Castle Biosciences, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020; interim financial statements are unaudited. Castle is a U.S. commercial-stage dermatological cancer diagnostics company. Most revenue comes from DecisionDx-Melanoma, with additional revenue from DecisionDx-UM.
Key financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $15.2 million | $14.8 million | $45.4 million | $34.2 million |
| Gross margin | $12.7 million; 83.7% | $13.1 million; 88.4% | $38.3 million; 84.5% | $28.9 million; 84.5% |
| Operating income (loss) | $(3.9) million | $4.4 million | $(3.5) million | $4.7 million |
| Net income (loss) | $(4.6) million | $5.8 million | $(5.4) million | $3.2 million |
| Operating cash flow | Not presented for the quarter | $10.3 million | $2.5 million |
At September 30, cash and cash equivalents were $183.1 million, up from $98.8 million at year-end 2019. Current assets were $201.1 million and current liabilities $30.2 million. Debt was $22.5 million net of unamortized discount and issuance costs ($23.4 million principal), including $10.0 million current. The company reported a 7.76:1 liquidity ratio under its credit agreement and compliance with its covenant. No income tax expense was recorded.
Nine-month operating cash flow included an $8.3 million Medicare advance payment and the $1.9 million HHS provider relief payment. The Medicare advance is a liability, not revenue; HHS relief income was reversed in Q3 and recorded as an accrued liability. Financing cash flow included $79.5 million net proceeds from the June/July follow-on offering, partly offset by $3.3 million of debt repayments. Investing cash flow was $(4.2) million, primarily reflecting facility expansion.
Material changes versus the comparable period
- Q3 revenue rose 3.0% year over year, while total DecisionDx-Melanoma and DecisionDx-UM reports delivered increased 5.4%. Q3 DecisionDx-Melanoma reports rose 6.7% year over year and 46.4% from Q2.
- Nine-month revenue increased 32.5%, driven by higher per-test revenue—including the DecisionDx-Melanoma Medicare ADLT rate—and higher test volume. Total Melanoma and UM reports delivered increased 6.8%. Prior-period revenue adjustments were smaller: $0.2 million for the nine months versus $2.4 million in 2019.
- Q3 gross margin percentage declined to 83.7% from 88.4%, as laboratory staffing and capacity were expanded. Nine-month gross margin percentage remained 84.5%.
- Operating expenses rose sharply: Q3 R&D increased 101.8% and SG&A 64.3%; nine-month R&D increased 105.3% and SG&A 65.9%. The company cited added staff, commercial expansion, clinical work, marketing and higher stock-based compensation.
- Results shifted to losses. The prior-year periods included a $5.2 million noncash debt-extinguishment gain and other fair-value items related to notes and warrants; these did not recur in 2020. Q3 2020 also included a $1.9 million reversal of previously recognized HHS relief income.
- DecisionDx-SCC launched August 31, 2020; 57 reports were delivered in Q3, but no related revenue had yet been recognized pending reimbursement experience and coverage decisions. DecisionDx DiffDx-Melanoma launched after the quarter, on November 2, 2020.
Outlook, commentary and risks
- Management said existing cash and anticipated product-sale collections should fund operations for the foreseeable future, while cautioning that assumptions could prove wrong. No quantified revenue or earnings guidance is provided in the filing. Management expects expenses to increase with commercialization, R&D, staffing and facility expansion.
- COVID-19 reduced patient visits, biopsies and test volume, particularly in Q2; volume improved in Q3. The company noted that U.S. cutaneous melanoma diagnoses were down approximately 12% year over year in Q3, based on third-party data, and said future effects remain uncertain.
- CMS recoupment of the $8.3 million Medicare advance was deferred to April 2021 under legislation enacted after quarter-end. CMS is to offset 25% of Medicare payments for 11 months, then 50% for six months; any remaining balance must be repaid.
- OMHA denied payment on a consolidated set of 2,698 DecisionDx-Melanoma claims in March 2020. Castle appealed; no revenue for these claims was recognized pending the appeal outcome.
- Revenue depends on third-party reimbursement and estimates of variable consideration; payor concentration, coverage decisions and collection timing can make reported revenue volatile. Medicare accounted for 54% of nine-month 2020 revenue; Medicare Advantage plans accounted for another 28%.
- Other key risks include ongoing COVID-19 disruption, dependence on the lead product, regulatory uncertainty for laboratory-developed tests, clinical and reimbursement acceptance of new products, and secured debt covenant restrictions. The term loan bears 8.55% interest, with principal installments due monthly and maturity on November 1, 2022.
Most important facts for investors to verify
- Whether test-report growth and reimbursement translate into durable revenue and collections, particularly given ASC 606 adjustments and payor concentration.
- The outcome and timing of the appeal covering the 2,698 denied historical Medicare claims; no related revenue is currently recognized.
- CMS recovery of the Medicare advance and the company’s eligibility to retain the HHS relief funds following revised reporting rules.
- Coverage, reimbursement and commercial adoption of DecisionDx-SCC and DecisionDx DiffDx-Melanoma, and the effect of expansion spending on margins and losses.
- Continued compliance with debt covenants and management’s cash runway assumptions amid COVID-19 uncertainty and planned investment.