Good afternoon and welcome to Castle Biosciences Third Quarter 2022 Conference Call. [Operator Instructions] I would like to turn the call over to Camilla Zuckero, Vice President, Investor Relations and Corporate Affairs. Please go ahead..

Thank you, operator. Good afternoon everyone. Welcome to Castle Biosciences third quarter 2022 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, 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 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 range of anticipated total revenue in 2025 and expected operating cash flow positivity by 2025 and our expectations and assumptions related to the impact of the COVID pandemic, macro conditions, inflation and of Hurricane Ian.

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 also 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 quarterly report on Form 10-Q for the quarter ended September 30th, 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.

And 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, cash flow 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..

Thank you, Camilla, and good afternoon, everyone. Today, we are pleased to share that Castle Biosciences delivered another strong quarter, growing revenue by 58% and total test report volume by 57% over the third quarter of 2021.

Based upon our year-to-date results and the momentum in our business, we have increased our full year 2022 guidance to between $132 million and $137 million, representing anticipated growth of at least 40% from 2021 total revenue.

Before I discuss the quarter in greater detail, I’d like to reiterate a few key points from our Investor Day that we held in September. In terms of our corporate strategy, we will follow our three guideposts to achieve what we believe is exceptional execution.

The guidepost, exceptional employees, continuous evolution and improvement, and customer and solution-centric are grounded in Castle’s mission, vision, and values and are foundational to how we operate our business.

As it relates to this first guidepost, exceptional employees, it’s important that I express my gratitude to those who make Castle what it is and to acknowledge that we wouldn’t be where we are if we weren’t for those of you who call Castle home. So, to all Castle employees, thank you for your dedication, your efforts, and your productivity.

As it relates to the remainder of this call, I will review highlights in the quarter. I will then turn the call over to Frank who will provide financial highlights for the period and we will finish up by responding to any questions that you may have. Let me now begin with our core dermatology business.

For our skin cancer test combined, we delivered 9,824 test reports, a 34% increase over the third quarter of 2021 and a 4% increase over the second quarter of 2022. Overall, our skin cancer test combined, we estimate that our third quarter 2022 test report volume represents market penetration of approximately 4%.

And for the 9 months ended September 30, 2022, we saw approximately 1,801 new ordering clinicians and approximately 6,763 total ordering clinicians for dermatologic tests combined. For DecisionDx-Melanoma, we delivered 7,354 test reports, an increase of 34% over the third quarter of 2021.

We believe the most significant drivers of our strong growth are the clinical impact our test can contribute to the management of melanoma, coupled with our prior commercial expansion investments intended to educate our customer base.

As it relates to the clinical impact, expanded real world data from our collaboration with the National Cancer Institute showed improved survival for patients who have a benefit of a DecisionDx-Melanoma test in addition to traditional clinical and pathologic data compared to untested patients who only had actions to traditional clinical and pathologic factors to determine their treatment and follow-up plans.

Specifically, the patients diagnosed with melanoma and tested with DecisionDx-Melanoma had a 27% improvement in melanoma-specific survival compared to untested patients.

And as a reminder, the melanoma-specific survival at 3 years was more than double of what was seen when NCI collaborated with Genomic Health and their Oncotype DX breast cancer test a couple of years earlier.

A key study published in the third quarter in the Journal of the American Academy of Dermatology show the DecisionDx-Melanoma with the integrated algorithms that combine clinical and pathologic factors with the DecisionDx-Melanoma continuous score result provides more personalized and accurate survival prognosis than clinical and pathologic factors alone, which can help guide risk-aligned patient management.

Further, the study showed that using DecisionDx-Melanoma test results in conjunction with current staging guidelines can help refine patient risk, reduce unnecessary procedures and ultimately improve patient care.

As the National Comprehensive Cancer Network or NCCN guidelines recommend risk-aligned decisions for individual patients, the use of DecisionDx-Melanoma test results could aid identifying patients with more or less aggressive cases of melanoma to align treatment decisions more accurately with patient risk and help ensure a more appropriate allocation of healthcare resources.

We believe the continued growth and evidence such as the NCI collaboration and the publication in the Journal of the American Academy of Dermatology I just discussed continues to demonstrate the impact that our tests can have toward improving patient outcomes.

We believe this marching data, coupled with our commercial expansion efforts are key factors that drove the accelerated market penetration this quarter. From a seasonal perspective, the third quarter has historically been flat or down sequentially as well as the fourth quarter.

Despite this typical seasonality of our dermatology business, we established another record in test volume, which you feel is a result of continued strong execution and careful investments in our growth initiatives.

Now, let’s turn to our diagnostic gene expression profile or DGEP offering, which includes both MyPath Melanoma and DiffDx Melanoma test for use in supporting diagnosis of melanoma or benign lesion in patients with a difficult-to-diagnose monocytic lesion. The primary call point for these tests is the dermatopathologists or the general pathologists.

As we discussed during our second quarter call, we reestablished a dedicated sales team to focus on our diagnostic GEP offering.

We have just more than 65 dermatology outside sales territories that are now focusing exclusively on our dermatology call point, supporting both DecisionDx-Melanoma and DecisionDx-SCC and we have a small team focusing on our diagnostic GEP offering.

We believe this adjustment to our sales teams will allow for the focus of our diagnostic GEP test offering in a manner that will support its growth appropriately. We also believe this realignment of our commercial sales team could contribute to improved reach and frequency for all of our cancer tests.

And historically, we have seen that our target market is promotionally responsive. So, we believe this change will contribute to continued momentum as we move into 2023. Historically, it takes about two quarters for dermatology sales reps to reach a level of optimal productivity.

We expect to evaluate the impact of our diagnostic GEP commercial team investment in our second quarter 2023 review. As it relates to reimbursement, you will recall that one of our motivations to acquire MyPath Melanoma in 2021 was to pull forward reimbursement for our diagnostic GEP business as MyPath Melanoma was covered under an existing LCD.

In the second quarter of 2022, Palmetto posted a draft LCD that would expand coverage to include DiffDx Melanoma as well. With MyPath Melanoma already covered by Medicare, this would ultimately give both tests Medicare coverage.

Benchmarking against historical timing patterns, we believe the DiffDx-LCD should be finalized for the end of the second quarter of 2023. Now, let’s turn to our DecisionDx-SCC test. We continue to see strong test support volume momentum in the third quarter of 2022, with volumes up 75% from the year ago period.

As with our growth in DecisionDx-Melanoma, we believe our strong growth in volume for DecisionDx-SCC test is due in large part to the combination of the high clinical need in the SCC coupled with the value our test provides.

Further, we are pleased to see the growth of the DecisionDx-SCC volume has come in conjunction with our strong growth in DecisionDx-Melanoma volume, not at the expense of it.

As it relates to reimbursement, we discussed on our second-quarter earnings call, Novitas, the Medicare contractor that manages claims related to our Pittsburgh, Pennsylvania laboratory completed the medical review of our DecisionDx-SCC test in the first quarter of this year and they subsequently priced our test at a rate of $3,873 per test, the usual and customary rate for risk stratification or prognostic gene expression profile tests such as those used in patients diagnosed with breast, prostate and other cancers, also recall that Novitas posted a broad track LCD entitled dl-39-365, genetic testing for oncology back in May.

Novitas did extend the commentary by an additional 45 days and this common period ended on September 6, 2022. We did not have additional updates at this time. In late September, CMS released the draft 2023 Clinical Laboratory Fee Schedule, or CLFS, pricing update for test with new codes.

Both our DecisionDx-SCC and DiffDx-Melanoma test were signed new PLA codes earlier this year and were included in the Draft 2023 CLFS. DiffDx Melanoma was [indiscernible] to MyPath Melanoma, which is what we recommended and what we believe is appropriate for a diagnostic support test like DiffDx Melanoma.

However, CMS proposed cross-walking or prognostic risk stratification, DecisionDx-SCC test to MyPath Melanoma as well. This was against the majority and the minority recommendation from the clinical diagnostic laboratory test advisory panel, also known as the CDLT advisory panel as well as against our recommendation.

The majority recommendation of the CDLT advisory panel was for DecisionDx-SCC to be crosswalk to DecisionDx-Melanoma. We have met with CMS and submitted comments to point out that the function of resources for risk stratification tests are significantly different from those required for diagnostic support tests.

We expect CMS to communicate a final determination on our 2023 rate late in the fourth quarter of 2022. Now let’s turn to our gastroenterology franchise. We delivered 690 TissueCypher test reports in the third quarter, nearly doubling the number of test reports delivered in the second quarter.

We believe the momentum that we are seeing will continue based upon several key factors. First, CMS granted advanced diagnostic laboratory test status or ADLT status for the test earlier in the year, which exempt TissueCypher from what is called the 14-day rule, simplifying the billing process for Medicare patients.

Second, the American Gastroenterological Association, or AGA, publishes clinical practice update on new technology innovation for surveillance and screening and Barrett’s Esophagus.

And the best practice advice statement stated of a TissueCypher test may be beneficial for risk stratification of patients with non-dysplastic Barrett’s Esophagus, which we believe represents on the low end, approximately 348,000 endoscopies per year or approximately 90% of the intended use market for Barrett’s Esophagus.

This clinical practice update provides guidance to clinicians on advances in innovation regarding the screening of surveillance of Barrett’s Esophagus, so it represents an important development in helping us drive greater product awareness and penetration.

Third, given the momentum we saw in the first half of the year, we added additional outside sales territories late in the third quarter of 2022.

We also updated our sales to and marketing materials for the third quarter, so that we are finishing the year and going into 2023 with refined messaging and more impactful materials that we believe will better inform and educate gas neurologists and drive greater levels of product adoption.

We will be training these personnel and bringing it up to speed, which we believe will put us in a strong position of growth going into 2023. On the reimbursement front, recall that Medicare granted ADLT status to TissueCypher late in the first quarter as part of the ADLT $350.

Beginning January 1, 2023 and going through December 31, 2024, so a 2-year time period, the reimbursement for TissueCypher will be determined based upon the median private payer allowable rate that was received between April 1, 2022 and August 31, 2022.

Data from this time period has been submitted to Medicare and we expect the rate for 2023 to 2024 to be published in December 2022 or early January 2023. To summarize, we are pleased with the results to-date of our gastroenterology business.

Keep in mind that our acquisition of this business as well as our mental health business was intended to build a stronger, profitable revenue growth trajectory for us with particular revenue contribution beginning in 2024, 2025 and beyond.

Our primary filters for our decision focused on estimated total addressable markets that were larger than any individual in-market dermatology test, which we anticipate it could drive material revenue for the long-term, products that were on the market, but not necessarily generating material revenue that were first-in-class or best-in-class with proprietary algorithms and that had already succeeded in achieving some percentage of positive reimbursement coverage.

We believe TissueCypher met these criteria. Finally, we are entering in the next phase of integration for TissueCypher, enhancement and optimization of processes and workflows, which we expect to complete by the end of the second quarter of 2023 or around 15 to 18 months post-acquisition. Now, let’s turn our attention to our mental health franchise.

We delivered 1,208 IDgenetix test reports in the third quarter of 2022, up 46% from the 827 test reports in the limited period during the second quarter of 2022 from April 26 forward when the acquisition was final. We believe the integration is progressing nicely and we are pleased with the progress we have seen so far.

However, as with our gastroenterology acquisition, we have a 15 to 18-month phase integration plan and are still early in the process.

We believe IDgenetix also met our acquisition filters of an estimated total addressable market that was larger than any individual in-market dermatology test, which we anticipated again could drive material revenue for the longer term that was on market, but not necessarily generating material revenue that was first-in-class or best-in-class with proprietary algorithms and had already succeeded in achieving some percentage of positive reimbursement coverage.

Our integration efforts will be critical to fully leverage the patient value of our mental health franchise. We believe the pharmacogenomics and mental health opportunity won’t just be a matter of a single large market, but could be an opportunity to enter a series of very large markets.

One of our integration objectives is to focus on those market segments where we expect the value of IDgenetix will be easily seen by clinicians and their patients. For example, the older patient population represents not just a large market but want a very high unmet clinical need.

These patients often have complex pinnacle histories and conditions and can be on multiple medications for their conditions. Our IDgenetix test provides a drug-gene interactions, drug-drug interactions and lifestyle factors into a single test report.

We believe that this proactive and early decision by the developers of IDgenetix is why the results in a randomized controlled trial in 2018 show that patients with severe and moderate to severe depression who are treated with IDgenetix guided therapy selection versus trial and error experienced tighter response and remission rates.

In fact, as I mentioned earlier, we came to believe during diligence that IDgenetix was a best-in-class pharmacogenomic test because of this prospective inclusion of drug-gene, drug-drug and lifestyle factors that are built into the bioinformatics or algorithm analysis.

In fact, a systematic review and meta-analysis was just published online in clinical and pharmacology and therapeutics, evaluating the pharmacogenomics test that had published clinical trials in patients with major depressive disorder.

Their analysis confirm what we came to believe during our diligence that the one pharmacogenomic test that displayed the most significant impact in a randomized controlled trial was the IDgenetix test with a risk ratio of 2.46% compared to the overall risk ratio seen in randomized controlled trials of 1.46.

We believe that the overall mental health market represents a $5 billion estimated U.S. TAM opportunity and in our view is slightly penetrated. We believe that our plan will enable us to gain share and make substantial inroads in the coming years.

I will now turn the call over to Frank who will provide details relating to our financial results and guidance..

Thank you, Derek and good afternoon everyone. Before I begin with our third quarter results, I would like to state that we may see impacts to our fourth quarter results due to Hurricane Ian. Historically, a significant number of orders for our skin cancer tests of clinicians based in Florida.

But at this time, we are still assessing the potential impact that Hurricane Ian could have on our test volumes and financial results for the fourth quarter of 2022, which will depend on future developments that cannot be predicted at this time.

As such, we are unable to predict the extent to which our future test report volumes and our results of operations, financial condition and cash flows will ultimately be impacted by Hurricane Ian.

Now, turning to the third quarter of 2022, we developed another strong quarter of top line growth and we have raised our outlook for anticipated total 2022 revenue to $132 million to $137 million from $130 million to $135 million.

In the third quarter 2022, revenue was $37 million, an increase of 58% over the third quarter of 2021 tracking closely to our overall test report volume growth. Once again, higher revenues were largely driven by our dermatologic test, primarily DecisionDx-Melanoma and DecisionDx-SCC.

The higher revenues also reflect Medicare reimbursements for DecisionDx-SCC as Derek discussed earlier, partially offset by the effect of higher negative revenue adjustments related to test delivered in previous periods, which were negative $0.3 million for the 3 months ended September 30, 2022 compared to negative $0.1 million for the 3 months ended September 30, 2021.

Excluding the effects of revenue adjustments related to tests delivered in prior periods, adjusted revenue was $37.3 million, an increase of 58% over the third quarter of 2021. Our gross margin for the third quarter was 69.8% compared to 77.9% in the third quarter of 2021.

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 76.2% for the quarter compared to 80.9% in the same period in 2021.

As we previously discussed, our GAAP gross margin will continue to be negatively impacted by the amortization of intangible assets associated with recent acquisitions. Our total operating expenses, including cost of sales for the quarter ended September 30, 2022 were $58.5 million compared to $35.3 million for the third quarter of 2021.

Our sales and marketing expenses increased by $9.1 million for the 3 months ended September 30, 2022 compared to the 3 months ended September 30, 2021, attributable to higher personnel costs, including salaries, bonuses and stock-based compensation.

Personnel costs have increased through the expansion of our dermatology facing commercial team headcount in 2021 and through our acquisition of Cernostics in December 2021 and AltheaDx in April 2022 as well as the increases in personnel costs for existing employees.

The remainder of the increase in sales and marketing expense was primarily associated with travel, training events, meetings, and other general increases. General and administrative expenses increased by $4.9 million in the third quarter of 2022 compared to the third quarter of 2021.

The increase is primarily attributable to higher personnel costs, including salaries, bonuses, and stock-based compensation. The higher personnel costs reflect expanded headcount in our administrative support functions including related to the acquisitions of Cernostics and AltheaDx.

R&D expense increased by $3.4 million in the third quarter compared to the third quarter of 2021 attributable to higher personnel cost primarily due to expansions in headcount in support of our growth, higher pay rates and higher stock-based compensation expense and also due to higher cost for clinical studies.

Cost of sales exclusive of amortization of acquired intangible assets for the 3 months ended September 30, 2022 increased by $4.4 million compared to the 3 months ended September 30, 2021 primarily due to higher personnel costs attributable to additional headcount and our laboratory testing operations, including increased headcount attributable to the addition of Cernostics and AltheaDx as well as higher pay rates.

We also saw increases in the cost of supplies and services, reflecting higher activity levels and increases in prices. Inflation has been a stubborn force and is impacting us most in terms of personnel costs. Given we believe the macro conditions are going to remain challenging, we expect future impacts due to inflation.

Total stock-based compensation expense, which is allocated among cost of sales, R&D and SG&A totaled $9.2 million for the third quarter compared to $5.2 million for the third quarter of 2021. We expect material increases in stock-based compensation expense in future periods, reflecting mainly higher rewards outstanding due to growth in our headcount.

As of September 30, 2022, we had 517 employees compared to 311 as of September 30, 2021. As of September 30, 2022, the total unrecognized stock-based compensation costs related to outstanding awards is $94.4 million, which is expected to be recognized on a straight line basis over weighted average period of 2.8 years.

We expect to continue granting stock-based compensation awards which we expect to further contribute to increases in stock-based compensation expense in future periods.

Operating expenses this quarter also included change in fair value of contingent consideration of $0.2 million of net gain that is primarily related to the remeasurement of the liability for earn-out payments in connection with our acquisition of AltheaDx and reflects changes in management’s projections regarding attainment of certain commercial milestones.

There was no such activity during the three months ended September 30, 2021. The contingent consideration expense can vary from quarter-to-quarter depending on any changes in assumptions and valuation results.

Further, we had amortization of acquired intangible assets for the 3 months ended September 30, 2022, up $2.3 million, which is related to the developed technology we acquired from the Myriad MyPath Lab, Cernostics and AltheaDx in mid to late 2021 and April 2022 respectively.

Our net loss for the third quarter of 2022 was $20.2 million compared to a net loss of $11.8 million for the third quarter of 2021. Basic and diluted loss per share for the third quarter was $0.77 compared to basic and diluted loss per share of $0.47 in the third quarter of 2021.

Adjusted EBITDA for the third quarter was negative $8.3 million compared to negative $5.5 million for the comparable period in 2021.

Net cash used in operating activities was $35.7 million for the nine months ended September 30, 2022 and was primarily attributable to the net loss of $46.5 million, with change in fair value of contingent consideration of $18 million, increases in the AR of $5.7 million partially offset by non-cash stock compensation expense of $26.4 million, depreciation and amortization of $7.7 million and the increase in accrued compensation of $3.7 million.

Finally, we had cash and cash equivalents at September 30, 2022 of $134 million. Additionally, the company held $132 million in short-term investments, which we purchased in order to take advantage of higher interest rates and help offset inflationary impacts.

These investments are classified as available-for-sale therefore have carried a fair value are not considered part of our cash holdings and are reported separately as marketable investment securities.

Also, unrealized gains and losses for these securities will be reported on the balance sheet under accumulated other comprehensive income or loss and not as part of net income. As we outlined in September at our Investor Day, we anticipate achieving total revenue in the range of $255 million to $330 million for the year ending December 31, 2025.

Combining our expectations for strong top line growth in gross margins, along with a continued disciplined approach to capital allocation, we expect our net operating cash flow to be positive by 2025. I will now turn the call back over to Derek..

Thank you, Frank. In summary, we delivered another strong quarter with an increase in revenue of 58% over last year, with total test report volumes trending closely at 57% growth, are executing well on our growth plans, and expect to finish the year in a position of strength with accelerated momentum going into 2023.

I would like to conclude today by thanking our Castle team and all of you for your continued interest in Castle. Now, we will be happy to take your questions.

Operator?.

Thank you. [Operator Instructions] And our first question today goes to Catherine Schulte of Baird. Catherine, please go ahead. Your line is open..

Hey, guys. Thanks for the questions. I guess first on Hurricane, Ian, so you are still assessing the impact there.

Can you just give us a sense of what the impact was in October and how that’s recovered so far? And what’s assumed in guidance?.

Hey, Catherine. Yes. We – if you recall back to some of the analysis we did way back at the beginning of the bid, there is a reasonable lag between when a patient is biopsied and when a DecisionDx-Melanoma order is placed. And it’s in the 2 to 3-week range. And so we really would not have started to see that until recently.

So, so far things appear not to be too disruptive, but we just wanted to highlight that because of that lag, we don’t yet have our arms around what the full impact could be and that’s why we were just noting that for everybody to keep in mind here..

Got it.

But is there something in guidance assumes that there will be some sort of impact there?.

Our view on what that impact is, is included in what we have what we raised to..

Okay, got it.

And then maybe for SEC, you talked about [Technical Difficulty] the final determinations to come out, any update on potential pathway for ADLT status and an application for that test?.

You broke up at the beginning of that, you were – can you repeat the first part of the question again, Catherine?.

Yes.

As you said for SEC, I heard your comments on Medicare I am waiting for the final determination around the payment for the new code, but is there any update on potential ADLT status or submitting an application for that test?.

Yes. So we certainly believe in our assessment that the SEC test should qualify for ADLT status. And we are evaluating our approach there. We will update you shortly as we sort of move forward..

Got it. Thank you..

Thank you. And the next question goes to Kyle Mikson of Canaccord. Kyle, please go ahead. Your line is open..

Hello. This is Alex [indiscernible] on the line for Kyle Mikson. Great quarter. I just wanted to cover really briefly. So you discussed that in 3Q, you had the new dedicated sales team for MyPath Melanoma and DiffDx Melanoma.

Can you go into that more and just characterize for the length of this team has been? It sounds like it’s been a quarter since this has been underway. And then then I have one more after that. Thank you..

Yes. So, good question here. I should clarify that. We began interviewing and I think the hiring date for the group was probably, what, Frank, mid-September, I think. So we are still completing training now. So I would say they were new employees doing at-home training during September. So, there would have been no impact from the third quarter per se.

That being said, we also had sort of refocused our dermatology facing group more closely aligned with the cutaneous melanoma test and the STC test.

So, if we – if the – if history is a predictor of the future for kind of sales effectiveness, I would expect – obviously we would expect to see some modest improvement here in the fourth quarter in terms of as they come out of training and get in the field more often.

But we would be really looking towards first quarter performance to kind of do or do a recheck and are resized correctly do we want to make some adjustments here in the second quarter of 2023?.

Got it. Thank you. Good color. I appreciate it. One more question if that’s alright. So, I was wondering if you could provide, I guess, some more qualitative color on early adoption of TissueCypher? Thanks..

Yes. Okay. So, let’s take a step back. So, one is that they had no commercial-facing effort until we acquired the company in December ‘21. So the Chief Executive Officer was the only sort of sales person. I think he fits in every other Friday in the afternoon type thing, because we had CEO to do to run the company.

So I would kind of call we are starting from a very low base of awareness and certainly a very, very low user base in – when we acquired the company in December ‘21. We ended up staffing up an initial sales force of, I think, 14 outside sales territories effective January 2 of this year.

They spend most the first quarter in training are part of it in training partner field. We made the subsequent second staffing up also in kind of a mid-September time period and that additional group of 9 people I think bring us at 24 – 20 to 24 territories total is moving through training as we speak.

So that’s sort of is the commercial background in terms of sales rep investments.

So qualitative adoption, if you look at the sort of market assessment of the – of how Barrett’s esophagus breaks out from a dysplasia grading perspective, we believe about 90%, so 9 in 10 patients probably is diagnosed with a Barrett’s esophagus lesion, but the pathologist can’t see any dysplasia.

So, we would call that non-dysplastic Barrett’s esophagus. And of the remaining 10% is kind of split roughly between patients who have low grade dysplasia in patients with what we would call indefinite dysplasia. So it’s kind of in the middle of – it’s kind of a warm dysplasia, I guess, if you want to view as an on pathologist.

So in that background, we believe that the most important element or the use of our test most likely would be adoption in that large 90 percentile group, which we think is at least 348,000 patients diagnosed per year with non-dysplastic Barrett’s disease.

Now, why is that? It turns out that a significant proportion of patients that end up progressing to either high-grade dysplasia or esophageal cancer are hiding out in that non-dysplastic Barrett’s esophagus group.

And so from a patient perspective and certainly a gastroenterologist perspective, the utility of our test is pretty clear to say, hey, I know my pathologists see sort of no dysplasia. I know they have the disease Barrett’s esophagus.

If I use your test, then based upon your, I think 7 clinical validation studies, including the pooled analysis at a Mayo Clinic back in April of this year, I am going to be able to find a significant number of those patients who have a high-risk TissueCypher test score.

And if I look at that from a standpoint of what does that mean for my patient, it turns out that non-dysplastic patients who have a high-risk TissueCypher test results end up having a risk of progression to high-grade dysplasia or esophageal cancer that’s actually slightly higher than low-grade dysplasia.

And at least the standard of care across the community GIs in the U.S. today is that many of those people with low-grade dysplasia on pathology do in fact receive endoscopic eradication therapy, which is most commonly ablation therapy. So, it’s a very actual endpoint.

And what we are seeing today is that the majority or roughly 90% or so of our orders coming in, in fact, match that non-dysplastic BE group. So I hope that – maybe that answers part of the qualitative question.

The other part, I think, is that as we have seen with the launch of our melanoma test, our squamous cell carcinoma test, our DiffDx Melanoma test in November of 2020, even though we believe we have a very exciting and very clinically actionable test, it does take repetition, 3, 4, 5 sales calls to have a gastroenterologist go from being unaware of our test, which is almost all of them, by the way, to being aware, to being interested to try it and to begin to incorporate into their practice.

So, we are quite pleased in seeing the sort of growth in the second quarter and third quarter this year relative to the quarter versus-quarter change because the feedback that we’re getting is right in line with our expectations..

Got it. Thank you very much..

You are welcome..

Thank you. And the next question goes to Puneet Souda of SVB Securities. Puneet, please go ahead. Your line is open..

Yes. Hi, guys. Thanks, Derek. Thanks for taking the question. So maybe just on SEC, just given that that’s an important point for the fourth quarter. If you could walk through maybe potential scenarios. Obviously, there is an ADLT side of things. But then on the other side, you could potentially apply to other math.

And so maybe just walk us through if the coverage was lost, what is the timeline to revenue impact, first of all? Secondly, are you able to pursue it through another jurisdiction? And if ADLT or another jurisdiction was – was the route, when do you think you can sort of address this? Obviously, a couple of questions there, so thanks for covering those..

Yes, absolutely, Puneet. Good to hear you. So as we talked about, I guess, at the second quarter call and a bit less so today, we requested a medical review through Novitas in earlier this year. And we were setting up that test to be processed out of our Pittsburgh, Pennsylvania laboratory, which Novitas overseas, Pennsylvania for Medicare.

And we had very positive interactions and came out of that with a thumbs up in our perspective. We were asked to submit a pricing dossier, which we did in late March. I think it was or mid-March ahead of our first reports being issued, which happened in April.

And as you know, Novitas price is at $300 and change, which is the – which I think what they did was they basically crosswalked us over to Oncotype for breast, Oncotype for prostate cancer. So that all lined up pretty well.

And then as you alluded to, I think in June of this year, Novitas published a broad – essentially a biomarkers in oncology draft LCD, looking to try and offload a medical review from their responsibility, that’s maybe a little harsh to say, but to try and reduce work and be more efficient to one of three databases.

And so if you’re included in those databases, then they assume that you’d be covered. And if you weren’t included, they assume that you would not be covered. That was the lay of the land for background.

And as the audience may know here, usually for draft LCDs, there is a 45-day public comment period, we believe, due to a significant number of people wanting to comment that was actually doubled to 90 days and closed out in early September of this year.

Our consultants believe and I guess we’re aligned to believe with our consultants that there is a high likelihood that, that LCD would not finalize as is and might be modified to include a fourth pathway such as if you aren’t already reviewed and covered by one of these other three databases, we will go ahead and do the medical review that we’re supposed to under our Medicare contract anyways.

That probably is the most likely scenario.

But that being said, you’re saying what happens if they finalize the LCD as is and you aren’t an NCC, and at that point in time, what does that mean? Our benchmarking would suggest that the earliest maybe Novitas might issue a final LCD sometime in the middle to late first quarter, but that’s based upon limited historical data, to be honest.

They would have to issue a finalized LCD by, I think, the date they posted the draft. So that would occur by June of 2023, you’d have a typical 45-day implementation period, a notice period. So maybe if those date ranges are accurate, you might have a gap in coverage maybe between April through maybe July depending on which states accurate.

So that’s that part. In the meantime, as you would expect, we’re working with other groups, including NCCN for reviews, and so that may come along at some point in time in the interim between now and then.

We also, as you may recall, from, I guess, 2020 or 2021 earnings calls, we did submit back in the summer of 2020, a technical dossier or technical assessment and a request to Palmetto for medical review for the SCC test. We know we got cut up in the middle of COVID, as you would expect.

And so things haven’t been running as fast as I used to run at Palmetto pre-COVID, but that potential outcome can be known any time next quarter, first quarter of next year, that would take a – if it goes through a standard for review cycle, that would take – we’d assume if it got post, let’s say, January 2nd, 2023, we wouldn’t plan for coverage model for covers until January 2024, about a 12-month cycle period there.

So I think the gap could be 6 months, 9 months potentially under the current scenarios there. But again, our current belief is that nothing is 100% certain anyways. We think there is a high likelihood that LCD gets modified from Novitas, but again, we’re not the ones on the inside evaluating what comments they received..

Got it. Super helpful. Thanks for all those details. And on – you’re obviously raising the full year guide here and appreciate the prior comments on the 2025 guide, Derek and Frank, how should we think about 2023 growth here, just given the sales rep increases that you’ve had DiffDx is getting reimbursed.

There is potential for some change on the SEC coverage here, but DecisionDx continues to have solid momentum. So maybe just talk to us about how should we think about given where we stand today 2023? Thank you..

Frank, do you want to cover that?.

Yes. I think it’s the setup is great, Puneet. We’ve got really good salespeople out there. We’ve got a lot of data coming. I think that the volume validates the clinical utility of each of our tests here, and we still are well positioned competitively.

So I think the setup is terrific for ‘23, and we’re excited about it and think that the data is demonstrating our careful investments are paying off..

Got it. And then just last one, if I could ask on TissueCypher? Is there any – you’ve submitted the medium tier rates already? Is there any reason why TissueCypher should dramatically differ from the ADLC rate, which was, I believe, slightly lower versus initial rates that was assigned to it, but you shouldn’t say in the same ballpark? Thanks..

Well, let’s see here. So one is that the – once ADLT status was attained as a new ADLT on March 28 of this year, the next 9 months were the price was set at the original list price, which was at $23.15 or $23.50 rate way back when.

So I wouldn’t necessarily call that the first ADLT rate, I would call that the original list price during the collection period. So we’ve obviously collected data during the first 6 months, that would end September,] and we will have our first ADLT rate post toward the end of this year. So I had a hard time seeing that rate going lower.

But again, that’s Medicare calculating the median private payer rate..

Thank you. And the next question goes to Thomas Flaten of Lake Street. Please go ahead. Your line is open..

Hey, Derek, I was wondering if you might be able to provide some color on how you guys are integrating the SEER data into both the reimbursement side of the business as well as in the commercial messaging..

Okay. So from a commercial messaging perspective, we certainly have trained up and outfitted the field team. So the sales group, the medical science liaison group, the other the medical directors in terms of the data as it’s been presented in abstract and poster form. So they are educating clinicians on the value that we’re seeing there.

Now an abstract is not the same level of evidence or review as a publication. But that’s what we are working with right now.

And that message that we’ve talked about before has been well received by clinicians, especially those who might be doubting of what does this really do for me? What it does for is it gives you more accurate information to make a more informed decision and that when you make those decisions, outcomes should improve, and this data seems to show that linkage between tested, untested patients similar to Oncotype for breast cancer.

That I mean Oncotype for breast cancer as a comparator, is really focused on removing unnecessary long-term taxane therapy, I guess, as opposed to somehow improving survival.

So similar kinds of withdrawal of unnecessary procedures or treatments, but the reality of it is that people who are picked up as having more aggressive disease are being funneled to where they should be funneled. That’s how we see the data. So that’s been released to the field probably during the second quarter of this year.

Again, that was not as strong as the publication. So we will have another more important way as we see a publication come out into the public domain.

From a commercial payer perspective, we have, I guess, I would say, tested the water slightly, but the reality of that is until that’s in a peer-reviewed publication that’s going to be put aside is that’s very interesting come back when I can pull up on pubmed or Google Scholar myself.

So I don’t think the impact on that one, is I think the impact is zero today on the commercial payer landscape; and two, that’s a great question to get back in touch with us a quarter or so after the publication gets out of the door..

Got it. And on the derm sales team, I know they have been in the field and the expanded size for a while now.

How would you maybe quantify or qualify them being on the ramp to full productivity?.

Dermatology. I think the dermatology sales team hit full stride probably late first quarter, second quarter, Frank, is that right? Now we did have, I think, a couple of dermatology representatives move over the TissueCypher earlier this year and a couple of move into the dermatopathology group, right just one, I can’t remember.

So there is some backfilling as you’d expect anyways right in typical organization. So I think one, third-quarter volume, second-quarter volume penetration probably reflects everybody being fully effective, knowing you’ve got just some background normal noise..

Thank you. And the next question goes to Mark Massaro of BTIG. Mark, please go ahead. Your line is open..

Hey, guys. Thanks for the questions. And congrats on the strong beat and raise. I know there is been a lot of detail covered on the squamous cell carcinoma tests, but I think a little bit of clarity could be helpful here. So I know that Novitas priced it at 38, 73 earlier this year.

I guess, were you expecting – it sounds like you were not expecting a crosswalk to the MyPath Melanoma test. And instead, you were expecting a crosswalk to DecisionDx-Melanoma. I guess I’m trying to put this in perspective.

Is there any risk that you don’t get paid here in Q4? And I know that there are a lot of moving parts to 2023, but I’m just wondering if you expect to get similar payment for SEC in Q4 as you did in Q3..

So the preliminary determinations – so the short answer is yes. The preliminary determinations turned final whenever they post them, but they are effective January 1st, 2023. So I would not expect any influence up or down in the fourth quarter, that would just – that would be unprecedented.

In terms of our expectations, I think given that Novitas and of course, CMS Central is under no restrictions to follow their approach. But I think if we look across the land, risk stratification tests like our SCC tests have historically been crosswalked over to Oncotype for prostate or Oncotype for breast cancer.

We would have expected that to be the normal approach to be honest, or they could have taken a position that there is another risk stratification test run by the same company. for another skin cancer and crosswalk up to DecisionDx-Melanoma, that would be less likely than more lastly, more likely would be acute breast.

We certainly, as I mentioned, had some interactions with the Central Medicare group at Baltimore last month. And I believe that one, this is a good group of people that we dealt with over the years, and they try to do the right thing for patient care and for companies.

My hope is that they understand the difference now between the level of resources needed to both develop and produce a diagnostic support test like MyPath versus a risk ratification test like our SCC test, will act accordingly. But of course, that’s their call not mine, but no impact in the fourth quarter. I think that shouldn’t be expected..

Okay, perfect.

So sorry, to clarify, do you think it’s now more likely if there is a change that it would go to the Oncotype breast at $38, $73 rather than your MyPath Melanoma? And just also to clarify, do you think there may be an update from CMS later in calendar Q4 ‘22?.

Yes. COVID has thrown off the normal posting period. You may recall that precut if we can think back that far. Typically, I think they usually got out the next year’s updated rate schedule like the Friday after Thanksgiving or 2 Fridays afterwards. That shifted a bit the last couple of years.

But sometime in December is when I would expect to have the final rates, not just for the new – for the test with new codes, but all codes will be posted in the final determination.

Now I think there are a potential for staying the same at 38, 73, I guess, potential to be cross blocked on the MyPath, potentially be crosswalk up to the DecisionDx-Melanoma.

And there is a fourth option, which is that they could go ahead and throw back and have the MAX move forward from a gap-fill process and that would go into effect in 2024 with the current rate staying throughout 2023. That would be a typical process. So there is a fourth potential outcome..

Thank you. And the final question goes to Mason Carrico of Stephens, Inc. Mason, please go ahead. Your line is open..

Hey, guys. Thanks for taking the questions. Most of mine have been answered, so maybe just one quick one here for me.

Thinking about the ramp for DecisionDx-SCC in 2023 in terms of test volumes, how have conversations differed with docs when it comes to the early adoption of that test versus DecisionDx-Melanoma when that test was early in the adoption curve? Have you guys seen a lot of leverage in the work you’ve done already in terms of educating derms on these types of tests or any color on maybe the overlap of who’s ordering?.

Yes. So there is a – so last first, there is a significant overlap between clinicians who are current or had already adopted the DecisionDx-Melanoma test, and those who are now adopting the squamous cell carcinoma test, and I think that’s probably due to two factors.

One of them is that we’ve obviously sat and had conversations about the additional value that one receives in managing melanoma when you have our test results in hand along with the clinical and pathologic factors versus not having our test results in hand.

So they are already thinking through and appreciate and have integrated that concept in the practice reality. So when we walk into that same clinician the next day and talk about we see a gap here in people with high-risk squamous cell carcinoma. Here’s how we see the world.

Do you agree with that, you can generally get head nodding, of course, and then they would follow along and saying, well, so what I really need to think through is am I going to make changes in how I manage these patients with your result.

Once they get there, then I think they become initial customers that might dabble a bit and test our test and begin adopting it. So I think that’s quicker than it was when we introduced the melanoma test a few years ago when there was nobody doing risk stratification in anything in dermatology like this. So certainly, that was helpful.

I think the other element, of course, is – and even though we made the test available before 2015, it was really 2015, we went to 14 sales representatives across the U.S. and then that was – maybe it was the first real launch, but we were at 14 people then we’re in the mid-60s right now.

So that’s a nice significant increase in terms of the visibility in the marketplace.

So I don’t quite know if it’s a more aware clinician and that’s leading to quicker adoption, if it’s having us being around those same clinicians for 3 or 4 or 5 years now and they are easier to have a conversation with and accept the message or if it’s also just promotional size of the company, that’s a driving factor.

But all of those, I think, are part of the mix of saying, certainly, we’re seeing more rapid adoption with the squamous cell carcinoma testing with melanoma, but as all of those features, I think, together..

Got it. That’s makes sense. Thanks, guys..

Thank you. We have no further questions. I’ll now hand back to Derek for closing remarks..

End of Q&A:.

Thank you, Nadia. So this concludes our third quarter 2022 earnings call. I want to thank you again on behalf of the Castle team for joining us today and for your continued interest in Castle Biosciences..

Thank you. This concludes today’s call. Thank you all for joining. You may now disconnect your lines..