CASTLE BIOSCIENCES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion and analysis of financial condition and results of operations together with our unaudited condensed 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, 2020 and 2019 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, including Critical Accounting Policies and Significant Judgments and Estimates, included in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission, or the SEC, on March 11, 2021. Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to “we,” “us,” and “our” refer to Castle Biosciences, Inc. Forward-Looking Statements 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, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or 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 “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and 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 and 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. Overview We are a commercial-stage dermatological cancer company focused on providing physicians and their patients with personalized, clinically actionable genomic information to make more accurate treatment decisions. We believe that the traditional approach to developing a treatment plan for certain cancers using clinical and pathology factors alone is inadequate and can be improved by incorporating personalized genomic information. Our non-invasive products utilize proprietary algorithms to provide an assessment of a patient’s specific risk of metastasis or recurrence of their cancer, allowing physicians to identify patients who are likely to benefit from an escalation of care as well as those who may avoid unnecessary medical and surgical interventions. Our lead product, DecisionDx®-Melanoma, is a proprietary multi-gene expression profile, or GEP, test that predicts the risk of metastasis or recurrence for patients diagnosed with invasive cutaneous melanoma, a deadly skin cancer. This test has two current clinically actionable uses. The first use immediately following diagnosis predicts a patient’s likelihood of having a sentinel lymph node negative biopsy result so that physicians and patients can discuss the risk and benefit of undergoing sentinel lymph node biopsy, or SLNB, surgery. The second use is to inform the appropriate treatment plan, regardless of the decision to undergo or avoid the SLNB surgery. In a typical year, we estimate more than 130,000 patients are diagnosed with invasive cutaneous melanoma in the United States. We launched DecisionDx-Melanoma in May 2013. In August 2020, we commercially launched our cutaneous squamous cell carcinoma, or SCC, proprietary GEP test, DecisionDx® ‑ SCC, and on November 2, 2020, we commercially launched our proprietary GEP test for suspicious pigmented lesions, DecisionDx® DiffDx™-Melanoma. These two indications are areas of high clinical need in dermatological cancer and, together, represent an addressable population of approximately 500,000 patients in the United States. In April 2021, we entered into a definitive agreement to acquire all of the equity of Myriad myPath, LLC, or the Myriad myPath Laboratory, from Myriad Genetics. The Myriad myPath Laboratory is a Clinical Laboratory Improvement Amendments of 1988, or CLIA-certified laboratory in Salt Lake City, where the myPath Melanoma 23-GEP test was developed and is currently owned and offered. The acquisition, which is subject to customary closing conditions, is expected to close in late May 2021. myPath Melanoma is a clinically validated GEP test designed to be used as an adjunct to histopathology when the distinction between a benign nevus and a malignant melanoma cannot be made confidently by histopathology alone. We anticipate that this test will complement our current offerings and enable us to provide a comprehensive molecular testing solution for difficult-to-diagnose melanocytic lesions. 15 Table of Contents In May 2021, we announced the launch of our innovative pipeline initiative to develop a genomic test aimed at predicting systemic therapy response in patients with moderate to severe psoriasis, atopic dermatitis and related conditions. In the U.S. alone, there are approximately 18 million patients diagnosed with psoriasis and atopic dermatitis, and approximately 450,000 of these patients annually are eligible for these systemic therapies, which has the potential to add approximately $1.9 billion to our current estimated U.S. total addressable market. We recently initiated a 4,800 patient, prospective, multi-center clinical study to develop and validate this pipeline test, and plan to enroll more than 50 centers with the leading experts in the field. Based upon our current development and validation timelines, we expect to launch this pipeline test by the end of 2025. We also market DecisionDx®-UM, which is a proprietary GEP test that predicts the risk of metastasis for patients with uveal melanoma, a rare eye cancer. We launched DecisionDx-UM in January 2010. Based on the substantial clinical evidence that we have developed, we have received Medicare coverage for DecisionDx-Melanoma and DecisionDx-UM, which represents approximately 50% of the addressable patient population for both of these tests. We have processed over 80,000 clinical samples since our inception. For the three months ended March 31, 2021 our revenue was $22.8 million compared to $17.4 million for the three months ended March 31, 2020. The numbers of DecisionDx-Melanoma, DecisionDx-SCC, DecisionDx-DiffDx and DecisionDx-UM test reports delivered by us during the three months ended March 31, 2021 and 2020 and for the year ended December 31, 2020 are presented in the table below: Proprietary Dermatologic GEP Tests DecisionDx- Melanoma DecisionDx-SCC (1) DecisionDx DiffDx-Melanoma (2) Dermatologic Total DecisionDx-UM Grand Total Q1 2021 4,060 527 218 4,805 337 5,142 Q1 2020 4,574 — — 4,574 361 4,935 Q2 2020 3,008 — — 3,008 306 3,314 Q3 2020 4,404 57 — 4,461 318 4,779 Q4 2020 4,246 428 73 4,747 410 5,157 For the year ended December 31, 2020 16,232 485 73 16,790 1,395 18,185 (1) We commercially launched the DecisionDx-SCC test on August 31, 2020. (2) We commercially launched the DecisionDx DiffDx on November 2, 2020. We continue to see new clinicians order our dermatologic tests for the first time. For the three months ended March 31, 2021, we saw approximately 410 new ordering clinicians for our dermatologic tests compared to 453 during the same period of 2020. We believe the year-over-year decrease is due to the impact of reduced physician access since the spring of 2020 as a result of the COVID-19 pandemic, as discussed further below. For additional information on the metrics we disclose, refer to “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 leverage as many of the current DecisionDx-Melanoma clinicians would likely be the same clinicians who would find value in these other skin cancer tests. The three months ended March 31, 2021 represented the second full quarter of clinical availability for our DecisionDx-SCC test and we found that over 80% of all DecisionDx-SCC ordering clinicians were clinicians that had ordered our DecisionDx-Melanoma test in the prior two and a half years. Since our inception in 2008, we have devoted substantially all of our resources to organizing and staffing our company, business planning, raising capital, discovering product candidates, conducting clinical study activities to generate evidence demonstrating the clinical validity, clinical utility, economic benefits, and patient outcomes of our products, and 16 Table of Contents commercialization activities for those products. We currently market four proprietary GEP products and generate substantially all of our revenue from DecisionDx-Melanoma and DecisionDx-UM. The principal focus of our current commercial efforts is to distribute our molecular diagnostic testing products through our direct sales force in the U.S. 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, the relevant information relating to that test is entered into our Laboratory Information Management System, the genomic profile of the sample is performed and a report providing the results of that profile is sent to the physician who ordered the test. 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, or LCDs, which provide coverage for our DecisionDx-Melanoma and DecisionDx-UM tests that meet certain criteria for Medicare and Medicare Advantage beneficiaries, representing approximately 60 million covered lives. As it relates to DecisionDx-UM, we have contracts or have received positive medical policy decisions from additional payors representing approximately 83 million covered lives. A ‘‘covered life’’ means a subscriber, or a dependent of a subscriber, who is insured under an insurance policy for such an insurance carrier. Palmetto GBA MolDx, or Palmetto, the Medicare Administrative Contractor, or 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, or 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. On May 17, 2019, the Centers for Medicare & Medicaid Services, or CMS, determined that DecisionDx-UM meets the criteria for existing advanced diagnostic laboratory test, or ADLT, status, also referred to as “existing ADLT” status. Accordingly, in 2021 the DecisionDx-UM Medicare rate will be set annually based upon the median private payor rate for the first half of the second preceding calendar year. Note that our rate for 2020 was set by Noridian, our local MAC, but our rate for 2021 for DecisionDx-UM will be $7,776 based on the median private payor. 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, CMS notified us that the rate will also be $7,193, which was calculated based upon the median private payor rate for DecisionDx-Melanoma from July 1, 2019 to November 30, 2019. B eginning in 2022, the rate for both DecisionDx-Melanoma and UM 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 2022 will be set using median private payor rate data from January 1, 2020 to June 30, 2020. 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 expect that draft LCDs for each of these tests will be posted in 2021. However, there is no assurance that the timing of any draft LCD or final LCD will match our expectations or our historical experience with LCDs for our other tests. Since becoming a public company, we have financed our operations with the revenue generated from the sale of our products, proceeds from our July 2019 initial public offering, or IPO, follow-on public offerings of common stock in June 2020 and December 2020 and 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 foreseeable future. However, we have based these estimates on assumptions, including those related to the impact of COVID-19 on our financial condition, that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. 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 , or ASC 606. We expect our expenses will increase substantially over time as we: • execute clinical studies to generate evidence supporting our current and future product candidates; • execute our commercialization strategy for our current and future products; • continue our ongoing and planned development of new products; 17 Table of Contents • seek to discover and develop additional product candidates; • hire additional scientific and research and development staff; 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. Recent Development On April 26, 2021, we signed a definitive agreement to acquire Myriad myPath Laboratory from Myriad Genetics for $32.5 million. Myriad myPath Laboratory is a CLIA-certified laboratory in Salt Lake City where the myPath Melanoma 23-GEP test was developed and is currently offered. We will finance the acquisition with cash and cash equivalents on hand. The transaction is expected to close in late May 2021, subject to customary conditions. Impact of COVID-19 Pandemic We are continuing to closely monitor the impact of the COVID-19 pandemic on our business and are 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 began experiencing declines in orders and test report volume. For the year ended December 31, 2020, our growth in DecisionDx-Melanoma test report volume was 4.5%, compared to year-over-year growth of 29.1% for the year ended December 31, 2019. In the first quarter of 2021, test reports delivered for DecisionDx-Melanoma decreased by 11.2% compared to the first quarter of 2020. We believe the decreases in our test report volume are linked to delays in the diagnoses as well as the cumulative impact on promotional responsiveness as a result of reduced sales calls per day and in-person sales call during the COVID-19 pandemic. • Orders for DecisionDx-Melanoma have shown positive trends during the first three months of 2021. Order volume for our DecisionDx-Melanoma test increased by approximately 30% in March 2021 compared to January 2021. This positive trend of increasing orders continued through April 2021, with April order volume exceeding March. • Our commercial team uses a combination of in-person, virtual, and non-personal promotional and educational efforts. During the three months ended March 31, 2021, we saw improvement in both the number of promotional calls per day as well as a continued shift from virtual to in-person sales calls with in-person sales calls accounting for just over 75% of all calls during such period. We have also seen increases in clinicians’ interest to attend and participate in peer-to-peer promotional and educational programs. • Our future results will be dependent upon the extent and duration of the COVID-19 crisis as well as the impact of ongoing state and local government restrictions, which are beyond our control, and which may be eased and/or reinstated from time to time 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, patient visits and diagnosis of cutaneous melanoma may be impacted by continued apprehension regarding possible exposure to the virus as well as telemedicine. • We continue to believe our cash and cash equivalents and anticipated cash to be generated from sales of our products, will be sufficient to fund our operations for the foreseeable future. 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 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 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,” of this Quarterly Report on Form 10-Q. 18 Table of Contents Factors affecting our performance We believe there are several important factors that have impacted and that we expect will impact 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 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 continue to be negatively impacted by the effects of the COVID-19 pandemic, as the crisis evolves, 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 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 about certain metrics The following provides additional information about certain metrics we have disclosed in this Management’s Discussion and Analysis of Financial Condition and Results of Operation. Test reports delivered for DecisionDx-Melanoma, DecisionDx-SCC, DecisionDx DiffDx-Melanoma and DecisionDx-UM 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 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. A dermatologic test is DecisionDx-Melanoma, DecisionDx-SCC or DecisionDx DiffDx-Melanoma. 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 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 a test report was delivered or in which any revenue was recognized. Components of the Results of Operations Net Revenues 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. 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 19 Table of Contents 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, including those claims subject to approval by an Administrative Law Judge, or ALJ, at an appeal hearing, 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 appe al 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 market, 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 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 records, 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 performing tests 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 anticipated growth of our recently launched tests. Gross margin, calculated as net revenues minus cost of sales, and gross margin percentage, calculated as gross margin divided by net revenues, are key indicators we use to assess our business. Research and Development Research and development expenses include costs incurred to develop our genomic 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 the proceeds from the June 2020 and December 2020 follow-on public offerings to further support and accelerate our research and development activities, including two important studies that we have recently commenced 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. Also, as noted above, we recently initiated a 4,800 patient, prospective, multi-center clinical study to develop, validate and bring to market a pipeline test aimed at predicting systemic therapy response for patients with moderate to severe psoriasis, atopic dermatitis and related conditions. Selling, General and Administrative Selling, general and administrative, or 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, equipment depreciation, and utilities. We expect continued increases in SG&A expenses related to compliance with the rules and regulations of the SEC and The Nasdaq Stock Market LLC, or Nasdaq, 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. 20 Table of Contents Interest Income Interest income consists primarily of earnings on cash and cash equivalents, primarily money market funds. Interest Expense Interest expense, if any, is attributable to borrowings under our term debt and also includes the amortization of debt discount and issuance costs. Income Tax Expense Our 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, 2020, we had federal net operating loss carryforwards of $55.9 million, of which $42.0 million will begin to expire in 2033 if not utilized to offset federal taxable income, and $13.9 million may be carried forward indefinitely. Also, as of December 31, 2020, we had state net operating loss carryforwards of $41.6 million, which begin to expire in 2028 if not utilized to offset state taxable income. Results of Operations Comparison of the three months ended March 31, 2021 and 2020 The following table summarizes our results of operations for the periods indicated (in thousands, except percentages): Three Months Ended March 31, Change 2021 2020 (unaudited) Net revenues $ 22,813 $ 17,418 $ 5,395 31.0 % Cost of sales 3,028 2,391 637 26.6 % Gross margin 19,785 15,027 4,758 31.7 % Gross margin percentage 86.7 % 86.3 % Operating expenses: Research and development 5,908 2,913 2,995 102.8 % Selling, general and administrative 18,161 11,078 7,083 63.9 % Total operating expenses 24,069 13,991 10,078 72.0 % Operating (loss) income (4,284) 1,036 (5,320) NM Interest income 4 298 (294) (98.7) % Interest expense — (764) 764 100.0 % (Loss) income before income taxes (4,280) 570 (4,850) NM Income tax expense — — — — % Net (loss) income $ (4,280) $ 570 $ (4,850) NM NM = not meaningful The following table indicates the amount of stock-based compensation expense reflected in the line items above (in thousands): Three Months Ended March 31, 2021 2020 Change Cost of sales $ 510 $ 206 $ 304 Research and development 1,058 234 824 Selling, general and administrative 3,345 1,137 2,208 Total stock-based compensation expense $ 4,913 $ 1,577 $ 3,336 21 Table of Contents Net Revenues For the three months ended March 31, 2021 net revenues increased by $5.4 million, or 31.0%, to $22.8 million compared to the three months ended March 31, 2020 and was primarily attributable to higher DecisionDx-Melanoma test revenues. Overall, the increased revenues reflect higher positive revenue adjustments related to tests delivered in prior periods and higher per-unit revenues, partially offset by lower test report volumes for both DecisionDx-Melanoma and DecisionDx-UM. The higher per-unit revenues include the effect of the expanded LCD for DecisionDx-Melanoma that became effective in the fourth quarter of 2020 and the higher Medicare rate for DecisionDx-UM that became effective January 1, 2021, as discussed above. For the three months ended March 31, 2021, we experienced a 10.9% decrease in total DecisionDx-Melanoma and DecisionDx-UM test reports delivered, compared to the three months ended March 31, 2020, which we believe is attributable to the COVID-19 pandemic. For the three months ended March 31, 2021 and 2020, we recorded net positive revenue adjustments of $5.3 million and $3.2 million, respectively, related to tests delivered in previous periods, associated with changes in estimated variable consideration. The year-over-year increase is primarily attributable to favorable adjustments related to the settlement and collection during the three months ended March 31, 2021 of certain groups of receivables from prior years. Cost of Sales Cost of sales for the three months ended March 31, 2021 increased by $0.6 million, or 26.6%, compared to the three months ended March 31, 2020, primarily due to higher personnel costs due to additional headcount in our laboratory testing operations. Our gross margin percentage was 86.7% for the three months ended March 31, 2021, compared to 86.3% for the same period in 2020. The slight increase in gross margin percentage reflects higher revenues related to prior periods and higher per-unit revenues, partially offset by the expansion of laboratory staff and related costs. 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. Research and Development Research and development expenses increased by $3.0 million, or 102.8%, for the three months ended March 31, 2021, compared to the three months ended March 31, 2020. Approximately 65% of the increase was associated with increased personnel costs, which were primarily attributable to additional headcount, with the remainder primarily associated with increased clinical study activity. Selling, General and Administrative SG&A expense increased by $7.1 million, or 63.9%, for the three months ended March 31, 2021 compared to the three months ended March 31, 2020. Approximately 72% of the increase is attributable to higher personnel costs, particularly due to increased headcount. We expanded our sales organization headcount in the third quarter of 2020 in preparation for the commercial launch of our DecisionDx DiffDx-Melanoma test and further expanded our sales team during the first quarter of 2021. The higher personnel costs also reflect expanded headcount in our administrative support functions. The remainder of the increase was primarily associated with conferences and training events as well as higher professional fees. Stock-based compensation expense included in SG&A expense was $3.3 million for the three months ended March 31, 2021 compared to $1.1 million for the same period in 2020, reflecting both higher post-IPO stock option valuations as well as additional awards outstanding due to growth in headcount. Interest Income Interest income decreased by $0.3 million for the three months ended March 31, 2021 compared to the three months ended March 31, 2020. The decrease is primarily associated with significantly lower interest rates this year, despite our higher average balances of cash and cash equivalents. Interest Expense Interest expense decreased by $0.8 million, or 100.0%, for the three months ended March 31, 2021 compared to the three months ended March 31, 2020. The decrease is attributable to the repayment of our outstanding debt in full in December 2020. Stock-Based Compensation Expense Stock-based compensation expense, which is allocated among cost of sales, research and development expense and SG&A expense, totaled $4.9 million for the three months ended March 31, 2021 compared to $1.6 million for the three months ended March 31, 2020. We expect material increases in stock-based compensation expense in future periods, reflecting both higher 22 Table of Contents post-IPO stock option valuations as well as additional awards outstanding due to growth in our headcount. As of March 31, 2021, the total unrecognized stock-based compensation cost related to outstanding awards was $55.4 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 3.3 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. Liquidity and Capital Resources Sources of Liquidity Our principal sources of liquidity are our cash and cash equivalents and cash generated from sales of our products. As of March 31, 2021 and December 31, 2020, we had cash and cash equivalents of $407.0 million and $409.9 million, respectively. In addition to the revenue generated from the sale of our products, we have financed our operations since July 2019 through the IPO and two follow-on public offerings of common stock in June 2020 and December 2020. On December 14, 2020, we filed an automatically effective shelf registration statement on Form S-3 (File No. 333-251331) with the SEC as a “well-known seasoned issuer.” The 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 such offerings of securities. Any future offerings under this 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. As mentioned above, we expect to use a portion of these proceeds to further support and accelerate our research and development activities, including the clinical studies noted above. Medicare Advance Payment On April 16, 2020, we received an advance payment of $8.3 million, or the Advance Payment, from CMS under its Accelerated and Advance Payment Program, which was expanded to provide increased cash flow to service providers during the COVID-19 pandemic. We have recorded the Advance Payment as a liability, consisting of both a current and noncurrent portion, on our balance sheet as of March 31, 2021. We will reduce the balance of the Advance Payment as it is applied to claims or is otherwise recouped by CMS. Recoupment will commence April 2021 during which the first eleven months CMS will apply 25% of the Medicare payments otherwise owed to us against the balance of the Advance Payment. After that eleven-month period, CMS will recoup at a rate of 50% of the Medicare payments otherwise owed to us for an additional six months. If the Advance Payment is not fully recovered by CMS after this recoupment period, we will be required to repay any remaining balance. Funding Requirements 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 facilities in support of our growth. We anticipate that a substantial portion of our capital resources and efforts in the foreseeable future will be focused on the commercialization of our existing products, the development of our future product candidates, the potential commercialization of our product candidates, should their development be successful, and general administrative costs. We may also, from time to time, consider various strategic opportunities, which may involve using a portion of our capital resources to fund acquisitions of businesses, assets, products or technologies. Since our inception, we have generally incurred significant losses and negative cash flows. For the three months ended March 31, 2021 we had a net loss of $4.3 million and an accumulated deficit of $66.8 million as of March 31, 2021. 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. 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 foreseeable future. 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 commencement and completion of clinical study protocols; 23 Table of Contents • successful identification and acquisition of tissue samples; • the development and validation of genomic classifiers; and • acceptance of new genomic tests by physicians, patients and third-party payors. 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,” of 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. As a result of the COVID-19 crisis and actions taken to slow its spread, the global credit and financial markets have experienced extreme volatility, including diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates and uncertainty about economic stability. There can be no assurance that further deterioration in credit and financial markets and confidence in economic conditions will not occur. If equity and credit markets deteriorate, it 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 equity or debt 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. Cash Flows 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, 2021 2020 (unaudited) Net cash used in operating activities $ (3,631) $ (251) Net cash used in investing activities (750) (500) Net cash provided by financing activities 1,510 559 Net change in cash and cash equivalents (2,871) (192) Cash and cash equivalents, beginning of period 409,852 98,845 Cash and cash equivalents, end of period $ 406,981 $ 98,653 Operating Activities Net cash used in operating activities was $3.6 million for 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 million and decreases in other accrued liabilities of $0.3 million, partially offset by stock compensation expense of $4.9 million and decreases in prepayments and other current assets of $1.7 million. Net cash used in operating activities was $0.3 million for the three months ended March 31, 2020 and was primarily attributable to a decrease in accrued compensation of $2.6 million and other minor variations, partially offset by non-cash charges of $1.9 million and net income of $0.6 million. Non-cash charges consisted of stock compensation expense of $1.6 million, amortization of debt discount and issuance costs of $0.2 million and depreciation expense of $0.1 million. Investing Activities Net cash used in investing activities for the three months ended March 31, 2021 and 2020 consisted of purchases of property and equipment. 24 Table of Contents Financing Activities Net cash provided by financing activities was $1.5 million for the three months ended March 31, 2021 and primarily consisted of $1.0 million in proceeds from the exercise of stock options and $0.9 million in proceeds from contributions to the employee stock purchase plan. Net cash provided by financing activities was $0.6 million for the three months ended March 31, 2020 and primarily consisted of cash received from contributions to the employee stock purchase plan. Critical Accounting Policies and Significant Judgments and Estimates During the three months ended March 31, 2021, there were no significant changes to the information discussed under “Critical Accounting Policies and Significant Judgments and 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, 2020. Recent Accounting Pronouncements Refer to Note 2, ‘‘Summary of Significant Accounting Policies,’’ in the accompanying notes to our unaudited condensed financial statements included in this Quarterly Report on Form 10-Q for a discussion of recent accounting pronouncements. JOBS Act Accounting Election We are an emerging growth company within the meaning of the Jumpstart Our Business Startups Act, as amended, or the JOBS Act. Section 107(b) of the JOBS Act provides that an emerging growth company can leverage the extended transition period, provided in Section 102(b) of the JOBS Act, for complying with new or revised accounting standards. Thus, an emerging growth company can delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. We have elected to use this extended transition period and, as a result, our financial statements may not be comparable to companies that comply with public company effective dates. We also intend to rely on other exemptions provided by the JOBS Act, including without limitation, not being required to comply with the auditor attestation requirements of Section 404(b) of Sarbanes-Oxley. We will remain an emerging growth company until the earliest of (1) December 31, 2024, (2) the last day of the fiscal year (a) in which we have total annual gross revenue of at least $1.07 billion or (b) in which we are deemed to be a ‘‘large accelerated filer’’ as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock held by non-affiliates exceeded $700.0 million as of the prior June 30 th , and (3) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period. As of April 30, 2021, the market value of our common stock held by non-affiliates exceeded $700.0 million. If the market value of our common stock held by non-affiliates exceeds $700.0 million as of June 30, 2021, we will cease to be an emerging growth company effective December 31, 2021. Item 3. Qualitative and Quantitative Disclosures About Market Risk. As a smaller reporting company, we are not required to provide the information required by this Item.