Castle Biosciences - Q1 2024

Transcript

Operator (participant)

Good afternoon, and welcome to Castle Biosciences' Q1 2024 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 (VP of Investor Relations and Corporate Affairs)

Thank you, operator. Good afternoon, everyone. Welcome to Castle Biosciences' Q1 2024 financial results conference call. Joining me today is Castle's Founder, President, and Chief Executive Officer, Derek Maetzold, and Chief Financial Officer, Frank Stokes. Information recorded on this call speaks only as of today, May 2nd, 2024. Therefore, if you are listening to the replay or reading the transcript of this call, any time-sensitive information may no longer be accurate. A recording of today's call will be available on the investor relations page of the company's website for approximately three weeks following the conclusion of the call. 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, GAAP, 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 2024 total revenue and our 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 quarterly report on Form 10-Q for the quarter ended March 31, 2024, under the heading Risk Factors and in the company's other documents and reports filed or to be 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 (Founder, President, and CEO)

Thank you, Camilla, and good afternoon, everyone. Building on our strength and momentum from 2023, I'm pleased to share that Castle delivered a strong start to the year, growing Q1 revenue by 74% and total test volume by 40% compared to the Q1 of 2023. With our team's consistent execution and successful track record of building a differentiated portfolio of tests across our therapeutic areas, we remain confident in our business and are raising our full year 2024 revenue guidance to $255 million-$265 million, up from the previously reported guidance of $235 million-$240 million. Now, let me take you through execution strategy highlights in the Q1, and then Frank will provide additional financing highlights before we turn to your questions.

Starting with our core dermatology business, for DecisionDx-Melanoma and DecisionDx-SCC combined, test report volume was 11,961 for the Q1 of 2024, a 20% increase over the same period in 2023. We believe our core dermatology offerings continue to present a long-term growth opportunity for us. Studies have shown that these two tests can positively impact patient outcomes and help reduce healthcare costs. For DecisionDx-Melanoma, we delivered 8,384 test reports in the Q1, an 11% year-over-year increase. As we've discussed, driving test adoption through robust clinical evidence remains a priority for us. This quarter was no exception.

As you know, our DecisionDx-Melanoma test has two clinical uses: ruling out a sentinel lymph node biopsy surgical procedure and predicting risk of recurrence so that patients can have their treatment pathways adjusted to be more aligned with their biological risk of progression. While one could view these two uses as separate and parallel, the use of our test to rule out a sentinel lymph node biopsy surgical procedure must be accompanied with evidence that avoiding this procedure will not put them in harm's way, that is, if they have an excellent prognosis, should they choose to avoid the sentinel lymph node biopsy surgical procedure. To this end, I am pleased to review data from an oral presentation that took place at the March 2024 meeting of the Society of Surgical Oncology. At this meeting, data was presented from one of our multicenter prospective U.S.-based studies.

The data examining the performance of DecisionDx-Melanoma in safely ruling out a sentinel node biopsy surgical procedure showed that of patients with a T1 or T2 melanoma and predicted to have less than a 5% likelihood of a positive sentinel lymph node by our test, no patients, as of the date of the data pull for this presentation, predicted to have a less than 5% likelihood of a positive node, actually had a positive node. That's a negative predictive value of 100% for this use of our test.

But as I noted earlier, and it's clinically important, the study also examined the recurrence of patients who were predicted to have a less than 5% likelihood of a positive node and chose to forego that surgical procedure, as well as patients who were also predicted to have less than a 5% likelihood of a positive node, but who, for personal preference, chose to undergo that surgical procedure anyway. I'm pleased to say that both of these groups were recurrence-free during the follow-up period, which had a median follow-up of two years. That is, in these two patient populations, our test had a negative predictive value of 100% for risk of recurrence. This is powerful data that shows the exceptional clinical value that DecisionDx-Melanoma brings to improving patient care, decisions, and outcomes.

Separately, in February, we announced a peer-reviewed publication of study data showing that DecisionDx-Melanoma provided significantly better risk stratification than the current American Joint Committee on Cancer Staging System in patients with stage one melanoma. This is an important patient group as it represents the largest group of melanoma patients. This publication reports the results of two large stage one cohort studies, including 5,561 patients from the National Cancer Institute's SEER program. This study supports the use of our DecisionDx-Melanoma test in stage one melanoma to obtain more precise information about a patient's risk of disease progression to, again, inform more personalized risk-aligned treatment and surveillance management plans.

Looking ahead, we will certainly be focusing our educational effort on these highly compelling data, along with the findings from our two publications in 2023 that highlighted the fact that the clinical use of our DecisionDx-Melanoma test correlated to improved patient outcomes. That is, patients lived longer compared to those patients who did not have DecisionDx-Melanoma included as part of their clinical care. That is, they were untested. Moving on to our DecisionDx-SCC test. We continue to see strong report volume momentum with 3,577 test reports delivered in the Q1, an increase of 48% compared to the same period in 2023. DecisionDx-SCC continues to be supported by a robust and growing body of evidence.

We are particularly excited about a study that was published in March of this year that showed, in addition to providing risk stratification information, our DecisionDx-SCC test identified patients most likely to benefit from adjuvant radiation therapy, or ART for short, and those who can consider deferring treatment given the lower likelihood of benefit. This ART response data is of high clinical importance for a couple of reasons. First, ART has been shown to be an effective adjuvant intervention in patients with high-risk SCC. However, some high-risk SCC patients are either not responsive to ART or the likelihood of metastasis is lower than predicted by their clinical pathologic risk factors. In either case, these patients can be subject to ART, which carries both significant complications as well as cost.

So the ability of our DecisionDx-SCC test to assist in identifying those who are likely not to benefit from ART, from those who are likely to benefit from ART, has high clinical actionability. Furthermore, based off of our three-year real-world data, more than 98% of the patients that we test clinically are eligible for ART consideration under one or more of the existing guidelines. Importantly, this was the third peer-reviewed study published since the start of 2024, demonstrating DecisionDx-SCC's clinical and/or economic value in guiding ART decisions in the high-risk cutaneous squamous cell carcinoma patient population. Now, let's turn to our gastroenterology franchise.

During the Q1 of 2024, we delivered 3,429 TissueCypher test reports, compared to 1,383 in the Q1 of 2023, which is 148% growth. As a reminder, we believe the total market opportunity encompasses approximately 415,000 patients annually who meet the intended use criteria for this test, representing an estimated U.S. addressable marketplace of approximately $1 billion. As such, we believe our TissueCypher test represents significant long-term growth opportunity as we're in the very early stages of market penetration. We're excited about the growth prospects of the test, and we are equally pleased by its clinical utility to determine a patient's individual risk of progression from Barrett's esophagus to cancer.

Turning to our mental health business, we delivered 4,078 IDgenetix test reports in the quarter, compared to 2,150 in the Q1 of 2023, which is 90% growth year-over-year. We believe the ongoing momentum we're experiencing is in part driven by our unique value proposition. In fact, data shows that using our test, which considers a combination of drug-gene, drug-drug, and lifestyle factors, contributed greater remission and greater relapse control in patients with major depressive disorder and anxiety than the trial-and-error method of therapy selection. Further, we recently announced new data showing that while two-thirds of IDgenetix recommendations for patients ages 65 and older were due to drug-gene interactions, one-third were due to drug-drug or lifestyle factor interactions, highlighting the value of the IDgenetix three-in-one approach to providing tailored guidance for neuropsychiatric medication selection.

Moving on to our pipeline, we're making good progress on our inflammatory skin disease pipeline initiative and expect to provide you with additional updates in the second half of this year. This pipeline genomic test for patients with moderate to severe atopic dermatitis, psoriasis, and related conditions, is targeted for launch by the end of 2025, assuming a positive outcome of our discovery, development, and validation efforts. Lastly, I'm honored to share that for the third year in a row, Castle has earned a Top Workplace USA award, underscoring our position as a leader in creating an exemplary workforce culture. I want to thank each and every member of the Castle team for their continued hard work. I'll now turn the call over to Frank, who will provide details relating to our financial results.

Frank Stokes (CFO)

Thank you, Derek, and good afternoon, everyone. As Derek highlighted, we delivered excellent financial results to start the year. Revenue was $73 million for the Q1 of 2024, an increase of 74% over the Q1 of 2023. The increase was driven by higher ASPs and test volume growth. I'd note the Q1 2024 volume reflects our historical quarter-over-quarter seasonality that is flat over the Q4. Further impacting our Q1 2024 volume is the timing of our national sales meeting, which occurred in the Q1 this year compared to the Q3 in previous years. Historically, the Q2 sees growth sequentially over the Q1, and we expect the Q2 of 2024 to follow our typical Q2 volume trend.

Adjusted revenue, which excludes the effects of revenue adjustments in the current period related to tests delivered in prior periods, was $71.3 million for the Q1 of 2024, an increase of 64% over the Q1 of 2023. Our gross margin during the Q1 of 2024 was 77.9%, compared to 70.5% in the Q1 of 2023. Our adjusted gross margin, which excludes the effects of intangible asset amortization related to our acquisitions and excludes the effects of revenue adjustments in the current period associated with test reports delivered in prior periods, was 80.5% for the quarter, compared to 76.5% for the same period in 2023, an improvement of 400 basis points.

Turning to expenses, our total operating expenses, including cost of sales for the Q1 of 2024, were $78.4 million, compared to $73.6 million for the Q1 of 2023. Sales and marketing expenses were $30.5 million, compared to $29.9 million for the same period in 2023. The increase is mainly due to higher expense for training events and speaker conferences and expenses for salary and wages, partially offset by lower expense for travel and lower stock-based compensation expense. General and administrative expenses were $18 million, compared to $16.8 million for the same period in 2023. The increase is primarily attributable to higher expense for professional services, higher general administrative costs, and higher salaries and wage expense, partially offset by lower stock-based compensation expense.

Cost of sales expenses were $13.9 million in the Q1 of 2024, compared to $10.2 million in the Q1 of 2023, an increase of $3.7 million, primarily due to higher personnel costs and increased expenditures on supplies. The increase in personnel costs primarily consists of higher salaries and wages, employee benefits and bonuses, reflecting headcount additions made to support business growth, as well as merit and annual inflationary wage adjustment for existing employees. Supply and service expenses increased largely due to our higher test volumes. R&D expenses were $13.8 million in the quarter, compared to $14.4 million for the same period in 2023, primarily consisting of lower clinical studies expenses and advisory board services, partially offset by higher personnel costs.

Total non-cash stock-based compensation expense, which is allocated among cost of sales, R&D, and SG&A, totaled $12.7 million for the Q1 of 2024, down from $13.5 million for the Q1 of 2023. Interest income increased by $0.7 million for the Q1 of 2024 compared to the Q1 of 2023. The increase primarily reflects higher interest rates earned on our cash equivalents and our purchases of marketable investment securities beginning in the Q3 of 2022. Our net loss for the Q1 of 2024 was $2.5 million, compared to a net loss of $29.2 million for the Q1 of 2023.

Diluted loss per share for the Q1 of 2024 was $0.09, compared to diluted loss per share of $1.10 in the Q1 of 2023. Adjusted EBITDA for the Q1 of 2024 was $10.5 million, compared to -$15.1 million for the Q1 of 2023, an improvement of $25.6 million. The substantial year-over-year improvement primarily reflects strong top-line growth along with continued disciplined expense management. Net cash used in operating activities was $6.8 million for the Q1 of 2024, due in part to annual cash bonus payments and certain healthcare benefit payments that are not expected to recur during the remaining three quarters of 2024.

Net cash used in investing activities was $19.7 million for the Q1 and consisted primarily of purchases of marketable investment securities of $60.8 million and purchases of property and equipment of $9.2 million, partially offset by the maturity of marketable investment securities of $50.2 million. Net cash provided by financing activities was $10.6 billion for the three months ended March 31, 2024, and consisted primarily of $10 million of proceeds from issuance of long-term debt and $1.1 million of proceeds from contributions to our 2019 employee stock purchase plan, partially offset by the $0.5 million dollar payment of employee taxes attributable to the vesting of restricted stock units.

We ended the quarter with cash, cash equivalents, and marketable securities of $239.2 million. As Derek mentioned, we are raising our 2024 revenue guidance to $255 million-$265 million, up from $235 million-$240 million, reflecting strong Q1 execution. In conclusion, we're very pleased with our execution in the Q1 of 2024, highlighted by strong revenue and test volume growth and an upward revision of our full year revenue expectations. I'll now turn the call back over to Derek.

Derek Maetzold (Founder, President, and CEO)

Thank you, Frank. In summary, the Q1 marked an excellent start to the year with strong execution across the company. I'd like to conclude today by thanking our Castle team. Thank you for your continued interest in Castle. Now, we will be happy to take your questions. Operator?

Operator (participant)

Thank you. In order to allow everyone in the queue an opportunity to address the Castle management team, please limit your time on the call to one question and one follow-up only. If you have additional questions, please return to the queue. Please stand by while we compile the Q&A roster. The first question comes from Subbu Nambi with Guggenheim. Your line is open. Please go ahead.

Subbu Nambi (Managing Director)

Hey, thank you for taking my questions. Could you provide initial thoughts on how should we think about Q2 across the different products, the typical seasonality for Derm, but how should we think about TissueCypher, IDgenetix, and we should still assume no revenue for SCC, right?

Frank Stokes (CFO)

Yeah, Subbu, we... The guide only has seq through this month, through May. And we, you know, we're still early in TC and IDgenetix, so I'm not sure that we're feeling seasonality yet in those two products. But in the case of TissueCypher, we probably need, you know, maybe one more quarter to be able to be a little bit more accurate in our modeling there, just because we—as you recall, we had the pause in orders in the second, Q3 last year. So we're probably seeing that just beginning to normalize. So we're liking what we're seeing. I don't—There may be seasonality there, but we're probably not able to model that in just yet.

Subbu Nambi (Managing Director)

Got it. Thank you. And then on LDT final rule, I think we all have clarity, but just any additional thoughts, given that all your current marketed proprietary tests are all approved under New York CLIA, could you provide any additional color, just specifically on TissueCypher, which has conditional approval, and my understanding is it still is under coverage, but any thoughts there?

Derek Maetzold (Founder, President, and CEO)

Yeah. So our Pittsburgh laboratory, which is where TissueCypher is run out of, passed. I guess that's the New York State inspection as a permanent laboratory. The conditional approval for TissueCypher is a timing process with New York State, as I understand that. So given the FDA language of New York State Department of Health approval, initial approval, I think all of our marketed proprietary tests are in good shape.

Operator (participant)

Our next question comes from Kyle Mixon with Canaccord Genuity. Your line is open. Please go ahead.

Kyle Mixon (Analyst)

Hey, guys. Thanks for the questions. Congrats on the quarter. Yeah, I guess, I guess, Frank, why, why the decision to exclude SCC past May? Why is May the right month, I guess, in June, to think about that? And then maybe for Derek, does the recent publication and the guidelines for SCC make a difference with reimbursement over time? Like, maybe like post this, like in the aftermath of the decision. Thanks.

Frank Stokes (CFO)

Sure. I'll go first, Kyle. I mean, we could, you know, we could pick any month, right? We know where we are now, and so that's the... We've got visibility on May, and so that's, you know, given the uncertainty and timing, that's where we picked to put the pin in it.

Derek Maetzold (Founder, President, and CEO)

Regarding the manuscript I discussed on the call earlier, Kyle, so we actually had four, or we saw four different publications come out around SCC, either primary publications or one was an expert panel/consensus review recommendation on clinical use of a test. On what I highlighted on the call, which was really the one focusing on the use of our test to predict therapy response to adjuvant radiation therapy. That's a pretty significant manuscript because more than 98% of the patients that we test clinically today are eligible for adjuvant radiation therapy under one or more of the society guidelines out there, including NCCN.

So that is our population that we're testing, and the ability to rule out a substantial number of patients, a majority actually, who we would predict would not receive a clinically determinable benefit, really has a great impact on patient care in terms of reducing complications through unnecessary procedure and also has a great savings to the Medicare Trust Fund, since these are mainly Medicare-based patients. So I think from a coverage perspective, if this article and these other three articles are not included in the reviews of any final LCD, these would certainly be clinically relevant articles to reopen up or challenge or initiate a reconsideration process, at least in our eyes.

Kyle Mixon (Analyst)

Okay, that was great, guys. Just a quick one. The dermatologic ASP increased 40% year-over-year. I think that makes sense given, I think, recent SEC ASP trends were pretty good. But it's also a 13% sequential increase from the Q4. So, you know, what's driving some of this movement, and can we see similar double-digit increases quarter-over-quarter going forward?

Frank Stokes (CFO)

I wouldn't model that level of increase going forward. We had some good progress on collections, and we did have some earlier claims, prior period claims, that we collected at a higher rate than we had anticipated, which accounted for some of the out-of-period or prior period revenue. But you know, we're continuing to make progress, but my expectation is it's slow and steady rather than accelerating.

Operator (participant)

We now turn to Sung Ji Nan with Scotiabank. Your line is open. Please go ahead.

Corey Rosenbaum (Healthcare Equity Research Associate)

Hey, this is Corey Rosenbaum. I'm for Sung Ji. Thanks for taking my questions. So regarding the final rule on the FDA's LDT regulations, I recognize your existing products are not affected. Obviously, the rule will take multiple years to be phased in and they may face hurdles along the way. But does this change your strategy or the timeline for your development pipeline, specifically for the inflammatory skin disease products? I know it might be too early to tell, but any insight here would be great.

Derek Maetzold (Founder, President, and CEO)

Now, that's an excellent question, Corey. So our guidance so far has been that we believe we were on track or remain on track to launch the initial version of our tests for inflammatory skin disease therapy response prediction by the end of 2025. There are a number of things, areas within the final rule that the FDA indicates they're going to be clarifying in the next period of time. I'm not sure if that means 2 months or 2 days or six months. We certainly plan to have discussions around what this means for future marketed tests, since there's no way that'll be launched by May 6th of this year.

But as of right now, I would say that we're so far out between now and the end of 2025, that we wouldn't be positioned to go ahead and say that that timing should change at this point. But obviously, as we work through the final rule and understand how we would have newer tests managed, we can provide clarity in future quarters.

Corey Rosenbaum (Healthcare Equity Research Associate)

Great. That's great insight. Appreciate it. Also, you previously mentioned a potential expanded market opportunity for uveal melanoma in the early detection of the disease. Are there any updates in terms of the development pipeline timeline there and when we might be able to get some updates on that initiative?

Derek Maetzold (Founder, President, and CEO)

Not on this call here, but that's a good question there. So, I can't recall any internal milestones that provide clarity on that, but let's get back to you guys in the summertime.

Operator (participant)

Our next question comes from Thomas Flaten with Lake Street. Your line is open. Please go ahead.

Thomas Flaten (Senior Research Analyst)

Great. Appreciate you guys taking the questions. On the Q4 call, you mentioned that in early 2Q, you would be evaluating a sales force expansion for TissueCypher. Do you have any updates for us on that?

Derek Maetzold (Founder, President, and CEO)

Yeah. So, we've actually expanded our sales force for TissueCypher. The majority of the expansion territories were filled, I think, effective April first, and there's a couple that have come in, in the last week or two. So the initial expansion efforts in 2Q are essentially done. We do plan on kind of watching the expanded territories, once we have the representatives trained up in the field full time, see how the responsiveness is, and may look to do an additional expansion here in the second half of 2024, depending on kind of what we're seeing in terms of territory productivity growth. But otherwise, though, that expansion, you could say, was largely completed by now. So you're really talking about sort of beginning to see, I think, an impact of that.

You know, we estimate 5-6 months from the date of hire to when you begin to see good productivity coming out of a new area manager. So I would think towards the end of the Q3, Q4, we should be able to see publicly a nice impact on expansion.

Thomas Flaten (Senior Research Analyst)

Got it. And then, Frank, the updated 2024 guidance is within range of your 2025 original long-term plan. Like, how should we think about 2025 in the context of having increased the guidance to this level for 2024?

Frank Stokes (CFO)

Well, recall that our guide, Thomas, assumes that we even though the evidence is, in our view, even to the layperson, clear that our SCC test is has great clinical utility, we are assuming that that comes out of our revenue in the back half of this year in 2025. So, you know, we would have that headwind there. But, you're right. We're close to there, as we sit here today.

Thomas Flaten (Senior Research Analyst)

Got it. Appreciate it. Thank you.

Operator (participant)

We now turn to Paul Knight with Keybanc. Your line is open. Please go ahead.

Paul Knight (Managing Director and Equity Research Analyst)

Hi, Derek. A question on the TissueCypher and IDgenetix. You're seeing obviously big growth there. Are you? Is it kind of pull through, or are you really putting in a focused marketing effort on those two tests?

Frank Stokes (CFO)

Yeah... Hey, Paul. Thanks for the question. We definitely market, you know, all of our tests in a very thoughtful and deliberate way. So, we do see great demand for those tests, but the hurdle to achieve that or to recognize that demand is physician education. And that's really what our marketing effort is focused around, is physician education. Making sure that the targeted healthcare providers-

... understand the benefit to their patients of using our tests. So, with both of those tests, once a healthcare practitioner understands that benefit, then there's really good pull-through. They get it, and they become adopters in many cases, pretty quickly. But to get them there, we have to educate. So, these are still fairly, you know, fairly pinpoint use here on the, on these tests. It's not... You know, it's a very distinct subset of patients. And so, you know, we need to first illustrate to the physician which subset of his patients will benefit, and then to help them understand what that benefit is. And then for many of them, then they want to say, "Okay, I get it.

I get which patient, I get how it can help. Now walk me through your data and let me get comfortable that you're gonna do what we think we're gonna do here. So, we have a very... I mean, it's very very detailed, very in-depth. The team has done an incredible job. Our physician-facing materials are incredibly well developed. We've got a large team of very smart people that work very hard to put that together, and it's very effective. But you still have to get it in front of the physicians, so that tip-of-the-spear interaction is still very important.

Paul Knight (Managing Director and Equity Research Analyst)

On SCC, are physicians ordering that test, are they also ordering more and more DX melanoma tests as well?

Derek Maetzold (Founder, President, and CEO)

I-

Paul Knight (Managing Director and Equity Research Analyst)

Meaning-

Frank Stokes (CFO)

I don't know if we've analyzed... Yeah, yeah. Is there a halo effect of having them see better utility for both disease states, you mean?

Yeah.

It's interesting. I don't... Frank was gonna coming off and vice versa. We haven't analyzed that from our perspective on a-

Operator (participant)

Ladies and gentlemen, we've lost connection with our speaker. Thank you for your patience as we reconnect them. Ladies and gentlemen, thank you for your patience. We have the speakers reconnected. Paul, please continue with your question.

Paul Knight (Managing Director and Equity Research Analyst)

Yeah, you know, the question on the halo effect of subsequent orders after an SCC prescription.

Frank Stokes (CFO)

Yeah, thanks, Paul. I gave such a great answer. I hate that it got cut off. We do think there's nice halo or pin action there. The clinical utility for the two tests is very similar. So once you illustrate to a healthcare practitioner the benefits of the SCC test to that group of patients, it's a fairly easy adjacency to demonstrate the benefit to melanoma patients of our melanoma test. So, it's very similar clinical utility, just for two different distinct groups of patients. Your instinct is right. That's a short step to the adjacency there.

Paul Knight (Managing Director and Equity Research Analyst)

Thanks.

Operator (participant)

Our next question comes from Mason Carrico with Stephens. Your line is open. Please go ahead.

Mason Carrico (Research Analyst)

Hey, guys. Thanks for taking the questions. I'll actually just keep it to one here. There's been a lot of questions in past quarters on how you guys will shift around resources if DecisionDx-SCC happens to lose coverage. I want to ask about the capital allocation strategy if coverage were to remain in place and cash generation was to remain elevated. How would you rank order, you know, your priorities in terms of organic investments, if that was to play out? How would you think about sales team additions across the franchises, and what other investments would you prioritize if that happens to play out?

Derek Maetzold (Founder, President, and CEO)

Yeah, I'll, I'll start with that here, and Frank can adjust it. So, I think, I think, we have plans that assume SCC coverage is maintained, but once the sort of cloud is lifted, then we can execute those with, with higher level of confidence based upon what you just pointed out, which is cash generation opportunity, right? So I think that we're probably close to where we should be in terms of our skin cancer dermatology-focused sales team. We, even with this most recent expansion going, what? Into the mid-30s, I guess, with TissueCypher, we probably are 60% to where we need to be at the end of the day. So we would certainly look at pulling forward some of those territory expansions.

Although, again, we also want to balance that against, you know, breaking too many relationships at one, at the same point in time between existing customers, with having them deal with new area managers as hires versus the ones they've been dealing with. So that's a balancing act there. We have certainly also held back on scaling our IGX sales team and marketing team as well, due, again, kind of waiting and watching and also getting our feet comfortable with where we're targeting our efforts and making sure that we're getting the kind of response that we expect.

So there are a number of areas there I could see us deploying capital in terms of just improving the rate of penetration of our existing tests, without much of a change in the core DecisionDx-Melanoma, SCC dermatology teams. I think below that level, there are probably some additional internal R&D activities that we'd be comfortable moving a little more quicker on, that we haven't talked about publicly. So we could see some deployment around internally developed pipeline tests, although one could say part of that might also need to be weighed against the sort of additional clarity from the FDA final rule here, in terms of how they're gonna deal with new LDT tests.

So that's something we would thoughtfully look at, evaluate, understand what we, what we do know, what we don't know. I think the last one there probably is saying, are there acquisition targets out there we'd be more comfortable pursuing, versus not pursuing? And obviously, in a couple years, we'd like to turn around and say we have two or three marketed, reimbursed tests in sort of the gastroenterology area. Those who come from internally generated assays, although it would be nice to find some additional tests that are out there that already have coverage and have been marketed, because that could go and slip in right away. But again, that's not necessarily a core rush.

But if we look sort of out to maybe 2027 and turn around, it'd be nice to have two or three tests that are, that are clinically actionable and valued by our dermatology... I mean, by our gastroenterology customers. The same goes for sort of this, this mental health franchise call point. And at that point in time, of course, we would have expected to launch our inflammatory skin disease test or series of tests to the dermatology market. We are evaluating right now, is that sort of a separate parallel sales force? Does that make the most sense to our customers? Is that too confusing, so we should actually go to a much, you know, to, to, to a much higher level of, of the number of dermatology sales representatives, but covering three or four products to the same customer?

So we have to work through what makes sense from a customer perspective and a confusion perspective. And so those are the kind of things I would say in order of ranking, commercial expansion efforts, some R&D internal activities, and then, you know, are there things that we can bring in a company that have been developed by others again?

Mason Carrico (Research Analyst)

Got it. That's helpful. Thanks, Derek.

Operator (participant)

Our next question comes from Katherine Schulte with Baird. Your line is open. Please go ahead.

Catherine Schulte (Senior Research Analyst)

Hey, guys. Thanks for the questions. First for MolDX, I think we're coming up on the one-year mark from the squamous cell draft LCD at the beginning of next month. Have you had any additional conversations with them? And, you know, what do you think the likelihood is that they could reverse their decision in the final LCD?

Derek Maetzold (Founder, President, and CEO)

So, we have ongoing interactions with the MolDX medical directors, as well as the other Medicare contractors as well, which I think we have always done that, or at least we've tried to anyways, I would say. So, they are certainly aware of these newer publications that have come out that support the clinical use of our tests, obviously from a standpoint of risk stratification, as well as predicting response or lack thereof to adjuvant radiation therapy. Even our risk stratification table has more than doubled in terms of the number of patients under study in published studies. So hopefully, those kinds of published elements make an impact on them.

I think the publication date, according to the Medicare Provider Integrity Manual, is 365 days from the date it's being posted. I've seen in the past where there were times when MolDX has taken a month or two longer, which I guess they're asking for a grace period on that. So we think kind of a June, July time period is the right time period to still think about, I think, in general. Now, in terms of likelihood of them reversing is a funny word. I would say the medical directors at MolDX, I think, have been fairly consistent publicly and also with us, that, you know, they're gonna try and review the literature, do the right thing from an evidence-based perspective.

And if they miss things, they are very appropriately look to take in public comments and say, "We kinda missed something here. We should go and make a change," as opposed to kind of digging their heels and saying, "Well, we said this a year ago, and we have nothing to go ahead and input on your comments for." So I think the most relevant recent example that we have talked about last fall was sort of the TissueCypher LCD, which sort of went from a foundational non-coverage LCD to a foundational covered LCD between draft and final posting. I think there are parallel elements between the TissueCypher data development and the SCC, but of course, that's an RI. It's not necessarily the eyes from all the external directors.

So I'm quite hopeful that once they see the significantly newer and greater data, certainly publications that were answering directly some of the questions they had about our test, as well as this new ART response data, provides a element of knowledge that we are creating new treatment pathways. Our test is having a tremendous impact in improving appropriate care within existing treatment pathways for patients based upon both risk stratification information as well as this newer data regarding adjuvant therapy, adjuvant radiation therapy response.

Catherine Schulte (Senior Research Analyst)

Okay, great. And then on TissueCypher, just with volume is flat sequentially here, you mentioned you're still figuring out that seasonality. So do you think that was seasonality, or were there other dynamics going on there beyond that and the national sales meeting?

Frank Stokes (CFO)

Yeah, I think it's probably some seasonality there, and maybe there could be a little bit of pull forward, I guess, pull through. You know, there may have been some patients who were seen when we were in a pause on taking orders, and those orders came through in the Q4, which might have, you know, shifted them from... They might have been Q3 orders and got shifted to fourth. And, you know, unfortunately, we don't know for sure. So that's a bit of a supposition there.

So I think after this quarter, we'll probably be able to see what a normalized kind of cadence looks like, and be a little bit more able to see where we are in the penetration pathway there.

Catherine Schulte (Senior Research Analyst)

All right, great. Thank you.

Operator (participant)

Our final question today comes from Mark Massaro with BTIG. Your line is open. Please go ahead.

Speaker 11

Hey, guys, this is Katie, and also Mark. Thanks for taking the questions. I apologize if this has been covered already. I had some technical difficulties. But, so I think in recent months, we started to see a pickup in opportunistic M&A. You have a very strong balance sheet, so I was just wondering how you're thinking about deploying that balance sheet, just in light of recent competitor valuations, and potentially adding to the bag here specifically for Derm. Thanks.

Frank Stokes (CFO)

Yeah, of course. So, you're right, our assets are challenged in valuation in many cases. We certainly look at other opportunities. I think the inorganic growth is down to priority, as we think about, one, the value of what we have in-house and two, our own capabilities. And so, we always look at things, we always evaluate things, and give them an objective view. But I think for now, external growth is still further down the list of priorities.

Okay, great. Thanks for taking the question.

Thank you.

Operator (participant)

This concludes our Q&A. I'll now hand back to Derek Maetzold for closing remarks.

Derek Maetzold (Founder, President, and CEO)

Thank you, operator. This concludes our Q1 2024 earnings call. Again, I thank you for joining us today and for your continued interest in Castle Biosciences.

Operator (participant)

Ladies and gentlemen, today's call is now concluded. We'd like to thank you for your participation. You may now disconnect your lines.