Castle Biosciences Inc Q4 FY2021 Earnings Call

Good afternoon and welcome to Castle Biosciences Fourth Quarter and Full-Year 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'd like to turn the call over to Camilla Zuckero, Executive Director of Investor Relations and Corporate Communications. Please go ahead.

Thank you, operator. Good afternoon, everyone. Welcome to Castle Biosciences fourth quarter and full-year 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, February 28, 2022. 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 statements made today will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include but are not limited to statements about our financial outlook and other matters referenced in our earnings release issued today, and statements containing projections regarding future events or our future financial or operational performance, including our expectations and assumptions related to the impact of the COVID-19 pandemic. Forward-looking statements are based upon current expectations and involve inherent risks and uncertainties, and there can 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-K for the quarter ended December 31, 2021 under the heading risk factors, 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. In addition, some of the information discussed today includes financial metrics such as adjusted revenue, adjusted gross margin, adjusted operating cash flow and adjusted EBITDA, which are non-GAAP financial measures that have not been calculated in accordance with Generally Accepted Accounting Principles in the United States or GAAP. The non-GAAP items should be used in addition to and not as a substitute for any GAAP results. We believe these metrics provide useful supplemental information in assessing our revenue and cash flow performance. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are presented in the tables at the end of our earnings release issued earlier today, which has been posted on the Investor Relations page of the company's website. I will now turn the call over to Derek.

Thank you, Camilla, and good afternoon, everyone. Thank you for joining us today for Castle's fourth quarter and full-year 2021 earnings call. Our comments today will cover our key accomplishments in 2021, as well as our plans to support continued growth in 2022 and beyond. 2021 was an exceptional year for Castle Biosciences, and I am extremely proud of the strong execution on our growth plans by our team. We exceeded the goals we set out to accomplish and beat our revenue expectations, increasing our full-year 2021 revenue by 50% to $94.1 million and growing gene expression profile testing volumes by 55% to 28,118, compared to 2020. We successfully doubled our dermatology-facing commercial team and accelerated investments in R&D, significantly advancing our scientific evidence that further demonstrates the clinical value of our tests. We executed on two strategic opportunities to acquire complementary areas that we believe enable long-term value creation and allow us to impact patient care in areas of unmet clinical needs. We believe our success in 2021 allows us to enter 2022 with momentum, a strong balance sheet, and the potential to further position the company as an industry leader. Looking ahead, we expect full-year 2022 revenue in the range of $115 million to $120 million, driven by the continued focus on our foundational patient-centric strategy. I will now discuss our dermatologic testing franchise. Our dermatologic testing franchise consists of three offerings: the first is DecisionDx-Melanoma. This test is used in patients diagnosed with invasive cutaneous melanoma to provide a personalized risk that allows clinicians and patients the ability to risk stratify decisions relating to both proceeding with a sentinel lymph node biopsy surgical procedure, as well as subsequent treatment decisions, which may include frequency of follow-up, initiation of active surveillance with advanced imaging, adjuvant therapy, and clinical trial enrollment. Our second dermatological test is DecisionDx-SCC. This test is used in patients diagnosed with one or more risk factors. At similar chart, DecisionDx melanoma tests, it is used to risk stratify treatment plan decisions related to sentinel lymph node biopsy, radiation, and clinical trial enrollment. Our third dermatological offering is comprised of two tests: the myPath Melanoma test and the DecisionDx DiffDx-Melanoma test. Both of these tests are used by dermatopathologists and dermatologists when faced with difficult-to-diagnose melanocytic lesions, essentially to assist in ruling-out or ruling-in melanoma. In 2021, our overall dermatologic test volume grew by nearly 58%, compared to 2020, despite the continued headwinds from COVID. As we have discussed, melanoma diagnoses were down approximately 11% in 2021, compared to pre-COVID 2019 levels. Our team delivered strong execution on our initiatives in 2021, which we believe positions us well for continued progress, further adoption of our dermatologic tests, and long-term growth. These ongoing initiatives include commercial team optimization, significant R&D investments. For instance, in dermatology alone, we had 14 peer-reviewed publications published in 2021, increasing our peer-to-peer programs and issuing our interface with the leading dermatologic electronic record system, Modernizing Medicine's, and health system, and our Federal supply schedule contract. As you know, we doubled our dermatology-facing commercial team in 2021 and continue to assess the optimal size of the team, but believe we could further expand by the end of 2022. We believe our representatives should spend about 50% of their time building deeper relationships with current customers and about 50% of their time targeting new ordering clinicians. We saw great progress in both areas, with approximately 1,900 new ordering clinicians and 5,900 total ordering clinicians for dermatologic tests. We will continue assessing data for the near-term and will keep you updated on potential plans for expansion, but at this time with three dermatology offerings, we consider around 80 to 100 outside sales territories a size that could make sense for us. Again, we will finalize plans based upon our ongoing assessment. I will remind you that in the fourth quarter of 2021, more than 90% of our sales calls were in person. We attribute this in part to the clinical value providers see in discussions with our sales team and the continued time of the evidence that we generate. In 2021, we conducted a collaborative patient survey with the Melanoma Research Foundation; the survey was highlighted at the Winter Clinical Dermatology Conference in January 2022 and shows that 90% of patients wanted information about their tumors at the time of diagnosis. Patients who received melanoma testing said the results were useful to them, testing gave them increased knowledge, relief from uncertainty, personalized treatment options, and information for life planning. That's a fantastic response from our patients. One of our most exciting accomplishments in 2021 was the initiation of our collaboration with the National Cancer Institute or NCI and their SEER melanoma registries program. I remind you that at Castle, a core commitment of ours is to improve the health and health outcomes of the patients that we serve through our innovative tests. In collaborating with the NCI, we were able to link patients who received DecisionDx-Melanoma test reports for those who entered into the NCI SEER registries’ program database and have associated outcomes, specifically overall survival and melanoma-specific survival. We also developed a cohort using a 1:3 ratio of patients who did not receive DecisionDx melanoma test results as part of their clinical care. That is, the clinician and the patient only had the traditional clinical and pathologic features upon which to develop a treatment plan. We matched 13 clinical, pathologic, and socioeconomic variables to ensure that those patients who had the benefit of both DecisionDx-Melanoma and traditional clinical pathologic features matched their balanced counterparts who only had traditional clinical pathologic features to determine their care plan. The first analysis, which was presented at a National Dermatology Meeting last month, focused on the Medicare-eligible population. That is, those patients who were diagnosed between 2016 and 2018 and who were 65 years of age or older at the time of diagnosis. Study results from this real-world, large, and unselected patient population show two important results: first relates to the performance of our test. Looking at survival outcomes, that is death from all causes or death from melanoma, we found that patients who had a low-risk Class 1 or Class 1A test result had a low-risk of progression and likelihood of dying from melanoma or death from all causes. Those patients with a high-risk Class 2 or 2B test result had a higher likelihood of dying from melanoma or dying from all causes. This data was similar to what we've seen published in our retrospective and prospective studies, and is a good confirmation that the test performs as it has before in this large unselected patient population of clinically tested patients. While the replication of prior studies in this large real-world unselected patient population is important from a standpoint of test reproducibility, the second result is far more important to our patients. Specifically, patients who received DecisionDx melanoma test results in addition to the traditional clinical pathologic features lived longer than patients whose clinicians relied solely upon traditional clinical pathologic factors. This is important as it shows a strong survival benefit in patients who received DecisionDx melanoma test results. We are looking forward to a full publication of this initial readout, as well as ongoing linkages over the next several years. As we think about additional 2022 dermatology franchise catalysts, we expect the potential draft LCD for DecisionDx-SCC by the end of the second quarter. You will recall that the technical assessment dossier for this test was submitted for medical review to PALMETTO in the second quarter of 2020. At that time, we expected a draft LCD sometime in 2021 with finalization in 2022. That timeline has been delayed. Do we see a draft LCD in the second quarter of 2022? We would expect finalization roughly 12 months following, but sometime in the first half of 2023. We continue to see adoption of the DecisionDx-SCC exceed our expectations as the unmet clinical need here is significant, and we are proud of the impact our test is having on patient care and will continue to do what we believe is the right thing for our patients, providing test results that impact treatment decisions and improve outcomes. As part of our strategic growth plans, we began development of our Gastroenterology Franchise with the acquisition of Cernostics and the TissueCypher spatialomics platform in December of 2021. Our TissueCypher test for use in Barrett’s esophagus is a risk stratification test designed to predict progression to high-grade dysplasia or esophageal cancer. We previously discussed our plans to hire a Gastroenterology commercial team of approximately 14 outside sales territories with additional medical science liaison and internal sales associate support. That team was hired and trained in the field in the second half of January. I will remind you that regarding M&A, we generally consider opportunities that are in complementary or adjacent areas to our foundational business and allow us to utilize a proven dermatology playbook where we have the opportunity to address areas of unmet clinical need supported by tests. Our early progress within our GI franchise is exciting. Initial response from providers is positive and with a strong execution on our commercial strategy, our team is seeing a promising start in accessing providers. Our 2022 metric is successful focus on a number of ordering clinicians, more so than order volumes. The TissueCypher Barrett’s Esophagus test is supported with eight peer-reviewed publications, and as part of our increased investments in R&D for 2022, we have initiated multiple initiatives to support adoption by providers and payers. Furthermore, we will continue to assess the early adoption of our test and expect to expand the commercial team sometime between mid-year and year-end 2022, but will continue to assess the market response and determine what that expansion will look like based on our initial market research, as well as a provider response. We would expect to end the year with approximately 30 outside sales territories. Turning to our optimization work in our new Pittsburgh laboratories, we've already seen encouraging results. Floor plan and workflow reconfigurations have increased efficiencies, with more progress expected throughout 2022. We believe that our planned CapEx investments, including expansion of the laboratory later in the year with additional headcount, should allow for further enhancements to automation, a significant increase in throughput, and provide support for potential future Gastroenterology tests using the TissueCypher spatialomics platform. Our expanded laboratory footprint should also enable us to use that facility to process our dermatology tests as or if needed. As you know, our DecisionDx-UM test is the standard of care in managing patients with newly diagnosed uveal melanoma, estimated at approximately 2,000 patients diagnosed annually in the U.S. In 2021, we provided test results for 1,618 patients, a nearly 16% increase over 2020. We believe this increase in reports was due in part to patients making up for lost opportunities in 2020 due to COVID. Therefore, we expect flat or even slight decrease in volume growth in 2022, compared to 2021. Furthermore, in 2021, our Medicare rate for DecisionDx-UM was $7,776, a significant increase over our 2020 rate. For 2022, our Medicare rate for DecisionDx-UM remains at $7,776. Before I turn the call over to Frank, I want to provide an update on our inflammatory skin disease tests that's in development to predict systemic therapy response. In 2021, we formed our steering committee with leading experts in the field, received necessary approvals for and initiated the development and validation study and have enrolled our first patient. We believe we are on track for launching this test by the end of 2025. As we noted last year, if successful, that pipeline test would add an estimated $1.9 billion for U.S. TAM. I will now turn the call over to Frank, who will provide additional detail relating to our financial results and what to expect in 2022.

Thank you, Derek, and good afternoon, everyone. I want to reiterate Derek’s thanks to the Castle team. Their consistent execution led to a strong 2021 that positions us well to continue creating value for patients, customers, and investors. In the fourth quarter of 2021, we delivered total revenue of $25 million, a 45% increase over the fourth quarter of 2020, and we delivered $94.1 million for the full-year 2021, a 50% increase over 2020. Overall, the increased revenues are primarily attributable to dermatologic test revenues, reflecting an increase in test report volume and higher per unit revenues. Our 2021 per unit revenues benefited from having the expanded LTV for our DecisionDx-Melanoma test effective December of 2020, which resulted in a higher Medicare reimbursement rate for the test. For 2022, our Medicare rate for DecisionDx-Melanoma is $7,193, also contributing to the revenue increase with a significantly higher Medicare rate for DecisionDx-UM of $7,776 that became effective January 1, 2021 and which will continue unchanged for 2022. For the fourth quarter of 2021, we recorded net negative revenue adjustments of $0.8 million, and for the year ended December 31, 2021, we recorded net positive revenue adjustments of $3.3 million related to tests delivered in previous periods. I want to remind you that these revenue adjustments result from key things. The first is revenue from tests that we recorded on a cash basis. For example, our newer tests for which we don't have sufficient reimbursement history or coverage. Second, other adjustments up or down from revenue we previously included, due to changes in estimates and final adjustments upon settlement of claims. Revenue adjustments related to tests delivered in prior periods will fluctuate from quarter to quarter and over time. Our adjusted revenue, excluding the effects of revenue adjustments related to tests delivered in prior periods, was $25.8 million for the quarter and $90.8 million for the full-year 2021. In 2022, we anticipate generating between $115 million and $120 million in total revenue, driven by further consistent execution on our growth plans. Additionally, we anticipate our growth rate from the report volume to exceed our growth rate for revenue in 2022, and it is there for obtaining reimbursement coverage. In order to continue to support and execute on our growth plans, we successfully scaled the organization in 2021 in alignment with our goals, and headcount increased from 201 on December 31, 2020, to 345 on December 31, 2021, representing growth of approximately 70%. For 2022, we expect further increases in total headcount, which we expect to be approximately 50% over our December 31, 2021 number. As of February 17, 2022, we had 382 employees. I will discuss our expectations for 2022 expenses in a moment, and our expected increase in headcount is a key driver in increased expenses in 2022. Our gross margin during the fourth quarter was 77.6%, compared to 84.5% in the fourth quarter of 2020, and our gross margin for the full-year was 81.1%, compared to 84.5% in 2020. Our adjusted gross margin, which excludes the effects of intangible asset amortization related to our two acquisitions and revenue associated with test reports delivered in prior periods, was 82.2% for the quarter and 82.6% for the year, compared to 80.6% and 84.5% for the same period in 2020. As we have previously discussed, in the near term, we expected our gross margin percentage will decline, likely in the range of mid-to-high single digits as we ramp up our investments to facilitate and support anticipated growth in report volumes that advance in obtaining reimbursement coverage. These investments include additional laboratory personnel and related resources. Additionally, as we discussed, our GAAP gross margin will also continue to be negatively impacted by amortization of intangible assets associated with the recent acquisitions. Our total operating expenses, including cost of sales for the quarter ended December 31, 2021, were $40.2 million, compared to $20.3 million for the prior year, and $144.2 million for the full-year, compared to $69.2 million for the full-year 2020. The largest driver of the 2021 increase was higher SG&A, which increased by $38.6 million compared to 2020, attributable largely to higher personnel costs associated with our increased headcount, which includes expenses related to salaries, bonuses, benefits, and stock-based compensation. These higher personnel costs were primarily attributable to the expansion of our sales and marketing teams, as well as through administrative support functions. The remainder of the increase in SG&A was primarily associated with the return of in-person and hybrid conferences, increased peer-to-peer promotional programs and training events, as well as a return to normalized travel costs. R&D expense increased by $4.9 million in the fourth quarter, and by $16.4 million for the full-year 2021, compared to 2020, and it's primarily associated with increases in personnel costs, including increases in stock-based compensation attributable to additional headcount required to manage and run our clinical studies and increases in other expenses associated with increased clinical study activity. Total non-cash stock-based compensation expense, which is allocated among cost of sales, R&D expense, and SG&A, totaled $21.7 million for the year ended December 31, 2021, compared to $8.3 million for the year ended December 31, 2020. Looking forward to 2022, we are confident in our growth plans, designed to enable long-term value creation and driven by our investments to support our plans. We expect the following increases in expenses over 2021. We expect our cost of sales, excluding amortization of acquired intangible assets, to increase by 65% to 75% as we continue scaling in our Pittsburgh lab, as well as further prepare for our anticipated increase in volume for TissueCypher, DecisionDx-SCC, and DecisionDx-Melanoma. We expect our R&D expense to increase by 50% to 60% as we continue to accelerate our plans to generate support for our Derm, GI, and pipeline tests. This increase includes additional clinical research and headcount. We expect SG&A expense to increase by 30% to 35% as we continue to optimize our commercial teams in Derm and GI. Expense increases in all prudent categories include significant increases in non-cash stock-based compensation, which we expect to be around $35 million to $40 million in 2022, driven by higher post-IPO stock option valuations and additional awards outstanding due to growth in headcount. Income tax benefit for the year ended December 31, 2021, was $8.7 million. The large non-recurring and non-cash income tax benefit was directly attributable to the acquisition of Cernostics. Specifically, due to deferred tax liabilities associated with Cernostics, we were required to release a significant portion of our existing valuation allowance on deferred tax assets during the fourth quarter of 2021. Our net loss for the fourth quarter of 2021 was 6.4 million, compared to a net loss of 4.9 million for the fourth quarter of 2020. Our net loss for the full-year of 2021 was $31.3 million, compared to a net loss of $10.3 million for 2020. Diluted loss per share in the fourth quarter was $0.25, compared to diluted loss per share of $0.23 in the fourth quarter of 2020. Diluted loss per share for the full-year 2021 was $1.24, compared to the diluted loss per share at $0.54 for 2020. Adjusted EBITDA for the fourth quarter and full-year 2021 were negative $6.9 million and $14.9 million, respectively, compared to positive $0.1 million and $2.6 million for comparable periods in 2020. For the 12 months ended December 31, 2021, net cash used in operating activities was $19 million, compared to positive $9.9 million for the same period in 2020. It was primarily attributable to our net loss, as well as recruitment of the Medicare advance payment of $8.4 million, partially offset by non-cash charges in changes and working capital. Investing cash flows during the 12 months ended December 31, 2021, was $66.7 million attributable to the acquisitions of the Myriad myPath Melanoma lab and myPath Melanoma test assets, and Cernostics for an aggregate of $63.2 million and purchases of property and equipment of $3.5 million. In 2022, as we further our position as a leader in diagnostic testing, our near and long-term capital allocation priorities allow us to continue creating shareholder value. These priorities include continued acceleration of our R&D efforts, to build on our extensive body of evidence that supports our marketing test, as well as develop our pipeline test. The continued optimization of our Derm and GI sales and marketing teams and opportunistic bolt-on M&A. Finally, we had cash and cash equivalents at December 31, 2021, of $330 million and no debt. With this strong balance sheet in mind, a reminder that in 2021, our net cash used in operating activities was $19 million and our adjusted operating cash flow was a use of $13 million. I want to outline what we believe is our line of sight to cash flow neutrality, the detail that could impact that. As the macro environment continues to evolve, we understand the shift taking place in the sector from primarily top-line growth focus to include a better understanding of a path to profitability. As you know, we continue to deliver very strong gross margins, demonstrating an effective pricing strategy and efficient use of our resources to maintain COGS even with our significant increase in testing volume. We're a growth company and believe in our 2022 growth plans and the investments we’re making in our infrastructure, including in the areas of commercial teams, accelerated R&D initiatives, reimbursement, and we will continue to build our foundation for future growth and profitability. However, we will closely monitor our investments and assess our performance, and we'll pull back these levers as warranted and appropriate to secure our future growth and profitability. With that, I'll turn the call back over to Derek.

Thank you, Frank. I would like to conclude today by thanking our Castle team. Our excellent progress in 2021 is due to their accomplishments. We look forward to continuing this momentum in 2022. This concludes our remarks. Thank you for your continued interest in Castle. Operator, we are now for Q&A.

Our first question goes to Mason Carrico with Stephens. Mason, your line is open. You can go ahead.

Hi everyone. This is Jacob speaking on behalf of Mason. I appreciate the opportunity to ask a question. I wanted to know how many clinicians you believe your GI sales team, with either 13 or 15 representatives, can reach. Have you identified a specific high-volume group that you are focusing on initially?

Yes, excellent question. They certainly have a targeted list, and of course, it's a wide-open opportunity here since there really wasn't a commercial effort at Cernostics before the acquisition. There are a sort of referral group within Gastroenterology, you could call them sort of specialists or clinicians who do more of the ablation work, which is kind of a limited subset, maybe 15%, 20%, maybe 10% of Gastroenterologists. They might represent slightly higher patient throughput of seeing diagnosed patients with Barrett’s esophagus, but the majority of any Gastroenterologist who is not specializing in lower GI work will be a reasonable target for us. Hope that answered that question?

Yeah. That did. Thank you.

Thank you, Mason. Our next question goes to Catherine Schulte with Baird. Catherine, your line is open. You can go ahead.

Hey guys, thanks for the questions. I guess first on the revenue guide, where are the assumptions in there for TissueCypher and for the core business? What does that assume in terms of trends and web access and a recovery in melanoma diagnoses?

Hey Catherine. Thanks. So, as you know, we give guidance based on conditions as they exist today. We're not in the business of predicting COVID trends or resurgence or whatever the new flavor is, but as we see it today, we've got good access. There's still a lag in diagnoses, but it feels like it's slowly closing the gap maybe. And we do have a little bit in there from TissueCypher, but we're not being too aggressive on that. It's a great test, and we're excited about the commercial team, but it's early days yet. So, we want to see how the conversions go before we get too much baked in for TissueCypher.

Okay, got it. And you talked about I think 90% of calls being in person in the fourth quarter, but how does the overall number of sales calls or maybe calls per rep just given your expansion? How does that compare to pre-COVID levels? I’d just be curious how much of a rebound do you think there’s still to be in terms of calls, pop volume from here?

Yes. So, I think back to pre-COVID. It almost seems like pre-historic, right? If you think back to pre-COVID levels, we had just expanded to 32 sales representatives in December 2019, and we went from 15 to 23 territories in February 2019 just before we went public. So, the 2019 comparison pre-COVID is probably off the base of probably 23 FTEs for the course of the year. And as the listeners will recall, we went from 32 dermatology sales representatives to the mid-60s in the middle of 2022. So, maybe the FTE was over the course of the year, probably 50-ish maybe just for the whole year. So, with that kind of compares to mine, 23-ish to 50-ish, we certainly had more calls than we've had in the fourth quarter of 2021 and the same with the third quarter of 2021. We are seeing, of course, more than 90% being in-person in those two in the second half of 2021. We are still a little bit below our sort of pre-COVID levels in terms of number of customer calls per day. I think we reported that around 20%. We were shy in the third quarter of this year. I didn't think we did release the fourth quarter, but it improved a bit there. So, not quite back to pre-COVID levels there for say now. What I don't know is that a reflection of COVID or is that a reflection of having essentially 3x number of sales representatives across the U.S. marketplace, and that just sort of reduced the opportunities for calls per day. So, that I don't point out to answer. We feel that there probably is still room to improve. In 2022, the number of customers we're seeing per day, but it won't be that dramatic. The fact that we continue to see throughout the fourth quarter interest in our clinicians to see us in person, I think it's a mixture of having in this case, three different products or test solutions to present to a single customer. I think that's why we have good access throughout 2021 certainly.

Alright, very helpful. Thank you.

Thank you, Catherine. Our next question goes to Puneet Souda with SVB Leerink. Puneet, your line is open. You can go ahead.

Yeah. Derek, Frank, thanks for taking the question. So, I have two, and I'm going to wrap that into one question and get back into the queue. So first one, really, it seems like based on what Frank has provided, this is going to be an investment year for you. So, maybe could you just update us on your cash burn expectations overall for 2022, and wondering if we should expect a moderation from that in 2023? And does this change your long-term gross margin expectations? And when thinking about profitability, do you see maybe DecisionDx-Melanoma being cash flow breakeven at some point? And the last one, around the EMR system that you mentioned, maybe Derek at a high level if you could talk to what that means for ordering patterns among the dermatology practices and how broad is the use of this EMR for the Derm practices? Thanks for taking those questions, guys.

So, I think I'll take the last one first and Frank can handle the cash question. Okay. Thanks Puneet. So, our understanding is that the largest EMR system in dermatology by market share is Modernizing Medicine's system from an EMR perspective. That's largely because I think it's a system built towards office-based procedures, and as we know, the vast majority of dermatologists are office-based private practice individuals. So, that fits their model. We have all of our dermatology connections through that system. The location certainly must take just DecisionDx-Melanoma as an example is that when a clinician sees a patient who's then diagnosed with melanoma, one of the dropdown menu options that you'd expect to see in any EMR system is what to do next, i.e. what's the treatment plan options, and one of those options that now pops up is the Castle Biosciences DecisionDx-Melanoma test. So that's where it sits. It makes ordering easier. It's a couple of clicks to go ahead and say yes that they want to order the Castle test on that patient, and that kind of sends off to us, both a signed physician form from that doctor, as well as the associated pathology reports. That's a smooth system. So, what does that mean in terms of potential upside? I think we're just rolling that out now with the agreement being signed in December. So, it's too early to say if we experience any impact yet, but our expectations would be, if we have a current customer who's using DecisionDx-Melanoma for appropriate patients in their practice, I would expect that we would see less, sort of loss of customers who might be seen on a Friday afternoon, for example. We have some reminder advertising gains in a customer who we know that there are always appropriate patients who might fall through the cracks here or there. I do see, we do believe based on interactions with some of our dermatology customers who are using our tests, you might say they are dabbler customers, those who are not using it very consistently or you know there is use here or there, but they don’t see melanoma that frequently or are not thinking about our test all the time. I think having that sort of drop down on the treatment plan page enables us to have a reminder opportunity that's right there in front of the doctor to ignore as opposed to having them recalling it. So, I do think we should expect to see some improvements in terms of tests coming out of individual, kind of a dabbler or just getting adopted clinician who may not have DecisionDx-Melanoma in the forefront of his or her mind all the time. I think that for a clinician who either had zero access to or maybe has reviewed our test and doesn't want to use it, I think it's a far stretch to think that sort of a reminder advertising opportunity like that will actually drive initiation, but I look forward to being proven wrong. Does that kind of give you a hand of what you're thinking about?

Yes, I will add and finish the question Puneet. So, you’re right. This will be an investment year, and we try to get some granularity on what we see as increases in various categories down the P&A. You'll see that volumes will certainly – volume growth certainly exceed revenue growth due to the delays in the Medicare reimbursement cycle that Derek referenced earlier. However, we still have, as I mentioned, very good line of sight on cash flow neutrality, and when you look at the volumes we report for squamous cell, for example, you can see what the impact would be to cash flow if we were getting paid by Medicare on that. So, we're going to continue to deliver those reports. We think it's important to serve patients with them, and we want to have that test offering be at a full run when we do have reimbursement appropriately in place. And then on the gross margin, as you know, we have begun to break out an adjusted gross margin to take out the amortization. There are intangibles associated with both myPath and Cernostics, and that flows through the COGS line. So, we've taken that out to offer a better view of how the business is performing. We will see the gross margin continue to be impacted by these tests we're delivering without reimbursement in place, but as we've said, all of our Dermatology tests run on the same instrumentation with the same people and very, very similar consumables. So, the COGS difference for those three tests is really just a handful of dollars. The gross margin for Melanoma is durable, it gives what it was prior to our launch of our new tests. The impact is nearly all the test reports that we're providing without accruing revenue brings that down. Now, so, that's a little bit of a challenge right now, but what's important to remember is that when we do get reimbursed on those tests, that cash drops all the way down to operating income, because we've already reflected the COGS for the test to deliver the tests, and we've already reflected the sales and marketing effort to generate the orders that could result in the reports. So, when we do have that reimbursement in place, that will drop all the way down and we'll have a big impact. And as we go through the year, we might sort of pro forma what it would look like if we were in a reimbursed environment on that test.

Thank you, Puneet. Our next question goes to Paul Knight with KeyBanc. Paul, your line is open. You can go ahead.

Hey guys. This is Harrison on for Paul. I was wondering if you guys could just kind of talk at a high level as to how Omicron impacted your business in 4Q. It seems like we – there’s good momentum in terms of overall volumes, and I think you called out growth in the call volume as well over the 3Q. So, just kind of wondering how Omicron affected you guys in the quarter, kind of what you're seeing there?

Yes. So, let me think that through out here. So, maybe sort of thinking that top down, so we did not see any sort of reversal in sort of representative access or sort of number of calls per day that were achieved. So, nothing on sort of a promotional responsiveness perspective from that. We did see overall, I think in 2021, we had about an 11% reduction in the overall diagnosis rates of melanoma compared to 2019, and that was 9% below 2019 for the fourth quarter. So, we saw continued improvement in terms of return of diagnosed skin cancer patients in the fourth quarter, compared to the other three quarters in 2021, just by that 9% versus the diagnosed rate. So, I don’t know patient flow was impacted by Omicron; I have to believe it probably was, because that had been 6% down or 3% down perhaps and it came in at 9% down that probably is the only tangible part I can see there, Harrison, in terms of the impact of Omicron in the fourth quarter.

Got it. And if I could just kind of follow-up as well. Just kind of following up on the overall headcount in trends that we're seeing here in OpEx, how do you guys think about the headcount increasing in the outer years and where OpEx might find a place to generally settle?

So, maybe I’ll cover the salesforce area or commercial side, and you can cover the rest, Frank. I think in terms of, sort of the sales and marketing investments, as Frank mentioned earlier, in response to Stephen’s question, we think that we may end up peaking out in dermatology over time at maybe 80 to 100 representatives. We’re kind of in the mid-60s right now. Most dermatology companies have that range when they fully mature, and that’s probably a number to think about in dermatology, if we have a single line of representatives there. Gastroenterology is a little bit lighter, and maybe part of that is because they're in a little bit larger groups overall. So, you can perhaps catch more customers at a single call point. It could be Gastroenterology over time ends up picking out. What do you think, Frank, between 16-18 is probably a reasonable number? But I think that's over time and depends on the number of products we have in our bag that we can offer up. So, those are sort of sales and you have associated medical science liaison support, inside sales associate marketing personnel as part of those multipliers. Can you comment on the rest of the organization?

Yes. So, what you see there, Harrison, most of the growth is in R&D and in marketing. In terms of the cost center part of the business or the non-revenue-generating part of the business, the increases are much lower. So that's where most of that growth is, is in those drivers of the business that will drive revenue in the coming years. I guess the last thing I would just say is, as we sit here today, we have a tremendous market opportunity, and we're excited to keep expanding our penetration of each of these areas now, each of the three Derm tests as we begin to penetrate on the GI side, and the possibilities are certainly exciting, and we're committed to that.

Thanks guys.

Thank you, Harrison. Our next question goes to Kyle Mikson with Canaccord. Kyle, your line is open. You can go ahead.

Thanks. Hey, guys, thanks for taking the questions, congrats on the quarter. And I just apologies in advance if I touch on anything that was already covered, but I had a few questions for you. So, again on Omicron, obviously it kind of hit hard in the first quarter, or in the first quarter. So, in January, I was wondering if you could talk about the percentage of melanoma diagnoses, how far below based on, was that like that below the 4Q level? I think that was 9%. And then how do you think that baseline sort of relative thought process will come above all throughout the year? Thanks.

So, no, no, no is the short answer. So, we purchased our third party diagnostic data from Symphony Health. They run anywhere from 4 weeks to 6 weeks after close of a month before the sort of diagnoses in that month of interest are kind of sold out. So, we're nearing what it should look like, but to be honest, there's a little uncertainty still. So, I'm uncomfortable giving you a number in January. I don't think it will be worsening, to be honest, in terms of what we saw in the fourth quarter of 2021. The only exception might be is, there were a couple of snow day issues, and you've got a couple of holiday issues in January, but if you average the fourth quarter, it may be a little different there. So, we would have to do a diagnosis per day analysis. We typically see that first week of January is quite variable based on the January 1, December 31 New Year's Day changes. So, when we don’t have data that we’d be able to cite this. I don’t think personally that I’ve heard any sort of patients weren't showing up. People were canceling in January because of Omicron, for example. So, I think we would see nothing that would be sort of COVID-related and probably more just to your typical mid-winter seasonality impacts.

Okay. Thanks, Derek, that was helpful. And you guys have 330 million on balance sheet and the cash flow in 2021, which was great. And I heard the investments you are going to be picking up this year, I saw the guidance for the expenses, that will make sense, I guess. I'm just curious if you're ready for the next deal, would you strengthen the Derm side like you did with myPath, or would you guys think about the GI side like you did with Cernostics? And obviously, I noticed the components of the slides earlier. So, I’m just curious what you're thinking about in terms of strategic capital deployment for this year and next year, going forward?

Yeah. So, maybe I’ll talk in terms of what we've been thinking about pre-IPO in the last couple of years, that's been a little not hampered, but impacted by COVID mind. So, we have a very strong balance sheet to make the right investments in 2022 without worry about being cornered financially. So that's a great position to be in. My hope, call it in 2025, is to put together a portfolio of dermatology pipeline programs coming to successful completion and we're looking at five or six or six or seven dermatology products or tests that we offer that dermatology commercial team could utilize. Those could all be organic if they're only pipeline; it could be that we seek additional assets like myPath to kind of fold-in to our current commercial investments. So, these are areas that we look at all the time. In Gastroenterology, our interest in Gastroenterology wasn't just a one-trick pony with Barrett’s esophagus, but to examine whether we believe there are interesting call points in Gastroenterology that clinicians could make better, more informed decisions if they had access to advanced diagnostics like we offer in dermatology, and we concluded, yes. From there, the question became, do we want to go and build this internally only or look for interesting assets out there, and that's where Cernostics came along. My expectation in 2025 is that we will ideally not just have one product, but have two or three or three or four tests for use in the Gastroenterology marketplace that will be well received by that customer base. Now, those might come from internal opportunities or acquisitions. These are considerations that we are looking at. The other question is whether there are other areas in the marketplace of diagnostics where we should acquire or build out organically a test or a business, and we have dermatology, and we believe Gastroenterology will reflect dermatology in a couple of years. Are there other areas that look like that? Those are certainly cards on the table at this point in time. That's an excellent question. I should have answered that the first time around. The other nice pickup from Cernostics is that as a company, we focus predominantly on discovery using AI tools using gene expression profiling as our platform. I think we could all hold ourselves up to the mirror and say we really had limited expertise or limited experience looking at a spatialomics approach. One of the nice pickups is that additional technology platform. I would not limit that just to Gastroenterology opportunities. We think there may be opportunities in the dermatology space to leverage that. As we go through our additional pipeline programs internally, that certainly is one expertise area that we now own and can make a pretty quick call saying let's go ahead and think about both pathways, gene expression profiling, and spatialomics to answer a specific question, and we'll take the right platform because we have the expertise in-house.

Great. Sounds promising. Thanks for the questions. Appreciate it.

Yes.

Thank you, Kyle. Our last question is to Thomas Flaten with Lake Street Capital. Thomas, your line is open. You can go ahead.

Hi, thanks, good afternoon, guys. Just two quick questions. With respect to the SEER data, I know you in your prepared comments you mentioned that you're looking forward to a publication, would that be based on the data that's been run so far, or are you going to hold off until you do additional linkage with more recent data? How should we think about that?

Excellent question. We purposely presented just an initial analysis of the SEER data at that dermatology meeting earlier in January, looking at a subgroup of the overall dataset. Our expectation here is that with the recent linkage updates we will have a fuller complete population analysis as part of our primary publication going out.

Got it. And then one on the DiffDx, myPath. So, if you guys run myPath initially and you get an indefinite result and you reflex to DiffDx-Melanoma, is that blinded to the provider? Is it done kind of at your cost just to keep the results at that 99% level? I'm just trying to think of how you guys think about the economics of that and kind of the service level of it?

Yes. We do indicate – so in that situation where we processed myPath first, it came back with an intermediate score from myPath, and we run a subsequent, the same sample on the DiffDx-Melanoma on that report, we do alert the clinician that this was an intermediate result from myPath, so they have that perspective with them. Now, while we could say that because you're issuing two results, you should go and yield for both tests, we don't do that at this point in time. We don't think that's appropriate.

Got it. Appreciate the clarity. Thank you.

Thanks, Thomas.

Thank you, Thomas. There are no further questions registered at this time. So, I will pass the conference back over to the management team for any closing remarks.

Thank you, operator. This concludes our fourth quarter and full-year 2021 earnings call. Thank you again for joining us today and for your continued interest in Castle Biosciences.

That concludes today's call. Thank you for your participation. And you may disconnect your lines.