CASTLE BIOSCIENCES INC Management report and analysis of the financial situation and operating results. (Form 10-Q)
You should read the following discussion and analysis of financial condition and results of operations together with our unaudited condensed consolidated financial statements and the related notes and other financial information included in this Quarterly Report on Form 10-Q and our audited financial statements and notes thereto as of and for the years ended
December 31, 2021and 2020 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, including the section entitled "Critical Accounting Estimates," included in our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the Securities and Exchange Commission(the "SEC") on February 28, 2022. Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to "we," "us" and "our" refer to Castle Biosciences, Inc.
The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which are subject to the "safe harbor" created by those sections. These forward-looking statements include, but are not limited to, statements concerning the impacts of COVID-19 on our business, our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words "anticipate," "believe," "estimate," "expect," "potential," "may," "plan," "will," "would" or the negative or plural of these terms or other similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions or expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part II, Item 1A., "Risk Factors" in this Quarterly Report on Form 10-Q and in our other filings with the
SEC. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements, except as may be required by law.
Castle Biosciencesis improving health through innovative tests that guide patient care. For the diseases that our portfolio of tests cover, we believe the traditional approach to developing a treatment plan for cancers and other diseases using clinical and pathology factors alone is inadequate and can be improved by incorporating the personalized information our diagnostic and prognostic tests provide. We currently market five proprietary multi-analyte assays with algorithmic analysis ("MAAAs") designed to answer clinical questions in dermatologic cancers, uveal melanoma ("UM") (a rare cancer of the eye) and Barrett's esophagus ("BE"). We also have a pharmacogenomic test to guide optimal drug treatment for patients suffering from depression, anxiety and other mental health conditions following our acquisition of AltheaDx, Inc.("AltheaDx") in April 2022, as discussed below. Our revenue is primarily generated by our DecisionDx®-Melanoma risk stratification test for cutaneous melanoma, a deadly skin cancer, and our DecisionDx®-UM risk stratification test for UM. The foundation of our business is our dermatologic cancer franchise, and our lead product is DecisionDx-Melanoma, a proprietary risk stratification gene expression profile ("GEP") test that predicts the risk of metastasis or recurrence for patients diagnosed with invasive cutaneous melanoma. In the management of melanoma, as with nearly all diseases, treatment plans are directed by patient risk-stratification. This test has two distinct, complementary clinically actionable uses. The first revolves around predicting the likelihood of having a sentinel lymph node ("SLN") negative biopsy result so that physicians and patients can discuss the risk and benefit of undergoing the SLN biopsy ("SLNB") surgical procedure. The second use is to inform the appropriate treatment plan during the initial five years post-diagnosis, regardless of the decision to undergo or avoid invasive SLNB surgery. In a typical year, we estimate approximately 130,000 patients are diagnosed with invasive cutaneous melanoma in the United States. We launched DecisionDx-Melanoma in May 2013. Based on the substantial clinical evidence that we have developed, we have received Medicare coverage for DecisionDx-Melanoma, which represents approximately 50% of the addressable patient population for this test. On August 31, 2020, we commercially launched our cutaneous squamous cell carcinoma ("SCC") proprietary GEP test, DecisionDx®SCC, for use in patients with one or more risk factors (also referred to as "high-risk" SCC). On November 2, 2020, we commercially launched our proprietary GEP test for difficult-to-diagnose melanocytic lesions, DecisionDx® DiffDx™-Melanoma, for use in patients with a melanocytic lesion and uncertainty related to the malignancy of the lesion. We believe that these two additional skin cancer tests address areas of high clinical need in dermatological cancer and, together, represent an estimated addressable population of approximately 500,000 patients in the United States. 16
We further expanded our commercially available dermatologic portfolio in
May 2021when we acquired Myriad myPath, LLC (the "Myriad myPath Laboratory") from Myriad Genetics, Inc. for a cash purchase price of $32.5 million. myPath Melanoma is a clinically validated GEP test that addresses the same unmet clinical need as our DecisionDx DiffDx-Melanoma test. Today, we offer both our myPath Melanoma test and our DecisionDx DiffDx-Melanoma test under an offering that we refer to as our comprehensive diagnostic offering ("CDO") of molecular testing solutions. By offering both of these tests in a single offering, we believe we have demonstrated the ability to improve the test result performance for patients with difficult-to-diagnose melanocytic lesions. In 2021, we announced the launch of our innovative pipeline initiative to develop a genomic test aimed at predicting response to systemic therapy in patients with moderate to severe psoriasis, atopic dermatitis and related inflammatory skin conditions. In the United Statesalone, there are approximately 18 million patients diagnosed with psoriasis and atopic dermatitis. Approximately 450,000 of these patients annually are eligible for systemic therapies. If successful, this inflammatory skin disease pipeline test has the potential to add approximately $1.9 billionto our current estimated U.S.total addressable market ("TAM"). In 2021, we initiated a 4,800 patient, prospective, multi-center clinical study to develop and validate this pipeline test and have 52 committed sites and approximately 146 patients enrolled. Based upon our current development and validation timelines, we expect to have initial validation and development data in 2023 and to commercialize this pipeline test by the end of 2025. In addition to our dermatologic franchise, we also market a test for patients diagnosed with UM. DecisionDx®-UM is a proprietary, risk stratification GEP test that predicts the risk of metastasis for patients with UM. We believe DecisionDx-UM is the standard of care in the management of newly diagnosed UM in the majority of ocular oncology practices in the United States. We launched DecisionDx-UM in January 2010. Based on the substantial clinical evidence that we have developed, we have received Medicare coverage for DecisionDx-UM, which represents approximately 50% of the addressable patient population for this test. In December 2021, we extended our commercial portfolio of proprietary tests into the gastroenterology market through our acquisition of Cernostics, Inc.("Cernostics") and the TissueCypher® platform. The TissueCypher platform focuses on unlocking, in the case of the initial test for use in patients with BE, the importance of the location of the expression of proteins or lack thereof within the morphology of the disease (also known as spatialomics). This "spatialomic" information is then interpreted using artificial intelligence approaches to predict the likelihood of progression to high-grade dysplasia and/or esophageal cancer in patients with non-dysplastic, indefinite or low-grade dysplasia BE. We believe the addition of expertise in the spatialomics area positions us for continued growth and success in the diagnostics space, complementing our first-to-market dermatologic franchise and our proprietary test for UM. On April 26, 2022, we completed our acquisition of AltheaDx, a commercial-stage molecular diagnostics company specializing in the field of pharmacogenomics ("PGx") testing services that are focused on mental health, and the provider of IDgenetix, a PGx test for mental health conditions. At closing, $65.0 millionin initial consideration was payable by us to AltheaDxsecurity holders, which consisted of $32.5 millionin cash, subject to adjustments for cash, debt, transaction expenses and working capital, and $32.5 millionin shares of our common stock. Further, up to an additional $75.0 millionin cash and common stock may become payable in connection with the achievement of certain milestones based on 2022, 2023 and 2024 performance and expanded Medicare coverage for the IDgenetix test. This acquisition enables us to offer a testing solution that we believe has the potential to accelerate our impact on patient care in an area of high unmet clinical need, significantly expand our in-market estimated U.S.TAM by approximately $5.0 billionand offer incremental value to patients and clinicians over the standard of care trial-and-error approach. A randomized controlled trial showed that patients diagnosed with depression, who were assessed with the IDgenetix test, showed a 2.5 times improvement in remission rates compared to those who did not have their genes tested. The number of test reports we generate is a key indicator that we use to assess our business. A test report is generated when we receive a sample in our laboratory, and then the relevant test information is entered into our Laboratory Information Management System, the expression of the biomarkers is measured, then a proprietary algorithmic analysis of the combined biomarkers is performed to generate a report providing the results of that analysis, which is sent to the clinician who ordered the test. 17
The number of GEP test reports delivered by us during the three months ended
March 31, 2022and 2021 and for the year ended December 31, 2021are presented in the table below: Proprietary Dermatologic GEP Tests DecisionDx- TissueCypher Barrett's Melanoma DecisionDx-SCC CDO(1) Dermatologic Total DecisionDx-UM Esophagus(2) Grand Total Q1 2022 6,023 1,142 950 8,115 456 56 8,627 Q1 2021 4,060 527 218 4,805 337 - 5,142 Q2 2021 5,128 784 627 6,539 468 - 7,007 Q3 2021 5,505 934 913 7,352 375 - 7,727 Q4 2021 5,635 1,265 904 7,804 438 27 8,269 For year ended December 31, 202120,328 3,510 2,662 26,500 1,618 27 28,145
(1)Includes DecisionDx DiffDx-Melanoma, which we launched commercially on
(2) We started offering the TissueCypher Barrett Esophagus Test on
For the three months ended
March 31, 2022, our dermatologic test report volume increased by 68.9% compared to the prior period in 2021, largely driven by continued growth from our DecisionDx-Melanoma test. For a discussion of how we recognize revenue derived from our tests, refer to "Net Revenues" under "Components of Results of Operations" below. The principal focus of our current commercial efforts is to educate clinicians and pathologists on the value of our molecular diagnostic testing products through our direct sales force in the United States. During the first half of 2021, we expanded our dermatologic commercial team, bringing our dermatologic sales force to the mid-60s. In connection with our acquisition of Cernosticsin December 2021, we hired an initial commercial team of approximately 14 outside sales territories, along with commensurate internal sales associates and medical science liaisons, to support our launch of the TissueCypher Barrett's Esophagus test. This dedicated team focuses on gastroenterology specialists that diagnose and manage patients with BE. Similar to our dermatology commercial team, we will continue to assess market response and determine what an appropriate commercial expansion will look like. Based on our initial market research, as well as initial provider response, we expect to add approximately 10-15 additional outside sales territories sometime in the third quarter, ending the year with approximately 25-30 outside sales territories. AltheaDx, which we acquired in late April 2022, had a commercial team covering approximately 20 outside sales territories, all of whom have continued with Castle following the transaction. We continue to see new clinicians order our dermatologic tests for the first time. For the three months ended March 31, 2022, we saw approximately 592 new ordering clinicians for our dermatologic tests compared to 410 during the same period of 2021. Total ordering clinicians for our dermatologic tests were approximately 3,629 and 2,456 for the three months ended March 31, 2022and 2021, respectively.
For more information about the metrics we disclose, see “Information About Certain Metrics” below.
In developing our DecisionDx-SCC and DecisionDx DiffDx-Melanoma tests, we believed that in addition to addressing significant unmet clinical needs, we would see strategic opportunities for leverage, as many of the clinicians currently ordering DecisionDx-Melanoma would likely be the same clinicians who would find value in these other dermatologic GEP tests. For example, we found that for the three months ended
March 31, 2022, approximately 56% of all clinicians ordering DecisionDx-SCC had also ordered our DecisionDx-Melanoma test during that same period. We bill third-party payors and patients for the tests we perform. The majority of our revenue collections is paid by third-party insurers, including Medicare. We have received local coverage determinations ("LCDs"), which provide coverage for our DecisionDx-Melanoma, myPath Melanoma, DecisionDx-UM and IDgenetix tests that meet certain criteria for Medicare and Medicare Advantage beneficiaries, representing approximately 60 million covered lives. In 2022, DecisionDx-UM received coverage from United Healthcarethat represents approximately 43 million covered lives. A ''covered life'' means a subscriber, or a dependent of a subscriber, who is insured under an insurance carrier's policy. The TissueCypher Barret's Esophagus test is paid by Medicare at the rate published on Medicare's Clinical Laboratory Fee Schedule ("CLFS") for the test. Effective March 18
On February 24, 2022, we received ADLT status for our TissueCypher test, as discussed in more detail below. ADLT status exempts TissueCypher from what’s called the “14-day rule,” which simplifies the billing process for Medicare patients.
Palmetto GBA MolDX ("Palmetto"), the Medicare Administrative Contractor ("MAC") responsible for administering MolDX, the program that assesses molecular diagnostic technologies, issued a final expanded LCD for DecisionDx-Melanoma, effective
November 22, 2020. With this expanded LCD and the accompanying billing and coding articles, we estimate that a significant majority of the DecisionDx-Melanoma tests performed for Medicare patients will meet the coverage criteria. Noridian Healthcare Solutions, LLC("Noridian"), the MAC responsible for administering claims for laboratory services performed in Arizona, has adopted the same coverage policy as Palmetto and also issued an expanded final LCD for DecisionDx-Melanoma, effective December 6, 2020. Separately, Palmetto issued a final LCD for DecisionDx-UM, which became effective in July 2017, and Noridian issued a similar LCD that became effective in September 2017. The Noridian LCD provides for coverage to determine metastatic risk in connection with the management of a patient's newly diagnosed UM and to guide surveillance and referral to medical oncology for those patients. On May 17, 2019, Centers for Medicare & Medicaid Services("CMS") determined that DecisionDx-UM meets the criteria for "existing advanced diagnostic laboratory test" status, also referred to as "existing ADLT" status. For 2020, our rate was set by Noridian, our local MAC, but effective in 2021 our rate is set annually based upon the median private payor rate for the first half of the second preceding calendar year. Our rate for 2021 was $7,776and will remain at $7,776for 2022, in each case based on the calculation of the median private payor rate. Also, on May 17, 2019, CMS determined that DecisionDx-Melanoma meets the criteria for "new ADLT" status. Accordingly, from July 1, 2019, through March 31, 2020, the Medicare reimbursement rate was equal to the initial list price of $7,193. From April 1, 2020, through December 31, 2021, the rate was also $7,193, which was calculated based upon the median private payor rate for DecisionDx-Melanoma from July 1, 2019to November 30, 2019. CMS has informed us that the rate for 2022 will continue to be $7,193, based on the median private payor rate. myPath Melanoma is currently covered under a MolDX LCD policy through Noridian, which oversees laboratories in both Utahand Arizona. Noridian issued an LCD that became effective in June 2019. On September 6, 2019, myPath Melanoma was approved as a new ADLT. The rate for 2022 will be $1,950. Beginning in 2023, the rates for DecisionDx-Melanoma, DecisionDx-UM, and myPath Melanoma tests will be set annually based upon the median private payor rate for the first half of the second preceding calendar year. For example, the rate for 2023 will be set using median private payor rate data from January 1, 2021to June 30, 2021. TissueCypher is performed in our Pittsburgh, Pennsylvanialaboratory and falls under the Medicare jurisdiction that is managed by Novitas Solutions("Novitas"). Novitas previously reviewed TissueCypher and we are receiving payments for claims according to the CLFS. For 2022, CMS published in its CLFS a payment amount of $2,513for the test. On March 24, 2022, CMS determined that TissueCypher meets the criteria for "new ADLT" status. From April 1, 2022through December 31, 2022, CMS has set the initial period rate equal to the original list price of $2,350, subject to the possible recoupment provision described below. Effective January 1, 2023, the rate will be based on the median private payer rates received between April 1, 2022and August 31, 2022. Note that for TissueCypher tests reported for April 1, 2022through December 31, 2022, CMS has the right to recoup the difference between the actual list and 130% of the weighted median if the original list price was greater than 130% of the weighted median of private payor rates. IDgenetix is currently covered under a MolDX LCD policy and an accompanying billing and coding article through Noridian, which oversees laboratories in California. The Medicare coverage includes depression and was recently expanded for the following seven additional mental health conditions beyond major depressive disorder: schizophrenia, bipolar disorder, anxiety disorders, panic disorder, obsessive-compulsive personality disorder, post-traumatic stress disorder and attention deficit hyperactivity disorder. The IDgenetix multi-gene panel is currently reimbursed by Medicare at approximately $1,500. In the second quarter of 2020, we submitted our technical assessment dossier for DecisionDx-SCC to Palmetto and Noridian. The dossier was accepted as complete in the third quarter of 2020. In early 2021, we submitted our technical assessment dossier for DecisionDx DiffDx-Melanoma. The dossier was accepted as complete in the first quarter of 2021. We are unable to predict when draft LCDs for DecisionDx-SCC and DecisionDx DiffDx-Melanoma will be posted and there is no assurance that any draft or final LCD will match our expectations, be posted in a timeframe consistent with our historical experience or will be posted at all. In the second quarter of 2021, Palmetto and the other MACs that participate in the MolDX program each released a revised draft LCD for DecisionDx-Melanoma. The draft LCD includes commentary about two publications regarding the clinical utility of GEP tests and includes an assessment stating that the new data is not sufficient to change the coverage criteria. There was an open public comment period, and we submitted comments in support of Medicare coverage. The comment period ended on 19
August 8, 2021. Potential outcomes following the public comment period include the posting of a final LCD consistent with the draft LCD, issuing a final LCD with coverage changes or not issuing a final LCD at all. We are unable to predict the ultimate outcome of this matter. Since becoming a public company, we have financed our operations with the revenue generated from the sale of our products, proceeds from our initial public offering of our common stock (our "IPO") that closed in July 2019, follow-on public offerings of common stock in June 2020and December 2020and bank debt, which has since been repaid in full. We believe that our existing cash and cash equivalents and anticipated cash generated from sales of our products will be sufficient to fund our operations for the next 12 months and into the foreseeable future. However, we have based these estimates on assumptions which may prove to be wrong and could result in us depleting our capital resources sooner than expected. Our net (loss) income may fluctuate significantly from period to period, depending on the timing of our planned development activities, the growth of our sales and marketing activities and the timing of revenue recognition under Accounting Standards Codification Topic 606, Revenue from Contracts with Customers ("ASC 606"). We expect our expenses will increase substantially over time as we:
•conducting clinical studies to generate evidence in support of our current and future product candidates;
•execute our marketing strategy for our current and future commercial products;
•pursue the ongoing and planned development of new products in our pipeline;
•seek to discover and develop additional product candidates;
•hire additional scientific and research and development personnel; and
• add additional operational, financial and management information systems and personnel.
Furthermore, we expect to continue to incur additional costs associated with operating as a public company, including significant legal, accounting, investor relations and other expenses.
Impact of the COVID-19 pandemic
We are continuing to closely monitor the impact of the ongoing COVID-19 pandemic on our business and taking proactive efforts designed to protect the health and safety of our workforce, continue our business operations and advance our corporate objectives. We are providing the following update with respect to the impact of COVID-19 on our business: •We have maintained and expect to continue to maintain uninterrupted business operations, with adequate access to reagents and consumables needed for testing patient samples and normal turnaround times for our delivery of test reports. We have continued to maintain our previously implemented adjustments to our operations designed to keep employees safe and comply with federal, state and local guidelines, including those regarding social distancing. •Following the onset of the COVID-19 pandemic, we experienced declines in orders and test report volume in certain periods. For example, in the second quarter of 2020, test reports delivered for our lead product, DecisionDx-Melanoma, decreased 18.5% compared to the second quarter of 2019. We believe these decreases in our test report volume were linked to delays and/or cancellations in patient visits, resulting in fewer diagnostic biopsies and thus a reduction in the number of diagnoses of cutaneous melanoma in response, as well as the cumulative impact on promotional responsiveness as a result of reduced sales calls per day and in-person sales calls during the ongoing COVID-19 pandemic. •Our commercial team uses a combination of in-person, virtual and non-personal promotional and educational efforts. Since the beginning of 2021, we have seen improvements in the number of promotional calls per day, as well as a continued shift from virtual to in-person sales calls. During the three months ended
March 31, 2022and 2021, in-person sales calls accounted for over 95% and 75% of all calls during such periods, respectively. However, we have not yet achieved pre-COVID-19 levels of calls per day per sales representative. •Our future results will be dependent upon the extent and duration of the COVID-19 crisis, including the emergence and spread of variants of the virus, and government restrictions, which are beyond our control. Although state and local government restrictions put in place to slow the spread of the virus have been eased in certain locations, restrictions may be reinstated from time to time in various regions depending on the circumstances, potentially impacting the flow of future patient visits as well as access to our sales targets. Even with the easing of state and local restrictions and the availability of vaccinations, patient visits and diagnoses of the diseases covered by our diagnostic and prognostic test may be impacted by continued apprehension regarding possible exposure to the virus as well as a general shift from in-person clinical visits to telehealth approaches, which may result in missed or delayed diagnoses of skin cancer and other diseases. 20
As conditions are continuously evolving, we are unable to predict how our future test report volume will be impacted, or the extent to which our results of operations, financial condition or cash flows will be impacted, by the ongoing COVID-19 pandemic or other future public health crises. Accordingly, the test report data presented above is not necessarily indicative of our results of operations that can be expected for future periods. For more information on the potential impact of the ongoing COVID-19 pandemic on our business, see the risk factors included under "Risks Related to Our Business" and the other risk factors included in Part II, Item 1A., "Risk Factors" in this Quarterly Report on Form 10-Q.
Factors affecting our performance
We believe that several important factors have had and which we believe will continue to have an impact on our operating performance and results of operations, including:
•Report volume. We believe that the number of reports we deliver to physicians is an important indicator of the growth of adoption among the healthcare provider community. Our revenue and costs are affected by the volume of testing and mix of customers. Our performance depends on our ability to retain and broaden adoption with existing prescribing physicians, as well as attract new physicians. In the near term, our report volume may be negatively impacted by ongoing developments of the ongoing COVID-19 pandemic, as discussed above. •Reimbursement. We believe that expanding reimbursement is an important indicator of the value of our products. Payors require extensive evidence of clinical utility, clinical validity, patient outcomes and health economic benefits in order to provide reimbursement for diagnostic and prognostic products. Our revenue depends on our ability to demonstrate the value of our products to these payors. •Gross margin. We believe that our gross margin is an important indicator of the operating performance of our business. Higher gross margins reflect the average selling price of our tests, as well as the operating efficiency of our laboratory operations. •New product development. A significant aspect of our business is our investment in research and development activities, including activities related to the development of new products. In addition to the development of new product candidates, we believe these studies are critical to gaining physician adoption of new products and driving favorable coverage decisions by payors for such products.
Information on certain measures
The following provides additional information about certain measures we have disclosed in this MD&A and Analysis of Financial Condition and Results of Operations.
Test reports delivered for DecisionDx-Melanoma, DecisionDx-SCC, myPath Melanoma/DecisionDx DiffDx-Melanoma, DecisionDx-UM and the TissueCypher Barrett's Esophagus test represents the number of completed test reports delivered by us during the reporting period indicated. The period in which a test report is delivered does not necessarily correspond with the period the related revenue, if any, is recognized, due to the timing and amount of adjustments for variable consideration under ASC 606. We use this metric to evaluate the growth in adoption of our tests and to measure against our internal performance objectives. We believe this metric is useful to investors in evaluating the volume of our business activity from period-to-period that may not be discernible from our reported revenues under ASC 606. We also sometimes present, on a limited basis, data on the number of orders received. We believe order data can provide additional insight on current demand trends, particularly during the ongoing COVID-19 pandemic and with respect to new product launches, when considered in conjunction with test report volume. However, orders received in a particular period do not necessarily correspond with actual delivered test reports or reported revenues for the same period or subsequent periods. New ordering clinicians for our dermatologic tests represents the number of clinicians who ordered a dermatologic test from us for the first time during the reporting period specified. Our dermatologic tests consist of DecisionDx-Melanoma, DecisionDx-SCC and our CDO. We believe this metric is useful in evaluating the effectiveness of our sales and marketing efforts in establishing new relationships with clinicians and increasing the adoption of our suite of dermatologic tests. We also believe this metric provides useful information to investors in assessing our ability to expand the use of our dermatologic tests. Since this metric is based upon the reporting period in which an order is placed, it does not necessarily correspond to the reporting period in which either a test report was delivered or revenue was recognized.
Components of operating results
We generate revenues from the sale of our products. Currently, our revenues are primarily derived from the sale of DecisionDx-Melanoma and DecisionDx-UM. We bill third-party payors and patients for the tests we perform. 21
Under ASC 606, we recognize revenue at the amount we expect to be entitled, subject to a constraint for variable consideration, in the period in which our tests are delivered to the treating physicians. We have determined that our contracts contain variable consideration under ASC 606 because the amounts paid by third-party payors may be paid at less than our standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration is recognized only to the extent it is probable that a significant reversal of revenue will not occur in future periods when the uncertainties are resolved. Variable consideration is evaluated each reporting period and adjustments are recorded as increases or decreases in revenues. Variable consideration for Medicare claims that are not covered by an LCD or otherwise, including those claims undergoing appeal, is deemed to be fully constrained due to factors outside our influence (i.e., judgment or actions of third parties) and the uncertainty of the amount to be received is not expected to be resolved for a long period of time. For these fully constrained claims, we generally recognize revenue in the period the uncertainty is favorably resolved, if at all. Due to potential future changes in Medicare coverage policies and appeal cycles, insurance coverage policies, contractual rates and other trends in the reimbursement of our tests, our revenues may fluctuate significantly from period to period. Additionally, our ability to recognize revenue for our recently launched tests, DecisionDx-SCC and DecisionDx DiffDx-Melanoma, is dependent on the development of reimbursement experience and coverage decisions for these tests. Due to limited reimbursement experience, we are currently recognizing revenues for these two tests on the basis of actual cash collections. Our ability to increase our revenues will depend on our ability to further penetrate our target markets, and, in particular, generate sales through our direct sales force, develop and commercialize additional tests, obtain reimbursement from additional third-party payors and increase our reimbursement rate for tests performed.
Cost of sales (excluding amortization of intangible assets acquired)
The components of our cost of sales are material and service costs associated with testing samples, personnel costs (including salaries, bonuses, benefits and stock-based compensation expense), electronic medical record set up costs, order and delivery systems, shipping charges to transport samples, third-party test fees, and allocated overhead including rent, information technology costs, equipment and facilities depreciation and utilities. Costs associated with testing samples are recorded when the test is processed regardless of whether and when revenues are recognized with respect to that test. As a result, our cost of sales as a percentage of revenues may vary significantly from period to period because we do not recognize all revenues in the period in which the associated costs are incurred. We expect cost of sales in absolute dollars to increase as the number of tests we perform increases. Additionally, we expect cost of sales to increase with the expansion of laboratory capacity and staffing in advance of the anticipated growth of our recently launched tests. Gross margin and gross margin percentage are key indicators we use to assess our business. See the table in "Results of Operations-Comparison of the three months ended
March 31, 2022and 2021" for details.
Research and development
Research and development expenses include costs incurred to develop our diagnostic and prognostic tests, collect clinical samples and conduct clinical studies to develop and support our products. These costs consist of personnel costs (including salaries, bonuses, benefits and stock-based compensation expense), prototype materials, laboratory supplies, consulting costs, regulatory costs, electronic medical records set up costs, costs associated with setting up and conducting clinical studies and allocated overhead, including rent, information technology, equipment depreciation and utilities. We expense all research and development costs in the periods in which they are incurred. We expect our research and development expenses to increase in absolute dollars as we continue to invest in research and development activities related to developing enhanced and new products. We expect to use a portion of our cash and cash equivalents to further support and accelerate our research and development activities, including three important studies that are underway to support our DecisionDx-Melanoma test. The first is the PERSONALize study, in which we are evaluating DecisionDx-Melanoma for interactions with adjuvant therapies. The second is the CONNECTION study, which is collecting long-term outcomes for up to 10,000 patients who have been tested with DecisionDx-Melanoma. The third is the DECIDE study, which is designed to determine the association of GEP test results with SLNB surgical decisions in patients eligible for SLNB as well as to track outcomes for patients who did and did not undergo SLNB. Also, as noted above, in 2021, we initiated our 4,800 patient, prospective, multi-center clinical study to develop, validate and bring to market a pipeline test aimed at predicting response to systemic therapy in patients with moderate to severe psoriasis, atopic dermatitis and related inflammatory skin conditions. We have also initiated two additional disease studies for pipeline tests for new indications.
Selling, general and administrative expenses
Selling, general and administrative ("SG&A") expenses include executive, selling and marketing, legal, finance and accounting, human resources, billing and client services. These expenses consist of personnel costs (including salaries, bonuses, benefits and stock-based compensation expense), direct marketing expenses, audit and legal expenses, consulting costs, training and medical education activities, payor outreach programs and allocated overhead, including rent, information technology, 22
equipment depreciation, and utilities. We expect continued increases in SG&A expenses related to compliance with the rules and regulations of the
SECand The Nasdaq Stock market LLC ("Nasdaq") (in particular as we have become a large accelerated filer), investor relations activities and additional insurance expenses. Other administrative and professional services expenses within SG&A are expected to increase with the scale of our business, but selling and marketing-related expenses are expected to increase significantly, consistent with our growth strategy.
Amortization of acquired intangible assets
The amortization of acquired intangible assets is mainly associated with the technology developed.
Change in fair value of contingent consideration
The change in fair value of the contingent consideration is associated with our acquisition of
Interest income consists primarily of income on cash and cash equivalents, primarily money market funds.
Interest expense is mainly attributable to a finance lease.
income tax expense
Our consolidated financial statements do not reflect any federal or state income tax benefits attributable to the net losses we have incurred, due to the uncertainty of realizing a benefit from those items. As of
December 31, 2021, we had federal net operating loss carryforwards of $99.4 million, of which $43.5 millionwill begin to expire in 2030 if not utilized to offset federal taxable income, and $55.9 millionmay be carried forward indefinitely. Also, as of December 31, 2021, we had state net operating loss carryforwards of $67.5 million, which begin to expire in 2028 if not utilized to offset state taxable income. Results of Operations Certain prior year amounts in the tables below have been reclassified to conform to the current year presentation. Specifically, we no longer present gross margin on the face of our financial statements and therefore the cost of sales line is now presented within the operating expenses section. This reclassification had no impact on operating loss, loss before income taxes or net loss. The calculation of our gross margin is instead presented in a separate table in following section. 23
Comparison of the three months ended
The following table summarizes our results of operations for the periods indicated (in thousands, except percentages):
Three Months Ended March 31, 2022 2021 Change (unaudited) Net revenues
$ 26,852 $ 22,813 $ 4,03917.7 % Operating expenses Cost of sales (exclusive of amortization of acquired intangible assets) 5,944 3,028 2,916 96.3 % Research and development 10,761 5,908 4,853 82.1 % Selling, general and administrative 30,453 18,161 12,292 67.7 % Amortization of acquired intangible assets 1,648 - 1,648 NA Change in fair value of contingent consideration 2,562 - 2,562 NA Total operating expenses 51,368 27,097 24,271 89.6 % Operating loss (24,516) (4,284) (20,232) (472.3) % Interest income 30 4 26 NM Interest expense (3) - (3) NA Loss before income taxes (24,489) (4,280) (20,209) (472.2) % Income tax expense 134 - 134 NA Net loss $ (24,623) $ (4,280) $ (20,343)(475.3) % NA = Not applicable NM = Not meaningful The following table provides a disaggregation of net revenues by type (in thousands): Three Months Ended March 31, 2022 2021 Change (unaudited) Dermatologic(1) $ 24,339 $ 20,910 $ 3,429Other(2) 2,513 1,903 610 Total net revenues $ 26,852 $ 22,813 $ 4,039
(1)Includes DecisionDx-Melanoma, DecisionDx-SCC and CDO. (2) Mainly consists of DecisionDx-UM.
The following table presents the calculation of gross margin (in thousands, except percentages): Three Months Ended March 31, 2022 2021 Change (unaudited) Net revenues
$ 26,852 $ 22,813 $ 4,039Less: Cost of sales (exclusive of amortization of acquired intangible assets) 5,944 3,028 2,916 Less: Amortization of acquired intangible assets 1,648 - 1,648 Gross margin $ 19,260 $ 19,785 $ (525)Gross margin percentage 71.7 % 86.7 % (15.0) % 24
The following table shows the amount of stock-based compensation expense (non-cash) reflected in the above line items (in thousands):
Three Months Ended March 31, 2022 2021 Change (unaudited) Cost of sales (exclusive of amortization of acquired intangible assets)
$ 853 $ 510 $ 343Research and development 1,828 1,058 770 Selling, general and administrative 5,738 3,345 2,393 Total stock-based compensation expense $ 8,419 $ 4,913 $ 3,506Net Revenues Net revenues for the three months ended March 31, 2022increased by $4.0 million, or 17.7%, to $26.9 millioncompared to the three months ended March 31, 2021, primarily due to $3.4 millionhigher revenue from dermatologic tests, primarily DecisionDx-Melanoma, and to a lesser extent, higher revenues from our other tests (non-dermatologic) of $0.6 million. The increase in dermatologic revenue was primarily attributable to a 69% increase in test volumes, with higher test reports delivered across each of our dermatologic offerings, due to a combination of increased patient flow attributable to the easing of COVID-19 restrictions and the effects of our dermatologic sales force expansion during the first half of 2021. The higher volumes were partially offset by the effect of lower positive revenue adjustments related to tests delivered in previous periods, associated with changes in estimated variable consideration, which were $0.6 millionfor the three months ended March 31, 2022compared to $5.3 millionfor the three months ended March 31, 2021. The year-over-year decrease is primarily attributable to the effect of favorable adjustments related to the settlement and collection during the three months ended March 31, 2021of certain groups of receivables from prior years that did not recur during the three months ended March 31, 2022. The increase in revenue from our other tests (non-dermatologic) of $0.6 millionwas primarily attributable to higher volume of DecisionDx-UM, which we believe is largely attributable to the easing of COVID-19 restrictions.
Cost of sales (excluding amortization of intangible assets acquired)
Cost of sales (exclusive of amortization of acquired intangible assets) for the three months ended
March 31, 2022increased by $2.9 million, or 96.3%, compared to the three months ended March 31, 2021, primarily due to higher personnel costs, attributable to additional headcount in our laboratory testing operations, including headcount attributable to the addition of Cernostics, as well as increased costs of supplies and services, attributable to the higher activity levels. Due to the nature of our business, a significant portion of our cost of sales expenses represent fixed costs associated with our testing operations. Accordingly, our cost of sales expense will not necessarily increase or decrease commensurately with the change in net revenues from period to period. We expect our cost of sales (exclusive of amortization of acquired intangible assets) to continue to increase in future periods as we hire additional laboratory personnel and related resources to support our expected growth in volume for our dermatologic, gastrointestinal, mental health and pipeline tests.
Our gross margin percentage was 71.7% for the three months ended
March 31, 2022, compared to 86.7% for the same period in 2021. The decrease was primarily due to this year's amortization expense associated with our acquired intangible assets, lower positive revenue adjustments related to tests delivered in previous periods and additional investments in laboratory headcount. In the near term, we expect that our gross margin percentage will decline, compared to prior periods, as we invest in additional laboratory personnel and related resources to support the anticipated growth in our report volumes for tests in advance of obtaining reimbursement coverage. Additionally, our gross margin percentage will continue to be negatively impacted by amortization of intangible assets associated with recent acquisitions. Research and Development Research and development expenses increased by $4.9 million, or 82.1%, for the three months ended March 31, 2022, compared to the three months ended March 31, 2021. Approximately 51% of the increase is attributable to higher personnel costs, primarily due to expansions in headcount in support of our growth, including higher stock-based compensation expense of $0.8 million, and approximately 20% is attributable to higher costs for clinical studies, including costs related to the PERSONALize, CONNECTION and DECIDE studies. The remainder of the increase is primarily associated with meeting costs and travel expenses. We expect to continue to increase our research and development expenses as we fund ongoing evidence development for our existing products as well as additional pipeline programs. 25
Selling, general and administrative expenses
The following table provides a breakdown of SG&A expenses (in thousands):
Three Months Ended March 31, 2022 2021 Change (unaudited) Sales and marketing
$ 18,221 $ 9,656 $ 8,565General and administrative 12,232
8,505 3,727 Total selling, general and administrative expenses
Sales and marketing expenses increased by
$8.6 million, or 88.7%, for the three months ended March 31, 2022, compared to three months ended March 31, 2021. Approximately $5.4 million, or 63%, of the increase is attributable to higher personnel costs including salaries, bonuses and stock-based compensation. Stock-based compensation expense included in sales and marketing expense was $2.8 millionfor the three months ended March 31, 2022, compared to $1.5 millionfor the three months ended March 31, 2021. Personnel costs have increased through the expansion of our dermatology-facing commercial team headcount to the mid-60s during the first and second quarters of 2021 and through our acquisition of Cernosticsin December 2021, where we hired an initial commercial team of approximately 14 outside sales territories, along with commensurate internal sales associates and other personnel, to support our launch of the TissueCypher Barrett's Esophagus test and to serve as a dedicated team focused on gastroenterology specialists that diagnose and manage patients with BE. The remainder of the increase in sales and marketing expenses was primarily associated with training events, meetings, travel and other general increases. The higher expenses for training events and travel reflect both a higher headcount as well a return to more in-person activities resulting from the continued easing of COVID-19 restrictions. We expect sales and marketing expenses to increase in future periods as we intend to expand our outside sales territories and sales force further during 2022, as discussed under "Overview" above. General and administrative expenses increased by $3.7 million, or 43.8%, for the three months ended March 31, 2022, compared to three months ended March 31, 2021. The increase is primarily attributable to $2.6 millionin higher personnel costs including salaries, bonuses and stock-based compensation. Stock-based compensation expense included in general and administrative expense was $2.6 millionfor the three months ended March 31, 2022, compared to $1.4 millionfor the three months ended March 31, 2021. The higher personnel costs reflect expanded headcount in our administrative support functions. The remainder of the increase in general and administrative expenses was primarily associated with professional fees and other general increases.
Amortization of acquired intangible assets
Amortization of acquired intangible assets was
$1.6 millionfor the three months ended March 31, 2022and was primarily associated with amortization of developed technology attributable to the acquisitions of Myriad myPath, LLC and Cernosticsin May 2021and December 2021, respectively. There was no such amortization during the three months ended March 31, 2021.
Change in fair value of contingent consideration
The change in fair value of contingent consideration for the three months ended
March 31, 2022of $2.6 millionis related to the remeasurement of the Earnout Payments associated with our acquisition of Cernosticsand primarily reflects the passage of time. There was no such activity during the three months ended March 31, 2021.
Stock-based compensation expense
Stock-based compensation expense, which is allocated among cost of sales, research and development expense and SG&A expense, totaled
$8.4 millionfor the three months ended March 31, 2022, compared to $4.9 millionfor the three months ended March 31, 2021. We expect material increases in stock-based compensation expense in future periods, reflecting mainly higher awards outstanding due to growth in our headcount. As of March 31, 2022, we had 400 employees compared to 242 as of March 31, 2021. As of March 31, 2022, the total unrecognized stock-based compensation cost related to outstanding awards was $97.1 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 3.1 years. We expect to continue granting stock-based compensation awards, which we expect to further contribute to increases in stock-based compensation expense in future periods. 26
Cash and capital resources
Sources of liquidity
Our principal sources of liquidity are our cash and cash equivalents and cash generated from the sale of our products. As of
March 31, 2022and December 31, 2021, we had cash and cash equivalents of $309.0 millionand $329.6 million, respectively. In addition to the revenue generated from the sale of our commercial products, we have financed our operations through our IPO in July 2019, two follow-on public offerings of common stock in June 2020and December 2020, and a $25.0 millionsecured term loan credit facility, which we repaid in full in December 2020. On December 14, 2020, we filed an automatically effective shelf registration statement on Form S-3 (File No. 333-251331) (our "Shelf Registration Statement") with the SECas a "well-known seasoned issuer." The Shelf Registration Statement allows us to issue an indeterminate number or amount of common stock, preferred stock, debt securities and warrants from time to time in one or more offerings. However, there can be no assurance that we will complete any further offerings of securities under our Shelf Registration Statement. Any future offerings under our Shelf Registration Statement will be dependent upon, among other factors, market conditions, available pricing, our financial condition, investor perception of our prospects, our capital needs and our ability to maintain status as a well-known seasoned issuer. Our market capitalization as of May 6, 2022is below the level required to maintain status as well-known seasoned issuer in the future. As mentioned above, we expect to use a portion of our cash and cash equivalents, including any proceeds from subsequent offerings under our Shelf Registration Statement, to further support and accelerate our research and development activities, including the clinical studies noted above in "Components of the Results of Operations-Researchand Development."
Material cash needs
Our primary uses of capital are, and we expect will continue to be, compensation and related expenses, clinical research and development services, laboratory operations, equipment and related supplies, legal and other regulatory expenses, general administrative costs and, from time to time, expansion of our laboratory and office facilities in support of our growth. We anticipate that a substantial portion of our cash requirements in the foreseeable future will relate to the further commercialization of our currently marketed products, the development of our future product candidates in our pipeline and the potential commercialization of these pipeline products, should their development be successful. In
December 2021, we acquired Cernosticsfor $30.7 millionin cash and in April 2022, we acquired AltheaDx, for $32.5 millionin cash and $32.5 millionin shares of our common stock. Under the definitive agreement to acquire Cernostics, we also agreed to pay up to an additional $50.0 millionof Earnout Payments, based on the achievement of certain commercial milestones relating to the year ending December 31, 2022. With respect to AltheaDx, we agreed to pay up to an additional $75.0 million, 50% in cash and 50% in common stock, based on the achievement of certain commercial milestones relating to the years ending December 31, 2022, 2023 and 2024. Our actual liability with respect to these commercial milestone payments from our acquisitions will depend, in part, on our ability to successfully integrate the TissueCypher Barrett's Esophagus test (acquired from Cernostics) and IDgenetix (acquired from AltheaDx) into our suite of commercial product offerings. Since our inception, we have generally incurred significant losses and negative cash flows. For the year ended December 31, 2021we had a net loss of $31.3 millionand an accumulated deficit of $93.8 millionas of December 31, 2021. For the three months ended March 31, 2022, we had a net loss of $24.6 millionand an accumulated deficit of $118.4 millionas of March 31, 2022. Our ability to generate revenue sufficient to achieve profitability will depend heavily on the successful commercialization of our currently marketed products and the products we plan to launch in the future as well as our spending on research and development activities. We expect to incur additional expenses and losses in the future as we invest in the commercialization of our existing products, the development of our future product candidates and the commercialization of our product candidates. Further, we expect that any acquisitions of businesses, products, assets or technologies will also increase our expenses. We believe that our existing cash and cash equivalents and anticipated cash generated from the sale of our commercial products will be sufficient to fund our operations for the next twelve months. We believe we will meet longer-term expected cash requirements and obligations through a combination of existing cash and cash equivalents, anticipated cash generated from sales of our products and issuances of equity securities or debt offerings, including through our Shelf Registration Statement. However, we have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. There are numerous risks and uncertainties associated with developing genomic tests, including, among others, the uncertainty of:
• successful initiation and completion of clinical study protocols;
•successful identification and acquisition of tissue samples;
•the development and validation of genomic classifiers; and
•the acceptance of new genomic tests by doctors, patients and third-party payers.
Because of the numerous risks and uncertainties associated with research, development and commercialization of product candidates, we are unable to estimate our exact working capital requirements. Our future funding requirements will depend on and could increase significantly as a result of many factors, including those listed above as well as those listed in Part II, Item 1A., "Risk Factors" in this Quarterly Report on Form 10-Q. We do not currently have any committed external source of funds. In the event additional funding is required, we expect that we would use a combination of equity and debt financings, which may not be available to us when needed, on terms that we deem to be favorable or at all. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of common stockholders. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making acquisitions or capital expenditures or declaring dividends. Any disruptions to, or volatility in, the credit and financial markets or any deterioration in overall economic conditions may make any necessary debt or equity financing more difficult to obtain, more costly and/or more dilutive. If we are unable to raise additional funds through debt or equity financings or other arrangements when needed, we may be required to delay, limit, reduce or terminate our product discovery and development activities or future commercialization efforts.
We have entered into various operating and finance leases, which are primarily associated with our laboratory facilities and office space. Total undiscounted future minimum payment obligations under our operating leases and finance leases as of
March 31, 2022totaled approximately $10.3 million, of which $1.0 millionis payable through the remainder of 2022 and $9.3 millionthrough the end of 2033. The leases expire on various dates through 2033 and provide certain options to renew for additional periods. On March 11, 2022, we amended an existing lease agreement to lease additional laboratory space in Phoenix, Arizona. On April 1, 2022, we entered into a new lease agreement with an initial term of 10.5 years for laboratory and office space located in Pittsburgh, Pennsylvania. As of March 31, 2022, neither of the two leases had commenced. Upon commencement, we expect these two leases to increase our undiscounted future minimum payment obligations by a total of approximately $13.8 million.
The following table summarizes our sources and uses of cash and cash equivalents for each of the periods presented (in thousands):
Three Months Ended March 31, 2022 2021 (unaudited) Net cash used in operating activities
$ (21,430) $ (3,631)Net cash used in investing activities (402) (750) Net cash provided by financing activities 1,216 1,510 Net change in cash and cash equivalents (20,616) (2,871) Cash and cash equivalents, beginning of period 329,633 409,852 Cash and cash equivalents, end of period $ 309,017 $ 406,981Operating Activities Net cash used in operating activities was $21.4 millionfor the three months ended March 31, 2022, and was primarily attributable to the net loss of $24.6 million, decreases in accrued compensation of $6.9 millionand increases in accounts receivable of $2.7 million, partially offset by non-cash stock compensation expense of $8.4 million, change in fair value of contingent consideration of $2.6 millionand depreciation and amortization of $2.2 million. Net cash used in operating activities was $3.6 millionfor the three months ended March 31, 2021, and was primarily attributable to the net loss of $4.3 million, decreases in accrued compensation of $3.9 million, increases in accounts receivable of $1.6 millionand decreases in other accrued liabilities of $0.3 million, partially offset by stock compensation expense of $4.9 millionand decreases in prepayments and other current assets of $1.7 million. The $17.8 millionadditional net cash used in operating activities for the three months ended March 31, 2022compared to the three months ended March 31, 2021is primarily due to cash requirements associated with the increases in operating expenses, the majority of which were attributable to salaries, bonuses and benefits due to our growth in headcount, as discussed in further 28
detail under "Results of Operations-Comparison of the three months ended
March 31, 2022and 2021" above. The effect of the higher expenses on net cash used in operating activities was partially offset by the higher revenues.
Net cash used in investing activities for the three months ended
and 2021 consisted of purchases of property, plant and equipment in both periods.
Net cash provided by financing activities was
$1.2 millionfor the three months ended March 31, 2022, and primarily consisted of $0.9 millionin proceeds from contributions to the employee stock purchase plan and $0.4 millionin proceeds from the exercise of stock options. Net cash provided by financing activities was $1.5 millionfor the three months ended March 31, 2021, and primarily consisted of $1.0 millionin proceeds from the exercise of stock options and $0.9 millionin proceeds from contributions to the employee stock purchase plan.
Critical accounting estimates
During the three months ended
March 31, 2022, there were no significant changes to the information discussed under "Critical Accounting Estimates" included in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended December 31, 2021.
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