Castle Biosciences - Earnings Call - Q3 2020

Transcript

Operator (participant)

Good afternoon and welcome to the Castle Biosciences third quarter 2020 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 Frank Stokes, Chief Financial Officer. Please go ahead.

Frank Stokes (CFO)

Thank you, Operator. Good afternoon, everyone, and welcome to Castle Biosciences third quarter 2020 financial results conference call. Joining me today is Castle's Founder, President, and Chief Executive Officer, Derek Maetzold. Information recorded on this call speaks only as of today, November 9, 2020. Therefore, if you are listening to the replay or reading the transcript of this call, any time-sensitive information may no longer be accurate. A recording of today's call will be available on the investor relations page of the company's website for approximately three weeks.

Before we begin, I would like to remind you that some of the information discussed today may contain projections or other forward-looking statements regarding future events or the future financial performance of the company, including expectations and assumptions related to the impact of the COVID-19 pandemic, and are made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon current expectations and involve inherent risks and uncertainties, and there can be no assurances that the results contemplated in these statements will be realized. A number of factors and risks could cause actual results to differ materially from those contained in these forward-looking statements.

These factors and other risks and uncertainties are described in detail in the company's annual report on Form 10-K for the year ended December 31st, 2019, 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. I'll now turn the call over to Derek.

Derek Maetzold (Founder, President, and CEO)

Thank you, Frank. Good afternoon, everyone. These are exciting times at Castle, and I appreciate you taking the time to join us today. As always, I would like to start today's call by thanking the Castle team. Through their hard work and dedication to improving the lives of patients with skin cancer, we successfully executed our strategic priorities in the quarter and remain optimistic about our growth initiative's ability to position us well for both near-term and long-term value creation. This afternoon, I'll discuss our performance for the quarter, along with recent developments, touch on what we believe the continued impacts of COVID-19 will be on our business, and then turn it back to Frank, who will provide more detail on the third-quarter results and our financial position. In the third quarter, we saw strong performance on multiple fronts.

This includes increased year-over-year revenue, return to year-over-year increase in DecisionDx-Melanoma report volume, and the successful execution on our commercial launch of DecisionDx-SCC, our gene expression profile test for patients diagnosed with cutaneous squamous cell carcinoma, commonly referred to as SCC, and with one or more high-risk factors. In other words, patients that today's guidelines label as high-risk. We estimate the high-risk SCC U.S.-only population to be 200,000 patients. To start, we are pleased that for the third quarter of 2020, we had an increase in total revenue to $15.2 million, or 3% from $14.8 million in the third quarter of 2019. This includes prior-period revenue for the third quarter of 2020 of $1.5 million, compared to $3.2 million for the same period of 2019.

I am pleased to report that report volume for DecisionDx-Melanoma, our current primary revenue driver, returned to year-over-year growth for the third quarter of 2020. As a reminder, our DecisionDx-Melanoma test is used to guide or inform management of patients who are diagnosed with early-stage cutaneous melanoma. The diagnosis of cutaneous melanoma requires that a biopsy be performed and that the dermatopathologists render a diagnosis of cutaneous melanoma. In the third quarter of 2020, we provided 4,404 DecisionDx-Melanoma test reports, representing growth of 7% compared to the third quarter of 2019 and a 46% increase over the second quarter of 2020. We delivered this increase in year-over-year report volume, even as our analysis of third-party data tells us that in the third quarter, cutaneous melanoma diagnoses decreased by approximately 12% compared to the same quarter in 2019.

Thus, we are very pleased with our third-quarter volume growth in the context of this baseline of reduced diagnoses and therefore patients. We continue to believe that the reduced cutaneous melanoma diagnoses are due to delays or cancellations in patient visits attributable to the COVID-19 pandemic, which then result in reduced diagnostic biopsies and thus reduced diagnoses of melanoma and appropriate patients for us to test. Additionally, as we have all seen, COVID cases are beginning to increase again in parts of the U.S., and that brings uncertainties about the continued impact to our business. As I just mentioned, diagnoses were down 12% in the third quarter compared to the third quarter of 2019. However, third-party data also showed an increase of diagnoses in the third quarter of 2020 compared to the second quarter of 2020.

If patient trends continue without a significant change, based on our third-party data, we estimate that the annual diagnoses of cutaneous melanoma may be reduced by approximately 20,000 or more compared to 2019's incidence. That is to say, we expect COVID to continue to impact our DecisionDx-Melanoma volume in the fourth quarter and into 2021 due to delays in the overall number of patients diagnosed with cutaneous melanoma, although there is a trend of increased diagnoses in the third quarter from the second quarter of 2020. Additionally, at some point, we believe that delayed melanoma diagnoses will be diagnosed, but we are uncertain as to when. Our commercial team continued with their promotional efforts of combined in-person and virtual events during the third quarter. This paralleled our continued successful conversion of the majority of our in-person peer-to-peer programs to virtual meetings.

Additionally, we did capture additional clinicians who ordered our DecisionDx-Melanoma test for the very first time during the third quarter of 2020. Turning to reimbursement, we accomplished an important DecisionDx-Melanoma milestone in the third quarter. As you may recall, the Medicare Administrative Contractor, or MAC, Palmetto MolDX, issued a draft Local Coverage Determination Policy, or LCD, in August 2019. The final positive expanded LCD and the accompanying billing and coding article were posted in October 2020. The effective date for the Palmetto LCD and the billing and coding article is November 22nd, 2020. Importantly, this LCD and article was nearly identical in terms of coverage to the draft August 2019 LCD, meaning that the expanded LCD provides reimbursement for the significant majority of Medicare beneficiaries whose clinicians order DecisionDx-Melanoma as part of their patient management plan.

It is also worth noting that comments were received during the comment period, and 100% of the comments were supportive of the expanded coverage. We believe this represents great alignment between Palmetto's assessment of the appropriate use of DecisionDx-Melanoma and the clinicians that use our test to guide their patient management decisions. Additionally, Noridian, the MAC that oversees our laboratory in Arizona, issued an identical LCD and article to the Palmetto LCD. The Noridian LCD and article will be effective on December 6, 2020. In addition to what we see as positive news surrounding our DecisionDx-Melanoma test, we successfully executed on the launch of DecisionDx-SCC, which became commercially available on Monday, August 31st, 2020.

The DecisionDx-SCC test is intended for use in adding actionable patient-specific information to risk assessment and to help guide management decisions in patients diagnosed with cutaneous squamous cell carcinoma with one or more risk factors, these so-called high-risk cutaneous squamous cell carcinomas. We have submitted our technical assessment dossier for Medicare coverage to Palmetto MolDX, and in the third quarter, Palmetto confirmed that it was accepted as complete. Accordingly, we expect a draft Local Coverage Determination Policy to be posted in 2021, with finalization expected approximately 12 months following the draft. As a reminder, we expect Medicare to be our largest payer for DecisionDx-SCC, as the typical age at time of diagnosis of SCC is near 70 years. While it is certainly early and the U.S. is still dealing with COVID, we have seen strong interest from clinicians.

You should recall that the target customer for our DecisionDx-SCC test is the same target customer for our DecisionDx-Melanoma test. That is, dermatologists and Mohs surgeons, a subspecialty of dermatology, who have a medical dermatology practice. Thus, we anticipate having significant leverage from our existing dermatology-focused sales team. From clinical availability on August 31st through October 31st, 2020, DecisionDx-SCC has been ordered 282 times by 193 clinicians, most of which were existing DecisionDx-Melanoma customers. Turning to our DecisionDx-UM test for patients diagnosed with UV melanoma, we delivered 318 reports in the third quarter of 2020 compared to 356 reports in the third quarter of 2019. As it relates to the impact of COVID-19 on our test, monthly year-over-year comparisons are difficult to interpret due to the low incidence of UV melanoma.

That being said, we continue to believe the year-over-year decrease is due to the pandemic, as the majority of UV melanoma diagnoses are made incidental to a routine eye exam, and routine eye exams are largely delayed during the second quarter. Due to our belief that the majority of UV melanoma diagnoses occur incidental to a routine eye exam, as compared to the majority of cutaneous melanoma diagnoses being self-detected by the patient, we expect recovery in the diagnosis of UV melanoma, and thus our order volume for DecisionDx-UM to be time-shifted relative to the recovery that we have observed for our DecisionDx-Melanoma test. As you know, two key components of our growth strategy for near and long-term value creation are evidence development to support appropriate use of our tests and support coverage by commercial payers and a strong pipeline.

We saw strong progress in both in the third quarter. Data from a systematic review and meta-analysis of the DecisionDx-Melanoma test was published in print in the September 2020 issue of the Journal of the American Academy of Dermatology, or JAAD. Under multivariate analysis, the DecisionDx-Melanoma test was shown to be independent from other clinical factors such as age, Breslow tumor thickness, ulceration, and node status, and our DecisionDx-Melanoma test improved upon risk assessment performed with these staging factors alone. Under the Strength of Recommendation Taxonomy, or SORT system, S-O-R-T, a systematic review and meta-analysis provides for the highest level of evidence for a prognostic biomarker. That is, level one evidence. The SORT system is used by the American Academy of Dermatology and other organizations to evaluate the quality, quantity, and consistency of evidence supporting tests such as DecisionDx-Melanoma.

Additionally, the publication of a retrospective study showing that DecisionDx-Melanoma impacted management decisions for patients diagnosed with stage I to III melanoma appeared in Future Oncology. Study authors developed a recommended melanoma patient care pathway that incorporates DecisionDx-Melanoma test results to help inform frequency and duration of follow-up visits, blood work, and surveillance imaging in line with predicted metastatic risk. A patient's DecisionDx-Melanoma test result was found to have an impact on the number and duration of follow-up and surveillance visits and that patients assessed as having high risk of metastasis, as designated by a DecisionDx-Melanoma class II test result, received more intensive management than patients assessed as having a low risk, as designated by a DecisionDx-Melanoma class I test result. Clinicians using the test were shown to adjust patient management in a risk-appropriate direction within recommendations of national guidelines.

The outcomes from this study parallel those of our previously published clinical utility articles and should help further drive market penetration and reimbursement. With regard to our pipeline, last week we launched our second new test for 2020. By the way, not just the second in 2020, but the second in a span of 10 weeks. This test is named DecisionDx DifDx-Melanoma, or DifDx-Melanoma for short. DifDx-Melanoma is our test for patients with a suspicious or difficult-to-diagnose pigmental lesion, and it became available for clinical use on Monday, November 2nd. DifDx-Melanoma is designed to aid dermatopathologists in characterizing difficult-to-diagnose melanocytic lesions and classifies these lesions as benign or suggestive of benign neoplasm or malignant or suggestive of melanoma. A small number of lesions will fall into the intermediate risk group, meaning that malignancy cannot be excluded.

We had several goals in mind when we set out on this pipeline program a couple of years ago. Our target product profile called for a gene expression profile test with a high level of accuracy and an improved rate of actionable results and technical success while minimizing intermediate results and including populations that have been underserved by existing technologies. We also took the same development approach that we used for our DecisionDx-Melanoma test with learnings gained over the last eight years or so. Specifically, we started the belief that melanoma, or a benign lesion, knows more about itself than we do. So rather than predetermining the selection of which genes matter, we let the tissue itself tell us which genes were important. As the development data was being analyzed, we used our latest artificial intelligence tools to identify a final gene list and algorithm.

We then tested this development or training cohort in an independent clinical validation. By the way, these are the same tools that we used for our DecisionDx-SCC test. Based on the intent to treat analysis of our validation study, which was presented just this morning at the American Society of Dermatopathology's annual meeting, DifDx-Melanoma accurately diagnosed malignant and benign cases with a 99.1% sensitivity, 94.3% specificity, 93.6% positive predictive value, and a 99.2% negative predictive value. Importantly, the intermediate risk result occurred in just 3.6% of the cases, which was better than a target performance we identified when we began the development of the test. Additionally, our technical success rate was 96.6%.

To some, we are so fortunate to have a research and development team located both in Friendswood, Texas, and Phoenix, Arizona, that work as a well-oiled machine, and in 2020, they are two for two, having completed validation on two clinically significant tests in skin cancer, DecisionDx-SCC and DifDx-Melanoma, both of which we expect to have positive impacts on the lives of patients diagnosed with skin cancer. To support our DifDx-Melanoma test, two peer-reviewed articles were submitted and subsequently accepted by Skin, the Journal of Cutaneous Medicine, and are expected to be published later this month. The first article is our development and validation study and includes the data I just outlined on DifDx-Melanoma's performance. The second is a clinical utility study demonstrating that DifDx-Melanoma test results increased diagnostic confidence in dermatopathologists.

The clinical utility study also demonstrated that clinical management decisions were influenced by DifDx-Melanoma in a manner that aligned with the test result in the majority of cases included in the study. These findings suggest that the DifDx-Melanoma test can help clinicians provide more informed patient management plans and improve care for patients with difficult-to-diagnose melanocytic lesions. You know, we entered 2020 with a single in-market skin cancer test that had a total U.S. addressable market of $540 million. With the launch of this third skin cancer test, we estimate that for DecisionDx-Melanoma, DecisionDx-SCC, and DifDx-Melanoma combined, our total addressable U.S. market is now approximately $2 billion. You may recall that we expanded our commercial team in the third quarter of 2020 to create a dedicated sales force to support the launch of our DifDx-Melanoma test.

This dedicated team is primarily introduced in the DifDx-Melanoma test to dermatopathologists, while our existing sales team will remain focused on DecisionDx-Melanoma and DecisionDx-SCC. At the end of the day, we believe that our DifDx-Melanoma test should be ordered by both dermatopathologists and dermatologists. Thus, it is our intention, once we are past this initial launch period, to fold this new dedicated team into the existing sales team as well as further expand, such that we expect to exit 2021 with approximately 55 outside sales territories. As we have discussed, in order to continue to increase our substantial body of evidence to support our gene expression profile tests, we are accelerating investments in our research and development activities, including our clinical trials. As we stated on our last earnings call in August, we recently initiated two key trials.

The first is the personalized study in which we are evaluating DecisionDx-Melanoma for interactions with adjuvant therapies. The second is a connection study, which is collecting long-term outcomes for up to 10,000 patients who have been tested with DecisionDx-Melanoma. We believe these studies combined will provide us with the largest database on patients with melanoma and their tumor biology. We will provide more information on these studies as we make progress. The development of our pipeline continues to be an important part of our long-term growth strategy, and we are or will shortly be initiating new clinical research and development programs for tests in other dermatologic diseases with high clinical need. We look forward to discussing these programs with you in 2021. I will now turn the call back over to Frank, who will provide additional detail relating to our financial results.

Frank Stokes (CFO)

Thank you, Derek.

To reiterate, we are pleased with the continued progress we made in our strategic growth initiatives in the third quarter, which we believe position us well for near and long-term growth. In the third quarter of 2020, we reported revenue of $15.2 million, a 3% increase from $14.8 million in the third quarter of 2019, primarily due to higher per-unit revenues and increased test volume, partially offset by reduced revenue adjustments related to prior periods. In addition to in-period test revenue, our third quarter revenue includes positive adjustments related to tests delivered in prior periods of $1.5 million compared to $3.2 million in the third quarter of 2019. We are pleased with our ability to maintain strong gross margins.

During the third quarter of 2020, our gross margin was 84% compared to 88% for the third quarter of 2019, reflecting the expansion of laboratory staff in preparation for both launches of DecisionDx-SCC and DifDx-Melanoma, as well as anticipated further volume growth for DecisionDx-Melanoma. Our operating expenses for the quarter ended September 30, 2020, were $16.6 million compared to $8.6 million for the same period last year. The increase was driven primarily by higher SG&A, which increased by $4.6 million, partly attributable to higher personnel costs associated with our increased headcount and, in particular, our expanded sales and marketing team and administrative support functions. Stock-based compensation included in SG&A was $1.5 million for the third quarter of 2020 compared to $0.2 million in the same quarter of 2019, reflecting both higher post-IPO stock option valuations as well as additional awards outstanding due to growth.

R&D expense increased by $1.5 million and was primarily associated with increases in personnel costs attributable to additional headcount as well as higher expenses for professional fees associated with our recently initiated clinical studies. As we've discussed over the past couple of quarters, with regard to our R&D expense, we expect further increases as we continue to fill critical roles, progress key clinical studies, including the two Derek just mentioned, and continue to invest in activities that support our products and position us well for continued growth. As noted on our second quarter earnings call in April of 2020, we received a one-time payment of $1.9 million in relief funds automatically allocated to Medicare providers under the CARES Act from the U.S. Department of Health and Human Services. Based on guidance issued by the government at that time, we concluded that we would be able to retain the payment.

This treatment was consistent with other healthcare companies that received such a payment. In September, HHS changed the criteria for retaining this payment. Now, based on this change in criteria, we reversed the income recognized previously. Interest expense decreased $0.4 million for the third quarter of 2020 compared to the third quarter of 2019, primarily due to interest on the convertible promissory notes that were outstanding last year. These notes converted into common stock in connection with the IPO in July of 2019. We began monthly scheduled repayments of our term debt in June and have paid down $3.3 million through September 30, 2020.

The third quarter of 2019 included two non-operating items that did not recur this year: a debt extinguishment gain of $5.2 million related to the convertible notes mentioned above, and certain mark-to-market losses of $2.7 million, which were primarily associated with a separate convertible note transaction entered into just prior to last year's IPO. Our net loss for the three months ended September 30, 2020, was $4.6 million compared to net income of $5.8 million for the three months ended September 30, 2019. Diluted loss per share attributable to common stockholders for the three months ended September 30, 2020, was $0.23 compared to diluted earnings per share attributable to common stockholders of $0.05 for the three months ended September 30, 2019.

Operating cash flow for the third quarter was negative $3 million compared to positive $0.8 million in the prior year period, primarily reflecting the previously mentioned planned acceleration of investments in the business, including increased R&D expenditures and the expansion of our sales and marketing team. For the nine months ended September 30, 2020, we generated $10.3 million of operating cash flow compared to $2.5 million during the same period in 2019. As a reminder, our operating cash flow for the nine months ended September 30, 2020, benefited from an advance payment of $8.3 million from CMS, which will be applied against future Medicare claims that we submit for reimbursement. Originally, recruitment was to start August of 2020, but recent legislation has delayed the start of the recruitment until April 2021, which will continue for a period of up to 17 months.

Excluding the $8.3 million payment, our adjusted operating cash flow, a non-GAAP measure for the nine months ended September 30, 2020, was $0.1 million compared to $2.5 million for the same period in 2019. Finally, we had cash and cash equivalents at September 30, 2020, of approximately $183.1 million. We believe our current cash position allows us to confidently continue to invest in R&D and sales and marketing activities to support the continued growth of our dermatology diagnostic portfolio as we build the company for near and long-term growth. I'll now turn the call back over to Derek.

Derek Maetzold (Founder, President, and CEO)

Thank you, Frank. In summary, with our strong execution in the third quarter, we are pleased with our third quarter results. We are optimistic that our investments and our growth initiatives will continue to drive growth and position us well.

Before we move on to Q&A, I want to express my gratitude to our employees. It is through their dedication to improving the lives of people diagnosed with skin cancer that we remain well-positioned for near-term and long-term success. This concludes our remarks. Thank you for your continued interest in Castle. Operator, we are now ready for Q&A.

Operator (participant)

Thank you. Ladies and gentlemen, if you have a question at this time, please press star, then one on your telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. I'm showing our first question comes from the line of Max Masucci with Canaccord Genuity.

Max Masucci (Managing Director and Senior Equity Analyst)

Hi. Thanks for taking the question. It's nice to see DecisionDx-Melanoma volumes return to growth.

Can you just give us a sense for what the recovery trends are that played out towards the end of Q3 and then how things are trending just with the recent COVID-19 resurgences? Are clinicians better equipped to deal with the pandemic this time around just to sort of avoid the magnitude of declines that we observed back in April?

Derek Maetzold (Founder, President, and CEO)

Yeah. Hi, Max. Thank you for joining and for the question. I'll maybe answer part of it, but probably not satisfactory. Maybe Frank can add some color. We did not do a sort of end of October, first week of November pulse the marketplace to kind of get a sense of what's happening with physician visits in terms of patients returning and any kind of trending post-third quarter, just to be honest.

Our third-party data that we purchased from Symphony Health takes about a month to sort of fully be accurate on the rate of diagnoses. Our most accurate data really probably extends into the end of September, first week of October maybe. I guess what the Symphony Health data appears to show, although it needs to mature out, is that we were not able to discern on a qualitative basis sort of any sort of visible national retraction despite having COVID cases pop up in August and September, etc. I think that hopefully will translate as we get further into the fourth quarter that physician practices were able to optimize whatever they could in the summertime, and patient flow has not seemed to be negatively impacted.

I guess the most concerning part we have, not about Castle's business but about patient care really, is if we end up exiting 2020 without sort of a significant trend improvement in terms of the rate of diagnosis in these last couple of months of the year, there's a lot of patients out there who are going to be diagnosed with a more worrisome, deeper, thicker, and by very nature a more aggressive melanoma. That really is not good from a patient care perspective, obviously. On the Castle side of the business, it means more and more those lesions are actually more concerning, and maybe it has some upside in test volume once they get diagnosed. In terms of sort of post-3Q trends, I think it's too early for us to give you any sort of solid commentary today. Frank, you want to?

Frank Stokes (CFO)

Yeah. Hey, Max.

I think we're still seeing sort of this dual impact of physicians probably seeing fewer patients, some of that from the logistical concerns of derms were previously roughly happy to double-book appointments. I don't know if you've ever been to the doctor and you look at the person next to them and say, "I got a 10:00 A.M. appointment. When's yours?" "Mine's 10:00 A.M. too." That was something they could manage with multiple consultation rooms, etc. Now there's a real limit to that. Finally, there are just a few, there's some patients that are still concerned about getting out at all in some cases and going to medical facilities. We will see that eventually begin to wane.

Certainly, the news through the fall of cases, sort of stubbornly staying, the COVID case rate staying stubbornly high, I think it continued to impact people's mindsets.

Operator (participant)

Thank you. Our next question comes from the line of Catherine Schulte with Baird.

Hey, guys. This is actually Tom on for Catherine. Appreciate the questions. Maybe just on the DifDx launch, I mean, I understand it's been a week since the official launch, a couple of weeks since you guys hosted the webinar. I'm just curious, what's the qualitative feedback been from industry and clinicians on the data that you guys presented? How have conversations gone with docs, if you've had them, who previously ordered the first-to-market test? How have those gone? Do you get a sense that they're open to making a switch to you guys' test?

Derek Maetzold (Founder, President, and CEO)

This is on our DifDx-Melanoma test.

One, too early, I guess, to really give anything that's going to be meaningful. We made the test available clinically on Monday of last week, so really only in-market five and a half, six days today. I would say that we did more market research ahead of launch for both our DifDx-Melanoma test and our squamous cell carcinoma test than we ever did before. Part of that's just maturing as a company, of course, having more resources. I believe that the target product profile that we were guided towards pursuing a couple of years ago when we started our program, which was, can you get to a really high technical success rate so that the vast majority of specimens that we send to you actually come back with a result of some kind?

Can you kind of reduce that sort of intermediate risk zone as narrow as possible so that most of the time we get back an actual data of either saying the biology looks like it lines up with a benign lesion or the biology looks like it lines up as a malignant melanoma? If you can achieve those things, then we're in like Flynn. I think, as you saw from our investor call, I guess it was about 10 to 12 days ago, I guess now, we hit all those boxes. We were able to maintain and actually have significant accuracy scores for both sensitivity and specificity while maintaining a very narrow intermediate zone. I think the market research that we conducted over the course of the summertime into the early fall hit the mark there.

Now, what do we think is going to happen in the marketplace as we kind of move out of the availability last week and look at the first sort of month or two of uptake? My sense is that we will have clinicians who perhaps have either been using on a routine basis or sporadically the other gene expression profile tests. I think if we walk in there and show them our data and obviously be careful because we do not have any head-to-head trial comparisons, and there is no reason to overstate the hand you have been dealt. I think to go ahead and walk up and have an honest conversation saying, "This is the kind of target product profile you asked us to go ahead and deliver. We have done it." Is there interest here in having you evaluate our tests in your next series of patients?

I think that's going to come over very, very positively because, again, we hit everything on all four cylinders. The final aspect, which I think is quite real, is to say, "You know what? We have over 4,200, 4,300 clinicians, dermatologists, and surgeons in the last year who have ordered our DecisionDx-Melanoma test." One of the beauties and one of the reasons why some of your peers encouraged us to develop the DifDx-Melanoma test was because of the ability to really hand a dermatologist and a patient a very quick one-two punch. It ends up lining up that the DifDx-Melanoma test is producing a tumor biology signature that looks like a malignant melanoma.

The dermatopathologist that you as a dermatologist make that call, we can very rapidly turn around the results for our DecisionDx-Melanoma test so that the right treatment plan can be initiated. Now, as a dermatopathologist, wouldn't you agree that's in the best interest of patient care? I think we have a couple of positive things there that make us very bullish, I guess, in terms of initial openness to evaluate and try our product out. I think our ability to deliver results in a fashion that's near what our validation study will go ahead and drive the rest of the equation. We're quite positive there.

I think it's too early to understand in the marketplace that those dermatopathologists who have not embraced gene expression profiling as an appropriate ancillary test, what's the trigger that will kind of move them from being non-users or non-believers to trying a product out and getting the benefit of having a more accurate diagnosis? That I think will have to work into the marketplace and maybe take a bit longer to kind of get a really, really good feel of how they'll react. Part of that was a request also to say there are some difficult-to-evaluate lesions that aren't even included in the validation studies of some of these existing tests.

If you could include some of those subtypes, that would really make me much more encouraged to think about the value of using gene expression profile tests to help get to a better, more accurate, more confident, I guess I would say, diagnosis. We tried to tackle all those things, Tom. As I said, we were successful. I think we'll have to report back here in another couple of months how the early market trends look.

Sure. Appreciate the color. If I could add a follow-up here. I think you guys had maybe commented briefly there. I may have missed a specific number on new ordering physicians for Dx-Melanoma in the quarter. How's that trend? Relatedly, are there any additional updates from the Salesforce? They've tried to make the increased reach given perhaps more limited access.

Are they still seeing limited access more broadly?

I'll start first. On the sort of maybe third quarter Salesforce trends compared to second quarter, I think largely speaking across the U.S., every sales territory is back open, I guess I would say. Whereas in the second quarter, you had certain parts of the country where you were under strict orders from an essential business standpoint to not be out there, both as a field force and also as dermatologists seeing patients. Both things were shut down in different spots of the country at different times in the second quarter and bleeding into July to a certain extent. I think as we closed out the third quarter of 2020, we did see all territories open for business, I guess you would say, or doctors in all territories open for business.

I think that we saw overall more clinician calls or sales calls being made in person than being made virtual or Zoom calls or telephone calls. I think those are very positive trends. That improved sort of from second quarter throughout the third quarter. I am looking forward to sort of seeing how fourth quarter opens back up. I think we are still believing with the sort of lower rates of melanoma diagnosis in third quarter 2020 compared to third quarter 2019 that we are still seeing clinicians having a difficult time, either one, getting back to seeing the same number of patients in a given day they used to see prior to COVID. That is probably just due to office-based constraints and exam room cleansing techniques, etc., in sort of the COVID area versus pre-COVID era.

I also, we've got some third-party data indicating that even in practices where you're getting close to back to 100%, the number of newly diagnosed skin cancers, not just melanoma, but also squamous cell and basal cell carcinoma, are down compared to where they were during COVID and during the pre-COVID time period. It seems that there is a sort of, and maybe that's all related to a more elderly population being a little more sensitive or cautious about returning for a sort of bump on their skin versus saying, "This bump could be cancer." Again, I think we expect that to go ahead and improve as we go on. Certainly, melanoma doesn't go away.

If you're looking at something on your arm or your forearm or your calf and you've been looking at it for a couple of months thinking, "When do I go in or do I wait?" At some point in time, that's going to get big enough and ugly enough where you're going to make the call to go in. I just hope for the patient's sake it occurs early rather than later. Frank, you want to?

Frank Stokes (CFO)

Yeah. Just to answer the question on clinicians, we had fewer new ordering clinicians this quarter, Q3 of 2020, than we did in Q3 of 2019. Just to be clear, that doesn't mean we had fewer physicians ordering. It just means the pool of new physicians was fewer than last year.

But anecdotally, we had physicians who ordered for the first time in the quarter despite only having virtual interactions with our field team, which we think is great. We'd much rather be live and in person. I think it's a tribute to the outside folks that they're finding ways to pivot to virtual interactions that are, in fact, quite effective.

Great. Very helpful. Thanks, guys.

Thanks, Tom.

Operator (participant)

Thank you. We have a follow-up from Max Masucci with Canaccord Genuity.

Max Masucci (Managing Director and Senior Equity Analyst)

Hey, guys. I think I got boxed out there. It's nice to see the early DecisionDx-SCC volume starting to come in. I guess what sort of early, I know it's early, but are there any early adoption trends that you're seeing?

Can you just give us a sense for how these sales interactions are going, just given the cross-selling opportunity and maybe any differences and similarities compared to the early days of the DecisionDx-Melanoma launch?

Derek Maetzold (Founder, President, and CEO)

Yeah. Thanks. That's a good question, Max. I can provide more color there than I can on the DifDx-Melanoma test just because of the timing, by the way. I think I don't want to get ahead of my enthusiasm here. I think launching new diagnostic tests is difficult to forecast for anybody. I think launching new diagnostic tests in the sort of not full access, not normal interaction period is difficult to forecast even on top of that.

I can't tell you how pleased I am that we had for the first, essentially, two months on the marketplace order flow coming in at, what was it, 280, 84 orders out of a base of 193 doctors. I mean, that is just fantastic as far as I'm concerned. If you map out the sort of first two months compared to other diagnostic tests of similar market sizes in terms of patients or even more, I don't think we've seen one when we kind of looked across the earnings of other companies that matches that. I think it's off to a very good start. Don't overpromise a whole lot, but I think it's off to a very good start.

One of our key goals on the commercial side of the business was to make sure that we tried to educate clinicians in a careful, thoughtful manner as we rolled out DecisionDx-SCC, with the most important measurement being the number of doctors that are ordering the test versus the number of tests that are being ordered. Those should go hand in hand.

I would far rather be in a position at the end of next year to turn around and say, "We have X number of doctors, 1,000, 2,000, 3,000 doctors who have begun incorporating our DecisionDx-SCC test into their practice management habits of patients with one or more risk factors in squamous cell carcinoma versus having 200 or 300 doctors who order a lot." I think that would show you that, one, since squamous cell carcinoma is largely diagnosed by frontline medical dermatologists, having a wider number of physicians evaluate, listen to the literature, understand what we're trying to do, and use our test, even if they order one, two, three, four, five, 10 tests in a year, is a far more sustainable base of business to really push through heavy as reimbursement comes through.

I think those two metrics are very, very positive for us, especially in the first sort of, I guess it's been what, eight or nine weeks? I don't know how many weeks are in September, October this year, but very, very short period of time, very nice trend. That's quite positive. I think that we have the fact that the majority or the vast majority of physicians who ordered our DecisionDx-SCC test are current doctors who are using our DecisionDx-Melanoma test. I think supports our thesis that if you build a business around what a customer needs and you have a customer call point like dermatology or skin cancer, then the ability to kind of leverage that channel should be seen. In fact, I think we're seeing that already in terms of our first two months in the marketplace.

All those things to me say that when we kind of turn the quarter into fourth quarter and the next two quarters of 2021, it's going to be wonderful to see how the DecisionDx-SCC test is impacting a significant number of patients, still very early in launch with a by significant number of healthcare providers. That just sets us up with a really, really wonderful opportunity later next year and in 2022.

Max Masucci (Managing Director and Senior Equity Analyst)

Absolutely. You're getting paid for a portion of your DecisionDx-Melanoma volumes on an out-of-network basis with some commercial payers. Can you just give us a sense for if this is achievable for DecisionDx-SCC and DifDx? Are there any unique factors that may influence your desire to seek out-of-network payments for your new pipeline test launches?

Frank Stokes (CFO)

Yeah, Max. We won't be accruing revenue for those new tests, the two new tests Derek referenced.

At the time we ship the report, we'll only reflect revenue when we actually collect some cash. To your point, that'll be through the appeals process through commercial payers. We think we'll have some success there. It is our policy, as you know. We do bill for the test. We think the evidence is clear that the test adds value to the diagnosis. We bill at appeal and push that through. I don't know how long it'll take to get to where we are with our first two tests, but we're going to work hard on that. As I think you know, we've got a really strong reimbursement and claims appeals team. We're confident that eventually they'll begin to start knocking those over.

Max Masucci (Managing Director and Senior Equity Analyst)

Great. Thanks for squeezing me back in.

Frank Stokes (CFO)

Thanks, Max.

Operator (participant)

Our next question comes from the line of Sung Ji Nam with BTIG.

Sung Ji Nam (Director and Managing Director)

Hi. Thanks for taking the question. Maybe another one for DecisionDx-SCC. Obviously, good volume out of the gate. I was wondering, was there a backlog built into that ahead of the launch? Or should we anticipate continued growth in terms of volume from the 282? Obviously, understanding that given the recent resurgences, there might be some disruptions in terms of patient flow.

Derek Maetzold (Founder, President, and CEO)

Great question. We did have a large or we do have a large number of collaborating centers in the U.S., I think over 50, 55, I think, through the second quarter of investigators or clinicians who are involved in our DecisionDx-SCC test.

We did not go out actively ahead of clinical availability to say, "Hey, this is available," or, "It'll be available in a month or two to hold up your patients," for example. I think the 282 reflects just true normal ramp in an environment here of launching without sort of any people kind of holding or pent-up demand per se. I say that because the other part of the equation is that given that the sales force that sells DecisionDx-Melanoma to dermatology and other skin cancer physicians like surgical oncologists is the one that's launching the DecisionDx-SCC test. Because reimbursement is solid or solid, or that's what is driving our revenue growth, is the melanoma test, the commercial focus really is to say every call during this launch period needs to start out with DecisionDx-Melanoma.

As you complete that and look to how you've moved your doctor along the educational curve, turn the corner and talk about DecisionDx-SCC. My understanding is that the vast majority of physicians have been interested in complying with that order. There are some that say, "Hey, I saw your email request in this call. Can we talk about SCC first?" We certainly comply with that. Thankfully, most of them have been quite good. I think as we move forward in the launch here, we didn't necessarily sort of have all 32 sales representatives on the inside, the entire MSL force, and the inside sales group moving on DecisionDx-SCC at the end of August and early September. They were first moving on the melanoma test and then introducing SCC. I think that gave us a very gentle ramp through September and October.

Sung Ji Nam (Director and Managing Director)

Great. That's very helpful. Then just a clarification question. For the DecisionDx-Melanoma, the study that you guys are doing to determine the appropriateness of adjuvant therapies, are you guys still looking at gene expression profiling or are there other biomarkers that you might consider incorporating?

Derek Maetzold (Founder, President, and CEO)

The protocol enables both, I guess I would say. We're looking at the ability of obviously the currently validated in-market DecisionDx-Melanoma test to identify which patients should be on adjuvant therapy. We also are including additional genomic analyses and also including some liquid biopsy polls to make sure we can tackle all the questions properly at one time.

Sung Ji Nam (Director and Managing Director)

Great. Lastly from me, it's great to see that you're adding new physicians.

We're curious in terms of for your existing physicians, are there efforts underway to help them identify additional patients for the existing physicians that are currently using DecisionDx-Melanoma? Let me have you repeat that one time. I think I'm not. I was just kind of trying to figure out kind of the same-store sales, if you will, given that you are adding new physicians, but was wondering if there are still, I'm assuming there are still a lot of opportunities to help your existing physicians identify other patients that might benefit from.

Derek Maetzold (Founder, President, and CEO)

Okay. I think you're talking about initiatives to kind of help practice marketing activities, which we would like to help our dermatologists become much more productive skin cancer specialists, certainly. That's not the question you asked. Yes, I think there is still plenty of room for same-store sales growth.

Certainly, any new-ordering clinician in the third quarter or first-time ordering doctor probably did not start out July 1 with 10 patients. It is almost always a ramp as somebody evaluates and adopts our tests. Our existing customers are usually more productive just because they are hopefully ordering during the whole quarter as opposed to at some time in the third quarter. We do see opportunities in our ordering doctors to expand the appropriate use of our tests. For example, there are some dermatology practices or physicians where they maybe initially or currently use our tests for only people who are clearly in the sentinel lymph node biopsy referral base. Somebody who has a melanoma that is 0.8 mm or thicker, that is not ulcerated.

We see a lot of dermatologists initially order our tests where they're thinking about referring out for that invasive surgical procedure because that's where they're concerned about risk. They pick 0.8, 0.7, 0.9 as their sort of threshold to start ordering our tests. We see no orders from anybody diagnosed with a melanoma between 0.3 and call it 0.8 millimeters. They're seeing those patients, but they made the decision in their minds that the risk is low enough, I don't need to worry about it. That being said, a significant number of sentinel lymph node procedures occur in those patients with those thinner melanomas. There are certainly recurrences that occur and potentially deaths from melanoma. Part of our commercial team's efforts are to arm each individual sales representative with their own physician data. If they look and see that Dr.

Maetzold, for example, is a pretty good user of our tests, he seems to be incorporating it in the patient care, but he only uses it on 0.8 mm or thicker, then they would tailor their discussion, their message to walk in there and say, "Hey, I think there's a lot of patients here who could benefit from the value of our test in this sort of 0.3 mm-0.8 mm range. Can we talk about that, please?" When that happens, over a couple of effective conversations, we do see many times that the same-store doctor begins using our tests in those thinner melanoma patients, which is fantastic for patient care.

Sung Ji Nam (Director and Managing Director)

Great. Thank you so much for taking the question.

Derek Maetzold (Founder, President, and CEO)

You're welcome.

Operator (participant)

Our next question comes from the line of Puneet Souda with SVB Leerink.

Puneet Souda (Senior Research Analyst)

Yeah, hi, Frank and Derek. A couple of quick questions here.

The volume came in a little bit lower than our estimate in cutaneous melanoma. I just wanted to get a clear view on number one, some of the things that you talked about, but just specifically the sales rep access to dermatology facilities. Do you expect that to tick up in the fourth quarter or maintain sort of at the same levels? We're asking this because obviously we're seeing some challenges from sales rep accessing the oncology clinics in the sort of the virtual setting. I mean doing more virtual versus in-person. Obviously, those are immunocompromised patients. With derm patients, it's a little bit different. The second question is, how should we think about volumes in the fourth quarter given sort of what you're seeing here? On top of it, the impact from holidays, if any?

Derek Maetzold (Founder, President, and CEO)

Great, great questions there.

I'll try to answer that in my order of importance and then see if Frank can correct, or you can double-check what I missed. Puneet, historically speaking, if we look at the last several years running up to our IPO and certainly last year, we usually see that overall fourth-quarter orders or the diagnosis of melanoma is usually similar to the third quarter of each year, kind of around the same ballpark. We do see seasonality in a non-COVID environment where, typically speaking, the third quarter of a year or the fourth quarter of any given year is kind of similar to the third quarter. The first quarter is similar to the fourth quarter. The second quarter is when you see your growth and diagnoses. It sort of is flat for the next three quarters, relatively speaking.

One is that we would not, in a normal year, expect a significant rise in the rate of diagnosis of melanoma in the fourth quarter compared to third quarter. That being said, I think to go to the rep access question first. We did see over the course of second quarter and certainly throughout the third quarter improving trends on a month-to-month basis. I think part of that was related to practices getting more comfortable. Part of it, as you can just see with national public data, is that across the board, healthcare practices are returning to whatever their normal state is. We certainly saw rep access improve as well third quarter compared to second quarter. Our modeling is that we would expect that to continue to improve over time.

Now, how much stronger it gets in the fourth quarter, I think, is tough to say relative to the sort of COVID resurgence concerns in September and October and that impact on sort of changing the mix of in-person calls versus virtual calls. However, on the back end of that, as you have a significant number of patients, we estimate potentially up to 20,000 people who have had a delayed diagnosis of melanoma. When do they come in? I think it's too aggressive to assume they come in in the fourth quarter. All of a sudden, that just doesn't fly past credibility a whole lot. I don't know quite how to guide you to kind of model throughout 2021, what do we see? Or is it sort of post some portion of the population gets a vaccine and all of a sudden they become unleashed?

I think that's going to be a tough thing to think about in the fourth quarter. We do know, though, that fourth quarter should be around what third quarter is in a given normal year in terms of the rate of diagnosis of melanoma. Our representatives are seeing increased access compared to second quarter. I think that carries through to fourth quarter unless you see a blow-up somewhere in the U.S. marketplace. That is positive because that would mean we're returning closer and closer to pre-COVID details or sales call trends. Whether or not that's going to impact what we see over the course of the fourth quarter, I think the more important dynamic is probably when are these missing patients get their melanoma diagnosed properly. I think the holidays are here every year.

Maybe the reason why fourth quarter is usually kind of flat to third quarter is because you have holidays reducing the number of working days in the fourth quarter. Maybe there actually is a slight increase in diagnoses in the fourth quarter over the third, but that gets normalized out by super offices. Frank, you want to?

Frank Stokes (CFO)

No, I agree, Puneet. It'll be interesting to see. I mean, certainly the nationwide COVID case rate has gone up, but it looks like maybe the morbidity has gone down. Maybe that helps people get comfortable. We are certainly glad to see Pfizer's announcement today on their 90% effectiveness vaccine. Some of the early data points we had heard were maybe the first vaccines would be 60%-70% effective.

Gosh, if Pfizer can get to 90%, that's certainly, I guess, better than the bullseye they put up when they started. That was nice to see this morning.

Derek Maetzold (Founder, President, and CEO)

I think the only other thing I think I missed on your questionnaire is I don't know if I view our rate of growth in third quarter 2020 relative to 2019 as soft in terms of the melanoma volume. I think if you take that and you take into consideration the nearly, what, 20% drop in the rate of new diagnoses, that's a pretty healthy jump over last year. We feel good about the overall strength of the business from that point going forward. Those reduced diagnoses are a temporary time shifted phenomenon because we're going to see a lot of patients being diagnosed with stage IV disease, which I don't believe is going to happen.

I think they're going to come back. The question is sort of, I think, when and how.

Puneet Souda (Senior Research Analyst)

Okay. That's helpful. Thanks for the details there. The second, and I'll try to wrap in another question in that as well, is from a point of ASP, it came in, again, a little bit light versus our estimate, sort of in the about $250-$260 lower from Q2 to Q3. Just wondering if there was anything to note there. Is it just reflective of the Medicare population that maybe is not accessing the clinics as much compared to the commercial population, commercial payer population of patients? Then on the expanded LCD, Derek, you said November 22nd as the date and Noridian is December 6. When should we start looking at the potential date for when you can book revenue for these expanded cases if you can elaborate on those two?

Thank you.

Derek Maetzold (Founder, President, and CEO)

Can you handle a second one? Can you handle that first one?

Frank Stokes (CFO)

Yeah. Yeah, Puneet, I don't see anything. Nothing in the ASP trends for the quarter caused us concern. I think that number is going to move around a little bit quarter to quarter. It does seem that the patient base who is most reluctant to get back into the flow is the older population who are, by definition, we're told, the most vulnerable. I suspect there's a modest amount of mixed impact there that may have driven that. Generally, we'll see it move a little bit quarter to quarter, but nothing durable or persistent there that strikes us.

You want to talk about the LCD?

Derek Maetzold (Founder, President, and CEO)

No, no, the LCD. Medicare regulations.

Number one, we certainly expect to have the expanded LCD and the associated billing and coverage article be effective for the full 12 months of 2021. Given the timing of November 22nd and December 6 for both of those MACs in terms of the effective date, the most important thing really is the way Medicare calculates the date of service for a test like ours or any test like ours. That date of service is usually going to be the date of surgery or the date the biopsy was taken. At least in our workflow, that's the majority of the time.

What that would mean is if somebody had, I think the 22nd is a Sunday, if somebody went into their dermatologist on Saturday and had a biopsy taken Saturday, even if a dermatologist ordered the test on the 23rd of November, that Monday, it's going to be a test that we would be reporting with a date of service that was November 21st. I think what you're looking at here is somewhere between probably three and four weeks of melanomas that are diagnosed mainly in December that would be eligible to be paid for under the expanded LCD. Certainly, our laboratory group and billing group are going to make sure that all appropriate cases are submitted as covered under the LCD as we always have.

I think the amount that would be flushed into the fourth quarter maybe, rather than having it be a three-month quarter for Medicare claims, ends up being a three and a half to three months and three weeks type of a thing is probably the way to kind of think through that from a modeling standpoint.

Puneet Souda (Senior Research Analyst)

Great. Thank you.

Operator (participant)

Thank you. Now I'll turn the call back over to President and CEO Derek Maetzold for any further remarks.

Derek Maetzold (Founder, President, and CEO)

Thank you, Andrew. This concludes our third quarter 2020 earnings call. I thank you again for joining us today and for your continued interest in Castle Biosciences. Have a good day.

Operator (participant)

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect.