Hi, welcome to the Canaccord Genuity Growth Conference. I'm Kyle Mikson, cover lifestyle tools and diagnostics for Canaccord. Pleased to present to you this fireside chat with Castle Biosciences. Castle is a leading diagnostics company across dermatology, cancer, GI cancer, and mental health. With us from the company, we have Derek Maetzold, CEO, and Frank Stokes, CFO. Thanks, guys, for joining. I think, Derek, if you wanna start with the presentation, you can go ahead and do Q&A afterwards.
Thank you, Kyle, for the introductions, and thank you to Canaccord for hosting another great conference here. I'll just walk through a little bit of the company, in terms of who we are, where we're going. Briefly touch on second quarter earnings that we reported early last week, and then I think go from there to Q&A, right? Okay.
Yeah.
Disclaimer statements. I encourage everybody to read these thoroughly and go to our website as appropriate. So, who are we? At Castle Biosciences, we focus on improving health through innovative tests, and I'll kind of unwrap that here over the next couple of slides with the expectation that if we focus here, we can transform patient outcomes by having patients put into better treatment pathways and receiving care that they wouldn't have otherwise received without the use of our tests, helping to direct it or inform more appropriate treatment pathways based upon their disease progression. Many ways to go ahead and summarize down what one does for a living. We think this is a way to crystallize Castle.
I think our first area is to try and focus on disease states or clinical questions of high unmet clinical need, look to either build or acquire, first-in-class and/or best-in-class, test solutions to help improve decision-making around those, clinical need nodes, and then focus on building and building and building a robust evidence database that will end up helping us improve penetration, both from a clinical use or adoption standpoint, as well as from a payer, reimbursement, perspective as well. So I'm gonna unpack a couple of things here. So from a focus standpoint, we really have five areas of growth we're focusing on today. Three of our test solutions are in dermatology, one is in gastroenterology, as Kyle mentioned, and one is in mental health. I'll just go over a couple of these things just to orient you.
So our sort of initial test on a broad marketplace of these ones up here was developing and completing a validation, launching our test for invasive cutaneous melanoma, which we call DecisionDx-Melanoma. It's a test for use, and we think around 130,000 patients in the U.S., and it helps answer two clinical questions that we'll go into in just a second. We think today we're sitting roughly around 30% run rate penetration of that marketplace, so certainly a long way to go. We certainly have come a long way in the last couple of years. The second test on here in dermatology is our DecisionDx-SCC test, which was also developed internally. This is the test for use in patients with high-risk cutaneous squamous cell carcinoma, so squamous cell carcinoma of the skin.
We believe there's about 200,000 patients diagnosed per year with what we would call, clinically high risk or very high-risk SCC tumors, which are essentially defined clinically or pathologically, and we help refine treatment choices within our treatment pathways within the currently established guideline aspects. The third test I'll spend a couple minutes on today is TissueCypher. This came to us through an acquisition. TissueCypher is a risk stratification test that is used in patients who are diagnosed with a condition called Barrett's esophagus disease, and we'll get into that in a couple of seconds here. But Barrett's esophagus disease is a large category of patients.
We estimate around 415,000 patient encounters or single patient encounters in a given year in the United States, and we help, again, identify patients who can move on different care pathways and have improved outcomes as a result of those test services. So what are we looking at here if we build evidence on these innovative tests? Well, let me just talk about two items here, the ones in the center here. TissueCypher first. So, Barrett's esophagus disease is the single largest known precursor to developing esophageal cancer, which is not a fun disease to have diagnosed, by the way.
And so one of the areas that we focus on, or our gastroenterology customers focus on today, is that they find a patient with Barrett's esophagus disease, that biopsy tissue is then graded by a pathologist, and if you happen to have a high-grade dysplasia grading of your Barrett's esophagus disease, those patients in the U.S. are largely recommended to go into to having that Barrett's lesion removed. The most common approach is really radiofrequency ablation with an ablation wand. There's other surgical removal techniques as well. The goal there is that these patients are at a high enough risk on an annual basis of progressing to esophageal cancer, that it's worth that intervention to basically try and kill off or remove that Barrett's risk, that Barrett's esophagus disease risk. There are other grades. There's low-grade dysplasia in the U.S.
Those are patients who are also similarly treated to high-grade dysplasia, but the bulk of the patients are diagnosed with what we call non-dysplastic disease. So these are patients with Barrett's esophagus, but under the microscope, the pathologist can't see dysplasia that's notable. This is the largest population of patients. The issue is that, as a group, these patients certainly have a low risk of progression on a group-wise population basis, but individually, more, the most patients who actually progress to esophageal cancer are those ones in this non-dysplastic group because they aren't treated today, because the overall population of risk to progress is low enough that we sort of watch and wait, and we re-biopsy them on a periodic basis every couple of years to try and find aggressive disease.
Our test comes in for use in those patients, because if we can find a patient who has a high risk of progressing according to our TissueCypher test, their risk of progressing is actually higher than having low-grade dysplasia, which today in the U.S. is commonly ablated. And so we have a nice direct intervention of a patient you would normally not offer ablation to. You can go in, have our test run, and those patients who have a high risk of progressing, you would normally put them in the same treatment pathway as if they had a similar risk of progressing using clinical or pathologic factors alone. So very, very nice direct treatment outcome. The second test up here, I'll spend a couple seconds on, is our DecisionDx-SCC test.
This is for use, as I mentioned earlier, in people who are only diagnosed with high-risk squamous cell carcinoma of the skin. We were pleased to publish earlier this year, a couple of studies showing that if you take patients from our large, nearly 1,000 patient study database, and you match patients who received adjuvant radiation therapy, which is a commonly used intervention in these high-risk patients, to similarly match patients, clinically and pathologically matched patients who did not receive adjuvant radiation therapy, but they're all eligible for it. What we found was that actually our test is able to find the majority of patients who actually have a low individual risk of metastasis and also appear to have no clinically discernible benefit from adjuvant radiation therapy. Thus, they could be considered to defer that intervention until later, because no test is perfect.
On the other end of the equation, we find a minority of patients who actually are high risk pathologically, but have a very high risk score by our SCC test. These are patients who actually get a tremendous improvement or rather, a reduction in their likelihood of metastasizing, upwards of 75%-80%, if they're receiving ART therapy versus deferring it. Very, very nice rule-out opportunity and confirmation of ruling in a substantial clinical benefit. It's these kinds of clinical uses that we believe lead to not only crisp decision-making pathways in the, in terms of, of physicians and their patients, but also outcome improvement as well. Slowing progression to esophageal cancer, reducing spread of, of squamous cell carcinoma because you're radiating it at the right time and eliminating, or you can do it most of the time without any patient harm being gained.
Great, great clinical utility and outcomes. So I'll drill down here to our flagship product, DecisionDx-Melanoma. This is a test which is used in early stage melanoma. I'll just highlight that it's, it has two embedded clinical uses in it. The first is that when a patient is diagnosed, one of the first decisions a dermatologist and a patient makes is: Do I have a high enough likelihood I will, I will have melanoma in my lymph nodes that I want to undergo a sentinel lymph node biopsy surgical procedure to see if that's the case or not? The second question that our test also informs is, regardless of that first decision, sentinel node biopsy procedure or not, how do I manage this patient?
Are they at a very, very low risk of progressing, and metastasizing from that melanoma, or is that melanoma biologically quite aggressive, in which case I'm gonna adjust how I treat them or how I manage that patient downstream. We've demonstrated, in a number of studies, both prospective and retrospective, that you can take our test to rule out largely that sentinel node biopsy surgical procedure. Why rule out? Well, it turns out that if you take 100 people to the operating room who qualify for that procedure under staging, 88% of them don't have any melanoma cells in their lymph nodes. You could have saved 88 people from an unnecessary surgical burden, if only you knew how to find them, and our test helps find them.
But the other use of our test is what's highlighted on the right-hand side of the screen, which is that physicians use our test to also adjust: How do I survey a patient? Do I, do I institute standard imaging studies once every three or four months to go ahead and try and pick up early metastatic disease? Why is that important? It's important because the newer therapies in melanoma, the PD-1 inhibitor therapies, even the targeted BRAF, BRAF MEK inhibitor therapies, have all shown that if you start these effective therapies when the tumor burden of a melanoma is small versus large, how do you find small metastases? By imaging and picking up before it's symptomatic. It's symptomatic when it's larger, typically. Those patients have improved survival outcomes.
So starting these newer therapies when the metastatic disease burden is small or picking it up asymptomatically, directly leads to improvement in outcomes. More people live longer. We've demonstrated through two different studies. One is a collaboration with NCI-SEER database, where we matched patients who received our test clinically with patients who actually were in the SEER database as well, but did not have our test result as part of their patient care. And we demonstrated that patients actually saw a significant improvement in survival when they received our DecisionDx-Melanoma test as part of their patient care, versus those that did not match for clinical, pathologic, and socioeconomic factors. Very, very nice, strong, real-world outcome study.
The second one below the orange line there was an independent study, also published last summer, which was a collaboration between Cleveland Clinic, Northwestern University or Medical Center in Chicago, and Oregon Health & Science University in Portland, and they pulled their own institutional data and said, "We have some physicians in our institutions who are early adopters of the melanoma test and some who were not." Let's go ahead and match up and see in the sentinel lymph node negative patients, what the outcomes are like if you match for clinical and pathologic factors between patients who had their care guided at our same institutions by the Castle test, and care that wasn't guided by patients at the same institutions because they didn't have the Castle test.
What they found was exactly the same results, relatively speaking, as what we saw with our SEER collaborations, that, which is that patients had an opportunity. If you knew they had high-risk disease, they were put on active imaging protocols in those three institutions. They got on drug earlier, and they lived longer as a group, compared to those that had not had the benefit of our test impacting care decisions. So, so two great outcomes there from one, collaborative study and one independent study. We continue our collaboration with SEER. We published earlier this year in Cancer, an article by Podlipnik and colleagues, which show that in Stage one patients, we also provide substantial risk stratification. Why is that important? Majority of people diagnosed with melanoma are Stage one patients.
Majority of patients who you're wrestling about that sentinel biopsy procedure, do I do it or not, are Stage one patients. So a very, very strong utility and use in our same population. That's a sweet spot of where the test impacts patient care, and then where the majority of patients happen to go ahead and live. We take this robust approach to building evidence, like I just reviewed briefly, and what does that do for us? Well, it does a couple of things. The right-hand bar chart shows that overall as a company, we see very nice growth in volume, year-over-year as a company. 28,000, 44,000, 70,000 test report volumes as an overall company in the last three years.
That's a very, very nice, strong demonstration of the clinical use of our test by our customer base, and the impact on building that evidence to help physicians be aware of the fact that with our test, they make better choices, without our test, they are a little less informed about what best choices to make. And of course, in the middle here, what we see here is the improvement or the march forward in terms of expert opinion, guidelines, reimbursement strategy approaches, and essentially continue how we go ahead and approach commercialization of our tests. So catalysts in 2024.
We expect to really benefit from the full year impact of those two studies I just talked about, in terms of really showing clinicians who aren't adopters of our test yet, aren't full adopters of our test, to say, "Hey, can we move you from point A to point B, so your patients can also have the opportunity to live longer?" That'll help continue to drive volume for us and value for us this year. We have continued to expand and invest in our commercial structures as well.
The most notable expansion this year was moving our TissueCypher sales territories from 24 to 40 in April of this year. They're now through training. We expect to go ahead and monitor the acceleration of performance and look to get closer to being right-sized in the gastroenterology sales division later on this year or early next year as circumstances dictate. We also saw, as I mentioned earlier, the publication of the benefit of our test in helping to guide adjuvant radiation therapy.
There was also an article published early in the fourth-- early in the first quarter of this year, which demonstrated that if you just take the patients who received adjuvant radiation therapy for the 12 months ending, I think it was May of 2022, and you apply our test to having our test results guide radiation therapy decisions, rule out or rule in, there's a net savings of direct radiation therapy costs, less the reimbursement cost for our Castle test of roughly $970 million to the Medicare budget in a single year. That's a fantastic demonstration of eliminating unnecessary radiation therapy and having a tremendous, a meaningful net savings to the Medicare Trust Fund to be applied to other advances in technologies. So financials, quick run-through here. Working time. Sorry about that, Kyle.
We closed out the second quarter this year, $87 million in revenue. Nice, strong growth, which was driven and accompanied, you can see as appropriate, volume by quarter as well, increases over time. If you look at our adjusted gross margin, so really taking out the amortization of our acquisitions, you can see that we're sitting in kind of the high 70s, low 80s, pretty comfortably as a company overall. That's a nice place to be at, obviously from a diagnostics perspective, and you've seen much more marginal growth in our operating expenses over the last five quarters. That all leads us to essentially improving our operating cash flow and adjusted EBITDA as a company here with nice marches from 2Q of last year through 3Q and 4Q.
You can see a drop in operating cash flow in the first quarter of 2024. That's primarily due to payout of annual bonuses company-wide, as well as some healthcare funding that's at a single year event. So we are back on the second quarter of this year through the consistent march towards profitability and cash flow positivity. To wrap it all up, we have roughly $260 million in the bank today. We generated $25 million in operating cash flow positivity in the second quarter. We believe we can continue marching forward towards allocating that capital towards commercial optimization, focused R&D efforts to both build our current pipeline tests, as well as evidentiary development for our current tests, and as lesser priority, looking for opportunities to continue to build out the company strategically. I think that's it, Kyle. Hopefully, that was okay.
Yeah, that was great. Thanks for that, Derek. Some time for Q&A, five minutes or so. Maybe a lot of talk on the SCC test, given coverage. Maybe we could talk about melanoma, DecisionDx-Melanoma, and how, you know, just looking at that business, I guess, what are your, kind of, options to, like, accelerate growth a bit, or do you think that that's going pretty well? I mean, just given penetration's high, as you talked—I think you talked about, like, maybe 30%+. Is that, you know, are there options that you have to kind of like go faster, grow faster there?
Good question there. So we have roughly 75 individual territories or 75 area managers across the U.S. in our dermatology division. They focus today, roughly 50/50, in terms of educating doctors on our melanoma test and educating doctors on our squamous cell carcinoma test. So 50/50 is the current split today. We've looked over the last couple of years at, in the kind of the post-COVID selling time period, with that sort of FTE equivalency of maybe 37.5, although it's obviously 75 people giving an appropriate educational opportunity to our customers, that we grow 4,000-5,000 tests per year over the prior year, 4,500-5,000 tests. So that seems to be a background run on the current sourcing of that.
We will certainly look to go forward here and look at staffing that in a different manner going forward, to go and see if we can accelerate that growth against our historical climb forward. But I think that's probably the background adoption rate of new customers becoming customers, and current customers who use us for some of their patients, rather than all appropriate patients, becoming more fuller adopters. That's going forward on a regular basis.
We are about 30% penetrated run rate, we think, in the second quarter of this year. Other test categories we benchmark ourselves against look like they get, or they begin peaking around 70%-75%. The older tests in our marketplace, breast cancer tests, even our own uveal melanoma tests, are sitting at 85%-90%. So maybe that's the altruistic upside, maybe 70% is more like it. So I think melanoma has an opportunity to at least double over the next several years here in terms of market penetration, which take that to a very, very nice, strong, test from a patient care standpoint.
Okay, and then the newer tests, like TissueCypher, and I guess IDgenetix, those are kind of contributing growth as well. What's really, like, helped the TissueCypher growth and, and like the in volume and then also the great payment rate? But, I mean, how do you think about that sales force going forward, too, just given you increases from 24 to 40 in April?
Yeah, that's an excellent question there. So we have, we think roughly 10,000 gastroenterology customers we should talk to. Forty people is insufficient. On the other hand, there are, there is a larger, grouping of private equity-owned or large group, gastroenterology practices out there. Some of them seem to have developed top-down treatment pathways as opposed to bottom-up pathways. So one of the opportunities we have to look at in the next six months to a year is to say, how many of these groups are gonna be interested in adopting a top-down approach? So evaluate TissueCypher, evaluate the benefits on improving or reducing esophageal cancer progression outcomes, and sort of force that to be a standard treatment protocol.
If that's the case, then I don't think we need to worry about calling all 10,000 gastroenterologists, if it's part of their forced protocol. So that needs to be worked out, but I think going from 24 to 40, we have a philosophy internally we've ran with for 6, 7 years, which is that we wanna be careful about not having too many handoffs of customers in case we drop a baton, if we have too many new representatives talking to the same person within a period of time.
So we went from 24 up to 40 territories, not 24 to 60, just to make sure we weren't disrupting our relationships and our handoffs. As these 40 settle in now, we'll look to go ahead and probably 60, 65 might be the right level to get to in 6 months to a year, and I think that's getting pretty close to seeing are we in the right area of the ballpark of at least the investment from a personnel standpoint.
Okay. Then sticking on this note, on this, like, GI cancer front, so like, obviously, Colon Cancer in that area is like definitely more publicized, I guess, from like a diagnostics perspective, but Esophageal Cancer, really tough, like, you know, really high death rate, like, like a big killer, honestly. It's a tough, tough, tough disease, tough cancer. There's a lot of, you know, Barrett's Esophagus, kind of pre-cancer. That's one aspect of the continuum here. Is there. Do you see there's, like, other, areas to penetrate this Esophageal Cancer space, just like from end to end?
Of the GI space?
Well, I mean
Yeah, there definitely should be, Kyle. There's,
Yeah.
We've identified a number of... We always start with a clinical question. What's a clinical question that a group of physicians needs an answer to? And we've identified plenty of clinical questions that GIs are faced with. So the question of whether we develop a test to meet those questions, or if there are tests that we can find externally, we'll certainly do that. But we've seen great synergy in our two dermatology products. With one channel and two products, I think we'll see the same in GI at some point.
Okay. And then in the guide, again, like big beat, big guidance range, raise, you're assuming just in the DecisionDx-SCC revenue, I think, through the third quarter, basically through, like, September.
Correct.
Yeah, is that, like, a typical three months? Just remind me, is that typically, like, when, like, a decision with a succession for Novitas would occur?
No, that's just the earliest sort of... If the contractor follows the rules they're supposed to follow, that's the earliest possible. When they finalize a policy, they're supposed to have a 45-day run-in until it's effective. So we're assuming when we gave the guide last week, 45 days out gets you to the end of September.
Like excluding that test, let's just forget, forget about it for a sec. What's exciting about 2025, I guess, for Castle?
I think if you look at our, at penetration, melanoma, 30%, TissueCypher run rate, about 4%. Squamous cell carcinoma, probably sitting at 7% or 8% today, but if you take that off and you look at our second quarter earnings, you'd say: Okay, we can go ahead and back out squamous cell carcinoma revenue and cash. We're getting awfully close to running a cash flow to cash flow positive business, so we're ahead of that. I think we're on track for that metric we set out, I guess, two and a half years ago for 2025.
So going the next year, I think, I think with squamous cell carcinoma of the skin, we will have an opportunity to make very significant changes to our business to go and set us up well for 2026, 2027, 2028. If we happen to have a gap in coverage in squamous cell carcinoma, we have a very, very strong, robust business that will also be looking at saying: How do you want to play in 2028, 2029, 2030? And we have the capital to do that, the resources to do it from a thoughtful standpoint, as opposed to doing it from a position-