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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 VicePresident & 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 discusstoday’s first quarter 2008 earnings news release. Today’s call is beingrecorded and will be available for replay beginning today and through December27th by dialing 719-457-0820. The confirmation number for the reply is 3988840. The replay may also be accessed for the next12 months at the company’s website which is at www.Healthways.com. To the extent any non GAAP financial measuresdiscussed in today’s call you’ll also find areconciliation of that measure to the most correctly comparable financialmeasure calculated according to GAAP in today’s news release which is posted onthe company’s website.

This conference call may contain forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995including statements among others regarding Healthways expected operatingfinancial performance for the second quarter and full year fiscal 2008. For this purpose any statements made duringthis call that are not statements of historical fact may be deemed to beforward-looking statements. Withoutlimiting the foregoing the words believes, anticipates, planned, expect andsimilar expression are intended to identify forward-looking statements. You are hereby cautioned that thesestatements may be affected by the important factors among others set forth inHealthways’ filings with Securities Exchange Commission and in its news releaseissued today and consequently actual operating results may differ materiallyfrom the results discussed in the forward-looking statements.

The company takes no obligation to update publicly anyforward-looking statements whether as a result of new information future eventsor otherwise. At this time for openingremarks I would like to turn the conference over to the company’s president andchief executive officer, Mr. Ben Leedle. Please go ahead sir.

Ben R. Leedle

Thanks Scott. Happyholidays to everyone and good afternoon. Thanks for being with us today for a discussion of our first quarterresults and our outlook for the second quarter and the rest of fiscal2008. I’m here this afternoon withHealthways CFO Mary Chaput and after our prepared remarks we’ll be happy totake your questions.

I’ll begin today by saying that our first quarterperformance both from an operating and a financial standpoint exceed ourexpectations and guidance. Thisperformance included as expected our recognition of initial costs associatedwith the development of four new call centers to support signed but not yetfully implemented new business. From allaspects our first quarter performance represents a solid start to our achievingour goals for fiscal 2008.

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

The flexibility that our market offerings presents tocustomers and prospects is enabling us to sign contracts for a healthy balanceof existing customers and new customers and for both health plans and selfinsured employers. To put it another waywe represent the sole source in the industry for customers to select andimplement a customized solution set designed to allow them to determine the degreeof value proposition that they wish to realize. As Mary will address in a moment the strong contracting momentumprovides fundamental support for our affirming our financial guidance forfiscal 2008 and the growth opportunities simply have never been larger.

Let me go ahead and review with you those growthopportunities. First, we are currentlyproviding services to and billing for more than 25 million people in the USand our current customers comprise an additional over 150 million individualsto whom we are not yet currently providing services. The insight we gained from the populationwe’re working with and the strong positive relationships we enjoy with thehealth plans and employers sponsoring these populations greatly enhance ourability to credibly demonstrate how those sponsors can benefit from ourexpanding capabilities. The long termgrowth potential inherent in these relationships is evident every quarter as wediscuss with you existing contracts which have expanded and typically extendedto include new levels of engagement with our health and care supportsolutions. Simply put we expect toincrease our billed lives as one source of growth.

A second substantial avenue for growth is increasing ouravailable lives. Currently our customerfootprint represents about 85% of the potential commercial marketdomestically. The contracts with newhealth plans and employer customers referenced in the earnings release todayare continuing evidence of our ability to sustain and to increase that footprint.

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

Equally as important is our fourth major driver for growththat is our ongoing effort to continue to expand our value proposition bymeeting market demand for new solutions to address the continuing relentlessincrease in healthcare costs. Thisdemand [inaudible] by employer and health plan recognition that the ultimatesolution rests in dramatically increasing the focus on health, wellness andprevention efforts designed to keep the healthy-healthy, to mitigate the impactof lifestyle choices on modifiable risk factors and to optimize care for thosewhose health circumstances have progressed to include chronic diseases and/orpersistent or high impact conditions. This perspective is the basis for our whole health initiative and beforeMary covers the financials in more detail I want to take a moment to update youon our progress.

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

Over the past year the momentum of this transformationincreased at an unprecedented pace driven principally by our acquisition ofAxia. Our first step in thistransformation was to quantify the total value of health improvement. Simply put the whole health value propositionwill move the measure of outcomes beyond our impact on just direct healthcarecosts by adding for the first time in the industry creditable methods toquantify the affect of health status on workforce productivity and then furtherdemonstrating the impact of our comprehensive differentiated services onreducing the costs associated with health related productivity losses.

To quantify this opportunity over the past year wedeveloped, tested and validated a new and proprietary simulation model designedto demonstrate this total economic impact. The model forecasts this value proposition at the individual employerlevel over five and 10 years. We areworking with a handful of large employers our strategic partners and leadingindustry experts in economic actuarial epidemiologic clinical and behaviorchange scientists to incubate the process for analyzing and interpreting theforecast for both future implications and opportunities related to workforceproductivity, medical cost impact and overall competitive advantage for theemployer. Accordingly, we believe wehave created a unique capability and established a clear way to size the valueproposition of whole health interventions.

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

As we hope you’ve come to expect from Healthways we willpursue these opportunities aggressively but ever mindful of the balance neededbetween growth in the top and the bottom lines. Fiscal 2007 was our seventh consecutive year of substantial profitablegrowth even with the dramatic changes in our business over that period and asMary 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 of2008 came in a little bit better than we expected. You have all read the press release on thecomparable quarter dynamics so let me spend a little time on the sequentialquarter dynamics. Revenues were higherby about $5.5. million from fourth quarter 2007 as new contracts implemented inthe quarter included Wellmark and a number of MyHealthIQ contracts as employersgeared up for January 1 employee benefit plan implementation.

Enrollment in our SilverSneakers program was up both inactual numbers over the prior four quarters and as a percent of eligiblemembers. Number of visits also increasedover the fourth quarter fiscal 2007. Afixed portion of the revenues from our participation in the CIGNA MHS pilot wasapproximately $1.2 million for the quarter. As expected and as we discussed in our last earnings call sequentialmargins were somewhat lower as we prepared for the opening of four new callcenters. The new center in Des Moines Iowa was completed andbecame operational in this first fiscal quarter. As expected the upfront cost associated withbringing up that call center in addition to preparing for the implementation ofthe other three centers two domestic and one international put pressure on ourpercent margins as did the accrual of colleague bonus based on achievement offirst quarter internal targets.

GAAP EPS in this first fiscal quarter of $0.30 exceeded ourguidance range of $0.27 to $0.29. Domestic EPS contributed $0.33 which included a net cost impact from ourMHS pilots of about $0.07. Internationalcame 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 estimatedannualized revenues at target performance for business committed but not yetimplemented totaled $51 million. Newcontracts going into back log for the quarter included Independence BlueCrossand Excellus BlueCross BlueShield an expansion of our CareFirst contract toinclude impact conditions and numerous ASO and employer contracts primarilythrough our health plan and Medco relationships. Operating cash flow in this first fiscalquarter of 2008 totaled approximately $25.5 million. We ended the quarter with approximately $54.5million in cash having paid down another $10.6 million in debt and havinginvested approximately $16 million in capital expenditures.

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

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

For the total fiscal year as just discussed we expectrevenues to accelerate in the second half of the year and our margins toimprove with increased capacity utilization of our new call centers. As previously announced the MHS pilot withCIGNA is scheduled to terminate in the middle of January so that the associatedfixed fee revenues will end in this second fiscal quarter. We expect the revenues from that pilot to beapproximately $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 rangeof $774 to $805 million.

Our headquarters move is scheduled for the end of our secondquarter and the beginning our third quarter so the costs associated with thatmove include the moving expenses themselves, the expected write off of certainfixed assets, penalty and overlapping rent and the resulting increase rent andappreciation costs going forward will be substantially spread over the nextthree fiscal quarters.

We continue to expect EBITDA margins for the fiscal year of2008 to be consistent with those for fiscal year 2007. Total year EPS guidance for the companyremains unchanged with domestic EPS still expected to be in the range of $1.87to $1.95 and the net cost impact of international operations expected to be inthe range of $0.09 to $0.11 for GAAP EPS of $1.77 to $1.86. We continue to think that operating cash flowwill meet our target for the year of approximately $150 million. We may somewhat adjust the use of that cashto maximize shareholder interest which could include stock repurchase or othercash uses in lieu of debt pay down which may affect our original target of debtto EBITDA ratio of close to one by the end of this fiscal year. However, we continue to expect that our debtto EBITDA ration will decrease steadily over the course of the year.

We’re on course and we’re excited about the current companygrowth and continued market opportunity and with that I’ll turn it back over toBen.

Ben R. Leedle

Thanks Mary. Tosummarize the remarks today we’re pleased with a first quarter that meetexpectations and that positions us to achieve substantial profitable growthinherent in our guidance that Mary just shared with you for our fiscal2008. We have outstanding prospects forcontinued significant long term growth beyond fiscal 2008. Among other strengths our prospects aresupported by our position as the clear industry leader in providingdifferentiated health and care support solutions with proven outcomes and costperformance.

In addition we have felt a long history and an establishedculture as an industry thought and innovation leader which has consistentlyenabled us to drive transformation of the industry status quo. Finally, we have the human and financialresources to leverage a proven business model and expand the breadth and depthof our unique value proposition. Inshort, we continue to believe that we stand alone in our ability to keephealthy people healthy to reduce lifestyle risk factors like smoking, obesitythat if left unchanged can and will lead people into serious health conditionsand to ensure optimization of care through best science for those with chronicdisease or intensive or persistent health conditions. As we continue to enhance this ability we areconfident that both our market capture and our stock holder value will benefit.

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

Question-and-AnswerSession

Operator

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

Michael Gwen – CreditSuisse

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

Mary A. Chaput

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

Michael Gwen – CreditSuisse

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

Mary A. Chaput

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

Michael Gwen – CreditSuisse

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 anddirect to employer that we don’t announce specifically.

Michael Gwen – CreditSuisse

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

Ben R. Leedle

From a standpoint of the international competitive landscapeHealth Dialog has been pretty open prior to BUPA’s acquisition of them of boththeir presence and their intent to compete and we’ve seen them out there in theinternational market. It’s not a newentry from that perspective but obviously it gives them a home with a base inthe UK thatwill probably give them some advantage in that specific market and BUPA alsohas some established relationships obviously, around the global with somebusiness with the privatized side of healthcare in some countries. We would expect that where Health Dialog hasbeen a great competitor here domestically we’re likely to see them be a goodcompetitor 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 thecall about new generation solutions and I was wondering if you could comment onthat a little bit further and whether you guys have the capabilities in house tosatisfy that demand for those products?

Ben R. Leedle

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

As employers have reviewed really the last decade of impactof things like intensive case management, disease management, the impactcondition efforts, they’re positive about the progress that those interventionsand solutions have made into the overall equation. But, they also see aconstant migration of people moving from the non-claims bucket one year intobeing next year’s claim producers and eventually the next batch of chronicallyill people. So, both the request forservices and solutions to be population wide and to be able to impact thedomains of prevention, lifestyle, modifiable risk, behavioral change as well asthe more traditional care support effort they’re looking for that on anintegrated platform.

Your question is what’s our capability? Our next generation software application tobe able to coordinate on a single platform the work flows to do that in a solesource way is already out in its prototypical form with a couple ofcustomers. We’ll continue to advance andexpand the migration of our business to that platform over the comingyear. We have the capability today tosupport the underlying work flows for that solution.

I think the other thing that I mentioned in my preparedremarks was the ability to understand how interventions relate to impact intothat area of productivity and while there has been some tremendous scienceapplied to that part of the economics of healthcare the data that has existedas minuscule to almost non-existent.

One of the things as you know that we had introduced to themarket several years ago was MyHealthIQ which combined HRA, biometricscollection which is objective lab data as well as tying that in with benefitdesign incentives in order to get very high activation and participation of avery high percentage of the population. Whatthat does is create not only the activation and the recognition by theindividual around their current health status and the opportunities to managethat over time it creates a database that didn’t exist before. From that database you can take informationturn it into an advanced analytics model which then feeds more knowledge modelsfor interventions that drive and create value.

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

Art Henderson –Jefferies & Company

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

Ben R. Leedle

Well, we know that there are ongoing discussions within thegovernment to the different areas with each other. We’ll be notified when things are final andwe have not been notified. That’s aboutall 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 anunderstanding for – it looks like the international cost came in a little bitlighter than what you had previously been expecting and you’re guiding forsomething that is a little bit less. Isthat just a function of the cost being a little bit better than you wereexpecting in terms of recruitment?

Mary A. Chaput

Well, yeah. I thinkthat the answer is that we had really good response to our recruiting effortsand we were capable of staggering the hiring so we actually had a number of thenurses come over and train here in the USand get all jazzed up and go back and train another group and then anothergroup. So, we’re going to be able tostagger 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 howmuch revenue was derived from Axia this quarter? It’s kind of the last quarter before itreally anniversaries the deal.

Mary A. Chaput

That’s right. It wasabout $48 million and you’re right as you’ve probably noticed from some of ourpress releases our health plans and our customers are buying integratedsolutions 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 seemedto be up significantly this quarter sequentially. Can you just talk a little bit about what thedynamics are that drove that?

Mary A. Chaput

A couple of things. Of course, revenues were up so that we have an increase in receivablesas a result of that. But, also due tothe holidays. Thanksgiving typicallydoes this to us. People are away andunavailable to sign invoices so we have a little back log but essentially allof that has been received by now.

K. Newton Juhng –BB&T Capital Markets

Okay. So it’s settledback?

Mary A. Chaput

That’s right. Noissues 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 downactually sequentially and I suppose part of that relates to the answer you gaveto Michael but, would you expect that SG&A spending to remain somewherenear 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 isnow taking on some cost of service costs and so as percent to the total isgoing to participate in shifting that mix upwards. I can research that for you. I can’t think of anything unusual thathappened in the fourth quarter that would have driven a significant change inthis quarter.

Brooks O’Neil –Daugherty & Company

Just while we’re on the details I noticed the tax rate wasalso 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 byour international activities. It’s at ahigher level due to lack of some tax benefit on certain expenses that we’veincurred in the international initiative and there’s also this state taxramifications which caused some shift from quarter-to-quarter. But, I thinkoverall we’re still thinking that the remainder of fiscal 2008 it’s going toland somewhere in the 40 to 41% range going forward and of course, it willdepend 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 youdiscussed both after the fourth quarter 2007 results and today the year isgoing 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 fourthquarter run rate somewhere around $0.70 or something like that. I’m not asking for a precise number because Iknow we don’t want to go there. But, asyou think about heading towards the back part of the year and then you thinkabout the sustainability of that number as you head into the forward year wouldit be reasonable to assume that the level you achieved in the fourth quarter iskind of a realistic run rate all else being equal?

Mary A. Chaput

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

Brooks O’Neil –Daugherty & Company

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

Ben R. Leedle

We’ve been excited and thrilled with the WellPointrelationship. As we talked about it whenwe signed that agreement we knew that it would be expansion off of businessthat had already been established as a business that Axia had started. We expanded last winter and we said that itwas a significant agreement that would obviously take time to phase in becausesome of the products and services were a function of fully insured books ofbusiness which would happen sooner and even some of that business wouldn’thappen until into 08 and a good portion of this obviously is aimed at their ASOpopulation which is no different than any other hunting license type ofrelationship that we might have with a health plan. We’re very pleased with the progress thatwe’ve made over the last year and we’re excited about the work that’s comingforward 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 withDAK. Are you still pretty much of theview that it’s going to be on a net basis aside from the internationalmarketing 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 expectto see before they would be willing to roll out beyond the barrier?

Ben R. Leedle

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

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

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

James J. Kumpel –Friedman Billings Ramsey & Co.

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

Ben R. Leedle

Sure. Let me answerthe first one. I think it’s prettywidely known that the fees paid by CMS to participant awardees for MHS were paidon the basis of target performance. Ithink you also know that there’s been a little difficulty within the context ofthe ability to measure performance and so – and this is a cooperative agreementwhich is different than a typical government contract. The intent was that if all systems were go inand around date research design and the ability to measure performance that itwould have been a very simple measurement of either met or not met and if metwe keep and if not met we return on a pro-rata basis down to returning all thefees if there was that lack of performance. We think that there’s work still ongoing by CMS to try to address theartifacts that have impacted the ability to cleanly look at performance and atthis point it is probably best for me not to try to get into forecasting thelikelihood disposition of what is on our balance sheet as billings in excess ofearnings amount related to this. You’rejust 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 notreceive an award.

James J. Kumpel –Friedman Billings Ramsey & Co.

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

Ben R. Leedle

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

Operator

Well take our next question from Darren Miller from GoldmanSachs.

Darren Miller –Goldman Sachs

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

Mary A. Chaput

Sure Darren. I thinkI mentioned in my comments, it goes by fast, I know that the enrollment in ourSilverSneakers program was up both in actual numbers over the prior fourquarters and as a percent of the eligible members. The participation increased both in numbersand in percent of eligible numbers. Thenumber of visits also increased over the fourth quarter of fiscal 2007. So, we were very pleased and not reallysurprised.

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 muchrevenue 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 Imentioned that WellMark was one of the major health plans that was in back logat the end of the fiscal year but rolled out in the quarter and a number of MyHealthIQcontracts. That is what we’re finding isemployers are gearing up for their January 1 employment benefit start andasking for the health risk assessments and the associated blood draws to occurin this quarter so we had some revenues from that that were in back log androlled out.

Ben R. Leedle

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

Darren Miller –Goldman Sachs

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

Ben R. Leedle

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

Darren Miller –Goldman Sachs

When would you guys get an update regarding the openenrollment 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 – LehmanBrothers

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

Mary A. Chaput

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

Josh Raskin – LehmanBrothers

Okay. So, there wasno changes?

Mary A. Chaput

No.

Josh Raskin – LehmanBrothers

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

Mary A. Chaput

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

Josh Raskin – LehmanBrothers

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

Mary A. Chaput

Continuously.

Josh Raskin – LehmanBrothers

Continuously. Okay. Better word. Lastly, there’s obviously a ramp up in EPSand 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 arevenue guidance number because we have learned historically we never getrewarded for being right or even close to being right. You should look at obviously what we bookedin fourth quarter – first quarter here and we’ll have some January 1 startdates and you know what the back log is. A substantial number of those will be January 1 so that will be twomonths in the quarter so I think I’m just going to have to leave it at that.

Josh Raskin – LehmanBrothers

That’s fair. So, usejust sort of a back log number, assume two months of implementation for themajority 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 WilliamBlair.

Ryan Daniels –William Blair & Company

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

Mary A. Chaput

The BIE I think was $76 million was the balance of whichabout $63 million was related to MHS so that’s up from $57 million at the endof 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 thinkit’s coming in around 21%.

Ryan Daniels –William Blair & Company

A lot of your larger health plans seem to be emphasizingcross selling specialty services more their ASO clients like diseasemanagement. Have you guys seen a trendthere where your partners on the distribution side are becoming more active inselling that to clients and in turn kind of helping you drive your revenuegrowth in that ASO segment?

Ben R. Leedle

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

Ryan Daniels –William Blair & Company

I’m talking about the health plan partners you currentlyhave which then work with their ASO accounts to sell your disease managementservices to them. It sounds like whatwe’re hearing in the market is there’s more of a focus on that at the end ofthis year and through next year on concentrating that as a novel growthopportunity. So, I was curious if youwere seeing that across the board? Ifit’s more focused with a couple of accounts? And, if that’s something that you think is going to continue to helpdrive 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 helpthem with their ASO and we do see things intensifying not in terms ofopportunity not dwindling.

Ryan Daniels –William Blair & Company

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

Ben R. Leedle

One of the reasons that we entered into the relation with Medcowas that we believed that largely pharma management and medical management satindependent of each other. The databasesweren’t very well leveraged. Theprocesses around pharmacist interacting with providers weren’t well matched andintegrated and coordinated with nurses interacting with patients from thingslike disease management and we just believed there was redundancy and waste inthe way in which processes were being rolled out and that there was opportunityto grow a bigger value proposition if you put those things together in terms ofwork flows.

So, the very first thing that you would do in looking atwork flows is how do you identify population and how can you improve the cycletime on that? Some of this is along thelines of six sigma approach to the process improvement and looking at the usetraditionally in disease management was through data provided us by healthplans that either had pharma carve outs put the data in or had their on PBMsputting the data through but the cycle times on that was typically every coupleof weeks to more typically monthly refreshes.

We worked with the Medco database and team to identify aproprietary approach to using pharmacy claims as a way to drive identificationto see if you did it solely with that what kind of fall off would you have interms of identification in terms of numbers? What happens to the sensitivity around false positives and that sort ofaspect of identification. When we gotcomfortable that we really weren’t given anything up what we found was theopportunity to tie the first phone intervention to the individual in and aroundan event that it occurred as an episode of care and to have that be very closeto 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 usbut across the industry been anywhere from 45 to 60 days and cycled that downto between seven and 12 days. You canimagine the different in the opportunity of someone being approached within theweek of when they were dealing with something significant either acute orongoing that they were trying to deal with in their life around their healthversus getting a phone call with essentially the same data and information butmoving that out in time four weeks. Mostpeople in the commercial environment would have to draw back up, “Yeah Iremember this. I remember that. I’ve dealt with this this way.” Is an opportunity to really affect bio pharmacompliance which as you know is a big part of the efficacy and underlyingevidence based science particularly in the treatment of a lot of the chronicillnesses.

What we have seen have been great both process and anecdotalsoft outcomes with that and we think we’ll be in a position to show hard claimsimpact differential as a function of that earlier identification cycle. Obviously, the other thing from a perspectiveis the clients who are getting that type of work together are either largeemployers or in one case a large regional health plan. They’re just darn excited to see two of theirvendors work together in concert to create more value that they can measure andsee. So, the reaction and the responsehas been very positive.

I don’t think there’s a wide spread understanding yet ofjust how big an opportunity there is around this theme on integration andobviously we thought the biggest and best place to begin to tackle thedisintegration would be to affect pharma and medical management. We think there’s other things and I thinkyou’re going to see people reach for vision, dental, behavioral and we’ll belooking to participate to drive those same things as well in order to continueto move towards more of the concept I just described which is around wholehealth and the kind of work that has to happen there in order to drive andmaximize the value on both the medical claim side as well as the productivityside 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 engagingthem quicker you probably get better responses and certainly better ROI. Is that something that you think in the nearterm you will be able to capture a higher portion of that via fees? Or, is this something that is more at thispoint just a competitive differentiator between you and some of the otherproviders in the market?

Ben R. Leedle

I think as we replicate the scale it will be a value that wecan capture. In the moment I think it isa 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 ofthe other activity? We’ve seen a coupleof other players over the last quarter being purchased by some domestic playersand just any thoughts you might have on the domestic market from a competitivefront or what you’re seeing on the sales pipeline has that really changed muchover 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 yetanother proof source of the validation of this strategy and how important it isparticularly given if you’ve looked at any of the valuations and thought aboutthose in the context of historic transactions that have taken place. These are assets that larger entities arelooking to gather and integrate around being able to compete in the marketspace that we call home. For us, I dothink it does mean that our competitors are likely to be bigger almost bydefinition because a lot of our traditional competitors are on the list offolks that you’ve referenced over the last two years and particularly over thelast six months that have been absorbed into larger entities. So, we would expect then that there’s abroader context, there’s deeper capital resources stability from those largerorganizations. I still think for us incompeting with maybe new forming competitors with those kinds of characteristicsis our differentiation is around scaled outcomes which we still believe that westand alone in that regard and that we’re still of a size in order to maintainour ability to get to market quick with new and with refined solutions and tobe able to assure that we have a single focus, single agenda which is to helpimprove the lives of people in and around their health outcomes.

One of the disadvantages I think and challenges that will befaced by the larger organizations collecting up these kinds of assets is it’snot the only thing they do. So, how tokeep the passion, the people that built those great companies engaged in a waywhere they’re still motivated to want to bring the leadership and experiencethat’s going to be required in order for those things to value out anywherenear 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 butcould you give us a sense of your annual expectation for Axia in 2008? And if you’re not willing to go for aspecific number which I sense you probably won’t could you give us anexpectation 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 aboutthe demand for wellness products in general and the integrated solutions. Ben you can jump in here I think the wellnessprograms are a larger part of not only our back log but also the demand in thepipeline at this moment. This is alwaysopen for change as the market evolves and I think the integrated solutions isreally where – and the single source provider is really where employers aregoing to want to land but, at this point having grabbed some disease managementthrough either us or others they are now looking for the wellness programs tosupplement that.

Thomas Carroll –Stifel Nicolaus

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

Ben R. Leedle

Yeah. I don’t thinkthat 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 yourpipeline for the next 12 months has Medicare assumed a larger percentage ofthat potential new business opportunity than it has in the past?

Ben R. Leedle

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

Thomas Carroll –Stifel Nicolaus

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

Ben R. Leedle

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

Thomas Carroll –Stifel Nicolaus

Mary, just a point of clarification you mentioned $1.2million 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 Garmontwith Broadpoint Capital.

Glen Garmont –Broadpoint Capital

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

Ben R. Leedle

I think a lot of – again, I made a comment earlier aroundthe process and tools that we’re using obviously at a macro level are veryconsistent with how we would look to move to a process of both integration andimplementation here. All of those keyprocesses on our dashboards are bright green and we’re ready to go for January1. Things that we’ve learned I would saythat we will be better around the translation of some of the print materialsthe next time around and I think we have addressed those. We had the time to be able to take test andeven post focus group needed to be able to do some tweaking there. But, outside of that particular lessonlearned everything else is right on track.

I think thebiggest learning’s arestill yet to come. When we go live wewill be learning from– drinking from theproverbial firehose. We should have awhole lot more color to beable to talk to you as we go through thequarter and we’re out of our quite period we’re happy to visit and give youthose updates to those who areinterested and certainly by thetime we’re back talking about our second quarter we’ll have alot more detail and color to share with you interms 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 andyour continued interest in Healthways. If you’d like to do a follow up call with Mary and/or I or both of uswe’re around this evening. We do haveoffsite meeting commitments tomorrow and Friday and then we’re into a holidayweek. If you need to get to us we’d encourage you to give us a call thisevening. Until next time. Thanks.

Operator

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

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

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