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Healthways, Inc. (NASDAQ:HWAY)

F1Q08 Earnings Call

December 19, 2007 5:00 pm ET

Executives

Ben R. Leedle – President, Chief Executive Officer & Director

Mary A. Chaput – Chief Financial Officer, Executive Vice President & Secretary

Analysts

Michael Gwen – Credit Suisse

Art Henderson – Jefferies & Company

K. Newton Juhng – BB&T Capital Markets

Brooks O’Neil – Daugherty & Company

James J. Kumpel – Friedman Billings Ramsey & Co.

Darren Miller – Goldman Sachs

Josh Raskin – Lehman Brothers

Ryan Daniels – William Blair & Company

Thomas Carroll – Stifel Nicolaus

Glen Garmont – Broadpoint Capital

Scott

Good afternoon and welcome to this Healthways conference call to discuss today’s first quarter 2008 earnings news release. Today’s call is being recorded and will be available for replay beginning today and through December 27th by dialing 719-457-0820. The confirmation number for the reply is 3988840. 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 correctly 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 financial performance for the second 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, planned, expect and similar expression 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 Securities Exchange Commission and in its news release issued today and consequently actual operating results may differ materially from the results discussed in the forward-looking statements.

The company takes 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 R. Leedle

Thanks Scott. Happy holidays to everyone and good afternoon. Thanks for being with us today for a discussion of our first quarter results and our outlook for the second quarter and the rest of fiscal 2008. I’m here this afternoon with Healthways CFO Mary Chaput and after our prepared remarks we’ll be happy to take your questions.

I’ll begin today by saying that our first quarter performance both from an operating and a financial standpoint exceed our expectations and guidance. This performance included as expected our recognition of initial costs associated with the development of four new call centers to support signed but not yet fully implemented new business. From all aspects our first quarter performance represents a solid start to our achieving our goals for fiscal 2008.

Now, as you saw in our release earlier today first quarter revenue increased 50% over the first quarter of fiscal 2007. The increase was driven primarily by sales of our enhanced health support capabilities resulting from the Axia acquisition in December, 2006. We’ve gained market advantage by combining Axia and Healthways best of class services into a comprehensive total population health impact solution. The effect has been continued sales momentum resulting in a back log of over $50 million at the end of the first quarter. This momentum is being driven by our unique ability to provide an integrated sole sourced and outcomes differentiated solution at scale.

The flexibility that our market offerings presents to customers and prospects is enabling us to sign contracts for a healthy balance of existing customers and new customers and for both health plans and self insured employers. To put it another way we represent the sole source in the industry for customers to select and implement a customized solution set designed to allow them to determine the degree of value proposition that they wish to realize. As Mary will address in a moment the strong contracting momentum provides fundamental support for our affirming our financial guidance for fiscal 2008 and the growth opportunities simply have never been larger.

Let me go ahead and review with you those growth opportunities. First, we are currently providing services to and billing for more than 25 million people in the US and our current customers comprise an additional over 150 million individuals to whom we are not yet currently providing services. The insight we gained from the population we’re working with and the strong positive relationships we enjoy with the health plans and employers sponsoring these populations greatly enhance our ability to credibly demonstrate how those sponsors can benefit from our expanding capabilities. The long term growth potential inherent in these relationships is evident every quarter as we discuss with you existing contracts which have expanded and typically extended to include new levels of engagement with our health and care support solutions. Simply put we expect to increase our billed lives as one source of growth.

A second substantial avenue for growth is increasing our available lives. Currently our customer footprint represents about 85% of the potential commercial market domestically. The contracts with new health plans and employer customers referenced in the earnings release today are continuing evidence of our ability to sustain and to increase that footprint.

Third, we are also continuing to expand our overall opportunity by adding new addressable markets. We previously discussed with you the potential represented by adding Germany as an addressable market to our first international contract with DAK as well as the potential Medicare opportunity represented by our participation in the MHF pilots. In addition, we are continuing to make progress towards new international contracts in Germany as well in other countries. We are also actively working to establish Healthways and future opportunities in a number of other European countries, South American and also Asia.

Equally as important is our fourth major driver for growth that is our ongoing effort to continue to expand our value proposition by meeting market demand for new solutions to address the continuing relentless increase in healthcare costs. This demand [inaudible] by employer and health plan recognition that the ultimate solution rests in dramatically increasing the focus on health, wellness and prevention efforts designed to keep the healthy-healthy, to mitigate the impact of lifestyle choices on modifiable risk factors and to optimize care for those whose health circumstances have progressed to include chronic diseases and/or persistent or high impact conditions. This perspective is the basis for our whole health initiative and before Mary covers the financials in more detail I want to take a moment to update you on our progress.

Healthways’ approach to the market has long been based on our simple value proposition that by improving the health of a population we can reduce its costs. Over the years we’ve focused on maximizing the impact of our value proposition by expanding it to all individuals in any given population. As we expand our value proposition to millions of people around the world our vision is that we will transform how individuals, providers, payers and policy makers think and act about health and wellbeing thereby moving ever closer to our goal of creating a healthier more productive world.

Over the past year the momentum of this transformation increased at an unprecedented pace driven principally by our acquisition of Axia. Our first step in this transformation was to quantify the total value of health improvement. Simply put the whole health value proposition will move the measure of outcomes beyond our impact on just direct healthcare costs by adding for the first time in the industry creditable methods to quantify the affect of health status on workforce productivity and then further demonstrating the impact of our comprehensive differentiated services on reducing the costs associated with health related productivity losses.

To quantify this opportunity over the past year we developed, tested and validated a new and proprietary simulation model designed to demonstrate this total economic impact. The model forecasts this value proposition at the individual employer level over five and 10 years. We are working with a handful of large employers our strategic partners and leading industry experts in economic actuarial epidemiologic clinical and behavior change scientists to incubate the process for analyzing and interpreting the forecast for both future implications and opportunities related to workforce productivity, medical cost impact and overall competitive advantage for the employer. Accordingly, we believe we have created a unique capability and established a clear way to size the value proposition of whole health interventions.

It is also very clear to us from this work that the large employers are willing to share the additional [inaudible] once proven. We believe our share of this new proven value will represents multiples of our current value share and thus a significant opportunity for major growth. We believe our capacity to deliver whole health at scale is a unique and differentiated advantage in the industry both today and for years to come.

As we hope you’ve come to expect from Healthways we will pursue these opportunities aggressively but ever mindful of the balance needed between growth in the top and the bottom lines. Fiscal 2007 was our seventh consecutive year of substantial profitable growth even with the dramatic changes in our business over that period and as Mary will now discuss we fully expect that fiscal 2008 will be our eighth. Mary?

Mary A. Chaput

Thanks Ben and good afternoon everyone. As Ben discussed our first fiscal quarter of 2008 came in a little bit better than we expected. You have all read the press release on the comparable quarter dynamics so let me spend a little time on the sequential quarter dynamics. Revenues were higher by about $5.5. million from fourth quarter 2007 as new contracts implemented in the quarter included Wellmark and a number of MyHealthIQ contracts as employers geared up for January 1 employee benefit plan implementation.

Enrollment in our SilverSneakers program was up both in actual numbers over the prior four quarters and as a percent of eligible members. Number of visits also increased over the fourth quarter fiscal 2007. A fixed portion of the revenues from our participation in the CIGNA MHS pilot was approximately $1.2 million for the quarter. As expected and as we discussed in our last earnings call sequential margins were somewhat lower as we prepared for the opening of four new call centers. The new center in Des Moines Iowa was completed and became operational in this first fiscal quarter. As expected the upfront cost associated with bringing up that call center in addition to preparing for the implementation of the other three centers two domestic and one international put pressure on our percent margins as did the accrual of colleague bonus based on achievement of first quarter internal targets.

GAAP EPS in this first fiscal quarter of $0.30 exceeded our guidance range of $0.27 to $0.29. Domestic EPS contributed $0.33 which included a net cost impact from our MHS pilots of about $0.07. International came in a penny better than guidance at a net cost impact per diluted share of $0.04 primarily due to the staging of nurse recruiting. Back log which represents the estimated annualized revenues at target performance for business committed but not yet implemented totaled $51 million. New contracts going into back log for the quarter included Independence BlueCross and Excellus BlueCross BlueShield an expansion of our CareFirst contract to include impact conditions and numerous ASO and employer contracts primarily through our health plan and Medco relationships. Operating cash flow in this first fiscal quarter of 2008 totaled approximately $25.5 million. We ended the quarter with approximately $54.5 million in cash having paid down another $10.6 million in debt and having invested approximately $16 million in capital expenditures.

As we discussed in our last quarter call we expect our second quarter to be as equally busy as our first. These additional three call centers should become operational this quarter. Offsetting the upfront cost of the management team, recruiting, hiring and training of the clinicians and coaches to deliver on new contracts and the development of data exchange processes and analysis with our new customers will be the recognition of revenues from those new contracts many of which will start on January 1st. We expect margins to improve slightly over first quarter levels. You may remember that last quarter we described the dynamics of the increasing mix of health support solutions being provided primarily to self insured employers with January 1 start dates. That dynamic will result in increasingly and substantially stronger revenue and margin growth in the second half of our fiscal year.

As a result of those dynamics we expect the contribution to EPS from our domestic business in our second fiscal quarter to be in the range of $0.36 to $0.37. The ongoing activities of the international business development team and the second quarter net cost impact of preparing for a January 1 start of our international contract somewhat offset by the associated revenues is expected to be in the range of $0.03 to $0.04. GAAP EPS is therefore expected to be in the range of $0.32 to $0.34.

For the total fiscal year as just discussed we expect revenues to accelerate in the second half of the year and our margins to improve with increased capacity utilization of our new call centers. As previously announced the MHS pilot with CIGNA is scheduled to terminate in the middle of January so that the associated fixed fee revenues will end in this second fiscal quarter. We expect the revenues from that pilot to be approximately $1.8 million for the year. However, we are reiterating total company revenue guidance of $782 to $815 million as we still expect domestic revenues to be in the original range of $774 to $805 million.

Our headquarters move is scheduled for the end of our second quarter and the beginning our third quarter so the costs associated with that move include the moving expenses themselves, the expected write off of certain fixed assets, penalty and overlapping rent and the resulting increase rent and appreciation costs going forward will be substantially spread over the next three fiscal quarters.

We continue to expect EBITDA margins for the fiscal year of 2008 to be consistent with those for fiscal year 2007. Total year EPS guidance for the company remains unchanged with domestic EPS still expected to be in the range of $1.87 to $1.95 and the net cost impact of international operations expected to be in the range of $0.09 to $0.11 for GAAP EPS of $1.77 to $1.86. We continue to think that operating cash flow will meet our target for the year of approximately $150 million. We may somewhat adjust the use of that cash to maximize shareholder interest which could include stock repurchase or other cash uses in lieu of debt pay down which may affect our original target of debt to EBITDA ratio of close to one by the end of this fiscal year. However, we continue to expect that our debt to EBITDA ration will decrease steadily over the course of the year.

We’re on course and we’re excited about the current company growth and continued market opportunity and with that I’ll turn it back over to Ben.

Ben R. Leedle

Thanks Mary. To summarize the remarks today we’re pleased with a first quarter that meet expectations and that positions us to achieve substantial profitable growth inherent in our guidance that Mary just shared with you for our fiscal 2008. We have outstanding prospects for continued significant long term growth beyond fiscal 2008. Among other strengths our prospects are supported by our position as the clear industry leader in providing differentiated health and care support solutions with proven outcomes and cost performance.

In addition we have felt a long history and an established culture as an industry thought and innovation leader which has consistently enabled us to drive transformation of the industry status quo. Finally, we have the human and financial resources to leverage a proven business model and expand the breadth and depth of our unique value proposition. In short, we continue to believe that we stand alone in our ability to keep healthy people healthy to reduce lifestyle risk factors like smoking, obesity that if left unchanged can and will lead people into serious health conditions and to ensure optimization of care through best science for those with chronic disease or intensive or persistent health conditions. As we continue to enhance this ability we are confident that both our market capture and our stock holder value will benefit.

Again, thank you for being with us today and for your patience and operator we’d now be happy to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Michael Gwen with Credit Suisse.

Michael Gwen – Credit Suisse

Can you comment on why there’s kind of a significant change in the cost of care ratio and the SG&A ratio? It seems like kind of inconsistent with historical trends.

Mary A. Chaput

I think that’s right Michael. I think what we have discovered and I think we might have talked about this a little bit in the fourth quarter call was the Axia organization was more product oriented and more wellness oriented so whole population and had marketing materials that appropriately were booked to cost of service which normally our marketing materials which are broader in nature and not specific to contract get booked below the line. So, what we see is a little shift to – in terms of percent of revenue heavier on the cost of service line and less on the SG&A. We have encouraged people now to start looking at our EBITDA line which is why we started to include that in our earnings release.

Michael Gwen – Credit Suisse

Why did the billable lives decrease a little bit in the quarter?

Mary A. Chaput

Actually, there was one contract which wasn’t renewed which was access to our CAM/Chiro networks so that included a large number of lives but not as much revenue.

Michael Gwen – Credit Suisse

Billable lives went up as a result of WellMart though? That was partially offsetting that affect?

Mary A. Chaput

That’s correct and other contracts that are in the ASO and direct to employer that we don’t announce specifically.

Michael Gwen – Credit Suisse

One quick question on the competitive environment. Health Dialog recently had a change in ownership from a London based company. I’m wondering if that changes your outlook on your international expansion and expectation for change in the competitive environment?

Ben R. Leedle

From a standpoint of the international competitive landscape Health Dialog has been pretty open prior to BUPA’s acquisition of them of both their presence and their intent to compete and we’ve seen them out there in the international market. It’s not a new entry from that perspective but obviously it gives them a home with a base in the UK that will probably give them some advantage in that specific market and BUPA also has some established relationships obviously, around the global with some business with the privatized side of healthcare in some countries. We would expect that where Health Dialog has been a great competitor here domestically we’re likely to see them be a good competitor in the international market.

Operator

We’ll go next to Art Henderson with Jefferies & Company.

Art Henderson – Jefferies & Company

Two questions. First, Ben you referred in the press release and a little bit at the beginning of the call about new generation solutions and I was wondering if you could comment on that a little bit further and whether you guys have the capabilities in house to satisfy that demand for those products?

Ben R. Leedle

The references that I’ve made have largely been in and around the request that we’ve been getting but also what we see as the market expecting to take the portion of the total healthcare dollar which has been related to in a large bucket called productivity particularly as you look at a commercial market and you look at the employer base. There is significant health related impact that occurs on both the rate of absenteeism and the rate of productivity when a person does show up with health issues not well addressed. We also know that it doesn’t even have to be necessarily the employee that is being impacted by health related issues it could be family, friends and or people in their social [inaudible] that creates that impact for them.

As employers have reviewed really the last decade of impact of things like intensive case management, disease management, the impact condition efforts, they’re positive about the progress that those interventions and solutions have made into the overall equation. But, they also see a constant migration of people moving from the non-claims bucket one year into being next year’s claim producers and eventually the next batch of chronically ill people. So, both the request for services and solutions to be population wide and to be able to impact the domains of prevention, lifestyle, modifiable risk, behavioral change as well as the more traditional care support effort they’re looking for that on an integrated platform.

Your question is what’s our capability? Our next generation software application to be able to coordinate on a single platform the work flows to do that in a sole source way is already out in its prototypical form with a couple of customers. We’ll continue to advance and expand the migration of our business to that platform over the coming year. We have the capability today to support the underlying work flows for that solution.

I think the other thing that I mentioned in my prepared remarks was the ability to understand how interventions relate to impact into that area of productivity and while there has been some tremendous science applied to that part of the economics of healthcare the data that has existed as minuscule to almost non-existent.

One of the things as you know that we had introduced to the market several years ago was MyHealthIQ which combined HRA, biometrics collection which is objective lab data as well as tying that in with benefit design incentives in order to get very high activation and participation of a very high percentage of the population. What that does is create not only the activation and the recognition by the individual around their current health status and the opportunities to manage that over time it creates a database that didn’t exist before. From that database you can take information turn it into an advanced analytics model which then feeds more knowledge models for interventions that drive and create value.

We think we are very far down the road on a relative basis in terms of having captured the simulated understanding of our intervention capability as it relates to the impact back into an entire population. So, we’re excited about that because the dollar cost associated with productivity is anywhere around three times what the direct medical impact of the interventions are that we can create. So, in a value creation value shared business model like we have it lends opportunity for us to be able to have to prove but then lay claim to a much larger value that’s been created. So, we’re excited about that opportunity and we stand ready to expand and scale in that manner.

Art Henderson – Jefferies & Company

There has been some discussion here recently that CMS and the OMB might be getting close to possibly reducing the hurdle, the 5% savings hurtle on this Medicare phase one pilot. Can you comment on what you’re hearing on that and if those discussions are actually taking place right now?

Ben R. Leedle

Well, we know that there are ongoing discussions within the government to the different areas with each other. We’ll be notified when things are final and we have not been notified. That’s about all I can tell you at this point.

Operator

Net we’ll go to Newton Juhng with BB&T Capital Markets.

K. Newton Juhng – BB&T Capital Markets

I just have a couple of quick questions here in getting an understanding for – it looks like the international cost came in a little bit lighter than what you had previously been expecting and you’re guiding for something that is a little bit less. Is that just a function of the cost being a little bit better than you were expecting in terms of recruitment?

Mary A. Chaput

Well, yeah. I think that the answer is that we had really good response to our recruiting efforts and we were capable of staggering the hiring so we actually had a number of the nurses come over and train here in the US and get all jazzed up and go back and train another group and then another group. So, we’re going to be able to stagger those hidings throughout the next few weeks.

K. Newton Juhng – BB&T Capital Markets

I was wondering if you could provide us with kind of how much revenue was derived from Axia this quarter? It’s kind of the last quarter before it really anniversaries the deal.

Mary A. Chaput

That’s right. It was about $48 million and you’re right as you’ve probably noticed from some of our press releases our health plans and our customers are buying integrated solutions already so it really is an allocation game already to discern that. Going forward it will be just one number.

K. Newton Juhng – BB&T Capital Markets

The last thing I was just wondering about was your AR seemed to be up significantly this quarter sequentially. Can you just talk a little bit about what the dynamics are that drove that?

Mary A. Chaput

A couple of things. Of course, revenues were up so that we have an increase in receivables as a result of that. But, also due to the holidays. Thanksgiving typically does this to us. People are away and unavailable to sign invoices so we have a little back log but essentially all of that has been received by now.

K. Newton Juhng – BB&T Capital Markets

Okay. So it’s settled back?

Mary A. Chaput

That’s right. No issues with our AR at all.

Operator

Well go next to Brooks O’Neil with Daugherty & Company.

Brooks O’Neil – Daugherty & Company

I was curious it looked like SG&A spending was down actually sequentially and I suppose part of that relates to the answer you gave to Michael but, would you expect that SG&A spending to remain somewhere near this low level as the year goes on? Or, should we expect that to start creeping up?

Mary A. Chaput

That’s a good question. I haven’t looked at it in isolation. I would suggest that international which all use to book to SG&A is now taking on some cost of service costs and so as percent to the total is going to participate in shifting that mix upwards. I can research that for you. I can’t think of anything unusual that happened in the fourth quarter that would have driven a significant change in this quarter.

Brooks O’Neil – Daugherty & Company

Just while we’re on the details I noticed the tax rate was also up a bit and I assume you’re still thinking 40% for the year?

Mary A. Chaput

I think the tax rate is going to be affected a little bit by our international activities. It’s at a higher level due to lack of some tax benefit on certain expenses that we’ve incurred in the international initiative and there’s also this state tax ramifications which caused some shift from quarter-to-quarter. But, I think overall we’re still thinking that the remainder of fiscal 2008 it’s going to land somewhere in the 40 to 41% range going forward and of course, it will depend on the geographic mix but that’s what we’re using in our own planning.

Brooks O’Neil – Daugherty & Company

I guess as I think about the year it certainly as you discussed both after the fourth quarter 2007 results and today the year is going to be pretty sharply backend loaded.

Mary A. Chaput

That’s correct.

Brooks O’Neil – Daugherty & Company

Suggesting in some kind of a round number to a fourth quarter run rate somewhere around $0.70 or something like that. I’m not asking for a precise number because I know we don’t want to go there. But, as you think about heading towards the back part of the year and then you think about the sustainability of that number as you head into the forward year would it be reasonable to assume that the level you achieved in the fourth quarter is kind of a realistic run rate all else being equal?

Mary A. Chaput

I think that would lead us to getting into some 2009 guidance and I’m not willing to go there yet Brooks. But, what I will say to your point the second half is going to be much improved in terms of the revenues over the first half and at the EPS level. We’re going to have full quarters of those January 1 start dates other contracts that we have in back log will start in the third quarter. We have visibility to a great looking pipeline. In addition, we’ll have improved capacity utilization from the new call centers we put in. I don’t expect that we’ll have any additional call centers at this moment that will put pressure on the margins so I expect the margins to improve. So that overall the margins will be consistent for the year with 2007. I’ll give you all that and you can model it. But, I don’t want to get into 2009 discussion at this point.

Brooks O’Neil – Daugherty & Company

I recall that you announced what I thought potentially was a quite significant contract with WellPoint last year particularly related to the Axia suite of services I assume. I was just curious if you could give us an update on how that’s going. I had some sense that you probably had some sell in that might have to go through some of their respective plans around the United States. Just any comments you can give us about the WellPoint relationship would be quite helpful.

Ben R. Leedle

We’ve been excited and thrilled with the WellPoint relationship. As we talked about it when we signed that agreement we knew that it would be expansion off of business that had already been established as a business that Axia had started. We expanded last winter and we said that it was a significant agreement that would obviously take time to phase in because some of the products and services were a function of fully insured books of business which would happen sooner and even some of that business wouldn’t happen until into 08 and a good portion of this obviously is aimed at their ASO population which is no different than any other hunting license type of relationship that we might have with a health plan. We’re very pleased with the progress that we’ve made over the last year and we’re excited about the work that’s coming forward for us as a result of that relationship in 08.

Operator

Next we’ll go to James Kumpel with Friedman Billings Ramsey.

James J. Kumpel – Friedman Billings Ramsey & Co.

I wanted to first ask about the German contract with DAK. Are you still pretty much of the view that it’s going to be on a net basis aside from the international marketing expenses about net neutral to earnings?

Mary A. Chaput

Yes.

Ben R. Leedle

Yes.

James J. Kumpel – Friedman Billings Ramsey & Co.

Can you talk about some of the milestones that they expect to see before they would be willing to roll out beyond the barrier?

Ben R. Leedle

Sure. I think they would be the things that you would probably be able to tick off. First is can we get it implemented and to do that in a way where there’s high critical mass positive receptivity of this solution within those targeted populations. So, early it’s going to be about can we have recruited trained and launched the program and the services? Then very shortly after that happens it’s going to be what is the typifying reaction of the individuals who are targeted for support? That’s really just a test of how well we have understood how to take American tools and know how and incorporate that into a solution for Germany within the specific aspects of their culture and within the specific aspects of the way in which healthcare gets delivered in that environment.

That’s the early on stuff. They’ll be looking for that quantified in terms of activities that relate to the amount and the intensity and the types of work that we’re doing. Then after that initial wave of what I would call kind of a kick off then they’re going to begin to look for the early indicators of success around the sustainability, the satisfaction of service not just with the individuals targeted with the key providers. That will be a big part of their early assessment. Then they’ll begin to look at clinical process and end point outcomes that translate into more macro utilization measures. Because, if you’ll remember this is not a claims based model it is a fixed capacity demand relief model that is expected to port changes in utilization patterns that can be tied and matched along with better health outcomes at the same time.

Those are going to be the things they look at and those latter two buckets are going to get compared probably beginning around the six to eight month of effort and will be measured on through the first 12 or 15 months. We would expect that by the time you get 18 months out in this relationship there is all the data and information that you would need to be able to make this decision to decide to expand or not. Does that help answer your question?

James J. Kumpel – Friedman Billings Ramsey & Co.

That’s very comprehensive. On the Medicare front I was curious if you could clarify on two points. One, on MHS can you just remind us of your responsibility in terms of returning cash or fees at the end of the project? What the criteria are? Then separately from MHS I was curious if you could talk about whether or not you actually competed for the senior risk reduction demonstration project that got awarded today.

Ben R. Leedle

Sure. Let me answer the first one. I think it’s pretty widely known that the fees paid by CMS to participant awardees for MHS were paid on the basis of target performance. I think you also know that there’s been a little difficulty within the context of the ability to measure performance and so – and this is a cooperative agreement which is different than a typical government contract. The intent was that if all systems were go in and around date research design and the ability to measure performance that it would have been a very simple measurement of either met or not met and if met we keep and if not met we return on a pro-rata basis down to returning all the fees if there was that lack of performance. We think that there’s work still ongoing by CMS to try to address the artifacts that have impacted the ability to cleanly look at performance and at this point it is probably best for me not to try to get into forecasting the likelihood disposition of what is on our balance sheet as billings in excess of earnings amount related to this. You’re just going to have to stay tuned with us as we stay tuned with the process

James J. Kumpel – Friedman Billings Ramsey & Co.

On that wellness question?

Ben R. Leedle

On the wellness question we did put in a bid and we did not receive an award.

James J. Kumpel – Friedman Billings Ramsey & Co.

Okay. Essentially do you have any comments about the potential for that much like MHS to do the expanded nationwide or any kind of [inaudible].

Ben R. Leedle

Well I do think for those – there maybe a contingent of folks that believe in the senior population that you can’t affect wellness. We would tend to disagree with that conclusion. We think you can and we’re seeing that through the innovative programs that we’re already working with a host of Medicare Advantage populations. So, we know that you can make a difference in terms of the health wellbeing and the wellness state of senior population. I think that this is an early effort by CMS. I think that I would categorize it as the pilot before the pilot and they’re really small scale and that there’ll be learning’s from that and there will be opportunities down the road for us to come back into this population on that side and until then we continue to enjoy access to the majority of enrolled Medicare Advantage participants in the senior population through a very successful and proven outcomes program on the wellness front.

Operator

Well take our next question from Darren Miller from Goldman Sachs.

Darren Miller – Goldman Sachs

Mary, I wondered if you could comment in the fourth quarter we saw a lower utilization in SilverSneakers pull down the Axia revenue. I was wondering if you could just let us know how SilverSneakers for 1Q – how the revenue trended.

Mary A. Chaput

Sure Darren. I think I mentioned in my comments, it goes by fast, I know that the enrollment in our SilverSneakers program was up both in actual numbers over the prior four quarters and as a percent of the eligible members. The participation increased both in numbers and in percent of eligible numbers. The number of visits also increased over the fourth quarter of fiscal 2007. So, we were very pleased and not really surprised.

Darren Miller – Goldman Sachs

So, we can imply that revenue was up quarter-over-quarter?

Mary A. Chaput

Yes.

Darren Miller – Goldman Sachs

I think you did comment on this sorry for asking how much revenue rolled off of back log and how much new revenue came in back log?

Mary A. Chaput

We don’t get specific on the dollar amounts but I think I mentioned that WellMark was one of the major health plans that was in back log at the end of the fiscal year but rolled out in the quarter and a number of MyHealthIQ contracts. That is what we’re finding is employers are gearing up for their January 1 employment benefit start and asking for the health risk assessments and the associated blood draws to occur in this quarter so we had some revenues from that that were in back log and rolled out.

Ben R. Leedle

I would characterize it this way that the back log that you are seeing reported today is not a stale back log.

Darren Miller – Goldman Sachs

With the Medicare Advantage plans moving through open enrollment now do you guys have any indication of how your SilverSneakers enrollment will move?

Ben R. Leedle

We’re expecting continued growth and adoption of the SilverSneakers solution and you saw in some of the announcement that we made inside of the earnings release continue adoption by the market with those programs. There’s no reason for us to believe that the same kind of benefit that it provides to that population historical wouldn’t be of interest and import going forward.

Darren Miller – Goldman Sachs

When would you guys get an update regarding the open enrollment population?

Ben R. Leedle

We can estimate it. I’d rather make sure we have the right date on that. Do you know that Mary?

Mary A. Chaput

No I don’t.

Ben R. Leedle

I don’t either.

Darren Miller – Goldman Sachs

Okay I’ll follow up.

Operator

We’ll go next to Josh Raskin with Lehman Brothers.

Josh Raskin – Lehman Brothers

Just to clarify the change in the SG&A it was just the ratios on the income statement in terms of the SG&A versus the cost of services. I certainly understand that the materials – that the printed materials for Axia type of businesses are included in cost of services. Do you think it was just simply growth in those businesses? Or, did you change some of the allocation on some of the legacy health [inaudible]?

Mary A. Chaput

We’re not doing allocations. It’s not of that. Here’s a little elaboration on what I was referring to. The wellness programs are population approach and so there’s a lot of specific marketing materials. I’ll be specific SilverSneakers t-shirts, caps, balls that are specifically manufactured and sent out as it relates the contracts. So, when you have a large number of specific marketing contract expenses you’re going to book that to cost of services. In addition, as we’ve seen historically on the disease management side we had higher fulfillment costs this quarter as it relates to flu shot reminders. There’s really nothing else unusual going on. We don’t do allocations up and down throughout the organization. At this point everything is very associated with direct costs and dedicated teams.

Josh Raskin – Lehman Brothers

Okay. So, there was no changes?

Mary A. Chaput

No.

Josh Raskin – Lehman Brothers

That’s what I was looking for. Second, I think Mary in your prepared remarks you talked about uses of capital and you mentioned potentially buy backs. I’m just curious to hear maybe a little bit more about the thought process and how you think about the timing of that decision throughout the year.

Mary A. Chaput

I think we stay fairly flexible in terms of when we’re going to be buying back stock. I think that we’ll do that opportunistically. We have that availability now to do that and so opportunistically and when it makes sense for the shareholder’s interest we will be out repurchasing stock.

Josh Raskin – Lehman Brothers

It doesn’t sound like you’ve got hard and fast plans currently but you’ll sort of be evaluating later?

Mary A. Chaput

Continuously.

Josh Raskin – Lehman Brothers

Continuously. Okay. Better word. Lastly, there’s obviously a ramp up in EPS and we understand all the additional costs. Can you give us just a ballpark of revenue growth? Maybe even just a second quarter ballpark?

Mary A. Chaput

I’m trying to think how you can do that without give you a revenue guidance number because we have learned historically we never get rewarded for being right or even close to being right. You should look at obviously what we booked in fourth quarter – first quarter here and we’ll have some January 1 start dates and you know what the back log is. A substantial number of those will be January 1 so that will be two months in the quarter so I think I’m just going to have to leave it at that.

Josh Raskin – Lehman Brothers

That’s fair. So, use just sort of a back log number, assume two months of implementation for the majority of that.

Mary A. Chaput

It won’t be all of the back log but it will be substantial.

Operator

We’ll take our next question from Ryan Daniels with William Blair.

Ryan Daniels – William Blair & Company

A couple of quick housekeeping questions up front. Mary, can you give me one the Medicare related portion of the BIE and then I also wanted to get your revenue concentration for the quarter.

Mary A. Chaput

The BIE I think was $76 million was the balance of which about $63 million was related to MHS so that’s up from $57 million at the end of the fourth quarter. Revenue concentration, is that what you said?

Ryan Daniels – William Blair & Company

Yes.

Mary A. Chaput

Customer concentration just one CIGNA over 10% and I think it’s coming in around 21%.

Ryan Daniels – William Blair & Company

A lot of your larger health plans seem to be emphasizing cross selling specialty services more their ASO clients like disease management. Have you guys seen a trend there where your partners on the distribution side are becoming more active in selling that to clients and in turn kind of helping you drive your revenue growth in that ASO segment?

Ben R. Leedle

Ask that again Ryan I want to make sure I caught which distribution you’re referencing.

Ryan Daniels – William Blair & Company

I’m talking about the health plan partners you currently have which then work with their ASO accounts to sell your disease management services to them. It sounds like what we’re hearing in the market is there’s more of a focus on that at the end of this year and through next year on concentrating that as a novel growth opportunity. So, I was curious if you were seeing that across the board? If it’s more focused with a couple of accounts? And, if that’s something that you think is going to continue to help drive growth in your ASO segment into 08 and 09?

Ben R. Leedle

We absolutely see it. It is across our market of customers where we have been engaged to help them with their ASO and we do see things intensifying not in terms of opportunity not dwindling.

Ryan Daniels – William Blair & Company

We’ve also see some press recently talking about some of the joint projects you’ve done with Medco and the ability to take the identification of disease management or care enhancement candidates from several months down to one or two weeks. Can you just provide a little more color on that in how rolled out of pressure book of business that is and maybe some early color on other feedback you’re getting from clients about that capability?

Ben R. Leedle

One of the reasons that we entered into the relation with Medco was that we believed that largely pharma management and medical management sat independent of each other. The databases weren’t very well leveraged. The processes around pharmacist interacting with providers weren’t well matched and integrated and coordinated with nurses interacting with patients from things like disease management and we just believed there was redundancy and waste in the way in which processes were being rolled out and that there was opportunity to grow a bigger value proposition if you put those things together in terms of work flows.

So, the very first thing that you would do in looking at work flows is how do you identify population and how can you improve the cycle time on that? Some of this is along the lines of six sigma approach to the process improvement and looking at the use traditionally in disease management was through data provided us by health plans that either had pharma carve outs put the data in or had their on PBMs putting the data through but the cycle times on that was typically every couple of weeks to more typically monthly refreshes.

We worked with the Medco database and team to identify a proprietary approach to using pharmacy claims as a way to drive identification to see if you did it solely with that what kind of fall off would you have in terms of identification in terms of numbers? What happens to the sensitivity around false positives and that sort of aspect of identification. When we got comfortable that we really weren’t given anything up what we found was the opportunity to tie the first phone intervention to the individual in and around an event that it occurred as an episode of care and to have that be very close to real time as that prescription was filled to be able to begin to intervene.

We took a cycle time that has traditionally not just with us but across the industry been anywhere from 45 to 60 days and cycled that down to between seven and 12 days. You can imagine the different in the opportunity of someone being approached within the week of when they were dealing with something significant either acute or ongoing that they were trying to deal with in their life around their health versus getting a phone call with essentially the same data and information but moving that out in time four weeks. Most people in the commercial environment would have to draw back up, “Yeah I remember this. I remember that. I’ve dealt with this this way.” Is an opportunity to really affect bio pharma compliance which as you know is a big part of the efficacy and underlying evidence based science particularly in the treatment of a lot of the chronic illnesses.

What we have seen have been great both process and anecdotal soft outcomes with that and we think we’ll be in a position to show hard claims impact differential as a function of that earlier identification cycle. Obviously, the other thing from a perspective is the clients who are getting that type of work together are either large employers or in one case a large regional health plan. They’re just darn excited to see two of their vendors work together in concert to create more value that they can measure and see. So, the reaction and the response has been very positive.

I don’t think there’s a wide spread understanding yet of just how big an opportunity there is around this theme on integration and obviously we thought the biggest and best place to begin to tackle the disintegration would be to affect pharma and medical management. We think there’s other things and I think you’re going to see people reach for vision, dental, behavioral and we’ll be looking to participate to drive those same things as well in order to continue to move towards more of the concept I just described which is around whole health and the kind of work that has to happen there in order to drive and maximize the value on both the medical claim side as well as the productivity side at the employer level.

Ryan Daniels – William Blair & Company

That’s helpful color. A quick follow up based on what you were saying. Obviously by identifying people and engaging them quicker you probably get better responses and certainly better ROI. Is that something that you think in the near term you will be able to capture a higher portion of that via fees? Or, is this something that is more at this point just a competitive differentiator between you and some of the other providers in the market?

Ben R. Leedle

I think as we replicate the scale it will be a value that we can capture. In the moment I think it is a deep differentiator in competitor advantage.

Ryan Daniels – William Blair & Company

You mentioned the Health Dialog acquisition by BUPA. I’m curious if you could comment on some of the other activity? We’ve seen a couple of other players over the last quarter being purchased by some domestic players and just any thoughts you might have on the domestic market from a competitive front or what you’re seeing on the sales pipeline has that really changed much over the last three or six months from what you’ve seen in the past?

Ben R. Leedle

Part of the reaction is that I think it serves as yet another proof source of the validation of this strategy and how important it is particularly given if you’ve looked at any of the valuations and thought about those in the context of historic transactions that have taken place. These are assets that larger entities are looking to gather and integrate around being able to compete in the market space that we call home. For us, I do think it does mean that our competitors are likely to be bigger almost by definition because a lot of our traditional competitors are on the list of folks that you’ve referenced over the last two years and particularly over the last six months that have been absorbed into larger entities. So, we would expect then that there’s a broader context, there’s deeper capital resources stability from those larger organizations. I still think for us in competing with maybe new forming competitors with those kinds of characteristics is our differentiation is around scaled outcomes which we still believe that we stand alone in that regard and that we’re still of a size in order to maintain our ability to get to market quick with new and with refined solutions and to be able to assure that we have a single focus, single agenda which is to help improve the lives of people in and around their health outcomes.

One of the disadvantages I think and challenges that will be faced by the larger organizations collecting up these kinds of assets is it’s not the only thing they do. So, how to keep the passion, the people that built those great companies engaged in a way where they’re still motivated to want to bring the leadership and experience that’s going to be required in order for those things to value out anywhere near the nature of what they’ve been expected to do.

Operator

We’ll go next to Tom Carroll with Stifel Nicolaus.

Thomas Carroll – Stifel Nicolaus

A few questions here. One on Axia and Mary thanks for the revenue number this quarter but could you give us a sense of your annual expectation for Axia in 2008? And if you’re not willing to go for a specific number which I sense you probably won’t could you give us an expectation of maybe percent increase year-over-year 07 to 08?

Mary A. Chaput

I think the way we’d rather approach that is to talk about the demand for wellness products in general and the integrated solutions. Ben you can jump in here I think the wellness programs are a larger part of not only our back log but also the demand in the pipeline at this moment. This is always open for change as the market evolves and I think the integrated solutions is really where – and the single source provider is really where employers are going to want to land but, at this point having grabbed some disease management through either us or others they are now looking for the wellness programs to supplement that.

Thomas Carroll – Stifel Nicolaus

How about this – when you first announced the Axia deal you mentioned that you expected it to grow somewhere in the neighborhood of 30% a year for a few years. Do you still feel like that?

Ben R. Leedle

Yeah. I don’t think that we’re thinking anything different than we were initially.

Thomas Carroll – Stifel Nicolaus

Another Medicare question. How many Medicare Advantage lives do you manage right now? And, as you sit back and look at your pipeline for the next 12 months has Medicare assumed a larger percentage of that potential new business opportunity than it has in the past?

Ben R. Leedle

I think it’s an important question because I know you followed us pre Axia and in the disease management realm of things we have several hundred thousand Medicare Advantage lies involved in what would traditionally be characterized in the solution set around care support and a very, very large number of participation of enrollees that are both eligible and connected in on SilverSneakers that comes in around 3 million lives. If you take the total amount of enrollment in Medicare Advantage our participation rate and involvement is significant and I think that number is around 7 million. Ballparkish between 40 to 50% of that population we’re doing something with.

Thomas Carroll – Stifel Nicolaus

The last thing you said there the 40 to 50% is that your pipeline? 40 to 50% of your pipeline is Medicare focused?

Ben R. Leedle

No. I would tell you we have a focus on all 7 million of those lives because some of those lives are participating in wellness programs. Some are participating as part of chronic illness impact condition programs and there’s opportunity to broaden our relationships across the board with those health plans that are signed up and supporting that.

Thomas Carroll – Stifel Nicolaus

Mary, just a point of clarification you mentioned $1.2 million came from the CIGNA MHS pilot in the quarter?

Mary A. Chaput

Yep.

Thomas Carroll – Stifel Nicolaus

With $1.8 million expected for the year?

Mary A. Chaput

Right.

Thomas Carroll – Stifel Nicolaus

So that implies what $600 grand for next quarter?

Mary A. Chaput

Yep. Half a quarter.

Operator

We have time for one final question. We’ll take that question from Glen Garmont with Broadpoint Capital.

Glen Garmont – Broadpoint Capital

With the international contract commencing in just a couple of days or a couple of weeks rather Ben, I was wondering if you could describe maybe how the integration process has gone? Presumably there has been data exchanges at this point and maybe give us an indication of how that process was either similar or different from how that process typically works with a domestic client.

Ben R. Leedle

I think a lot of – again, I made a comment earlier around the process and tools that we’re using obviously at a macro level are very consistent with how we would look to move to a process of both integration and implementation here. All of those key processes on our dashboards are bright green and we’re ready to go for January 1. Things that we’ve learned I would say that we will be better around the translation of some of the print materials the next time around and I think we have addressed those. We had the time to be able to take test and even post focus group needed to be able to do some tweaking there. But, outside of that particular lesson learned everything else is right on track.

I think the biggest learning’s are still yet to come. When we go live we will be learning from – drinking from the proverbial fire hose. We should have a whole lot more color to be able to talk to you as we go through the quarter and we’re out of our quite period we’re happy to visit and give you those updates to those who are interested and certainly by the time we’re back talking about our second quarter we’ll have a lot more detail and color to share with you in terms of our operating experience.

Operator

At this time I’d like to turn the program back over to Mr. Leedle for any additional or closing comments.

Ben R. Leedle

I just want to thank everybody for your questions today and your continued interest in Healthways. If you’d like to do a follow up call with Mary and/or I or both of us we’re around this evening. We do have offsite meeting commitments tomorrow and Friday and then we’re into a holiday week. If you need to get to us we’d encourage you to give us a call this evening. Until next time. Thanks.

Operator

That does conclude today’s conference. You may disconnect your lines at this time.

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Source: Healthways F1Q08 (Qtr End 11/30/07) Earnings Call Transcript
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