Myriad Genetics Inc (MYGN) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Myriad Genetics fiscal second quarter earnings call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder this, conference is being recorded Tuesday, January 31, 2012. I would now like to turn the conference over to Rebecca Chambers, Director of Investor Relations. Please go ahead, ma'am.

Thank you, Lindsey. Good afternoon everyone, and welcome to the Myriad Genetics second fiscal quarter earnings call. During the call, we will review the financial results we've released today and the progress we have made this quarter on our strategic directives, after which we will host a question-and-answer session.

If you have not had a chance to review the earnings release, it can be found in the investor relations section of our website at Myriad.com. Presenting for Myriad today will be Pete Meldrum, President and Chief Executive Officer; Mark Capone, President, Myriad Genetic Laboratories; and Jim Evans, Chief Financial Officer. This call can be heard live via webcast along with the slide presentation at Myriad.com. The call is being recorded and will be archived along with the presentation in the investor section of our website.

Please note that some of the information presented here today may contain projections or other forward-looking statements regarding future events or the future financial performance of the Company. These statements are based on management's current expectations and the actual events or results may differ materially and adversely from these expectations for a variety of reasons.

We refer you to the documents the company files from time to time with the Securities and Exchange Commission, specifically the Company's annual report on Form 10-K, its quarterly reports on Form 10-Q, and its current reports on Form 8-K. These documents identify important risk factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements. With that, I will now turn the call over to Pete.

Thank you, Rebecca. To begin, I would like to provide highlights of our second quarter results and introduce the Company's updated financial guidance for fiscal 2012. I'm extremely pleased to report that our second quarter revenue increased 22% year-over-year to a record $122.8 million. This is the second quarter in a row that growth in the total Company revenues exceeded 20%.

Molecular diagnostic revenue grew 17%, as compared to the second quarter of fiscal 2011, with all of our products demonstrating strong growth, especially COLARIS. For the second quarter in a row, demand for the COLARIS test exceeded expectations as product sales grew 56% year-over-year to $10.9 million. We remain excited about the clinical value of this product and expect strong growth to continue in the future.

Our profitability improved during the second quarter, as operating income grew 18% year-over-year to $45.5 million, and diluted earnings per share increased 27% to $0.33. Given these strong results, we have increased our guidance for fiscal 2012. Revenue is expected to be $465 million to $475 million, which represents a 16% to 18% growth over the prior fiscal year and a significant increase from our original fiscal 2012 revenue guidance of $445 million to $465 million.

Our expectation for higher revenue growth is due to the strong results we have seen from several initiatives that we have put in place to expand our oncology and women's health markets. Mark will provide an update on each of these initiatives later on in the call.

Diluted earnings per share guidance has also been increased to $1.24 to $1.28, representing a 13% to 16% growth over fiscal 2011 earnings per share of $1.10, and up from the original guidance of $1.20 to $1.25. These strong results have positioned us well for continued success, particularly when combined with the strategic directives that we are focusing on for long-term revenue growth.

First, we are aggressively growing our existing tests and markets. Second, we are committed to expanding our business internationally. Third, we intend to launch new transformative products across the diverse set of major disease indications.

Mark will provide an update on the first strategic directive, to grow existing tests and markets, and I will focus my remaining comments on our European operations and new product development. With respect to our international strategy, I'm pleased to report that our laboratory in Munich, Germany is open and operational as of the beginning of January.

As a reminder, this lab has sufficient capacity to generate $50 million in revenues each year, a level which we believe is achievable within the next five years. We have hired country managers for all five major markets that we are focused on, Germany, France, Italy, Spain, and Switzerland.

These individuals will be traveling to Salt Lake in February to complete their training sales program, after which, they will be focused on growing Myriad's presence in each of their respective countries. We have obtained reimbursement in all five major markets for three of our products, BRACAnalysis, COLARIS, and COLARIS AP.

Additionally, we are initiating clinical studies in numerous European countries to demonstrate the clinical utility of our Prolaris product. We feel these trials will help accelerate demand for Myriad's prostate cancer prognostic test in Europe. We are pleased with the progress made in Europe thus far, and continue to view this as an exciting growth opportunity for the Company.

Our third strategic directive is to bring new products to market, including those for companion diagnostics. Today, our industry-leading pipeline across multiple disease indications continues to progress nicely. We believe it will provide patients and physicians with answers for the most pressing clinical needs, and the six medical specialties identified in our strategic plan.

As a reminder, these medical specialties include oncology, women's health, urology, dermatology, autoimmune and inflammatory disease, and neuroscience. To accomplish this strategic goal of growing and diversifying our business in the future, we are pursuing a combination of internal product development, technology and biomarker in-licensing, and company acquisitions.

We recently announced the acquisition of an exclusive worldwide license with co-exclusivity in Germany to intellectual property for the RAD51C gene for hereditary breast and ovarian cancer testing. This intellectual property will augment our already strong IP position around hereditary breast and ovarian cancer, and we anticipate that the RAD51 gene will play an important role in our future product development.

The RAD51C gene's association with breast and ovarian cancer was identified by the German Consortium for Hereditary Breast and Ovarian Cancer. Data published in the April 22, 2010 issue of Nature Genetics showed the mutations in the RAD51C gene were present in 480 pedigrees with a family history of breast and ovarian cancers, but not in any of the 2,912 cancer-free individuals.

We are making progress on a number of fronts toward the goal set forth in our strategic plan to diversify across multiple disease indications and grow revenues both domestically and abroad. We are pleased with the strong performance of the core business in this fiscal 2012 to date and believe that our ability to execute on our strategic plan for the long-term growth is very strong. Now, it is my pleasure to turn over the call to Mark Capone.

Thank you, Pete. As Pete mentioned, we saw strong growth in molecular diagnostic revenue during the second quarter. This was driven by substantial growth in all products and segments of the business, including a record quarter for COLARIS. The oncology segment grew 15% year-over-year, while women's health grew 22%.

Simply put, these significant growth rates are direct results of the focused execution by our talented employees on the strategies articulated for our first strategic directive to grow our existing tests and markets. I would like to provide a brief update on the progress made during the second quarter on these strategies, and then also provide an update on the Prolaris launch.

In our oncology segment, BRACAnalysis growth was driven by continued focus on the ovarian cancer, carcinoma in situ, and triple-negative breast cancer indication. As a reminder, these indications increase the addressable oncology market for BRACAnalysis by approximately $200 million to an annual market potential of $650 million. In total, these new indications grew 41% this quarter compared to the second quarter of last year, and we continue to see significant opportunity for growth.

Most importantly, the growth in the triple-negative breast cancer indication has been impressive, given that the NCCN guidelines were updated in April 2011 and within six months Myriad was able to obtain reimbursement from all of our major insurers.

The women's health segment continues to focus on growing same-store sales, adding new territories, and implementing our interactive media direct-to-physician and direct-to-consumer campaigns. In the second quarter, same-store sales initiatives, new territories added in fiscal year 2011, and interactive media campaigns generated over $5 million of revenue growth.

By way of example, our interactive media campaign has led to over 100% increase in our web traffic, and a 700% increase in our social media followers. We are also starting to see contributions from the new territories added in the beginning of fiscal 2012, which experienced a 35% increase sequentially in revenue.

In the women's health segment, we continue to monitor physician office visit trends. In the second quarter, we saw somewhat mixed signals from IMS data, which showed office visits up, and Thomson Reuters data which showed visits down. In triangulating with our field teams, we continue to view physician visits as essentially flat last quarter and going into the third quarter. However, with the women's health segment less than 10% penetrated, there remains significant growth opportunities in this market for the foreseeable future.

The record 56% growth rate in the COLARIS product family was attributed equally to the impact of PMS2 and increased demand for market growth and market share gains. We expect COLARIS to continue to demonstrate strong double-digit growth in the second half of this fiscal year.

From our market research, customers are choosing Myriad because of the strength of our database in Variant Classification Systems, our short turnaround times, excellent customer service relative to reimbursement, strong field support, and the availability of a saliva-based sample as an alternative to the more invasive blood sample.

Despite a number of competitors and no IP competitive advantage, Myriad has demonstrated the ability to capture the majority of this market. We also have seen promising early results from our eight-member colorectal cancer specialist team in our oncology segment. We will be discussing this strategy in more detail on our next conference call.

Lastly, I would like to summarize a number of positive advancements in our commercialization efforts for Prolaris. Prolaris is a 46-gene expression assay, which distinguishes indolent, or less aggressive forms of prostate cancer, from more aggressive forms. Prolaris has demonstrated strong predictive power in both biopsy and post-prostatectomy tissues.

We have completed four clinical studies and have three more underway, representing over 3,000 prostate cancer patient samples. Study PRO003, our second pre-prostatectomy study, which was presented at ASCO last June, has been accepted for publication in the British Journal of Cancer and should be published within this quarter. Study PRO004, the second post-prostatectomy study, conducted in collaboration with UCSF, is in the process of being submitted for general review and has been accepted as an abstract for the presentation at the ASCO GU meeting coming up this weekend in San Francisco.

The PRO006 study, a Phase IV prospective US study with an organization representing 25% of community urologists is designed to document the distribution of Prolaris scores and the resulting treatment decision, both of which will be used for reimbursement discussions. This study has been extremely well-received and recruitment is exceeding traditional metrics. This spring, we are also presenting Prolaris-related abstracts at the EAU annual congress in Paris at a special AACR conference on advances in prostate cancer research in Orlando, and at a podium presentation during the May AUA annual meeting in Atlanta.

Our commercialization efforts are also progressing well for Prolaris. We have completed extensive market research with physicians and payers and have seen a significant increase in interest that can be attributed to three factors. The first is the recommendation to suspend PSA screening until a test can distinguish between the indolent and aggressive forms of prostate cancer.

The second is the removal of a digital pathology test from the market that had similar indications as Prolaris. This test had an order run rate in excess of 10,000 samples per year, and those users are looking for another solution.

Lastly, recent publications have demonstrated the clinical and health economic benefits of adjuvant radiation post-prostatectomy for aggressive prostate cancers, yet have highlighted serious underutilization. As a result of these positive developments, I am pleased to announce that we will begin accelerating commercialization of Prolaris in February, with both payers and physicians. As part of this accelerated commercialization, we will double our urology sales teams to approximately 20 field-based personnel.

In summary, we are very pleased with the execution of our strategic initiatives and our financial results for the second quarter. We continue to see significant opportunities for growth with our existing products and are excited to be leading the revolution of the urology market with new transformative molecular diagnostics. I will now turn the call over to Jim.

Thanks, Mark, and good afternoon everyone. It is my pleasure to present a more detailed look at Myriad's financial results for the second quarter of fiscal 2012. As Pete mentioned, Myriad's revenues for the fiscal second quarter were $122.8 million, an increase of 22% over the same period in the prior year.

Molecular diagnostic revenue grew 17% year-over-year to $117.6 million. Of this 17% growth, price contributed approximately 1.5 points, and the impact of increased sample volumes and new products, including PMS2, contributed approximately 15.5 points to growth. A breakdown of revenue by products shows BRACAnalysis grew 14% to $101.4 million, compared to $89.2 million in the same period last year.

Revenue from COLARIS and COLARIS AP increased 56% year-over-year to $10.9 million, and Myriad's other molecular diagnostic products grew 24% year-over-year to $5.3 million. Companion diagnostic services revenue equalled $5.2 million. We expect companion diagnostic services revenue to fluctuate from quarter-to-quarter, due primarily to the timing of projects with our pharmaceutical partners.

Moving down the income statement, second quarter SG&A expense equalled $51 million, or 41.5% of revenue. This represented an increase of 17% over the prior year, and was used to support the Company's 22% revenue increase, and included $2.7 million in administrative costs for Myriad RBM and approximately $800,000 associated with our new European operations.

Research and development expense was $10.2 million, or 8.3% of revenue, versus the $6.1 million reported in the second quarter last year. As we have discussed in the past, Myriad is increasing its investment in R&D to grow and diversify our business. R&D tends to be lumpy given the timing of sample acquisitions and external costs associated with our ongoing clinical trials.

In the second half of the year, we project these activities will increase and R&D expense will be approximately 9% of revenue as we invest in new products and accumulate additional clinical evidence for Prolaris and OnDose. Operating income for the quarter was $45.5 million, resulting in an operating margin of 37%. This level of operating margin represented a 140-basis-point contraction year-over-year, which is primarily a result of higher R&D expenses to ensure future revenue growth and diversification, higher bad debt, and the impact of increased SG&A costs associated with our European subsidiary, and Myriad RBM.

The second quarter effective tax rate was 39.5%, as compared with the 38.1% tax rate in the same period of the prior year. For the full year, we now expect an effective tax rate of approximately 40%. This increase is due to a number of factors, including the timing and magnitude of tax deductions associated with incentive stock options, the amount of expenditures outside the US for our international operations, and the distribution of revenue among states with higher or lower income tax rates.

Additionally, as of December 31, we have exhausted our net operating loss carry-forwards, and therefore, we will begin paying cash taxes in the second half of the year. Diluted weighted average shares outstanding were 86.2 million shares. During the second quarter, we bought back $18 million in stock, and have $173 million of the $200 million authorization remaining. Diluted earnings per share, including book tax, were $0.33 for the second quarter of fiscal 2012, an increase of 27% over the $0.26 reported in the same period of the prior year.

Moving on to the balance sheet and cash flow, our earning cash and investments for the quarter were $428.3 million. This compares to $401.7 million at the end of the first fiscal quarter. Cash from operating activities equalled $27.5 million. Capital expenditures were $3.1 million, and included purchases of new instrumentation for our production and research in development laboratories. Total cash generated during our second fiscal quarter equalled $38.9 million, and year-to-date, $85.7 million.

Highlights of the first half of fiscal 2012 include an increase in revenue of 21% year-over-year, and 15% growth in molecular diagnostic revenue. Operating income grew 17% as compared to last year, and earnings per share have grown 24%. We are pleased with our results thus far and are now focused on executing in the second half of fiscal 2012.

As Pete mentioned, given our strong performance through the first half of fiscal year, we are increasing our expectations for fiscal 2012. Revenue is now expected to grow 16% to 18% year-over-year, and equal $465 million to $475 million.

We've increased our guidance for molecular diagnostic revenue to $440 million to $450 million, while we continue to expect companion diagnostic revenue of $24 million to $26 million. Diluted earnings per share guidance has been increased to $1.24 to $1.28, representing 13% to 16% growth for fiscal 2011 earnings per share of $1.10.

This EPS guidance takes into account the impact of stock buybacks we have completed in the first half of fiscal 2012, but does not factor in the impact of any future buybacks. Additionally, the timing and magnitude of buybacks will continue to be opportunistic and dependent on market conditions.

Other items considered in this guidance are as follows. During the third fiscal quarter, we typically encounter head winds of newly reset and higher deductibles compared to the higher quarter. SG&A expense is expected to increase in the second half of the year, as the number of investments ramp up, as compared to the first half of the fiscal year.

Specifically, the impact of the commercial launch of the pre-prostatectomy indication for Prolaris, including the impact of the additional urology sales representatives, a modest increase in bad debt, and the remaining $4 million of the $6 million investment in salaries and marketing in Europe, and finally, the impact of a projected full year income tax rate of approximately 40%. With that, I will hand it over to Rebecca for the question-and-answer portion of the call.

Thank you, Jim. In order to ensure broad participation in today's Q&A session, please limit your questions to one plus a related follow-up and then jump back into the queue. Lindsey, we are now ready for the Q&A portion of the call.

(Operator Instructions)

Amanda Murphy, William Blair.

Hi, thanks. I just had some questions on the international side. You mentioned that you're getting reimbursement for the three primary products. I'm curious, is it basically coming in, in line with where you expected? And any -- in terms of the guidance increase, is there any contribution there at all from the international operations?

Thank you, Amanda. No, the international operations having just opened their doors in January won't make a substantial contribution this fiscal year. The reimbursement has come in line with what we were anticipating. Of course it varies from country to country, and the certain countries within state to state or canton to canton. But we're very pleased with the reimbursement on BRAC, COLARIS, COLARIS AP. I'm very excited about the European opportunity, but I think you'll see that make a much more significant contribution in 2013.

Got it. Okay, and then I had just this one more. It's not really related, so I apologize for that. But I'm curious, if you look at the deductible effect that you've seen over your -- the year that you've been selling the BRAC test, have you seen that change at all in terms of the impact to revenue through the year? Is it getting more meaningful over time? Just curious with the impact of higher deductible plans, et cetera.

Sure, Amanda. This is Mark. Thanks for the question. As you rightly mentioned, we have always seen a cyclical nature to our business. In the second quarter, our strongest quarter, as cafeteria plans come to an end and then the reset of deductibles in the third quarter, that is a head wind for us going into that quarter. And that's a pattern that we continue to expect to see, as the percentage of people in high deductible plans, in particular, continue to increase, which looks like it will be somewhere north of 37% this particular year. Now that being said, we have seen a gradual change in that pattern, but overall it hasn't been a monumental shift. It's one that we continue to look at in the women's health segment, which is the most impacted by more elective testing. We're less than 10% penetrated, and so as I talk to our team and as they look at opportunities, there's still plenty of women coming into the physicians' offices that have healthcare plans that allow them to entertain purchases of these tests early on in the year. So there is an effect. It has become a little more pronounced over the years. But we still think there's plenty of opportunities for us to work with the patients that we have coming into the office.

Okay. Thanks very much.

Jon Wood, Jefferies.

Hi, thanks a lot. This is for Mark. I think on Prolaris, when do you expect to be able to offer some update on any reimbursement traction there? Can this happen within six months or so of that February ramp date, or do you expect we will have to wait longer for the initial traction there?

Thanks for the question, Jon. As I mentioned, the exciting new news is that the additional study has been accepted by the British Journal of Cancer. That will now give us two studies in the pre-prostatectomy indication, and as a basis of that, we will be going in and talking to payers beginning in February. We never like to try to project exactly what the outcome of those discussions will be, but we do believe on the pre-prostatectomy indication, that we have sufficient evidence to provide the types of data that those payers generally look for, for reimbursement. On the post-prostatectomy, we've completed the fourth study, the second post prostatectomy study, and that study, we were in the process of submitting to journal articles. And we think with that second post prostatectomy study, we can begin the discussions with payers on that indication as well.

And so we will have a much better idea on where we stand on the reimbursement discussions probably on our next conference call, but we certainly believe there's sufficient data to begin those discussions in earnest. And as you know, payers are particularly interested in this. This, unlike some of our others, offers the opportunity for some cost savings to payers in the same year because they potentially can avoid some very costly treatments. And so they are very interested in this data and are anxiously awaiting the additional data that we'll be presenting in February.

All right. Appreciate the color, Mark. One unrelated one, sorry. On the women's health side, your revenue per rep grew at the fastest rate in memory during this quarter. What would you say was the largest driver to the sales force productivity -- the increase in the sales force productivity in women's health?

Yes, I think it was -- I don't know that it was a single item. I think all of the items that we've mentioned I think certainly have had an impact on some of the work that we've been doing in direct-to-physician and direct-to-consumer, through our interactive media literally had some effect. We've got a same-store sales initiative where we've introduced lean systems types approaches to help physicians that have already shown an interest in testing, but need additional help in identifying all of the appropriate patients. That certainly, we have seen some improvements there as well. And I think we've been very pleased with the new territories that we've added in fiscal year '12. As I mentioned, we've seen some significant sequential growth with the new territories for fiscal year '12, which typically we see in six to nine months. But we're actually beginning to see some impact from that a little earlier. So I think it's really the combination of all of those things. I'm not sure one in particular was probably the most impactful. But overall, we're pleased that we've set a good direction and the execution has really been outstanding.

Very good. Thanks for the color.

Scott Gleason, Stephens.

Hi, guys. Congratulations on a great quarter. I guess just to start off, if we're looking at COLARIS, can you guys give us an idea of what percentage of doctors now are ordering the PMS2 gene in concert with the core COLARIS test?

Sure, Scott. Thanks for the question. Overall, certainly the majority are now ordering PMS2 with the three-gene product. That number is now over 70% of physicians. So in effect, it's almost becoming a four-gene product at this point.

Okay, great. And then I guess if we look into the recent announcement by you guys with the RAD51C gene, when we look for -- after you guys have done some potential validation work, is there the potential that, that could become an addendum product for the term line BRACAnalysis test similar to what PMS2 is today?

Thank you. The RAD51C gene is one that we are in the process of doing additional studies and validation work on. And so it's a little premature to project exactly how we'll use that particular gene. But we're excited enough about it that we think it definitely will play a role in future product development, and that role may go beyond even our current BRACAnalysis product. So it definitely plays an important role in hereditary breast and ovarian cancer, and once we can develop additional studies to validate that, we'll give you additional clarity on what our strategy is in terms of launching that in future products.

Great. Thanks for taking my questions, guys.

Michael Yee, RBC Capital Markets.

Great, thanks. A question for Pete actually. It's a high level capital allocation question, and that is, if you look at your free cash flow, it continues to grow. You are piling up cash on your balance sheet, although I know you have a stock buyback program. Where in the list of your priorities is a dividend, and how reasonably likely is this as you think about your plans for next year?

Thank you, Michael. As you're aware, Myriad has a very specific capital allocation plan that focuses initially on reinvesting in the Company, both internal product pipeline development, as well as in-licensing opportunities and acquisitions. But as you pointed out, we have very strong cash flow generating capacity, and we generate more cash than we can productively spend investing in the business, and therefore are able to return cash to the shareholders. The board of directors decided that the most appropriate initial entry into returning cash to investors was through a stock repurchase program, and we have repurchased to date over $300 million of Company stock representing about 12% of the outstanding shares and have a fourth $200 million stock repurchase program in place. As you're aware, Michael, I am supportive, however, of the concept of paying dividends, and I do believe there are certain advantages to shareholders and dividends over share buyback. That is, however, a much more permanent commitment on the part of the Company and one which particularly the board of directors discusses from time to time, and while I can't say anything specific about those discussions, it's certainly not out of the question at some future date.

Can I just follow up? Is there something that would change -- or what would change to change your thinking about that, to give you more confidence on getting one?

I think it's just additional analysis and study on the part of the Company to look at the advantages of paying a dividend versus the stock buyback. And the thing that we have to be cognizant of is once you begin paying a dividend, you can never stop paying that dividend. And in fact, you need to grow that dividend over time. It can't even be held constant. And so at some point in time I think in the future, the Company will waive the benefits and the commitment that, that represents and then we'll make an announcement.

Okay, thanks.

Doug Schenkel, Cowen and Company.

Hi, good afternoon. Clearly, this was another very strong revenue quarter and it was a balance. With that acknowledged, your guidance I believe implies that organic growth will moderate below, it's either to about 10% or just below 10% in the fiscal second half. Assuming I'm doing the math right, could you just provide some color on what support this outlook -- don't get me wrong, that's a pretty good growth rate, especially in the current environment. But I just would love to hear how you guys are thinking about potential sources of upside versus downside risk, given this seems like fairly conservative guidance coming off a couple very strong quarters.

Our revenue expectations, as you said, have increased significantly since the beginning of the fiscal year. We are looking at comparables to last year, where in the first half of the year, we had grown 8.1% and the second half was 14%. So it does give us some tougher comps that we're going to be compared against in the second half of the year. That being said, we think that there are potentials for upside, but we do want to be cognizant of some of the headwinds that we talked about earlier with the resetting deductibles, and just looking at all the different factors that come into play. We were comfortable in increasing the revenue guidance to where what used to be the top end of our guidance is now the bottom end and we've been able to move beyond what our original expectations were. But we do want to make sure that we are conservative in looking at the guidance going forward and something that we feel very comfortable with.

Okay. That's helpful. Thanks for walking through that. A high level question, just on the broader environment. As I'm sure you're aware, Roche's hostile bid for Illumina has brought a lot of attentions to the prospects for broader utilization of genomics and I would say specifically sequencing and diagnostics. That being said, there's still a lot of hurdles to certain areas of sequencing and diagnostics in terms of driving broader utilization. Just to name a few, these include bio-informatics, regulatory development, and how you're actually going to defend these tests from a proprietary standpoint. So with that all said, in your mind, is there any reason to think that the service model is not going to be the best model for sequencing-based diagnostics at least over the next several years? And is there a broader role you would envision for Myriad as maybe exome and full genome sequencing becomes increasingly utilized in a clinical setting?

Thank you for the question. Let me start off by talking a little bit about acquisitions that have occurred in our industry, and then I'll get more specifically into discussion about the service model. Certainly the news about Illumina was good news for the life science tools and diagnostic industry since it validates the important future potential of our industry. While the number and quality of companies in this industry is declining, we certainly believe it represents an exciting future both for tools, kit, and service companies. Myriad is very much committed to the service model. It allows us to control the quality of the product that we offer, and it allows us to capture the maximum value and the clinical utility of the products that we develop.

We're very comfortable with the current regulatory environment, and we're very comfortable if that shifts to more of an FDA regulatory environment because we think FDA regulation actually for a companies the size of Myriad could be a positive since it creates barrier to market entry for some of the smaller venture capital backed companies. We're very comfortable with the progress that's been made in sequencing and bio-informatics and we certainly invest heavily in the latter portion of our technology development, and are on top of not only DNA sequencing, but exome sequencing and transciptome sequencing. So it's I think a very exciting industry, very much in its infancy, but with significant potential. And I think given the complexity of the test, it's very well suited for the service model and that's of course is where Myriad has its expertise.

Great. Thank you again.

Tycho Peterson, JPMorgan.

Hi, good afternoon. Pete, in your prepared comments, you talked about some competitive disruption for digital pathology. Can you just talk about how quickly you can go after some of those customers? I recognize you're obviously adding additional resources in that channel, but talk about how you think about swapping some of those accounts. And I think did you say it was 10,000 tests that they are on a run rate of?

Yes, that's correct. There was a product in the market that was recently withdrawn, that represented about 10,000 patient samples that assisted pathologists in deliberations around prostate cancer. And we are moving aggressively not only to expand our sales force, but to assist physicians in understanding the value and the benefit of a Prolaris score and to realize that Prolaris can provide that same benefit, if not better, than the previous test. So we do see that as an interesting opportunity to enter this market more aggressively than we had originally thought, and that was why Mark had put forth our strategy for the Polaris product.

And then as we think about the in-licensing, with RAD51C obviously you got some content around breast and ovarian. How should we think about how much IP there is out there for you to potentially in-license, and should we think about a consortium potentially around breast cancer through which you can in-license a broader suite of biomarkers? I'm just wondering where you are in the process of in-licensing additional content here to offset the patent.

We have a very strong intellectual property estate around hereditary breast and ovarian cancer. 23 issued patents in the United States, 5 issued patents in Europe, and those composition and matter patents go out to about 28 teams, and we have method of use patents that go out to about 2022. But we are also looking to improve the patent estate and looking at in-licensing additional opportunities such as RAD51C. Not only in breast cancer, but in colon cancer, breast cancer, and in the other areas we're focused on, women's healthcare, dermatology, neurology, autoimmune, and infectious diseases. So we view patents as important. Myriad is fortunate to have one of the strongest patent estates in the industry, and we'll continue to collaborate with our friends in the United States and Europe to augment our own in-house discovery and broaden that patent estate as much as possible.

Okay. And then last quarter you noted a change in your DTC efforts with more of a shift toward social media as you describe it. How do you feel like this is resonating? Are you getting more bang for you buck with more targeted campaigns?

Yes, Tycho, this is Mark. Thanks for the question. We've been very pleased with the shift. I think you see some of that reflected in the results that we had, particularly in the women's health section where most of the traffic is generally more around some of the unaffected patients. I think I gave a couple of pieces of data that shows that we've seen 700% increase in the number of followers we have on our social media, 100% increase in our web traffic. All of that, we actually have ways of tracking the hits to our website and the ultimate resolution of those hits. And so we can take a look at the impact to the business, how many people are following up, requesting additional information and things like that. And we've been very pleased with that. We think it's a more cost effective way than the mass media which obviously is not nearly as targeted as we can be with social media. So we've seen significant increases in our return on investment by moving to this media. And our approach now is really just to begin to broaden that with more national efforts versus some of the smaller pilot activity that we had tried, just to see if in fact we saw some sort of increases in the return. So we're pleased with it. You'll see more of it. And we think we're already getting some nice returns.

Okay. Last one, if I can squeak one more in, we start to get a lot of questions this time of year on reimbursement and as we think about kind of CMS and the way things could go later this year, any preliminary thoughts about any changes that we should be thinking about?

Sure. There's not a lot new on the reimbursement front. We anticipate the next time that we'll get some sort of indication will be early or late spring or early summer. CMS will have a public hearing on the clinical laboratory fee schedule in July, and 30 to 60 days before that hearing, CMS will ask for public commentary. And we think that's when we'll begin to see any indications around reimbursement for BRACAnalysis. I think it's worth noting still that 10% of our business comes from Medicare and that's the portion of our business that's going to be directly impacted by some of those reimbursement discussions. We continue to believe that BRACAnalysis, it does not require physician interpretation and therefore would make the most sense to be on the clinical laboratory fee schedule. And as a reminder as well, if we were to charge what Medicare allowable is for BRACAnalysis, BRAC would be over $5,000 to CMS, but we already provide more than 35% discount to CMS on BRACAnalysis relative to what other laboratories charge for the similar codes. So we'll probably get some indication in a few months and if asked in between then, we'll obviously be providing feedback that CMS will use to crosswalk, but overall, where we stand, we feel very good that we've been delivering some good value to CMS.

Okay. Thank you very much.

Thanks, Tycho.

Isaac Ro, Goldman Sachs.

Good evening. Thanks for taking the questions. If I could just ask a first one on your guidance, just to be clear on your underlying assumptions, I think one thing everyone in healthcare is wrestling with right now is the outlook for utilization, and just to be clear on your revised guidance, does that include any assumptions on improved volumes in the overall healthcare environment, or at least relative to what you saw 90 days ago at this time?

As we mentioned in our remarks, we've seen office visits flatten out we think. And so that's been what we've seen over the last couple of quarters, and that's what we took into consideration as we put our guidance together.

Got it, okay. And then just second question, more big picture on the regulatory environment, there's obviously a lot of controversy around the Palmetto precedent that's being set. Wondering specifically if you have any view on whether or not that will be a widespread practice down the road, and if so, how that impacts your business and your strategy?

Sure. Thanks, Isaac. Yes, just -- as a reminder, I think most know that we actually do not submit any of our products through Palmetto. We go through Meridian, and as of yet, we have not heard -- and we have been in conversations with Meridian. We have not heard any commentary as to whether or not they are going to modify their process by which they will provide a local coverage decision. We do have local coverage decisions on BRACAnalysis and on COLARIS, and were they to implement a go-forward process, it should not affect the local coverage decisions that have been already made on those two products.

Now, overall, our view of what Palmetto is trying to do is, we're very supportive of. What they have really done, just to ask when you make a submission, that you provide evidence of analytical validity, clinical validity, and clinical utility. Those are all things that we do as a standard course of business, and so we're very prepared to provide any of the technical assessment data that might be requested. In fact, we already do that now. The other thing we have seen is, in Palmetto's process, is a nice recognition for the importance of value-based pricing on both CMS in Baltimore and Palmetto have gone out of their way to mention the importance of value-based pricing, if in fact these products are going to be developed and the decisions that have been made already by Palmetto to that regard have been very supportive of value-based pricing. So as a process as a whole, we're supportive of what Palmetto's doing, but as of now, it doesn't look like our local carrier has made any determination to embrace a change in what historically has been their process.

Got it. Thanks very much.

Bill Quirk, Piper Jaffray.

Good afternoon. Thanks for squeezing me in. Question I have following up on the last one there. In terms of some of the other payers, and obviously Palmetto isn't that big of a deal for you guys, but a lot of the payers are watching this pretty carefully. So I'm curious, given that McKesson's expected to release the Z-codes here in April, May, I would be curious to see how quickly do you think we could see other payers jump on here? Secondly, you mentioned that you are in the process of preparing the appropriate information. Is that safe to assume guys, that you're going through the Z-code processes right now?

Thanks for the question, Bill. As to how quickly other carriers might modify their processes and use or not use Z-codes I think would be hard to speculate. I think if we would have -- I think we might have seen something by now if Meridian intended to go that way. It's important to keep in mind that we're already going to be shifting at least for most of the top molecular diagnostics to individual codes in 2013. And so this interim step of shifting to a Z-code which is individualized to a particular product and then six months later moving to an alternative code from the AMA process. I'm not sure whether others are going to actually go through that since the intention of this was all to give visibility and that's exactly what's been done with the codes established by the AMA. So we -- I don't know that we could speculate that. We haven't heard anything. We haven't been asked to prepare anything to that effect. And so for us, at least for our local carrier, things are pretty much business as usual.

Understood. And then as a follow-up, just working off Amanda's question earlier, Pete, you mentioned you're pleased with the reimbursement. Could you elaborate a little bit in terms of what indications you can pursue in Europe with respect to BRACAnalysis, COLARIS, and COLARIS AP? And then the second question there is can you just comment, reimbursement levels, obviously they vary, how do they compare in aggregate to what you're getting in the US? Thanks.

Thanks for the question. Let me start first with reimbursement levels. Reimbursement levels throughout Europe are actually quite comparable to what we get reimbursed here in the United States. I'll remind you that our ASP for BRACAnalysis in the US is about $3,000. And we get anywhere from $2,200 to $2,500 -- sorry, EUR2,200 to EUR2,500 in Europe for the BRACAnalysis. So the reimbursement in Europe is actually quite comparable to that in the United States. It's particularly good in Northern Italy compared to Southern Italy, and it's a little stronger in Switzerland and Germany than it is in Spain, for example. But pretty much in our five major market countries, it's quite comparable to the US reimbursement rate. So we were very pleased with that and very comfortable with moving forward with our European operations, given the strong reimbursement that we're seeing.

The reimbursement is primarily in the oncology setting. There's very little women's healthcare pre-symptomatic reimbursement in Europe. That's one of the things we'll be doing to grow the market in Europe. But right now, reimbursement in oncology for both breast cancer and ovarian cancer is quite comparable to the professional society guidelines that we have here in the United States for reimbursement in a similar group of patients. So I would say on both cases, very comparable to the US.

Got it, thank you.

Dan Leonard, Leerink Swann.

Thank you. Just two quick ones. You mentioned that 10% of your revenue comes from Medicare. Can you remind us what proportion of your commercial payers benchmark Medicare in some fashion? I assume it's very small, but there's probably something.

Yes, let me start off and I'll ask Mark to chime in with additional information. We really don't have any of our current payers that benchmark off of CMS or Medicare. We negotiate contracts directly with the payers and give them a discount on our list price. So based on volume, they will get a discount, for example, on BRACAnalysis, which has a list price of $3,340, and again, the ASP is around $3,000. So it is based on the list price, not as a percentage or any reference to Medicare reimbursement.

We also put a lot of effort into economic studies that show the value of BRACAnalysis and COLARIS and other products, and have recently seen very strong support at a recent publication for COLARIS that showed that COLARIS was as cost effective as mammograms and Pap smears and colonoscopies, and at the most recent breast cancer symposium showed the cost effectiveness of BRACAnalysis, which was around $30,600, well below the $50,000 per quality adjusted life year that is typically thought of as cost effective. So given the strong cost benefit, given the fact that we actually save the insurance system money, as well as saving lives and improving quality of life, we feel very good with where all of our products sit on that cost-benefit spectrum. And again, it's based on direct discussions with the private payers and at discount to list price. It's not based on any relationship with what CMS reimburses.

Okay, thank you. And then for my follow-up, can you remind me what ability you have to pursue a DTC strategy in Europe to target the asymptomatic market? I believe the regulations over there are a little bit different, but could you give us an update?

Thank you for a very easy question because we have no capability of doing a direct-to-consumer marketing strategy in Europe. That is not legal in the European environment. So that is something that has worked well for us initially with the mass media, and now, much more cost effectively, as Mark mentioned with the social media in the United States, but it is illegal in Europe. So we will not be doing any of those campaigns in Europe.

That's what I thought. Thank you.

Thanks, Dan. Operator, I think we have time for one more question.

Peter Lawson, Mizuho Securities USA.

I may have missed this. The slight weakness in gross margins, what was weighing on them and what's the impact from Europe on margins?

Margins are being impacted by the combination of RBM activities with our historic Myriad diagnostic activities. So the margins that we see coming out of RBM are not going to be up to the same level that we've seen historically. So while our diagnostic testing continues to have the same type of margins that it's always had, we haven't seen any degradation there, we see that the COGS for RBM are really more fixed in nature and so they will be influenced by the amount of revenue that we happen to recognize in that particular quarter. And that revenue really does fluctuate, as I've mentioned, based off of the collaboration and the timing of samples that we received from our partners in processing those partners -- processing those samples. So I think you'll see as a combination of the two companies together, that the margins will be a little bit lighter than what we've seen historically, but that's not any impact to what's been going on with the molecular diagnostic side of the business.

And let me just add in, with regards to Europe, we opened our labs January 1. So obviously we didn't see any impact from the European operations on our gross profit margins this past December 31 quarter. Going forward in the future, we're using the same equipment and the same informatic processes in Europe, so at volumes, we should have similar margins in Europe as we have here in the United States.

Thank you. And just another follow-up on the other income, it bounced up a little bit. What was behind that?

That's something that's a direct result from our Crescendo deal that we announced last quarter. We're receiving a 6% interest on the $25 million loan that we provided to Crescendo. Additionally -- this gets a little complicated -- for accounting purposes, $17 million of that $25 million was classified as a note receivable, but we also needed to ascribe some value to the option that we have with that deal. Now, obviously at the end of the day, we need to get that receivable back up to the $25 million and so we accrete the value of that $8 million over the three year life of the option through interest income. So we'll recognize approximately $660,000 a quarter just of the accretion of that $8 million back in to establish that note receivable back to its full $25 million. So it's the impact of the 6% interest and the accretion of the value of the option.

Great, thank you. That's very helpful.

This concludes our second quarter earnings conference call. A replay will be available via webcast on our website for one week. Thank you all for joining us this afternoon.

Ladies and gentlemen, that does conclude your conference call for today. We do thank you for your participation and ask that you please disconnect your lines.