CASTLE BIOSCIENCES INC 10-Q

Item 1. Financial Statements. CASTLE BIOSCIENCES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data) September 30, 2022 December 31, 2021 ASSETS (unaudited) Current Assets Cash and cash equivalents $ 134,180 $ 329,633 Marketable investment securities 131,802 — Accounts receivable, net 22,835 17,282 Inventory 3,802 2,021 Prepaid expenses and other current assets 6,795 4,807 Total current assets 299,414 353,743 Long-term accounts receivable, net 1,187 1,308 Property and equipment, net 13,054 9,501 Operating lease assets 12,604 7,383 Goodwill and other intangible assets, net 130,357 88,922 Other assets – long-term 1,195 1,715 Total assets $ 457,811 $ 462,572 LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities Accounts payable $ 5,768 $ 2,546 Accrued compensation 19,532 15,483 Operating lease liabilities 1,535 1,179 Other accrued and current liabilities 5,107 5,678 Total current liabilities 31,942 24,886 Noncurrent portion of contingent consideration 1,798 18,287 Noncurrent operating lease liabilities 11,900 6,900 Deferred tax liability 614 635 Other liabilities 124 124 Total liabilities 46,378 50,832 Commitments and Contingencies (Note 12) Stockholders’ Equity Preferred stock, $ 0.001 par value per share; 10,000,000 shares authorized as of September 30, 2022 and December 31, 2021; no shares issued and outstanding as of September 30, 2022 and December 31, 2021 — — Common stock, $ 0.001 par value per share; 200,000,000 shares authorized as of September 30, 2022 and December 31, 2021; 26,350,530 and 25,378,520 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively 26 25 Additional paid-in capital 551,883 505,482 Accumulated deficit ( 140,287 ) ( 93,767 ) Accumulated other comprehensive loss ( 189 ) — Total stockholders’ equity 411,433 411,740 Total liabilities and stockholders’ equity $ 457,811 $ 462,572 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 1 Table of Contents CASTLE BIOSCIENCES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (in thousands, except per share data) Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 NET REVENUES $ 37,011 $ 23,475 $ 98,701 $ 69,046 OPERATING EXPENSES AND OTHER OPERATING INCOME Cost of sales (exclusive of amortization of acquired intangible assets) 8,859 4,500 22,489 11,225 Research and development 10,907 7,500 33,594 20,201 Selling, general and administrative 36,626 22,595 104,577 61,578 Amortization of acquired intangible assets 2,306 694 6,051 950 Change in fair value of contingent consideration ( 151 ) — ( 17,987 ) — Total operating expenses, net 58,547 35,289 148,724 93,954 Operating loss ( 21,536 ) ( 11,814 ) ( 50,023 ) ( 24,908 ) Interest income 1,293 23 1,693 51 Interest expense ( 6 ) — ( 13 ) — Loss before income taxes ( 20,249 ) ( 11,791 ) ( 48,343 ) ( 24,857 ) Income tax (benefit) expense — — ( 1,823 ) 5 Net loss $ ( 20,249 ) $ ( 11,791 ) $ ( 46,520 ) $ ( 24,862 ) Loss per share, basic and diluted $ ( 0.77 ) $ ( 0.47 ) $ ( 1.79 ) $ ( 0.99 ) Weighted-average shares outstanding, basic and diluted 26,316 25,287 25,938 25,072 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 2 Table of Contents CASTLE BIOSCIENCES, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED) (in thousands) Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Net loss $ ( 20,249 ) $ ( 11,791 ) $ ( 46,520 ) $ ( 24,862 ) Other comprehensive loss: Net unrealized loss on available-for-sale securities ( 189 ) — ( 189 ) — Comprehensive loss $ ( 20,438 ) $ ( 11,791 ) $ ( 46,709 ) $ ( 24,862 ) The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 3 Table of Contents CASTLE BIOSCIENCES, INC. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED) (in thousands, except share data) Preferred Stock Common Stock Additional Paid-in Capital Accumulated Deficit Accumulated Other Comprehensive Loss Total Stockholders’ Equity Shares Amount Shares Amount BALANCE, JANUARY 1, 2021 — $ — 24,812,487 $ 25 $ 478,162 $ ( 62,496 ) $ — $ 415,691 Adoption of ASU No. 2016-02 — — — — — 21 — 21 Stock-based compensation expense — — — — 4,913 — — 4,913 Exercise of common stock options — — 171,315 — 991 — — 991 Issuance of common stock under the employee stock purchase plan — — 70,711 — 1,233 — — 1,233 Public offering of common stock, adjustment to offering costs — — — — 39 — — 39 Net loss — — — — — ( 4,280 ) — ( 4,280 ) BALANCE, MARCH 31, 2021 — $ — 25,054,513 $ 25 $ 485,338 $ ( 66,755 ) $ — $ 418,608 Stock-based compensation expense — — — — 4,766 — — 4,766 Exercise of common stock options — — 109,540 — 1,354 — — 1,354 Net loss — — — — — ( 8,791 ) — ( 8,791 ) BALANCE, JUNE 30, 2021 — $ — 25,164,053 $ 25 $ 491,458 $ ( 75,546 ) $ — $ 415,937 Stock-based compensation expense — — — — 5,210 — — 5,210 Exercise of common stock options — — 82,756 — 1,523 — — 1,523 Issuance of common stock under the employee stock purchase plan — — 39,737 — 855 — — 855 Net loss — — — — — ( 11,791 ) — ( 11,791 ) BALANCE, SEPTEMBER 30, 2021 — $ — 25,286,546 $ 25 $ 499,046 $ ( 87,337 ) $ — $ 411,734 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 4 Table of Contents CASTLE BIOSCIENCES, INC. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED) (in thousands, except share data) Preferred Stock Common Stock Additional Paid-in Capital Accumulated Deficit Accumulated Other Comprehensive Loss Total Stockholders’ Equity Shares Amount Shares Amount BALANCE, JANUARY 1, 2022 — $ — 25,378,520 $ 25 $ 505,482 $ ( 93,767 ) $ — $ 411,740 Stock-based compensation expense — — — — 8,419 — — 8,419 Exercise of common stock options — — 62,102 — 399 — — 399 Issuance of common stock from vested restricted stock units and payment of employees’ taxes — — 2,466 — ( 56 ) — — ( 56 ) Issuance of common stock under the employee stock purchase plan — — 42,332 — 1,457 — — 1,457 Net loss — — — — — ( 24,623 ) — ( 24,623 ) BALANCE, MARCH 31, 2022 — $ — 25,485,420 $ 25 $ 515,701 $ ( 118,390 ) $ — $ 397,336 Stock-based compensation expense — — — — 8,783 — — 8,783 Exercise of common stock options — — 36,634 — 110 — — 110 Issuance of common stock from vested restricted stock units and payment of employees’ taxes — — 6,358 — ( 32 ) — — ( 32 ) Issuance of common stock in acquisition of business — — 763,887 1 17,110 — — 17,111 Net loss — — — — — ( 1,648 ) — ( 1,648 ) BALANCE, JUNE 30, 2022 — $ — 26,292,299 $ 26 $ 541,672 $ ( 120,038 ) $ — $ 421,660 Stock-based compensation expense — — — — 9,196 — — 9,196 Exercise of common stock options — — 17,093 — 166 — — 166 Issuance of common stock from vested restricted stock units and payment of employees’ taxes — — 4,818 — ( 46 ) — — ( 46 ) Issuance of common stock under the employee stock purchase plan — — 36,320 — 895 — — 895 Unrealized loss on marketable investment securities — — — — — — ( 189 ) ( 189 ) Net loss — — — — — ( 20,249 ) — ( 20,249 ) BALANCE, SEPTEMBER 30, 2022 — $ — 26,350,530 $ 26 $ 551,883 $ ( 140,287 ) $ ( 189 ) $ 411,433 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 5 Table of Contents CASTLE BIOSCIENCES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (in thousands) Nine Months Ended September 30, 2022 2021 OPERATING ACTIVITIES Net loss $ ( 46,520 ) $ ( 24,862 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 7,702 1,956 Stock-based compensation expense 26,398 14,889 Change in fair value of contingent consideration ( 17,987 ) — Deferred income taxes ( 1,839 ) — Accretion of discounts on marketable investment securities ( 184 ) — Other 186 ( 99 ) Change in operating assets and liabilities: Accounts receivable ( 5,678 ) ( 6,087 ) Prepaid expenses and other current assets ( 1,870 ) ( 734 ) Inventory ( 1,502 ) ( 28 ) Operating lease assets 694 641 Other assets 533 ( 193 ) Accounts payable 2,155 673 Operating lease liabilities ( 559 ) ( 638 ) Accrued compensation 3,669 3,012 Medicare advance payment — ( 5,351 ) Other accrued liabilities ( 853 ) 619 Net cash used in operating activities ( 35,655 ) ( 16,202 ) INVESTING ACTIVITIES Purchases of property and equipment ( 3,845 ) ( 2,590 ) Asset acquisition 547 ( 33,184 ) Acquisition of business, net of cash and cash equivalents acquired ( 26,966 ) — Proceeds from sale of property and equipment 9 6 Purchases of marketable investment securities ( 131,808 ) — Net cash used in investing activities ( 162,063 ) ( 35,768 ) FINANCING ACTIVITIES Payment of common stock offering costs — ( 336 ) Proceeds from exercise of common stock options 675 3,868 Payment of employees’ taxes on vested restricted stock units ( 134 ) — Proceeds from contributions to the employee stock purchase plan 1,812 1,763 Repayment of principal portion of finance lease liabilities ( 88 ) — Net cash provided by financing activities 2,265 5,295 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 6 Table of Contents CASTLE BIOSCIENCES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (UNAUDITED) (in thousands) Nine Months Ended September 30, 2022 2021 NET CHANGE IN CASH AND CASH EQUIVALENTS ( 195,453 ) ( 46,675 ) Beginning of period 329,633 409,852 End of period $ 134,180 $ 363,177 DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Accrued purchases of property and equipment $ 1,131 $ 190 Common stock issued in acquisition of business $ 17,111 $ — Contingent consideration in acquisition of business $ 1,528 $ — Operating lease assets obtained in exchange for lease obligations $ 5,912 $ 427 Property and equipment acquired with tenant improvement allowance $ 51 $ 54 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 7 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Organization and Description of Business Castle Biosciences, Inc. (the ‘‘Company,’’ “we,” “us” or “our”) was incorporated in the state of Delaware on September 12, 2007. We are a commercial-stage diagnostics company focused on providing physicians and their patients with personalized, clinically actionable information to inform treatment decisions and improve health outcomes. We are based in Friendswood, Texas (a suburb of Houston, Texas) and our laboratory operations are conducted at our facilities located in Phoenix, Arizona, Pittsburgh, Pennsylvania and San Diego, California. 2. Summary of Significant Accounting Policies Basis of Presentation Our unaudited condensed consolidated financial statements include the accounts of Castle Biosciences, Inc. and our wholly owned subsidiaries and have been prepared in conformity with accounting principles generally accepted in the United States of America (‘‘U.S. GAAP’’). All intercompany accounts and transactions have been eliminated in consolidation. Unaudited Interim Financial Information The accompanying condensed consolidated balance sheet as of September 30, 2022; the condensed consolidated statements of operations, the condensed consolidated statements of comprehensive loss, the condensed consolidated statements of stockholders’ equity for the three and nine months ended September 30, 2022 and 2021; and the condensed consolidated statements of cash flows for the nine months ended September 30, 2022 and 2021 are unaudited. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for the fair statement of our consolidated financial position as of September 30, 2022, the results of our consolidated operations for the three and nine months ended September 30, 2022 and 2021 and our consolidated cash flows for the nine months ended September 30, 2022 and 2021. The financial data and other information disclosed in these notes related to the three and nine months ended September 30, 2022 and 2021 are also unaudited. The results for the three and nine months ended September 30, 2022 are not necessarily indicative of results to be expected for the year ending December 31, 2022, any other interim periods, or any future year or period. The balance sheet as of December 31, 2021 included herein was derived from the audited financial statements as of that date. Certain disclosures have been condensed or omitted from the unaudited interim consolidated financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the Securities and Exchange Commission on February 28, 2022. Use of Estimates The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates include revenue recognition, the valuation of stock-based compensation, assessing future tax exposure and the realization of deferred tax assets, the useful lives and recoverability of long-lived assets, the valuation of acquired intangible assets, the valuation of contingent consideration and other contingent liabilities. We base these estimates on historical and anticipated results, trends, and various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities and recorded revenues and expenses that are not readily apparent from other sources. Actual results could differ from those estimates and assumptions. We have considered the potential impact of the COVID-19 pandemic on our estimates and assumptions. The extent to which the COVID-19 pandemic may impact our estimates in future periods is uncertain and subject to change. Cash and Cash Equivalents including Concentrations of Credit Risk Cash equivalents consist of short-term, highly liquid investments with original maturities of three months or less. Our cash equivalents consist of money market funds, which are not insured by the Federal Deposit Insurance Corporation (“FDIC”), that are primarily invested in short-term U.S. government obligations. Cash deposits at financial institutions may exceed the amount of insurance provided by the FDIC. Management believes that we are not exposed to significant credit risk on our cash deposits due to the financial position of the institutions in which deposits are held. We have not experienced any losses on our cash or cash equivalents. 8 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) Marketable Investment Securities All debt securities are recognized in accordance with Financial Accounting Standards Board (‘‘FASB’’) Accounting Standards Codification (‘‘ASC’’) Topic 320, Investments-Debt Securities (‘‘ASC 320’’). Management determines the appropriate classification of securities at the time of purchase and re-evaluates such determination at each balance sheet date. All debt securities are classified as available-for-sale and are recorded at fair value in accordance with ASC 320. We recognize the unrealized gains and losses related to changes in fair value as a separate component of accumulated other comprehensive loss within total stockholders’ equity, net of related deferred income tax effects on our condensed consolidated balance sheets. Premiums or discounts from par value are amortized to interest income over the life of the underlying investment. Realized gains and losses on available-for-sale securities are calculated at the individual security level and included in interest income in the condensed consolidated statements of operations. Impairments on available-for-sale debt securities, if any, are recorded in condensed consolidated statements of operations. See Notes 5 and 11 for further details. Revenue Recognition In accordance with ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”), we follow a five-step process to recognize revenues: (1) identify the contract with the customer, (2) identify the performance obligations, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations and (5) recognize revenues when the performance obligations are satisfied. We have determined that we have a contract with the patient when the treating clinician orders the test. Our contracts generally contain a single performance obligation, which is the delivery of the test report, and we satisfy our performance obligation at a point in time upon the delivery of the test report to the treating physician, at which point we can bill for the report. The amount of revenue recognized reflects the amount of consideration to which we expect to be entitled, or the transaction price, and considers the effects of variable consideration. See Note 3 for further details. Accounts Receivable and Allowance for Credit Losses We classify accounts receivable balances that are expected to be paid more than one year from the consolidated balance sheet date as noncurrent assets. The estimated timing of payment utilized as a basis for classification as noncurrent is determined by analyses of historical payor-specific payment experience, adjusted for known factors that are expected to change the timing of future payments. We accrue an allowance for credit losses against our accounts receivable based on management’s current estimate of amounts that will not be collected. Management’s estimates are typically based on historical loss information adjusted for current conditions. We generally do not perform evaluations of customers’ financial condition and generally do not require collateral. Historically, our credit losses have not been significant. The allowance for credit losses was zero as of September 30, 2022 and December 31, 2021. Adjustments for implicit price concessions attributable to variable consideration, as discussed above, are incorporated into the measurement of the accounts receivable balances and are not part of the allowance for credit losses. Goodwill Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired in a business combination. In accordance with ASC Topic 350, Intangibles—Goodwill and Other , our goodwill is not amortized but is tested for impairment on an annual basis or whenever events or changes in circumstances indicate that it may be impaired. We perform annual impairment reviews of our goodwill balance during the fourth quarter of each year. We may perform a qualitative assessment to determine if it is necessary to perform a quantitative impairment test. If we determine that a quantitative impairment test is necessary, we apply the guidance in Accounting Standards Update (“ASU”) No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment , by comparing the fair value of the reporting unit to its carrying value, including the goodwill. If the carrying value exceeds the fair value, we recognize an impairment loss for the amount by which the carrying value exceeds fair value, up to the total amount of goodwill allocated to the reporting unit. We did no t incur any goodwill impairment losses in any of the periods presented. 9 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) Acquisitions We assess acquisitions under ASC Topic 805, Business Combinations (“ASC 805”) to determine whether a transaction represents the acquisition of assets or a business combination. Under this guidance, we apply a two-step model. The first step involves a screening test where we evaluate whether substantially all of the fair value of the gross assets acquired is concentrated in a single asset or a group of similar assets. If the screening test is met, we account for the set as an asset acquisition. If the screening test is not met, we apply the second step of the model to determine if the set meets the definition of a business based on the guidance in ASC 805. If so, the transaction is treated as a business combination. Otherwise, it is treated as an asset acquisition. Asset acquisitions are accounted for by allocating the cost of the acquisition, including transaction costs, to the individual assets acquired and liabilities assumed on a relative fair value basis without recognition of goodwill. Business combinations are accounted for using the acquisition method. Under the acquisition method, goodwill is measured as a residual amount equal to the fair value of the consideration transferred less the net recognized fair value of the identifiable assets acquired and the liabilities assumed, as of the acquisition date, and transaction costs are expensed as incurred. Contingent Consideration Under the terms of business combinations or asset acquisitions, we may be required to pay additional consideration if specified future events occur or if certain conditions are met. In a business combination, in accordance with ASC 805, contingent consideration is recorded at fair value as of the acquisition date and classified as liabilities or equity based on applicable U.S. GAAP. For contingent consideration classified as liabilities, we remeasure the contingent consideration at fair value each period with changes in fair value recorded in the statements of operations each period. For contingent consideration in transactions that are not business combinations, we apply applicable U.S. GAAP. With respect to the additional consideration that may be payable in connection with the acquisitions of Cernostics, Inc. (“Cernostics”), an asset acquisition we completed on December 3, 2021, we account for the contingent consideration as a liability in accordance with ASC Topic 480, Distinguishing Liabilities from Equity (“ASC 480”), under the guidance for obligations that must or may be settled by issuance of a variable number of shares. In accordance with ASC 480, we record the contingent consideration initially and subsequently at fair value with changes in fair value recorded in the statements of operations each period. Contingent consideration is classified as current or noncurrent in our condensed consolidated balance sheets based on the contractual timing of future settlement. For additional information on contingent consideration, see Notes 6 and 11. Accrued Compensation We accrue for liabilities under discretionary employee and executive bonus plans. These estimated compensation liabilities are based on progress against corporate objectives approved by our board of directors, compensation levels of eligible individuals, and target bonus percentage levels. Our board of directors reviews and evaluates the performance against these objectives and ultimately determines the actual achievement levels attained. We also accrue for liabilities under employee sales incentive bonus plans with accruals based on performance achieved to date compared to established targets. As of September 30, 2022 and December 31, 2021, we accrued $ 13,667,000 and $ 12,071,000 , respectively, for liabilities associated with these bonus plans. These amounts are classified as current or noncurrent accrued liabilities in the condensed consolidated balance sheets based on the expected timing of payment. Comprehensive Loss Comprehensive loss is defined as a change in equity during a period from transactions and other events and circumstances from non-owner sources. Comprehensive loss is made up of net loss plus other comprehensive loss, if any. 3. Revenue All of our revenues from contracts with customers are associated with the provision of diagnostic and prognostic testing services. Most of our revenues are attributable to our DecisionDx®-Melanoma test for cutaneous melanoma. We also provide a test for uveal melanoma, DecisionDx®-UM, a test for patients with cutaneous squamous cell carcinoma, DecisionDx®-SCC, two tests for use in patients with suspicious pigmented lesions, MyPath® Melanoma and DiffDx®-Melanoma, and a test for patients diagnosed with Barrett’s esophagus (“BE”), the TissueCypher® Barrett’s Esophagus Assay. We also began offering a pharmacogenomics (“PGx”) testing service focused on mental health, IDgenetix®, following a business combination completed in April 2022. Information on the disaggregation of revenues is included below. 10 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) Once we satisfy our performance obligations and bill for the service, the timing of the collection of payments may vary based on the payment practices of the third-party payor and the existence of contractually established reimbursement rates. Most of the payments for our services are made by third-party payors, including Medicare and commercial health insurance carriers. Certain contracts contain a contractual commitment of a reimbursement rate that differs from our list prices. However, absent a positive coverage policy, with or without a contractually committed reimbursement rate, with a commercial carrier or governmental program, our diagnostic tests may or may not be paid by these entities. In addition, patients do not enter into direct agreements with us that commit them to pay any portion of the cost of the tests in the event that their insurance provider declines to reimburse us. We may pursue, on a case-by-case basis, reimbursement from such patients in the form of co-payments and co-insurance, in accordance with the contractual obligations that we have with the insurance carrier or health plan. These situations may result in a delay in the collection of payments. The Medicare claims that are covered by policy under a Local Coverage Determination (“LCD”) or otherwise are generally paid at a rate established on Medicare’s Clinical Laboratory Fee Schedule or by the respective Medicare contractor within 30 days from receipt. Medicare claims that were either submitted to Medicare prior to the LCD or other coverage commencement date or are not covered but meet the definition of being medically reasonable and necessary pursuant to the controlling Section 1862(a)(1)(A) of the Social Security Act are generally appealed and may ultimately be paid at the first (termed ‘‘redetermination’’), second (termed ‘‘reconsideration’’) or third level of appeal (de novo hearing with an Administrative Law Judge). A successful appeal at any of these levels may result in prompt payment. In the absence of LCD coverage, contractually established reimbursements rates or other coverage, we have concluded that our contracts include variable consideration because the amounts paid by Medicare or commercial health insurance carriers may be paid at less than our standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration attributable to these price concessions is measured at the expected value using the ‘‘most likely amount’’ method under ASC 606. The amounts are determined by historical average collection rates by test type and payor category taking into consideration the range of possible outcomes, the predictive value of our past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of our influence, such as the judgment and actions of third parties. Such variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainties with respect to the amount are resolved. Variable consideration may be constrained and excluded from the transaction price in situations where there is no contractually agreed upon reimbursement coverage or in the absence of a predictable pattern and history of collectability with a payor. Accordingly, in such situations revenues are recognized on the basis of actual cash collections. 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 (e.g., 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. Variable consideration is evaluated each reporting period and adjustments are recorded as increases or decreases in revenues. Included in revenues for the three months ended September 30, 2022 and 2021 were $( 277,000 ) and $( 92,000 ), respectively, of net positive (negative) revenue adjustments associated with changes in estimated variable consideration related to performance obligations satisfied in previous periods. Such amounts of variable consideration for the nine months ended September 30, 2022 and 2021 were $( 1,850,000 ) and $ 4,130,000 , respectively, of net (negative) positive revenue adjustments. These amounts include (i) adjustments for actual collections versus estimated amounts and (ii) cash collections and the related recognition of revenue in current period for tests delivered in prior periods due to the release of the constraint on variable consideration. Because our contracts with customers have an expected duration of one year or less, we have elected the practical expedient in ASC 606 to not disclose information about our remaining performance obligations. Any incremental costs to obtain contracts are recorded as selling, general and administrative expense as incurred due to the short duration of our contracts. Contract balances consisted solely of accounts receivable (both current and noncurrent) as of September 30, 2022 and December 31, 2021. 11 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) Disaggregation of Revenues The table below provides the disaggregation of revenue by type (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Dermatologic $ 33,924 $ 21,593 $ 90,160 $ 62,881 Other 3,087 1,882 8,541 6,165 Total net revenues $ 37,011 $ 23,475 $ 98,701 $ 69,046 Payor Concentration We rely upon reimbursements from third-party government payors (primarily Medicare) and private-payor insurance companies to collect accounts receivable related to sales of our diagnostic and prognostic tests. Our significant third-party payors and their related revenues as a percentage of total revenues and accounts receivable balances are as follows: Percentage of Revenues Nine Months Ended September 30, Percentage of Accounts Receivable (current) Percentage of Accounts Receivable (noncurrent) 2022 2021 September 30, 2022 December 31, 2021 September 30, 2022 December 31, 2021 Medicare 52 % 57 % 26 % 24 % — % — % Medicare Advantage plans 33 % 27 % 44 % 40 % — % — % BlueCross BlueShield plans 6 % 7 % 16 % 22 % 55 % 58 % 4. Loss Per Share Basic loss per share is computed by dividing net loss for the period by the weighted-average number of common shares outstanding during the period. Diluted loss per share reflects the additional dilution from potential issuances of common stock, such as stock issuable pursuant to the exercise of stock options or purchases under the 2019 Employee Stock Purchase Plan (“ESPP”). The treasury stock method is used to calculate the potential dilutive effect of these common stock equivalents. However, potentially dilutive shares are excluded from the computation of diluted loss per share when their effect is antidilutive. Because we reported a net loss for all periods presented, all potentially dilutive securities are antidilutive and are excluded from the computation of diluted loss per share for such periods. The table below provides the weighted-average number of potential common shares associated with outstanding securities not included in our calculation of diluted loss per share for the three and nine months ended September 30, 2022 and 2021 because to do so would be antidilutive (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Stock options and restricted stock units (“RSUs”) 5,285 3,369 4,982 3,401 ESPP 168 58 124 63 Total 5,453 3,427 5,106 3,464 In addition, in connection with the acquisitions of Cernostics and AltheaDx, Inc. (“AltheaDx”), we may issue, or may be required to issue, shares of our common stock to satisfy our contingent consideration obligations, pending the outcome of certain commercial and regulatory milestones, as required by the respective definitive agreements. See Notes 6 and 11 for additional information. 12 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) 5. Marketable Investment Securities The following table presents our available-for-sale debt securities (in thousands): Amortized Cost Unrealized Estimated Fair Value Gains Losses As of September 30, 2022 U.S. Government Securities $ 131,991 $ — $ ( 189 ) $ 131,802 Total $ 131,991 $ — $ ( 189 ) $ 131,802 We had no available-for-sale debt securities as of December 31, 2021. Although available to be sold to meet operating needs or otherwise, securities are generally held through maturity. We classify all investments as current assets, as these are readily available for use in current operations. The cost of securities sold is determined based on the specific identification method for purposes of recording gains and losses. There were no realized gains or losses on sales of investments for the three and nine months ended September 30, 2022 and 2021. We evaluated our investment portfolio under the available-for-sale debt securities impairment model guidance and determined our investment portfolio is comprised of low-risk, investment grade securities. As of September 30, 2022, unrealized losses on available-for-sale investments are not attributed to credit risk. We believe that an allowance for credit losses is unnecessary because the unrealized losses on certain of our marketable investment securities are due to market factors. No credit-related or noncredit-related impairment losses were recorded for the three and nine months ended September 30, 2022 and 2021. The allowance for credit losses was zero as of September 30, 2022 and December 31, 2021. As of September 30, 2022, all of our available-for-sale debt securities had contractual maturities of one year or less. Accrued interest receivable is included in prepaid expenses and other current assets in our condensed consolidated balance sheets. As of September 30, 2022 and December 31, 2021 the accrued interest receivable balance was immaterial and zero, respectively. Additional information relating to fair value of marketable investment securities can be found in Note 11. 13 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) 6. Acquisitions Myriad myPath, LLC On May 28, 2021, we completed the acquisition of all of the equity of Myriad myPath, LLC, a laboratory in Salt Lake City, for a cash purchase price of $ 32,500,000 . Based on the guidance in ASC 805, we concluded that substantially all of the fair value of the gross assets acquired was concentrated in a single identifiable asset, the developed technology, and therefore the transaction represents an asset acquisition rather than a business combination. Cernostics, Inc. On December 3, 2021, we completed the acquisition of Cernostics, which offers the TissueCypher Barrett’s Esophagus Assay for patients with BE, for total consideration of $ 49,019,000 , consisting of cash consideration of $ 30,732,000 and contingent consideration with an acquisition date fair value of $ 18,287,000 . In connection with the acquisition, we recorded a receivable as of the acquisition date for the post-closing purchase price adjustment, representing the difference between actual and estimated cash and working capital. During the nine months ended September 30, 2022, we received cash of $ 547,000 in settlement of this receivable. AltheaDx, Inc. On April 26, 2022, we completed the acquisition of 100 % of the equity interests in AltheaDx. AltheaDx offers the IDgenetix test, a PGx test focused on mental health. We believe this acquisition enables us to expand upon our existing portfolio of testing solutions in support of our growth strategy. We have concluded that the transaction represents a business combination under ASC 805. The financial results of AltheaDx have been included in our unaudited condensed consolidated financial statements since the date of the acquisition. The amount of revenue from AltheaDx included in the unaudited consolidated statements of operations from the acquisition date was not material. The loss attributable to AltheaDx included in the unaudited consolidated statements of operations from the acquisition date was approximately $ 8,199,000 . This amount does not reflect transaction costs from the acquisition or the effects of the valuation allowance reduction discussed in Note 14. Transaction costs associated with the acquisition were $ 1,711,000 for the nine months ended September 30, 2022 and were recognized as expenses in the unaudited condensed consolidated statements of operations. The preliminary acquisition-date fair value of the consideration transferred consisted of the following (in thousands, except shares): April 26, 2022 Cash $ 30,502 Common stock ( 763,887 shares) 17,111 Contingent consideration 1,528 Total $ 49,141 The fair value of the common stock issued was measured using the April 26, 2022 closing price of $ 22.40 per share, as reported by the Nasdaq Global Market. With respect to the contingent consideration, we may be required to pay up to $ 75.0 million in cash and common stock in connection with the achievement of certain milestones based on 2022, 2023 and 2024 performance and expanded Medicare coverage for the IDgenetix test (the “AltheaDx Earnout Payments”). Upon achievement of each relevant milestone event, each milestone will be paid 50 % in cash and 50 % in shares of our common stock based on a price per share equal to the volume-weighted-average price of our common stock for the 20 trading days as of the applicable milestone determination date. In accordance with the terms of the definitive agreement governing the acquisition of AltheaDx, the maximum number of shares of our common stock issuable to former AltheaDx security holders may not exceed 1,271,718 shares. Therefore, taking into consideration the number of shares already issued at closing, a maximum of 507,831 additional shares of our common stock remain issuable with respect to the AltheaDx Earnout Payments. In the event a number of shares in excess of 507,831 would otherwise be issuable in connection with the AltheaDx Earnout Payments, we will issue shares up to the maximum number permitted and pay cash for the remaining portion of the obligation. See Note 11 for additional information on the measurement of the contingent consideration. 14 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) The following table summarizes the preliminary allocation of the fair values of assets acquired and liabilities assumed in the acquisition of AltheaDx at the date of acquisition (in thousands): April 26, 2022 Cash and cash equivalents $ 3,536 Accounts receivable 302 Inventory 279 Prepaid expenses and other current assets 262 Property and equipment 314 Intangible asset 37,000 Other assets – long-term 12 Accounts payable ( 231 ) Accrued compensation ( 380 ) Other accrued and current liabilities ( 532 ) Deferred tax liabilities ( 1,819 ) Other liabilities ( 88 ) Net identifiable assets acquired 38,655 Goodwill 10,486 Total consideration transferred $ 49,141 The intangible asset is comprised of developed technology with an estimated useful life of 15 years and is being amortized on a straight-line basis. The goodwill, which is not expected to be deductible for income tax purposes, was primarily attributable to potential future growth opportunities and the organized workforce. Our calculations of the consideration transferred and the purchase price allocation for the acquisition of AltheaDx are based on a preliminary valuation and are subject to revision as the valuation is finalized and additional information about the fair value of the assets and liabilities becomes available. The primary areas that are not yet finalized are income taxes, intangible assets, contingent consideration and the resulting goodwill. The final valuation of assets acquired and liabilities assumed is expected to be completed as soon as possible, but no later than one year from the acquisition date. During the three months ended September 30, 2022, the Company recognized an immaterial measurement period adjustment to cash consideration transferred with a corresponding adjustment to goodwill. Unaudited Pro Forma Financial Information The following unaudited pro forma financial information for the three and nine months ended September 30, 2022 and 2021, respectively combines our historical financial results and the results of AltheaDx, assuming that the companies were combined as of January 1, 2021, and includes adjustments for amortization expense from the acquired intangible assets and additional stock-based compensation expense. Nonrecurring pro forma adjustments consist of acquisition-related transaction costs of $ 1,711,000 and an income tax benefit of $ 1,769,000 , both assumed to have been recognized during the nine months ended September 30, 2021 and therefore removed from the nine months ended September 30, 2022 . The following unaudited pro forma financial information (in thousands) is for informational purposes only and is not necessarily indicative of (i) the results of operations that would have been achieved if the acquisition had taken place as of January 1, 2021 or (ii) the results of operations that are expected in future periods: Pro Forma Data Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Net revenues $ 37,011 $ 23,665 $ 99,253 $ 69,341 Net loss $ ( 20,211 ) $ ( 14,577 ) $ ( 52,313 ) $ ( 31,664 ) 15 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) Related Party Transaction Derek J. Maetzold, our President and Chief Executive Officer, and a member of our board of directors, and Daniel M. Bradbury, the Chairperson of our board of directors, each served on the board of directors of AltheaDx until the acquisition of AltheaDx was completed, were direct or indirect beneficial owners of AltheaDx securities and received consideration in the transaction. Further, Frank Stokes, our Chief Financial Officer; Tobin W. Juvenal, our Chief Commercial Officer; Kristen Oelschlager, our Chief Operating Officer and certain immediate family members of Mr. Maetzold and Ms. Oelschlager were direct or indirect beneficial owners of AltheaDx securities and received consideration in the transaction. These individuals may receive additional consideration in the form of AltheaDx Earnout Payments if the relevant commercial and regulatory milestone events occur. Our entry into the definitive agreement to acquire AltheaDx was approved by our board of directors based upon the unanimous recommendation of a special transaction committee comprised entirely of independent members of our board of directors without any financial interest in AltheaDx or any conflict of interest with respect to the acquisition of AltheaDx. 7. Property and Equipment, Net Property and equipment, net consisted of the following (in thousands): September 30, 2022 December 31, 2021 Lab equipment (1) $ 8,326 $ 3,727 Leasehold improvements 5,145 5,044 Computer equipment 4,306 2,457 Furniture and fixtures 1,654 1,288 Construction in progress 879 27 Total 20,310 12,543 Less accumulated depreciation (1) ( 7,256 ) ( 3,042 ) Property and equipment, net $ 13,054 $ 9,501 (1) Includes lab equipment under a finance lease of $ 369 thousand and accumulated depreciation of $ 101 thousand as of September 30, 2022 and $ 237 thousand and accumulated depreciation of $ 8 thousand as of December 31, 2021. Depreciation expense was recorded in the unaudited condensed consolidated statements of operations as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Cost of sales (exclusive of amortization of acquired intangible assets) $ 267 $ 120 $ 621 $ 333 Research and development 85 67 255 175 Selling, general and administrative 265 208 775 498 Total $ 617 $ 395 $ 1,651 $ 1,006 8. Goodwill and Other Intangible Assets, Net Goodwill Information on the change in carrying value of our goodwill is presented below (in thousands): Goodwill Balance, December 31, 2021 $ — Acquisition of AltheaDx 10,486 Balance, September 30, 2022 $ 10,486 There were no accumulated impairments of goodwill as of September 30, 2022 or December 31, 2021. 16 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) Other Intangible Assets, Net Our other intangible assets, net consists of the following (in thousands): September 30, 2022 Gross carrying value Accumulated amortization Net Weighted-Average Remaining Life (in years) Developed technology $ 127,318 $ ( 7,916 ) $ 119,402 13.5 Assembled workforce 563 ( 94 ) 469 4.3 Total intangible assets, net $ 127,881 $ ( 8,010 ) $ 119,871 December 31, 2021 Gross carrying value Accumulated amortization Net Weighted-Average Remaining Life (in years) Developed technology $ 90,317 $ ( 1,949 ) $ 88,368 13.2 Assembled workforce 563 ( 9 ) 554 4.9 Total intangible assets, net $ 90,880 $ ( 1,958 ) $ 88,922 The estimated future aggregate amortization expense as of September 30, 2022 is as follows (in thousands): Years Ending December 31, 2022 (remainder of year) $ 2,305 2023 9,147 2024 9,172 2025 9,147 2026 9,137 Thereafter 80,963 Total $ 119,871 Amortization expense of intangible assets was $ 2.3 million and $ 6.1 million for the three and nine months ended September 30, 2022, respectively. Amortization expense of intangible assets was $ 0.7 million and $ 1.0 million for the three and nine months ended September 30, 2021. 9. Other Accrued and Current Liabilities Other accrued and current liabilities consisted of the following (in thousands): September 30, 2022 December 31, 2021 Accrued service fees $ 2,564 $ 1,905 Clinical studies 1,725 1,655 Payroll-related liabilities 317 695 Employee stock purchase plan contributions 220 760 Other 281 663 Total $ 5,107 $ 5,678 17 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) 10. Leases Adoption of ASC 842 In the fourth quarter of 2021, we adopted ASU No. 2016-02, Leases (Topic 842), and ASC Topic 842, Leases (“ASC 842”) using the modified retrospective approach with an effective date of January 1, 2021. The adoption had no effect on the condensed consolidated statements of operations for the three and nine months ended September 30, 2021. Net cash (used in) provided by operating activities, investing activities or financing activities for the nine months ended September 30, 2021 were also unchanged, but the presentation of certain prior period amounts within the operating activities section of the condensed consolidated statements of cash flows has been retrospectively adjusted to give effect to the adoption of ASC 842. The changes are set forth in the table below (in thousands): Nine Months Ended September 30, 2021 Before Adoption of ASC 842 Effect of Adoption After Adoption of ASC 842 Effect on Condensed Consolidated Statements of Cash Flows OPERATING ACTIVITIES Adjustments to reconcile net loss to net cash used in operating activities: Operating lease assets $ — $ 641 $ 641 Operating lease liabilities $ — $ ( 638 ) $ ( 638 ) Other liabilities $ 3 $ ( 3 ) $ — Additionally, the condensed consolidated statement of stockholders’ equity for the three and nine months ended September 30, 2021 has been retrospectively adjusted to reflect a credit to accumulated deficit of $ 21,000 in connection with the adoption of ASC 842 effective January 1, 2021. Lease Amendment On March 11, 2022, we amended an existing lease agreement to expand rentable space in Phoenix, Arizona. We evaluated the amendment under ASC 842 and determined that the modification was a new contract and an operating lease. In August 2022, we took control of the facilities and recognized $ 0.9 million of additional operating lease liabilities arising from obtaining operating lease assets. Payments for the amended lease will begin after the commencement date, upon the completion of certain leasehold improvements, and will continue for an initial term of 10.3 years. We intend to use the additional space for laboratory facilities. Pittsburgh Lease On April 1, 2022, we entered into a lease agreement for commercial office space in Pittsburgh, Pennsylvania, which provides for a term of 10.5 years, a five-year renewal option, an early termination clause, and a lease incentive allowance of $ 2.5 million to apply toward leasehold improvements. In September 2022, we took control of the facilities and recognized $ 5.0 million of additional operating lease liabilities arising from obtaining operating lease assets. Lease payments will commence at a future date upon the completion of leasehold improvements, at which point the facilities will be ready for intended use. We intend to use the additional space for general office and laboratory facilities. 11. Fair Value Measurements Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. The fair value hierarchy prioritizes the inputs to valuation techniques used in measuring fair value. There are three levels to the fair value hierarchy based on the reliability of inputs, as follows: Level 1 – Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 – Unobservable inputs in which little or no market data exists, therefore requiring us to develop our own assumptions. 18 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) Financial instruments measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability. The use of different assumptions and/or estimation methodologies may have a material effect on estimated fair values. Accordingly, the fair value estimates disclosed, or amounts recorded may not be indicative of the amount that us or holders of the instruments could realize in a current market exchange. The table below provides information, by level within the fair value hierarchy, of our financial assets and financial liabilities that are accounted for at fair value on a recurring basis as of September 30, 2022 and December 31, 2021 (in thousands): As of September 30, 2022 Quoted Prices in Active Markets for Identical Items (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Money market funds (1) $ 124,095 $ — $ — $ 124,095 U.S. Government Securities (2) $ 131,802 $ — $ — $ 131,802 Liabilities Contingent consideration (3) $ — $ — $ 1,828 $ 1,828 As of December 31, 2021 Quoted Prices in Active Markets for Identical Items (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Money market funds (1) $ 327,721 $ — $ — $ 327,721 U.S. Government Securities (2) $ — $ — $ — $ — Liabilities Contingent consideration (3) $ — $ — $ 18,287 $ 18,287 (1) Classified as “Cash and cash equivalents” in the condensed consolidated balance sheets. (2) Classified as “Marketable investment securities” in the condensed consolidated balance sheets. (3) Current portion, if any, classified as “Other accrued and current liabilities” in the condensed consolidated balance sheets. Contingent Consideration In connection with our acquisition of Cernostics, we have recorded a contingent consideration liability for the additional consideration of up to $ 50.0 million that may become payable based on the achievement of certain commercial milestones relating to the year ending December 31, 2022 (“Cernostics Earnout Payments”). The Cernostics Earnout Payments may be settled in cash or shares of our common stock, at our sole discretion. The portion of any Cernostics Earnout Payments that may be settled in shares of our common stock is subject to certain limitations and the aggregate number of shares that may be issued for the Cernostics Earnout Payments may not exceed 5,034,653 shares. Any Cernostics Earnout Payments in shares of our common stock will be based on the volume weighted-average price of our common stock for the 15 trading days ending December 30, 2022. If the settlement were to occur as of September 30, 2022, we would make no Cernostics Earnout Payments based on the achievement of the performance conditions to date. In connection with our acquisition of AltheaDx, we have also recorded a contingent consideration liability for the additional consideration of up to $ 75.0 million that may become payable based on the achievement of certain commercial milestones relating to the years ending December 31, 2022, 2023, and 2024, as discussed further in Note 6. If the settlement were to occur as of September 30, 2022, we would make no AltheaDx Earnout Payments based on the achievement of the performance conditions to date. 19 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) The contingent consideration is classified as a Level 3 fair value measurement due to the use of significant unobservable inputs and a Monte Carlo simulation to determine its fair value. The Monte Carlo simulation uses projections of the commercial milestones for the applicable period as well as the corresponding targets and approximate timing of payment based on the terms of the arrangement. The analysis for the Cernostics Earnout Payments uses assumptions for expected volatility of the financial metrics and a risk-adjusted discount rate, which were 40.0 % and 20.0 %, respectively, as of September 30, 2022, and 20.0 % and 16.1 %, respectively, as of December 31, 2021. The assumptions for expected volatility of the financial metrics used in the analysis for the AltheaDx Earnout Payments was 36.0 % as of September 30, 2022. The risk-adjusted discount rate for years 2022, 2023, and 2024 were 7.7 %, 8.8 % and 8.9 %, respectively. The contingent consideration liability is remeasured at fair value at each reporting period taking into account any updated assumptions or changes in circumstances. Any changes in the fair value are recorded as gains or losses in our condensed consolidated statement of operations. The following table discloses the summary of changes in the contingent consideration liability measured at fair value using Level 3 inputs for the nine months ended September 30, 2022 (in thousands): Cernostics AltheaDx Total Balance, December 31, 2021 $ 18,287 $ — $ 18,287 Acquisition of AltheaDx — 1,528 1,528 Change in fair value ( 18,257 ) 270 ( 17,987 ) Balance, September 30, 2022 $ 30 $ 1,798 $ 1,828 12. Commitments and Contingencies From time to time, we may be involved in legal proceedings arising in the ordinary course of business. We believe there is no threatened litigation or litigation pending that could have, individually or in the aggregate, a material adverse effect on our financial position, results of operations or cash flows. 13. Stock Incentive Plans and Stock-Based Compensation Stock Incentive Plans Effective January 1, 2022, an additional 1,268,926 shares became available under our 2019 Equity Incentive Plan (the “2019 Plan”) pursuant to an automatic annual increase. As of September 30, 2022, 583,279 shares remained available for grant under the 2019 Plan. Stock Options Stock option activity under our stock plans for the nine months ended September 30, 2022 is set forth below: Weighted-Average Stock Options Outstanding Exercise Price Remaining Contractual Term (Years) Aggregate Intrinsic Value (in thousands) Balance as of December 31, 2021 3,586,688 $ 34.75 Granted 263,486 $ 22.35 Exercised ( 115,829 ) $ 5.83 Forfeited/Cancelled ( 238,450 ) $ 31.87 Balance as of September 30, 2022 3,495,895 $ 34.96 7.7 $ 15,481 Exercisable at September 30, 2022 1,764,834 $ 28.26 7.0 $ 13,411 20 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) Restricted Stock Units The following table summarizes our RSU activity for the nine months ended September 30, 2022: Restricted Stock Units Outstanding Weighted-Average Grant Date Fair Value Balance as of December 31, 2021 1,050,174 $ 44.31 Granted 937,435 $ 24.81 Vested ( 18,015 ) $ 68.20 Forfeited/Cancelled ( 225,710 ) $ 26.35 Balance as of September 30, 2022 1,743,884 $ 35.90 Employee Stock Purchase Plan The ESPP provides for certain automatic increases in the number of shares of common stock reserved for issuance, which resulted in an additional 253,785 shares becoming available under the ESPP effective January 1, 2022. During the nine months ended September 30, 2022, we issued 78,652 of common stock pursuant to scheduled purchases under the ESPP. As of September 30, 2022, 814,599 shares remained available for issuance under the ESPP. Determining Fair Value - Summary of Assumptions We use the Black-Scholes option pricing model to estimate the fair value of each option grant on the date of grant or any other measurement date. The following table sets forth the assumptions used to determine the fair value of stock options: Nine Months Ended September 30, 2022 2021 Average expected term (years) 5.9 6.0 Expected stock price volatility 68.34 % - 73.33 % 66.50 % - 68.83 % Risk-free interest rate 1.54 % - 3.03 % 0.51 % - 1.09 % Dividend yield — % — % The following table sets forth assumptions used to determine the fair value of the purchase rights issued under the ESPP: Nine Months Ended September 30, 2022 2021 Average expected term (years) 1.2 1.2 Expected stock price volatility 62.98 % - 91.78 % 62.17 % - 86.50 % Risk-free interest rate 0.60 % - 3.45 % 0.06 % - 0.20 % Dividend yield — % — % The fair value of our common stock is also an assumption used to determine the fair value of stock options and purchase rights under the ESPP. The fair value of our common stock is the closing price per share, as reported by the Nasdaq Global Market, on the date of grant or other relevant determination date. Previously, because of the limited period of time our stock had been traded in an active market, we calculated expected volatility by using the historical stock prices of a group of similar companies looking back over the estimated life of the option or the ESPP purchase right and averaging the volatilities of these companies. In the third quarter of 2021, we adjusted this calculation to include our own stock price on a relative basis to the peer group in the calculation of expected volatility, as our common stock has now been traded in an active market for more than two years. We use the closing price of our common stock on the date of grant to determine the fair value of RSUs. 21 Table of Contents CASTLE BIOSCIENCES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) Stock-Based Compensation Expense Stock-based compensation expense related to stock options, RSUs and the ESPP is included in the statements of operations as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Cost of sales (exclusive of amortization of acquired intangible assets) $ 975 $ 555 $ 2,725 $ 1,480 Research and development 1,948 1,135 5,607 3,266 Selling, general and administrative 6,273 3,520 18,066 10,143 Total stock-based compensation expense $ 9,196 $ 5,210 $ 26,398 $ 14,889 For the nine months ended September 30, 2022 and 2021, the weighted-average grant date fair value of options granted was $ 14.34 and $ 40.76 per option, respectively, and the weighted-average grant date fair value of the purchase rights granted under the ESPP was $ 16.79 and $ 28.23 per share, respectively. As of September 30, 2022, the total unrecognized compensation cost related to outstanding awards was $ 94,365,000 , which is expected to be recognized on a straight-line basis over a weighted-average period of 2.8 years. The total unrecognized compensation cost will be adjusted for forfeitures in future periods as they occur. 14. Income Taxes In connection with our acquisition of AltheaDx, we recorded $ 1,819,000 in deferred tax liabilities based on our preliminary allocation of the fair values of assets acquired and liabilities assumed. As a result of these additional deferred tax liabilities , we determined that $ 1,769,000 of our existing valuation allowance on deferred tax assets should be reduced, which was reflected in our income tax benefit on the condensed consolidated statements of operations for the nine months ended September 30, 2022 as a discrete item. 22 Table of Contents