Good afternoon, and welcome to Castle Biosciences First 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.

Thank you, Shannon. Good afternoon, everyone. Welcome to Castle Biosciences' first-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, May 11, 2020. Therefore, if you're 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 provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon current expectations and involve inherent risks and uncertainties, and there can be no assurances that the results contemplated in these statements will be realized. A number of factors and risks could cause actual results to differ materially from those contained in these forward-looking statements. These factors and other risks and uncertainties are described in detail in the company's annual report on Form 10-K for the year ended December 31, 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.

Thank you, Frank, and good afternoon, everyone. Thank you for joining us today. I hope, first of all, that you are safe and healthy, and our thoughts go out to those who have been impacted by the COVID-19 pandemic. As you would expect, today's call has a different structure than normal. Before we discuss our 1Q results in detail, we'll talk about the actions we've taken to respond to the situation, the impact the COVID-19 pandemic is having on our business and what we are seeing in terms of clinician behavior and diagnosis of melanoma. And of course, unfortunately, the march of skin cancer does not stop. And that means that we need to focus on what is best in managing a patient's diagnosed with early stage skin cancer. At Castle, we are committed to our employees, to patients, customers and communities in this unprecedented, uncertain environment. While we can't predict how things will turn out, as has been our practice, we will be transparent here about our assumptions and what we know today. We will continue to be forthcoming as the situation evolves, and we believe we will have more visibility in the coming months. Before I provide details around our response to the pandemic, I would like to point out that our team performed extremely well in the first quarter. As a reminder, we had significant momentum drivers in the second half of 2019, including additional evidence development, as well as commercial expansion that occurred on December 1. These drivers were essential our first quarter 2020 year-over-year quarterly revenue growth of 100%, reflecting a mix of both growths in ASP, as well as the DecisionDx test report volume. Our business in the first quarter on track. And I'm excited to see our team regain momentum and perform as…

Thank you, Derek. As Derek shared earlier, we're confident that our business fundamentals are strong and the continued investments we are making in our business enable us to navigate the COVID-19-related uncertainties that lie ahead, as well as continue to position us for long-term growth. We're pleased with our strong execution and growth in the first quarter. We reported revenue of $17.4 million in the first quarter of 2020, a 100% increase from $8.7 million in the first quarter of 2019. Our increased revenue was driven by a 42% increase in the first quarter in DecisionDx-Melanoma test reports compared to the first quarter of 2019 and higher revenue per test, or ASP. The first-quarter revenue includes $3.2 million of positive revenue adjustments, compared to positive adjustments of $0.6 million for the first quarter of 2019. The increase in positive revenue adjustments primarily relates to cash collections in the period on test reports delivered prior to the first quarter, in other words, in previous periods for which no revenue was recognized originally. No revenue was recognized originally in line with the requirements for revenue recognition under GAAP. We believe, based on recent reimbursement activity, additional positive adjustments in future periods at some level are possible. Our gross margin during the first quarter was 86%, compared to 82% for the first-quarter 2019. The improvement in gross margin was primarily driven by operating leverage as a result of our strong volume growth and higher ASP. Our operating expenses for the quarter ended March 30, 2020, were $13.9 million, compared to $7.4 million for the same period last year. This increase was primarily the result of higher personnel costs particularly due to the expansion of our sales and marketing organization but also due to the expansion of administrative support functions, as well as increases…

Thank you, Frank. In summary, we are extremely pleased with our team's first-quarter performance, including strong year-over-year growth in revenue and volume for our DecisionDx-Melanoma test. Although near-term uncertainties exist, we remain confident in our long-term outlook for the company and our ability to maintain our position as a leading skin cancer diagnostics company. Thank you for your continued interest in Castle. This concludes our remarks. Operator, we are now ready for Q&A.

[Operator Instructions]. Our first question comes from Max Masucci with Canaccord Genuity. Your line is open.

So I guess as it relates to the delay between a patient's initial tissue biopsy and when that DecisionDx-Melanoma test is run, how should we be thinking about the timing of volume impacts, whether that's Q2, Q3 or beyond as we just look at the current state of elective procedures?

I think the evidence that we've gathered from both our proprietary studies, as well as data in the dermatological practice surveys overall, it appears that the vast majority of dermatological offices lease those that are medically oriented. I can't comment on cosmetics by any means, at least the medically oriented clinics are planning on opening up as soon as they can. They're planning on adding an extra day to practice to try and catch up will be delayed or canceled or rescheduled appointments, and they're estimating two to three months before they are sort of caught up. So that's kind of our customers' expectations. I guess the sort of the larger question might be, do patients feel comfortable coming back in early May, early June, for example, as that's going to take another couple of months before they get comfortable coming into seeing their physicians. So that's the part we obviously don't have a handle on. And I guess our hope would be that individuals who are at risk to develop skin cancer had developed a pigmental lesion on their skin that they're seeing, does that cause a patient of Medicare age to wait an extra month or so before they come in? I think we have a hard time thinking given the sort of growth patterns of melanoma that you'd see a patient ignoring that growing melanoma or growing compete for melanoma on their skin for the entirety of 2020. But again, that's the part we don't quite have a handle on is sort of what that patient fear factor balances against the patient's desire to actually have that lesion be looked at and hopefully confirm at it may not be melanoma as opposed it is melanoma. The other element, I think, which probably, I would say, moves in our favor necessarily, but certainly, if we go ahead and look at the difference of expectations between private practice dermatology opening up and institutional academic practices or tertiary care centers, it does seem that the tertiary care centers are moving a little bit slower from what we can gather across the U.S. than their counterparts in private practice that bodes a bit better for us. The vast majority of our orders and, certainly, our call patterns with our commercial groups are on private practice clinicians as opposed to institutional-based clinicians. I don't know if that gets to the answer you were thinking about trying to get to.

And then great to see the two pipeline tests on track to launch in Q3 and later this year. Just within the current environment, can you just help us understand your expectations for the launches of DecisionDx-SCC in the early days? And then maybe any comment on cross-selling or the attachment rate to DecisionDx-Melanoma would be great.

So we've been evaluating the complexity that we're going to add into our field forces to launch both the DecisionDx-SCC test, as well as other pipeline tests for assisting in differential diagnosis of suspicious pigmental lesions. We have made, I guess, the following decisions. One of them is that we will fully train our existing 32 sales representatives and their counterparts in the medical affairs or medical science liaison group on the cutaneous squamous cell carcinoma tests, and that those groups will sort of launch that test nationally. On a relative balance expectation, we would expect kind of the vast majority, call it, 90% of interactions to be continuing to educate our core customers and future customers on our cutaneous melanoma assay with a second call position, if you want to kind of call it first and second on the squamous cell carcinoma test. And we believe we have the people in place to be able to balance that properly. In terms of the suspicious pigmental lesion assay, we made the decision that when we launch that, we will launch that with a separate, dedicated expansion force that will be focused on sort of the dermatic pathology call point as opposed to the dermatology call point, which the other sales force will focus on, and that will be important. I think that reduces the complexity of trying to have our representatives and our medical science liaisons balance two new products plus a recently new product, the DecisionDx-Melanoma test and by reducing that complexity by having, at least initially, a separate car route group and what that group focuses predominantly on the second pipeline test launch. And then we can see over time, if we believe it is in our benefit to keep that separate or to go ahead and pull that back in once we kind of see performance over time.

And then maybe just a quick modeling question for Frank, as it relates to the $8.3 million Medicare payment. I guess, will that hit the balance sheet and then gradually convert to revenues over time? And we've seen some other specialty labs start getting paid expanded LCDs ahead of the finalization. So I'm just thinking in regards to the timing of any step-up in ASPs in our models. And that's it for me, a nice quarter.

It won't impact revenue. Revenue, of course, will be reflected as we ship test reports out. Obviously, it's cash and a liability, and that liability will sort of erode away as we file claims. And those claims are recouped against that advance.

Our next question comes from Catherine Schulte with Baird. Your line is open.

I guess just first, you talked about seeing a stabilization in the decline of orders beginning in the second week of April. Any color on what terms have looked like in recent weeks or how orders trended so far in May compared to last year, just to give us a sense of how activity levels might be coming back?

We're pointing fingers to each other here, Catherine.

So I think that's a finance question for Derek, Catherine, let me take a swipe at it. We saw the order rate drop as the shutdown sort of spread and then kind of there was a sort of bolus of shutdowns that came through. So we saw orders drop on a week-to-week basis in the early kind of middle part of April, and then that drop sort of tapered off and have kind of stabilized. And we're not far enough in yet, I think, to say that we're seeing things accelerate again yet. But we are encouraged that the drop seems to have kind of found itself a bottom here.

And certainly, as you can expect, as you see different states and even different locales within a state different policies of sort of reopening for what we would view as essential medical commerce, we are hearing from our field-based groups that some places are sort of back up and running, I guess, you would say, as hard as they can to go ahead and try and catch these patients who had for delayed appointments. And other places are still saying, give us a couple of weeks or two, before we move forward. So I think during the course of the next, I'm assuming four to five weeks, we're going to kind of see geographical variations of what that looks like. So hopefully, by the time we enter the early parts, the middle of June, we'll have a much better handle on what patient flow looks like in the field of dermatology.

And how receptive have derms been to virtual appointments with your reps? Have you been able to get new practices? Or is it primarily existing customers? And to that vein, what's been your typical mix of volume growth originating from new customers versus existing accounts?

So I'll answer the first part of that. I don't know if we've disclosed the volume by new or old customers through the quarter. So I think that the group has been very effective at converting appointments to either significant telephonic or email conversations, including web-based appointments. We've pivoted all of our speaker programs certainly toward web-based seminars, have also been doing quite a lot of advisory board work to try and understand the marketplace and the kind of adjustments here better, too. And I think I have nothing but high compliments in terms of the output of those interactions. I don't have any quantitative data regarding our 90% of our interactions with better web-based, telephonic or web-based discussions with current customers versus kind of new customers. I know I can think anecdotally of discussions I had last week with our head of the commercial group where there have certainly been interactions with nonordering clinicians that are coming onboard. So those are happening. But I would assume that the focus of the access point is probably very, very tilted toward individual clinicians who have reviewed our tests, decided to adopt it, and they're giving us time to understand how the latest publications and papers can help improve their use of the test clinically. And we probably are seeing a reduction in terms of new customer visits, so that would be my natural sense, but I would expect we'll see and we kind of trim the corner to analyze that data later on this quarter.

And the last one for me. For the separate dedicated sales force to focus on selling the suspicious pigmental lesion test and the derm path lab call point, how large are you thinking that group will be?

I think that's under evaluation. We had indicated, I guess, earlier in the year that we were certainly budgeting at least sort of a nine to 10-person expand and weren't quite sure if we would hold that in or keep it separate. I don't know if we know that big, to be honest, but that's kind of what we're thinking about right now. We'll kind of scale down or scale up as we get through market research over the course of the summertime. I think it's essentially kind of a single region. Now what that rep control looks like is the question we're wrestling well.

Our next question comes from Sung Ji Nam with BTIG. Your line is open.

Hope everyone is staying safe and healthy. I was wondering, I don't know if this might be early, and there are a lot of moving pieces, but how is the value proposition for your test? Have they resonated the value proposition resonated better in the current COVID-19 pandemic environment given that the test could potentially eliminate other more invasive procedures?

So qualitatively, I would say yes. But if you ask me to point to a study, I would say I don't have that. Just as maybe a 30-second reminder for the others on the call here, so our cutaneous melanoma test is a DecisionDx-Melanoma test, of course, is able to predict spreading our metastasis, and that includes starting to the sentinel lymph node biopsy or the sentinel lymph node area. So it can affect that biopsy decision of the sentinel lymph node. It also predicts recurrence to any part of the body beyond the sentinel lymph node, as well as system metastasis and depth of the melanoma. So the impact of being able to perhaps safely have a patient ruled out or safely triaged for a sentinel lymph node biopsy procedure and sort of this COVID-19 rebalancing and risk-benefit, I think, is very real, if that's what you're kind of getting at. I think that's a point we're going to continue to understand with our customers in a careful manner of what's best for the patient. In terms of the next series of decisions, do we have that patient come back to an ambulatory care center or to an institution for active surveillance with CT imaging, for example? Are we OK having that patient being seen only for clinical follow-up visits in a private practice setting? I think we can impact that kind of risk-benefit as well. As we talked about maybe earlier, we do have data indicating that people who have stage three disease, so those patients who are sentinel lymph node-positive, we do, in fact, achieve a very, very nice, strong stratification in that overall group between people who actually have a low-risk of metastasizing and perhaps succumbing to melanoma from a high-risk. That data set is more limited than our data in earlier stage one and two patients have localized these earlier. But one can imagine as we sort of get back into the clinics here, do we see an increase in perceived utility because maybe we're helping make decisions on watchful waiting as being a much more appropriate way to go or at least clinically, watchful waiting versus kind of being aggressive either in the surgical procedure area or with sentinel lymph node biopsy procedures or even adjuvant therapy. Again, I don't have hard data to say that we've seen sort of a life for many customers. We certainly hear those interactions today.

And then you talked about the proprietary dermatology practice surveys, as well as other studies out there. Just curious, if there's any information around what the role of telemedicine is in the current environment and was curious given the urgency of some of these potential patients, do you think that could be a driver of the patient flow going forward in terms of creating more urgency for the patients to go see their dermatologist?

So, yes, we are aware of some data, including our own. We saw a shift. I think the last survey that we did, the one we just talked about on the earnings call was sort of field maybe a week and half ago. And I believe that the data on that show that 90% of practices were practicing teledermatology in that week of April, April 28, that's a significantly greater number than we're practicing the dermatology in February, certainly. That being said, I think part of the concerns that we see in our customers is that the patient population that probably is most at risk of those over 55, those over 65 of developing melanoma. If you just look at -- this is my personal bias, but I'm assuming that if you look at who buys new Samsung and new iPhones, it's not the 75-year-old person who might have skin cancer. They might have an older phone with a poor photo opportunity there. So I think there are concerns among our clinicians that the ones who we are most concerned about missing a melanoma probably have the poorest IT skills as a group and probably the lowest technology. And that's really concerning that they may be missing things. So my sense here is that they're going to hopefully try, and if they maintain a dermatology going forward after this near-term period, that that will be focused more on non-skin cancer concerns, unless they can get really, really comfortable that they're not missing early stage skin cancer because the patient isn't able to quite get the focus point ready to go. So I think that's quite a concerning aspect. Now that being said, the fact that 80% of melanomas are sort of self-detected by patients, I think, is very comforting that at least the majority melanoma should be diagnosed in a fairly routine flow, although I think it's certainly been delayed here during the lockdown across the U.S. The other 20%, that's the question of how do you pick up incidental findings with high levels of confidence using teledermatology, and that's a question that we'll have to wait and see. And hopefully, from just a patient care perspective, we see a normalcy in terms of the routine diagnosis of melanoma and other skin cancers, so that we are perceiving we're going to see just a worsening of outcomes because the deeper and thicker these things go, the worse the prognosis is.

And then just lastly, maybe one for Frank. How should we think about gross margins in the second quarter? You talked about roughly 40% behind on test volumes in the first month or so. Just what could gross margins look like in that kind of environment?

So I don't want to guide to a number here, but as you know, the cost is a combination of space for the lab, people to run tests and consumables. So fewer tests, fewer consumables, but space and people are largely stable. So I would expect gross margin to come down a bit. But as you know, we have a nice, healthy gross margin. So there's room there for us.

Our next question comes from Puneet Souda with SVB Leerink. Your line is open.

So the first question I have is -- I appreciate the 80% statistics where patients are self-referring themselves to the dermatologist. But given the progression of melanoma is multiyear, what's your expectation of the mix of dermatologists that are willing to push the clinical visit further for Medicare age patients and above, 65 and above, versus those that are likely to review it more sooner as the derm practices open across the country.

So I think I can answer that directly, but if I miss the answer, propose a little differently for you that. OK. So our sense is that from our surveys and studies and also individual clinician contact is that there is concern about taking individual who is compromised or at risk and not doing the wrong thing. That certainly is the case. That being said, the individuals that are at greatest risk of dying from melanoma are those in the Medicare population. So you've got sort of a really hard balancing act here. And at least, the clinicians I've talked to directly, there is a real concern that we're going to be doing a great disservice by not diagnosing early these melanomas because we all know that as they grow bigger and thicker and their biology changes, the likelihood of that becoming a more aggressive melanoma increases day by day. And so there's a balance there that if they snip out over the phone, for example, or on a video teledermatology visit, that there's an inkling of potential skin cancer, our understanding is they're prioritizing those patients and encouraging them to come in ASAP. And perhaps some of the office procedures that they're putting in place in terms of spacing out patients, and etc., to go reduce infection potential is going to have an impact where those older individuals will be more comfortable coming into the practice. Now the reality in terms of numbers of patients returning, I think that's going to be the one that we talked about earlier is the question we don't have a handle on. Certainly, dermatology clinicians are highly attuned to the downside impact of diagnosing melanoma and other skin cancers later rather than earlier. So I think they'll be encouraged to say that is the more important concerning issue. hat's going to be a matter of the patients being uncomfortable, either calling in the first place until they wait for another, what, cycle of time, I guess, or not. Did I get at the heart of your question there?

And if I could ask in commercial payers, where do you stand currently? What are some of the efforts? It looks like you had a number of efforts sort of planned out. But where do you stand for commercial payers? And do you expect those efforts to be pushed out given the COVID impact here? Or are those still on track? And then one for Frank, on sales team additions, overall operating expenses, I appreciate you'll be expanding the commercial team. But if you could give some numbers on that. For the second half of the year, are your expectations the same? And if you can provide us numbers on sales or adds for the second half of the year that you expect, too.

So as I was asked last quarter, the first question. Yes, go ahead.

Puneet, can you repeat the first part of the question? We're focused on the second part.

Yes, and so the first part is on the commercial payers, where do you -- or yes.

So as a reminder, but we haven't probably discussed this probably at least last call from an earnings call standpoint. Most of the commercial payers that are reviewing melanoma tests or cutaneous melanoma test or melanoma, in general, seemed to fall into the first quarter and third quarter kind of triage. So our managed care group and our medical affairs group is working hard at impacting and providing the right information to allow individual plans and tech assessment groups to review the most up-to-date data. And for those who are on the review cycle for the third quarter, we have expectations of seeing a number flipping from either nothing to positive or negative to positive well, more in early 2021, and more in later in 2021 as well. In speaking with our head of managed care, I'm only aware of maybe a couple of plans that have sort of said we're way too busy here. I think the reality of it is that most of the medical directors who are reviewing diagnostic tests, undoubtedly, has had some additional workload in terms of reviewing maybe which COVID-19 test to bring onboard and maybe other medical policy issues. But my understanding is that most of them are working against the normal cycle anyways. Most of them already were working as off-site employees, so I think we're hearing minimal delays because of COVID disrupting kind of office flow or review flow, but we did hear a few in the late March, early April time period. So maybe there's an impact that one could see in the third quarter of 2020, but I don't think we'd be able to point to something and say, the lack of a change to a positive policy was because of COVID and this payer, it seems to be much more minimalized in that. Any other questions?

And then, Puneet, keep in mind, we've got a multi-arm marketing effort here. So with the next expansion, and we're not quite sure yet, we're still doing the market research work, but somewhere in the seven to nine or 10 range in terms of outside reps for the diff product. We'll certainly hire at least one more medical science liaison to complement that force. And then as you recall, we have a very important function of an internal sales associate that supports that field team. And our current ratio would suggest we would probably add two of those. So it's a similar wave, if you will, or a similar expansion to what we did back in December and as well on February 1, kind of the same scope and scale. That's been very much by design. We sat there last year and said if we think we need to expand by x, should we just bring all these people on. And we did it in a more measured fashion to make sure we weren't disrupting physician relationships, and we were continuing to generate quality opportunities for those salespeople and the folks in that effort.

Thank you. And I currently show no further questions at this time. I'd like to turn the call back over to Derek Maetzold for closing remarks.

Thank you, Shannon. This concludes our fourth-quarter 2020 earnings call. I want to thank you again for joining us today and for your continued interest in Castle Biosciences.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.