Castle Biosciences, Inc. (CSTL) Earnings Call Transcript & Summary

For our next presentation, we have Castle Biosciences. Representing Castle is Derek Maetzold, CEO. The floor is yours, Derek.

Thank you, [ Dam ]. And thank you, Credit Suisse, for the invitation to come and have a conversation about Castle Biosciences. So I'm going to run through some top line of our second quarter -- our third quarter earnings release a couple of weeks ago and then move into kind of a broader business conversation where Castle is today and where we think we're going to go tomorrow. Disclaimer and forward-looking statements. So -- we had an excellent third quarter performance from my perspective. We saw both test report volume and revenue grow 57%, 58%, respectively over the respective quarters in 2021. So nice solid performance from the team in the third quarter. On an adjusted gross margin perspective, we are coming in at 76.2% for the third quarter, down from 80%, but that really reflects scaling up in terms of test volume that we're seeing from a forward-looking perspective. So about where we thought we would be a year or so ago. So that feels nice and strong, still industry-leading margins from adjusted gross margin perspective. And we ended up utilizing just over $5 million in cash in the third quarter of this year, and we're sitting on $166 million in cash and cash equivalents. So very healthy from a financial balance sheet to really continue to allocate our capital in a fashion to grow our business to profitability in the next couple of years. So from an overall company perspective, I'm going to focus more on the -- let's see here -- more and I think where we sort of see our products today and where they fit in on from a patient journey. Just to give you a better sense of the company. So we focus on really 4 areas from a customer call point perspective. Our largest franchise offers 4 tests that serve 3 different patient populations in the dermatology, skin cancer marketplace today. DecisionDx-Melanoma for patients who are diagnosed with invasive melanoma. DecisionDx-SCC, which is for patients diagnosed with cutaneous squamous cell carcinoma or squamous cell carcinoma of the skin. And then 2 tests that are offered to help dermatopathologists or pathologists who are reviewing a biopsy that was taken to rule in or rule out melanoma and are sitting on 1 of those lesions or biopsies, which is really quite difficult to diagnose. Is this really melanoma am I looking at? Or is it the benign lesion? So both of our tests, MyPath Melanoma and DiffDx-Melanoma are used to help the pathologists make a more definitive diagnosis in calling 1 of those borderline lesions, melanoma or not. We have a legacy test in a small area of melanoma called Uveal Melanoma that we will not be discussing beyond this slide today. This is a rare cancer disease state. That was one of the first test to help launch the company a little over a decade ago. This is currently standard of care in about -- in a patient population of roughly 2,000 patients diagnosed per year. It's not a revenue driver about a very, very important test in terms of meeting the needs of patients who have a great clinical need to help their management post diagnosis be guided by the risk of progression. We have, in the last 12 months, completed 2 acquisitions. One of them took us into the gastroenterology marketplace with a product called TissueCypher for patients diagnosed with Barrett's esophagus. We'll spend a few minutes on that later on in the presentation. And then in April of this year, we completed an acquisition that brought us a product called IDgenetix, which is used to really help guide therapy selection based upon the pharmacogenomic profiling coupled with drug-drug interaction profiling, coupled with lifestyle profiling. So we have 1 test in IDgenetix that actually reports out 3 different elements that are combined together and a buyer from [indiscernible] platform that includes drug gene, drug-drug and lifestyle factors. That's a differentiator in this marketplace of sort of pharmacogenomic testing overall. From a strategic guidepost perspective over the next couple of years, we really focus on trying to do well, do exceptional in these 3 areas. First is to really recruit and maintain -- and retain and grow an exceptional employee base. Without the employee base at Castle Biosciences, we would not be developing the test that we've developed so far. We would not be generating evidence that helps clinicians think about how to use our tests and also have payers pay for our tests. And without our sales force and our commercial team, medical affairs team, we wouldn't be moving forward to improve use of these tests to improve penetration. And of course, the backbone of the company from a manufacturing standpoint, laboratory, laboratory services and reimbursement groups. We also work to continuously evolve our products and improve upon them. We'll touch upon that a little bit, I think, in the DecisionDx-Melanoma test section. And then finally, everything we do executionally, I think focuses around our customer. Are the decisions that we're making are the products that we're offering going to have an impact in improving patient care? And if they are, then let's stay focused, we're going to do that better. And if we stay within these 3 guideposts, we believe that's what leads Castle to execute how it has so far since the IPO and how we expect to do the next several years going forward. From a growth perspective, if we sort of put those 3 franchises or products together, what you can see here is sort of near to midterm growth and the mid- to long-term growth. We still expect our dermatology franchise in the mid- to long-term growth to be really the bulk from any individual business unit perspective in terms of driving revenue. We believe that we will have a mixture looking out of both our existing gastroenterology franchise and our mental health franchise contribute meaningfully to revenue in the mid- to long term. And as we see our pipeline products that we're currently working on come to marketplace, there will obviously be important contributors in the mid- to long term in terms of overall gross output. It gives you a sense of where we see the business in the near term and where we think it's going to go in the mid- to long term. From a where does Castle play perspective, we think about clinical needs along kind of a patient continuum. Patients who are healthy might have a need to undergo screening tests. Patients who have some kind of signs or symptoms of disease may have a need to improve diagnostic accuracy or diagnostic support tests. All patients who were diagnosed with disease states need support in terms of risk stratification or prognostic information. What am I facing tomorrow with the disease, I've just been diagnosed with and what's the right treatment or management plan I should be undergoing as an individual patient or as a clinician, which should I be recommending to my patients. And that includes, to a certain extent, early therapeutic response markers. And then finally, certainly in the case of cancer, you have sort of a minimal residual disease or disease recurrence monitoring. From Castle's perspective, we believe that we don't have any value today in working on tests that support screening opportunities. We also believe that we don't have any value today in focusing on tests that are providing recurrence monitoring opportunities downstream. So we focus our development efforts, our R&D efforts and our commercial efforts really on trying to assist better patient care by adding clarity to sort of difficult to diagnose diseases by helping to improve risk stratification and therapeutic and treatment selections. And if we can stay here, we believe we found a winning form to go ahead and manage revenues today and grow tomorrow. From an overall TAM perspective, we went from having just under, I guess, you call it, $3 billion in commercialized U.S. products 1.5 years ago to now having a U.S. TAM that we believe is approaching $8 billion in opportunity for Castle Biosciences. As I said earlier, we have these 3 franchise areas in dermatology which are adding up to around $2 billion. That represents our more mature product opportunity with the acquisition of TissueCypher for use in patients with Barrett's esophagus in our gastroenterology franchise. We believe that's roughly a $1 billion opportunity at today's pricing. And our Mental Health franchise offers the largest opportunity over time to grow, which is a potential $5 billion U.S. market opportunity. We also have an active pipeline, as I mentioned earlier. And of those development tests turning to market realities in the near term, we think that walks us into another $3.6 billion U.S. TAM. So from an organizational perspective and a strategic imperative perspective, we believe, as we move towards the middle of marketplace of this decade, we can move from an $8 billion market potential with very low penetration in general to adding another $3 billion, $3.5 billion of marketplace as kind of middle of the decade going to the end of the year without any additional development efforts or acquisitions efforts, which puts us, I think, a new very, very nice sweet spot from a company growth perspective. We did, in our September investor meeting, provide some guidance in terms of what we were thinking about what we should look like in the 3-year period outlook of looking at 2025 overall. We believe that in the next 3 years with assumptions that we made that are not aggressive assumptions that we will end up with a revenue in 2025, somewhere between $255 million and $330 million, representing roughly 25% to 35% CAGR growth in the next 3 years. That's the reason revenue target for us to get to. We believe, as we scale our laboratory facilities and reimbursement matches tests delivered, that we will have our adjusted gross margins end up floating around the 80 to 85 percentile range. And from an operating revenue perspective, we expect -- our other operating expenses, we expect those to run about 75%, 80% of revenue by 2025, and we expect 2025 to be a net operating cash flow positive. So reasonable metrics to go what's out there today, high-growth opportunity sitting on $266 million in cash, and getting to net operating cash flow positivity here in the next couple of years. We have seen over the last year or so, here, you can see third quarter '21 through third quarter 2022. Growth in our operating expenses on a quarterly basis, but it will point out to you that with the acquisition closure of AltheaDx in the second quarter of this year, we're actually seeing a nice moderation of our operating expenses. If you go ahead and adjust out a change in contingency consideration, we're sitting in the third -- in the second quarter of this year with roughly $56 million, $58 million in expenses, which was essentially what our burn rate was, our expense investment wise in the third quarter of 2022. So a stabilization, I think, of our expense growth, at least in the last 2 quarters from a net standpoint. Highlighting our accomplishments here. You can read this slide in detail. I would just point out a couple of points. One of them is, again, very nice strong revenue growth of 58% third quarter over third quarter 2021, which paralleled out our total test volume growth of 57% over last year third quarter. We did see in the early part of July, the American Gastroenterology task force that reviews technologies and Barret's esophagus was published. That update was published and included a best practice statement, which essentially recommends the use of the TissueCypher test in patients diagnosed with non-dysplastic Barrett's esophagus. I'll get into why that's important here, a few slides down the road. We continue to see a very nice movement forward in terms of peer-reviewed publications with more coming out later this year. And we continue to see ourselves as a company being recognized both nationally by our engagement surveys, from employee base as well as on a local basis in terms of the progress that we're making in this case, noting that we were one of the few recipients to receive the AZBioFast Lane Award opportunity here in September this year. Upcoming, I think what we see here are several things that you should be thinking about. One of them is that we talked earlier this year, I think it was the first time it was probably second quarter earnings about the fact that we entered into an ongoing collaboration with the National Cancer Institute SEER Registry program. And the first effort of that was to match clinically tested patients who had received DecisionDx-Melanoma test reports as part of their care to the patients who are in the SEER Registry program and then look at the outcomes of that. And although the peer-reviewed publication has not yet made its way through the editorial process, this represents a very large prospective real-world opportunity to look at the performance of DecisionDx-Melanoma in the U.S.-based population as data is reported in the SEER and compare it by the way to how patients who aren't tested with DecisionDx-Melanoma fair, I'll go into that data here in a little while as well. The other area I would point out is that we did apply for and did receive ADLT status for our TissueCypher test for Barret's esophagus at the end of March of 2022. This did a few things. It simplifies billing certainly for Medicare beneficiaries due to the exemption from the 14-day rule. But it also, as an ADLT test, meant that April through August was our first 6-month collection period that ended at the end of August, we submitted our data to CMS in the September window. And sometime later this year in December, maybe early January, we will have our 2-year rate established for the TissueCypher test for '23 and '24 based upon the 6-month collection period from April through August. So we're looking forward to that coming out here and being effective in January 1 of 2023. So let's talk a bit about the DecisionDx-Melanoma from a test perspective. So the purpose of this slide is to recognize that the majority of patients diagnosed with melanoma, thankfully or diagnosed with what we would call low-risk disease. They have stage 1 or 2 disease, which, by definition, means it's localized only. There's no evidence that the melanoma has spread beyond the primary tumor site. And that's a good thing as opposed to diagnosing patients with later-stage regional disease or even metastatic disease, which has a worse outcome from a patient care standpoint. But the crux of the issue is that because these patients with lower risk represent so many patients out there. And many of these patients' treatment pathway because they are expected to have a low risk of disease progression are put on more watchful waiting protocols. They go back to a dermatologist for routine skin checks predominantly. Every now and then, one would go ahead and check for is there a metastatic event going on. Basically speaking, we assume they're out of the woods. Because there are so many of them though, they actually represent more than half of the patients who go on and our risk of succumbing to death from that melanoma because there are so many of them. And the value of our test is to go into this group of low-risk patients and find those patients actually harboring very aggressive disease. And we answer 2 specific questions that are important in the early management of melanoma. The first 1 is to say, is this patient at a high enough risk that they should be set forward to a surgeon for a sentinel lymph node biopsy surgical procedure. This is a procedure that requires general anesthesia. A couple of dies are injected at the tumor site, and 1 goes and sees if we can find melanoma cells in the sentinel or the nearest lymph node to that melanoma. It's a procedure that we thought a couple of decades ago was therapeutic, i.e., removing those melanoma cells, a patient would live longer. Unfortunately, that doesn't seem to be the case. So it's really just an invasive surgically directed prognostic test or risk stratification procedure. Now that sounds good from a standpoint of patient care. You want to find people harboring aggressive disease, but if you just use pathology factors alone to determine which patients should go for that procedure and which should not, it finds out that the pathology features leave some things to be desired. For instance, if you take 100 people on average, who meet the qualifications to undergo that sentinel lymph node surgical procedure, 88 of them have no melanoma in their sentinel lymph nodes. So 88 out of 100 could have potentially avoided this unnecessary procedure if only you had a tool to figure out in advance of surgery who those patients may or may not be. One of the uses of our test is to go ahead and interrogate the biology of that primary melanoma using the biopsy specimen that was taken for diagnosis and be able to say, does this patient have a low likelihood? In this case, the national standards are less than 5% chance of being sentinel lymph node positive. And if that's the case, the national guidelines say you shouldn't be offering that patient that procedure. In our studies that we published so far, that means we could potentially remove about 70%, 75% of sentinel lymph node biopsy procedures in patients who would qualify for that procedure who could potentially take off of the table because they have such a low likelihood of having a positive node that goes forward. The other use of our test is really saying, well, after that procedural decision was made, am I facing a patient with low-risk disease or high-risk disease because those patients are in 2 different management pathways. And our test again helps to take these more [ cruder ] pathology features and restructure them so that we get more patients with lower disease, active identified who can go on more of a watchful waiting skin check approach and we can find those more aggressive bad-acting melanomas and make sure they're in a high-risk treating pathway going forward. Those are the 2 uses of our tests that are validated, that are covered today from a health care policy standpoint. I will skip through these couple of slides here in the essence of time. I want to touch base on this collaboration with the National Cancer Institute I talked about earlier. There are 2 slides here. A little bit of data on these slides. The element here to think about is the lower row of data here. What this shows you is that when you match patients who were tested with DecisionDx-Melanoma in the SEER database to patients who looked the same. So same level of Breslow's thickness, same pathology factors, gender, age, where they live, what their income level looks like, what county they live in, the access to care, match all those elements where we saw at 3 years post diagnosis was a 27% improvement in survival in patients who have the benefit of having DecisionDx-Melanoma as part of their care compared to those patients who did not receive our test as part of their care. Now you might say that sounds pretty impressive, which I think it is, by the way, but what's the absolute difference? How does that compare to what else we see? We went back and pulled up a previous collaboration that was done with Genomic Health or Exact Sciences Oncotype DX for breast cancer test published just a couple of years ago. In that study, if you go ahead and calculate the 3-year breast cancer survival rate, so BCSS, what you see is a 0.5% absolute mortality improvement in patients who received Oncotype for breast cancer compared to matched patients who did not. So not only are you able to go ahead and reduce unnecessary chemotherapy use in this patient population, but patients actually show an improved survival because you're also getting the prognostic benefit of who has aggressive disease versus who doesn't. Similarly, in the case of our DecisionDx-Melanoma test on the right-hand side of the slide, what we saw in the first matching of data was nearly a doubling of the absolute mortality benefit in melanoma. Again, a test in DecisionDx-Melanoma, which number one, helps define patients remove an unnecessary treatment or procedure in this case is in the biopsy procedure and then improve risk stratification. So we see one, a similar risk stratification of our test in low risk versus high-risk disease. And then comparing to unmatched patients, we see nearly a doubling benefit compared to Oncotype for breast in breast cancer compared to DecisionDx-Melanoma in melanoma patients. So what does that mean clinically? Or what does that mean from a company standpoint? We believe that when the peer-reviewed publication comes out that our clinicians can read through and sort through and challenge and jump on, that this will be a nice driver from [ Prue ] penetration, '23 and '24. This is also an ongoing collaboration. So we expect to match future data sets as we go forward to have us be a driver of a very, very nice risk data set demonstrating the improved outcomes that use of our test provides compared to nonuse of our test. The other benefit which I think we will see materialize later in '23 and '24 will be the opportunity to see improved commercial coverage. Why would that be? One of the core questions or pushbacks that all tests have is if I pay for your test, I can see that decisions are being made short term, but does it really change patient outcomes. I would say taking data that's not Castle's, but taking data from the National Cancer Institute SEER-Registry program, real-world evidence, prospective data sets, large unbiased data sets and demonstrating improved outcomes as in people live longer when they receive our test results versus those that do not is about as good as you can get. So we expect, again, this data will be foundational to improving penetration over time of our test results. And #2 is that we expect to see improved reimbursement success on the commercial side. Again, not immediate upon publication but an important element to move through the review process of major payers. So let's talk a bit about DecisionDx-SCC. This is another skin cancer test, as I mentioned earlier. It's interesting we used to believe that melanoma was the most significant skin cancer in terms of mortality. It turns out, though, in the last several decades, we've seen a more rapid increase in the diagnosis of squamous cell carcinoma of the skin such that today, it's estimated that there are nearly twice as many deaths from squamous cell carcinoma as from what is the most deadly cancer of the skin, which is melanoma. So again, a very important unmet need here, which is to say, can we find people who appear to be mismatched. Their outcomes are worse than a squamous cell carcinoma tells us or vice versa. They have a fairly aggressive looking squamous cell carcinoma on pathology, but actually have a relatively benign course of outcomes. That's what our test was targeted on, and that's the uptake that we're seeing in the current clinical marketplace. So what's that look like? Similar to our DecisionDx-Melanoma test, the patient presents to a clinician in this case, dermatology, again, is a marketplace. A biopsy is taken, they have pathologically confirmed cutaneous melanoma with 1 or more high-risk factors. That qualifies that patient for testing if the doctor and the patient, I think, they'll use our results to make a difference in patient care. And then we report out either a low-risk Class 1 result, a moderate risk Class IIa or high-risk Class IIb results. So very similar in outcomes as we do with our DecisionDx-Melanoma test. And the data shown here in this [indiscernible] curve shows you the kind of risk stratification that we can provide in a patient population who is deemed to be high risk by NCCN guidelines. So people are in the green bar there, have a much lower likelihood of progressing and metastasizing than people in that red Class IIb bar. So again a very, very strong risk stratification. And that translates into very, very healthy clinical utility changes because our clinicians, our dermatologists or radiation oncology are thinking about is this a patient who is risky enough that I, for instance, want to prescribe radiation therapy to sort of slow down the chance of metastasis or is this patient's risk of progression low enough where I can potentially avoid that interventional therapy. So again very, very nice strong utility data. We're in the early launch of that test. But again, a very, very promising uptake from a clinical standpoint. And as you know, we went through a Medicare review earlier this year and are currently receiving reimbursement for this test for this high-risk defined patient population. I'm going to skip through MyPath Melanoma and DiffDx, I want to spend a few minutes here on our Barret's esophagus disease test. So let's talk about this disease state here. One is that we think on the low end, there are roughly 435,000 Barret's related endoscopies done per year. So a nice large patient population. Keep in mind, we're at 200,000 patients with squamous cell carcinoma and 130,000 patients with cutaneous melanoma. So 3x the potential market size of our melanoma test overall, if we assume full penetration rates. And most patients, I mentioned earlier, are diagnosed with non-dysplastic Barret's esophagus, which is where AGA recommends our test be utilized in. So why is that important? One is that because there are so many patients in this non-dysplastic group, and despite them having "the lowest risk progression likelihood" because there are so many in the denominator, they, again, like melanoma, make up about half the patients who actually progress. So we're missing people who could be treated to slow down the progression to esophageal cancer -- excuse me a second. So why is that important? Well, it goes to. This slide here. So this slide shows you the likelihood of progressing over 5 years to either -- to a high-grade dysplasia or esophageal cancer by grade. Non-dysplastic patients are the most benign patients, indefinite, IND, the next group, then low-grade dysplasia and actually. Now why is this important to think about? Well, in the U.S. today, nearly every patient who receives a high-grade dysplasia diagnosis or low grade gets offered ablation therapy. So we're intervening, we're essentially trying to kill that Barrett's lesion in the esophagus. So it will not progress to esophageal cancer. That's current standard of care. That sounds great because that has the highest risk of progression if left untreated compared to non-dysplastic disease. What turns out when you use our TissueCypher test on top of pathology grading and look just at those 2 red bars on the right-hand side of your slide, if you receive a high-risk TissueCypher test score in patients with non-dysplastic disease, you actually have a risk that's more than 50% likely progressing without treatment to esophageal cancer compared to patients with low-grade dysplasia, which today, we offer ablation therapy to intervene and hopefully stop that progression. That is real clinic utility, which should help save lives over time. That's the value we saw during [indiscernible] diligence. That's exciting from my standpoint is this test just gets launched in the U.S. marketplace and moving forward in the future. In the case of IDgenetix, which is our most recent acquisition, entering us into the Mental Health field, I'll remind you that we -- this acquisition brought us into what we believe is on the upside, roughly a $5 billion U.S. TAM. We like this category of testing because, one, it's not a category we have to build from ground zero or hope that our market research is there. We see examples a very nice progress of pharmacogenomic testing alternatives in the marketplace today. We believe we have a best-in-class test that can provide value to patients, which means value to Castle Biosciences and its shareholders over time. So the most important element here is that there have been several randomized controlled trials looking at if you have therapy selected based upon a test like IDgenetix versus physician's choice, doesn't make a difference. In the case of our randomized controlled trial, what we were able to demonstrate was an improvement in both response rate and remission rates in patients diagnosed with major depressive disorder compared to physician's choice. It's this kind of clinical data when you take it forward to physicians who says, "Wow, that's pretty interesting. I can actually improve my patient's response quicker if I know what drugs to use. That also is why we believe we received a really solid and expanded Medicare coverage opportunity early this year. It's why we believe UnitedHealthcare also covers this test is because it sees the value of a randomized controlled trial to make therapeutic selection choices. And with that, I'll summarize that because we are out of time, [ Dan ].

Well, great. Thank you, Derek.

Thank you.