Exagen Inc. Q2 FY2023 Earnings Call

Greetings. Welcome to the Exagen Inc. Second Quarter 2023 Earnings Call. All participants are in a listen-only mode, and a question-and-answer session will follow the formal presentation. This conference is being recorded. I would like to hand the call over to Ryan Douglas of Investor Relations. Thank you. You may begin.

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.

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 AVISE. 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 that 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 supporter 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.

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 was 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 the 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.

Thank you. We will now begin the question-and-answer session. Our first questions come from Dan Brennan with TD Cowen. Please go ahead with your questions.

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?

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.

Great. Regarding the cash burn for the quarter, it seems that after factoring in some changes, your underlying cash burn was 3.8 million. If that's accurate, what level of burn can we expect in the second half of the year? Also, considering the impact on accounts receivable that you mentioned, will that situation improve? Should we expect a normalization going forward?

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 held 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.

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 collections 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.

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?

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.

Great. Thank you very much. I'll get back in the queue.

Thank you. Our next questions come from the line of Mark Massaro with BTIG. Please proceed with your questions.

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?

Great. Good morning, Mark. Thanks for joining the call and for your question about what stage we're in. I appreciate the baseball analogy, especially during this season. From my perspective, I think we are in the early stages. Much of the first half of 2023 has been focused on preparation and game planning. We are now beginning to implement those efforts. The purpose of holding claims was to avoid triggering timely filing deadlines for our appeals process, which is essential for improving our revenue cycle operations. This aspect will significantly impact our long-term performance. I aimed to delay the timely filing deadlines tied to claim denials for as long as possible. As we start to release those, I anticipate seeing denials come in around September to October, marking our first round of appeals. To clarify, I believe we will have the opportunity to appeal up to three times, with the final appeal often involving an external review by a specialist. It is at this point that we expect the clinical data we've gathered to be most valuable. While it's challenging to pinpoint exact timelines, we consistently communicate that our growth towards the end of this year and into 2024 will derive from both volume and ASP growth, with ASP growth being the primary driver. This presents a significant opportunity for us. We have a strong volume, proving our ability to continue growing with our current sales approach, and we need to focus on pursuing more profitable business. The list price for AVISE CTD is $1,650, while our Medicare rate stands at $1,067. Our quarterly ASP was about 330 this quarter, and our trailing twelve months ASP is around 320. Although there will be some fluctuations, I am pleased with our direction, and we need to reach the $500 to $600 ASP range to truly transform the organization. I hope this provides clarity on our timing and strategy.

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?

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.

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?

Certainly, Mark. I’ll add my thoughts here. Regarding seasonality, the July 4 holiday fell on a Tuesday, which significantly affected the first week of July, and we're about a month into Q3 now. Currently, the quarter has started off slowly. This seems to be influenced by the holiday and we're also noticing that many of our customers are on vacation. I've observed similar trends in airline reports as well, with a rise in international travel, particularly among some of our key roles, who have taken extended international trips. We've conducted research and surveyed some of our customers about this. I feel confident that our team has managed the initial transition from the sales force restructuring successfully. We are now a leaner organization while still providing a high level of service, allowing us to cater to our key customers effectively. As for the impact of the reduction in force, I don't think it's significant. The current situation appears to largely stem from seasonality, alongside some adjustments in our billing policies aimed at pursuing more profitable business. As I mentioned, we've increased some patient cost sharing and adjusted test prices. While we don’t expect this to affect the majority of our business, there will be some impact on a smaller scale. This is our perspective on the matter.

Okay. That's it for me. Thanks for the questions.

Thanks.

Thank you. Our next questions come from the line of Andrew Brackmann with William Blair. Please proceed with your questions.

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?

Hi, Dustin. Good morning. Thank you for being on the call and for your question. I can address this from a qualitative perspective, focusing on some key aspects we monitor. As an organization, we analyze orders per physician and our physician base. In the second quarter, we saw growth in both our overall physician base and our high-order physicians. Our performance metrics have shown positive results across the board. Regarding driving new business and increasing penetration with existing clients, I believe our team has performed exceptionally well during the rep transition. Our reputation and brand recognition within the rheumatology community remain robust, and the transition has had a lesser impact than we initially expected. Looking ahead to the third quarter, the scenario is slightly different due to shifting expectations from our customers. The price of our test has remained unchanged for ten years, creating established expectations. Managing these changes can be challenging, particularly with pricing and physician behavior. However, our team is skilled in this area and our company has a strong record of launching and expanding our product offerings. We have effectively prepared to educate our physician base with new materials aimed at explaining the changes and their implications. We've also developed supportive resources for patients. Our internal team is compassionate and well-informed on how to communicate these updates to both patients and clinicians. I believe we've prepared thoroughly. Recently, I visited Houston and St. Louis to engage with key clinicians and understand the implications of these changes for their practices. Of the 17 or 18 clinicians I met with, the response was mostly positive once we clarified the reasons behind the changes. Some cases may be affected negatively, particularly those that are more price-sensitive, and we've factored that into our guidance. Overall, from a sales representative and organizational preparedness standpoint, I believe we are in a strong position to handle the situation effectively.

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?

Great question. While we don't separately report this as an individual metric, I can share some highlights. We're doing well with large academic institutions, and we are particularly strong in community-based practices. Rheumatologists in these settings face different pressures and are trying to manage their practices effectively, often seeing upwards of 20 patients per day, making time a critical factor. In academic and large institutional settings, there's usually a mix of research demands and clinical requirements, which can allow for more discussion but may also result in less patient flow, often dealing with more complex cases. When patients are referred to academic institutions, their conditions have typically worsened, and they may have already gone through community-based practices. In the first half of this year, we've achieved significant milestones, including a major system in San Diego adopting our product and signing a contract to offer the AVISE test throughout their network. We've also established a new contract with Northwestern, a prominent academic institution, following a multi-year effort to build that partnership, and we're set to launch within that system in Q3. We continue to excel in servicing our clients and providing strong value, as we help save costs for integrated systems while delivering clinical benefits. We have a dedicated team focused on these larger practices, equipped with the skills and experience needed to navigate the bureaucracies of these institutions. Although we don't regularly report every improvement, we concentrate on the overall performance of the organization and key metrics like trailing 12-month average selling price, overall revenue, and cost per revenue. We believe these efforts will lead to improvements and ultimately contribute to achieving a profitable organization.

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.

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.

Great. Thank you, John.

Thank you. Our next questions come from the line of Kyle Mikson with Canaccord. Please proceed with your questions.

Hi, everyone. Thank you for the questions, and congratulations on a strong quarter. I want to address something. The ACR Convergence is approaching in early to mid-November, which falls in the fourth quarter. Aside from the RCM changes, did the third-quarter guidance appear to show any slowdown among doctors as we lead into ACR? Historically, ACR has influenced the fourth quarter, but I’d like to ask about any seasonal factors we should keep in mind for the second half of the year.

Certainly. Thanks, Kyle, for joining the call. I can share a bit about our guidance and how ACR is a direct factor. To directly answer your question, it is part of our considerations. ACR is an annual meeting for the rheumatology community that takes most practitioners out of their practice for about a week, which results in a loss of 12th or 13th of patient flow productivity in any given quarter. I believe it is happening around September this year in San Diego, which is local to us. We're looking forward to that meeting as it's a productive opportunity to engage with our customers. However, this event wasn't the sole driving factor behind our guidance. Overall, we've made strong progress year-to-date in implementing our strategy, and I'm quite encouraged by this year's results. We are making significant changes in the business, which may lead to some uncertainty regarding the timing and impact on our performance. We are consistently communicating that pursuing more profitable business will affect our performance, but it is challenging to pinpoint the timing and extent of that impact. Changes in our billing policy and the increase in cost-sharing for patients are expected to influence our near-term results, and we took that into account when setting our guidance. Additionally, we believe there is still a notable effect from physicians taking vacations, though it's difficult to accurately assess the proportional impact. We've done our best with the information available.

That was great, thanks for that, John. Kamal, regarding the gross margins, which are nearly 60%, I'm reminded of the presentation where we saw a 100% margin. How should we approach the gross margins moving forward? If revenue is decreasing in the third quarter and likely in the fourth quarter as well, we can expect the margins to decline. What is a reasonable perspective on this? It seems the high 50s is acceptable, but should we anticipate them dropping to the low 50s or something similar in the future?

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, we 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%.

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?

Thank you for the opportunity to elaborate, Kyle. When we resized our sales force last December, our goal was to evaluate each territory based on whether it at least offset the cost of the sales representative. We wanted to determine if we were breaking even for having a field presence in those areas. For 23 territories, the answer was no. In fact, it was slightly higher than that. Currently, we are focusing on maintaining about four to five territories that are covering at least the cost of the rep, which is consistent with the number we had at the beginning of the year. Our aim is to grow those territories so they become profitable. This approach provides us with a data-driven method for expansion, allowing us to assess if we have the right territory and the right person assigned to it while making adjustments in a more thoughtful way. Additionally, this helps us understand the financial requirements for expansion. Currently, we are supplementing these territories by about $1 million a year in relation to the rep's costs. Moving forward, as our growth territories have the potential to become profitable, we will add new ones, creating a self-sustaining cycle. I hope we can achieve some progress in Q1, but we still have some factors to consider, such as the suitability of the territory and the potential for our business there, along with the capability of our team members. We're continually evaluating these aspects. For now, we are confident in the 40 territories we have and will wait for sustained performance in our growth territories to transition them into profitability before adding more. We will ensure to communicate this clearly.

Perfect. That was great, John. I'll leave it there. Thanks, guys. I appreciate the time.

Thanks.

Thank you. Our next questions come from the line of Ross Osborn with Cantor Fitzgerald. Please proceed with your questions.

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.

Sure. Good morning, Ross. I got the first question. The second question was timing to market for those, just to be clear.

Yes, that's correct. Thank you.

Thank you for the clarification. Regarding our R&D pipeline and activities from the last six months, the main focuses upon my arrival included the RADR program for therapeutic selection in rheumatoid arthritis, the fibromyalgia diagnostic assay, and therapeutic response assays in the interferon area. We took a thorough approach, establishing criteria for success before evaluations. We aimed to identify technologies that were proprietary, demonstrated realistic clinical utility, and could achieve value-based pricing, alongside ensuring reimbursement certainty before product launches, particularly from Medicare. Additionally, we sought to create products that addressed existing customer needs, and having a strategy for inclusion in clinical guidelines was vital in deciding whether to proceed with opportunities. This process led to the discontinuation of several projects in the pipeline, but we have reignited some efforts focused on the lupus patient journey. We currently have a program examining both diagnostic and therapeutic monitoring of disease activity in lupus nephritis, where inflammatory flare related to the kidneys can be life-threatening and is often diagnosed at an advanced stage. There are existing therapeutic options on the market, which makes this a promising opportunity for us. We're also exploring lupus in terms of disease activity, as current clinical nomograms are complex and time-consuming, making it challenging to assess disease progression in community settings. Developing a solution in this area excites us, and we have encouraging initial data. We have other projects underway too. I am committed to sharing updates on our pipeline products when we have significant developments, rather than speculating about potential. We are enthusiastic about the prospects for AVISE CTD and the anticipated ASP improvements in the coming quarters and into 2024 and 2025. Therefore, our focus remains on those developments. If we achieve meaningful breakthroughs or data, we will share those insights. For now, I will provide more information externally once we can see a clear commercialization pathway within a 12 to 24-month timeframe. While our current R&D projects do not fit that mold, it's possible they could in the future as we seek certainty and mitigate risks regarding technical performance or reimbursement issues before making further comments. That outlines our careful approach toward detailing our R&D pipeline. I hope this information helps, Ross.

Thanks for the update. Congrats again on the quarter.

Thanks.

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.

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.

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.