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HealthwaysInc. (NASDAQ:HWAY)

F4Q07 (Qtr End 08/31/07) EarningsCall

October 17, 2007 5:00 pm ET

Executives

Ben Leedle - President and CEO

Mary Chaput - CFO

Analysts

Ryan Daniels - William Blair

Art Henderson - Jefferies andCompany

Thomas Carroll - Stifel Nicholas

Glenn Garmont - BroadpointCapital

Darren Mueller - Goldman Sachs

Brooks O’Neil - Dougherty &Company

Michael Glynn - Credit Suisse

Operator

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

To the extent any non-GAAPfinancial measures discussed in today's call, you'll also find a reconciliationof that measure to the most directly comparable financial measure calculatedaccording to GAAP in today's news release, which is posted on the company's website.

This conference call may containforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995, including statements, among others, regardingHealthways' expected operating and financial performance for the first quarterand full year fiscal 2008. For this purpose, any statements made during thiscall that are not statements of historical fact may be deemed to beforward-looking statements. Without limiting the foregoing, the words believes,anticipates, plans, expects and similar expressions are intended to identifyforward-looking statements.

You are hereby cautioned thatthese statements may be affected by the important factors, among others, setforth in Healthways' filings with the Securities and Exchange Commission and inits news release issued today. Consequently, actual operations or results maydiffer materially from the results discussed in the forward-looking statements.The company undertakes no obligation to update publicly any forward-lookingstatements, whether as a result of new information, future events, orotherwise.

At this time, for openingremarks, I would like to turn the conference over to the company's Presidentand 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 thecompany's performance for the fourth quarter and for fiscal 2007. We will alsoaddress our outlook for fiscal 2008, which we presented in our news releaseissued earlier this afternoon. And as usual, I am here with Heathway CFO, MaryChaput, and after our prepared remarks, we will be happy to take your question.So let's begin.

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

As anticipated, our corecommercial business drove our growth throughout the year, either meeting orexceeding the high end of our earnings guidance each quarter. While we produceda 37% increase in core commercial earnings per diluted share for the year, Iwould suggest, that the more important achievement during fiscal 2007 was interms of laying the foundation for continuing future growth of the company withthe Axia acquisition.

The Axia transaction represents morethan 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 intodisease management from our hospital based treatment center business years ago,or even our launch the industry's first programs for multiple chronic diseasesand impact conditions from our previous diabetes only focus.

Through this transaction we notonly substantially expanded our market presence, we also integrated ourindustry leading array of proven Care Support solutions with the industry'sleading suite of Health Support solutions and networks. As a result we areuniquely positioned today to provide our health plan, employer, government andinternational customers with solutions that will have a meaningful impact onthe healthcare and health related costs of every individual, regardless of ageor health status. Continued integration and innovation on this space will onlystrengthen that capability in the future.

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

As I mentioned earlier, the Axiaacquisition has opened broad new market opportunities for us. One clear exampleof the magnitude of these opportunities in the short to intermediate term isour own base of existing customers.

Our billed lives increased 10fold to 27.4 million at the end of fiscal 2007 from 2.4 million at the end offiscal 2006. And the number of our health plan customers increased from 33 to102 and now represent approximately 85% of all commercially insured people inthis country. This dramatic expansion of our customer base represents atremendous cross-selling opportunity, which has already begun to be reflectedthrough the addition of over 30 contracts with existing customers foradditional services.

Our ability to make meaningfulprogress against these opportunities is also supported by the strongcontracting momentum, evident in our signings of both new and extendedcontracts during fiscal 2007. As we indicated in the press release today, wesigned 150 new extended or expanded programs since the end of fiscal 2006. It'sfour to five times the numbers in any comparable period before.

Based on our growing pipeline ofpotential new sales, we anticipate this momentum continuing for the foreseeablefuture. This momentum is being driven by rising market demand, especially fromself-insured employers for single-source full population solutions.

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

We have the proven ability toimplement our programs at scale, assuring our customers of efficientdistribution and we have the industry's best track record of outcomes forimproved health and reduce cost at scale. These unique capabilities combinedwith strong market demand enabled us to expand our core commercial business atan unprecedented pace.

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

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

As you are well aware, our growthin fiscal 2007 was achieved while not only carrying out the innovation thatI've just described, but also well bearing the cost associated with our effortsto open and establish a foothold in both the Medicare and internationalmarkets.

Our guidance for fiscal 2008includes continuing investments in both of these areas. So despite ourcontinuing positive interactions with CMS, I can update you that nothing hasyet occurred that materially changes the discussion we had in our third quarterrelease and conference call about either our MHS pilot or anything that comeafter the pilot. Accordingly, our fourth quarter results, and our guidance for2008 cost, with respect to MHS remain the same as we presented to you lastquarter. Nevertheless, our commitment to the MHS process remains firm. Whilethere are no guarantees about whether there will be a Phase II or whether wewill participate, we are confident first of our ability to maintain or improvethe outcomes of the Medicare population while lowering its healthcare cost.Second, is the very large need and opportunity that aggregate Medicare marketrepresents. And third, that the best path we have towards any potential PhaseII participation is through completion of the work that we began in Phase I. Aswe have done through our participation in the pilots, we will be as timely andtransparent as we can with regard to any developments.

So, moving to our internationalinitiative, we were delighted to announce that in late August the industry’sfirst international Health and Care Support contract with Deutsche AngestelltenKrankenkasse, or from hereon out better know as DAK, a 33 year old, 6.2 millionmember statutory health insurance company in Germany. This contract, whichresulted from a competitive RFP process validates the unique positioning wehave achieved through our demonstrated ability to deliver proven solutions atscale.

Now, initially we will besupporting approximately 50,000 DAK members in two regions of Southern Germany. The criteria, for eligibility in these regions, will be adiagnosis of heart failure, chronic obstructive pulmonary disease and/ordiabetes.

In addition, positive operationalprogress and outcomes from this effort will create an opportunity for us topursue expansion to all of DAK's members who have these conditions. That's anestimated 750,000 individuals with these chronic illnesses or a potential for a15 times growth opportunity within DAK.

In addition, there are manysmaller sick funds in Germanywhich are expected to be consolidated over the next few years. DAK, currentlyat 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 thiscontract are a fixed fee per participant. With performance in excess ofestablished targets, the contract includes a gain share mechanism for thecompany. This is a clear indication that DAK is buying to maximize outcomes, asoppose to minimizing fees to just have a program.

I want to share another pointregarding the competitive nature of the bid process. There were multipleparties involved, as I mentioned, and in fact DAK originally expected towardstwo company's one region each and then compare overtime.

I believe in part it is a strongtestament to our model, our credibility, the team of people we have working onthis, and our preparedness, that in the end both regions were awarded toHealthways exclusively. The DAK contract also supports our ongoing initiativeswith other potential international customers in other countries.

As I said before, the sameconcerns that are at the center of the healthcare debate domestically aredriving our conversations with potential governmental and commercial customersinternationally and we anticipate additional international contracts duringfiscal 2008.

So, as you saw in our newsrelease, we expect new contract implementation cost in our ongoinginternational development costs to more than offset our initial internationalrevenues for fiscal 2008. However, as we gain critical mass in theinternational market, we anticipate that it will prove to be a significantcontributor to our continued long-term profitable growth.

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

Mary Chaput

Thank you, Ben, and goodafternoon everyone. Fiscal 2007 wraps up another year of solid performance forHealthways. Revenues were up 49% to approximately $616 million from $412million in fiscal 2006. Core commercial revenues were up 54% over the sameperiod, even including the $5 million of integration cost due to the Axiaacquisition and the increased cost of both our international and MHSinitiatives.

Total company EBITDA in fiscal2007 increased slightly as a percent of total revenues over 2006 levels,primarily as a result of increased capacity utilization, and a reduction in thelevel 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 strategicallyimportant year, which drove a variety of financing activity. We completed theacquisition of Axia, the market leader in health support solutions on December1, 2006. We acquired a small web development company [Vigot] on March 1st.

We made a minority investment inD2Hawkeye, a leading provider of medical analytics and reporting and acquiredthe assets of First Opinion, an automated diagnostic software company on August1st.

We completed a syndicatedfinancing package totaling $600 million and achieved our first corporate agencyrating. We established international legal entities and banking processes andhave begun implementing our first international contract in Germany.

The contribution to EPS for thefourth quarter from our core commercial business was $0.45, one step above thehigh-end of our guidance and $1.77 for the fiscal year, up 37% from fiscal2006. Additional cost associated with securing and beginning the implementationof our international contract in the fourth quarter added $0.02 cents to ourexpected dilution from international activities, resulting in the net costimpact for the fiscal year of $0.12.

The next cost impact from the MHSPhase 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 fourthquarter of $0.31 was on the high-end of our guidance.

Operating cash flow in fiscal2007 totaled approximately $107 million for the year. We ended the year withapproximately $48 million in cash, following cash expenditures of $151 millionin acquisitions and investments, the pay down of $51 million in debt and the repurchaseof approximately $6 million of stock.

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

For fiscal 2008, we expect totalcompany revenues to be in the range of $782 to $815 million, which wouldrepresent a 27% to 32% increase over fiscal 2007. Domestic revenues in fiscal2008 are expected to be in the range of $774 million to $805 million, a 26% to31% increase over domestic revenues in fiscal 2007. This amount includesexpected fixed fee revenues from the MHS pilots of $4 million to $5 million.

Given the relative size, term andfinancial predictability of the MHS Phase I pilots, we will be combining theresults of what we have previously referred to as our core commercialoperations with the MHS pilots, and reporting them as one number for ourdomestic markets going forward.

We will continue to recordinternational operations separately and will of course provide you necessarydetails regarding the MHS pilots and their financial impact as new eventswarrant.

International revenues from thenewly signed contract with DAK in Germany, which goes live on January1st, are expected to be in the range of $8 million to $10 million. Some of thedynamics that we anticipate in the year ahead, include significant contractstarts in our second quarter, primarily on January 1st, related to the backlogthat Ben mentioned earlier.

We expect first quarter revenuesto be slightly higher than the fourth quarter of fiscal 2007, and increasinglystronger revenue growth over the remainder of the year. This seasonalityreflects an aspect of and an increase in the mix of Health Support solutionsbeing provided primarily to self insured employers.

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

In addition to the upfront costof the management team, recruiting, hiring and training of the clinicians andcoaches to deliver on those contracts, and the development of data exchangeprocesses and analysis with our new customers.

As a result of those dynamics, weanticipate that the contribution to EPS, from our domestic business in ourfirst fiscal quarter, will be in the range of $0.33 to $0.34. The ongoingactivities of the international business development team and the first quarternet cost impact and preparing for January 1 start of our international contractis expected to be in the range of $0.05 to $0.06.

Contribution to EPS from our domesticbusiness for fiscal 2008 is expected to be in the range of $1.88 to $1.95 whichis 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 movingcost, duplicate rep for a short period of time, and an expected write-off ofcertain fixed assets primarily, furniture and fixtures. The net cost impact ofthe last year of the Phase I MHS pilots, which is included in this EPS rangefor our domestic business, is expected to be as we have previously discussedapproximately $0.25.

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

Regarding the balance sheet andcash flow in fiscal 2008, with four anticipated care enhancement centers, threedomestic, and one international, and our new headquarters all coming on line infiscal 2008, we anticipate that our capital expenditures will be in the rangeof $70 million to $75 million, which will also include continued systemsintegration of our Care and Health Support solutions, ongoing productenhancement and development and infrastructure upgrades.

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

And with that, I will turn itback over to Ben.

Ben Leedle

Thanks, Mary. I want to concludetoday with some thoughts about what we intend to build on a foundation that welaid this past fiscal year. Those of you have followed us for sometime knowthat we have been guided by consistent vision, which recognizes that the bestway to drive the most improved outcomes possible and thereby the greatesthealthcare and health related cost savings, would be the development ofcomprehensive, integrated, and personalized solutions that would address theneeds of each individual, regardless of health status, when first engaged.

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

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

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

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

So, as we enter fiscal 2008, weare actively engaging full populations of our health plan and importantcustomers who are supporting our efforts by incentivizing their members or employeesto participate.

In addressing the needs of thewhole population, our value proposition has expanded beyond the impact ofdirect healthcare cost savings, enabling us to credibly address with ourcustomers the hidden and largely unmeasured health related impact on employeeproductivity. These issues are very real for our customers, be it health plansor employers, and we expect our ongoing innovation toward a comprehensive wholehealth solution, that meets the needs of individual sponsors and providers willbegin to bear fruit in fiscal 2008.

Healthways commitment to andmeasured progression toward our vision over the years and has createdtremendous growth and significantly increased stockholder value. As both theshareholder 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 opportunitiesthat lie ahead of us as we pursue to three key initiatives. First, thecontinued expansion of our value proposition to legitimately include bothhealthcare cost savings and health related cost savings. Second, furtherdeveloping and implementing the solutions that will deliver on that expandedvalue proposition for our customers. And third, to deliver those solutions toliterally hundreds of millions of people around the world as we furtherpenetrate our domestic markets, while we are actively expanding ourinternational markets.

Now, just two weeks ago,Healthways market cap touched $2 billion. Just this week, we were againacknowledged by Fortune as one of the nations leading growth companies. We havebeen presented with significant opportunities for growth over the past severalyears and we have been there each time with the solutions the market wasdemanding. Equally as important, those solutions worked, delivering for ourcustomers each element of the value that we promised that they would, whileproducing profitable growth for our stockholders.

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

And as an ending point here, asyou 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 thecompany's progress. We have organized our capital resources, our people,processes and tools, to address the domestic market separately with the sameapproach dedicated to the international market. We think the size and relativepredictability of our domestic business allow for a simplified way to fullyunderstand our progress on this front.

Given the conversation of ourinternational efforts, or the conversion of our international efforts fromessentially a business development effort only to now additionally thebeginning of an operating business, we believe that it is the right time tomove communication and metrics out of our business results and growthprospects, to terms of domestic and international.

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

Question-and-Answer Session

Operator

(Operator Instructions). We willtake 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 housekeepingquestions and some broader ones. Mary, can you, just a feel on the headquartermove cost, how that will flow through the year? Do you think that will be aheavier, kind of Q1, Q2 and then dissipate with just the remnants of some ofthe 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 ofit in Third quarter and then some ongoing depreciation in Q4, which is notincluded in that $0.10.

Ryan Daniels - William Blair

Okay, great. And then, I know youguys break this out in the queue. I am hoping you could give it now. Do youhave 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 wasa little bit below your thoughts because of some weakness in SilverSneakers. Doyou have any feel for what may have driven that? Is that…?

Mary Chaput

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

Ryan Daniels - William Blair

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

Mary Chaput

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

Ryan Daniels - William Blair

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

Mary Chaput

Yeah, absolutely I think wementioned that the international initiative actually was $0.02 more dilutivethan what we originally guided to and that was because we have started thatimplementation.

Ryan Daniels - William Blair

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

Ben Leedle

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

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

When you look at the evolvingmarket over the past three or four years, Ryan, we've been talking about it andhas reflected in our business three or fours years ago, even the ASO businessline of our health plan had not yet been penetrated at all with even thingssuch as disease management. In the short three or four years since when youinclude all of the Axia business, which the biggest chunk of that was obviouslyand still is SilverSneakers, which is a Medicare advantage customer set and afully insured book in that regard, that overall, we have grown to about a thirdor 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 atinterventions to drive more and more value, the solutions that they are lookingfor are beyond what is being delivered to-date. They openly acknowledge and areconsuming more and more of the Health and Care Support type capability, theyare asking now for direct cause and effect linkage for solutions that addressand lower cost associated with lost productivity, whether that be toabsenteeism and presenteeism, and a deep willingness, or maybe three, five,ten, fifteen years ago, there wasn’t the urgency, maybe to do this, now willingto pay for definitive cause and effect relationships from solutions into theirpopulation, to drive more activity of their employees, but also reaching beyondtheir employee base to the dependent families, that they are paying for andassuring that they are purchasing, not only better health, but higherperformance, 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 medicalspend side to now that plus the impacts that can be made and captured aroundthe improved lost productivity issue. And the Axia business happen to bring usassets, proven outcomes, management, people, talent, product solutions andtechnology that is been aimed for years. In some cases portions that ourbusiness 15, 20 years at exactly that. And so with speed, we quickly were ableto bring two leaders, one of the leaders in the area, that we traditionallyhave aim to drive improved clinical performance and outcomes which related tolower claim spend with prevention and primary prevention and lifestyle riskmanagement, which drove outcomes and improvement around the issue of lossproductivity.

We brought them together, and atfairly 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 ofthat value proposition.

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

Ryan Daniels - William Blair

Yeah I know that's really helpfulcolor.

Ben Leedle

Okay.

Ryan Daniels - William Blair

Thanks so much. I will hop backin the queue

Ben Leedle

Alright.

Operator

We will take our next questionfrom 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 housekeepingquestions also. Looking at the international expense that you have gotforecasted for Q1. I know that you are staffing up a call center outside of Berlin, I guess as Irecall. As we look throughout the year are the first two quarters going to bethe quarters, where you see most of the expense and then it becomes more of apositive earnings trajectory?

Mary Chaput

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

Art Henderson - Jefferies and Company

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

Mary Chaput

Well again the call center as youknow run some were around $4 million to $5 million and we have got three, fourof them going in the first half the year. So, that will push most of that intoQ2.

Art Henderson - Jefferies and Company

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

Mary Chaput

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

Art Henderson - Jefferies and Company

Okay. And then one last questionfor you, Mary. What's the difference between getting to the low-end of yourguidance, since you have here in the high-end and what accounts for thatdifference, is its strength that you are expecting in core commercial mostly oris 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, youhave been aggressive at times at buying products and services that you thinkwill work very well. Do you feel at this juncture you got everything in-housethat you need to sort of drive the business for a period of time or there arethings that you are looking at out there that look attractive to you to add onas additional products and services and if so what are those?

Ben Leedle

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

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

Art Henderson - Jefferies and Company

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

Ben Leedle

It's absolutely accelerating. Weare 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 aboutthat with you because I know that it's been a point of interest. We'veindicated that you'll start to see the reflection of the work that we have beendoing with Medco, show up more in the back half of our fiscal year and we havelot to do with a lot of the Medco customers who have joined in, in that number16 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 ofour year. So from a standpoint of sales, I am a guy who is never completelysatisfied with sales but the momentum is building. I think the other part ofthat deal, which I would remind everyone, is the purpose of the long termnature of that relationship was to afford a true product innovation that isaimed specifically at work that is bringing the best practice in pharmamanagement with the best practice in care management together to drive bothefficiencies, as well as the opportunity to expand on already established valueand to materially increase that leveraging, both the skill sets of people withsubject matter expertise i.e. pharmacists and nurses and to get there was muchmore deeply coordinated and advantaged by an integrated database. So, that workhas been moving along actually better than expectation for the timeframe thatwe have had. So, overall, we still look at that as an important part of thestream of story around integrating the capability, so that we are helping tobreak down one of the biggest problems in healthcare today, which are the silosthat exist, that don't interact or talk with each other. So, this is a chanceto knock down a really big wall and bring the value that comes with that in ameasurable way.

Art Henderson - Jefferies and Co

Okay, that's great, thanks. Keepup the great work.

Ben Leedle

Well, thanks.

Operator

We will take our next questionfrom Thomas Carroll with Stifel Nicholas.

Thomas Carroll - Stifel Nicholas

Good evening, Ben and Mary. Howare you?

Mary Chaput

Hi, Tom.

Ben Leedle

How are doing Tom.

Thomas Carroll - Stifel Nicholas

Very good, couple of quickquestions I think that are related to the ones we have already heard. Could yougive us a sense of new sales traction for Axia's SilverSneakers product, whichabsolutely seems to be very robust? In terms about what I am looking for hereis, maybe something to compare to what you originally said, when you did theacquisition. Is it 25%, is it 30%, is it in that ballpark and you certainly canuse whatever language you like. And then secondly, I guess more theoreticalhave any of our Medicare advantage health plan customers had conversations withyou about, payment reform in the Medicare advantage program and what that mightmean 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 wegave you when we did the transaction remained intact.

Thomas Carroll - Stifel Nicholas

Okay.

Ben Leedle

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

I would not use that as anindication. That is not something that we and they are keeping track of. Thenature of the solution that SilverSneakers is lends itself for strongly as amarketing differentiation, for those Medicare advantage plans and then servesas a health enhancement, health improvement vehicle in that population. And sothere is a whole lot of reasons around, the strategic opportunities for growth,regardless and agnostic to the reimbursement model, where it may actuallyintensify both the need and the interest in SilverSneakers if the kind ofreform you are referencing actually were to come about.

Thomas Carroll - Stifel Nicholas

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

Ben Leedle

I think the other thing thatthose Medicare advantage plans would tell you straight up is that makingcertain that they slow the turn or the turnover or the existing of theirmembership once after they've sunk in the acquisition cost of growing thatmembership. It's probably one of the single greatest levers that they have andwe have really strong data from the outcomes of those that are participatingSliverSneakers as they say. And so that's the other economic factor, this aswell that plays into it.

Thomas Carroll - Stifel Nicholas

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

Ben Leedle

No, absolutely. This is not, we aregoing dark on MHS. It's just, as we looked at the relative size of that portionof our business and the steps that we went to basically forecast and clarifyfor all of you what the downside impact of this was through 2008, from back atour third quarter earnings. We felt like at this point given the size of ourdomestic market and how we are looking at both organizing ourselves and movingforward strategically that this, you want to think of it as a line of businessinside of domestic as we go forward. We are not going to stop talking about itand we promise you that we'll keep you up-to-date when things happen and wewill 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 questionfrom Glenn Garmont with Broadpoint Capital.

Glenn Garmont - Broadpoint Capital

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

Mary Chaput

Okay, yeah, we're still using40%, you are going to see this tax rate fluctuate, we do quarterly true ups, wehave got more states now international is going to have some effect on itovertime but right now we're using 40%.

Glenn Garmont - Broadpoint Capital

Okay.

Ben Leedle

Okay, and back to your questionabout the message for eligibility and participation, obviously the plan willidentify those cohorts provide those to us and I would think of it as the way Iwould describe it as modified opt out and it would take the similar process asto the front end of Medicare Health Support, so that's the one and onlysimilarity. Just to maker sure that I am not sending you down the wrong courseand if you'll remember within a one and half, two months period we were inexcess 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 theparticipation and all that's been factored into the forecast and theprojections that we have.

Glenn Garmont - Broadpoint Capital

Okay, great. Thanks for thecomments 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 anupdate on the Wellmark relationship?

Ben Ledlee

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

So, it was tumultuous and kind ofcomplicated process over the last year to get it back to where we were, interms 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 awhole health model, in and around the newer value proposition that includeslost productivity, Wellmark, obviously has a model that’s very consistent withthat. It’s very committed to creating a much deeper integration and dedicatedmedical home. You may have seen recent headlines yesterday, the day before,where the Blues Association had talked about a very formal commitment, alongwith providers and other entities to drive a fully integrated and fullyleveraged point of care medical home on behalf of that value proposition and I thinkthat's the kind of opportunity that we have and that we are working on withWellmark, going forward in term to, create and work with them and their otherpartners in doing that.

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

Darren Mueller - Goldman Sachs

Thanks Ben. Another question withyour decision to combine the commercial and MHS results, has there been anyoperational changes with the MHS pilot, I believe that would be in around of itown call facility?

Ben Leedle

No.

Mary Chaput

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

Darren Mueller - Goldman Sachs

So it's a dedicated team?

Mary Chaput

Yes, nothing changing on thatfront.

Darren Mueller - Goldman Sachs

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

Mary Chaput

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

Darren Mueller - Goldman Sachs

Okay, thank you.

Operator

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

Brooks O’Neil - Dougherty & Company

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

Ben Leedle

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

So those are inside ourgovernment workings and then there is always continued conversations with CMSwith 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 forecastand predict around win definitive decisions and not just the decisions but onthat decision, the definitive reconciliation of its implications would put usin a position to talk about that means to us both strategically andfinancially. So, we are not trying to be purposely not exact about this, butthere is just really nothing new that we can share with you.

Brooks O’Neil - Dougherty & Company

That's fine. I appreciate thatand I think it's probably good approach. Secondly, I just want to make sure Iam doing the math right, that your guidance, Mary, for the first quarter wouldequate to essentially $0.27 to $0.29 and that does not include any of the $0.10of 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 firstquarter.

Mary Chaput

Yes.

Brooks O’Neil - Dougherty & Company

And that does not include any ofthe moving costs?

Mary Chaput

It does include the moving cost.

Brooks O’Neil - Dougherty & Company

So there is some moving cost inthat number?

Mary Chaput

Oh, yeah, the $0.10. You mean inthe 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'vesaid repeatedly I am not in the count but I am just curious when we considerthis $0.10 of moving expense sort of a non-recurring type item?

Mary Chaput

Well, I think generally the SEChas not very clear on using more of like non-recurring or one-time. And thereason for that, the thought behind that is the implications would be you arenever moving again, and so we have been careful not use that term.

Brooks O’Neil - Dougherty & Company

I understand. Third question, Ibelieve and at least my thinking the international effort was going to continueto involve roughly the $0.10 of base infrastructure cost that you establishedfor 2007 and then perhaps there would be some implementation and a startup costrelated to the actual contract, your guidance seems to suggest that you thinkthat, that contract might actually be profitable in this fiscal '08 year. Am Imissing 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 pennymaybe either way.

Ben Leedle

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

Brooks O’Neil - Dougherty & Company

Okay, and then I just want to besure, you did say, you are not including any other international contracts inthat, 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 lastquestion, and it's just kind of a nip, but I think this maybe the second yearout 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 ofthe company and their participation in your success?

Ben Leedle

Great question and actually, itis not second in three, second in the four. So, three years ago and then thislast year, we ended up with, we set our short term incentive plan based on internaltargets. If you think about the distribution of profitability, we are aiming tomeet our shareholders promises, and the internal targets are set, so that ourcolleagues understand where our performance has to be to also distributeprofitability to them in the form of short term incentives. And it wasprimarily related to MHS, that those internal targets were not reached, and Idon't think that would have been a surprise or a shock to anybody this pastyear.

I would keep in mind, so as youthink about MHS, and the short term incentive issue, and I will get back to whyI think it's important about the other culture, that BIE that sits there, atsome point gets reconciled from Phase I. And it's probably going to be out intime somewhere before that happens, probably not in '08, maybe '09, could beeven pushed out, depending upon government timelines in and around theirdecision making process for Phase II, probably largely, if and when there arerevenues taken in out of that BIE. Obviously, there will be a reverse in orderof priority, meaning that the shareholders will be sharing with our colleaguesat that point.

So, the comment is made one, sothat you are not surprised by that under that event. But more importantly, tounderstand 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 stripaway the artifact, of the implications of some of the design issues that havebeen made very made public around this. That the underlying tenants ofperformance on every dimension or at are better than what we would haveexpected to be doing to deliver on the Phase I value proposition to push us toPhase II.

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

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

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

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

Don't ever expect me though tojust make that blindly. If I felt like that decision would put the long-term viabilityor put at risk the challenge that's here in this organization, I wouldobviously be talking to you about that and maybe make a different kind ofdecision. 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 disappointmentgiven that the external view into the company, particularly if you set MHSaside it's been a very positive and spectacular year on many fronts.

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

Brooks O'Neil - Dougherty & Company

Hopefully, stock-basedcompensation 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 Iappreciate all your thoughtful answers. It sounds to me like a little bit of ashift I guess, continuing shift towards the focus on the direct to employermarket and the significant importance of the employer perhaps a little bit lessof a focus, sounds like Medco is more direct to employer and a lot of the workyou're doing outside is direct. Are you seeing a diminution of the interest inpartnering with you from health plans or you continue to see that pipe asrobust as it's always been?

Ben Leedle

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

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

Brooks O’Neil - Dougherty & Company

That's great. Thank you verymuch.

Operator

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

Michael Glynn - CreditSuisse

Hi, Ben. You have talked about silos in healthcare, gettingdifferent healthcare entities to interact, talk with each other, certainlythere 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 businessplan. The other big thing out here, we hear frequently is electronic healthrecords and you hear in Aetna Health, Pfizer and recently Microsoft's HealthVault I believe it is. Do you view this as competition, or do you view it asyou will partner with electronic health records in order to deliver yourservice?

Ben Leedle

Great question, because I thinkthat, that's consuming a lot of the intellectual space strategically inhealthcare. This wasn’t my insight, but it is an insight that I recently heardfrom another CEO, that in that space, in terms of where they are focused and itwas interesting, cause his insight was, it's not the health record itself thatmatters. It’s not like I am going to take my health record and go, oh, let metake that down to my file in the basement and put right next to all the otherthings I need to store away. It doesn’t rise to that kind of level, it’s whatyou 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 andsupporting an individual’s health improvement efforts.

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

I think we are, there is allsorts of poor man version of electronic health record being created and populatedwith a lot of the traditional data that exist in healthcare today. I don’tthink that that’s going to, that kind of data in and of itself is going tofulfill the promise of what electronic health record can do. So, as we thinkabout, kind of the forward looking ecosystem, the electronic health record whendone to the ideal that everybody is thinking about, I think only raises the barin an around the quality revolution that’s taking place. It's going to create ahigher awareness and therefore a higher demand for transparency, when thathappens, the reimbursement potentially, gets rewired and realigned and youactually see a real paper performance opportunity.

I love, follow those implicationsbecause I think in a large way, we have been one of the poster child, for truepaper performance which is, if you don't move the outcomes needle you don't getto stick around and keep doing your business. And so we like and understandthat model, there is many other constituency in Healthcare traditionally thatwon't like that model.

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

And that answers your questionsor not?

Michael Glynn - CreditSuisse

Yeah, that's helpful, I just hadview that the nurse call center, that you provide as well as electronic healthrecord just way to make the physicians office, a more efficient place and so Iam just trying to get feel for how you viewed it and if that's competition orcomplimentary?

Ben Leedle

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

Once established, I think we area critical player in bringing richness to the data that can flow, as well asbringing other capability in asset to allow the connection points to take placefor all the players in the medical and the health home and down at the consumerlevel.

Michael Glynn - CreditSuisse

Great thanks.

Ben Leedle

Yes.

Operator

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

Ben Leedle

I just want to say thanks toeverybody for your patience and being on the call, Mary and I will be aroundthis evening for a little while, if you want to touch base and we are both heretomorrow and look forward to continue in conversations, we are out of our quiteperiod obviously and looking forward to the coming weeks and getting out andhaving 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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