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Healthways Inc. (NASDAQ:HWAY)

F4Q07 (Qtr End 08/31/07) Earnings Call

October 17, 2007 5:00 pm ET

Executives

Ben Leedle - President and CEO

Mary Chaput - CFO

Analysts

Ryan Daniels - William Blair

Art Henderson - Jefferies and Company

Thomas Carroll - Stifel Nicholas

Glenn Garmont - Broadpoint Capital

Darren Mueller - Goldman Sachs

Brooks O’Neil - Dougherty & Company

Michael Glynn - Credit Suisse

Operator

Good afternoon and welcome to the Healthways Conference Call to discuss today's Fourth Quarter 2007 Earnings News Release. Today's call is being recorded and will be available for replay beginning today and through October 24th by dialing 719-457-0820. The confirmation number for the replay is 4396238. The replay may also be accessed for the next 12 months at the company's website, which is at www.healthways.com.

To the extent any non-GAAP financial measures discussed in today's call, you'll 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 the first quarter and full year fiscal 2008. For this purpose, any statements made during this call that are not statements of historical fact 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. Consequently, actual operations or 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, Mr. Ben Leedle. Please go ahead, sir.

Ben Leedle

Thank you and hello everyone. Thank you for being with us this afternoon, for our comments concerning the company's performance for the fourth quarter and for fiscal 2007. We will also address our outlook for fiscal 2008, which we presented in our news release issued earlier this afternoon. And as usual, I am here with Heathway CFO, Mary Chaput, and after our prepared remarks, we will be happy to take your question. So let's begin.

We are very pleased with the company's performance for the fourth quarter and full year fiscal 2007. Our fourth quarter results met the high end of our expectations, and as we have for each of the past seven years, once again we produced strong, profitable growth for the full fiscal year.

As anticipated, our core commercial business drove our growth throughout the year, either meeting or exceeding the high end of our earnings guidance each quarter. While we produced a 37% increase in core commercial earnings per diluted share for the year, I would suggest, that the more important achievement during fiscal 2007 was in terms of laying the foundation for continuing future growth of the company with the Axia acquisition.

The Axia transaction represents more than just another milestone in a long line of transforming events for Healthways. I believe it will prove to be even more important than our expansion into disease management from our hospital based treatment center business years ago, or even our launch the industry's first programs for multiple chronic diseases and impact conditions from our previous diabetes only focus.

Through this transaction we not only substantially expanded our market presence, we also integrated our industry leading array of proven Care Support solutions with the industry's leading suite of Health Support solutions and networks. As a result we are uniquely positioned today to provide our health plan, employer, government and international customers with solutions that will have a meaningful impact on the healthcare and health related costs of every individual, regardless of age or health status. Continued integration and innovation on this space will only strengthen that capability in the future.

Let me also point out that the innovation, which has kept us at the forefront of our market, has been accomplished for the past seven years in the context of producing year-after-year of strong profitable growth. As our guidance for fiscal 2008 indicates, we have no intention or expectation of changing that pattern.

As I mentioned earlier, the Axia acquisition has opened broad new market opportunities for us. One clear example of the magnitude of these opportunities in the short to intermediate term is our own base of existing customers.

Our billed lives increased 10 fold to 27.4 million at the end of fiscal 2007 from 2.4 million at the end of fiscal 2006. And the number of our health plan customers increased from 33 to 102 and now represent approximately 85% of all commercially insured people in this country. This dramatic expansion of our customer base represents a tremendous cross-selling opportunity, which has already begun to be reflected through the addition of over 30 contracts with existing customers for additional services.

Our ability to make meaningful progress against these opportunities is also supported by the strong contracting momentum, evident in our signings of both new and extended contracts during fiscal 2007. As we indicated in the press release today, we signed 150 new extended or expanded programs since the end of fiscal 2006. It's four to five times the numbers in any comparable period before.

Based on our growing pipeline of potential new sales, we anticipate this momentum continuing for the foreseeable future. This momentum is being driven by rising market demand, especially from self-insured employers for single-source full population solutions.

Healthways is at the forefront of meeting this demand. We have the industry's most comprehensive suit of Health and Care Support services augmented by the industry's only network of health providers and health venues.

We have the proven ability to implement our programs at scale, assuring our customers of efficient distribution and we have the industry's best track record of outcomes for improved health and reduce cost at scale. These unique capabilities combined with strong market demand enabled us to expand our core commercial business at an unprecedented pace.

We added more than 1 million billed lives in just a second half of fiscal 2007 compared with about one half that numbers for all of fiscal 2006. In addition, our backlog of annualized revenues from contracts signed but not implemented at year-end stood at $40 million compared with $7 million at the same time a year earlier.

So, our fiscal 2007 was a year of significant growth in its own way. We believe the important stories of the expansions of our value proposition represented by the Axia acquisition has positioned our domestic business to continue growing at a rate of 25% to 30% for fiscal 2008 and beyond.

As you are well aware, our growth in fiscal 2007 was achieved while not only carrying out the innovation that I've just described, but also well bearing the cost associated with our efforts to open and establish a foothold in both the Medicare and international markets.

Our guidance for fiscal 2008 includes continuing investments in both of these areas. So despite our continuing positive interactions with CMS, I can update you that nothing has yet occurred that materially changes the discussion we had in our third quarter release and conference call about either our MHS pilot or anything that come after the pilot. Accordingly, our fourth quarter results, and our guidance for 2008 cost, with respect to MHS remain the same as we presented to you last quarter. Nevertheless, our commitment to the MHS process remains firm. While there are no guarantees about whether there will be a Phase II or whether we will participate, we are confident first of our ability to maintain or improve the outcomes of the Medicare population while lowering its healthcare cost. Second, is the very large need and opportunity that aggregate Medicare market represents. And third, that the best path we have towards any potential Phase II participation is through completion of the work that we began in Phase I. As we have done through our participation in the pilots, we will be as timely and transparent as we can with regard to any developments.

So, moving to our international initiative, we were delighted to announce that in late August the industry’s first international Health and Care Support contract with Deutsche Angestellten Krankenkasse, or from hereon out better know as DAK, a 33 year old, 6.2 million member statutory health insurance company in Germany. This contract, which resulted from a competitive RFP process validates the unique positioning we have achieved through our demonstrated ability to deliver proven solutions at scale.

Now, initially we will be supporting approximately 50,000 DAK members in two regions of Southern Germany. The criteria, for eligibility in these regions, will be a diagnosis of heart failure, chronic obstructive pulmonary disease and/or diabetes.

In addition, positive operational progress and outcomes from this effort will create an opportunity for us to pursue expansion to all of DAK's members who have these conditions. That's an estimated 750,000 individuals with these chronic illnesses or a potential for a 15 times growth opportunity within DAK.

In addition, there are many smaller sick funds in Germany which are expected to be consolidated over the next few years. DAK, currently at number two in size, stands the benefits from growth due to consolidation. This contract is important in another dimension as well.

The business terms for this contract are a fixed fee per participant. With performance in excess of established targets, the contract includes a gain share mechanism for the company. This is a clear indication that DAK is buying to maximize outcomes, as oppose to minimizing fees to just have a program.

I want to share another point regarding the competitive nature of the bid process. There were multiple parties involved, as I mentioned, and in fact DAK originally expected towards two company's one region each and then compare overtime.

I believe in part it is a strong testament to our model, our credibility, the team of people we have working on this, and our preparedness, that in the end both regions were awarded to Healthways exclusively. The DAK contract also supports our ongoing initiatives with other potential international customers in other countries.

As I said before, the same concerns that are at the center of the healthcare debate domestically are driving our conversations with potential governmental and commercial customers internationally and we anticipate additional international contracts during fiscal 2008.

So, as you saw in our news release, we expect new contract implementation cost in our ongoing international development costs to more than offset our initial international revenues for fiscal 2008. However, as we gain critical mass in the international market, we anticipate that it will prove to be a significant contributor to our continued long-term profitable growth.

Now, with that, we'll shift gears and I will ask Mary Chaput to address our fourth quarter results in more detail as well as our guidance. Mary?

Mary Chaput

Thank you, Ben, and good afternoon everyone. Fiscal 2007 wraps up another year of solid performance for Healthways. Revenues were up 49% to approximately $616 million from $412 million in fiscal 2006. Core commercial revenues were up 54% over the same period, even including the $5 million of integration cost due to the Axia acquisition and the increased cost of both our international and MHS initiatives.

Total company EBITDA in fiscal 2007 increased slightly as a percent of total revenues over 2006 levels, primarily as a result of increased capacity utilization, and a reduction in the level of quarterly bonus due to miss in meeting the internal incentive targets. A significant portion of which related to the MHS Phase I pilot.

2007 was a busy and strategically important year, which drove a variety of financing activity. We completed the acquisition of Axia, the market leader in health support solutions on December 1, 2006. We acquired a small web development company [Vigot] on March 1st.

We made a minority investment in D2Hawkeye, a leading provider of medical analytics and reporting and acquired the assets of First Opinion, an automated diagnostic software company on August 1st.

We completed a syndicated financing package totaling $600 million and achieved our first corporate agency rating. We established international legal entities and banking processes and have begun implementing our first international contract in Germany.

The contribution to EPS for the fourth quarter from our core commercial business was $0.45, one step above the high-end of our guidance and $1.77 for the fiscal year, up 37% from fiscal 2006. Additional cost associated with securing and beginning the implementation of our international contract in the fourth quarter added $0.02 cents to our expected dilution from international activities, resulting in the net cost impact for the fiscal year of $0.12.

The next cost impact from the MHS Phase I pilot in the fourth quarter was $0.8, $0.01 better than our guidance. For a total year, net cost impact of $0.44. Total GAAP EPS for our fourth quarter of $0.31 was on the high-end of our guidance.

Operating cash flow in fiscal 2007 totaled approximately $107 million for the year. We ended the year with approximately $48 million in cash, following cash expenditures of $151 million in acquisitions and investments, the pay down of $51 million in debt and the repurchase of approximately $6 million of stock.

As expected capital expenditures for the year totaled $30 million lower than we originally anticipated, a result of the timing of new sole business that will be implemented in fiscal 2008.

For fiscal 2008, we expect total company revenues to be in the range of $782 to $815 million, which would represent a 27% to 32% increase over fiscal 2007. Domestic revenues in fiscal 2008 are expected to be in the range of $774 million to $805 million, a 26% to 31% increase over domestic revenues in fiscal 2007. This amount includes expected fixed fee revenues from the MHS pilots of $4 million to $5 million.

Given the relative size, term and financial predictability of the MHS Phase I pilots, we will be combining the results of what we have previously referred to as our core commercial operations with the MHS pilots, and reporting them as one number for our domestic markets going forward.

We will continue to record international operations separately and will of course provide you necessary details regarding the MHS pilots and their financial impact as new events warrant.

International revenues from the newly signed contract with DAK in Germany, which goes live on January 1st, are expected to be in the range of $8 million to $10 million. Some of the dynamics that we anticipate in the year ahead, include significant contract starts in our second quarter, primarily on January 1st, related to the backlog that Ben mentioned earlier.

We expect first quarter revenues to be slightly higher than the fourth quarter of fiscal 2007, and increasingly stronger revenue growth over the remainder of the year. This seasonality reflects an aspect of and an increase in the mix of Health Support solutions being provided primarily to self insured employers.

Overall, we expect the EBITDA margins in 2008 to be consistent with 2007. We anticipate that there will costs in our first quarter associated with the preparation for those January 1 contract starts, including an unprecedented expansion of infrastructure, including three new domestic care enhancement centers in the first half of the fiscal year.

In addition to the upfront cost of the management team, recruiting, hiring and training of the clinicians and coaches to deliver on those contracts, and the development of data exchange processes and analysis with our new customers.

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 $0.33 to $0.34. The ongoing activities of the international business development team and the first quarter net cost impact and preparing for January 1 start of our international contract is expected to be in the range of $0.05 to $0.06.

Contribution to EPS from our domestic business for fiscal 2008 is expected to be in the range of $1.88 to $1.95 which is a 40% to 46% increase over 2007, and includes approximately $6 million or $0.10 of cost in 2008, associated with our move into our new headquarters.

That $6 million includes moving cost, duplicate rep for a short period of time, and an expected write-off of certain fixed assets primarily, furniture and fixtures. The net cost impact of the last year of the Phase I MHS pilots, which is included in this EPS range for our domestic business, is expected to be as we have previously discussed approximately $0.25.

Total company GAAP, EPS guidance is expected to be in the range of $1.77 to $1.86 of 45% to 52% increase over fiscal 2007. We expect the total year and net cost impact from our international business to be in the range of $0.09 to $0.11, since the eight months of revenue from the DAK contract will not be sufficient in that fiscal year to offset the upfront costs of our preparation and the full year cost of the international team. This guidance does not include the impact of any new international contracts that may be signed during fiscal 2008.

Regarding the balance sheet and cash flow in fiscal 2008, with four anticipated care enhancement centers, three domestic, and one international, and our new headquarters all coming on line in fiscal 2008, we anticipate that our capital expenditures will be in the range of $70 million to $75 million, which will also include continued systems integration of our Care and Health Support solutions, ongoing product enhancement and development and infrastructure upgrades.

We expect the cash flows from operations for the fiscal year will be approximately $150 million. We will continue to pay down debt, maintain a cash balance in the range of $40 million to $50 million, and borrow any additional significant investments. We anticipate that our debt-to-EBITDA ratio will be right around one by the end of the fiscal year.

And with that, I will turn it back over to Ben.

Ben Leedle

Thanks, Mary. I want to conclude today with some thoughts about what we intend to build on a foundation that we laid this past fiscal year. Those of you have followed us for sometime know that we have been guided by consistent vision, which recognizes that the best way to drive the most improved outcomes possible and thereby the greatest healthcare and health related cost savings, would be the development of comprehensive, integrated, and personalized solutions that would address the needs of each individual, regardless of health status, when first engaged.

Put in another way, we saw the maximum benefit deriving from providing all of the solutions necessary and this is important to keep the truly healthy, healthy to reduce modifiable lifestyle risk factors, such as obesity and activity of smoking that when left unchanged, progress the serious health circumstances, such as chronic disease and to assure the optimization of care where best scientist consistently apply to the individual and provider level to address the management of health issues. So, those who had already progressed to chronic or intensive stage, we have the opportunity for best health as well. That vision is now the industries both purchasers and suppliers perceived wisdom.

Over the years, you've watched us steadily progress, building first the leading capability for serving those people already affected by chronic disease or other impact conditions.

We next turned our attention to the larger part of the typical commercial population, to those people who are only minimally engaged in the healthcare system because either they are healthy, or if that risk not yet manifesting material disease symptoms.

Beginning with our initial contract for Myhealthways, Care Enhancement services in 2001, we expanded our ability to have a meaningful impact on the outcomes of each person in our customer’s populations. Our 2005 acquisition of the business that became myhealthIQ marked another major milestone. And as we have discussed previously, Axia represented another tremendous step in this progression towards making our vision a reality.

So, as we enter fiscal 2008, we are actively engaging full populations of our health plan and important customers who are supporting our efforts by incentivizing their members or employees to participate.

In addressing the needs of the whole population, our value proposition has expanded beyond the impact of direct healthcare cost savings, enabling us to credibly address with our customers the hidden and largely unmeasured health related impact on employee productivity. These issues are very real for our customers, be it health plans or employers, and we expect our ongoing innovation toward a comprehensive whole health solution, that meets the needs of individual sponsors and providers will begin to bear fruit in fiscal 2008.

Healthways commitment to and measured progression toward our vision over the years and has created tremendous growth and significantly increased stockholder value. As both the shareholder and as CEO, I am gratified by what we have accomplished to-date. But we are not even close to being done. I am excited about the opportunities that lie ahead of us as we pursue to three key initiatives. First, the continued expansion of our value proposition to legitimately include both healthcare cost savings and health related cost savings. Second, further developing and implementing the solutions that will deliver on that expanded value proposition for our customers. And third, to deliver those solutions to literally hundreds of millions of people around the world as we further penetrate our domestic markets, while we are actively expanding our international markets.

Now, just two weeks ago, Healthways market cap touched $2 billion. Just this week, we were again acknowledged by Fortune as one of the nations leading growth companies. We have been presented with significant opportunities for growth over the past several years and we have been there each time with the solutions the market was demanding. Equally as important, those solutions worked, delivering for our customers each element of the value that we promised that they would, while producing profitable growth for our stockholders.

I have every confidence that our whole health solutions will achieve that same standard of performance and, as a result, our opportunities for future growth far exceed the historic growth we have already achieved.

And as an ending point here, as you saw today in our earnings release and have heard Mary's prepared remarks, going forward we are trying to simplify our reporting and communication on the company's progress. We have organized our capital resources, our people, processes and tools, to address the domestic market separately with the same approach dedicated to the international market. We think the size and relative predictability of our domestic business allow for a simplified way to fully understand our progress on this front.

Given the conversation of our international efforts, or the conversion of our international efforts from essentially a business development effort only to now additionally the beginning of an operating business, we believe that it is the right time to move communication and metrics out of our business results and growth prospects, to terms of domestic and international.

We will continue to provide you with the information you need, to understand our business results, our strategy, and our forward growth prospects. So please stay tuned, and again thank you for being with us today, and for your patience with our prepared remarks and now operator we will be happy to take any questions, at this point.

Question-and-Answer Session

Operator

(Operator Instructions). We will take our first question from Ryan Daniels with William Blair

Ryan Daniels - William Blair

Hi, guys good evening.

Ben Leedle

Hi Ryan.

Mary Chaput

Hello.

Ryan Daniels - William Blair

Couple of quick housekeeping questions and some broader ones. Mary, can you, just a feel on the headquarter move cost, how that will flow through the year? Do you think that will be a heavier, kind of Q1, Q2 and then dissipate with just the remnants of some of the duplicate rent going on through the year. Any feel for that?

Mary Chaput

Yeah, I do. And the question, when we'll move in exactly. But, we are thinking it'll be the end of February, beginning of March. So you are going to see some of that affect Q2, but more of it in Third quarter and then some ongoing depreciation in Q4, which is not included in that $0.10.

Ryan Daniels - William Blair

Okay, great. And then, I know you guys break this out in the queue. I am hoping you could give it now. Do you have the Axia revenue?

Mary Chaput

Yeah. It came in at $137 million.

Ryan Daniels - William Blair

For the year?

Mary Chaput

For the year.

Ryan Daniels - William Blair

Okay. And it sounds like that was a little bit below your thoughts because of some weakness in SilverSneakers. Do you have any feel for what may have driven that? Is that…?

Mary Chaput

Yeah, I wouldn't call it weakness. I think, and we are just learning a little bit about this, but there were probably two things that we weren't familiar with originally, which was the seasonal nature, was the most bullish of fitness center, SilverSneakers utilization was in the summer and then secondarily a lot of the revenues came on January 1, with the self-insured employers. So, both of those things occurred instead of push revenue out into thus fall.

Ryan Daniels - William Blair

Okay. That's helpful. And then one more housekeeping, just on the Medicare BIE, do you have that number that you could breakout for us?

Mary Chaput

Yes, and the BIE is $57 million and was in MHS, and the remainder in the core.

Ryan Daniels - William Blair

Okay, great. And then, if we look at the -- two more quick ones and then I'll hop-off. If we look at the international ramp, I guess it costs $0.06 this quarter. I guess I'm a little surprised to see the guidance of only $0.05 to $0.06 next quarter thinking that you would be kind of actively building the call center and hiring staff ahead of that January launch. Was there some of that, that actually spilled into fiscal 2007 on the hiring and construction cost if you will?

Mary Chaput

Yeah, absolutely I think we mentioned that the international initiative actually was $0.02 more dilutive than what we originally guided to and that was because we have started that implementation.

Ryan Daniels - William Blair

Okay, and then Ben, a couple of broader ones. You mentioned at the start of the call, something that was interesting that Axia to you and I know you've been there two decades, now it was more important than the move from the hospital base into disease management. Can you elaborate that a little bit more; you think the market is bigger, you think it's more of a defendable position, something more likely to be outsourced? What's really driving you to say that that is a more important milestone for the company if you will?

Ben Leedle

I think, since the time when we moved from a hospital treatment center, only kind of business model into what materialized as underlying disease management business. We moved from a value proposition that was aimed at customers in hospitals only to a value proposition that was aimed as sponsors, and as you know, we traditionally, and so had Axia aimed at health plans as their primary integrating partner to deliver that into the marketplace.

The value proposition, all along the string of expansions from that point forward has been on the basis of, obviously, improved health status and focused on an economic opportunity that was driven in and around the reduction in trend or actual spend on claims.

When you look at the evolving market over the past three or four years, Ryan, we've been talking about it and has reflected in our business three or fours years ago, even the ASO business line of our health plan had not yet been penetrated at all with even things such as disease management. In the short three or four years since when you include all of the Axia business, which the biggest chunk of that was obviously and still is SilverSneakers, which is a Medicare advantage customer set and a fully insured book in that regard, that overall, we have grown to about a third or a little over a third of our entire business from a revenue perspective, being driven specifically by large self insured employers.

And as it continues to look at interventions to drive more and more value, the solutions that they are looking for are beyond what is being delivered to-date. They openly acknowledge and are consuming more and more of the Health and Care Support type capability, they are asking now for direct cause and effect linkage for solutions that address and lower cost associated with lost productivity, whether that be to absenteeism and presenteeism, and a deep willingness, or maybe three, five, ten, fifteen years ago, there wasn’t the urgency, maybe to do this, now willing to pay for definitive cause and effect relationships from solutions into their population, to drive more activity of their employees, but also reaching beyond their employee base to the dependent families, that they are paying for and assuring that they are purchasing, not only better health, but higher performance, in and around their workforce.

So, why I made the comment was, when you look at the size of the market opportunity, it’s expanding again, Ryan, from the amount of savings that you could create on the direct medical spend side to now that plus the impacts that can be made and captured around the improved lost productivity issue. And the Axia business happen to bring us assets, proven outcomes, management, people, talent, product solutions and technology that is been aimed for years. In some cases portions that our business 15, 20 years at exactly that. And so with speed, we quickly were able to bring two leaders, one of the leaders in the area, that we traditionally have aim to drive improved clinical performance and outcomes which related to lower claim spend with prevention and primary prevention and lifestyle risk management, which drove outcomes and improvement around the issue of loss productivity.

We brought them together, and at fairly short period of time, have seen the market place moved quickly to adopt, the idea and the benefits of a sole source provider brining the full array of that value proposition.

So that's why I made the comments that I did. Is that make sense to you?

Ryan Daniels - William Blair

Yeah I know that's really helpful color.

Ben Leedle

Okay.

Ryan Daniels - William Blair

Thanks so much. I will hop back in the queue

Ben Leedle

Alright.

Operator

We will take our next question from Art Henderson with Jefferies and Company.

Art Henderson - Jefferies and Company

Hi, good afternoon.

Mary Chaput

Hey there.

Art Henderson - Jefferies and Company

Hi, couple of just housekeeping questions also. Looking at the international expense that you have got forecasted for Q1. I know that you are staffing up a call center outside of Berlin, I guess as I recall. As we look throughout the year are the first two quarters going to be the quarters, where you see most of the expense and then it becomes more of a positive earnings trajectory?

Mary Chaput

Yeah, I would say so, and similar to domestic, you will probably see more of the cost at the tail end of Q1 and the beginning of Q2. As we get operational and through the hiring and the training in those cost of the management team.

Art Henderson - Jefferies and Company

Okay, okay good. And then on the CapEx side is there any sort of trend that we should look at there in terms throughout the year?

Mary Chaput

Well again the call center as you know run some were around $4 million to $5 million and we have got three, four of them going in the first half the year. So, that will push most of that into Q2.

Art Henderson - Jefferies and Company

Okay. That's helpful. And then, at this point is the integration of Axia pretty much complete from a system standpoint or is there additional things that you can do as there as well?

Mary Chaput

Yes. We've been very happy with Axia and we're going to be continuing. We did no harm this year, but the market demand was much stronger than we anticipated and, so we will be continuing to integrate the Health and Care Support solutions and in addition more of the HR stuffs and benefits, harmonization and probably spending another close to $5 million again this year as we do those things. The technology piece of course will go along with that as well.

Art Henderson - Jefferies and Company

Okay. And then one last question for you, Mary. What's the difference between getting to the low-end of your guidance, since you have here in the high-end and what accounts for that difference, is its strength that you are expecting in core commercial mostly or is it?

Mary Chaput

Yes. I think its revenue driven.

Art Henderson - Jefferies and Company

Okay. It's revenue driven. Okay. And then Ben, one last question. I'll jump back in the queue. Obviously, you have been aggressive at times at buying products and services that you think will work very well. Do you feel at this juncture you got everything in-house that you need to sort of drive the business for a period of time or there are things that you are looking at out there that look attractive to you to add on as additional products and services and if so what are those?

Ben Leedle

Yeah. Good question. We have a dedicated corporate development team and they are constantly looking at what's out there. They are doing that through, obviously, a strategic length. I would want to kind of put to bed any kind of concern or issue if anybody we believe that we are looking at something on the order of another Axia in '08, I can relieve that tension for you across the board that, that just not in the plan.

However, as May listed out there was some smaller things that we did even after the Axia transaction was done and those are related to the platform around continuing to drive our strategy anything that we think on a timing basis brings us an advantage around integration or to drive a better analytics that focus on the specificity of the intervention first or anything that we think can materially advance the behavioral change science that's the underlying core to our platform, we will texture is look that but we think we have what we need from a set of assets to go pursue all dimensions of what I described for our business ahead in '08 and beyond. Then I would largely say there is a heavy, heavy emphasis to take those assets integrate them and execute on them.

Art Henderson - Jefferies and Company

Okay, that's great and then one last one I'll jump in the queue. Medco obviously you are getting some traction there, I've noticed in your press release you have talked about 16 customers initiated, is that accelerating? Is Medco talks to their plan sponsors?

Ben Leedle

It's absolutely accelerating. We are working hard. Again ten year relationship, we are about a year and half in, we've got some good wins in the call and we wanted to share a little bit about that with you because I know that it's been a point of interest. We've indicated that you'll start to see the reflection of the work that we have been doing with Medco, show up more in the back half of our fiscal year and we have lot to do with a lot of the Medco customers who have joined in, in that number 16 or large self-insured employers. The calendar 11 or 21 or 31, goal lives, related to those, obviously start getting fully expressed in the back cap of our year. So from a standpoint of sales, I am a guy who is never completely satisfied with sales but the momentum is building. I think the other part of that deal, which I would remind everyone, is the purpose of the long term nature of that relationship was to afford a true product innovation that is aimed specifically at work that is bringing the best practice in pharma management with the best practice in care management together to drive both efficiencies, as well as the opportunity to expand on already established value and to materially increase that leveraging, both the skill sets of people with subject matter expertise i.e. pharmacists and nurses and to get there was much more deeply coordinated and advantaged by an integrated database. So, that work has been moving along actually better than expectation for the timeframe that we have had. So, overall, we still look at that as an important part of the stream of story around integrating the capability, so that we are helping to break down one of the biggest problems in healthcare today, which are the silos that exist, that don't interact or talk with each other. So, this is a chance to knock down a really big wall and bring the value that comes with that in a measurable way.

Art Henderson - Jefferies and Co

Okay, that's great, thanks. Keep up the great work.

Ben Leedle

Well, thanks.

Operator

We will take our next question from Thomas Carroll with Stifel Nicholas.

Thomas Carroll - Stifel Nicholas

Good evening, Ben and Mary. How are you?

Mary Chaput

Hi, Tom.

Ben Leedle

How are doing Tom.

Thomas Carroll - Stifel Nicholas

Very good, couple of quick questions I think that are related to the ones we have already heard. Could you give us a sense of new sales traction for Axia's SilverSneakers product, which absolutely seems to be very robust? In terms about what I am looking for here is, maybe something to compare to what you originally said, when you did the acquisition. Is it 25%, is it 30%, is it in that ballpark and you certainly can use whatever language you like. And then secondly, I guess more theoretical have any of our Medicare advantage health plan customers had conversations with you about, payment reform in the Medicare advantage program and what that might mean for SilverSneakers in '09, 2010 and beyond?

Ben Leedle

Yes, so we take the first one. The simple answer is the growth conditions on a percent growth basis that we gave you when we did the transaction remained intact.

Thomas Carroll - Stifel Nicholas

Okay.

Ben Leedle

Secondly, we have not had any conversations with any of our Medicare advantage customers where they are sitting down with us wanting to talk, about the implications of any kind of reform around reimbursement related to Medicare advantage.

I would not use that as an indication. That is not something that we and they are keeping track of. The nature of the solution that SilverSneakers is lends itself for strongly as a marketing differentiation, for those Medicare advantage plans and then serves as a health enhancement, health improvement vehicle in that population. And so there is a whole lot of reasons around, the strategic opportunities for growth, regardless and agnostic to the reimbursement model, where it may actually intensify both the need and the interest in SilverSneakers if the kind of reform you are referencing actually were to come about.

Thomas Carroll - Stifel Nicholas

Yeah, okay may all the Medicare advantage plans, and this no secret. I will talk about, all the wiggle room they have so to speak in terms of maintaining margins if payment does get restricted somewhat which inevitably I think it will at some point. But it sounds like I'm too early in my question in terms of that occurring just yet?

Ben Leedle

I think the other thing that those Medicare advantage plans would tell you straight up is that making certain that they slow the turn or the turnover or the existing of their membership once after they've sunk in the acquisition cost of growing that membership. It's probably one of the single greatest levers that they have and we have really strong data from the outcomes of those that are participating SliverSneakers as they say. And so that's the other economic factor, this as well that plays into it.

Thomas Carroll - Stifel Nicholas

Okay. And then quickly on the MHS program. It sounds like you are rolling that performance into your domestic bucket of reporting. If MHS impacts this category either in a very unexpectedly favorable or unexpectedly unfavorable way, can we expect you guys to provide some visibility on that or is it just going to be here goes the number?

Ben Leedle

No, absolutely. This is not, we are going dark on MHS. It's just, as we looked at the relative size of that portion of our business and the steps that we went to basically forecast and clarify for all of you what the downside impact of this was through 2008, from back at our third quarter earnings. We felt like at this point given the size of our domestic market and how we are looking at both organizing ourselves and moving forward strategically that this, you want to think of it as a line of business inside of domestic as we go forward. We are not going to stop talking about it and we promise you that we'll keep you up-to-date when things happen and we will do that. You're not going to have to guesstimate on.

Thomas Carroll - Stifel Nicholas

Great, thank you very much.

Ben Leedle

Yes.

Operator

We will take our next question from Glenn Garmont with Broadpoint Capital.

Glenn Garmont - Broadpoint Capital

Thanks, good afternoon. Ben just quickly with regard to the international contract, the 50,000 person potential target in those two regions, is that opt in or is that opt out, can you just talk a little bit about the process of actually procuring patients there? And then real quick on the numbers side; Mary, look like the tax rate was a bit higher in the quarter. What's the tax rate that's assumed in your fiscal '08 guidance?

Mary Chaput

Okay, yeah, we're still using 40%, you are going to see this tax rate fluctuate, we do quarterly true ups, we have got more states now international is going to have some effect on it overtime but right now we're using 40%.

Glenn Garmont - Broadpoint Capital

Okay.

Ben Leedle

Okay, and back to your question about the message for eligibility and participation, obviously the plan will identify those cohorts provide those to us and I would think of it as the way I would describe it as modified opt out and it would take the similar process as to the front end of Medicare Health Support, so that's the one and only similarity. Just to maker sure that I am not sending you down the wrong course and if you'll remember within a one and half, two months period we were in excess of 80% participation confirmed. So it’s not a negative election solely, it is a modified opt out and that we need to get some confirmation for the participation and all that's been factored into the forecast and the projections that we have.

Glenn Garmont - Broadpoint Capital

Okay, great. Thanks for the comments guys.

Ben Leedle

Yes.

Operator

We'll take our next question from [Darren Mueller] with Goldman Sachs.

Darren Mueller - Goldman Sachs

Good evening. Thanks, guys.

Mary Chaput

Hi, there.

Darren Mueller - Goldman Sachs

A question. Can you provide an update on the Wellmark relationship?

Ben Ledlee

Sure. Nothing but good things to update you with. As you know, we have the ASO and the fully insured contract with Wellmark. It was about this time, a year ago, that we shared with you that they were going to move that business to a competitor, just the fully insured piece, while we kept the ASO piece. It was the end of February, March, where we actually transition that program over, and by May, we had regained that business back, we contracted for it, and we just went live October 1, on the fully insured book of business that we had a year ago.

So, it was tumultuous and kind of complicated process over the last year to get it back to where we were, in terms of a year ago, prior to that change. The difference is, this time around, the term of the agreement is a long-term and what I have sketched out as a whole health model, in and around the newer value proposition that includes lost productivity, Wellmark, obviously has a model that’s very consistent with that. It’s very committed to creating a much deeper integration and dedicated medical home. You may have seen recent headlines yesterday, the day before, where the Blues Association had talked about a very formal commitment, along with providers and other entities to drive a fully integrated and fully leveraged point of care medical home on behalf of that value proposition and I think that's the kind of opportunity that we have and that we are working on with Wellmark, going forward in term to, create and work with them and their other partners in doing that.

So, I can't think of a more exciting forward looking relationship that we have in the business today. So thanks for asking.

Darren Mueller - Goldman Sachs

Thanks Ben. Another question with your decision to combine the commercial and MHS results, has there been any operational changes with the MHS pilot, I believe that would be in around of it own call facility?

Ben Leedle

No.

Mary Chaput

It's just going to continue with the declining population will continue to serve their population, the cost that will be booked to that business a line of business if you will, will stay the same.

Darren Mueller - Goldman Sachs

So it's a dedicated team?

Mary Chaput

Yes, nothing changing on that front.

Darren Mueller - Goldman Sachs

Okay and one last question. Mary, can you separate the $107 million cash flow last year into maybe core MHS international just getting out ahead?

Mary Chaput

I don't have that readily, we simply don't talk about the MHS revenues. So you and the BIE, so you should be able to call that apart, we talk about the EPS and the revenue so you should be able to get with the cost side. I could take a stab at it, it's not something that we do, internally but we could take it offline.

Darren Mueller - Goldman Sachs

Okay, thank you.

Operator

We will take our next question from Brooks O’Neil with Dougherty & Company.

Brooks O’Neil - Dougherty & Company

Hi, guys. Couple of follow-on questions. I have been hearing, some fairly optimistic talk about the potential for changes in the performance criteria related to MHS, based on your comments. I am assuming, you are not currently expecting, any changes in those criteria during your fiscal '08 period. Is that right? Can you just give us any additional color on what the discussions have been and why or why not we might see changes?

Ben Leedle

Yes. I don't know what you are hearing Brooks and so I am interested in what you are hearing, but it's not that there isn't conversation about changes as it relates to the implications of design issues. Implications of data implications about possibly moving the performance bar from 5% net to budget neutrality. All that's in the works we shared that at the end of the third quarter. It's -- until there is something definitive there is nothing for me to be able to share with you. So, it doesn't mean that there isn't conversations or work being done and I just reminded there is other party and the government involves rather than CMS that are implicated in some of those changes.

So those are inside our government workings and then there is always continued conversations with CMS with the award easing so. Nobody stop talking and nobody stops working on this, but as I told you guys, more than 90 days ago we are done. Trying to forecast and predict around win definitive decisions and not just the decisions but on that decision, the definitive reconciliation of its implications would put us in a position to talk about that means to us both strategically and financially. So, we are not trying to be purposely not exact about this, but there is just really nothing new that we can share with you.

Brooks O’Neil - Dougherty & Company

That's fine. I appreciate that and I think it's probably good approach. Secondly, I just want to make sure I am doing the math right, that your guidance, Mary, for the first quarter would equate to essentially $0.27 to $0.29 and that does not include any of the $0.10 of moving cost, you highlighted in overall year guidance?

Ben Leedle

Can you say that again, Brooks?

Mary Chaput

It doesn’t.

Brooks O’Neil - Dougherty & Company

$0.27 to $0.29 for the first quarter.

Mary Chaput

Yes.

Brooks O’Neil - Dougherty & Company

And that does not include any of the moving costs?

Mary Chaput

It does include the moving cost.

Brooks O’Neil - Dougherty & Company

So there is some moving cost in that number?

Mary Chaput

Oh, yeah, the $0.10. You mean in the first quarter.

Brooks O’Neil - Dougherty & Company

Right.

Mary Chaput

I am sorry, I misunderstood, yeah, there is a little bit in there.

Brooks O’Neil - Dougherty & Company

Little like penny or?

Mary Chaput

Yeah, Penny or two.

Brooks O’Neil - Dougherty & Company

It’s now -- as you know and I've said repeatedly I am not in the count but I am just curious when we consider this $0.10 of moving expense sort of a non-recurring type item?

Mary Chaput

Well, I think generally the SEC has not very clear on using more of like non-recurring or one-time. And the reason for that, the thought behind that is the implications would be you are never moving again, and so we have been careful not use that term.

Brooks O’Neil - Dougherty & Company

I understand. Third question, I believe and at least my thinking the international effort was going to continue to involve roughly the $0.10 of base infrastructure cost that you established for 2007 and then perhaps there would be some implementation and a startup cost related to the actual contract, your guidance seems to suggest that you think that, that contract might actually be profitable in this fiscal '08 year. Am I missing something there or?

Mary Chaput

Yeah, or breakeven.

Brooks O’Neil - Dougherty & Company

Breakeven kind of a thing.

Mary Chaput

You are going to see a penny maybe either way.

Ben Leedle

Yeah, if you look at it exactly to bridge a penny up, penny down based on the map.

Brooks O’Neil - Dougherty & Company

Okay, and then I just want to be sure, you did say, you are not including any other international contracts in that, but you still think there might be some.

Ben Leedle

That's right.

Mary Chaput

Yeah.

Brooks O'Neil - Dougherty & Company

Okay, great. And then, just last question, and it's just kind of a nip, but I think this maybe the second year out of three in which your colleague bonuses were reduced for various issues. Just give us a quick feel for, how employees are feeling about the performance of the company and their participation in your success?

Ben Leedle

Great question and actually, it is not second in three, second in the four. So, three years ago and then this last year, we ended up with, we set our short term incentive plan based on internal targets. If you think about the distribution of profitability, we are aiming to meet our shareholders promises, and the internal targets are set, so that our colleagues understand where our performance has to be to also distribute profitability to them in the form of short term incentives. And it was primarily related to MHS, that those internal targets were not reached, and I don't think that would have been a surprise or a shock to anybody this past year.

I would keep in mind, so as you think about MHS, and the short term incentive issue, and I will get back to why I think it's important about the other culture, that BIE that sits there, at some point gets reconciled from Phase I. And it's probably going to be out in time somewhere before that happens, probably not in '08, maybe '09, could be even pushed out, depending upon government timelines in and around their decision making process for Phase II, probably largely, if and when there are revenues taken in out of that BIE. Obviously, there will be a reverse in order of priority, meaning that the shareholders will be sharing with our colleagues at that point.

So, the comment is made one, so that you are not surprised by that under that event. But more importantly, to understand that the colleagues here believe in what we are doing with MHS.

Brooks O'Neil - Dougherty & Company

Yes.

Ben Leedle

They believe that when you strip away the artifact, of the implications of some of the design issues that have been made very made public around this. That the underlying tenants of performance on every dimension or at are better than what we would have expected to be doing to deliver on the Phase I value proposition to push us to Phase II.

So I think, with that belief model, our colleagues are hard at work, and we continue moving forward, and they know there is just a little timing issue, in terms of the distribution of what might have been short-term incentive for them, in fiscal '07 at some later date down the road.

Now when we think about and if you will think back to four years ago, I got the same kind of questions. And I told you that I felt like we had a performance based culture here and our colleagues would respond to the challenge associated with that and they did. We did not, now to look back on a fact basis there is an opinion, we did not loose people as a function of that event. And I am confident, that our culture will carry us through this particular issue as well.

I think it's different, than the prior time where it wasn't an MHS like event. It was just simply we deliver the value necessary that would meet shareholder promises and nothing more at that point and so it's a fairly simple decision.

So I think one, is just a continued reflection that a lot of organizations will say they're aligned with their shareholders. I would tell you, I think we've proven that pretty emphatically as evidence around the decisions we make on this issue.

Don't ever expect me though to just make that blindly. If I felt like that decision would put the long-term viability or put at risk the challenge that's here in this organization, I would obviously be talking to you about that and maybe make a different kind of decision. But I am just trying to be straight forward with your question, Brooks. I think we are fine, but obviously it's nothing but a disappointment given that the external view into the company, particularly if you set MHS aside it's been a very positive and spectacular year on many fronts.

So it's a challenge. We will manage it and we will be prepared to deliver on several dimensions of performance expectations, both the external and the internal one in '08.

Brooks O'Neil - Dougherty & Company

Hopefully, stock-based compensation is offsetting some of the disappointment in the cash or bonuses?

Ben Leedle

Maybe.

Brooks O'Neil - Dougherty & Company

Now, just one last question and I appreciate all your thoughtful answers. It sounds to me like a little bit of a shift I guess, continuing shift towards the focus on the direct to employer market and the significant importance of the employer perhaps a little bit less of a focus, sounds like Medco is more direct to employer and a lot of the work you're doing outside is direct. Are you seeing a diminution of the interest in partnering with you from health plans or you continue to see that pipe as robust as it's always been?

Ben Leedle

No. We continue to see just as much activity if not continued more from health plans looking to partner with us around addressing that self-insured employer market. And as you know both Axia and Healthways' largely have built those businesses overtime and together we continue to strengthen that on the basis of primary health plan customers.

Obviously, Medco is a representation of another large entity that has aggregated the touch points on a lot of lives for which value can be driven by integrating rather than working independently. So, it really goes to the fact, Brooks that competition is competing on the value that can be created and I'm a firm believer that collaboration as a team and approach to this is the best way to go do this. So as long as health plans will have it, and organization like Medco have it and see the opportunity and expansion of value together as an independently we will continue to pursue those track.

Brooks O’Neil - Dougherty & Company

That's great. Thank you very much.

Operator

We have time for one more question. We'll take our next question from Michael Glynn with Credit Suisse

Michael Glynn - Credit Suisse

Hi, Ben. You have talked about silos in healthcare, getting different healthcare entities to interact, talk with each other, certainly there is a lot of talk in healthcare reform. That's a theme we hear frequently. Wellness effort gets its share, headlines which obviously get nicely with your business plan. The other big thing out here, we hear frequently is electronic health records and you hear in Aetna Health, Pfizer and recently Microsoft's Health Vault I believe it is. Do you view this as competition, or do you view it as you will partner with electronic health records in order to deliver your service?

Ben Leedle

Great question, because I think that, that's consuming a lot of the intellectual space strategically in healthcare. This wasn’t my insight, but it is an insight that I recently heard from another CEO, that in that space, in terms of where they are focused and it was interesting, cause his insight was, it's not the health record itself that matters. It’s not like I am going to take my health record and go, oh, let me take that down to my file in the basement and put right next to all the other things I need to store away. It doesn’t rise to that kind of level, it’s what you do with the information that’s in that health record, and is it portable, connected, wired in, and accessible to all of the parties that are touching and supporting an individual’s health improvement efforts.

So, a health record for the sake of a health record is not much of a powerful mover, the needle that people are looking to move. I think the promises there is the thought that if it is electronic, if it is put together with a rich data source, if the consumer isn't been motivated to take it and act with it and share it and make it accessible, all the other parties on their medical and health home team, then I think that there is a benefit, because you got people working off of, hopefully timely data being set in from many different sources and updated.

I think we are, there is all sorts of poor man version of electronic health record being created and populated with a lot of the traditional data that exist in healthcare today. I don’t think that that’s going to, that kind of data in and of itself is going to fulfill the promise of what electronic health record can do. So, as we think about, kind of the forward looking ecosystem, the electronic health record when done to the ideal that everybody is thinking about, I think only raises the bar in an around the quality revolution that’s taking place. It's going to create a higher awareness and therefore a higher demand for transparency, when that happens, the reimbursement potentially, gets rewired and realigned and you actually see a real paper performance opportunity.

I love, follow those implications because I think in a large way, we have been one of the poster child, for true paper performance which is, if you don't move the outcomes needle you don't get to stick around and keep doing your business. And so we like and understand that model, there is many other constituency in Healthcare traditionally that won't like that model.

And so I think it's going to be sometime yet, before that reaches your liquidity that going to be required in order for it to play in at an elemental level. I think there is a lot of mini-micro silos being creating around electronic health records. Which is just another way to segment and well off sharing of information because everybody wants to control and own the end all be all electronic health record.

And that answers your questions or not?

Michael Glynn - Credit Suisse

Yeah, that's helpful, I just had view that the nurse call center, that you provide as well as electronic health record just way to make the physicians office, a more efficient place and so I am just trying to get feel for how you viewed it and if that's competition or complimentary?

Ben Leedle

Yeah I mean, we are forward. We would like to see its continued development, we as a company aren't going to go build the end all be all electronic health record we are wishing good luck to all of those who are pursuing that.

Once established, I think we are a critical player in bringing richness to the data that can flow, as well as bringing other capability in asset to allow the connection points to take place for all the players in the medical and the health home and down at the consumer level.

Michael Glynn - Credit Suisse

Great thanks.

Ben Leedle

Yes.

Operator

That concludes the question-and-answer session today. At this time Mr. Leedle, I will turn the conference back over to you for any additional or closing remarks.

Ben Leedle

I just want to say thanks to everybody for your patience and being on the call, Mary and I will be around this evening for a little while, if you want to touch base and we are both here tomorrow and look forward to continue in conversations, we are out of our quite period obviously and looking forward to the coming weeks and getting out and having conversations with you all. That’s it.

Operator

Thank you for your participation. This concludes today's conference, you may now disconnect.

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Source: Healthways F4Q07 (Qtr End 08/31/07) Earnings Call Transcript
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