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Executives

Ben R. Leedle Jr. - President, Chief Executive Officer, Director

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

Analysts

Glenn Garmont - Broadpoint Capital

Arthur Henderson - Jefferies & Company

Newton Juhng - BB&T Capital Markets

Brooks O’Neil - Dougherty & Company

Darren Miller - Goldman Sachs

James Kumpel - Friedman, Billings, Ramsey

Ryan Daniels - William Blair

Constantine Davides - JMP

Healthways, Inc. (HWAY) F3Q08 Earnings Call June 18, 2008 5:00 PM ET

Operator

Good afternoon and welcome to the Healthways conference call to discuss the third quarter 2008 earnings news release. Today’s call is being recorded and will be available for replay beginning today and through June 26th by dialing 719-457-0820. The confirmation number for the replay is 9329154. 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 will also find a reconciliation of that measure to the most directly comparable financial measure calculated according to GAAP in today’s news release, which is posted on the company’s website.

This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements among others regarding Healthways' expected operating and financial performance for fourth quarter and full-year fiscal 2008. For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects, and similar expressions are intended to identify forward-looking statements. You are hereby cautioned that these statements may be affected by the important factors, among others, set forth in Healthways' filings with the Securities and Exchange Commission, and in its news release issued today. And consequently, actual operations or results may differ materially from the results discussed in the forward-looking statements. The company undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events, or otherwise.

At this time, for opening remarks, I would like to turn the conference over to the company’s President and Chief Executive Officer, Mr. Ben Leedle. Please go ahead, sir.

Ben R. Leedle Jr.

Good afternoon and thank you for being with us today. I am here this afternoon with Mary Chaput, Healthways' CFO. I have some relatively brief remarks about our third quarter results and then I will turn the floor over to Mary who will cover our numbers and guidance in greater detail. And following Mary’s prepared remarks, then we’ll be glad to take your questions.

So let me begin by saying that we are pleased with Healthways' performance for the third quarter. In this regard, our third quarter results, which met expectations, represented a substantial step toward achieving our revenue and earnings guidance for the fiscal year.

We produced a 14% growth in revenue for the third quarter to $191.4 million. This growth was the product in part of our adding 1.8 million billed lives since the third quarter last year, taking our total billed lives now to 28.9 million.

In addition, available lives expanded by 2 million on a comparable period basis, resulting in an increase in penetration to 15.3% of our available lives. While this penetration rate is our highest level yet, we believe the significant long-term expansion opportunity we have within our current base of customers is still readily apparent.

New contracts we entered into in the third quarter were driven by demand across all of our market segments, including all health plan lines of business, direct-to-employer, and through our Medco alliance. Further, the growth in billed lives during the third quarter continued to be drive primarily by existing customers that have expanded or extended our relationship with them.

Our business with employers continues to expand. As mentioned in today’s news release, we now work with over 1,000 large self-insured employers, predominantly on behalf of our health plan customers. We expanded the number of employers served at a rate of approximately 20% on a comparable quarter basis. We believe this growth illustrates the strong, ongoing demand from employers for comprehensive, integrated solutions that address both the health and healthcare costs of their employees.

In addition to our revenue growth, we are pleased with our margin expansion for the quarter as well. Our results were consistent with our expectations for improving in the second half of fiscal 2008 from lower than historic margins for the first half of fiscal 2008.

As we have indicated previously, we expect to generate margins for the full fiscal year consistent with our recent multi-year averages.

Based on the strength of our third quarter performance and our expectations for revenue growth and margin improvement for the fourth quarter, we have affirmed our established guidance for the fiscal year.

Now, looking out over the next few years, we believe it’s reasonable to expect some important trends evident in the market today to continue, if not intensify. Perhaps most important, we expect the cost of healthcare to continue to rise as, sadly, disease prevalence and incidents, obesity, and underlying lifestyle behavioral factors that drive chronic disease continue to increase, in turn driving demand from employers for solutions that produce measurable and sustainable outcomes in support of these people.

Based on our market assessments and those of other experts in the fields of health and productivity, we expect that employers will move beyond a sole focus on medical cost savings as they move more fully to comprehend the relationship between employee health and lost productivity.

Our assessment in this regard received significant validation as recently as yesterday, with the publication of a study by the Health Research Institute at Price Waterhouse Coopers, titled “Behind the Numbers: Medical Cost Trends for 2009”. The study concluded that medical costs were increasing for employers by about 10% this year and would again in 2009. The study went on to say that health plans and employers will focus on member and employee satisfaction, their wellness, to focus on specialized disease management interventions, and through limited cost sharing.

To address these projected cost pressures, the employers are stepping forward. If you haven’t seen the report, you can link at it at our website or through the Price Waterhouse Coopers website.

Healthways is committed to remaining on the forefront of driving this continuing evolution, consistent with our long-term position of being a leading industry innovator. We have shared with you over the last several quarters our ongoing progression toward fully integrated, whole health solutions which we believe have the potential to drive a substantial increase in the value we can create for our customers.

Accordingly, we remain fully engaged in developing the solutions, evaluation methodologies, and the technologies to produce that higher order result which we believe will increase the economic benefit for our customers from hundreds of dollar per life today to thousands of dollars of life tomorrow.

Implementing these solutions will also positively impact our other two growth initiatives -- increasing our domestic commercial business and expanding our addressable markets around the world.

Because of these trends, we believe we and our industry have very attractive growth dynamics and that we are strongly positioned to benefit from them. In the final analysis, however, success will be determined by outcomes. We’ve been clear about our intention to raise the industry’s performance bar by strengthening the sophistication, power, and comprehensiveness, both of our solutions and of the outcomes they produce. As we continue to prove our ability to deliver on this expanded value proposition, we believe employers that are not benefiting from similar outcomes will recognize that they are operating at an increasing competitive disadvantage.

So accordingly, as we consider existing competition and new entrants to our market from non-traditional healthcare participants all the way to health plans building capabilities in-house, one of the factors we evaluate is the outcome performance their approaches might produce.

In that evaluation, one thing is clear -- an integrated comprehensive solution that will help healthy people stay healthy, will help establish healthy lifestyle behaviors for those individuals at risk, and will help those with conditions or disease to optimize their care and wellbeing, will produce the most value for all the stakeholders.

While competition has been and will continue to be a market reality, we remain confident in our ability to execute our plan successfully and produce industry-leading outcomes. Continuing to deliver this proven value for our customers will have the most significant impact on our long-term growth.

So thanks for your time this afternoon and stay tuned for some Q&A, but first I will ask Mary to review the financials.

Mary A. Chaput

Thanks, Ben and good afternoon, everyone. As we reported earlier today, third quarter revenues totaled $191.4 million. This amount included approximately $3.4 million from international operations and $5.2 million from the MHS pilot. Commercial domestic revenues increased approximately $6.6 million. Additive to the net increase over second quarter were new or expanded contracts started in the third quarter, as well as an increase in participation in our health support programs.

As we previously discussed, somewhat offsetting these positive gains was revenue lost as a result of some of our health plan customers losing several very large ASO employer clients and, to a lesser degree, the loss of some of our smaller contracts due to market consolidation activities, or customer financial hardship. You’ll remember we discussed those in our second quarter earnings call.

As expected and reflected in our previously issued guidance, gross margins improved significantly in the third quarter. We’ve discussed previously the impact on our gross margins of having built four new call centers in the first half of this fiscal year, and how those margins would improve in our second fiscal half as a result of the increased capacity utilization.

In addition, because of the higher revenues and improved gross margins, third quarter EBITDA margins improved by almost a full point-and-a-half above second quarter, despite the move into our new headquarters and associated costs.

As a result of the increase in both revenues and margins, total company EPS for the third quarter, including a net cost impact of $0.02 from international operations, was $0.39, compared to our guidance of $0.38 to $0.39.

Domestic EPS for the quarter was $0.41, a 32% increase over domestic EPS of $0.31 in the third quarter a year ago, and a 14% increase over the $0.36 we reported in our second fiscal quarter this year.

Regarding our balance sheet, our cash balance at the end of the third quarter was about $23 million lower than at second quarter 2008. The main drivers behind that reduction was a $10 million debt pay-down, an increase in accounts receivable of about $15 million, and approximately $25 million of capital expenditures. The increase in accounts receivable was primarily related to slow payments from four large health plan customers. We have received approximately $40 million in collections since the quarter end. As expected, the $25 million of capital expenditures was primarily related to our new headquarters and data center consolidation.

In the third quarter, our total debt level increased by approximately $76 million from $278 million to $354 million. During this period, we repaid $10 million and borrowed $85 million for the sole purpose of repurchasing Healthways stock.

In the quarter, we repurchased $89 million, or approximately 2.5 million shares of our common stock, which completed our authorized $100 million stock repurchase plan.

For the total year, as announced in today’s press release, we are reaffirming our total year guidance for revenues in the range of $720 million to $740 million, which includes expected revenues from international operations in the range of $8 million to $10 million.

EPS is expected to be in the range of $1.50 to $1.55, including the expected net cost impact from international operations in the range of $0.09 to $0.11 per diluted share. Margins are expected to continue to improve in the fourth quarter as the major cost of the new headquarters is behind us and the savings associated with the consolidation of capacity and the continued synergies from the Axia integration increased.

All in all, a solid quarter as we expected, and we are on pace to meet our guidance for the year.

With that, we can open the line for questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Glenn Garmont with Broadpoint Capital.

Glenn Garmont - Broadpoint Capital

Thanks. Good afternoon and congrats on the quarter. Just a couple of quick questions; first with respect to the $0.07 that you spent on the headquarters move, I guess that’s just south of $4.5 million. That’s all -- presumably that’s all in SG&A and as we are modeling out the fiscal fourth quarter, SG&A should more closely resemble the levels seen in the first half of the year.

And then secondarily, Ben, can you talk maybe about how the landscape has changed, if at all, since the acquisition of Matria was completed?

Ben R. Leedle Jr.

Sure. I’ll let Mary answer the SG&A question first.

Mary A. Chaput

It is -- in SG&A, there is approximately $1 million, $1.2 million in depreciation that will be ongoing for the headquarters move.

Ben R. Leedle Jr.

Okay. And then your second question was what’s happening on the competitive landscape -- is that the nature of the question related to post Inverness acquiring Matria?

Glenn Garmont - Broadpoint Capital

Yes.

Ben R. Leedle Jr.

I think Matria being acquired by Inverness was just one example of activity that is going on in the marketplace. As we look out at the competitive landscape, we have had our traditional competitors and the number of those traditional competitors has become fewer and fewer, as many of those companies have become part of merged entities, larger organizations.

I think the idea of Matria combining with a company that has products aimed at both the commercial and consumer markets is an interesting and different type of model, which it’s still very early in their work with a lot of integration ahead of them to bring that model to bear in the market, so we’ll see.

There’s also things that you guys have seen in the broader market in and around aims of traditional retailers looking at advancing into the space that we have competed in, so you think of Walgreen’s and their activities, Caremark CVS, aimed at obviously the value propositions to drive improved health for people over the lifetime.

We are seeing pharmaceutical companies make interesting steps back towards things like disease management after stepping away from that for some time. And I think we’ll continue to see increasing energy to evaluate and to answer just exactly what is a medical home and how would that work and can that responsibility also be combined with capabilities to scale and addressed to deliver these types of things.

So I would tell you our competitive landscape is easily as intense as it’s ever been, with many different types of organizations facing into a common value proposition. I think I mentioned in my prepared remarks the demand continues to increase. The population statistics here in the U.S. and around the world continue to point toward the problem that’s trying to be addressed only getting bigger, more complex, requiring more sophistication and more resources to be able to make a difference.

And so we always have had competition. The forms of that competition are in I think pretty drastic change as we look at the market now, and to the point in my prepared remarks, everyone is going to have to step up to a common scorecard, which in the end of the day gets measured in terms of whether or not you can make a difference. So this is not your traditional fee-for-service healthcare industry. This is a pay-for-performance industry that requires those participants to prove that their approach, their thesis on how to be able to drive a bigger value here actually works and can be proven.

So from a standpoint of near-term, if your question is more toward RFPs, you know, what do we see there, I think more of our traditional competitors are still in the mix in the short-term, as those other non-traditional competitors that I described are continuing to put their game plan in place.

Does that answer your question?

Glenn Garmont - Broadpoint Capital

It does. Thanks for the comments, Ben.

Operator

Thank you. We’ll go next to Arthur Henderson with Jefferies & Company.

Arthur Henderson - Jefferies & Company

Good afternoon. Real quick on the share repurchase -- you said you’ve used the authorization. Do you plan on going back to the board for another one?

Mary A. Chaput

You know, we don’t anticipate another repurchase plan at this point, in the near-term, anyway. We’d like to keep some dry powder for possible strategic opportunities.

Arthur Henderson - Jefferies & Company

Okay. As you look at the landscape out there, obviously the economy is struggling here. Are you seeing any indication of any sensitivity in your business to the economy, whether it’s customers that are saying look, we want to wait on wellness but we’ll take disease management, or have you see any sort of trends in that direction?

Ben R. Leedle Jr.

You know, I would be crazy to tell you that there’s no impact, because I think that there is and where that shows up first is in the translation. The same people that are driving the demand having to rationalize what’s happening in their core business and what available funds do they have for their perceived short- and long-term investments in and around employee and dependent family initiatives around their health.

So I think there hasn’t been a difference, Art, in terms of the nature of the requests for proposals from a scope. They continue to be aimed at integration, single source, broad-based across prevention, wellness, and disease and care management.

We are still in the sales cycle and coming to the last part of that for 1/1/09 decisions and I think what’s still out ahead of us is to learn whether or not the original intended scope of purchases remain at the same breadth. And if they don’t what are the decisions being made? Wait until later or to scope down and buy less than what they originally intended? And right now, the data is still not clear on that, just because of the nature of the timing and where we are in the year in that sales cycle.

Arthur Henderson - Jefferies & Company

Okay, that’s helpful. And then two other quick questions; could you give us sort of what the current state of your selling season looks like, if you have any -- you know, what percentage of your contracts are coming up for renewal I guess in the next few quarters?

And then secondarily, I know you have done some restructuring internally. If you could articulate kind of what you’ve done, what still you are working through and what we might want to think about as we model out for the remainder of the year? Thanks very much.

Mary A. Chaput

Sure. Let me go to the renewals first. In this year, we only have three health plan contracts left to renew, and they represent less than 1% of our year-to-date revenues. In 2009, we have four health plans that exceed 2% of our current year-to-date revenues and together they represent about 12% of total year-to-date revenues this year.

And 2010, we have none that are over 2% that will be coming up for renewal.

Arthur Henderson - Jefferies & Company

Okay. And then just real quick on the restructuring you’ve done internally, to any degree that you can provide some color on that would be great.

Ben R. Leedle Jr.

Well, I think we communicated that, if you are referring to back in May where we laid off, as we had shared with the market, between 100 and 200 people, that process has gone well in terms of the plan that we laid out and we are moving forward with what we think are the right level of resources to address the business that we have on hand and will flow out of backlog as we move forward.

Arthur Henderson - Jefferies & Company

All right, thank you.

Operator

Thank you. We’ll go next to Newton Juhng with BB&T Capital Markets.

Newton Juhng - BB&T Capital Markets

Thank you very much. I just wanted to ask a few questions here; one was just with regard to the gross margin level. Obviously you gave some guidance here to how fourth quarter is looking but I’m just kind of thinking about beyond that -- should we be looking at that as being relatively flat year over year as we look out into fiscal 2009, or kind of again a little bit of an ebb and flow in terms of that number?

Mary A. Chaput

You know, we have refrained from giving any 2009 guidance because we are in the midst of the selling season, which will impact that. I think what you can expect, Newton, is that we’ve got capacity levels currently at 75 -- about 75%. Now that number is getting a little difficult to measure, what with our successful Telework model that we implemented over the last couple of quarters that’s not seats in a call center. We’ve got co-shared space with some of our strategic partners, which kind of makes that a difficult calculation. We have a lot of web-based interaction.

So a lot will depend on the mix and the new sales that come in over the course of the next few months and the timing of that. So those are just some of the dynamics you can expect.

Obviously to Ben’s point on the actions we took in May, that will continue to have a benefit going forward on the gross margin and on the EBITDA margin as well. So those are just some of the dynamics you can expect.

Newton Juhng - BB&T Capital Markets

Okay, Mary. I guess when you are talking about that capacity at about 75%, I know that you’ve pushed higher into the 80s and into the mid-80s, actually at some point in time. At what level would you expect that you have to make another capital investment into another call center or something along those lines?

Mary A. Chaput

Well, right now I would say that we’ve got available seats and facilities that we can build out and again, the Telework model is going to provide all sorts of flexibility in that regard. So again, no ’09 guidance at this point but I don’t see a call center in the near future.

Newton Juhng - BB&T Capital Markets

Okay. Thanks for the comments there. Can you also just speak to -- was there any severance cost associated with the employees that were one-time in nature that we can kind of back out that came here in the quarter?

Mary A. Chaput

Certainly there were associated with the activities in May and there was also a leasehold and termination of lease costs that did impact the third quarter and will be gone in the fourth, which will contribute obviously to the improved margins in the fourth quarter. We are not going to give exact numbers on that, however.

Newton Juhng - BB&T Capital Markets

Okay. All right. And then -- all right, well, the last thing I was just wondering about is debt to cap moving up to where it is right now, about 52% you pointed out in your release. I’m just curious as to what level you are comfortable with. I know that you have considerably more in your term loan and so on that you can go after, but I’m just kind of curious where your comfort level runs up to, or does it just run up to that point?

Mary A. Chaput

Well, as you know, this company has historically not been a highly leveraged company. We use leverage judiciously and as needed. We don’t have a specific target but we analyze the opportunities when they arise and I think that’s the best way I can put that.

Newton Juhng - BB&T Capital Markets

Okay, and clearly this quarter you felt like the best thing to do was to buy back your shares.

Mary A. Chaput

I think that’s right.

Newton Juhng - BB&T Capital Markets

Okay. Well, thank you very much.

Operator

Thank you. We’ll go next to Brooks O’Neil with Dougherty & Company.

Brooks O’Neil - Dougherty & Company

Good afternoon. I have a couple of questions as well. The first I guess is I would say congratulations on recognizing $5.2 million of revenue from the MHS pilots. I am curious if you would say that you are performing in that refresh cohort at this point. I think your initial indication was you were close. Maybe if you can give us an update on that.

Ben R. Leedle Jr.

Sure, Brooks. We did on our conference call that we held specifically around that news during this quarter had indicated that the only reason we were able to recognize revenue is that we were showing performance financially. I think we’ve been a pretty clear record for quite some time that we have been performing around the beneficiary satisfaction and the clinical metrics that are associated with that pilot.

And I would just recall to make certain that we are clear the performance related to the revenue recognition was associated with the cohort of beneficiaries that were a part of the refresh population that was added at the beginning of the second year of our three-year pilot with CMS.

Brooks O’Neil - Dougherty & Company

Yes, so you are saying that you are performing at this time based on the data you see?

Ben R. Leedle Jr.

Yes, based on the data that we’ve got and the reports we’ve gotten from CMS and their third-party evaluator. So one of the things that, as you know, we’re not finished yet. Our pilot concludes at the end of this July, so we are coming very near to the end of our three-year pilot. We should get another arc report for the one more quarter’s worth of performance in the next few weeks, so we’ll know by the end of July or early August any kind of next frame of incremental improvement around that performance. And then upon completion, we’ll get a couple more arc reports, the data will run out for six months and then we’ll begin a process with CMS to do the full-fledged evaluation with them in terms of performance.

Mary A. Chaput

Brooks, we couldn’t recognize revenue if we weren’t performing.

Brooks O’Neil - Dougherty & Company

Okay, that’s great. I thought that was true. Could you comment -- Mary, you’ve commented a little bit about the attrition I think going back to the second quarter, some of the health plans and employer contracts that went away. Obviously there’s been quite a lot of visibility on Blue Cross Minnesota. Just any comments or updates you can offer in terms of either attrition that’s occurred or attrition you expect to occur here in the balance of your fiscal year.

Ben R. Leedle Jr.

I think it’s a good question because it’s a question around the risk related to the retention of our client base. You know we’ve had a pretty doggone good track record over the past five to seven years as a contract service business in healthcare services of retaining a very high percentage of customers and associated revenues. I’ll just touch back on what Mary talked about; we’re going into a next fiscal year where about 12% of our revenues are wrapped up in some really key renewal process. At this point, those are works in progress. There is nothing really for us to share that we haven’t already shared, with respect to Blue Cross/Blue Shield Minnesota, and I think the references that Mary made to some of the attrition were that we have had relationships go away from us this year, and we talked about it in the second quarter, that were a function of customer -- small customers having really difficult financial situations in and around their existence, and then secondly for a couple of customers who were part of consolidation activities in the marketplace.

Part of the back half revenue attrition that fits into the net positive gains that we have achieved in the third quarter would have been the 1101 changes on behalf of our health plan customers where they would have lost -- totally lost their ASO clients where we would have been servicing business. So there’s opportunity, obviously, for us to recapture that through other channel, distribution channel mechanisms with other health plan relationships, direct to the employer or through other avenues like our relationship with Medco.

But those are -- have not been major agreements. They’ve been smaller customers, with the exception of Blue Cross/Blue Shield Minnesota which I think is -- we’ve talked about a lot and I think has been well understood the intentions there.

Brooks O’Neil - Dougherty & Company

Yes. Just a couple more quick questions -- I think we are all expecting some ramp-up in the new business coming in related to the Medco alliance. Are you seeing some pretty good traction in the marketplace there?

Ben R. Leedle Jr.

Yes, I do believe we will continue to be able to see good momentum. Again, the sales season for Medco with its employers and its health plan clients is the same as everybody else’s which is they are at the same point in the sales cycle as we have alluded to that we are in as a business and when it comes to the optimal health solution. I would note that in this quarter, we opened and went live with a dedicated call center environment where we have co-located pharmacists, nurses, and health coaches that are sharing integrated data platform and working to service Medco’s clients. And so business is robust enough to have now created a dedicated operating site. So I think those are good indications of the forward progress of that relationship.

Brooks O’Neil - Dougherty & Company

That’s great. How is [DAK] going?

Ben R. Leedle Jr.

[DAK] is going great. We are pleased with our international progress. We are absolutely on our plan for fiscal ’08. The partners that we thought would be really good partners have proven themselves out -- DAK in Germany has been extraordinary as a partner and our progress there operationally has been great, and we are looking forward to this early fall when we share our year-end and our forward-looking thoughts for our business to share with you a whole lot more color around the early process outcomes related to the work that we are doing with the population there. And then our other international contract, which we signed this year is with Fleury in Brazil and just as we speak this week, June 16th, Monday, we went live with a successful launch and we are very excited to go live there from an operating perspective and expect that that will be a long-term successful relationship as well.

The pipeline, the issues that we see here in the U.S. from the dynamic of the population in some cases aren’t as intense as other parts of the world, so the same problems that employers, payers, government, individuals face here are the same around the world and the demand for the kinds of capabilities that we have, the solutions that we have to bear on the market continue to show up in an ever-expanding pipeline that has good activity.

Now, you know our guidance for the remainder of this year, and we haven’t talked about ’09, doesn’t include any additional contracts and the approach that we’ve taken there is rather than try to guess and be wrong, we’ll be happy to tell you what any new contracts in international mean as we go forward, both in terms of the impact that they have strategically as well as financially.

So the international report I’m happy to say is healthy as well.

Brooks O’Neil - Dougherty & Company

That’s great. Last question; Mary, would 35,971,000 shares be a pretty good estimate for the fourth quarter, or will it be materially different from that?

Mary A. Chaput

I am thinking that it will be a little lower than that.

Brooks O’Neil - Dougherty & Company

Okay, great. Thank you very much.

Operator

Thank you. We’ll go next to Darren Miller with Goldman Sachs.

Darren Miller - Goldman Sachs

Good evening. Mary, a question for you; the costs associated with the revenue you recognized in MHS, how much was that and where was that booked?

Mary A. Chaput

Good question. As we have mentioned in previous calls with you all, we thought it was important to our shareholders to keep our colleagues motivated and retain them and as you all know, we did not pay a colleague bonus in fiscal 2007 because we did not hit our internal targets and that was primarily because of our Medicare health support performance. Therefore, the $5.2 million of performance revenue that we recognized in this quarter will be paid out to colleagues, non-officer colleagues in the fall, which is part of our established plan.

And because the domestic, the colleague bonus is a pool that is shared with all domestic colleagues, so both those that work on MHS and those that work on commercial contracts, the accrual is made to the same call centers where those colleagues work, where their salaries are booked. So it’s spread throughout the organization is the short answer there, so it’s booked to cost of sales, it’s booked in SG&A, it’s booked in MHS line of business and it’s booked in the commercial line of business.

So given that, trying to pull apart what is the EPS contribution from MHS versus commercial is no longer really relevant. Needless to say, both are on plan to hit our combined guidance for the year.

Darren Miller - Goldman Sachs

Can you just break out cost of service versus SG&A?

Mary A. Chaput

I don’t actually have that.

Darren Miller - Goldman Sachs

Okay. I’ll follow-up with you on that then. Where are we in terms of capacity utilization for the quarter? I know it was about 68% in the second quarter.

Mary A. Chaput

Yeah, I answered that a little earlier -- we ended the quarter at the 75% to 76% level, as expected, and we know that capacity utilization will improve over the fourth quarter. We are finding it difficult, Darren, as I mentioned earlier, to provide that, given the Telework model and as Ben mentioned, we’ve opened a San Antonio center with Medco, so that’s going to confound that metric and we will have to come up with something that provides information to you but is reasonably estimated or calculated.

Darren Miller - Goldman Sachs

Can you provide a sense, as far as the improvement that we saw, how much of it was due to additional revenue coming on versus how much was cost containment?

Mary A. Chaput

Well, it came from both. I don’t have a breakout on the two but we mentioned that we closed the center in Ohio and that obviously provided some improvement in that capacity utilization and the rest is the increased revenue. So I don’t have a breakout.

Darren Miller - Goldman Sachs

Okay. And then can you remind me, what was the share repurchase assumption that was in your guidance?

Mary A. Chaput

We assumed -- we were very close to our assumption, and so -- I don’t have that number in front of me but it was not a big variance from our forecast and our guidance assumed.

Darren Miller - Goldman Sachs

Okay. And then Ben, quick question for you -- how is the 1109 selling season shaping up versus the same time last year looking at the 1108 selling season?

Ben R. Leedle Jr.

I would tell you probably the best indication of that that we track and I share from time to time is the data around the number of RFPs and the scope and the nature of those RFPs in terms of what they represent as potential revenue for the organization. And there is a slight up-tick year-to-date in our fiscal ’08 as compared to fiscal ’07, so the activity of our sales season is every bit as intense as what was yielded last year in terms of business development, if not a little bit more. So we continue to see that strong demand. It’s not waning. If anything, while there’s slightly more RFPs that have come our way this season, the nature of those RFPs have been aimed at least at the front-end intent to be broader in scope by looking for integrated solutions between prevention wellness, lifestyle coaching, disease in case and high risk care management.

I did mention earlier in some of my other comments to other questions that we’ll see as final decisions are made and those final decisions are wins or losses for Healthways in this mix exactly what the final intent and steps that people choose to take in terms of what they finally purchased. That’s still -- it’s still a little early for us to be talking about that or provide you with any kind of ’09 guidance. But sales season has been equally as strong as the ’07, if not a little bit stronger from a standpoint of both opportunity and activity.

Darren Miller - Goldman Sachs

Okay. Thank you very much.

Operator

Thank you. We’ll go next to James Kumpel with FBR Capital Markets.

James Kumpel - Friedman, Billings, Ramsey

Today I just wanted to get your comments about the acquisition of MEDecision by Health Care Service Corp. I guess they have Blue Cross/Blue Shield operations in Illinois, Texas, Oklahoma, and I wanted to see if you do business with those Blue Cross/Blue Shield plans.

Ben R. Leedle Jr.

We do business with HCSC across the board with all their plans on the health support side of our business and we have a more concentrated book of business on the disease management services with Blue Cross/Blue Shield Illinois. And MEDecision has been one of the entities, and they’ve been there for some time, we’ve been there for some time, so we have worked side-by-side in the same environment for a good period of time.

James Kumpel - Friedman, Billings, Ramsey

And have you touched base with Health Care Service Corp. since the announcement to just determine how they view your place in their future plans?

Ben R. Leedle Jr.

Well, since that release came out today and since I’ve been preparing to talk to you today, no, I haven’t talked to HCSC since the release came out. But we are always in constant conversation with our clients and customers and if the question is do we see this as a threat to our current customer relationships, I think the answer from us would be we worked well together. The work that a MEDecision does versus what a Healthways does on behalf of a health plan have been at least historically separate and distinct, where the health plan has asked us to work together to coordinate those things.

I do think MEDecision, which has roots in utilization review, utilization management software, has been making attempts to create care management, disease management, broader software tools that a health plan might use. And so to the degree, if you are looking at all angles of this thing, if those are effective agents and enable health plans to do more of those activities on their own on a homegrown basis by purchasing those assets and then integrating them themselves with all the other pieces, I guess you could say longer term a question mark out there, what does this mean?

But I think in the near-term, it’s business as usual and I think that this is just a good indication that the leadership at HCSC is clearly looking at ways to assure that they have the capabilities they need to be successful in what I described earlier as a very competitive landscape, and obviously they are a very large health plan on any front and you would expect to see them do those things.

I also think HCSC was by far the single largest client for MEDecision, so that dynamic I think was a part of the equation as well.

James Kumpel - Friedman, Billings, Ramsey

And also just kind of on that front, can you talk about your conversations with the clients who basically postponed the implementations that you had originally planned for fiscal ’08? And maybe give us a sense where that stands and what their view is looking into fiscal 2009?

Ben R. Leedle Jr.

I think you are referring back to the conversation from our February 26th conversation, is that right?

James Kumpel - Friedman, Billings, Ramsey

Yes.

Ben R. Leedle Jr.

Is that what you are referring to?

James Kumpel - Friedman, Billings, Ramsey

That’s right.

Ben R. Leedle Jr.

There was a couple there. One was we had talked about a [CAM] services opportunity and there was an incumbent and we had had high confidence that we would be winning that business. Obviously we didn’t. We think that that will cycle back as an opportunity not in this fiscal year, potentially in fiscal ’09 or ‘010. And then the other one was a current customer who also had expanded with a couple of programs who had intended to do a third and based on where they were from a decision point, held on third program and it’s still a little early in the health plan budget and planning cycle as to whether or not they would expect in ’09 or ‘010 to revisit that.

James Kumpel - Friedman, Billings, Ramsey

Okay, and I guess the third question would be as it relates to the guidance, Mary, you know, you are sticking to the 720 to 740 for the year in terms of revenues, but that would imply a really wide range for the fourth quarter of revenues of as little as $174 million to as much as $194 million. Are there factors in the fourth quarter that could drive the revenues down by 10% sequentially? Or is this just being very, very, very cautious?

Mary A. Chaput

I think what I would characterize this as we’ve never seen any benefit to narrowing the range, so I guess I would just say that we established the range in the beginning of the year, we still feel very comfortable about that range today, and of course in that number is the international from 8 to 10 and I guess you might have factored that into your variance, but we feel good. A 10% reduction from our range would be a huge surprise.

James Kumpel - Friedman, Billings, Ramsey

Well, I mean sequentially, because you did $191 million this quarter, so to get down to the bottom end of that range would be -- you know, that would be a 10% decline.

Mary A. Chaput

That would probably be something we’d be talking about now to prepare you.

James Kumpel - Friedman, Billings, Ramsey

Okay. Last one, I guess as it relates to future NAS revenue recognition, do you anticipate that any potential recognitions off the balance sheet would be just added to the bonus pool and would not be a part of your fourth quarter guidance?

Mary A. Chaput

Right. I would suggest, and I think we talked about this at the last quarter, that there might be another $500,000 or so that would be available for recognition, depending on the next arc report. We were at about 93%, the fees that we had accrued, which last about 7% or close to $500,000, $600,000. And just one thing I wanted to mention going back to your Q4 to Q3 revenue differential, of course we did recognize that $5.2 million in MHS that we don’t expect to be -- to occur at that level again in the fourth quarter.

James Kumpel - Friedman, Billings, Ramsey

So the appropriate baseline would be more like 186?

Mary A. Chaput

Yes, that’s right.

James Kumpel - Friedman, Billings, Ramsey

Okay, great. Okay, thank you.

Operator

Thank you. We’ll go next to Ryan Daniels with William Blair.

Ryan Daniels - William Blair

Good afternoon, everyone. A couple of quick questions, again on the model; Mary, can you give us an assumption of what you are using on the tax rate? I think we had discussed in the past you thought it might be similar year over year. It now looks like you are trending a little more than 100 basis points higher, so in the guidance, are you considering a 41% tax rate for the year and in the fourth quarter?

Mary A. Chaput

Yes, we are and that is primarily up a little bit, Ryan, because of the German profitability that we are beginning to see.

Ryan Daniels - William Blair

Okay, and if we look at the cash flow statement, you mentioned the DSOs jumped a little bit because of four large health plans kind of holding back on payments. Do you have any other color there, or is that just them being a little slower, given some of the challenges that market has seen? And has that fully recovered, so we should see more normalized cash flows in the fourth quarter?

Mary A. Chaput

Yeah, I think that’s right. I mean, a couple of these large customers can swing AR pretty strongly and as I mentioned, we received over close to $40 million since the end of the quarter, so there is nothing unusual going on with our AR. We don’t anticipate any issues there.

Ryan Daniels - William Blair

Okay, great. And then, either Ben or Mary, I noticed there was a fairly large sequential jump in the number of billed lives. It looks like it was up about 2.5 million sequentially, which is probably the biggest move we’ve seen in the last year or two. Is there anything unique in that? Is that a large CAM contract that’s bringing that number up pretty significantly? Or any color you could provide there would be helpful. And then a second follow-up to that -- did we see the full impact of those lives increase during the quarter or was that kind of spread out throughout the period, so we don’t really have a good run-rate looking at your Q3 numbers?

Ben R. Leedle Jr.

Yeah, the second part of that is most of it was in for most of the quarter.

Ryan Daniels - William Blair

Okay.

Ben R. Leedle Jr.

There will be obviously some ramp left to that, and the reason for the billed lives jumping in that level as you could guess probably, Ryan, knowing our service lines as well as you do, is that it’s in the health support arena. So services that are being provided across an entire population means that we are billing a PMPM for every member that they have, so that drives disproportionate billed lives up as compared to historically, we were looking at 2% or 1% slices of populations on a specific disease or condition basis to drive those billed lives.

So it continues to be a combination of those things but you can bet it’s an indication that’s pretty consistent with some of the comments that I had in my prepared remarks around what the data from independent third-party surveys are looking like in terms of the intentions of the employers to aggressively do the things that are going to set the resources in a way that their employed population and their families, and that’s a really important point, and their families have access to health support type capabilities, whether that be a [CAM] services network, fitness centers, or whether that’s lifestyle health coaching or web-based lifestyle behavior change self-directed modules.

Ryan Daniels - William Blair

Okay, that’s helpful color. And then just to follow-up on the HCSC acquisition, it was my impression that Life Masters had the bulk of that business, so I’m curious -- do you do things for the fully insured lives or is that mostly ASO here in Illinois with a Blue Cross/Blue Shield plan?

Ben R. Leedle Jr.

For us with HCSC, it’s the ASO side of the business and traditionally, a concentration there in Illinois. Life Masters I think, as pretty well-known, while they do business across HCSC as well, started and created their concentration in Blue Cross/Blue Shield Texas.

Ryan Daniels - William Blair

Okay, so is that naturally in your view a little less at risk, given that it’s ASO business, that they’ve offered multiple vendors and the clients have chosen the Healthways offering? Or is that --

Ben R. Leedle Jr.

I don’t know that I can put any qualifiers around what parts of our business are more or less at risk, but I do think obviously as we do a good job on behalf of -- and a coordinated effort with the health plan with their large self-insured employers, I think as you’ve seen in the past, those are pretty sticky solutions.

Ryan Daniels - William Blair

Okay, and then the final question, one of the new potential competitive models you discussed earlier was the medical home, and I think you are actually doing that and helping Wellmark, if I’m not mistaken, kind of implement that across their book of business. Can you talk a little bit about what you are doing there and how Healthways is involved in the medical home?

Ben R. Leedle Jr.

Sure, and I think credit needs to go to Wellmark for their design on this, but the idea is not to just simply dump a responsibility for all kinds of things that have been advanced over the last decade around wellness and health management and care support back to the primary care physician, but it really is an approach that identifies the primary care physician as the captain of the process and the captain of a provider team that gets designed uniquely for each individual. And that resources are brought to bear in order to support the physician in that leadership role with their relationship with their individual patient or the member of the health plan.

And obviously the big progress that has to get done in general around medical home but specifically with the work that we are doing with Wellmark is to be able to create common shared views of comprehensive data that is as close to if not real-time as possible in order to inform the very best decision making that the individual patient/consumer needs to make in this model, as well as to give a much broader view so that all of the team of providers that range anywhere from a health coach and a nurse to the primary care physician to the specialist physician, home health, acupuncturist, whatever may be included in the mix, that the team for that individual that they are all able to act off of shared information. And I think that unleashes the power of the model and it says that the centricity of this is in and around the relationship between the patient and the physician which is, as you know, something we’ve subscribed to for a long, long time in the business models that we’ve developed.

So we are excited to be working on all fronts, the integration of those, the establishments of regional pilots around that model, and supporting the data and the technology aspects of that effort.

Ryan Daniels - William Blair

Okay, great. Thanks a lot for the color.

Operator

Thank you. We have time for one final questioner. We’ll take that question from Constantine Davides with JMP.

Constantine Davides - JMP

Thanks. Mary, one last question on Medicare; I don’t have the data in front of me but I remember at the beginning of the year, you guided to $0.25 dilution for Medicare health support this year. Can you update that for us based on what happened in Q3 and what your expectation is for the fourth quarter? Thanks.

Mary A. Chaput

Sure. Well, we actually had revised that to a net cost impact of $0.22 during the year, but as I just mentioned, Constantine, with the colleague bonus getting booked across the organization, the separation of the MHS EPS impact and the domestic is going to be convoluted. So at this point, we’re not trying to break that apart. Needless to say, without the revenue and without the bonus accrual, we are on plan for that $0.22, but now it’s not $0.22 because of the accrual. So we are not going to break it out anymore. Just suffice it to say we are on plan.

Constantine Davides - JMP

Okay, thanks.

Operator

Thank you. And at this time, I would like to return our Mr. Leedle for any additional or closing comments.

Ben R. Leedle Jr.

I just want to thank everyone for their participation today. If you have any quick follow-up questions, please give us a ring now. Mary and I are available. Tomorrow, just so you know, if you are counting on trying to get in touch with us, we are going to be consumed for the day at the William Blair growth conference in Chicago, so I know our presentation there will be webcast and we will be in lots of one-on-ones, so if you are needing to touch base with us, now is the time to put in a call. Thanks again. Stay tuned.

Operator

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

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Source: Healthways F3Q08 (Qtr End 5/31/08) Earnings Call Transcript
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