Castle Biosciences Inc Q1 FY2021 Earnings Call

Good afternoon, and welcome to Castle Biosciences' First Quarter 2021 Conference Call. As a reminder, today's call is being recorded. We will begin today's call with opening remarks and introductions, followed by a question-and-answer session. I would like to turn the call over to Camilla Zuckero, Executive Director, Investor Relations & Corporate Communications. Please go ahead.

Thank you, operator. Good afternoon, everyone. Welcome to Castle Biosciences' first quarter 2021 financial results conference call. Joining me today is Castle's Founder, President, and Chief Executive Officer, Derek Maetzold, and Chief Financial Officer, Frank Stokes. Information recorded on this call speaks only as of today, May 10, 2021. Therefore, if you are listening to the replay or reading the transcript of this call, any time-sensitive information may no longer be accurate. A recording of today's call will be available on the investor relations page of the company's website for approximately three weeks. Before we begin, I would like to remind you that some of the information discussed today may contain projections or other forward-looking statements regarding future events or the future financial performance of the company, including expectations and assumptions related to the impact of the COVID-19 pandemic, and are made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon current expectations and involve inherent risks and uncertainties, and there could be no assurances that the results contemplated in these statements will be realized. A number of factors and risks could cause actual results to differ materially from those contained in these forward-looking statements. These factors and other risks and uncertainties are described in detail in the company's annual report on Form 10-Q for the year ended March 31, 2021 and in the company's other documents and reports filed with the Securities and Exchange Commission. These forward-looking statements speak only as of today, and we assume no obligation to update or revise these forward-looking statements as circumstances change. I'll now turn the call over to Derek.

Thank you, Camilla, and good afternoon, everyone. This afternoon, I will discuss highlights of our first quarter results and provide an overview of development on our key priorities. Frank will then provide additional detail on our financial results and company performance. I would like to start today's call by thanking the Castle team for their dedication and commitment to improving the lives of patients with skin cancer and other dermatological diseases with high unmet clinical need. They continue to execute our growth strategy at a very high level, including furthering our evidence development, progressing on our commercial team expansion, advancing our pipeline, and providing strategic support for the pending acquisition of Myriad's myPath Melanoma laboratory. We are off to a great start for the year. We delivered excellent top line growth with first quarter revenue of $22.8 million, a 31% increase over the first quarter of 2020. As we look forward to our growth potential in 2021, although there remains continued uncertainty relative to the impact of COVID-19 regarding the timing of the return to historical levels of skin cancer diagnoses, we are confident in providing 2021 revenue guidance of $80 million to $83 million. We expect continued investments in our growth initiatives including our commercial team expansion, our body of evidence, and acceleration of our R&D efforts to support our continued growth. In the first quarter of 2021, we delivered 5,142 total gene expression profile test reports, and we are encouraged by what we believe to be positive recovery trends. Although melanoma diagnoses have not yet returned to pre-COVID levels, as we discussed in the past, we expect the majority of the estimated 26,000 patients who were not diagnosed in 2020, as well as those who were not diagnosed in early 2021, to be diagnosed later this year or in 2022, which can be impacted by the timing of both COVID vaccinations and a continued return to in-person medical care. As such, we anticipate continued improvement to our volume growth rate for the second half of 2021 and into 2022. I cannot predict the rate of progression for a full return to in-office visits or when all representatives will be allowed to visit all clinicians' offices. We are seeing increased levels of in-person visits by our commercial team, with just over 75% of our sales calls being live and in-person. We're also seeing a return of in-person peer-to-peer activities. Despite the impact of COVID on both diagnoses of melanoma and in-office, in-person visits, we delivered 4,060 DecisionDx-Melanoma test reports in the first quarter. Importantly, we saw order volume for DecisionDx-Melanoma, increased by approximately 30% in March 2021 compared to January 2021. In March, clinicians ordered DecisionDx-Melanoma more times than in any other previous March. This positive trend has continued through April, with April order volume exceeding that in March. Turning to our DecisionDx-SCC tests for patients diagnosed with high-risk squamous cell carcinoma and one or more risk factors, we delivered 527 test reports for those tests. We launched DecisionDx-SCC last August in 2020. In the fourth quarter of 2020, we delivered 428 test reports. As you may recall, we are focusing our commercial incentives on our DecisionDx-Melanoma test. In this context, we remain extremely pleased with this early adoption. The DecisionDx-SCC test continues to exceed our expectations, and we believe that performance is due in part to the high unmet clinical need that this test is filling. Equally important now is the value that we are seeing through leveraging our dermatologic commercial channels. Specifically, more than 80% of clinicians who ordered this test for SCC have also ordered our DecisionDx-Melanoma tests within the last two and a half years. In other words, we believe that being able to walk into the office of a current customer, one who has adopted DecisionDx-Melanoma as an important tool in managing their patients with melanoma, makes it easier for us to layout the clinical need and the value of our DecisionDx-SCC test in those patients with high-risk squamous cell carcinoma. The technical assessment dossier for the DecisionDx-SCC test was submitted to Palmetto and Iridium in the second quarter of 2020. We received confirmation of acceptance of the submission as being complete in the third quarter of 2020, and although there can be no assurances, we believe that a draft LCD could be posted in 2021. I remind you there is no specific timeframe under which Palmetto and Iridium must operate. Now let's discuss our comprehensive test solutions for difficult-to-diagnose melanocytic lesions. In the first quarter of 2021, we delivered 218 DecisionDx DiffDx-Melanoma test reports. Similar to what we are seeing with the DecisionDx-SCC, the early uptake of our DiffDx-Melanoma test is exceeding our expectations. You may have seen our important milestone announcement from April 27, regarding the definitive agreement we signed to acquire the Myriad myPath Melanoma Laboratory. We believe this acquisition will add incremental value to both myPath Melanoma and DiffDx-Melanoma by leveraging the strengths of these two validated tests. We believe that more patients will receive actionable results more of the time, enabling a more confident diagnosis and a clearer treatment path. We expect this transaction to close in late May 2021. Our evidence development remains a key component of our near- and long-term growth strategy, which stands at our significant body of evidence in 2020 with 11 supportive peer-reviewed publications published for our proprietary gene expression profile tests. In the first quarter of 2021, we added two additional articles for DecisionDx-Melanoma, which is now supported by 30 peer-reviewed publications. In March, you may recall that we announced our Integrated Test Result or ITR for DecisionDx-Melanoma. The ITR is calculated by the independently validated, integrated 31-GEP, or i31-GEP algorithm, designed to provide a more precise and personalized prediction of sentinel lymph node positivity in order to guide discussions and recommendations with incidence risk-based guidelines for the settlement of biopsy surgical procedures. The i31-GEP is an artificial intelligence-based neural network algorithm that integrates the DecisionDx-Melanoma test result with the patient's traditional clinical and pathologic features. The algorithm has been validated in a cohort of 1,674 tested patients with T1 to T4 cutaneous melanoma. We presented data on a validation study at the World Congress in Melanoma in April. The independent validation phase shows that the i31-GEP test provides a highly important prediction of sentinel lymph node positivity rate, compared to the actual observed rates, with a linear regression slope of 0.999, with a slope of 1.0 representing complete importance. Additionally, patients originally classified with a 5% to 10% likelihood of sentinel lymph node positivity using clinical or pathologic features only, the i31-GEP was able to reclassify 63% of those patients whose actual risk of sentinel lymph node positivity was either below 5% or above 10%. Finally, the i31-GEP has a high negative predictive value of 98% in patients with T1 to T4 melanomas. We plan to continue investing in the development of all of our GEP tests, as it remains a key component of our growth strategy supporting the adoption of our tests, both by clinicians and reimbursement by commercial payers. We are a data-driven evidence-based company, and we invest heavily in evidence development supporting not only our existing tests, but also our pipeline tests as well. Earlier today, we announced one of our innovative pipeline programs. The program's initiative is to develop and validate a genomic test aimed at predicting systemic therapy response for patients with moderate to severe psoriasis, atopic dermatitis, and related conditions. Essentially those patients with inflammatory skin conditions that have reached the severity of disease to be considered for systemic therapy. With our industry-leading position as the only diagnostics company with a suite of commercially available tests for dermatologic cancer, we have demonstrated our ability to successfully develop, validate, and bring to market clinically actionable, innovative genomic tests. We start by identifying dermatologic diseases with high unmet clinical need. We then use the gene expression profile, the individual patient's biology, in an effort to develop a gene expression profile test designed to assist clinicians and their patients by better informing treatment to optimize both health outcomes and reduce healthcare costs. This pipeline test has the potential to expand our reach into non-skin cancer medical dermatology diseases and is expected to provide additional value for clinical customers and their patients. We recently launched a 4,800-patient prospective multicenter trial, to develop and validate this pipeline test and plan to enroll approximately 50 centers with leading experts in the field. This pipeline test, along with our other pipeline products, has the potential to increase our U.S. total addressable market to slightly more than $5.5 billion. Another important component of our growth strategy is the expansion of our commercial team. I'm pleased to say that we have completed our expansion ahead of schedule with all new outside sales territories filled, and we expect to enter the third quarter of 2021 with a total of 60 to 65 sales representatives, all calling on dermatologists as a primary call point, followed by most surgeons, including surgical oncologists and head-and-neck surgeons, as well as dermatopathologists. This expansion will nearly double our dermatology-focused sales efforts compared to the 32 outside sales territories we had before the expansion and in time for the expected continuous positive trends of offices opening back up for in-person sales calls, and in-person peer-to-peer programs. We expect each of our 60 to 65 sales representatives to sell all four dermatologic tests, DecisionDx-Melanoma, DecisionDx SCC, myPath Melanoma, and DiffDx-Melanoma. Additionally, we have seen that our market is promotionally responsive. So we expect that as offices open more fully, our Salesforce expansion efforts will have a positive impact on our 2021 exit volume and position us well for growth in 2022. Before I turn the call over to Frank, let me summarize our takeaways. We delivered an excellent quarter of financial performance with strong execution on our growth initiatives. We increased investments in these initiatives during COVID to ensure resiliency and are seeing the benefits of those actions, which we believe furthers our position as the leading dermatologic diagnostics company, strengthening our value proposition and continuing to create shareholder value. I will now turn the call over to Frank, who will provide additional details relating to financial results.

Thank you, Derek. As Derek stated, we're pleased that the investments we've made in our growth initiatives, along with solid execution from the team enabled us to deliver a strong start to the year. We reported revenue of $22.8 million in the first quarter of 2021, compared to $17.4 million in the first quarter of 2020, a 31% increase primarily due to higher revenue adjustments related to prior periods and higher per unit revenues, partially offset by lower test report volumes for DecisionDx-Melanoma and DecisionDx-UM. Positive prior period revenue adjustments for the first quarter of 2021 were $5.3 million, compared to $3.2 million for the same period in 2020. Our gross margin in the first quarter was 87%, compared to 86% for the first quarter of 2020. Our operating expenses for the quarter ended March 31, 2021 were $24.1 million, compared to $14 million for the same period last year. This increase was driven primarily by higher SG&A expenses, which increased by $7.1 million for the quarter primarily attributable to the expansion of our sales and marketing teams for the launch of our DiffDx Melanoma test, administrative support functions, and higher personnel costs associated with our increased headcount, including salaries, bonuses, benefits, and stock-based compensation. R&D expenses increased by $3 million in 2021 compared to 2020, primarily associated with increases in personnel costs attributable to additional headcount and costs incurred in our clinical studies. We expect our R&D expenses to increase further as we continue to invest in activities that support our commercial products and pipeline initiatives to position us well for near- and long-term growth. Non-cash stock-based compensation expense, which is allocated among cost of sales, R&D, and SG&A, totaled $4.9 million for the quarter ended March 31, 2021, compared to $1.6 million for the quarter ended March 31, 2020. We expect material increases in stock-based compensation expense in future periods reflecting both higher post-IPO stock option valuations as well as additional awards outstanding due to our growth in headcount. Our net loss for the first quarter of 2021 was $4.3 million compared to a net income of $0.6 million for the first quarter of 2020. Diluted loss per share attributable to common stockholders for the first quarter of 2021 was $0.17, compared to diluted earnings per share attributable to common stockholders of $0.03 for the first quarter of 2020. Operating cash flow for the three months ended March 31, 2021 was negative $3.6 million compared to negative $0.3 million for the same period in 2020. Finally, we had cash and cash equivalents at March 31, 2021, of $407 million and no debt. Although we can't predict the trajectory of continued COVID recovery, our core business and underlying fundamentals remain strong. We are initiating 2021 revenue guidance of $80 million to $83 million. We are excited about the opportunities that lie ahead and remain committed to building a dermatologic diagnostics company focused on making a positive impact on patient outcomes. I'll now turn the call back over to Derek.

Thank you, Frank. In summary, we delivered strong execution in the first quarter with strong top line growth and significant positive trends in order volume in March 2021 compared to January 2021. We saw excellent progress on our key growth initiatives, including expanding our body of evidence, completion of our commercial team expansion, and the initiation of our development and validation study for psoriasis, atopic dermatitis, and related conditions. Before we move on to Q&A, I want to again express my gratitude to our employees for their hard work and dedication to improving the lives of patients with skin cancer and other dermatological diseases with high unmet clinical needs. This concludes our remarks. Thank you for your continued interest in Castle. Operator, we are now ready for Q&A.

Thank you. Our first question comes from Thomas Flaten with Lake Street Capital Markets. Your line is now open.

Good afternoon, and thanks for taking the questions. Frank, just a quick clarification on the guidance. Does that include any contribution from myPath? Or is that a TBD at this point?

We're including a little bit of contribution there. Keep in mind we'll own that business for a little more than six months this year. And we'll be new with it. But yes, we do have a little bit of benefit from myPath.

And then flipping to the new pipeline product. I'm just out of curiosity, could you share maybe some thoughts on what the overlap in potential gene expression? I think you characterized that between the two disease states. Are there significant numbers of genes that are present in both disease states? And is gene expression typically the vehicle you would use? Or are there other, for example, non-coding regions that would be important in better understanding those diseases?

Hi, Thomas, this is Derek. I think we'll have an answer for that question specifically towards the end of 2022. Our belief is that there's enough literature out there to go ahead and demonstrate that we should be able to identify a gene expression profile signature that will assist in predicting treatment response. I don't know how much overlap we're going to see between sort of classical atopic dermatitis, as well as classical psoriasis. But I think that if we view these as inflammatory skin diseases rather than two different programs, our belief is working with our Steering Committee that we should approach this in a significant manner, which is why we are initiating this with roughly just under 5,000 patients study, to go and answer those questions. So today, I don't have a definitive answer for you, except that we've seen good proof-of-concept work in the literature in our own hands and say we can move forward here.

And then just one quick one to finish up on the field force. Congrats on getting that done early. I was curious if you had any anecdotal feedback from the sales reps that have been carrying all three products in the bag to date. What are common objections? What are the kind of unique selling points? I know you touched on a little bit in the prepared comments, but I'm just curious to get some qualitative understanding of how they've kind of experienced that in the field today?

Yes. Let me separate one comment there. We have 32 dermatological focused sales representatives. So maybe 80% call volume is on dermatologists, which would include dermatological physicians, NPs and PAs who work in their practices, most surgeons, and then the remaining part of our calls are largely on surgeons who do skin cancer work, like surgical oncologists, and a smattering of dermatopathologists and medical oncology. They are only covering two tests today, the DecisionDx-Melanoma test and the DecisionDx SCC test. In that context, I think I can answer your question here. When we introduce the DecisionDx SCC test, we often get head nodding, there's an agreement that there is a significant unmet clinical need in these patients with one or more risk factors, that there are a wide range of treatment options, everything from doing nothing to doing everything. The tools they have pathologically and clinically aren't that good. So the conversation more quickly goes into discussing the right patients to use your test. We are seeing a nice leverage effect off of our melanoma reputation in those same practices. That's also why we're seeing about 80% of the physicians who have ordered our DecisionDx SCC test have also ordered the DecisionDx-Melanoma test in the last couple of years. The other small sales force of 10 individuals, we trained up and let them go in early November of 2020, focusing solely on our DiffDx-Melanoma tests with two dermatopathologists. The reason for that was to introduce that test to that specialty group, and following this expansion, the 60 to 65 representatives will then have each individual representative selling all three products in a smaller geography. So let's hold off on more commentary until we get past July 1.

Great. Thank you.

Thank you. Our next question comes from the line of Catherine Schulte with Baird. Your line is now open.

Hey, guys, congrats on the quarter. And thanks for taking my questions. I guess first on guidance. Can you just walk through what that assumes for the rebound you'll see in volumes in the second quarter, maybe how melanoma diagnoses improved for the balance of the year, and what's baked in there for the impact of the newly expanded Salesforce?

Hey, Catherine. Thank you. We're assuming that the current environment is steady state. We'll get some of the misdiagnoses coming in over time. We don't expect a big rush to see that true-up all at once. We are optimistic that things will continue to thaw and get better. Of course, it varies regionally around the country. Some places are catching up with others. As it relates to Salesforce, we have always assumed a six-month ramp to average productivity. So, with the new representatives starting now, we'll see some benefit from their efforts, but we certainly won't see full effects yet. We expect the benefit of that expansion will start to be felt in the back half of 2021 and then be nicely felt in 2022.

Okay, great. And then I think the NCCN non-melanoma skin cancer panel is meeting this month. How should we think about the path to guideline inclusion there for SCC? And is there any data that you've submitted to the panel for this meeting?

We think that the pathway is similar to other disease states and tests. The NCCN SCC panel is relatively new. I can't remember when they started reviewing SCC individually, but it hasn't been more than a couple of years ago. They're still trying to wrestle with how to categorize different risk groups. We are pleased to see the increased clarity that came about in January 2021 when they went from just a low-risk bucket and a high-risk bucket to now having a low-risk, high-risk, and what they call a very high-risk bucket. If you happen to have an aggressive Class 2B test result from our DecisionDx SCC test, your risk of metastasizing is extremely high. They are working to stratify these groups finer, which I think will be helpful for us. We have engaged as part of our normal investigator work and publication work with a number of the NCCN SCC panel members, and those we've spoken with are favorably disposed to considering integrating genomic testing information into their guidelines. Unlike melanoma, where there have been higher barriers due to the legacy of ownership in pathology, the opportunity to expedite integration for squamous cell carcinoma is certainly there. If they have not submitted their data already, they'll be submitting shortly for the upcoming review cycle.

Yep. Very helpful. And then last one for me. Pretty strong quarter for prior period collections. Any movement on the commercial payer side, and thoughts on the outlook for incremental coverage decisions?

Yes. The prior period revenue collections in Q1 were indeed larger than we have seen on trend. We wouldn't expect that to continue. There were reasonable buckets of appeals that we had negotiated with payers that were successful. Although those tests were from last year, we were able to successfully collect on those through the appeals process. That of course doesn't impact commercial payer policy. We continue to make small progress on that front, and it's important not only to achieve policy progress but also to ensure continued success on appeals.

Thank you. Our next question comes from the line of Max Masucci with Canaccord Genuity. Your line is now open.

Hi. Thanks for taking the questions. First one, did you expand the Medicare payments for DecisionDx-Melanoma cash flow into the model as expected in Q1? And if so, how should we think about any sort of sequential increase we could see in DecisionDx-Melanoma ASPs in Q2 and beyond?

Yes, Max. It did flow as we expected. We are being reimbursed on the percentage of those cases that we anticipated. So that trend is playing out as we'd expected with a nice increase in ASPs in Q1 compared to Q4. Improvements for the rest of this year will be more measured, and I don't think we'll see any significant stepwise increases. It will be more steady and typical for our historical progress.

Great. And then maybe a big picture question. Great to learn more about the tests and your development pipeline. Can you just walk us through how you arrived at inflammatory skin disease as a new category of interest for your product portfolio? And at this point in time, I imagine that precision oncology hasn't quite made its way into inflammatory skin disease the way it has for some other disease categories, which would make this another somewhat first of its kind market opportunity. Does that logic sound correct?

Correct. So, we've been looking at inflammatory skin diseases as potential pipeline opportunities since we got past the IPO. The original recommendation came from some of our current customers and KOLs mentioning significant issues in this area. We see the march of biologics and systemic therapies in psoriasis and atopic dermatitis. In clinical trials, they perform remarkably well, yet many patients switch for various reasons. They might not respond as well in the real world compared to clinical trials, side effects, cost, or access issues. The lack of objective data to make a better choice when choosing treatments is significant. If we can assist in predicting better treatment options, that would be incredibly valuable. Therefore, we see this as a great opportunity moving forward and we're excited about the potential development in this area.

Thank you. Our next question comes from the line of Puneet Souda with SVB Leerink. Your line is now open.

Hi, Derek. Frank, thank you for addressing my question. I want to apologize if this has already been discussed. I'm interested in the pipeline expansion for atopic dermatitis and related conditions. What are your thoughts on the large study? When do you anticipate the results will be available? What updates on the data can we expect?

Yes. Good questions there. We anticipate that by the end of 2025, we should have a test ready for the marketplace as we work through this large, nearly 5,000 patient program. As we move through the study, we can expect early data readouts maybe in the first half of 2022 with some preliminary updates potentially discussed publicly in the second half of 2022, but I don't expect it to be earlier than that. The execution feels strong due to our experience with clinical research sites that have performed well on other studies in dermatoses including squamous cell carcinoma and melanoma.

Okay, that's very helpful, Derek. Thanks for that. In terms of access, I think you mentioned the 75% number today, with the reps sort of being in-person. Given what you're seeing, do you expect that to recover completely to in-person by summer time? Or anything you can provide in terms of continued improvement of that rep access to the physician community that you're serving?

Yes, it's interesting. Before COVID, we were focused more on the actual interactions rather than distinguishing between in-person or virtual. I wouldn't be as aggressive as saying that we will be completely back to 100% interactions by July. A more reasonable approach might be around Labor Day. There will be differences in state regulations affecting this. The fact that 75% of our sales calls in Q1 were in-person is promising, indicating that clinicians value those personal interactions.

Okay, that's great. And then last one, Frank, maybe for you. As we think about the second quarter, given what you're seeing as three-fourths of the reps in-person and the recovery and the conversations you're having, anything you can provide in terms of the Q2 volume pickup that we should be thinking about? And then, broadly that accelerating through the year. Lastly, Derek, if you could gauge how you're approaching the commercial payers today after having solid reimbursement, and thoughts on the broader pipeline? Thank you.

Sure. We're hopeful that physician interactions will continue at the same pace, and it would be great if they accelerate. If that happens, we're confident that our commercial team can capture more patient encounters and diagnoses. It's tough to pinpoint exactly how that pace will be, but other areas of the economy are experiencing recovery, so we are optimistic there. On the commercial payer side, we continue to provide them with evidence to demonstrate the benefits of our tests to patients and the healthcare system. We believe that our strong clinical evidence will make it difficult for them to deny the coverage we are asking for.

Thank you. There are no further questions. I will now turn the call back over to Derek Maetzold for closing remarks.

In summary, we delivered strong execution in our first quarter, with strong top line growth and positive trends in order volume in March 2021 prior to January 2021, with March being our highest ever order volume month for DecisionDx-Melanoma, and April exceeding that. This concludes our first quarter earnings for 2021. We thank you again for joining us today and for your continued interest in Castle Biosciences.

Ladies and gentlemen, this concludes today's conference call. We thank you for your participation. You may now disconnect.