Castle Biosciences, Inc. (NASDAQ:CSTL) Q3 2023 Earnings Call Transcript

Castle Biosciences, Inc. (NASDAQ:CSTL) Q3 2023 Earnings Call Transcript November 3, 2023

Operator: Good afternoon and welcome to Castle Biosciences Third Quarter 2023 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, Vice President, Investor Relations and Corporate Affairs. Please go ahead.

Camilla Zuckero: Thank you, operator. Good afternoon, everyone. Welcome to Castle Biosciences third quarter 2023 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, November 2, 2023. 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 3 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, TAM and similar items referenced in our earnings release issued today and statements containing projections regarding future events or our future financial or operational performance, including our anticipated 2023 total revenue and our full year 2023 to 2025 outlook; our expectations regarding reimbursement for our products; and the impact of our investments in growth initiatives and expanded commercial teams. 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 year ended December 31, 2022, 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 non-GAAP financial measures such as adjusted revenue, adjusted gross margin and adjusted EBITDA that have not been calculated in accordance with generally accepted accounting principles in the United States, or GAAP. These 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 operating 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.

Derek Maetzold: Thank you, Camilla and good afternoon everyone. As you saw from our announcement a few minutes ago, Castle delivered yet another outstanding quarter, continuing our track record of strong execution. Revenue grew by 66% to $61.4 million, and total test report volume grew by 52% compared to the third quarter of 2022. We achieved these strong results while generating $5 million in cash flow from operations and $6.6 million in adjusted EBITDA. Given our consistent performance throughout the year and our confidence in the business, we are again raising our full year 2023 revenue guidance and now anticipate achieving at least $200 million in revenue, an increase of at least 45% over 2022. I attribute our continued strong performance in no small part to the culture we built at Castle.

And the foundation of this culture is the people who call Castle home. I cannot thank them enough for their decision to join Castle, lean in and help drive our success. Now, let me take you through execution and strategy highlights from the quarter, and then Frank will provide additional financial highlights for the period before we turn to your questions. Let’s start with our core dermatology business, which continues to perform extremely well. For DecisionDx-Melanoma and DecisionDx-SCC combined, test volume was 11,379, growth of 27% year-over-year. For the trailing 12 months as of September 30, 2023, the combined test volume growth was 33% when compared to the preceding 4-quarter period. We are very pleased with our third quarter and trailing 12 months volume performance.

For the 3 months ended September 30, we had approximately 500 new ordering clinicians, that is clinicians ordering our tests for the very first time, and approximately 5,000 total ordering clinicians across all three dermatologic tests. As a reminder, there is significant overlap between clinicians who order our DecisionDx-Melanoma test and those who are now adopting our DecisionDx-SCC test. In fact, during the 9 months ended September 30, 2023, approximately 75% of all clinicians ordering DecisionDx-SCC had also ordered our DecisionDx-Melanoma test during that same period. We believe this is a result of the high unmet clinical need that our tests are designed to address, coupled with the decision-making value that is acted upon by dermatological providers and the leveraging of our sales efforts across growth products effectively.

As it relates to the impact on decision making, I remind you of the results of a multi-center study published in the second quarter of this year from Cleveland Clinic, Northwestern University and Oregon Health & Sciences Center that showed a direct benefit in outcomes, that is, survival in patients whose early stage melanoma treatment plans were guided by the DecisionDx-Melanoma test results compared to those patients managed at the exact same institutions whose treatment plans did not include the knowledge of our decision DecisionDx-Melanoma test results, that is, untested patients. For DecisionDx-Melanoma, we delivered 8,559 test reports in the third quarter, a 16% year-over-year increase and roughly flat compared against 2Q, reflecting normal third quarter seasonality.

We are pleased by this performance. From a patient standpoint, we estimate that we have reached about 25% market penetration, and we believe substantial growth opportunities are still ahead of us. We believe the most significant drivers of growth are the documented clinical impact our test has on improving outcomes in patients diagnosed with early stage melanoma, coupled with our prior commercial expansion investments intended to educate our customer base. One of our evidence development goals is to continue to compare the value of our test to other tools or other tests for patients diagnosed with melanoma, primarily for reimbursement purposes but also as proactive competitive purposes with our customers. In the past, this meant focusing on comparing the independence of our DecisionDx-Melanoma test to the American Joint Committee on Cancer, or AJCC, staging factors or the National Comprehensive Cancer Network’s risk criteria.

In addition to these two risk assessment tools, there is also the existence of nomograms. During the third quarter, we announced a new study demonstrating DecisionDx-Melanoma outperformed a nomogram that was developed at the Memorial Sloan Kettering Cancer Center in predicting the risk of sentinel lymph node positivity in patients with cutaneous melanoma. This study provides further evidence that using DecisionDx-Melanoma to help guide decisions regarding sentinel lymph node biopsy procedures improves patient selection, potentially reducing unnecessary surgical procedures and ultimately improving the care of patients with melanoma. Similar to DecisionDx-Melanoma, we continue to see strong report volume momentum for our DecisionDx-SCC test in the third quarter of 2023, with volumes up 72% year-over-year.

As with our growth in DecisionDx-Melanoma, we believe that our strong growth and volume for the DecisionDx-SCC test is due in large part to the combination of the high clinical need for SCC coupled with the value that our test provides. We continue to expand the body evidence surrounding the test. This quarter, for example, we shared new data demonstrating the ability of our DecisionDx-SCC test to identify patients with localized but high-risk cutaneous squamous cell carcinoma who may benefit as well as those who may not benefit from adjuvant radiation therapy. Now let’s shift our focus to our gastroenterology franchise and our TissueCypher test that was designed to predict the development of high-grade dysplasia or esophageal cancer in patients diagnosed with non-dysplastic indefinite or low-grade dysplasia Barrett’s esophagus disease.

During the third quarter, we delivered 2,829 TissueCypher reports compared to 690 in the third quarter of 2022. As with our DecisionDx-Melanoma and DecisionDx-SCC test, I’m pleased to share that during the third quarter, we had multiple data announcements demonstrating the significant clinical utility of TissueCypher in guiding risk-aligned care for patients. Turning to our mental health franchise. We delivered 2,791 IDgenetix test reports during the third quarter of 2023, up from 1,208 in the third quarter of 2022. We are extremely pleased with the momentum thus far, including two consecutive quarters of triple-digit year-over-year volume growth. We believe our success is due to a differentiated test, including identifying drug-drug and drug-gene interactions with lifestyle factors, to help improve medication response and remission rates in a mental health market which we believe offers significant opportunity for growth.

In fact, recent data from a study showed the addition of drug-drug interactions and lifestyle factors to drug-gene interactions provided by our IDgenetix test significantly impacted a number of drug recommendations and contributed to improved remission rates for patients with moderate to severe depression. Specifically, patients whose medication management was guided by our IDgenetix test were 2.65x more likely to achieve remission of depressive symptoms compared to patients whose medication was guided by standard of care trial-and-error approach. That is a clinically meaningful improvement to patients suffering from moderate to severe depression. Moving to our longer-term growth initiatives. I’m excited to share some early discovery data on our inflammatory skin disease pipeline program.

As you may recall, we launched the program with the goal of developing a genomic test aimed at guiding systemic therapy selection for patients with moderate to severe atopic dermatitis, psoriasis and related conditions. We are pleased with the early discovery data, which we presented in October at the Fall Clinical Dermatology Conference. For instance, the data demonstrated that in patients with moderate to severe atopic dermatitis, we were able to show that using our non-invasive method of tissue sampling, coupled with gene expression profiling, can separate out responders from non-responders. Furthermore, our inflammatory skin disease pipeline test could help distinguish atopic dermatitis, psoriasis and mycosis fungoides skin lesions to ensure proper selection based upon an individual patient’s molecular profile.

This test has the potential to represent a significant advancement in the care of patients grappling with these debilitating skin conditions. Importantly, it could empower clinicians to tailor therapy choices by considering their molecular profiles, potentially sparing patients undergoing numerous ineffective and costly medication trials before discovering an effective treatment to manage their specific symptoms. We are encouraged by the data we have generated to date and look forward to providing you with additional development updates in 2024 with the test launch targeted for the end of 2025. Now, shifting our focus to development related to uveal melanoma. Discovery data on a potential complementary test is being presented this weekend at the American Academy of Ophthalmology.

As you know, uveal melanoma is a rare disease with approximately 2,000 patients diagnosed annually in the U.S. Our DecisionDx-UM test is standard of care for newly diagnosed patients, and we believe we test about 85% of such patients. In our ongoing dedication to this patient population, we’re currently conducting a study to explore the potential of developing a test that will be tailored for individuals presenting with very small suspicious lesions with uncertain malignant potential. The current approach in deciding whether to intervene and treat these suspicious lesions is based on a watch-and-wait approach, where some change in the clinical characteristics of the lesion prompts the decision to definitively treat it and perform a prognostic biopsy.

However, the decision to intervene is highly subjective and can lead to both undertreatment or delayed treatment of aggressive lesions and overtreatment of lesions that would probably have been fine to follow without any intervention. We are looking for a simple, minimally invasive and objective signal that can identify aggressive biology earlier than the current clinical standards in order to allow for potentially earlier interventions. We see this potential test as a complementary test to our prognostic DecisionDx-UM test. Our data is still in the early stages of discovery, but we expect additional data in 2024, indicating whether development of this type of complementary test may be possible. Lastly, I am honored to share that Castle Biosciences has recently been awarded a Top Workplaces National Industry Award, securing the third position among 84 top workplaces in the healthcare sector.

People come first at Castle, and our unique culture reflects that mindset. Our success is not possible without the entire Castle team, and I would like to express my sincere appreciation for their contributions. I will now turn the call over to Frank, who will provide details relating to our financial results and outlook.

Frank Stokes: Thank you, Derek. Good afternoon, everyone. Third quarter revenue was $61.5 million, an increase of 66% over the third quarter of 2022. Overall, the increase primarily reflects significant growth in revenue from DecisionDx-SCC and DecisionDx-Melanoma driven by ASP growth and strong test adoption through robust clinical evidence. Adjusted revenue, which excludes the effects of revenue adjustments related to tests delivered in prior periods, was $60.6 million, an increase of 63% over the third quarter of 2022. Our gross margin during the third quarter was 77.9% compared to 69.8% in the third quarter of 2022. Our adjusted gross margin, which excludes the effects of intangible asset amortization related to our acquisitions and revenue associated with test reports delivered in prior periods, was 81.3% for the quarter compared to 76.2% for the same period in 2022.

Turning to expenses. Our total operating expenses, including cost of sales for the quarter were $71.1 million. This compares to $58.5 million for the third quarter of 2022 and $71.3 million for the second quarter of 2023. The largest driver of the year-over-year increase in total operating expenses was SG&A expenses, which increased by $8 million compared to 2022, attributable in large part to higher personnel costs, including bonuses, stock-based compensation, salaries primarily within the sales and marketing functions. Cost of sales expense increased by $2.5 million, primarily due to increased expenditures on supplies and higher personnel costs associated with the growth in test volume. R&D expense increased by $2 million in the third quarter of 2023 compared to 2022, which was attributable to higher personnel costs driven primarily by expansions in headcount in support of our growth and other costs associated with clinical studies.

Total non-cash stock-based compensation expense, which is allocated among cost of sales, R&D expense and SG&A expense, totaled $13 million for the third quarter of 2023 compared to $9.2 million for the third quarter of 2022. The increase was primarily attributable to our annual equity awards granted in December of 2022. Interest income increased by $1.5 million for the third quarter of 2023 compared to the third quarter of 2022, primarily a result of higher interest rates and our purchases of marketable investment securities beginning in the third quarter of 2022. Our net loss for the third quarter of 2023 was $6.9 million compared to a net loss of $20.2 million for the third quarter of 2022. Diluted loss per share for the third quarter was $0.26 compared to diluted loss per share of $0.77 in the third quarter of 2022.

Adjusted EBITDA for the third quarter was $6.6 million compared to negative $9.6 million for the comparable period in 2022, an improvement of $16.2 million. The substantial year-over-year improvement reflects strong top line growth, along with continued disciplined expense management. Net cash provided by operating activities was $5 million for the third quarter, and net cash used in operating activities was $24.2 million for the 9 months ended September 30, 2023. Net cash used in investing activities was $8.5 million for the 9 months ended September 30, 2023, and consisted primarily of purchases of marketable investment securities of $136.7 million and purchases of property and equipment of $9.8 million, partially offset by the maturity of marketable investment securities of $138 million.

Our balance sheet remains very strong. We increased our cash position by more than $4 million in the third quarter of 2023 compared to the second quarter of 2023, ending the quarter with cash, cash equivalents and marketable securities of $229.8 million. Together with the anticipated cash generated from sales of our tests, we expect that our cash operating runway will extend through 2025, at which time we expect operating cash flow positivity. As Derek mentioned, we are increasing 2023 revenue guidance to at least $200 million, up from at least $180 million. Importantly, this updated guidance represents an increase of at least $25 million compared to the midpoint of our expectations at the beginning of this year. Supporting our long-range targets for ASP improvements, we continue to make progress for Castle’s tests with commercial and state health plans and expect that to continue over time.

Furthermore, there has been a growing trend of states implementing biomarker state laws with about 14 states with existing laws that will go into effect over the next 14 months. While implementation and the impact of biomarker laws are still in the initial stages, we see these developments as a strong statement on the value of biomarkers in directing treatment plans and applaud the state legislatures and governors in supporting improvements in patient treatment plan decisions as a result of biomarker test results. In conclusion, we had a great quarter from a financial perspective, highlighted by strong revenue and test volume growth, positive operating cash flow and adjusted EBITDA, and a substantial upward revision of our full year expectations.

I’ll now turn the call back over to Derek.

Derek Maetzold: Thank you, Frank. In summary, Q3 was an exceptional quarter with continued strong execution. Additionally, we’re making progress across our pipeline initiatives. We are excited about our performance through the first three quarters of the year and believe our ability to create value for our stockholders in the near and long-term remains intact. I would like to conclude today by again thanking our Castle team. Now, we will be happy to take your questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question today comes from the line of Thomas Flaten with Lake Street. Thomas, please go ahead. Your line is open.

Thomas Flaten: Thank you. Hey, guys. Appreciate you taking the questions. I was wondering if you could provide us with an update on the Pittsburgh facility in TissueCypher and whether or not that had anything to do with essentially doubling of volumes from the second quarter to third quarter?

Derek Maetzold: I think we announced at a conference in mid-September that we had completed our scaling expectations that we thought would be completed by the end of the quarter a little early. And we are beginning to accept new orders from current customers, and as of now, that everything is sort of back to normal there. So I think that the generation demand that we began seeing in the second quarter is certainly – that backlog is reported now and things are running as normal. Does that answer the question, Thomas?

Thomas Flaten: Yes. No, that’s great. And then if I might, the 500 new docs that you brought in are prescribers to the derm business. Was there kind of an even distribution of which product they were coming in for or was it more heavily weighted towards Dx-Melanoma?

Derek Maetzold: I didn’t look at that breakdown. Did you, Frank? I don’t think so.

Frank Stokes: I didn’t look at it that way, Thomas.

Derek Maetzold: My assumption is we have been running at – if you think about the earlier commentary there, that about – of physicians who have been ordering DecisionDx-SCC, 75% of them also order the melanoma test. I assume that ratio is pretty consistent in the third quarter.

Thomas Flaten: Got it. Appreciate it. Thank you.

Derek Maetzold: Thank you.

Operator: The next question comes from the line of Puneet Souda with Leerink Partners. Puneet, please go ahead. Your line is open.

Puneet Souda: Hey, guys. Thanks for taking the questions and congrats on a strong quarter here. Maybe this is maybe Frank or Derek, if you could parse out what you received in the quarter as the ASP for SCC. And I recall last quarter, you were expecting – you had eliminated that from the second half. Sort of how should we think about SCC growth in the first half or any payments that could come in the first half of ‘24?

Frank Stokes: We don’t know if coverage will be in place in the first half of ‘24, Puneet. So that’s still to be determined. But yes, correct, we did have coverage in place for the third quarter. And so we were appropriately reimbursed for the value of that test during the quarter.

Puneet Souda: Okay. And then maybe just a broader question for Derek, I mean, I am sure you had some time to think about the FDA regulation and their attempt to regulate the LDT market. Maybe just walk us through what tests that you think you can go easily – more easily through the process versus where you need to produce more data or in order to – if that process was implemented? Thank you.

Derek Maetzold: That’s a good question, Puneet. Yes. I think, one, we all have to wait for a little more clarity and specifics from the FDA on their proposed rule. It’s a little nebulous from my perspective. That being said, we have in the past looked at sort of the level of evidence and the FDA’s approach when they were clearing or approving similar kinds of diagnostic tests. In many instances, they deferred to New York State Department of Health laboratory permitting and test approvals. Both of our laboratories and I think all of our tests but TissueCypher are approved through New York State Department of Health. TissueCypher’s just a timing thing in terms of when they get around to reviewing it. So our perspective has been, we believe that we have more than adequate data that once one understands if the FDA will, in fact, regulate the laboratory developed test industry, and we were required to or submitted a PMA application that we have, that each one of our tests has adequate data behind it already published in the public domain.