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Castle Biosciences, Inc. (NASDAQ:CSTL)
Q3 2019 Earnings Call
Nov 11, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to the Castle Biosciences' third-quarter 2019 conference call. As a reminder today's call is being recorded. We will begin today's call by with opening remarks and introduction followed by question-and-answer session. I would like to turn the call over to Frank Stokes, chief financial officer.

Please go ahead, sir.

Frank Stokes -- Chief Financial Officer

Thank you, Catherine. Good afternoon everyone and welcome to the Castle Biosciences third-quarter 2019 financial results conference call. Joining me today is Castle's Founder, President and Chief Executive Officer Derek Maetzold. Information recorded on this call speaks only as of today, November 11, 2019.

Therefore, if you are listening to this replay or reading the transcript of this call, any time sensitive information may no longer be accurate. A recording of today's call will be available on the Investor Relations page of the company's website for approximately three weeks. Before we begin, I would like to remind you that some of the information discussed today may contain projections or other forward-looking statements regarding future events or the future financial performance of the company and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon current expectations and involve inherent risks and uncertainties, and there can be no assurances that the results contemplated in these statements will be realized.

A number of factors and risks could cause actual results to differ materially from those contained in these forward-looking statements. These factors and other risks and uncertainties are described in detail in the company's final prospectus filed with the Securities and Exchange Commission on July 26, 2019, relating to our registration statements on Form S-1 and then the company's other documents and reports filed with the Securities and Exchange Commission. These forward-looking statements speak only as of today, and we assume no obligation to update or revise these forward-looking statements as circumstances change. I'll now turn the call over to Derek Maetzold.

Derek Maetzold -- Founder, President, and Chief Executive Officer

Thank you, Frank. Good afternoon, everyone, thank you for joining us today. We're pleased to report strong third-quarter performance, which includes increases in year-over-year revenue, volume and gross margin. For the third quarter, we reported revenue of $14.8 million and increase on $11.1 million in the third quarter of 2018.

Our primary growth driver, our DecisionDx-Melanoma test, we provided 4,126 test reports in our third quarter of 2019, compared with 3,136 reports during the third quarter of 2018 representing growth of 32%. Additionally, we continue to demonstrate growth in new ordering clinicians at 26% for the third quarter of '19 compared to September of 2018. For further comparison of our growth in new ordering clinicians, note that we saw a 5% growth in the third quarter of 2018, compared to the third-quarter 2017, so a jump to 26% is substantial. Overall, we delivered 4,482 proprietary gene expression profile tests reports for DecisionDx-Melanoma and DecisionDx-UM during the third-quarter 2019, representing overall growth of 30% compared to the third quarter of 2018.

As you can see from our DecisionDx-Melanoma test volume increase, we continue to see excellent growth following both our first-quarter 2019 commercial expansion and our ongoing development of evidence. You may recall that in the first quarter of 2019, we increase the number of outside sales territory from 14 to 23 along with the associated headcount for our commercial and medical sales personnel. As a result of the acceleration of growth in the second quarter and third quarter this year, we decided to execute our commercial expansion plans in December 2019 and plan to add nine additional outside sales territories and higher additional commercial and medical affairs staff accordingly. We these additional nine, we will now have 32 outside sales territories.

Turning our DecisionDx-UN tests, we delivered 356 test reports for uveal melanoma patients during the third-quarter 2019, a 10% increase in the same period last year. For the first nine months ended September 30, 2019, uveal melanoma test report volumes were up 6% compared with same period in 2018. As a reminder, our DecisionDx-UM test is standard-of-care for patients diagnosed with uveal melanoma and we currently test more than 80% of the estimated, newly diagnosed patients in the U.S. Now I would like to turn to several significant highlights from our third quarter.

First is that relates to our new pipeline products. We remain on track for commercial launch of our two pipeline products for second half of 2020 DecisionDx-SCC for patients who diagnosed with localized, high-risk cutaneous squamous cell carcinoma and our tests for suspicious pigmented lesions. We believe these two late-stage pipeline products will increase our estimated total addressable U.S. market by approximately $1.4 billion.

Regarding DecisionDx-SCC, during October's Annual Meeting of the American Society for Dermatologic Surgery, we reported data from the clinical validation study for this test for use in patients who diagnosed with localized, high-risk cutaneous squamous cell carcinoma also called SCC. We estimate that approximately 1 million patients are diagnosed with high risk SCC -- with SCC overall in the U.S each year and the instance is growing. SCC has historically been viewed as a lower risk skin cancer relative to melanoma; however, due to the high incident rate, it is estimated at approximately 15,000 patients will die from SCC this year, more than will die from continuous melanoma. So the historically benign, lower-risk disease today contributes more death than the most aggressive form of skin cancer.

Our cutaneous squamous cell carcinoma is currently focused on approximately 200 patients who identified as having one or more high-risk or pathologic features. We believe appropriate use should be focused on the patient with one or more clinical or pathologic high-risk features. Now, let's talk about the differences in treatment plans between low-and high-risk patients and where we believe our test and impact treat plan decisions. Currently, National Cancer Guidelines defined two different treatment plans for patients with localized cutaneous squamous cell carcinoma, based upon low-risk versus high-risk categorizations.

Low risk is defined as having no high risk clinical pathologic features while high risk is defined as having one or more of these same features. Treatment plan differences include a process to novel staging, use of neoadjuvant radiation, use of neoadjuvant chemotherapy, use of active surveillance and clinical trial enrollment recommendations. The clinical issue based in position in their patients is that the Positive Predictive Value or PPD of available staging systems is low. That is to say that the majority of patients identified as having high-risk disease do not actually go on to metastasize.

This means the majority of high-risk patients may be undergoing aggressive treatment plans they don't plan, they don't need and therefore will benefit from. Our development goal is to identify a gene expression profile test will that would enable a rule out for de-escalation approach in these high-risk patients. I'm pleased to say that our R&D team with the assistance of 23 active clinical study centers in the U.S., we're able to develop a training cohort, lock the gene, set an algorithm based upon the training cohort, and then complete validation independent cohort of 321 patients. Importantly, 93% of all validation cohort patients who are high risk by the National Comprehensive Cancer Network or NCCN risk criteria.

So our validation cohort mirrors the population so we believe meet the appropriate use criteria for our DecisionDx-SCC test. The data presented the American Society for Dermatologic Surgery shown a Negative Predictive Value or NPV for DecisionDx-SCC Class 1 test results of 91.1%. The result in PPV for the highest risk DecisionDx-SCC Class 2b test result was 60%, this compared to a 35.3% PPV for the Brigham and Women's Hospital staging system, 20.9% for the American Joint Committee on Cancer staging system, and 16.7% for SCC as risk criteria. Regarding the potential clinical impact or DecisionDx SCC tests, 61% of patients who had tumor with a Class 1 for the lowest-risk test result, meaning a clinician could consider deescalating care in approximately 60% of high risk patients.

And the highest risk Class 2b test result provides the clinician with objective data to confidently proceed forward with implementing a high-risk treatment plan that may include adjuvant radiation chemotherapy and clinical trial recommendations as noted earlier. We have engaged through late last month, a total of 56 U.S. centers who are working with us in both these initial validation study and ongoing performance studies for DecisionDx-SCC tests, including a prospective study. The DecisionDx-SCC test is the second skin cancers test discovered, developed and validated by Castle Biosciences.

Validation studies are under way for our third skin cancer tests. This one targeted the patient with a suspicious pigmented lesion. We do not have a data update at this time. However, we continue to believe that pending successful validation both the DecisionDx SCC tests and the suspicious pigmented lesion tests are in position to launch in the second half of 2020.

Lastly, in the third quarter, we saw continued publication evidence to support appropriate use of our DecisionDx-Melanoma test and covers by commercial payers. One of these peer reviewed studies was published in the American Journal of Clinical Dermatology by Danielle Dubin and colleagues in title level of evidence for gene expression profile test for cutaneous melanoma. The objective of the study was to review peer reviewed published literature and establish the level of evidence for DecisionDx-Melanoma. A review of seven development and validation for DecisionDx-Melanoma was conducted.

The respective strengths, which to the each study were applied to the level of evidence criteria for major organizations that published guidelines from melanoma management, including the American Joint Committee on Cancer, the National Comprehensive Cancer Network or NCCN, and the American Academy of Dermatology, this manuscript shows that based upon evaluation of all the published evidence of the DecisionDx-Melanoma test achieves a higher level evidence than the one determined by each of these groups. Of note is that the level of evidence achieved in Dr. Dubin's manuscript was due to the timing of the analysis without the inclusion or benefit of three prospective studies published between February and May of 2019. This study brings the total number of peer reviewed publications to 22 that support one or both of its current two clinically actively uses of the DecisionDx-Melanoma test.

The first clinical use of our test is to inform decisions on clinical biopsy in patients when the tumor thickness is less than or equal two millimeters, and the second use is to guide subsequent treatment plan decisions. As previously stated, we believe our continued investment in evidence development is key to supporting both patient penetration and covered by commercial payers. We recently received notification at the American Medical Association, CPT Editorial Panel, accepted our application for a Category 1 MAAA CPT code for DecisionDx-Melanoma test. The code will be effective on January 1, 2021, attained a Category 1 MAAA CPT code means that we have met certain levels of evidence requirements.

For example, the clinical efficacy needed to be documented in the literature, hence are focused on evidence development. Additionally, it requires of the test to use be performed with a frequency consistent with the intended use, that is use of consistent with current medical practice, and it is performed by many physicians or other qualified healthcare professionals. Our DecisionDx-Melanoma test was viewed at meeting all of these criteria, which we agree with. The acceptance now means that both of our proprietary MAAA tests, DecisionDx-UM and DecisionDx-Melanoma have met the criteria required for Category 1 MAAA CPT code.

I will now turn the call back over to Frank who will provide additional detail related to our financial results.

Frank Stokes -- Chief Financial Officer

Thank you, Derek. We're pleased with the strong growth we delivered in the third quarter of 2019. We reported $14.8 million in revenue, an increase of $11.1 million over the third quarter of 2018. This was driven by a 32% increase year over year in our cutaneous melanoma test reports volume and higher revenue per test.

As a reminder, the year-over-year comparability of our revenue is affected by the Medicare Local Coverage Determination or LCD for our DecisionDx-Melanoma test that was issued in the fourth quarter of 2018. While the LCD covered reimbursement for test reports delivered prior to the fourth quarter of 2018, due to the timing of the issuance of the LCD, and GAAP revenue recognition requirements, all 2018 DecisionDx-Melanoma Medicare revenue was only recognized in the fourth quarter of 2018 when the LCD became final and effective. The amount of such revenue derived from DecisionDx-Melanoma test reports delivered in the third quarter of 2018, but not recognized until the fourth quarter of 2018 was $2.2 million. Additionally, in the third quarter of 2019, favorable revenue adjustments related to test reports delivered in prior periods, impacted revenue.

The third quarter of 2019 includes $3.2 million of positive revenue adjustments, compared to negative adjustments of $1.2 million for the third quarter of 2018. The increase in positive revenue adjustments primarily relates to cash collections in the current period, on test reports delivered in prior periods, for which no revenue was recognized in those periods. No revenue was recognized originally in alignment with the requirements for revenue recognition under GAAP. We believe based on recent reimbursement activity, that additional positive adjustments in future periods at some level are possible for at least the next few quarters.

Our gross margin during the quarter increased to 88%, compared to 64% during the third quarter of 2018. This improvement was primarily drive be operating leverage as a result of our strong volume growth. Our operating expenses during the third quarter were $8.6 million, compared to $5.2 million during the same quarter in 2018, an increase of 66%. This increase was primarily the result of higher personnel costs, particularly due to the expansion of our expanded sales and marketing organization, but also within our administrative support functions, as well as increases and administrative expenses associated with growth and public company preparedness and higher R&D expense, which increased by $0.2 million in the third quarter of 2019 as compared to the same period in 2018.

In future quarters, we expect our R&D expense to increase as we continue to invest in activities related to enhancing our existing products and developing new products. As a percentage of revenue, our SG&A expense was 48% for the third-quarter 2019, compared to 106% in the same period of 2018. Interest expense for the third quarter of 2019 was $1.1 million, compared $2.6 million in 2018, driven by the issuance of convertible promissory notes in the first quarter of 2019. These notes were converted into common stock in July 2019 in connection with the IPO.

The remainder of the increase is primarily due to higher average outstanding balances under our credit facility. For the 2019 third quarter, we recorded a onetime noncash debt extinguishment gain, totaling $5.2 million. This extinguishment gain is associated with the convertible notes originally issued in the first quarter of 2019 and relates to the final conversion of these notes in the common[Technical difficulty]OK, apologies to everyone via weather, weather or what we had an internet outage here in Friendswood and we use voice over internet phones. So we dropped from the call.

I'm going to start where I picked the call up, if I'm repeating some for some of you, I apologize. But we'll go through the financial section and update again. And if you're hearing it twice, we'll just get the note very well. We're pleased with a strong growth we delivered in third quarter of 2019.

We reported $14.8 million in revenue, an increase an $11.1 million over the third quarter of 2018. This was driven by a 33% increase year over year in the cutaneous melanoma test report volume and higher revenue per test. As a reminder, the year-over-year comparability of our revenue is affected by the Medicare Local Coverage Determination or LCD for our DecisionDx-Melanoma test that was issued in the fourth quarter of 2018. While the LCD covered reimbursement for test reports delivered prior to the fourth quarter of 2018 due to the timing of the issuance of the LCD and GAAP revenue recognition requirements, all 2018 DecisionDx-Melanoma Medicare revenue was only recognized in the fourth quarter of 2018 when the LCD became final and effective.

The amount of such revenue derived from DecisionDx-Melanoma test reports delivered in the third quarter of 2018, but not recognized until fourth-quarter 2018 was $2.2 million. Additionally in the actually of 2019, favorable revenue adjustments related to test reports delivered in prior periods impacted revenue. The third quarter of 2019 includes $3.3 million of positive revenue, compared to negative adjustments of $1.2 million for the third quarter of 2018. The increase in positive revenue adjustments, primarily relates to cash collection, in the current period, our test reports delivered in prior periods for which no revenue was recognized when those reports were originally.

No revenue was recognized originally in alignment with the requirements for revenue recognition under GAAP. We believe based on recent reimbursement activity that additional positive adjustments in future periods at some level are possible for at least the next few quarters. Our gross margin during the quarter increased to 88%, compared to 64% during the third quarter of 2018. This improvement was primarily driven by operating leverage as a result of our strong volume growth.

Our operating expenses during the third quarter were $8.6 million, compared to 5.2 million during the same quarter in 2018, an increase of 56%. This increase was primarily the result of higher personnel costs due to the expansion of our sales and marketing organization, but also there are administrate support functions, as well as increases in administrative expenses associated with growth in public company preparedness, as well as higher R&D expense, which increased by $0.2 million in the third quarter of 2019 compared to the same period 2018. In future quarters, we expect our R&D expense will increase as we continue invest in activities related to enhancing our existing products in developing new products. As a percentage of revenue, our SG&A expense was 48% for the 2019 third quarter, compared to 106% in the same period 2018.

Interest expense for the third-quarter 2019 was $1.1 million, compared to $0.6 million in 2018, driven by the issuance of convertible promissory notes in the first quarter of 2019. These notes were converted into common stock in July 2019 in connection with the IPO. The remainder of the increase is primarily due higher average outstanding balances under our credit facility. For the 2019 third quarter, we reported a onetime noncash debt extinguishment gain totaling $5.2 million.

This extinguishment gain is associated with the convertible notes originally issued in the first quarter of 2019 and relate to the final conversion of these note in the outstanding common stock in connection with the IPO in late July. Partially offsetting this gain was a mark-to-market loss of $2.1 million related to a separate $10 million we issued in July, 2019. Like the other convertible notes, this note was also converted in the common stock in connection with the IPO in late July. Our net income for the 2019 third quarter was $5.8 million or $0.05 diluted earnings per share, compared to the net loss of $3.5 million or $2.33 loss per diluted share for the third quarter of 2018.

Moving next for cash flow performance, for the third-quarter 2019, capital flow generated $0.8 million in positive operating cash flows, compared to negative operating cash flows of $1.9 million in the prior-year quarter, and generated positive operating cash flows of $2.5 million for the nine months in September 30, 2019, compared to negative operating cash flows of $9.1 million for the same period in 2018. Finally, we had cash and cash equivalents at September 30, 2019 of $94.5 million, which we believe along with cash generated for sales of our products will be sufficient to fund our operating expenses for the foreseeable future. Additionally, we believe our balance sheet positions as well to execute on our expansion plans and support our ongoing research and development activities. I'll now turn the call back over Derek.

Derek Maetzold -- Founder, President, and Chief Executive Officer

Thank you, Frank. In summary, we are truly pleased with our third-quarter performance across the entire company. Our commercial execution coupled with continued evidenced development enabled us to drive strong year-over-year test reports and revenue growth, led by our DecisionDx-Melanoma test. With second-quarter and third-quarter gains, we decided to execute our commercial expansion plans in December 2019.

Finally, we are pleased to announce positive top-line data from our clinical validation study to our Decision-Dx SCC tests. Both of our pipeline tests, DecisionDx-SCC tests and the suspicious pigmented lesion tests continue to progress on-time and assuming successful validation remain on track for commercial launch in the second half of 2020. Operator, we are now ready for Q&A.

Questions & Answers:

Operator

Thank you. [Operator instructions] And our first question comes from Catherine Schulte with Baird. Your line is open.

Catherine Schulte -- Robert W. Baird and Company -- Analyst

And first for me on the salesforce extension to add another nine sales territories, is your goal to have the hiring complete by the end of December? Or is that when you're planning to start? And then are these new territory splits of existing regions? Or will these be completely new?

Frank Stokes -- Chief Financial Officer

Excellent questions, Catherine. We are currently targeting start dates for December 1, 2019, and believe we will achieve full employment for the extended territories by the December 1. These are territories which are being split among existing geographies, so our territories will be one territory for given zip codes, 32 across the country as opposed to layer.

Catherine Schulte -- Robert W. Baird and Company -- Analyst

OK, and then I know you aren't specifically giving guidance, but as we head into the fourth quarter. Anything from a seasonality perspective we should think about when it comes to volume?

Frank Stokes -- Chief Financial Officer

Now, that's a good comment. As you can maybe have in front of you, we do see seasonality over the course of the year. We presume part of it could be driven by deductibles, but I think more of it's also driven by behavior people who have brambles and probably are not ever going in the physician's office on a regular basis. So we do see slower growth in the fourth quarter in terms of newly diagnosed patients compared to the third quarter for example.

We also know that with the winter vacations and plus winter holidays, we have less physicians in the offices and we have less patients go into offices for a biopsy as well. So we do expect the fourth quarter to be lower from a growth standpoint in terms of overall diagnosis from over 3Q to 2Q, 4Q to 3Q should be slightly from growth quarter to quarter.

Catherine Schulte -- Robert W. Baird and Company -- Analyst

And last one for me, and I'll jump back in the queue. But I believe your collection period for the cutaneous test goes through the end of this month. Based on your collections today, do you remain confident that should have at least stable pricing once the rate goes to the private payer median?

Frank Stokes -- Chief Financial Officer

Yes, we do, Catherine.

Operator

Thank you. And our next question comes from Sung Ji Nam with BTIG. Your line is open.

Sung Ji Nam -- BTIG -- Analyst

Hi, thanks for taking the questions and congrats on the quarter as well. Just a couple of quick ones. The AMA Category 1 CPT code, that's actually happening much sooner than I had anticipated. Could you talk about maybe what are some of the potential positive implications of that in terms of the sustainability of the ADLT pricing, as well as your discussions with privateers in terms of coverage?

Derek Maetzold -- Founder, President, and Chief Executive Officer

Yes, so I don't think it's -- one is it relates to ADLT status, if I don't think it will have an impact on pricing per se, on Medicare side. Now, that being said, one of the requirements for attaining or being granted I guess, you would say ADL status in May of 2019, was that we would seek a unique CPT code. As you may know, most of the tests -- MAAA tests in the marketplace today are going for the PLA code route, which requires no evidence you just need to send us a form and they'll give you a PLA the next quarter as you're aware. So our decision to seek a category of one code was to look at it more long term versus short term with the expectation that if we -- AMA, Editorial Panel believe that we submitted enough evidence that will be seen as a positive benefit from a commercial payer perspective, versus a negative benefit that we see in the marketplace with PLA codes and coverage.

That is the question.

Sung Ji Nam -- BTIG -- Analyst

OK. And then just on the private payer side. Is that -- are there any potential implications there?

Derek Maetzold -- Founder, President, and Chief Executive Officer

We think over time, this is one more positive, I guess, spend in our camp. Regarding having yet another external agency, in this case, the AMA, review our application literature behind that and agreeing that at least the category one requirements which is a fairly high hurdle in terms of achieving clinical validity or documentation that in the literature, but equally as important is the test being used consistently for medical practice. And by a large number of clinicians, be it physicians and or other ancillary healthcare providers as practitioners and PA. So we think its a positive overall trend for us now how fast that change to positive policy LED to the fact that I don't have a good history now.

Sung Ji Nam -- BTIG -- Analyst

OK. And then lastly, for me, we'd love to hear any feedback on the squamous cell carcinoma pipeline products that you're getting on the preliminary data -- on the actual validation data that you presented. And also, I don't know if it's too early to talk about it, but what's the kind of the go to market strategy there are you going to be leveraging the 50-plus centers that are currently involved in the validation study as potential early customers? Thank you.

Derek Maetzold -- Founder, President, and Chief Executive Officer

I want you to take that a part of it, Sung Ji. We are going to be going out and testing the reaction to our clinical validation data confirming our messaging and positioning over the next couple of months. I'd rather hold that information back maybe until we can talk with some solid data behind us that's based upon the back of the test itself. That being said, over the last year and a half, as we worked with not only the centers involved those actively with our steering committee, and other individual we believable will be customers we have heard consistently, that there was a need or helping them to sort through the appropriate treatment plan for patients with high risk squamous cell carcinoma.

So the one thing I would say is that, it's important to, I guess, discern that while there are over a million tumors diagnosed each year with SCC, 800,000 of those are fairly small benign and considered low risk. We don't think we offer value in that population, at least in Version 1.0. We do think or the main issue is, is those patients who have one or more high risk features where the clinician which is largely in dermatology practice or than those version is struggling between, do I proceed forward with a high risk patients and send them to a surgeon for consideration of surgical no staging, that spin into radiation oncologist for radiation therapy, a medical oncologist for chemotherapy, or do we not do that? And that was a struggle with the current staging systems having a low positive to value really where I asked him can do a couple of things. One of them is to roll out nearly 60% of the higher risk patients from requiring or major perhaps requiring adjuvant interventions like I just mentioned, and the result being opposite end of any questions are high risk Class 2 patient, 2b patients now have a transfer to value of 60% in this initial validation study.

So that feels very clinically actionable both to rule out a high risk patients who may be safe with monitor and the other one is to be much more confident going forward. And that matches the product profile expectations of our customer base when we first went out with this study, two years ago.

Sung Ji Nam -- BTIG -- Analyst

Right. Thank you.

Derek Maetzold -- Founder, President, and Chief Executive Officer

I guess, the second question was on go-to-market strategy. So we'll talk about that a bit more next spring, I guess, maybe the most important aspects of have understanding I was that, based upon our market data from the last year and a half to two years. We believe that the primary position who will be ordered our test, our squamous cell carcinoma test, will be the most surgeon and a large subset of the medical dermatologists in the U.S. marketplace.

Those are the physicians who are the highest volume adopters and users of our current cutaneous melanoma tests, so we believe we'll be able to appropriately educate the exact same clinician on both of our cutaneous melanoma test, as well as this new case cutaneous chromosome carcinoma test. I think that answers that question.

Operator

And our next question comes from Puneet Souda with SVB Leerink.

Puneet Souda -- SVB Leerink -- Analyst

Hi, Derek and Frank, thanks for the question. So far in my first question is around the rep and what you're seeing as productivity among the reps, you hired a number of reps earlier in the year. So are they tracking per your expectations? And could you remind us with the additional nine sales territories? How far would that take you in terms of the peak sales reps needed to sort of penetrate the market for cutaneous melanoma ultimately?

Derek Maetzold -- Founder, President, and Chief Executive Officer

So we -- one is that you just reset for rate in falling here, we have our first scale up was on February 1, 2019. We went from 14 to 23 outside sales territories. You may recall we also employee inside sales territories support group four to one ratio we increase those laws are medical affairs at the same time. We had model based upon prior experience and industry knowledge that we would probably need around six to nine months to see those this expansion group, kind of the fully integrated in terms of the call them customers effectively, educate confidently and you have an impact on the marketplace, and we saw as early as the second quarter of this year that are we're probably too conservative, I guess, in our expectations of the quality of the scale up and also have the demand that was out there that we just couldn't reach successfully with only 14 outside sales territories.

So we have a very promotional response at marketplace that we think around 10,000 skin cancer clinicians of which the majority of those are dermatologist or the nurse practitioners businesses work with them. Some of those are surgeons who do skin cancer resections and know biopsy procedures and the remaining are reminder calls to medical oncology and the amount of pathology about what our test results due for patient care. 10,000 clinicians and 40 representatives is just an insufficient ratio. So we're pleased to see that quick ramp up in the second quarter that continue with the third quarter as we saw in 32% growth reports year over year, that still quite strong and good.

So we made the decision to go ahead and pull-forward these additional region nine sales territories to get to a 32 number. That was important to us, not to kind of double in size nine months later because we have disruption in terms of customer contact and hand off. So we went up one region only. We believe we will hold there for the first part of 2020 and kind of see again how the promotion responsiveness stands out with this group.

I think if we had -- we are launching no additional tests in the skin cancer category, we would probably hold around 32, 33, 35 fields about right base product metrics that still gives you a targeted group of around 300 doctors per territories, if you assume 9,000 or 10,000 doctor is the correct number. So still a little high ratio standpoint, but we also have a very high complexity, clinical cell to go ahead and talk to our customers. What we don't have a handle is we launch our second test the cutaneous squamous cell carcinoma test and also the suspicious pigmented lesion 32 feel white, depending upon how we can actually wrestle through the trade off and improvisation of those are sales calls. So we do the model we think will expand again one more region or region and half to get to mid-40s and that scales about saturated to what maximize the educational value or penetration to the sort of skin cancer marketplaces that we focus on.

Puneet Souda -- SVB Leerink -- Analyst

That's helpful. Thanks for the details. Frank, another question that I have is on, the catch up payment. I know it's hard for you to provide guidance.

Bu I mean, how should we think about additional catch up payments so that could or prior-quarter payments here in fourth quarter as we come into the end of the year.

Frank Stokes -- Chief Financial Officer

I think like other companies are factor, we will continue to see some of that going forward, it's hard to, it's hard to, to, frankly predict the magnitude of that. I mean, keep in mind, this is these collections are a good thing. We only reflect the revenue because that's cash in the door. So it's reflective of our getting paid for more tasks than we originally would have expected to be paid for.

So we're pleased with our reimbursement team's efforts and we're pleased with their effectiveness. We will continue to see some of that, but as we said before, as we move more and more of our test report volume, as we move more of that into policies, and that number will come down over time, unless that while until we launch our new products, when you may see it, come back up again.

Puneet Souda -- SVB Leerink -- Analyst

OK, and then on pipeline if I could ask. You've presented at ASDS, clearly the data is well ahead of Bergersen moments and AGCC in terms of NPVs, PPVs. And could you just give a sense of the test of performance that you have seen and sort of past? And would -- I know there was a question on this before, but sort of what do expect that test performance to continue or sort of step down slightly in the perspective of study that you're trying to do? Thank you.

Derek Maetzold -- Founder, President, and Chief Executive Officer

So relative to perspective study is the question.

Puneet Souda -- SVB Leerink -- Analyst

If I could rephrase it, essentially, if you could provide, the NPVs PPVs are likely to hold as you do broader prospective studies? Thank you.

Derek Maetzold -- Founder, President, and Chief Executive Officer

Yes. So a couple things, first of all, maybe on the Clinical validation study, we were way overpowered at 321 patients now of course we started the protocol, we weren't quite sure of the metrics of our potential tests. But when you look at our training sets, we needed far fewer patients to go ahead and hit with confidence our primary endpoints in terms of, risk of metastasis or risk of recurrence in the study. So when we were pleased with that, first of all.

Second is we purposely went wide in terms of initial clinical study centers, as opposed to kind of going to one or two or three or my risk, both sample bias. They only have high risk really, really patients that were they were seeing, are they a little unusual, so by going to 23 centers for the initial 321 patient validation study, we think kind of provides enough balance out there to wash away at single center biases. That we might have mother having patient data available or sample it available. So I don't think we expect to see a whole lot of movement on archival studies that are ongoing.

Now relative to the prospective questions, if our experience that in our cutaneous melanoma test is similar, we would expect actually to come up with improved accurate statistics because you're kind of testing consecutively diagnosed patients we found prospectively. So what is it like I think our default is that, it would be similar, but our experiences as it should be improved because historically we have some consecutive diagnose patients, and you've also got this much closer follow up going forward. So I guess, the best way to summarize that, I would say we are under a high belief based upon the overpowering of our initial clinical validation study that we would not see a whole lot of movement against those statistics going forward.

Operator

Thank you. Our next question comes from Mark Massaro with Canaccord Genuity. Your line is open.

Mark Massaro -- Canaccord Genuity -- Analyst

Hey, guys, thanks for taking the questions. I too wanted to ask about the study at the American Society for Dermatologic Surgery in Chicago. So it seems to me like the 91.6% metastatic free survival rate for the lowest risk Class 1. It's that metric that sort of jumps off the page for folks that are eligible for de escalation.

Can you just give us a sense for any general level of awareness of this data readout for maybe some of your existing ordering, docs and any buzz or discussions that you've heard coming out of the conference that would suggest interest in this product in the future?

Derek Maetzold -- Founder, President, and Chief Executive Officer

Yes. So we conducted a small number test, but as I mentioned earlier, we're going to be completing our positioning and starting work over the next couple of months. So it's limited anecdotal data. So far, I think we've heard from a sort of head nod and confirmation perspective is that, there is a need in squamous cell carcinoma that's localized and high risk to really help the clinician and the patients make a much more informed objective decision about, do I not go forward with these interventions or do I go forward.

So that's come through consistently as certainly once they saw the presentation on Thursday, I believe our most of interactions were on Friday and Saturday. We had good that I would call an early feedback that when we thought we were marching toward two years ago was when we got in that surgery to be seen. And I think what's important though especially if you happen to make diligent calls to customers or to dermatologist and get some reactions off the data, is that it's also quite clear that if we don't set up the expectation that we don't believe there is an appropriate use of our tests, and people with low risk disease. So when you hear about a test for Castle for use in squamous cell carcinoma, and if the commission is thinking automatically, that's a low risk, run of the mill, squamous cell that's easily cured surgically.

One might hear back, I don't think there's a need for this in this category because we can cure them surgically. So we have learned somehow the last four or five months in talking to our existing melanoma customers that we want to be able to first say, this is not the test for everybody, this is a test for that patient with localized high risk disease where you're looking at a comfort level that you want to improve tremendously of your decisions to implement adjutant therapy or interventions versus not NTS study care. That's come through because that came through a bit of ASDS, formally, but there's also the consistency we heard leading up to this presentation.

Mark Massaro -- Canaccord Genuity -- Analyst

That's great. And then Frank, a question on gross margins, not only were they strong at 88%, but even the cost of goods declined about 300,000 in the quarter. Is there anything to point to on the cost of goods line? Or is that lumpy or timing related?

Frank Stokes -- Chief Financial Officer

I think it's just timing related, Mark, there was some annual cost cycle things that were in prior quarter, so really nothing other than just timing, just normal timing issues through the year.

Mark Massaro -- Canaccord Genuity -- Analyst

OK, and then as it relates to the onetime payment, I think you called out 3.2 million in Q3 of '19. Frank, is it right that if you strip that payment out, gross margins would have been about 85%? And if that's the case, can you help us, I guess, the difference between the 85, adjusted in the 81 in Q2 is the result of the higher ASPs from a new Medicare rate?

Frank Stokes -- Chief Financial Officer

Yes, so you do have higher ASPs in there, but also that's a little bit apples to oranges Mark because we do believe that there were test performed in the third quarter for which we've recognized the cost of those tests that we hope to be paid for and later periods. So you can-if you want to look at, if you want to take out prior-period revenue and look at gross margin there, that way we think it still look very good, but that probably still understates gross margin a little bit because we will be paid on some of the tests that we run. But yes, when you look sequentially quarter to quarter, the primary driver there is increasing ASP.

Mark Massaro -- Canaccord Genuity -- Analyst

And is there any potential that -- so far they look at your model, revenues have increased sequentially, every quarter, you reported. So can you help us think about Q4, understanding that there is a timing element, I should say, a seasonality element in December, but any perspective would be appreciated?

Frank Stokes -- Chief Financial Officer

Yes, as you know, Mark, we haven't given guidance on the year here. But as Derek very sad, we do see a little bit of seasonality Q3 to Q4, driven by patient behavior, but also clinician behavior. Some, as you're probably aware from your own experience, some practices close for around the holidays, some close the last couple weeks of the year, even. And then there are some that recognized many of their patients are at the end of their deductible cycle.

So they stay open to give them the opportunity to seek treatment while they're in that posture. So I would say that if you look historically at our report performance, Q3 to Q4, we don't see anything fundamental or systemic that would change that type trends for this year.

Mark Massaro -- Canaccord Genuity -- Analyst

Just one last one for me. Can you just talk about some of the early discussions you're having with commercial payers? And how should we be thinking about 2020 setting up for potential commercial coverage expansion?

Derek Maetzold -- Founder, President, and Chief Executive Officer

So we certainly are in an active discussion with a number of commercial payers. We did have three positive policies flip over in the third quarter. We have ongoing dialogues. Most of the commercial payers are in sort of a January 1 or a July 1 or cycle for medical policy turnover.

Our managed care group expects to have this kind of a slow slog or slow fall. So we have expectations for some changes at the first of the year 2020, a little higher expectation for middle of the year and higher as we go ahead in 2021. From an internal ASP or kind of imagine perspective or assuming, this is kind of a slow, long hour slog because that's what it's been for other disease states and we shouldn't be assuming a much more aggressive ramp up on that.

Operator

Thank you. And there's no other questions in the queue, I could turn it back to Mr. Derek Maetzold for any closing remarks.

Derek Maetzold -- Founder, President, and Chief Executive Officer

Thank you, operator. Now, this concludes our third-quarter 2019 earnings call. I want to thank you again on behalf of the company for joining us and your continued interest in Castle Biosciences. Goodbye.

Operator

[Operator signoff]

Duration: 59 minutes

Call participants:

Frank Stokes -- Chief Financial Officer

Derek Maetzold -- Founder, President, and Chief Executive Officer

Catherine Schulte -- Robert W. Baird and Company -- Analyst

Sung Ji Nam -- BTIG -- Analyst

Puneet Souda -- SVB Leerink -- Analyst

Mark Massaro -- Canaccord Genuity -- Analyst

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