Good day, ladies and gentlemen, and welcome to the Castle Biosciences’ Second Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Frank Stokes, Chief Financial Officer. You may begin..

Thank you, operator. Welcome to the Castle Biosciences second quarter 2019 financial results conference call. Joining me today is Castle's Founder, President and Chief Executive Officer, Derek Maetzold. Information recorded on this call speaks only as of today, September 3, 2019.

Therefore, if you are listening to this 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 two 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 and are made pursuant to the Safe Harbor provisions 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 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 final prospectus filed with the Securities and Exchange Commission on July 26, 2019, relating to our registration statements on Form S-1 and 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 Maetzold.

Thank you, Frank. Good afternoon, everyone, and welcome. We are pleased to report that Castle had a strong second quarter performance, recognizing $10.7 million in revenue.

Overall, we delivered 4,067 proprietary gene expression profile tests for our DecisionDx-Melanoma and DecisionDx-UM tests during the second quarter of 2019, representing an overall growth of 24% compared to the 3,281 test reports delivered during the second quarter of 2018.

Our primary growth driver, our DecisionDx-Melanoma proprietary gene expression profile test for cutaneous melanoma, we provided 3,691 test reports in the second quarter of 2019, compared to 2,899 reports during the second quarter of 2018, representing growth of 27%.

As a reminder, we expanded our sales team from 14 to 23 outside territories in the first quarter of 2019.

This second quarter represents, therefore, the first full quarter since this expansion, and our performance during this quarter is a reflection of this expansion, which drove both continued penetration within our base of existing physicians as well as accelerated conversion of new prescribing physicians.

I would now like to highlight several important achievements during the second quarter. For DecisionDx-Melanoma, we saw continued increased traction during the quarter. Our growth in new ordering clinicians was 34% during this quarter.

New ordering physicians represents an important source of future growth as these physicians incorporate DecisionDx -Melanoma into their practices.

There have been two additional peer-reviewed clinical studies published recently, bringing the total number of peer-reviewed publications, supporting the two current clinically actionable uses of DecisionDx-Melanoma, to 19 studies. The first study, an independent prospective publication from Dr.

Eddie Shane colleagues at Saint Louis University Hospital, was published during the second quarter in the journal Cancer Medicine. This study demonstrated that DecisionDx -Melanoma accurately identified risk of melanoma recurrence, independent of other prognostic factors such as Breslow thickness and sentinel lymph node biopsy status.

These results are consistent with previously published prospective and retrospective studies demonstrating and confirming the high performance of DecisionDx-Melanoma to predict the outcomes and thus supporting its clinical value to inform patient management decisions.

The second recent study, the 19th peer-reviewed publication supporting DecisionDx-Melanoma’s use in cutaneous melanoma was published in the journal Skin in early July.

The study was an evidence-based analysis of the clinical performance and utility of the DecisionDx-Melanoma test using four different datasets or cohorts ranging in size from 403 patients to 8,944 patients.

The study focused on identifying a tumor thickness that would be appropriate for use of the test to guide follow-up decisions in cutaneous melanoma patients. Results demonstrate that a minimum tumor thickness of 0.3 millimeters and thicker is an appropriate population to use the test to guide clinical follow-up decisions.

As you may recall, based on previously published validation performance and utility studies, the test has two primary clinical uses following the diagnosis of melanoma.

The first is to inform decisions on sentinel lymph node biopsy in most eligible patients with a tumor thickness less than or equal to 2 millimeters and with no minimum tumor thickness requirement. And the second use is to guide to follow-up decisions, which was the focus of this publication in Skin.

On August 22, 2019, Palmetto GBA, a Medicare Administrative Contractor, posted a draft Medicare Local Coverage Determination policy or LCD, that, if approved would result in expanded Medicare coverage for our DecisionDx-Melanoma test. The comment period for this draft LCD opens on October 7, 2019 and closes on November 21, 2019.

Any final effective date is not known at this time. However, we expect that Palmetto will finalize to implement the draft LCD after soliciting public comments. Based upon our prior experiences in this process, we anticipate that if finalized, the LCD could become effective in late 2020.

The evidence-based analysis in the July Skin publication noted above supports the expanded use in this draft LCD. Turning to our second proprietary test, DecisionDx-UM, our uveal melanoma franchise continues to be a durable source of revenue for Castle and provides important prognostic information to an underserved population of cancer patients.

We delivered 376 DecisionDx-UM test reports during the second quarter of 2019, relatively consistent with the same period last year. For the six months ended June 30, 2019, DecisionDx-UM uveal melanoma tests volumes were up nearly 5% compared to the same period in 2018.

Based upon our data, we test approximately 75% of the patients diagnosed with uveal melanoma in the United States each year. In addition to our currently marketed test, we have made important progress in advancing our product pipeline as well.

In May, we presented data from an ongoing development study of our cutaneous squamous cell carcinoma prognostic test at the American College of Mohs Surgery Annual Meeting.

That data showed continued progress towards validation of this prognostic test, and we have additional archival studies and a prospective validation study for DecisionDx SEC underway. We also initiated the initial development of validation studies for our suspicious pigmented lesions test.

I will now turn the call back over to Frank to provide additional detail regarding our financial results.

Frank?.

Thank you, Derek. Castle continue to drive growth during the second quarter of this year. In the second quarter of 2019, we recognized $10.7 million in revenue, an increase of $6.8 million as compared to the second quarter of 2018.

There are several items that I would like to highlight with respect to our strong year-over-year revenue growth during the quarter. First, the 24% growth in GEP test report volume was a significant driver, as Derek mentioned earlier.

Additionally, revenue growth benefited from the Medicare Local Coverage Determination or LCD for our DecisionDx-Melanoma test that was issued in the fourth quarter of 2018.

While the LCD covered reimbursement for test reports delivered prior to the fourth quarter of 2018, due to the timing of the issuance of the LCD and GAAP revenue recognition requirements, all 2018 DecisionDx-Melanoma Medicare revenue were only recognized in the fourth quarter of 2018 when the LCD became final and effective.

The amount of such revenues derived from DecisionDx-Melanoma test delivered in the second quarter of 2018, but not recognized until the fourth quarter of 2018 was approximately $2.2 million. Other significant items affecting revenue for the second quarter of 2019 are favorable revenue adjustments related to test reports delivered in prior periods.

The second quarter of 2019 includes $3.3 million of these positive revenue adjustments compared to negative adjustments of $0.8 million for the second quarter of 2018.

The increase in positive revenue adjustments primarily relates to cash collections in the current period on test reports delivered in previous periods for which no revenue was recognized initially. No revenue was recognized initially due to not meeting all the requirements for revenue recognition under GAAP.

We believe based on recent reimbursement activity, that additional positive adjustments in future periods at some level are possible over the near term. Our gross margin during the quarter was 81% compared to 67% during the second quarter of 2018. This improvement was primarily driven by the revenue increases I discussed earlier.

Our operating expenses during this quarter ended June 30, 2019 were $8.1 million compared to $5.3 million during the same quarter in 2018, an increase of 53%.

This increase was primarily the result of our expanded sales and marketing organization, as well as increases in administrative expenses associated with growth in public company preparedness and higher R&D expense.

As a percentage of revenue, our SG&A expense was 63.5% for the 2019 second quarter compared to 104.5% in the same period of 2018, an improvement of 41 percentage points. Interest expense for the second quarter 2019 was $1.7 million, compared to $0.5 million in 2018.

Most of the increase in interest expense was associated with the issuance of convertible promissory notes in the first quarter of 2019. These notes were converted into common stock in July 2019 in connection with our IPO.

Our net loss for the 2019 quarter was $1.3 million or $1.05 loss per diluted share, an improvement compared to the net loss of $3.2 million or $2.15 loss per diluted share for the second quarter during 2018.

Moving next to our cash flow performance, Castle generated positive operating cash flows of $0.5 million during the quarter ended June 30, 2019, compared to negative operating cash flows of $4.7 million for the same period in 2018, which represents an improvement of $5.2 million. We believe Castle is positioned to execute its growth strategy.

Our cash balance at June 30, 2019 was $17.5 million. This does not include the proceeds from the issuance of a $10 million convertible note on July 12th, 2019, and the net proceeds of approximately $66 million from our IPO on July 29th. I'll now turn the call back to Derek..

Thank you, Frank. In summary, we are pleased with our strong second quarter performance, including growth in proprietary test reports, associated with the first four quarter of our commercial expansion and revenue increases associated with achieving Medicare coverage for DecisionDx-Melanoma.

We are also encouraged by the success of our recently completed initial public offering, which we believe positions as well to execute on our expansion plans and support our ongoing research and development activities..

[Operator Instructions] Our first question comes from Catherine Schulte with Baird. Your line is now open..

Hey, guys, congrats on the quarter and thanks for the question. I guess first looking at the new order in physician, you had a big acceleration in that number this quarter. It sounds like you largely attribute that to your sales force expansion from earlier in the year.

How is that new cohort of reps doing relative to your expectations? And then how do you expect the pace of new doc additions to trend going forward?.

Thank you, Catherine. [As we get towards the] [ph] strong quarter, the sales force expansion, just as a reminder, we hired the expanded team effective early February of this year.

Our internal model is based upon our past experience and some benchmarking suggested that we thought it would take six to nine months to have them fully [seasoned] [ph] and become fully effective. So to be quite frank, we were nicely caught off guard with the rate of growth in new order and physician capture rate in second quarter.

We obviously are in the middle of a third quarter right now, looking forward to seeing how the information flow comes out after that.

But as of right now, certainly our expansion shows that I think there was a promotion responsiveness in this marketplace that we are missing by being constrained with having 14 outside sales territories expanding to 20, at least some of that opportunity will have to go ahead and see towards the end of this year what the next step in expansion will look like..

All right, great. And then you have far more penetration with ordering docs then overall volume market share. I believe they're about 30% penetrated amongst docs, but only about 10% from a volume perspective.

For your sales force today, you know how much of that focus is on reaching more ordering docs versus increasing call frequency to drive up order rates with existing docs?.

Excellent question. So those numbers are approximately correct in terms of 30% penetration of what we believe are the targetable clinician community who is seeing and diagnosing cutaneous melanoma and roughly 10% is what we think our current penetration is in terms of the incidence of patients that are proper to be tested.

We try to balance our sales force roughly 50:50, 50% hunting and educating clinicians who have not ordered in the past and 50% moving clinicians to seeing greater utility of our tests in their patient population. We think that's the right mix over time.

Some of these publications that we've been generating in 2019, the most recent of which was the July 2019 SKIN Publication, provide additional data for clinicians who had maybe pigeonholed us in a smaller part of their patient population and a larger part to really see the opportunity to get good utility of our tests by expanding the population within our current practice base..

All right. And then last one for me, maybe one for Frank.

How should we think about volume growth and OpEx for the balance of the year?.

So we see volume growth continuing in line with where it's been. The OpEx will be modestly higher; as a note, the expenses that were directly related to the IPO -- deferred until the IPO. And so they'll be reflected in the Q3 quarterly results.

And there will be some modest impact, while there'll be some increase in OpEx as a result of our growth and being public. So I would say volume growth consistent with where you've seen and then OpEx will be a bit higher for the second half of the year..

Great. Thank you..

Thank you. And our next question comes from Puneet Souda from SVB Leerink. Your line is now open..

Hey Derek and Frank, thanks for the question. So first, congrats on the -- first of all, congrats on the first quarter as a public company.

If I could ask on the draft LCD, it's obviously a positive, but hoping if you can elaborate on how it broadens your overall targeted Medicare population and sort of what's the immediate benefit you're expecting here? Can this -- and how soon can you bring this into a sales conversation in the -- among the commercial sales force? And how soon can they start talking to the physicians about this? And then I have a few more questions..

Yes, excellent questions there Puneet. I'll try and answer them in order here and come back and challenge me, if I'm going to have missed something accidentally.

So in terms of the use of our test by clinicians who have adopted it in their practice today, as you may recall, if I turn the clock back a little bit here, we originally developed our initial set of data around the cutaneous melanoma test, focusing on the ability of a test to independently predict the patient's risk of recurrence from metastasis, independent that is of the clinical pathologic features a physician has in front of him or her, such as Breslow thickness, ulceration, sentinel lymph node status, the kind of classical cancer staging parameters.

Most physicians begin using our tests in that manner of using our assay on top of what they had in front of them to really help decide what is the right follow-up for this patient after I sort of fully stage the patient initially.

So should I be seeing this patient myself, perhaps as a dermatologist or referring this patient out to an oncologist because the risk of metastasis is high enough to justify an oncologist seeing this patient, do we consider initiating active imaging surveillance such as CT of the abdomen, MRI of the brain, et-cetera or not.

And so, since the launch of our test and certainly since the first publication early-2015, most of our data was really focused on helping clinicians see the value of our test on top of what they have in front of them to really help inform these follow-up surveillance and referral decisions.

More recently, beginning a couple of years ago, we began developing data for the other use of our test, which is to enable a physician and a patient to take not only the clinical and pathological factors in front of them regarding the decision to undergo or to pursue a [similar] [ph] biopsy surgical procedure, but to also decide that if you incorporate this genomic information from our test, could you potentially safely rule out or avoid [some of the] [ph] procedure in some patients.

And so I mentioned that for two reasons. One of them is that, there are these two distinct uses of our tests, both of which occur very, very close after diagnosis, but are a little different.

And secondly is that, most of the physicians who have ordered the Castle Bioscience’s DecisionDx-Melanoma test, began ordering it with the decision about follow on surveillance referral adjustments and only recently have adopted the use of the test for guiding or informing [sentinel] [ph] biopsy procedure decisions, mainly because that primary publication was first published in February of this year, February 2019.

And that was also the focus of the original Medicare LCD, which is really taking people who had a melanoma that was 2 millimeters or thinner, and eligible for some of the biopsy procedure and enabling the physician and the patient to make an informed decision about, do I have a high enough likelihood of being node positive, that I should go ahead and proceed for that procedure, or should I consider aborting it with the risk and benefit weighing of complication rate, false negative values, et cetera.

This expansion here essentially folds in that initial use that physicians have been using since 2015 into the second use of our tests, which is the decision to rule in or rule out [based on some of] [ph] the biopsy procedure.

So in terms of the impact on physicians first, I would say that our field force and our educational efforts have been focused on getting the most use out of our test, which is both the decision to push forward or to consider ruling out [based on some of] [ph] the biopsy procedure.

And secondly would be to go ahead and just follow-up regimens or recommendations.

We do see some of the data like this most recent publication in July of 2019, which identified a strong bifurcation point at a 0.3 millimeter of thickness and greater to enable physicians to make a evidence based decision about how low is too low? Or how thin is too thin in terms of using the test for that second use or from a follow-up perspective? And that data clearly came to a conclusion that showed that if you have a patient who has a tumor, that is 0.3 millimeters or thicker, the use of our test will generate a clinically meaningful differentiation between low risk and high risk.

And therefore, we would recommend that being appropriate use population. We do believe that that data, which is in the hands of our sales group, as well as our medical education group, will be important in helping clinicians enjoy the benefits of our tests in a broader population going forward..

Okay. That's very helpful. Thanks for all the details.

So, looking at the commercial payors strategy with the LCD and the Medicare reagents place already, I mean, is it safe to assume that your commercial payors strategy is also going to incorporate the 0.3 millimeter and higher going forward? And maybe at a higher level, could you just elaborate on what the commercial payors strategy is going to be looking like going forward for the next couple of months?.

Yes is the answer.

Our feedback so far is that the evidence analysis that was done by Palmetto's medical records on the use of our tests for both of these indicated uses is getting good and appropriate reception for medical records of commercial insurance carriers, do we expect that as we see policies moving forward in the next couple of years, that will be the foundation to making that change to a positive commercial policy decision.

Now, the speed at which that happens is something that we're obviously have poor control over. We expect to see some continued positive coverage decisions in the next kind of cycle of reviews more in mid-2020 or in 2021..

Okay. Got it. And then last one, if I could ask around the squamous cell.

When is the earliest data that we can see here and I wasn't sure if you gave some comments around that and then when should we expect earliest data around that? And if and then if there was any change in the timing wise on the launch of the test and potential reimbursement? Thanks..

You want to cover that? Okay, I'll cover that Frank. One is I think it's too early to go ahead and change are our initial thoughts that were relayed in the prospectus. I believe that both the squamous cell carcinoma test and the second test, which is for suspicious pigmented lesions remain on track.

And that if they're developed or validated successfully, we should be able to be in a position to have those commercially available by the end of 2020. I would say give us another few months here to see us the validation studies progressing before May, we have an update that's actually based on some more factual perspective later this year..

Okay. Great. All right. Thank you. Thanks. Congrats on the quarter..

Thank you.

Operator?.

And pardon me, Shenji [ph], if your line is muted, please unmute..

Thanks for taking the questions.

So just a few clarification questions for me, as far as -- first of all, congratulations on the draft LCD expansion, and as far as that's concerned, could you guys comment on whether there could be some retrospective payment once, if and when, if and or when that becomes finalized?.

That's a great question, Shenji. My -- I don't have any direct contact or interaction with Palmetto or anybody on that question for this expansion. So this is all expectations.

My understanding is that what the 21st Century Cures Act that went into effect late last year, that the operating principle, I guess you would call it, or approach that was taken between molecular diagnostic companies and Palmetto a couple of years ago is no longer an opportunity to go back and that kind of secure payments from sort of retrospective cases.

But that being said, we certainly aren't at that point in a dialogue with Palmetto at this point in time, and we're waiting for the draft policy decision to hopefully be issued as a final effective next year before we have that discussion..

Okay. Great.

And then Frank, sorry if I missed it, but were there any other kind of one time or non-recurring revenue items this quarter such as contract research revenue that you guys recognized last quarter for example?.

Not, not in this quarter..

Okay, great. And then just lastly, just another question on the pipeline for the differential diagnosis test.

Where -- have you guys talked about any kind of early data on that test? And if any comment you can make on in terms of any early kind of data has been presented for that particular test?.

You haven't missed anything. We have not presented any early data on that second pipeline product..

Okay. Fantastic. Great. Thank you so much..

Thank you..

Thank you. And our final question comes from Mark Massaro with Canaccord Genuity. Your line is now open..

Hey, guys. Thanks for the questions and I too will congratulate you on a great quarter. Yeah, I guess, Frank, a question for you. Certainly the revenue came in well above us and consensus. The press release called out $3.3 million of payments that came in from prior periods.

And I think you made a comment that, you may recognize some additional catch up payments in future quarters.

Can you just kind of give us a sense for how we should be thinking about that, just as we contemplate our model going forward? Maybe, what are some of the factors that trigger some of these catch up payments that might be different than your initial expectations..

Sure, Mark. Thanks. Recall, we're early in the reimbursement pathway for the commercial side on our melanoma test. And so, under GAAP, we estimate what we expect to collect from each test report. And as you saw in Q1 and again in Q2, we were able to collect more than we had initially estimated and therefore accrued.

I think, we'll continue to have some impact of that going forward as we mature the reimbursement landscape around the product that will become less and less of an issue. And of course eventually, we would hope to be under contract with all payers. And then you can effectively -- your estimate is right on what you see.

So, we had a little bit more this quarter than we did in Q1, but I think, we'll continue to see some going forward and over time, that trend will trend lower..

Okay. And then maybe on the gross margin line, I know a lot of this depends on certainly how you do with catch up payments and growing the business.

But is this reasonable to think that you can continue to generate gross margins of either in the high 70s or continue to generate gross margins in the low 80s?.

We will continue to have those margin levels Mark, until we launch -- our expected launch of our pipeline products. When we launch those, of course, those products will all be back at sort of step one on the reimbursement path and so we'll accrue very, very small amounts of revenue for those new products in the early days.

So, in the early days of the launch of those products, you'll see test volume being run and costs incurred for those tests, but modest revenue being recognized.

So, until we launch those, the gross margin should be very stable and then they'll come down a little bit, and how much they come down, just frankly depends on how quickly we get uptake in the new products, if and when we launch them, and then what the reimbursement path looks like from there..

Okay. Great.

And then, as we think about planning just sort of for long term, can you comment about how you guys plan on potentially initiating guidance, whether or not we might expect that on a full year basis and when we might see something like that?.

Nothing, Mark, this is Derek here. It's too late, not appropriate I guess to do any kind of guidance modeling for 2019. So that certainly is not the case.

We're currently formulating our expectations and plans internally for 2020 and we'll get back to you towards the end of this year, early next year in terms -- if we're going to guide 2020 and if so, kind of when..

Okay. Perfect. And then another question on the financials side, I was sort of expecting your R&D spend to come in over, call it $2 million a quarter and it actually was slightly down sequentially.

Should we expect R&D to sort of ramp back up or ramp up to the $2 million a quarter level? Or is that more like a 2020 event?.

No, we should see, as Frank mentioned earlier, I think with maybe Catherine's discussion, we would expect to see our OpEx line go up, including R&D in the last half of this year compared to the first half. I think, the anomaly of the second quarter was basically was more linked to patient accrual and ongoing study.

We have a number of studies that are initiating this fall and a number of centers that came on board in the second quarter, which would expect to go ahead and accrue patients in the third and fourth quarters. So I would not view that as kind of a trend line to take down..

Okay. I think that's it for me. Thanks, guys..

Thank you, Mark..

Thank you, Mark..

This concludes today's question-and-answer session. I would now like to turn the call back over to Derek Maetzold for any closing remarks..

Thank you. Thanks for participating in our second quarter 2019 financial results call. As you notice in our press release and the SEC filings, we closed out with a very strong performance in this quarter and I'm encouraged certainly by the success of our recently completed IPO and the strong level of interest and support from our investors.

We believe that the proceeds from our initial public offering to mild existing working capital, position us to execute upon our expansion plans and fund our research and development activities. Again, we thank you for your support. Have a good evening..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a wonderful day..