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Healthways, Inc. (NASDAQ:HWAY)

F4Q08 Earnings Call

October 16, 2008 5:00 pm ET

Executives

Ben R. Leedle Jr. - President, Chief Executive Officer, Director

Mary A. Chaput - Chief Financial Officer, Executive Vice President

Analysts

Tom Carroll - Stifel Nicolaus

Ryan Daniels - William Blair & Company

Newton Young - BB&T Capital Markets

Brooks O'Neil - Dougherty & Company

Josh Raskin - Barclays Capital

Gregg Genova - Deutsche Bank Securities

Constantine Davides - JMP Securities

Daryn Miller - Goldman Sachs

Unidentified Corporate Participant

At this time I would like to welcome everyone to the Healthways Fourth Quarter 2008 Earnings Conference Call. Today’s call is being recorded and will be available for replay beginning today and through October 24 by dialing 719-457-0820. The confirmation number for the replay is 770-4049. The replay may also be accessed over the next 12 months at the company’s web site which is at www.healtthways.com.

To the extent any non-GAAP financial measures are discussed in today’s call you will also find a reconciliation of that measure to the most directly comparable financial measure calculated according to GAAP in today’s news release which is posted on the company’s web site.

This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including statements among others regarding Healthways expected operating and financial performance for the three months ending November 30, 2008. For this purpose any statements made during this call that are not subject to historical facts may be deemed to be forward looking statements.

Without limiting the foregoing, the words believes, anticipates, plans, expects, and similar expressions are intended to identify forward-looking statements. You are hereby cautioned that these statements may be affected by the important factors among others set forth in Healthways filings with the Securities and Exchange Commission and in its news release issued today and consequently actual operations and results may differ materially from the results discussed in the forward-looking statements.

The company undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events, or otherwise.

At this time for opening remarks I would like to turn the conference over to the company’s President and Chief Executive Officer, Ben Leedle.

Ben Leedle

I am here with Healthways CFO Mary Chaput.

I will begin with some remarks about our fourth quarter results, our central growth initiative, the exciting addition of Steve Brueckner to our leadership team, and the process to strengthen and optimize our management structure for the future that we announced in today’s news release. Mary will then cover our numbers in greater detail and review our guidance for the current quarter. After her remarks we will be glad to take your questions.

Healthways fourth quarter results met our expectations in nearly every respect, continuing the earnings ramp and the margin expansion that we experienced in the third quarter. As a result of this performance we produced 20% revenue growth for the full fiscal year and 23% growth both our EBITDA and earnings per diluted share is consistent with the range of guidance that we established last February.

As anticipated our comparable quarter revenue growth for the fourth quarter was primarily driven by our domestic core commercial business. We added 2.8 million domestic commercial build lives during the quarter and 4.3 million for the fiscal year for a total of 31.7 million domestic commercial build lives at year-end. Despite concurrent growth in the total number of available lives to 192.5 million, these additions resulted in an increase of our overall penetration to 16.5%. The revenue produced by these lives as well as $2.2 million in fourth quarter revenue from the Medicare Health Support Pilot contributed to 38% comparable growth in domestic EPS for the quarter. With the net costs of our international business improving by $0.04 per share for the fourth quarter our total fourth quarter EPS increased 58% or $0.18 from $0.31 in the fourth quarter of 2007 to $0.49 in the fourth quarter of 2008.

I am also pleased to note that our focus on each of our three central growth initiatives produced tangible results during fiscal 2008 and we are fully confident that each represents a compelling long-term growth opportunity for Healthways and its stockholders.

Now I want to take a few minutes to review the progress we’ve made on each initiative during the past year and to discuss what we expect in the coming quarters.

The first of these initiatives is to increase our domestic commercial business. The addition of the 4.3 million new billed lives during fiscal 2008 that I just discussed represents a 16% increase over fiscal 2007. We produced this growth primarily by signing hundreds of new contracts during the fiscal year across our program continuum. The majority of these contracts were awarded for self-insured employers, primarily on behalf of existing health plan customers.

We also executed contracts with new health plans during the year, expanded our extended contracts with existing health plans, and added scores of contracts directly with employers. Included in the contracts that were extended was our 11-year relationship with Cigna, our largest health plan customer. The Cigna relationship accounted for approximately 20% of fiscal 2008 revenue and while this contract was not up for renewal until 2010, we and Cigna extended our relationship essentially under the same economic terms and conditions for an additional three years through February 2013.

As we look forward to fiscal 2009, let me remind you that we advised you on a previous call that among our contracts up for renewal in the next year, we have four significant contracts up for renewal, each of which accounted for over 2% of fiscal 2008 revenue and in aggregate accounted for approximately 12%. I am delighted today to be able to tell you that two of these contracts have already been renewed. We are, as you might imagine, working hard to renew the contracts with the other two customers and we believe we will renew them as well.

We also made you aware last February that a relatively large contract with Blue Cross Blue Shield of Minnesota, which accounted for approximately 3% of fiscal 2008 revenue, would be terminated at the end of calendar 2008 as a result of that organizations intent to provide services internally.

Let me make a couple of points about this specific situation and the general topic of health plan in sourcing of services similar to those that we provide.

First, although there is a lot of discussion in the financial community about health plans internalizing these programs, the decision by Blue Cross Blue Shield of Minnesota is our first and only experience to date in which a major health plan customer of ours has decided to try and duplicate a multi-program relationship internally.

A great strength that we bring to our partnerships with health plan is our proven ability to successfully integrate our capabilities with theirs. We have also been clear that working with health plans as aggregators of millions of lives has been a primary and highly successful strategy for both them and us. That is not to say that the scope of responsibilities between our customers and us is static or unchanging.

Over the years we have worked profitably and cooperatively with many customers to restructure our relationships to meet both their current market needs and future objectives. In most cases these restructurings have resulted in a broader scope for Healthways. In some cases the health plan has enlarged its own role. In either event it has been the cooperative efforts between us that have led to the delivery of proven solutions to the benefit of the plan and its customers.

Our confidence in our ongoing relationships with customers, including health plans, rests on our historical and continuing success in expanding the value proposition that we offer to those customers. Just as we help our customers remain relevant to employers, we have remained relevant to the health plan industry by constantly raising the performance bar with solutions of increasing power, sophistication and breadth that actually produce outcomes and do so at scale and in the final analysis outcomes, the ability to improve health and lower costs at a large enough scale to matter will determine success or failure, whether the solution set is ours or any of the other existing or new entities in this marketplace.

Employers know that without the best outcome their business performance and competitiveness will suffer. That is one reason why we continue to see strong employer interest in our state of the art capability to provide sole source, fully integrated solutions that meet the needs of every person within a given population. That is also why we believe a significant portion of the ASO business we are currently serving in Minnesota, including five of Fortunes largest 250 companies, have opted to stay with Healthways going forward.

While we continue to believe that the best solutions are collaborations with large aggregators of membership and data such as health plans, if we are left with no other choice, as was the case in Minnesota, we can be extremely successful in competing for this business either directly or with other partners.

Secondly, the demand in the industry continues to grow. I can share what we experienced on the sales front this past year. Our request for proposal pipeline increased on a year-over-year basis by 22% largely driven by self-insured employers who made up 68% of the RFD volume; however it is also important to note that health plan and employer RFPs were up 13% each on a year-over-year basis comparison.

In terms of the scope of these RFPs 17% were for disease management only which is the same as the prior year; 44% were for wellness and lifestyle coaching only, that is down from 66% in the prior year and most significantly fully integrated service offerings composed 40% of the mix, up from only 17% a year ago.

The market clearly indicates continued demand for stand-alone disease management, stand-alone wellness, while also driving fully integrated requests as it continues to grow to be the dominant request from the market.

As we think about our domestic commercial business for 2009 and beyond we continue to be confident about our long-term growth opportunities. Simply put, we believe we are the leading supplier with the most comprehensive solutions and the most documented outcomes for programs that improve health and productivity while reducing costs, costs that we all know will continue to expand at a rate significantly higher than the general rate of inflation. We firmly believe that the market need for our solutions will not diminish and we are fully committed to assuring that those solutions fully meet the value promises that we make.

Moving to our second growth initiative, to expand our adjustable markets we are very pleased with the results of our international business development during the fiscal 2008 and for the outlook for continued growth in the future. As you know we launched our first international contract in Germany for DAK in January 2008 and to date the contract is progressing as planned in every major respect and we ended the year with approximately $10 million in revenue. As we have previously discussed, we would expect to begin to see formal confirmation of these indications by mid-year 2009, which in turn will begin to give us a reasonable basis for expectations regarding contract expansion.

In addition during fiscal 2008 we signed an innovative contract with Fleury in Brazil and launched it on schedule in June. As expected our entry into this market has not been capital intensive and with no risk fixed fees the contract has already become profitable.

Our progress on the international front in fiscal 2008 as well as our ongoing discussions around the world validate that the most urgent healthcare issues we address domestically are also common in other countries. As a result we believe we have strong prospects to expand our international business in 2009 and in the years beyond.

Our third central growth initiative is to continue increasing the value proposition we provide our customers. Less than a year ago we introduced our next generation concept for integrated whole health solutions that would move beyond direct medical cost savings to also address the much greater costs of lost productivity related to health and well-being. We have continued to make significant progress during fiscal 2008 as evidenced by the introduction of the Gallup-Healthways Well-Being Index, which is already changing the way communities, health plans and employers measure and benchmark individual health.

The potential for integrative whole health solutions that both reduce medical costs and improve employee productivity has resonated strongly in our discussions with many health plans and employers. By expanding our value proposition through whole heath we will again raise the industries performance bar and our continuous pursuit not only of results, but more importantly of results that matter. We expect to take another tangible step towards this goal during 2009 with the signing of our first whole health contract that will include measures of productivity impact as part of the outcomes promise and will pay for those results as well as the traditional results of improved health and reduced direct health care costs.

Based on my regular interactions with customers and prospects, both health plans and employers, there is no question in my mind that the expansion of our solutions set to effectively address the entire population, the healthy, the at risk, and those already suffering from chronic disease, the expansion of our value propositions include both direct health care costs and health related productivity cost savings and the ability to deliver solutions in a comprehensive, integrated and disease agnostic manner are the must haves for future success. This is a market perspective we have long predicted and diligently worked to be ready to meet.

To optimize our ability to manage the company in a fully integrated environment we have announced today a process to simplify our management structure. We have initiated this process to close the gap between our current management structure, which has been developed to manage the broad continuum of individual programs that have contributed so much to our historic growth with the integrated structure that we expect will enable us most effectively to manage the opportunities and challenges of a fully integrated environment.

This realignment will be a top down process that will examine every management layer in our company and which we anticipate will result in a company wide reduction and the number of layers between me and our nurses and health coaches directly interacting with our participants. As a result we expect to improve the quality, timeliness, and efficiency of our decision making, the effectiveness with which we communicate these decisions across the company, and most importantly our responsiveness to the rapidly changing needs of the market and of our customers.

This process should be largely complete by the end of calendar 2008 and we will announce additional information about the results of the process and its financial impact in conjunction with our regular financial reporting. Because we are just at the start of this process, it is too early to give you any specifics in terms of cost or related anticipated savings.

While we expect that a small amount of the cost attributable to this effort will be incurred in the current quarter, we expect a significant amount of the costs related to this process, such as severance and any other related restructuring charges, to be recorded in December as the process moves towards completion.

As you know from the news release today, I am pleased to announce the hiring of Steve Brueckner as president and COO. After an extensive national search for the right person, I proposed this change, which was enthusiastically approved by our board, in order to assure the requisite levels of executive focus on both our day-to-day operations and also on the strategic initiatives that are essential to our future growth.

By having a proven executive of Steve’s caliber focus undivided attention on the disciplined execution of the day-to-day management of our business, I will be able to be engaged more fully in driving Healthways growth globally through our three central initiatives.

At the end of this process we believe Healthways will be better suited than ever to deliver on the significant growth opportunities that reflect the still increasing market demand for solutions that make a difference. We are committed to maintaining the company’s industry leading position as we meet that market demand.

Thanks for you time this afternoon and stay tuned. I will now ask Mary to review the financials before we open this up for questions.

Mary Chaput

Fiscal 2008 wraps up another busy year for Healthways. Revenues were up $120 million to approximately $736 million from $616 million in fiscal 2007 and squarely in our guidance range of $720 to $740 million. As expected, both fourth quarter gross margins and EBITDA improved significantly as we move beyond both the impact of the new call centers in the first half of the year and the move to our new headquarters in the third quarter.

In addition to the previously discussed savings associated with the work undertaken in the third quarter, consolidating capacity and recognizing synergies from the Axia integration. In fact, total company EBITDA in fiscal 2008 increased 23% on a 20% increase in revenues over 2007 levels to $161 million or 21.9% of revenue.

As expected and reflected in our guidance provided in February, year-over-year GAAP EPS growth was 23%. The contribution to EPS for the fourth quarter from our domestic business was $0.51 compared to $0.37 in the fourth quarter of 2007. For the fiscal year our domestic business delivered $1.61 in earnings per diluted share, which compares to $1.34 in 2007. The net cost impact in the fourth quarter of 2008 from our international business was $0.02 and in the fiscal year $0.11 which included the costs associated with the start up of our Fleury contract in Brazil.

In fiscal 2008 we generated approximately $105 million in operating cash flow and completed our $100 million stock repurchase plan. We borrowed an additional $85.4 million in connection with the $94.3 million of shares that we repurchased in the fiscal year. We also repaid $38 million on our debt, the balance of which, on 8/31/08 was approximately $348 million. Our debt to EBITDA ratio at the end of the fiscal year was 2.2 and our total debt to capitalization was 49.6%.

Capital expenditures for the fiscal year totaled $82.5 million, approximately $40 million of which related to the new headquarters and the new call center. Approximately $18 million was spent on software development and another $10 to $15 million on data center consolidation, technology licenses and upgrades.

Our fourth quarter accounts receivable balance was down sequentially by about $8 million, but up year-over-year by about $33 million due to higher revenues and the timing of current, albeit slightly late payments from a handful of large customers. We have since received a majority of those payments and have also repaid approximately $26 million of debt since the end of the fiscal year. We ended the fiscal year with approximately $35 million in cash.

Our back log, which represents the estimated annualized revenues of business awarded but not yet started totaled $13.6 million on August 31, most of which is scheduled for a 01/01/09 start. This backlog number does not reflect business awarded since the end of the fiscal year. We are obviously still in the selling season and there continues to be ongoing discussion both through the RSV process and with current customers for potentially more business and our new fiscal, now that is calendar 2009.

We affirmed today our existing guidance for earnings per diluted share for the three months ended November 30, 2008 in a range of $0.34 to $0.37 which represents a 13 to 27% increase over comparable quarters in fiscal 2008.

In addition to the streamlining of management layers that we announced today there are a number of other factors affecting these upcoming quarterly earnings that were discussed in our press release on August 25. Those factors include the historical costs associated with preparation for new January 1 contract starts.

In addition to the hiring and training of skilled personnel and the development of data exchange processes and analysis with new customers, these start-up costs include significant participant directed marketing expenses associated with our silver sneakers contracts which we are expanding significantly this year to accommodate new regions and new participating locations yet to be announced.

Other factors include previously announced and discussed lower revenues associated with the restructuring of certain contracts, the wind down of the Blue Cross Blue Shield Minnesota contract and a full quarter impact of the terminations of some small contracts due to financial insolvency or consolidation, all of which we discussed at our second quarter 2008 earnings call last February. This decline in revenue represents just under 50% of the sequential EPS decrease.

Finally there is the smaller impact of merit increases historically awarded in the first fiscal quarter and the cost of the change in our fiscal year. As a result of those dynamics we anticipate that the contribution to EPS from our domestic business in our first fiscal quarter will be in the range of $0.36 to $0.38. The ongoing activities of the international business development team somewhat offset by the continuing revenue generated from our German and Brazilian contracts are expected to be dilutive in the range of 40.01 to $0.02. This does not include the impact of any new international contract signings. There are no ongoing costs associated with the Medical Health Support pilot.

We anticipate our balance sheet and cash flow to remain strong. Although we don’t anticipate a significant net cost impact in side of the current quarter period from this process to remove management layers, because of the way the process works it has been mentioned we aren’t able to size it exactly; however we believe that the primary cost impact will occur inside our December results. In order to provide as complete an update as possible on the cost and potential savings in the reduction of management layers by the next time we speak to you, we will be moving our earnings release for the three months ending November 30, 2008 into the first week of January instead of the previously expected mid-December.

We will, as previously announced, report our results for the full stop period September through December and our 2009 calendar year guidance in February 2009.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Tom Carroll of Stifel Nicolaus.

Tom Carroll - Stifel Nicolaus

On the two of the four large health plan renewals that you mentioned can you provide us some sense of how the terms changed? For example was price cut in half or additional services added for a low price, I mean what concessions were made in renewing these customers?

Secondly, I am wondering if shareholders will see any insider buying this coming week when the window opens up because the story certainly seems good and the stock is relatively cheap to where it has been in the past.

Mary Chaput

With out giving a lot of detail about any of our contracts, what we can tell you is that we think that the strategically important thing to do is retain customers. We know our customers are under certain pressures as they look forward into 2009 and we have been successful in the past and I think have shown success this year in negotiating contracts that are win win. I think that that is in the best interest of the company. We are a service contract organization and we have proved flexible in maintaining appropriate levels of margins in these renewal discussions.

Ben Leedle

I would just add onto that, the levers inside of those renewals and conversations are pretty much the same. We have been in the contract service industry for 26 years now. It is our core business and we are experienced at this. It is always a function of turnkey and scope of service or programs that are there and the mix of that, as Mary said, is really an aim to create meeting the needs of our clients as well as making those arrangements successful for Healthways and valuable to shareholders: related to the insider buying, when the window opens up we expect that to be an attractive opportunity.

Tom Carroll - Stifel Nicolaus

So is it fair to say your cautious tone about 2009 renewals that we have been hearing about through the summer still holds true?

Ben Leedle

Absolutely, all you have to do is continue to look at communication from companies across all different industries. I know for certain, I have been with this company for 23 years and I have not seen the kind of macro environment that we are operating in at the speed with which it is moving. I think anyone that is feeling a sense of certainty about what all is going to happen in the next 12 to 18 months might have a different crystal ball than we do.

We have been cautious in our statements and I think we will continue to be cautious in those statements, but at the same time we are not sitting back and blaming a macro environment for where this company is. You can see in today’s press release that we are taking very definitive steps, such as brining on additional talent, making the effort to streamline the organization from a management standpoint to make certain that we are in a position to migrate all of our customers onto our next generation technology platform. We are going to continue forward moving aggressively, managing this company for the long-term and we will deal with the challenges that are in front of us.

Operator

Your next question comes from Ryan Daniels with William Blair & Company.

Ryan Daniels - William Blair & Company

I have a quick follow-up on the contract re-signings. It sounds like there are now only two outstanding and I am hoping you could perhaps give us the percentage of revenue that those two represent?

Mary Chaput

The last two represent approximately 6% of that 12% year-to-date revenues for 2008.

Ryan Daniels - William Blair & Company

If we look at those two remaining are those start dates or will those contracts expire in January or are those things that while they are 6% of revenue for ’08 might be something that doesn’t have to renew until midway through the year etc…I am just trying to get visibility on that.

Mary Chaput

That’s right. It varies through out the year and some are toward the end of the year.

Ben Leedle

I would add also Ryan, remember when we talked about that we said we got lots of contracts and so those four we highlighted because of the materiality that they represented, each was at least 2% or more of fiscal 2008 revenues. In this mix also is a lot of work to do as it relates to a much broader set of contracts up for renewal that are beneath that 2% threshold. We are making good progress but we have a lot ahead of us to still get done.

Ryan Daniels - William Blair & Company

Could you comment perhaps, given that that’s the case, on what the cumulative impact on sales is for the remaining contract? So we know we have 6% in the two big ones and then if you look at the cornucopia of smaller ones what it would be?

Mary Chaput

We talked about not doing that only because there are a number of employer contracts that auto renew and we don’t want to misrepresent that percentage.

Ryan Daniels - William Blair & Company

If we think of the cash flow use, could you talk a little bit about the thoughts internally about debt pay down versus share repurchases at this price? It sounds like you use the bulk of cash already to start paying down some of that debt, so just any thoughts on that.

Mary Chaput

Our current credit facility has limited us to that $100 million that we have already executed on. We generally think that this is not a good time to open up our credit facility and ask favors of our bank.

Ryan Daniels - William Blair & Company

Gotcha, that’s fair. Then any way you can share with us, I know you have done this in previous quarters, the backlog today? I know you gave us the $14 million or so at the end of August. There have probably been a lot of sales, I would assume, over the last two months. Is there any way you can give us an update on that or maybe a kind of more recent update on the selling season?

Ben Leedle

Interesting you ask Ryan. I know we have talked about it and several other analysts as well have looked at backlog and have run every possible calculation of that metric to actual revenues that materialized and I know you are one of them and that it is become a metric that is more difficult because of the amount of employer business that flows through on a quarterly basis rather than when that metric was historically established we were pretty much purely putting into that backlog a large fully insured health plan contract. The utility of that metric we have continued in order to remain consistent; we will probably finish the remainder of this calendar year with that metric and then likely not to be reporting in that.

As you know we work really hard to educate shareholders and people about our company, so it is not a response to be less transparent, it is just we are going to have to look for some kind of metric that more clearly represents meaningfully what kind of sales we have had and what kind of revenue comes out of that.

Ryan Daniels - William Blair & Company

Looking at the sales pipeline you mentioned it was up 22% year-over-year in regards to RFPs. Is that just pure number or is that associated revenue on an annualized basis?

Ben Leedle

It is pure number. We have not sized that revenue wise.

Mary Chaput

There is a reason for that and that is because RFPs often are everything under the sun, so they would be huge in dollars and what actually gets bought is frequently something smaller in scope. One of the things is we don’t want to mislead people on what is really expected to be purchased in the upcoming year.

Ben Leedle

I think the other thing, I didn’t mention it in my prepared remarks, but we have done a lot of work as you would expect in trying to understand what are really the near term dynamics and how did this season shape up as compared to prior seasons and we do know that there was a 27% increase in the number of RFPs where no decision was made. That is a significant increase. I think that has a lot to do with the macro environment and we have got probably about a 75% increase in the number of RFPs still pending for disposition as we complete this cycle.

I talked this summer about the fact that we were seeing decisions being pushed out, cycles taking a little bit longer and some re-scoping of what originally were some pretty large modeled requests and I think it has lot to do with where companies are finding themselves this fall as they were finishing their decision making process.

Operator

Your next question comes from Newton Young with BB&T Capital Markets.

Newton Young - BB&T Capital Markets

One aspect that I wanted to ask you about was Minnesota and clearly you are going after the population there in a slightly different manner now. The handful of contracts that you talked about earlier in your prepared remarks, can you give us some idea of that impact that comes from that or just on a percentage basis from what you lost prior to?

Ben Leedle

You have to remember there were two parts to the Minnesota contract, so there was the fully insured book of business and then there was the business that we built over the last five years over time selling with them into the self-insured market place. We are really excited in that to date and our work is still not done, that we are just north of about 1/3 of the effort that we had in place.

For us, we are exceeding the expectations given the fact that we really didn’t get news about Minnesota’s decision until after the real intense part of the sales season began last January and on fairly short notice organized ourselves well to be able to compete effectively in that marketplace.

Newton Young - BB&T Capital Markets

That is obviously a good work in a short amount of time and we will be looking for a little bit more going forward if possible.

I was also just wondering about kind of your relationship with your customers over the past 12 months. Can you just talk a little bit more about how things have been going there on that front? Obviously their demands are changing on you and you are trying to kind of morph with those demands. Just in terms of generally speaking do you think the relationship has moved more to the positive or maybe gotten slightly away weaker over the past 12 months?

Ben Leedle

I think over the last 12 months it has kind of cycled through some different kinds of toner tenor. I think obviously with the news of Blue Cross Blue Shield Minnesota many of our health plans kind of paused to kind of try to get a better understanding of what was really happening there. I think as the summer has gone on and we have been successful, as I pointed out, in being able to help those health plans secure more business with their ASO accounts that I would say that the momentum is actually in a positive light with our health plan customers.

Operator

Your next question comes from Brooks O'Neil with Dougherty & Company.

Brooks O'Neil - Dougherty & Company

First I would ask you that in light of the change in your fiscal year to reflect, what I believe is the changing perception of the purchasing pattern of customers, would you guess that the delay in signing new business related to the economy is going to result in customers delaying a purchase decision until the new calendar year, specifically 2010 or do you think you might be successful, as you have in the past, to sign some business through out the calendar year as you move forward?

Ben Leedle

We talked about the change in fiscal year aligning both the seasonality and the business cycles of our client and I think that we will continue to see the bulk of decisions being made on a 01/01 calendar basis, but I also know and fully expect, just as we did this year, that we will continue to sign business through out the year.

I think to the earlier part of your question, I would just tell you there seems to be a higher degree of decisions to at least hold for now or people taking longer to get to the final disposition. I can’t believe anything other than the debt would actually reduce the number of remaining decisions that would be effective for 01/01.

We are getting close to that time where if you want to implement in a first class way and make certain that it is the right kind of implementation those decisions have to be coming to conclusion here in the near term to afford the implementation; so whether those become opportunities through out the year or whether people just hold and say 2009 looks tough I am going to be back or I am going to do a whole lot less and wait until later 2010, we don’t know yet. We are waiting to see how a lot of the open items get disposition as well.

Brooks O'Neil - Dougherty & Company

I know you are not ready to provide guidance for 2009, but I am trying to weigh the backlog, which we know is not useful, with a very challenging economic backdrop. Are you guessing that 2009 is going to be a year where there will be some revenue growth or do you think it is more of a flat year or do you have any commentary or color you can offer us at this time?

Mary Chaput

Yes I think it is premature for that. I know that’s the thing that we’re all focused on and I guess the best way to put it is we are obviously not immune from the pressures of the current economic slow down, but we think that our products are ideally positioned to help our customers by controlling costs and enhancing productivity. We think we have got a strong sales pitch on that and we just have to see how it plays out over the last couple of months here in the calendar year.

Brooks O'Neil - Dougherty & Company

Do you have any update on Medco? I mean are you seeing any traction either with them as a partner or with customers buying integrated solutions that link the two of you?

Ben Leedle

Yes I will just color comment that we had a significant increase in the number of contracts that we and Medco signed during the sales season.

Brooks O'Neil - Dougherty & Company

That’s great. Second, you mentioned $2 million of revenue related to MHS being at the end of the contract. I am guessing you assessed that you actually did perform sufficient to keep the $5, $6, $7 million of revenue that you’ve recognized through the end of the contract, is that right?

Mary Chaput

That’s right. Actually we are seeing some gross savings in both the stand-alone and in the refresh. Right now we’ve got cranes [ph] run out, we’ve got I think at least three more ark reports to go. GMS is not going to let us talk about the details associated with what we’re seeing at this point, but I would like to remind everyone the intellectual property that we have developed in this particular program has been leveraged both in Germany and in our new Medicare Advantage Care Support product.

Ben Leedle

We didn’t get it into our earnings release today, but that new product for the seniors’ population we think has a huge opportunity to be leveraged against about a 50% of the Medicare Advantage market where we already have a relationship for Silver Sneakers. Today we signed a large Blues plan to that new product for a significant Medicare Advantage population that they manage and you will be hearing more about that soon.

Brooks O'Neil - Dougherty & Company

I noticed $75.5 million in the BIE category. Can you tell us how much of that is related to MHS and how much of it you expect to be able to retain?

Mary Chaput

We don’t like retaining the BIE, we like to recognize it as revenue, but yes. So MHS is $58 million of that and I think it is a little early to say. We are going to need to clean through a lot and in the agreement there is a whole process about how long it will take and who does what and we’re thinking it will probably be mid calendar year ’09 before it comes to any kind of resolution and our relative positions on that.

Brooks O'Neil - Dougherty & Company

I was talking to a significant shareholder yesterday, who you can imagine is not a happy camper right now. This person suggested that the enormous value destruction at your company in the last year. So I am curious, as you assess the environment what are the things you believe you need to get done to recreate some or all of that value and when do you think you can get those things done?

Ben Leedle

I would just start off by reminding, Brooks, what we reported today for the year was 20% top line and 23% EPS growth. So we think we are continuing to create value in the marketplace. I think we also outlined in today’s press release some pretty definitive aims around our three central growth initiatives.

We talked about the work that we’re doing in advancing a streamlined management to prepare us for really a tough environment and to also position us again, really a deep inflection point that’s taking place in the market going from individual programs to integrated solutions and to broaden our value proposition, so I think the plan is fairly straightforward.

We are focused on disciplined execution on the current promises that we have made and are held accountable to by our health plan customers and to prepare as the value proposition opportunities continue to expand and to be prepared to go into the next sales season that’s coming up here soon for 01/01/10 sales and a very very strong position in the marketplace.

Brooks O'Neil - Dougherty & Company

You think if during the year you execute on these plans you can generate the kind of sales growth and earnings growth that will return your stock somewhere near its historic lofty position?

Ben Leedle

You know, I am not in charge of the stock price, I am in charge of leading a company to product value in the marketplace, and to have that be value that is persistent and sustained. That’s our aim, that’s going to be our continued push and I would love to say that I am ready to give you 2009 guidance but we indicated that we are not. We will get that out as soon as we are in a position to clearly represent that to you.

Operator

Your next question comes from Josh Raskin with Barclays Capital.

Josh Raskin - Barclays Capital

What was sort of the catalyst of the management realignment, what exactly was sort of the change in the business, I think the movement towards integration has been sort of well under way. What precipitated that change?

Secondly, it sounded like there was going to be some costs in December, but should we think about this in ’09 as a cost savings initiative?

Ben Leedle

To the last part of your question, absolutely. To the first part I think it’s, there is key data that I provided that was hopefully meaningful to you in terms of getting a sense of what it is that people are asking us to do.

A management structure that is really supporting 30 to 35 individual products put out into the marketplace and then coordinated together as people extend their relationship with us over time requires a different sales approach and a different management approach to service those kinds of relationship, as we have done more and more. You know our history is to expand those relationships with our clients; we are seeing a shift now to looking for the streamlining of those arrangements and to fully integrated models.

The impetus for this was trying to service that integrated model with a management structure that was aimed at those individual product and service placement is more cumbersome and less efficient than what it needs to be. As we looked at our work going forward it was how do we get alignment around increasing the responsiveness, the speed and the decision making in the organization to be able to bring forth the model that our customers are asking us to interact and engage them in.

Josh Raskin - Barclays Capital

As we think about 2009, maybe just broadly speaking as sort of easy as it is to line up, what are the big pluses and minuses? I mean it sounds like pluses are contracts. The big contracts have been renewed, at least two of the four have been renewed, but conversely you’ve got the Minnesota disappearing. I’m just curious how do you sort of line that all up for 2009?

Mary Chaput

You want us to answer that without giving guidance right?

Ben Leedle

I think you’re onto the pieces. There is our run rate business and how strong is our hold and retention of that. I think it’s largely been represented that the bulk of both the risk and the opportunity is in completing those renewals. We also indicated there are other renewals of smaller size that if we’re not consistent in renewing those they can add up as well.

There is, I think, more pressure on and complexity to the retention side of this equation than ever before and the broader environment certainly isn’t helping that equation. Obviously we fully expect to continue to sell more business across all of our services, all of our lines of business, across al of our different and with our distribution partners.

We will continue to expect new business to grow for us. The question then becomes what is the net and the offset between the retention part of the equation and the growth part of the equation. I think also you can’t under estimate that I think our NCO clients are challenged with their own set of retention with an employer base that often times we’ve penetrated pretty deeply with them and so if a health plan loses employer customers where we’re doing business, obviously that’s churn and we might pick it back up in another channel or with a different health plan client, but that’s always at least a momentary partial year loss of momentum in that regard. So, we’ve got some insight into some of that activity.

Then obviously we are more than just domestic and I think that there is a great opportunity to continue to grow and expand our presence internationally and I guess for those following the political scene, we know we’re getting an administration change, we just don’t know for sure who. We think the kinds of services that we deliver are important for either campaign, but it’s still a change. The opportunities and the impact from decisions there are still not clear and we will have to see how that plays out.

Josh Raskin - Barclays Capital

You guys have been at this for a long time, so I’m just curious from the economic pressures. I know it sort of sounds like everyone has to say we’re nervous about the economy; but if you look back seven, eight years ago when we had the last downturn and understanding that unemployment levels were not that high, what were some of the impacts on our business? I mean I don’t remember it well, but I don’t remember business sort of falling off a cliff.

Ben Leedle

Well one, we were probably a single product company doing diabetes disease management and just beginning to get traction in the marketplace and we were helping the fully inured side of health plans business specifically in their HMO physician primary gatekeeper models deal with medical RS ratio challenges: a much narrower niche.

To even think how far this company has come in terms of who we are today, what we do, the sophistication and complexity of our business and to try to make a comparison, I just don’t know how to do that for you.

Mary Chaput

In 2001 we were just finishing a year of $75 million in revenue. Probably over half of that was coming from the hospital business. We probably had three health plan customers and I would have to look back, but I think we still have those three today. I have to agree with Ben, it was not a [interposing].

Gregg Genova - Deutsche Bank Securities

We have never operated this business in this kind of environment.

Operator

Your next question comes from Gregg Genova with Deutsche Bank.

Gregg Genova - Deutsche Bank Securities

If you could talk about the percentage of your Silver Sneakers business that is in private fee for service versus network products and now the effect of the elimination of deeming in that product in 2011 affects you guys, if at all.

Ben Leedle

It’s a small amount. The majority of our business is in the traditional Medicare Advantage plan.

Gregg Genova - Deutsche Bank Securities

In past quarters you have gone into some detail about customer consolidation and which acquisitions have caused you to lose membership versus those that presented an opportunity to pick up some new memberships. Can you get into any more detail on those acquisitions that you mentioned going into 2009? Are there any updates on that?

Mary Chaput

You are talking about lost contracts due to consolidation?

Gregg Genova - Deutsche Bank Securities

Yes or opportunities like Cigna for example or opportunities to pick up new contracts for 01/01/09 or?

Mary Chaput

Right, right and of course we went through quite a bit of detail in our second quarter earnings call on some specifics on that. We have, I think there has probably been one more small health plan that has been recently acquired by a larger health plan. Let’s see if there are any others here.

Ben Leedle

It’s been acquired by a larger health plan that we do business with. So there have been a couple of those, as you know, and I think people continue to ask us about Cigna and Great West and will we be doing that business and I really don’t have anything to update you on at this point on that.

The contract Mary is referring to was a Medicare Advantage plan that was a smaller regional plan that was picked up by a big national Medicare Advantage player.

Operator

Your next question comes from Constantine Davides with JMP Securities.

Constantine Davides - JMP Securities

I just have a follow up on the renewals you have completed and the ongoing discussions with some of your existing customers. Is there anything structurally significant about some of these new contracts? That is to say are you seeing an increased appetite for opt in pricing or perhaps an increased level of maybe merit based revenue recognition or things along those lines?

Ben Leedle

I don’t know if the last part of your question was, are we taking more risk in the renewals or not on our fees and I would tell you the answer to that is no.

Mary Chaput

Year-to-date it is still at 4% revenues recorded that haven’t been reconciled with the customers.

Ben Leedle

To your other point we are seeing some customers both new opportunities as well as renewals looking at paying specifically in a model that would be based either on an opt in or a per participant basis and so there are ways for us to be able to accommodate that in the text of things.

I think the big risk is as you start thinking about either more transparent payment schemes and structures for those business relationships tied to the activity and the actual interactions that we are having with members, the higher the risk for the buyer later to forget that while process is important and it has to be there and make the high plausibility as a test to being linked to outcome, it is the outcome that is a basis on which we still are pricing our business.

Constantine Davides - JMP Securities

Would either of those two renewals you signed actually implement that type of structure?

Ben Leedle

One of them certainly implemented something in that nature. Not exactly that but along those lines.

Constantine Davides - JMP Securities

Mary on the guidance for the next quarter, you have done a good job of laying out some of the top line events. Would you feel comfortable giving us sort of a revenue range for the November quarter at this point given that we’re halfway through it?

Mary Chaput

I think I have given some sort of a clue, which I will work to calculate, which I mentioned that about half of the decline in EPS is related to the revenue decline and I think if you work backwards on a reasonable side on what semi-variable costs might be associated with revenue you will come to a number.

Operator

Your last question comes from Daryn Miller with Goldman Sachs.

Daryn Miller - Goldman Sachs

Mary, I have a question for you on the first quarter guidance. I was wondering if you could size the three drivers of the lower revenue in terms of how much each of those are contributing to lower revenue?

Mary Chaput

I haven’t done that. I will tell you that the EBITDA percent in the first quarter is pretty consistent with the total year of ’08.

Daryn Miller - Goldman Sachs

But if we were to look at contract renegotiations, the winding down of terminating contract, what are the sizes of each of those?

Mary Chaput

Again, in the second quarter earnings call I got very specific and I could probably tell you some of that, which is, so this would be a year-over-year and at that time it was a fiscal year-over-year. We talked about a $9 million reduction in the second half compared to the first half, so you can imagine that that will continue and then again working from some of the other details I have given you.

I am not trying to be a lot of mysterious here, but some of the contracts can be identified and I think probably have been identified by somebody else and again we are not going to get into pricing or specific contract details. That is why I am trying to stay somewhat vague about this.

Daryn Miller - Goldman Sachs

On the first quarter guidance, on the higher cost side, can you spike out implementation costs versus other costs?

Mary Chaput

Again, I said half of the EPS decline was coming from revenue, so you can imagine the other [interposing] of the costs and we talked about merit increases and they are relatively small and the impact of the fiscal year change is pretty small in that quarter as well, so you can imagine that the costs represent that slightly greater than 50% in that EPS stock.

Daryn Miller - Goldman Sachs

Okay and the MHS EPs impact in the fourth quarter?

Mary Chaput

I think I mentioned this also on the call. We came in about where we expected to, $0.21, $0.22 dilutive for the year. Why we haven’t broken it out this quarter is because costs have started to shift back into the domestic side. We had the colleague bonus associated with that $5.2 million in revenue that we said was domestic wide.

Daryn Miller - Goldman Sachs

What do you mean by that, that costs started to shift back to the domestic side?

Mary Chaput

Well you know the pilot wound down at the end of July, so in August there were some severance costs associated with the [inaudible] let go and there were costs associated with the management team that then moved over to the commercial. We applied them to new business and so it gets a little convoluted is all.

Probably the biggest piece of that is again, the colleague bonus which was, the revenue came in on the MHS side, but the bonus is spread across the whole domestic colleague base; the non-officer, I like to point out.

Daryn Miller - Goldman Sachs

Your LIBOR exposure is that all swapped out or do you still have some?

Mary Chaput

Well we have a policy that keeps us in 60 to 70% is fixed and so we have a slight exposure. We also have hedge our foreign exchange and we are doing very, very well on those fronts.

Operator

There are no further questions.

Ben Leedle

We just want to say thanks for your questions today and for your continued interest in Healthways. I think that there were still some people in the queue that we didn’t get to for questions. I want to apologize for that, but Mary and I are here for the duration of the evening and we will be happy to take your calls and spend time with you. Again, if any of you have further questions give us a call and have a good night.

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Source: Healthways, Inc. F4Q08 (Qtr End 08/31/08) Earnings Call Transcript
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