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Healthways, Inc. (NASDAQ:HWAY)

2008 Guidance Call

February 5, 2009 5:00 pm ET

Executives

Ben R. Leedle Jr. - Chief Executive Officer

Mary A. Chaput - Chief Financial Officer

Analysts

Joshua Raskin - Barclays Capital

Thomas Carroll - Stifel Nicolaus & Company.

Gregg Genova – Deutsche Bank

Kristina Blaschek - William Blair & Company

Brooks O'Neil - Dougherty & Company

Newton Juhng - BB&T Capital Markets

Unidentified Analyst – Goldman Sachs

Operator

Good afternoon, and welcome to the Healthways Conference Call to discuss today’s earnings news release about the company’s 20009 financial guidance. Today's call is being recorded and will be available for replay beginning today and through February 13th by dialing 719-457-0820. The confirmation number for the replay is 4709943. The replay may be accessed for the next 12 months at the company's website which is www.healthways.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 website.

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 2009. For this purpose, any statements made during this call that are not statements of 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 Chief Executive Officer, Mr. Ben Leedle.

Ben R. Leedle Jr.

I appreciate everybody being with us today to discuss our guidance for 2009 as well as our results for both the last month and the last months of calendar 2008. As usual this afternoon with Healthways' CFO, Mary Chaput, and today I’m going to focus my comments on the state of the market, states of Healthways, and what we see for 2009 and beyond, but first I’m going to ask Mary to begin our discussion this afternoon by reviewing in more detail our guidance for 2009 as well as the financial results for the end of calendar 2008. After she is done, I’ll make my remarks, and after that, we will be glad to take your questions.

Mary A. Chaput

As reported in our release today, we have provided total company revenue guidance for calendar year 2009 in the range of $652 to $680 million. With domestic operations expected to contribute $635 to $660 million and international operations expected to contribute $17 to $20 million. In the last comparable period last year, that is calendar 2008, domestic operations produced revenues of approximately $731 million of which approximately $721 million came from our domestic commercial business and approximately $10 million related to the recognition of performance-based revenues from the Medicare health support pilot. There is no revenue in our 2009 guidance for the Medicare health support pilot.

So the range of revenues in our guidance related to our domestic commercial operations of $635 to $660 million represents a decrease of 8% to 12% from 2008 calendar year. We just discussed frequently the factors contributing to this revenue decline, including restructured or terminated contracts on our runrate revenues, the potential churn in our health plans of their employer customers, and the potential impact of unemployment attrition on the membership of both our health plans and employer customers. The revenue guidance for our domestic business includes assumptions about that churn and attrition and the low end of our revenue guidance assumes only signed business. Let me repeat that. The low end of our revenue guidance assumes only signed business.

The international revenue guidance includes a full year of revenues from our Fleury contract in Brazil which started in June 2008 as well as seven months of the Hospital Contributions Fund of Australia or HCF which goes live on May 1, 2009. It’s important to note that the HCF revenues are based on participation, and so are expected to ramp up over time. Offsetting these revenue increases is an assumption of less favorable exchange rates than in 2008. Although early indications regarding the impact of our programs in Germany are positive, we have not included in our guidance any gain share revenues from DAK. The reconciliation of that performance is scheduled for later in this calendar year.

Regarding earnings per diluted share, 2008 calendar year EPS was $1.10. I’d like to spend some time talking about expected margins in 2009. For comparison, I will use our old fiscal 2008. This comparison will be more helpful because it avoids the complexity associated with adjusting for the impact of the charges incurred in the stub period.

When comparing our 2009 guidance to our old fiscal 2008 results, I think you can see that margins are expected to decline. Despite a concerted cost takeout effort, we expect that cost of services as a percent of revenue will increase in a range of approximately 250 to 300 basis points from the 68.4% reported in fiscal 2008. We expect SG&A costs as a percent of revenue to remain relatively consistent at approximately 10% of revenue in calendar 2009. The primary reason for the comparable decline in margins are a change in product mix and the difficulty to reducing costs at the same rate or in the same period as expected decline in run rate revenues.

In addition, we plan to continue to invest in our future capabilities, continuing to position the company for the long term worldwide demand generated by increasing disease prevalence and lack of healthy behaviors that we believe will only be accelerated by the current economic conditions.

We would expect to incur costs associated with the following initiatives: Implementation costs associated with the growth of the Silver Sneakers network including the 6000 new participating Curve locations; the development, implementation, and migration of customers to are new integrated data and technology platform which is designed to take full advantage of our advanced analytics capabilities and full suite of solutions, advancing the impact of behavior change while increasing operational efficiency; completion of our Whole Health Solution aimed at creating value through improvements in health, productivity and related costs in securing our first contract; and the establishment of the Gallop Healthways Well-Being Index as a scientifically rigorous industry standard for measuring the physical, social, and emotional health for individuals and for the communities and employers in which they live and work.

Additionally, depreciation expense is expected to increase in the range of $5 to $10 million in calendar 2009 over fiscal 2008 as a result of the full year impact from capital expenditures in 2008 and the depreciation expense associated with the approximately $35 million of planned capital expenditures in fiscal 2009. Interest expense is expected to be lower as we intend to apply free cash flow aggressively toward debt reduction. Tax rates are expected to be in the range of 40% to 41%, and we expect cash flow from operations to be in the rage of $90 to $110 million.

Regarding our first quarter EPS guidance, as reported today in our release, first quarter EPS is expected to be range of $0.24 to $0.28 per diluted share. Domestic operations are expected to contribute in the $0.27 to $0.30 per diluted share, which is $0.08 to $0.11 lower than the $0.38 reported for the quarter ended November 30, 2008, primarily due to the termination of Blue Cross Blue Shield Minnesota contract, the loss by some of our health plan customers of their ASO employer accounts, expected attrition due to employer layoff, and the absence of any revenue from the Medicare health support pilot, all of which are somewhat offset by new contract starts. The net cost impact of international operations is expected to be in the range of $0.02 to $0.03 as progresses toward the start date of the HCF contract in Australia.

Now a bit about December results. Having previously discussed our actual results for the quarter ending November 30, 2008, on our last conference call a month ago, I will provide a little more color today on the month of December wrapping up the 4-month stub period associated with the previously announced change in our fiscal year to a calendar year.

December revenues totaled $59.3 million, of which domestic operations contributed $58.1 million and international operations delivered $1.2 million. The net loss per diluted share in December totaled $0.35, which included the impacted of the previously discussed charges in the month of $25.5 million, or $0.45 per diluted share, of which $15.6 million were non-cash charges.

The recording of the $25.5 million charged in the month of December was as follows: A total of $11.5 million related to the tender offer of which approximately $7.4 million was charged to cost of services with approximately $4.5 million charged to SG&A, $4.3 million related to the write-off of a trade name was charged to a line item on the income statement labeled impairment loss, and $9.7 million was charged to a line item on the income statement labeled restructuring and related charged, which included primarily severance net of equity forfeitures and costs related to capacity consolidation. Excluding these costs, domestic operations contributed $0.11 per diluted share and international operations broke even in the month of December.

Cash flow from operations in the 4-month stub period ending December 31, 2008, totaled $22 million despite an increase in deferred income taxes related to timing differences from routine items and those related to the restructuring activities in the month of December. Over the past several quarter, we have implemented an aggressive daily cash management program designed to minimize idle cash and thereby maximize paydown of our revolving debt in order to take advantage of the interest rate spreads given the nominal investment returns available today.

Accordingly, in the stub period, we paid down $42 million on our debt. We think this is prudent fiscal management, so you should expect to continue to see low cash balances and aggressive debt pay down during 2009. Finally, the availability under our credit facilities totaled $288 million at December 31, 2008.

On that note, I’ll turn this back over to Ben.

Ben R. Leedle

In developing our guidance for 2009, we’ve already shared with you specific events over the last few quarters that we expect would affect our top line and our margins, both positively and negatively. Much of the impact from these items reflect the expected ebb and flow of the business in any given year, and historically we’ve been able to offset any negative event through topline growth from both new and existing customers. Principally, due to the overwhelming impact of the current economic situation, however, our revenue guidance for 2009 reflects our expectation that topline growth will not be sufficient to overcome the impact of both the usual and the unusual negative events.

We began to feel the impact of the recessionary economy during calendar 2008 and that in turn affected our business levels at the start of 2009. Further, our visibility about business expansion during 2009 is limited simply because the depth and the duration of the economic downturn still remain unknown. As a result, our guidance for earnings reflects the impact of both the decline in revenue and the de-leveraging effect of this expected decline on our margins.

Now, as disappointing as this guidance is in an absolute sense, I’ll also point out that despite the worst economic environment that this company has ever experienced, we expect to be solidly profitable for 2009, with substantial free cash flow which we intend to use to further strengthen our financial position. We are not cutting back on our investments for the future, and in fact, we’ll be launching our next generation solutions platform later this year.

Even in the midst of an expected ongoing economic downturn, we continue to have meaningful discussions around potential contracts with both health plans and employers, and these prospects’ interest in addressing the health and the healthcare costs of their members or employees has in fact been heightened by the current economic environment. So despite the step-back in revenue and earnings reflected in our guidance, we’re excited about the opportunities for 2009 during which we expect to expand our prospects for ongoing long-term growth.

Among these opportunities, we expect to sign additional domestic contracts with both new and existing health plan and employer customers. Our more than 100 existing health plan customers and over 1000 employer contracts represent about 85% to 90% of all the commercially insured lives in the US. During 2008, our penetration increased by 6.2 million lives to 16.9% from 14.5% at the end of 2007.

At this level, we still have tremendous growth opportunities with our current customer base and our pipeline for new customers is very active. The December signing of our Australian contract demonstrates that the international arena continues to represent another opportunity for significant progress during 2009, and we expect to launch this new contract in May, as Mary pointed out, and then later in the summer, we also look forward to analyzing data from the first year of our 3-year agreement in Germany.

In addition, we’re continuing on our work to establish new international markets and expand our presence in our existing countries. Our confidence in the long term growth potential of our international business reflects our continuing discussions around the globe which make clear that many other countries are just as focused on addressing the healthcare needs and the costs of their populations as we are here domestically.

A third area of concentration for 2009 is our ongoing strategy to broaden the debate in the healthcare industry beyond simply disease management or wellness or prevention to an understanding and an embrace of well being. Briefly, for those new to Healthways, well-being is a function not just of physical health, but also of emotional health and social health, and we believe that by improving well being that we can have the greatest impact on medical costs as well as on the cost of lost productivity related to health. To improve well being in any given population requires a new level of comprehensiveness and capability focused on helping healthy people stay healthy, helping reduce risk for future disease by mitigating unhealthy lifestyle habits, and certainly as we learn and improve, helping people that already have a disease or persistent condition to evidence based medicine and support.

We’re also hearing the voice of employers become louder and more insistent that incremental steps to improve health are no longer enough. They are coming to understand first the potential of well-being solutions to make being healthy pay. Second, that they can prove it, and third that they can drive better and better business performance over time as well-being improves among their work force and their dependent families. As we’ve experienced repeatedly in our history of pioneering new concepts to improve outcomes, the momentum behind well-being is building to an inflection point in which demand for integrated comprehensive solutions that improve well being will predominate. We are and intend to remain at the forefront of this momentum with our Whole Health Solution and with the Gallup Healthways Well-Being Index.

So to summarize my comments today before we move to Q&A, we’re going to remain fully engaged in delivering on our current promises to our current customers and in building Healthways’ future during 2009 despite this economic downturn. The time to act on our opportunities to drive the healthcare industry’s continuing evolution to solutions that will improve well-being is now. The market sees this. We have a distinct first mover advantage, and because of the strength of the Healthways’ business model and its results, we have the financial capacity to act. With an installed base of long term contracts with over 100 health plans and over 1000 employers and with 33 million billed lives, we are confident of weathering the current environment, and as a result, we expect to continue building our potential for long term growth during 2009.

I appreciate your patience for Mary’s and my prepared remarks. Operator, we’d now be happy to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Thomas Carroll with Stifel Nicolaus & Company.

Thomas Carroll - Stifel Nicolaus & Company

With respect to the qui tam lawsuit that you mentioned in your press release, I have a two-part question. What does your counsel tell you about the potential timing of when a trial date may be set on that because it looks like it was remanded on December 9, ’08, so we’re two months into that situation, so maybe some feedback on timing, and then secondly, if you could please size for us what substantial increase in legal fees potentially means to ’09 earnings.

Ben R. Leedle

Let me make sure I give a little bit of overview on this. Obviously, there may be some things that you may be asking that we’re just not at liberty to give detailed detail, but as you do know, we have discussed this lawsuit in our filings for a good period of time now. The lawsuit was filed over 14 years ago, and the allegations relate to a legacy business line involving the operation of inpatient diabetes treatment centers and hospitals, and a lawsuit does not, it is important to understand, relate to the company’s current business or the services provided to current customers. The plaintiff is a terminated employee who is bringing this lawsuit on behalf of the government, and the government investigated the allegations when the lawsuit was originally filed, and the government decided not to intervene and prosecute the case.

As we’ve discussed in our filings, the case has been remanded back to Nashville for trial, and while a trial date has not yet been set, it is possible that the trial could be scheduled for 2009 or early 2010 as I think we mentioned in our press release, and we do not have specific reserves for this case, and in the event the trial is set for 2009 or even early 2010 or were we to settle this case, we just thought it was appropriate to be clear that such events had not been factored into the guidance that we provided today, and then obviously with respect to the substance of the lawsuit, we just continue to believe that the plaintiff’s claims lack merit and that the evidence will show that we conducted our operations in compliance with the applicable laws. I know you’re asking for a sizing of this and some timing, but those specifics aren’t available, or we’d be out there with that information for you.

Thomas Carroll - Stifel Nicolaus & Company

So you just have absolutely no idea of what the legal fees could be?

Ben R. Leedle

Obviously by bringing this out in the press release and to your question, they’re going to be higher obviously than they’ve been on a run rate basis during this period, and as you can imagine, the different courses that this could take could take this to varying and different increased levels.

Thomas Carroll - Stifel Nicolaus & Company

Will you provide pro forma quarterly ‘08 calendar financials for us at all? I thought we were going to get that today.

Mary A. Chaput

That’ll be included in our Q which will be filed soon. When we look at those quarters, we realized that they were essentially the same as the comparable quarters of fiscal ’08, and so as a result of that, rather than introduce a whole new set of numbers for you, we would really recommend that you take the comparable quarter from ’08 to do any year over year comparisons. It just seemed like there were enough numbers here that adding that to the mix would just be a confusing and time-consuming effort.

Operator

Your next question comes from the line of Josh Raskin with Barclays Capital.

Josh Raskin - Barclays Capital

First question is just on the customers that have come to you for renegotiations. I was wondering any update in terms of are customers still coming to you? Are there new ones that are still entertaining that process of we want to renegotiate?

Ben R. Leedle

As you can imagine, Josh, part of the reason why we changed calendar year was to get our planning and budgeting processes in sync with our clients, and most of them are on a calendar year. I’m not saying that there wouldn’t or can’t be any further possibilities. We never know when a customer may ring up and make the request, but the largest intensity of that has been through the fall as the people had been preparing and planning their financial plans for their fiscal years.

Josh Raskin - Barclays Capital

It sounds like there’s been noticeable slowdown since the fall in that activity. You guys are still investing in the business obviously as you go forward. Is there a way to size, I don’t know if it’s in the SG&A or if it’s in the cost of services but I assume it’s in cost of services, or break out what is new investment as opposed to ongoing expansion, just so that we can get a sense of what is the run rate business?

Mary A. Chaput

I would say Josh that we have continued to invest over time, and so to some degree, those costs are part of our run rate. I mean we’ve developed new solutions over time, and we’ve converted companies over time to different platforms or different programs, so I don’t have that number for you, and I think it’s because basically it’s been baked in. What I can tell you given the details that I did provide to you based on the EPS which you have the high and low of the guidance, I gave you the tax rate, gave you depreciation range of $5 to $10 million, you can back into the total cost that we’ll be incurring at the high and the low end of our guidance, and that number will be about $20 to $40 million in that range. Of course, our depreciation as I mentioned is higher, so the savings and the cost takeouts have actually been greater than that, and I’ve given you the percent of cost of sales, so you can determine percent of revenue for cost of sales and SG&A, so you can back into that whole model. We’re trying to be as transparent as we can be this year because of the visibility that people feel that this economic condition doesn’t really provide, and so we’re telling you what we know, and other than, I’m not going to trying and break out those costs any further.

Joshua Raskin - Barclays Capital

In the spirit of transparency, following up on Tom’s, are you suggesting that for the March quarter of ’09, we should simply compare that to a February quarter of ’08?

Mary A. Chaput

I think so. The stub period, even the 3 months of the stub period carried about a penny worth of restructuring costs, and as we said $0.45 in restructuring and tender offer, so it just gets very complicated when you try to look at the calendar year, and then to break up the quarters inside the calendar year, you’re going to see a whole of new numbers that aren’t going to be materially different from those comparable quarters. To me, and maybe I’m not capturing what you all need, a look back to the sequential quarter and a look forward to the next two or three sequential quarters really is telling you what’s going on with the business.

Joshua Raskin - Barclays Capital

We’re just trying to figure out on a year over year basis. December of ’07 looked a lot of different than January or February of ’08, and if you look at the May quarter, there was sort of a significant 7% sequential ramp in revenue, so I think there are big changes here on a monthly basis.

Mary A. Chaput

We will put those in our 10-Q filings, and I guess the only other thing that you might try is one third and two thirds. We looked at all of that and said this is so many numbers to give back to analyzing what happened in the three-month period in the calendar year of ’08, and spending our time on that just didn’t seem like the best use of our shareholder time and money.

Joshua Raskin - Barclays Capital

If you were talking votes, I’ll vote for let’s get the extra numbers. I’m willing to go through them.

Mary A. Chaput

I don’t have those numbers right now, but we can provide those off line to folks if they want them.

Operator

Your next question comes from the line of Gregg Genova with Deutsche Bank.

Gregg Genova – Deutsche Bank

Can you discuss maybe the third contract that you guys renewed if you can give maybe a little bit more color that, maybe some terms, the length, the renewal, and if any services were added or removed?

Ben R. Leedle

I think we can characterize it that in the renewal it’s going to be bigger contract, and we have not released on that on a specific contract basis. It seems more and more of our customers are less inclined to want to put the details and color out that they have in the past, but we’re very satisfied with the conditions and the terms of that renewal, and you know obviously to minimum, all three of these contracts were over the 2% mark as a function of revenue in ’08. We were happy to get that done, and as you know that leaves us one more planned renewal process that we’ve shared and indicated would pick up pace later on this calendar year.

Gregg Genova – Deutsche Bank

As far as seasonality, Mary, maybe you could talk about that. Will the quarters be steady quarter to quarter, or will there be something we should be aware of as far as maybe marketing expenses in the back half of the year or how should we think about that?

Mary A. Chaput

If you take the high and low EPS range and subtract the first quarter, you’re going to see that it’s basically flat the remaining three quarters, so I think we will have the international Australian contract kicking in a little bit in the first quarter and more in the second quarter. We have a couple of contracts that will start over the course of the year, but we’ve baked in the attrition contingency. We’ve layered that in over each of the quarters, so that’s kind of providing us some offset to those increased revenues.

Operator

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

Kristina Blaschek - William Blair & Company

This is Kristina Blaschek for Ryan today. First regarding 2009 guidance, just to be clear, this guidance assumes no increasing revenues in Germany. Is that correct? I know that Germany could be expanded as early as mid 2009.

Ben R. Leedle

It does not include any revenues associated with expansion.

Mary A. Chaput

Or any revenues associated with gain share. It think it is probably pretty flat.

Kristina Blaschek - William Blair & Company

If it is expanded, that would more than likely be a 2010 event. Correct?

Ben R. Leedle

That’s most likely. I think the process steps are that we completed the first year of operations in early January here, and with a maturing in the information related to the operations, it’ll be late spring/early summer as we look at year one performance per that agreement with them, and then to the degree that we’ve performed in excess of target, there’ll be the reconciliation around the gain share piece, and I think getting those two pieces clarified will take a couple more months, and we would expect by late summer/early fall for them to be in a position to be making their decision around expansion, and then with a position, we would need to do obviously implementation for that expansion then in the late fall, and hopefully we’ll be looking at, with positive performance and a decision to expand, expanding that agreement in ’10 early in the first half.

Kristina Blaschek - William Blair & Company

Now that we have 2008 and 2009 revenue figures, can you provide just a little bit more color on how much of the year over year drop is due to contract losses versus renegotiations to lower-priced or different types of service offerings?

Mary A. Chaput

I think that we talked quite a bit about this about a month ago, in which we described that the contract restructurings and terminations and inside of some of those restructurings were scope changes and sometimes there were program terminations but not customer terminations. It was $70 million, and I think at that time, we talked about attrition being in the $20 million range, and we’ve revised that attrition number for the assumptions based on unemployment as they continue to be reported, so we haven’t broken that $70 million out any more than that. We talked about Blue Cross Blue Shield of Minnesota, and we provided that at the $22 million range, and that by far is the largest.

Kristina Blaschek - William Blair & Company

Can you talk a little bit more about how you model Silver Sneakers? I know you have a big expansion in the network recently, so I’m just trying to determine what that does to your revenue outlook. Is it as assumption that utilization will go up, so you can gain more per use fees in that segment?

Mary A. Chaput

I think the accessibility to more participating locations is designed to increase in participation and actually a specific group, which would be the participation of women, into the Curves network, so the way it works is there is an upfront management fee. We do provide fitness coaches, and then it is by participation. So there are marketing costs that are pretty much direct to consumer oriented in order to encourage participation and to build a social network as much as a fitness network, so people come and may get their friends to come and they’ll join the Medicare Advantage program whoever is carrying that program which is great for the health plan, and so we like to think as with all our programs that it’s a win-win-win, but that’s basically how it works. So we get paid on participation. We pay the fitness center on participation, and there are some marketing expenses as well. So when we talk about product mix change, to some degree that includes the Silver Sneakers, which is enjoying nice growth for us.

Kristina Blaschek - William Blair & Company

Can you provide us a feel given the December restructuring of what type of stock compensation expense savings you guys will see in 2009?

Mary A. Chaput

We have provided the details of the charge associated with the tender offer as being about $11.5 million, so that represents the unamortized costs of those options over time, and those options had a 3- to 4-year vesting period, so you can assume that the savings over time would actually be in the 40 to 30 to 20 to 10% range over the next 4 years in that range.

Operator

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

Brooks O'Neil - Dougherty & Company

Could you just say whether the $0.08 to $0.10 assumption for international cost includes any assumption about additional contract wins internationally this year?

Ben R. Leedle

No, it does not.

Brooks O'Neil - Dougherty & Company

Do you expect to win additional contracts internationally this year?

Ben R. Leedle

Our guidance does not include or contemplate any revenue or profit or additional costs from new contracts. It doesn’t mean that in any way we’re signaling or indicating that we think our international market we’ve worn it out. We continue to have a very robust pipeline and continue to make great progress on business development. We just think with that business the last thing we need to do is to start trying to predict timing and sizing of the contracts, and you can just look at the three that we have and understand that depending upon what possibility there is for contracts to sign in the year that different development efforts move at different speeds at different times, so we just thought it’d be easier to keep treating international the way we have since we began our work in that area 3 or 4 years ago, and that is to tell you about what we know and that we’re not slowing down our efforts to continue to do development nor is the rest of the world slowing down with their interest in talking to us about how we can come help translate the successes here into helping to form organizations and businesses in their country to try to drive the improvement in health and well being. So no, there is nothing in our guidance that would reflect an additional contract beyond the Australia contract.

Brooks O'Neil - Dougherty & Company

Secondly, can you give us any update on the MEDCO joint venture or any progress there, any positive developments or negative that you see happening in the market place now?

Ben R. Leedle

I think I gave good color on that in the fall in October when we talked about the successes that we had had in terms of significantly increasing the amount of business in 2008 and for 2009, so you can expect that it’s cycling up just like all our other customers and distribution partners are which is we expect the sales season obviously to intensify particularly with employers over the next 3 or 4 months, and so I’d tell you for our teams this will be the third full sales season, so that team keeps in our opinion on a combined basis getting better and better at leveraging the integrated value proposition of pharma management and medical management, so we continue to be positive.

Brooks O'Neil - Dougherty & Company

Any recent contacts with CMS or Medicare that indicate either positive or negative, anything like that?

Ben R. Leedle

No, not really. Nothing since that period where we shared last time, and in waiting for our final ARC report which we wouldn’t expect till the end of March or so, and that will complete the run out on the claims data from the pilot, and then that will put their third parties and our external experts in motion to begin to do the math and measure up and be prepared to sit down to follow through on understanding the performance and reconciling the work that we’ve down. No real new news for us. We’re waiting for the next report.

Brooks O'Neil - Dougherty & Company

Lastly, I’m just curious if you could give us a little more colon on what exactly the integrated data and technology solutions platform is, whether that is just sort of an expense item that you’re incurring or whether there is any response needed or gotten from customers on that, and then how that might vary or interplay with the whole health initiative you have and what the response to that has been so far in the market place.

Ben R. Leedle

I think the easiest way to think about it Brooks is over the past three years, we’ve continued to build solutions here. We’ve acquired companies and capabilities with solutions. There are multiple technology and platform delivery models that we’ve found ourselves in ownership of, and obviously the marketplace as you know has continued to push real hard rather than to think of programs in a silo or in a niche to actually expand and push for support of integrating data across all types of data and information for whole population and then leverage those with software capabilities that help drive efficiencies by automating the workflows that are aimed at helping people change behaviors or support processes for better care.

We had been in the disease management part of our business on our fourth iteration of a system we call Popworks that largely was an automated platform to help support outbound telephonic support and inbound telephonic support. We’re bringing the web portal capabilities for the consumer, for other providers, for our customers to be able to look into see the data and share it on a much broader basis and absolutely bringing the kinds of tools that can be afforded to people via the web, via monitoring and devices the ability for us to support interventions into the home, support venue-based programs like our Silver Sneakers but also continue to strengthen our capabilities like Quick Net which is virtual web-based social community for people that are trying to quit smoking, so it really is a tremendous amount of work that we’ve done that then launches forward by the beginning migration of customers by mid year and probably over the next 6 to 12 months before we complete that whole migration process, and what it affords us once we migrate is higher degree of flexibility, lower cost of service, really a flexibility that strengthens an anywhere anytime user, begins to integrate views for all the different stakeholders particularly the consumer, and it puts us in a position so that as we want to modify and change the way we can figure technology, data, and intervention support on behalf of individuals by our customers that we’re removing the more cumbersome that we and a lot of other companies are burdened by which is go right to business spec, put them into technical spec, let’s then figure out how many man hours it takes and the cycle time and the relative capital intensive process that making those changes are, and puts in a much easier form where you’re not going to be needing to have programmers but rather just well-trained people who understand the business that can make the technical adjustment to afford confirmation of that platform, so we’re excited about this.

I think you need to think of it as normal course of business around the intentions that we’ve had. Where to place it now? Well, this is I think going to benefit us significantly on the competitive front and in terms of being able to, as you saw the pressure on our margins and Mary’s notes in the press release today, afford us the opportunity that as we look out forward with time, flexibility with scope and being able to do that at a lower cost of delivery across the board.

Brooks O'Neil - Dougherty & Company

And how does that tie in to the whole health industry?

Ben R. Leedle

The other beauty of this is that this is the underlying platform that affords the whole health intervention sets and capabilities we brought to life on behalf of those interested in expanded value proposition.

Brooks O'Neil - Dougherty & Company

Have you got pretty good interest from customers in trying that?

Ben R. Leedle

We absolutely do, so you can imagine. We wouldn’t be cycling this forward if we hadn’t alpha/beta testing with customers to see both what this can do, what the reaction is, and obviously not doing this in a vacuum using our customers and partners to help guide this to the very best possible place, so we’re obviously heads down, nose to the grindstone to push to begin for a launch of that migration mid year.

Operator

Our next question comes from the line of Newton Juhng with BB&T Capital Markets.

Newton Juhng – BB&T Capital Markets

Mary, I was kind of wondering if you could give us a little bit more detail on your expectations with regard to your cost take out, what you have taken out so far and whether or not in the first quarter we should expect to see a little bit more charge associated with that because, Mary, I think on the last call you may have mentioned something about some employees that were looking at some open positions within. There seemed to be some uncertainty still at that point in time, and then just in terms of the cost of services number going up 250 to 300 basis points, in the guidance there, I’m just kind of curious how you are looking at that number trending going forward in terms of can you see that come down over time or is that going be something of a stable number for a while?

Mary A. Chaput

Yes. I think there will be a minimal amount in January of carry over from the process in November and December primarily. In terms of the margins over time, I think, the range that we provided in terms of revenues is wide enough and the EPS as well that depending on what the attrition really does is going to drive that margin, so if you look at the low end, and again I’m sort of comparing the fiscal 2008. You heard me walk Josh how you could get in to total cost and you can actually calculate given the gross margin percent that I provided. I provided percent of cost of service to revenue, so you can get to the gross margin percent. The year could go either down as low to a percent gross margin of 300 basis points below the 31.4% that we had in the fiscal 2008 or 250 basis points again at the high range, so I know that you want all of this piece together for the entire year, and we are giving you the first quarter or we are giving you the whole year, and we are trying to tell you what’s going on in terms of what we can see right now. I think the question mark will be attrition, and how that occurs over the course of the next four quarters. I don’t expect unemployment to have all happened in this first quarter, so we have layered that out over the fourth quarters, and I’m just going to have to leave it for you to model in between.

Newton Juhng – BB&T Capital Markets

The attrition number, in the past you’ve said 3% attrition impacting revenue by $20 million or so, but it sounded like from you previous comments that it was a little bit greater. Is there any chance you could give us kind of a little bit more insight into what you have baked into the guidance at this point?

Mary A. Chaput

It’s a range. On the high end, it’s less, and on the low end, it’s greater. It is greater than the 2.5% to 3% that we talked about before because quite honestly every week we are hearing about more, and so we have tried to provide on the low end of our range. As I mentioned, no unsigned business and the largest amount of attrition. Whether that will occur, hopefully not for America, but we’ll see.

Newton Juhng - BB&T Capital Markets

Understandable. This is a really tough time, and there is a lot of uncertainty there. I was just kind of curious what you had baked into your assumptions. Just in terms of your capacity, I was wondering if there was still more room to cut there, how far along you are in that process as well and whether or not that’s already been baked into your guidance and we should just expect that unless there’s a significant increase in sales that we shouldn’t expect too much more capacity to be cut.

Ben R. Leedle

Yes, and I think you should think of our work there as a process, not an event, so the work that we did this last fall around looking at layers of management and range of scope of those people is completed, and the work that we look at when we think of capacity and maybe in the way you’re thinking of it is based on the business we have, the number of lives we are serving, what is that field force that is working with us. Obviously, it will be ongoing titration, and the balance of what’s our available capacity, what does the pipeline look like, what does the implementation schedule look like in any given moment, so we’re going to manage it to assure that we are not in a position to compromise, doing excellent flawless implantations on new business and assuring that we don’t risk the value creation that we have been historically known for and has driven our success long term, so it’s not an exact science, but we have a lot of attention being put to making sure our capacity is optimized.

Newton Juhng - BB&T Capital Markets

Accounts payable, it looks like it jumped about $6 million over the course of December, looking at your end December number versus the previous number disclosed. Just wondering if you could give us a little bit more detail about whether or not there was some delay in payment, and if so why and just anything you can do to enlighten us on that front?

Mary A. Chaput

No. I don’t think there was any change in our process or delay of payments. I think once again we knew that this was going to be the end of a reportable period, and we did all the appropriate things in terms of ensuring that everything was in the system, and of course the holidays were there, so there were probably some late invoices coming in that didn’t get processed. That’s all.

Newton Juhng - BB&T Capital Markets

Well, just to reiterate what some of the other analysts have said. We are looking to try and get a certain amount of apples to apples basis here. It’s a little difficult if we don’t have the historicals to look at, so we’re looking forward for the Q but any additional detail would be definitely appreciated.

Operator

Your next question comes from the line of Daryn Miller with Goldman Sachs.

Unidentified Analyst – Goldman Sachs

We’re wondering with EBITDA and earnings coming down the way they have, how much more room is there before you guys start reaching your debt covenants?

Mary A. Chaput

Well, we’ve certainly looked our guidance. We don’t anticipate any issues with our debt covenants at all. By the end of the year, we’ve given our plans that the debt to EBITDA ratio will be below two, and we’ve got lots of head room.

Unidentified Analyst – Goldman Sachs

What’s the actual number there that would trigger the covenants?

Mary A. Chaput

We have three covenants, and I think it’s 3.5 times leverage, at 12.31.

Unidentified Analyst – Goldman Sachs

Do you guys know where did Blue Cross Blue Shield contract go? Did it go to a competitor or was it in-house?

Ben R. Leedle

Which Blue Cross Blue Shield?

Unidentified Analyst – Goldman Sachs

Minnesota.

Ben R. Leedle

They’re doing their own program.

Operator

It appears that is all the time we have questions today. I’ll turn the program back to Mr. Leedle.

Ben R. Leedle

Just want to thank you again for listening to the call. Mary and I and Chip will be in New York at the UBS Conference early next week, and we look forward to hearing from you guys and will be available for questions if you’re interested.

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Source: Healthways, Inc. 2008 Guidance Call Transcript
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