except as required by law, to update or revise any information, financial projections or other forward-looking statements, whether because of new information, future events, or otherwise. I will now turn the call over to John Aballi, President and CEO of Exagen.
John Aballi: Thanks, Ryan, and thank you to everyone joining the call. Today, I’ll discuss our second quarter results and provide updates on our revenue cycle initiatives, including our path to profitability. I’ll then turn over the call to Kamal, our CFO, for details on our financial performance. Our strategy to prioritize and focus on AVISE CTD has resulted in another strong quarter, with over 37,000 AVISE CTD tests delivered and total revenues of 14.1 million. As a reminder, we’ve made substantial changes to the structure and size of our sales team and we believe that our Q2 performance is testament to the fact that we continue to serve the rheumatology community in a highly effective manner. I’m encouraged to see consecutive quarterly growth in volume as we make operational improvements to our business.
But this also reinforces the strategic decisions we made at the end of last year. Exagen has significant opportunity ahead, and we’re really starting to get on track as a team. It’s exciting to see our progress reflected in the performance of the company this quarter. Our revenue for the second quarter was reflective of the strong testing demand and volume delivered in Q2, but also a result of improved cash collections from testing performed in prior quarters. We continue to focus heavily on our revenue cycle operations and have made major strides in Q2 to improve our processes, which I’ll detail shortly. We expect to see incremental improvement in ASP as we move into early 2024, but we believe these early improvements in cash collections are a positive sign.
Overall, we’re seeing positive momentum in our operations and our efforts to achieve profitability continue to progress. One of the key metrics where we saw improvement quarter-over-quarter was our trailing 12-month ASP, which increased to $320 from $279. The increase in Q2 was aided by timing of cash collections on claims from prior periods, which we don’t necessarily expect to recur each quarter. However, this was nonetheless a positive development reflected in the improvement in ASP. In general, we’re beginning to trend in the right direction, but expect the bulk of our efforts to materialize into 2024. As we conveyed in Q1, we held claims to give ourselves time to optimize our appeal process, including an effort to increase the overall volume, quality and persistence of appeals.
To give some color on the extent of our efforts to date, we’ve brought in new leadership to this area of our business. We’ve worked with a technical writer to revise all appeal letters sent to payers on denied claims. We’ve restructured the appeals process with our internal team, redefining roles and responsibilities for every person involved in the process. We’ve worked with our clients to improve the clinical notes they draft on each patient to better communicate the rationale for ordering and utilizing advice. We’ve worked to improve the process for exchanging these progress notes with our team to lessen the burden on our customer staff. We brought in other personnel to increase the outbound calls to insurance companies, allowing us to keep better track of our appeal status.
We strengthen the documentation around test ordering and the list continues. These efforts have been a substantial adjustment compared to what we were doing even six months ago. And we’re still making progress to execute efficiently with these changes. All this requires communication and resetting of expectations with our customers in a manner which minimizes disruption and reinforces the value they’ve seen with AVISE testing for the last 12 years. We continue to focus on achieving a profitable business. We refinanced our loan this quarter, which included a principal payment of $10 million. Our changes to revenue cycle management increased our accounts receivable by 6.9 million. Excluding these two items, our cash decreased 3.8 million in the second quarter.
We are making progress in all areas of the company to operate as a leaner, more effective organization, and the team at Exagen is striving to deliver the best service in the industry with a markedly improved cost structure. Additionally, we continue to expect our annual R&D expenses to approach 6 million, and therefore our Q2 performance was aided by the timing of some of these expected expenses. As an ancillary item, we recently reached an agreement in principle with the Department of Justice to settle an investigation that was initiated in February of 2022. This investigation was related to conduct that occurred in 2014 and 2015. We agreed in principle to make a settlement payment with associated fees of approximately $700,000 and admitted to certain facts, although we did not concede liability.
The DoJ will not require an outside compliance monitor to oversee our operations going forward. The definitive settlement agreement is subject to further negotiations. But ultimately, we look forward to putting this issue behind us so we can continue to focus on operating the business. In closing, it’s rewarding to see another quarter where our organizational performance is trending in the right direction. This is testament to the hard work of the Exagen team and the value AVISE testing provides the rheumatology community. I’m very encouraged by our recent performance, knowing that we continue to improve in many areas and have yet to see the results from several ongoing efforts. Before I hand the call over to Kamal, I’d like to note that at our annual meeting this past quarter, Jim Tullis retired as a member of the Exagen Board of Directors.
Jim had been a director on the Board for nine years and a vital member of the team. I want to thank Jim for his guidance and support to me personally. Jim has been a strong supportive of Exagen throughout much of the company’s history, and we wish him well. Additionally, I’d like to extend a warm welcome to Paul Kim, the newest member of our Board. Paul joins us with vast business and leadership experience and currently serves as the CFO of Fulgent Genetics, where he played a pivotal role in growing the company into a successful and profitable business. I’ll now turn the call over to Kamal.
Kamal Adawi: Thank you, John, and good morning, everyone. For Q2 2023, total revenues were 14.1 million compared with 11.2 million in Q1 of 2023 and 7.6 million in the second quarter of 2022. As a reminder, for year-over-year comparisons, in 2022, payments for Medicare were delayed from Q2 to Q3. Sequential quarter growth in revenue was driven primarily by an increase in ASP. The increase in ASP was a result of improved collections from prior quarters dating back to Q1 2022, mostly due to greater than expected cash collections. Testing volumes for AVISE CTD were record 37,749. Other testing revenue was 1.6 million in the second quarter of 2023 compared with 1.4 million in the first quarter of 2023, and 1.7 million in the second quarter of 2022.
Cost of revenue were 5.8 million in Q2, resulting in a total gross margin of 58.7% compared to 47.2% in Q1 of 2023 and 20.1% in the second quarter of 2022. The increase in gross margin percentage from the first quarter was primarily due to increased accrual rates from improved collections in prior periods. Operating expenses were 19.1 million in the second quarter of 2023 compared with 21.7 million in the second quarter of 2022, primarily driven by a decrease in employee-related expenses due to the reduction in force in early December 2022. For the second quarter of 2023, our net loss was 5 million compared with a net loss of 7.7 million for the first quarter of 2023 and 14.7 million for the second quarter of 2022. As a reminder, we refinanced our debt on April 28 which included a principal prepayment of 10 million.
The refinance was through our existing lender and the current balance of the loan is 18.1 million. The terms of the agreement include a floating interest rate, which is greater of 10%, or prime plus 2%, resetting the interest-only period to three years, the implementation of a new management plan and improved covenants. Cash and cash equivalents as of June 30, 2023 were approximately 31.5 million. As John mentioned, with our revenue cycle management strategy, the claims held in Q1 and Q2 contributed to the AR balance increasing to 16.2 million, which is offset by a lower cash balance. Overall, the company is performing better operationally than we were even a few quarters ago. And we’re seeing the results in our key metrics. As you heard from John, excluding the loan principal prepayment and changes in AR, this resulted in a decrease in our cash balance of 3.8 million in the second quarter.
I’m very proud of the team and the changes we have implemented as we’re off to a great start in our path to profitability. Our cost of revenue is lower, our operations are much more efficient, and all departments have goals that align across the organization and continue to drive improved operations. Not to get lost in all the numbers, but just as important is the culture of the organization. I originally joined the company almost 10 years ago, and the culture is stronger than I’ve ever seen which is reinforced by a decrease in our trailing 12-month voluntary turnover rate. The rate has decreased 36% from the end of 2022 to June 30. Turning to guidance. Some of the changes in revenue cycle management that John mentioned will have an impact on future quarters.
We’re modeling a softening in volume in Q3 due to changes in revenue cycle optimization, but are anticipating the lower volume to begin to be offset by higher ASPs in 2024. For Q3, we’re providing revenue guidance in the range of 10 million to 10.5 million. We will now open the call for questions.
Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first questions come from the line of Dan Brennan with TD Cowen. Please proceed with your questions.
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Dan Brennan: Great. Thanks for taking the questions. Congrats on the quarter. Maybe just a couple. Maybe just in terms of the benefit this quarter that you had from past collections, can you just quantify kind of what that was? And are you expecting any more benefit in the back half of the year?
Kamal Adawi: Hi, Dan. Thanks for the question. Yes. To quantify the prior period collections that were received in Q2 of ’23, but mainly took place in the prior year, it was just under $2 million. This is a very positive impact. But I view it as one-time. It’s very tough to quantify if this is going to occur again. So this comes from mainly 2022. And sometimes there are payments that take up to a year to be received. But I wouldn’t anticipate it to be as large as what we just saw for ’22 and in future quarters.
Dan Brennan: Great. And then on the burn in the quarter. So the way I understand it is, I guess when you net out some of the changes that you had there, it sounds like you’re basically saying your underlying cash burn was 3.8 million. If that’s correct, then what level of burn — which is a nice step down obviously from what you guys have been having, what level of burn should we be expecting in the back half of the year? And with the impact on the account receivables that you highlighted, is that going to stop? So should we see that kind of normalize going forward?
John Aballi: Great. Good morning, Dan. This is John. So here’s kind of the way we think about the cash burn in general, if I can open up the question a little bit more broadly. So we burned almost 40 million of cash or an average of just over 9 million of cash per quarter in 2022. So far here in 2023, looking at the change in cash, as you mentioned, accounting for the AR as well as our debt principal payment, we burned approximately 11 million operating the company these past two quarters. And that was driven largely by some of the improvements we made. Just to recap, we’ve had the reduction in force of 42 individuals at the end of Q4. That was a substantial cost savings. We’ve completed the evaluation of our R&D pipeline. We’ve set up criteria to pursue what we consider real business opportunities.
These also strive to ensure financial success of the projects we’re working to develop. We’ve worked to reduce the cost of our internal operations. And we’ve seen a reduction in our COGS as well. You see that with similar overall COG expense, yet an increase in volume year-over-year. We’ve created an awareness and accountability at the company level. From a budgeting standpoint, that’s been one of the key things I’ve worked to implement is transparency into the expenses that we’re incurring as a business all the way throughout the organization, especially at the department head level. And then everyone is generally bought into our efforts to reduce costs. Kamal spoke to it a little bit about the culture. It’s certainly a team effort, but it’s embraced that way.
So we intentionally helped claims the first part of the year because we have the cash to do so and because we are working to improve our revenue cycle operations. I gave details in prior quarters. But this was a huge undertaking and a significant opportunity for us. We began releasing these claims at the end of the quarter. And this will obviously slow the pace of cash burn going forward is how we look at it. I’ll let Kamal maybe speak a little bit more on some of the specifics. But I wanted to give you our view here. We’re ahead of schedule with the strategy we put in place, very positive from our standpoint. The success we’re having in reducing the cash used for operations has come down pretty substantially, dramatic changes relative to where we were really even six months ago.
Our AR balance has increased, as we said, about 10 million here in 2023. It gives a sense of the cash we expect to collect over the next several months. That should be weighed in as well when considering our cash balance. But ultimately, we’re always looking for ways to improve the organization. So I’ll let Kamal maybe speak a little bit to the cash burn for future quarters and how we’re thinking about that too.
Kamal Adawi: Yes. Thanks, John. So as John mentioned, AR was one of the items that we have to exclude to get to the number 3.8. And part of the reason why it increased from 3.2 to 6.9 from Q1 to Q2 was we’re holding all claims in Q2 where we started midway through the quarter in Q1. And so in regards to cash burn going forward, we’re providing guidance on a quarterly basis because sometimes there’s quarters like we just had in Q2 where we had very positive impact from that, just under 2 million of additional [indiscernible] received from prior periods into Q2. And it’s tough to see the timing of some of these items. That had a very positive impact on our gross margins. We saw those increased to 58.7%, but again very tough to project the timing of that.
On the previous call, what I had mentioned on the Q1 earnings was we were at a $7 million cash burn in Q1, and we see it gradually come down quarter-after-quarter. Now again, Q2 was a very pleasant surprise with the additional collections. But that wasn’t projected. And we did say that we would expect to see it come down slightly each quarter. That has not changed. That is still what we believe. We just had a really good Q2, but we believe that we’re going to beat year-over-year improvements. But again, starting at 7 million in Q1 and coming down from there.
Dan Brennan: Great. Thank you. And maybe just one last one, the 3Q volume guidance. Obviously, you guys are on a journey here over the next couple of years, so might be a loss in incremental. But why would the volumes go lower in 3Q given all the positive changes you guys are putting in place? I know you’ve talked about on the last call, maybe some in the near term, could have some disruptions from the sales force realignment, and then eventually you begin to see the positive benefit. But is that the reason why you’re guiding to sequentially lower volumes?
John Aballi: Certainly. So to give a little extra color there, Dan, in Q1, Q2, we expected some impact from the reduction to the sales force. We detailed that extensively. Of the 42 individuals that were caught up in the reduction at the end of December, a third of that was sales based. So we expected some impact of volume from reducing our U.S. base footprint by about 30% or so. That was factored into our Q1 and Q2 guidance. It didn’t happen, to be totally frank. And we’ve seen now multiple quarters that even with a more streamlined and condensed sales force, we’re able to deliver actually record growth here. So that’s been very pleasant. What we’re factoring in, in Q3 are some changes to our revenue cycle operations, which are being translated to the customer.
So just to give you a sense, one example, we’ve implemented a new billing policy this past quarter, towards the end of this past quarter, which increases the cost sharing proportion for patients on our testing. The price of the AVISE test really hasn’t changed in about a decade. And so we’re making those changes as we’ve telegraphed pretty clearly, as we pursue profitable, more profitable business. And so these changes will improve the profitability of our portfolio, we anticipate, but could have some near-term impact to volume. And so again, the magnitude and timing are always challenging to know ahead of time, but that’s really what we factored into in our Q3 guide.
Dan Brennan: Great. Thank you very much. I’ll get back in the queue.
Operator: Thank you. Our next questions come from the line of Mark Massaro with BTIG. Please proceed with your questions.
Mark Massaro: Hi, guys. Thanks so much. Congrats on the strong revenue growth and reduction in cash burn. I guess, one for you, John. You’ve outlined a lot of changes to revenue cycle management. And certainly, I appreciate a lot of the color that you provided. I think it’d be interesting to get your sense for like what inning do you think we’re in with the changes to revenue cycle management? I’m just trying to determine how much continued improvement do you think we can see as we think about the business into 2024 and beyond?
John Aballi: Great. Good morning, Mark. Thanks for joining the call. Thanks for the question. What inning we’re in? I love it. I love the baseball analogy, especially given the season. So from my standpoint, I think we’re early innings. And the reason I say that is because we put a lot of work in terms of prepping. That’s what I’ve considered much of the first half of 2023 to be, a lot of game planning there. And we’re starting to put some of those efforts into play really, right? So the whole point of holding claims — just to give context to those comments. The whole point of holding claims was that we didn’t trigger timely filing deadlines for our appeals process. And the core — kind of a core tenet to our improvement in revenue cycle operations is improving the way we do appeals.
I think that’s really where the rubber meets the road in terms of impact for us longer term. And so I wanted to postpone as long as possible really the timely filing deadlines that would be associated with claim denials. And so as we started to release those, I expect — for the claims that we are going to be denied on, I expect to start seeing those come in sometime around September-ish into October. And then that will be our first round of appeals. I’ve tried to detail this in the past. But just to refresh everyone, I think that we’re going to have the opportunity to appeal somewhere around three times. That third level of appeal is oftentimes associated with an external review by a specialist. And that’s where we think really the value of the clinical data we’ve assembled and the value proposition will resonate most with that reviewer.
So from our standpoint, we’ve — it’s always been tough to nail down exact timing. But what we’ve tried to maintain consistency in communicating is sometime towards the end of this year and really into 2024, our growth will be a combination of both volume and ASP growth, our revenue growth that is, but it will be largely driven by ASP growth. And I think that that’s really the opportunity for the organization. Again, I think that’s the most sensitive lever we have to employ in growing this organization. We have substantial volume. We’ve shown we can continue to grow that volume with the current sales footprint, and we just need to pursue I think more profitable business from our standpoint. I’ve also detailed — the list price of AVISE CTD is $1,650.
And our Medicare rate for AVISE CTD is $1,067. You see our quarterly ASP was in the 330 range this quarter, our trailing 12 months is about 320. So we’re moving along in the right direction. I think they’ll have some quarter-to-quarter gyrations, but generally so far I like the trajectory we’re moving in, and I think we need to get to that $500, $600 range on an ASP level to really have some — transform the organization. So hopefully, that gives you some context to timing and how we’re thinking about it.
Mark Massaro: Okay, great. And maybe one for Kamal. Kamal, if I strip out the nearly $2 million of one-time payments, you would have done around 12 million in Q2. You’re guiding to 10.25 at the midpoint in Q3. How much of that sequential decrease would you think is related to the reduction or the softening volumes in Q3 versus some of the collections from prior payments and/or other ASP dynamics?
Kamal Adawi: Yes. Thanks for your question, Mark. So our ASP, when you back out that approximately 2 million from prior period collections, is still increasing. We did see that improved collections from prior periods does have an impact on current quarter ASP. So we did have to adjust our accrual rate up for our test performed in Q2. That’s going to continue forward into Q3. So I do anticipate our ASP to continue that improvement, so it’s going to be higher than what we saw in Q1. So to answer your question, it’s primarily going to be driven from a softening in volume and not being driven by the ASPs since that has improved.
Mark Massaro: Yes. And just to confirm, I know Dan asked you in the prior question, sometimes, obviously, there’s summer seasonality in Q3. I know in prior years, there have been some quarters where volumes stepped down sequentially. But can you just maybe walk me through maybe how much of it is seasonality versus the reduction in force versus other factors?
John Aballi: Certainly, Mark. I’ll chime in here. In terms of seasonality, we had July 4 on a Tuesday, really ate away a good portion of the first week of July, and we’re basically one month in to Q3, right? So where we’re sitting at today is the quarter started off soft. It’s a mix between the holiday impact that we believe, but we’re also actually seeing in our customer base a decent number of vacations. I know I’ve seen this with some of the airline reporting as well, international travel is up, especially with some of our key positions. We’ve had them go on fairly extended international trips. We’ve conducted some of this research ourselves and surveyed some of our customers. From our standpoint, I have a lot of confidence that our team has executed the initial transition from a sales force restructuring standpoint very well.
And I think we are a leaner organization, but we’re delivering a very high level of service. And we’re able to serve our key customers extremely well. So I think — how much is related to the reduction in force? I don’t believe much. I believe the impact here is a mix of seasonality along with some of our transition on the billing policy side in pursuit of more profitable business. As I mentioned, you increase some of the patient cost sharing, you change some of the prices of your tests. And while we don’t believe it will impact the bulk of our business, it will impact a small amount. So that’s kind of how we think about it.
Mark Massaro: Okay. That’s it for me. Thanks for the questions.
John Aballi: Thanks.
Operator: Thank you. Our next questions come from the line of Andrew Brackmann with William Blair. Please proceed with your questions.
Dustin Scaringe: Hi, guys. This is Dustin on the line for Andrew. Maybe a little bit more about the sales productivity, which I know you’ve touched on in past questions, but maybe more so how should we expect that going forward? Is there really any impact that you still think might linger in the third and fourth quarters from a reduction in territory and people? And how exactly are you tracking those people maybe besides volume per rep?
John Aballi: Hi, Dustin. Good morning. Thanks for joining the call. Thanks for the question. So I can speak to this from a qualitative standpoint really queue [ph] in on some of the things that we look at. In terms of performance as an organization, we take a look at orders per physician. We take a look at our physician base. In Q2, we had a growth in our physician base. We’ve had a growth in our higher ordering physicians. I think we have the overall outsized performance really across the board for all of our key metrics. So from that standpoint, when we take a look at it whether it be driving new business, whether it be further penetration with any existing business, I think throughout the rep transition, we’ve done a phenomenal job — the team’s done a phenomenal job in executing well.
And so I think that we’re very strong in that regard. Our reputation, our brands within the rheumatology community is extremely strong, and the transition has had much less of an impact than we originally anticipated to be completely frank. So from that standpoint, I think we are right on track. Really as we get into Q3, as I tried to detail, it’s a slightly different scenario, right? You’re changing expectations with our customer base. And when the price of our test hasn’t changed for 10 years, there’s an ingrained expectation that’s out there. And change management is always challenging I think, especially when it comes to pricing and especially when it comes to physician behavior. So our team is adept at this. The company has a history of launching and expanding the product portfolio.
And so in terms of educating the physician base, I think we’re very good at it. We’ve prepared extremely well. We’ve generated quite a bit of new collateral that’s gone out really to aid in explaining the change and the why to the physician. We’ve developed quite a bit of patient support material as well. And then we have a very compassionate team internally that’s been educated as to how to communicate these changes and how to articulate them to patients as well as clinicians. So I think we’ve done what we can to prepare. And I’ve seen it firsthand. I was in the field actually in Houston and St. Louis over the last couple of weeks, specifically for this reason, working to have conversations with some of our key clinicians, understand what the challenges of these changes mean for them and their practice.
And the majority that I visited, I visited over I think it was 17 or 18 different clinicians over a couple of week period. And it was well received. Once you explain the why, I think it was very positive. There are some use cases that will likely fall off better, more price sensitive. And so that’s being taken into account into our guide. But from a sales rep standpoint and from a preparation standpoint as an organization, I think we’re right where we want to be, I think handling it as best we can.
Dustin Scaringe: Got it. In the past, you’ve also talked about opportunities with large academic institutions. Just wondering how you guys are tracking in there in terms of ordering dates and trends?
John Aballi: Great question. So we don’t pull this out as an individual metric to report on, but I can give you a few highlights. We continue to do well with large academic institutions. I think we are strongest in the community-based practices, where rheumatologists have kind of different pressures, if you will. They’re trying to operate a more effective business on their own, and they’re seeing upwards of 20 patients per day. So time is of the essence in that context. In the academic setting or maybe even in the large institution setting, there’s typically a combination of research demands along with clinical demands. And so there may be some more time for discussion, but also may be less patient flow and they tend to see some of the more severe patient cases.
Once you get referred into some of the academic institutions, your disease has likely progressed, you’ve likely filtered through some of the community-based practices as well. But we’ve had — over the first half of this year, we’ve had some significant wins. We’ve had a major system in San Diego actually take on our product, and we signed a contract with them to offer the AVISE test throughout their entire system. And then additionally, we’ve had Northwestern as well, that’s a new contract for us, major academic institution that we’ve worked with. That was a multiyear effort to get that partnership established. And we’re launching within that system here in Q3. So I think we continue to do well. I think we serve the client bill, if you will, customer very well and we have a very strong value proposition.
We save the system money. And so for those systems which are integrated within themselves and maintain a cost share component, it’s a very attractive value proposition not to mention the clinical benefit of the test. So we continue to do well on both fronts. We have a team that’s focused on this area, a team of individuals that their sole responsibility is to take a look at some of these large practices. There’s quite bit of bureaucracy. So you have to have the skill set, you have to have the experience to work through these institutions. And so we have a strong team that continues to do so. And we’ve seen some of those improvements. We just don’t telegraph all of them on a regular basis or kill this part out mostly because I think when it comes down to it, what really matters is the performance of the organization as a whole and within the numbers.
And so we’ve queued people into the trailing 12-month ASP, we’ve taken a look at overall revenue and then the cost per revenue. And so we think that all of our efforts will culminate in improvements there and subsequently help us achieve a profitable organization.
Dustin Scaringe: Got it. Good to see progress going on there. And just the last small one for us. Any update on the AVISE CTD to mid last July? Thank you.
John Aballi: Sure. So just to level set everyone as well on the call, we obtained a proprietary PLA code for the AVISE Lupus testing and it was granted in April of 2022. We went through the pricing procedure over the past 12 months or so. And pricing for AVISE Lupus was finalized in January of this year. And then we’ve maintained coverage as well as payment for 2022 and 2023 claims throughout that process. As part of this, Medicare had asked us to submit for and apply for an LCD. We did so in September of last year. And we got acknowledgement at the time that it was a valid submission. And we are waiting for the next contractor advisory committee meeting, CAC meeting, to understand when a draft LCD will be published. At that point in time, it will be approximately about a year before any coverage document will be finalized and public comments will be welcomed throughout that approach.
But for now, there’s no statutory requirement for timelines and we’re just waiting on our local MAC, that’s Noridian to hold this meeting and to push the ball forward. So for now, no additional updates. We have a great working relationship with the Noridian team. And to date, they’ve given us no indication as to when that meeting will occur. So we remain in the queue and exactly where we were almost a year ago at this time.
Dustin Scaringe: Great. Thank you, John.
Operator: Thank you. Our next questions come from the line of Kyle Mikson with Canaccord. Please proceed with your questions.
Kyle Mikson: Hi, guys. Thanks for taking the questions. Congrats on the great quarter. I’m going to take a stab at something here. So ACR Convergence is coming up in early mid November, so the fourth quarter. Apart from these RCM changes, [indiscernible] relatively saw 3Q guidance at least on the surface reflect any kind of air pocket, I guess, among docs leading up to ACR? And in the past, ACR actually impacted the fourth quarter, but I just want to kind of ask a question around seasonality factors that we should be considering in the second half of the year.
John Aballi: Certainly. Thanks, Kyle, for joining the call. Maybe I can share a little bit regarding guidance, how we’re thinking about it with ACR a direct factor. I think in general — just to directly answer your question in general, it’s part of it. ACR certainly pulls — it’s an annual meeting for the rheumatology community. It pulls most of the rheumatology community out of their practice for approximately about a week. So you lose 12th or 13th of the patient flow productivity through any given quarter. And it’s occurring I believe in September-ish of this year. It’s in San Diego actually, local to us. So we’re excited for that meeting. It’s a productive meeting where we certainly get to engage with our customers.
But in terms of guidance, that wasn’t necessarily one specific driving factor in the guidance. Overall, we’re seeing very strong progress year-to-date in executing our strategy. I am not very encouraged by the results we’re seeing this year. I hope that’s coming across. We continue to change significant aspects of the business. And these changes can contribute to either a lack of visibility in the magnitude or timing or really both in terms of the ultimate impact to the business. So we’ve been consistently communicating that there will be some impact to our performance as we pursue more profitable business. And it’s just challenging to know the exact timing and extent. Obviously, when you make a change to the billing policy and you start to increase some of the cost share component related to the patient, we think that that is going to be a driving factor for some near-term impact.
And that was really what we took into account when making this guidance. As I mentioned, we do still have what we believe is some outsized impact from vacations of physicians, but it’s tough to exactly narrow in on proportionality there and quantify the magnitude of impact. We think we’ve done the best job we can with the information we have.
Kyle Mikson: Yes. Okay. That was great. Thanks for that, John. And then, Kamal, on the gross margins, almost 60%, getting flashbacks [indiscernible] in the presentation with 100% margin. How should we think about the gross margins going forward? Obviously, like tied to revenue and if that’s dipping in the third quarter, and I guess fourth quarter clearly margin should decline from here. But what’s a good way to think about this? It sounds like the high 50s is good. But should we expect low 50s or something like that going forward?
Kamal Adawi: Yes. Thanks for the question, Kyle. So in 2022, our gross margin percent was 47%. Year-to-date through the first two quarters of 2023, were 54%. Now keep in mind that 2 million or roughly 2 million that we’ve been talking about prior year collections, that does have an impact on the gross margin. A lot of that occurred in 2022. So if you back that out, that has about a 7% impact on year-to-date gross margin. So I’m very pleased with how the lab has been performing. As John has touched on, the company has been very focused on a path to profitability and just operating as a lean organization. That’s true across the entire company, but it’s definitely true in the lab. And we’re seeing a lot of improvements there. And they’re doing a fantastic job of focusing on driving that gross margin percentage up.
Now we spoke about the goals of achieving 60% as an organization. We’re trending in the right direction, and I feel confident that we’re going to be able to achieve 60%. Now in terms of trying to guide to that this year, we haven’t guided on gross margin in the past. But I think that tells you we should be seeing improvement quarter-over-quarter from how we’re operating as an organization. Seasonality is always an impact for us. It’s a positive impact as each quarter goes on, because of the deductible reset at the start of the year. So we should see higher gross margins as the year goes on. But like I said, we’re trending in the right direction. And as a company, our goal is to achieve the target of 60%.
Kyle Mikson: Okay. Thanks, Kamal. And then, I know, John, it’s kind of early to be talking about the ’24 strategic priorities. But as you evaluate this path of profitability, are you guys hoping to increase the sales force and the territory footprints maybe like early next year? I guess could you just kind of walk through your thoughts on the expansion in the next 12 months to kind of drive that market penetration and the top line growth and everything?
John Aballi: Great. Thanks for the opportunity to go into detail here, Kyle. So when we did a right sizing of the sales force in December of this past year, our logic or rationale at the time was to take a look at each of our territories, and on a per territory basis to see which of them covered at least the cost of the sales rep. Were we breaking even for having a field-based presence in that given territory? That was the question we tried to answer across the board. And for 23 territories, the answer was no. Actually a little bit more than that. What we’ve done now is from a footprint standpoint, but then this also carries into an expansion strategy, is we’ve taken a look at which territories were supplementing at least the cost of the rep.
And we’re maintaining about four to five of them right now. That’s the same number as at the start of the year. And we’re working to grow those territories so that they at least cover the cost of the rep. The idea here is it gives us an empirical approach to expansion where we can really see if it’s the right territory, if it’s the right individual for that area. And it lets us change some of those variables in a more measured, meaningful way. But ultimately, it also lets us have great visibility on the cash required, the expense required to expand. So right now, it’s about $1 million a year that we’re supplementing the territory on a — when you weigh it against the cost of the rep. And so that’s going to be our approach going forward. As we have our expansion territories or growth territories that over time will flip over into a profitable state, then we’ll add a new growth territory.
And that way, it will kind of be self fulfilling and cyclical in that manner. So that’s our approach. Whether that occurs in Q1, I hope so to be honest with you. But we have some — we have some verticals really to figure out there. Again, is it the appropriate territory? What’s the potential relative to the business that we have there? Is it the right individual? We have quite a few things to evaluate and are constantly working with. So as of right now, we feel very comfortable with the 40 that we have. We’ll see when we have some sustained performance in some of those growth territories that flips them over to a profitable state. And then at that point, we’ll add. We will also be very clear in that communication.
Kyle Mikson: Perfect. That was great, John. I’ll leave it there. Thanks, guys. I appreciate the time.
John Aballi: Thanks, Kyle.
Operator: Thank you. Our next questions come from the line of Ross Osborn with Cantor Fitzgerald. Please proceed with your questions.
Ross Osborn: Good morning and congrats on the quarter. Just one for us. Would be curious to hear if there’s any update on the pipeline with regard to nephritis? And if you can provide any more color on where you are in terms of time to market? Thank you.
John Aballi: Sure. Good morning, Ross. I got the first question. The second question was timing to market for those, just to be clear.
Ross Osborn: Yes, that’s correct. Thank you.
John Aballi: Okay, great. Thanks for the clarification. So in terms of our R&D pipeline, in terms of what’s occurred over the last six months, the key cornerstones when I joined the company were the RADR program, which was therapeutic selection in the context of rheumatoid arthritis along with the fibromyalgia diagnostic assay and then some therapeutic response assays in the interferon space as well. So at the time, we took a pretty detailed approach to this. I’m a big fan of setting up the criteria for success before conducting the evaluation. And so we put this criteria in place and we thought that if we can identify technologies that were kind of one, proprietary in nature; two, have an ability to demonstrate clinical utility that we thought was realistic; three, have the ability to achieve value-based pricing.
We believe that you have to have some certainty in your reimbursement before launching a product. So Medicare coverage was a fourth component here. Also, we want to develop products that meet customer needs, existing customer needs. So that was another component. And then lastly, really having fleshed out the guidelines strategy, I think having inclusion in guidelines or at least a pathway to getting there is incredibly important when you’re weighing whether or not to move forward with a given opportunity. And so we put those in place as a way to evaluate the pipeline. It ultimately resulted in discontinuing quite a few of the projects that were in the existing pipeline. But we’ve rekindled some of those efforts in the context of really owning the lupus patient journey.
That’s kind of how we’re doing it internally. And so we have a program ongoing now to take a look at both diagnostic as well as therapeutic monitoring or disease activity in lupus nephritis. So this is the indication where you have inflammatory flare in the context of lupus but related to the kidney, it’s potentially life threatening, very significant consequences for the patient. And unfortunately it’s detected oftentimes late stage when the kidney has progressed quite a bit in the context of that inflammatory state. There’s also therapeutic options on the market that are available. You have a couple from some pharma companies that bid on the market for a little bit of time here. So we believe that’s a pretty exciting opportunity we’re pursuing.
We’re also looking at lupus in general from a disease activity standpoint. Right now, there’s some clinical nomograms that exist, but they’re extremely cumbersome, very time consuming to execute or not done practically in the community setting. And really understanding how the disease is progressing over time is essential to modulating therapy in this context, so exciting for us to develop something here. And I think we have some great initial data showing we can do so. And then there’s a few other projects that we’re working on. What I’ve really committed to externally is talking about some of our pipeline products as we have meaningful developments, not so much selling the future on the come. We’re very excited about the potential for AVISE CTD and the ASP improvements that we believe will develop here over the next several quarters, and well into 2024 into 2025.
So that’s where a lot of our focus is. And opportunistically, we have some meaningful data, some scientific breakthroughs, if you will, we will disclose those. Right now, I’ve said — I think I’ll make more comments available externally once we have a clear path to commercialization within the 12 to 24-month timeline. And right now, our current R&D pipeline doesn’t have projects which fit that. But that doesn’t mean that the current projects can’t fall into that over time. I just need to gain a level of certainty and derisk in some of the — either whether it be technical performance of the assay or in the reimbursement side before commenting on them. So that’s kind of the conservatism we’ve taken in detailing our R&D pipeline. Hopefully, that helps, Ross.
Ross Osborn: Thanks for the update. Congrats again on the quarter.
John Aballi: Thanks.
Operator: Thank you. There are no further questions at this time. I would now like to turn the floor back over to John Aballi for closing comments.
John Aballi: Great. Q2 was another strong quarter where we continue to execute on our objectives and in pursuit of a profitable organization. We’re making great progress. And I’m especially proud of the Exagen team for navigating these changes effectively through this point. Thank you for your interest in Exagen. And we look forward to continuing to provide updates on our progress as we work to improve our organization. Thank you.
Operator: Thank you. This does conclude today’s teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.