Tivity Health, Inc.
Q2 2008 Earnings Call Transcript

Published: 19 Mar 2008

[Operator:]

Good afternoon and welcome to this Healthways conference call to discuss today’s second quarter 2008 earnings news release. Today’s call is being recorded and will be available for replay beginning today and through March 25 by dialing [phone]. The confirmation number for the replay is 1193407. The replay may also be accessed for the next twelve months at the company’s website at www.healthways.com. To the extent that any non-GAAP financial measures are 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 the third quarter and full year of 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 Exchange Commission and in its news release issued today and consequently actual operations and 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 the result of new information, future events or otherwise. At this time for opening remarks I’d like to turn the conference over to the company’s President and Chief Executive Officer, Mr. Ben Leedle. Please go ahead sir.

[Ben Leedle:]

Good afternoon everyone and thanks for being with us today for a discussion of our second quarter results. I’m here today with Mary Chaput, Healthways CFO. After our prepared remarks we’ll be happy to take your questions. To outline our remarks for today I’ll give you a brief overview of the quarter and our outlook for the rest of the fiscal year, which Mary will discuss in much more detail. Then I’ll spend some reviewing in more depth our three central growth initiatives that we described in our earnings release today. I also want to stress that our recent press releases about our relationships with Cigna, Fleury and Gallup reflect important current and future trends of our marketplace. Understanding these trends and the relative position of strength of the company are critical to your having meaningful insight into our long-term growth prospects. So before turning the call over to Mary for more details on our financial performance for the quarter and our forward-looking guidance for the rest of the fiscal year, let me share my perspective on the second quarter. So for the quarter we delivered on our guidance as originally established in our first quarter earnings release last December. Further, during the three weeks since our last call we announced several new contracts and in today’s release shared additional, previously unannounced new business agreements signed since our first quarter earnings call. We are pleased with these agreements and their related contribution to the company’s overall growth. Obviously some of these agreements contributed to the $90 million in annualized revenue from new contracts signed year-to-date that we discussed in our February conference call while some have contributed to the updated year-to-date total of $97 million in annualized revenue from new business shared in today’s release. At the mid point of this fiscal year then we are confident that both the new business we have gained today, as well as continuing our execution on the remaining opportunities within this fiscal year will support the achievement of our overall revenue and earnings guidance that we have firmed again in today’s release. So with that I’ll ask Mary to review our numbers in a lot more detail.

[Mary Chaput:]

Thanks Ben. The company’s total second fiscal quarter revenues of $179 million were $19 million higher than our second fiscal quarter of 2007 which was approximately $160 million and included approximately $2 million in revenues generated from the DAK pilot in Germany. Despite a strong number of new health and care support contracts that went live on January 1, our domestic programs delivered approximately $177 million in revenues only slightly higher sequentially than our first fiscal quarter. The new contract revenues were significantly offset by

[Ben Leedle:]

Thank you Mary. In an industry that has been undergoing and will continue to undergo steady and significant transformation, we have consistently implemented a three-prong growth strategy. Leverage the high levels of current demand, drive future demand and maintain our strong position of industry leadership. The first of these growth initiatives is to increase our domestic business. In this regard the early extension of the Cigna contract through 2013 is very significant. First because of what it does to support our revenue visibility over the next five years. Second, in the context of the concern we have all heard in the financial community about health plans internalizing health improvement programs such as disease management. As we have long stated, we believe the best in class solutions for health plans will always be a combination of in-source and out-sourced capabilities that are well-knit together. Of much greater importance, however, will be the sustainability of the proven value created by improved outcomes that those solutions actually produce. Looking at last week’s turmoil in the financial markets with respect to health plans, we don’t think it coincidental that Cigna with its strong commitment to comprehensive, best in class disease management, faired relatively well versus many of its peers whose disease management programs are, as you know, principally in-sourced. Further evidence of our continuing success in g rowing our domestic business can be found in the more than 200 contracts signed year-to-date. These contracts cover all of our market segments and for all of our products, and include all health plan lines of business, direct employer and also work that we do integrating with a PDM. While we have added new customers, we continue to expect the majority of growth to come from satisfied and existing customers who are expanding and/or extending their contracts and increasingly leveraging our relationship to create more value. In addition, as we discussed in our February call, the number of Requests for Proposal or what we call RFP’s for integrated single-source health and care support solutions have grown rapidly to nearly ½ of the total that we have been receiving. We are and we believe ideally and uniquely positioned to fill this demand. As a result, we expect to produce continued substantial long-term growth in our domestic business. Our second central growth initiative is to expand our addressable market beyond our domestic business. One way we are doing this is through our international initiative. As you know, we launched our first international agreement on January 1 with DAK, the second largest statutory insurer in Germany. Our engagement of the population has gone really well and we have exceeded our targeted participation more quickly than we had anticipated. As always we will keep you updated with any further information about our progress when we can. As you know, the opportunity to expand into a broader population with DAK is dependent on our achieving outcomes. We did not expect to reconcile on our outcomes with DAK until some time after the first year of the operations. Accordingly, a decision on expansion isn’t likely until some time in the back of fiscal 2009. Now, two weeks ago Brazil became our latest new addressable market with the signing of a ten year disease management services agreement with Fleury FA. This agreement represents a great opportunity for Healthways. Fleury provides a unique physician-to-physician diagnostic clinical model for healthcare support to approximately 6 million of the nearly 40 million people with private insurance in Brazil. That is roughly 17% of the privately insured population in that country. Fleury is also known for its work to improve executive and corporate health through its wellness services. It is the leading and largest provider to this market and widely considered the premier brand name in the field. There is simply no other company in Brazil that would be a better partner for Healthways for our entry into this very substantial market for disease management. As a healthcare provider, Fleury has a deep and intuitive understanding of the potential of our solutions to improve outcomes and lower costs. As a result, our teams were able to work extremely well together to quickly and effectively strike a truly innovative agreement. It is also important to note that Fleury’s needs as a healthcare provider are significantly different than the needs of say DAK in Germany, for instance, or even those of our U.S. customer base. Essentially, Fleury has the human and infrastructure assets it needs to engage its population but lacks the proven expertise, tools and intellectual property that we can provide right now and into the future that are critical to driving value to improved outcomes. As a result, the business model we are implementing in Brazil will be supported by long-term revenue streams related to licensing, management and consulting services. Our revenues will not reflect investment in people and hard asset that accounts for much of the revenue and costs in our typical contract structure because these costs will be born by Fleury. As a result, this business model represents a low capital intensive approach to the market for Healthways. In addition to our not being at financial risk for outcome, we will receive fixed fees for the first three years of the agreement and then for the remainder of the term we will see those fixed fees increase based on actual participation. Because of these characteristics we expect the contract to be accretive quickly even at low initial volume and to grow in value over the term of the agreement. As the contract with Fleury shows, we are willing to adapt our business model to the needs of the market provided that the execution of our programs has the necessary ingredient to be successful in fulfilling our value proposition. That is, sustainably improving health outcomes, reducing costs and improving productivity. Based on the strength and quality of Fleury’s reputation and success, we have high expectations for our entry into Brazil. The relatively condensed sales cycle is indicative of both the demand driving net market and the flexibility and innovation that we and Fleury brought to the task of creating a new standard for healthcare in Brazil. We are completely open to the possibility that the resulting business model, which includes long-term commitment, could have applications in other countries and with the right partner even domestically. Now let me make a few brief comments about our third central growth initiative and why our recently announced exclusive strategic relationship with Gallup is such an integral part of our plan. For several months we have been discussing with you the next generation of capabilities that we have been developing in order to expand our historical value proposition by bringing integrated solutions to market. These new solutions will achieve three critical objectives. Keeping healthy people healthy, mitigating modifiable lifestyle risk factors and optimizing care for people who have chronic disease or persistent conditions. As you might expect, data is the foundation of our ability to effectively and efficiently implement these solutions. In past calls I have shared with you the intense work that was required just to model the impact of a future perfect environment on potential population based averaged cost and productivity benefits. To narrow the focus down to a company, or a family, even an individual while continuing to make an outcomes promise requires a comprehensive understanding of the drivers of health and well being in a way that is simply unavailable through typical industry data today. Further, because the data being collected in this relationship will be indexed, it offers the promise of becoming a single credible metric for performance. In this context, an exclusive and long-term relationship with Gallup, the world’s premier polling and analytic organization makes perfect sense. Gallup will make at least 365,000+ annual surveys for the next 25 years. Coupled with the deep clinical, behavior change and claims data Healthways will provide, the Gallup Healthways Well-being Index will be the touchstone for companies, government and community leaders seeking to measure the health and well being of their population to guide their strategies for improvement and to evaluate the effectiveness of selected solutions with a vent to drive higher performance. Before opening this call up to Q&A, I do want to close by commenting on state of the industry. I’ve gotten a lot of questions regarding the emergence of new competitive forces and the introduction of new models for enhancing the value for health improvement. There is much current debate and no shortage of theses. However, I would offer a very simple score card for your evaluation. The score card embodies the six essential competencies of any organization or solution aiming to drive enhanced value for the future. They are

[Operator:]

Thank you, Sir. The question-and-answer session will be conducted electronically. At this time if you do have a question you may signal by pressing *1 on your touchtone phone. If you are using a speakerphone today please be sure you mute function is turned off to allow your signal to reach our equipment. Once again it is *1 for question. We’ll go first with Tom Carroll of Stifel Nicolaus & Company, Inc.

[Tom Carroll:]

Hey, good afternoon. Two quick questions on your new business comments on your press release. One I guess a quick one on your international business in Germany you mentioned $8-10 million in revenue. When do you expect that really to come in? A little bit in third quarter, more in fourth quarter? Maybe if you could give us some color on that. Secondly, I see you highlight I think three Silver Sneakers contracts; United, Horizon and Bravo Health. Did any of these forward-looking contracts show price pressure relative to Silver Sneakers contracts you have signed in the past say last year given that these contracts kind of look good into the next coupe of years? I’ll stop there.

[Mary Chaput:]

I’ll take that first one. We did recognize about $2.3 million for the two months of January and February in the international so it’s a fairly big fee. We should have some foreign exchange benefit, but you can expect that to come in to just over $1 million a month.

[Ben Leedle:]

On the second question, this is Ben, both for Silver Sneakers I think that you saw in the release as well as Forever Fit, which is another seniors activities program that we delivered into the Medicare Advantage market, the pricing related to those agreements have been consistent with past practice.

[Tom Carroll:]

Okay thanks.

[Operator:]

We’ll go next with Brian [Tankelit with Jefferies and Co].

[Brian [Tankelit:]

First question, if you could provide us some color on the terms of the Cigna contract expansion specifically in how it compares to your previous contract with Cigna?

[Ben Leedle:]

This is a pretty simple one to answer. I would say this is simply an extension of the basic terms and conditions under which we currently operate. There is no expanded programs with this. We will continue to provide disease management and impact conditions within that relationship. I think one of the things we noted in our joint release is both parties can take non-disease management solutions to the market. What that meant was we both have ideas and thoughts about next generation market and we will work together as a primary effort to create an integrated solution but to the degree that either party wants to pursue a next generation model that is inconsistent with the other party, then both parties are free to do that out in the marketplace. But that is a statement related to the non-DM aspects of this thing.

[Brian [Tankelit:]

So is it safe to assume that pricing is relatively constant?

[Ben Leedle:]

Yes.

[Brian [Tankelit:]

Okay. Mary, just a question on the decision to buy back stock versus pay down debt or vice versa. You paid down $10 million of debt, bought back $4 million of stock in your shares. What is the dynamic in deciding whether to allocate capital towards the buy back as opposed to a debt pay down?

[Mary Chaput:]

It is a pretty simple one, as long as it is accretive or we are going to buy back stock. So we put in a 10B5 plan in the open window back in December and it executed all during the quarter. We had no idea we’d be revising guidance or that the stock would have the significant drop it has had, so you can imagine as the window opens again in about three days we will probably put a more aggressive plan in place.

[Brian [Tankelit:]

So how much more do you have left in this buy back?

[Mary Chaput:]

$90 million worth about.

[Brian [Tankelit:]

Gotcha. Last question Ben and then I’ll jump back in the queue. If you don’t mind just giving us some of your thoughts on the economic sensitivity on your product whether it is wellness or standard disease management given all these plan sponsors are going back on expenses or they are being more careful on expenses. If you could just give us some more thoughts on that?

[Ben Leedle:]

Let me just make sure I understand your question. Your question is referencing health plans or employers?

[Brian [Tankelit:]

Both.

[Ben Leedle:]

You’re identifying a trend that says they are pulling back from…

[Brian [Tankelit:]

Are they pulling back is the question.

[Ben Leedle:]

I did share some data on the last call. I think I even tried to point people to recent surveys that are done by the benefit consulting houses that deal with where the demand gets created out at the employer level and all of those numbers through those external validated sources indicate a ramping demand for all aspects of the capabilities that we have. Internally I think I shared on the last call when we analyze things like requests for proposals the number is up and really what we are seeing is a very strong shift and a rapid move for disease management and wellness programs to be integrated. So the economy probably is affecting employers and health plans in lots of different ways. I don’t necessarily believe that there is anything we are seeing in internal or external trend data that would have us believe that there is a pull back.

[Operator:]

We’ll go next to Michael Glynn of Credit Suisse.

[Michael Glynn:]

Thank you. So your third quarter EPS guidance would imply the fourth quarter you’re going to need to see a sequential growth of 35% or so to get to the mid-range of the full year guidance. Could you maybe detail how you are going to see such a sequential improvement?

[Mary Chaput:]

I think basically you are going to see the revenues increase significantly. We have in the third quarter the 10 cents or about 10 cents, probably a little closer to 8 cents in the third quarter for the new headquarters and that’s going to go away in Q4.

[Michael Glynn:]

Entirely?

[Mary Chaput:]

There will be a couple of cents ongoing for the increase on the rent and space. So the increased capacity utilization, the cost of the headquarters will be essentially behind us, the cost of the new call centers, we’ll have a full quarter of revenue and some additional contracts starting up. Capacity utilization should move…I think we’re probably sitting around 68% at the end of this second fiscal quarter and we’ll expect to see improvement maybe up to as high as 85%.

[Michael Glynn:]

Okay. Back to the Cigna contract just to try to get a little more specific if we could. It is an extension of years, but perhaps maybe not in revenue? Can you comment? I guess $135 million of your revenue is from Cigna in fiscal 2007. Can you comment on whether that will be up, down, sideways?

[Ben Leedle:]

I think that the premise around the extension and off of the earlier question that was asked as to have these been renewed on equivalent economic terms the answer is yes. What I can’t predict for you is over the next five years what will happen to Cigna membership. So obviously it is their membership that yields a particular prevalence of diseases we work with them or impact conditions. But barring some major change in the membership at Cigna overall we would expect this to continue forward as we have been experiencing. The best we can tell in the marketplace they seem to be doing well and in a near-term downward pressure on all the MCO’s they seem to be doing as good or better than any of them.

[Michael Glynn:]

Right. Thanks. One more question. You’re probably sick of MHS questions, but I’m still a little confused on the CMS press release or posting on their website versus…I’m not sure exactly what you guys are saying but the numbers they put up obviously was aggregate data but they did put up a range of $300-800 per member per month of necessary cost reductions for the remainder of the pilot to hit budget neutrality. So even if you guys are the top performer in there that would put you at needing $300 per member per month to hit that budget neutrality. Am I thinking about that the right way?

[Ben Leedle:]

I think you have the data right that was provided. What we don’t know any more than you do is where that data came from or have the opportunity for CMS to share with us how they came to those conclusions. I think in fact you know we went public with a statement about request for that clarification. One thing I can update you with is actually yesterday I got an email from CMS that indicated they acknowledged the letter and the information we had sent to them and the request that went with that and we should expect follow-up. Also as a point of progress for those interested, we have received the CMS draft of the amendment for budget neutrality. Obviously we just received this recently and are in active discussions with CMS to work through both the language and then hopefully we’ll be in a position to give you some sense of the implications once that is signed and finalized. I’m not going to give you any predictions on the timing of that because I’ll only be wrong. The other thing is you have probably picked up if you have been following this closely is that there is continued momentum and gain in support on the hill. In fact, Senators Alexander, Kennedy, Kerry and Corker have sent communication in the form of a letter to Mr. Weens encouraging and asking for more diligence and work to be done around the evaluation of these programs. I think the one thing to keep in mind is the difference between any kind of financial reconciliation related to the Cooperative Agreement and the construct and concept and work that will be done to evaluate the performance of these pilots consistent with the way that the Statute was written. I think there is still confusion in the marketplace around the difference in those two things and it is going to be really important that you keep that in mind. The only other color I would add on MHS is we continue to deliver on our program to our original population in Maryland, D.C. as well as the refresh population we picked up a couple of years ago. We are seeing attrition in terms of the reduced number of participants due to death rate net population happening a little bit quicker than we expected, but we will be finalizing our work for our three years on this pilot at the end of July and that remains on course with our work. I’d just add that there is pretty good energy from the whole group of the Medicare Health Support organizations that continue to deliver on their pilots as well to remain active on the front of assuring that evaluation takes place the way it was originally prescribed and intended. So that is MHS for anybody out there listening on that.

[Michael Glynn:]

Sounds like you have some good things in place to make a come back perhaps .

[Ben Leedle:]

We’re not predicting necessarily anything other than sharing with you the process we are engaged in.

[Michael Glynn:]

Is it possible that the $300 or $800 level could have been faulty data?

[Ben Leedle:]

I really can’t comment on that only because I can’t draw any conclusion around it until I understand directly from CMS how they arrived at those numbers and for what time periods they arrived for it and what was their work done in being able to calculate relative trend lines and the rate of change that has to occur with remaining months. In aggregate it is going to be very complex across a staggered group of time and participants through different programs.

[Michael Glynn:]

Thanks Ben.

[Operator:]

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

[Newton Juhng:]

Good morning Ben and Mary. Good afternoon. I would like to ask a little bit on the contract billings and excessive earnings line on the balance sheet I noticed that was down a little bit quarter for quarter and I’m just trying to get a feel for how we should be looking at that. In the past I know there was bonus, I know that is not the case. But how we could be looking at the in-flows and out-flows that created a $200,000 decline?

[Mary Chaput:]

Good. As a matter of fact the balance of the BIE was pretty close to the same, about $76 million, but the composition inside of that whereas in first quarter MHS made up about $63 million of that and by that I mean the Medicare Health Support side of that and in Q2 it was $67 million so that went up $4 million. So you can infer from that the commercial which was in Q1 approximately $13 million is now down to $9 million.

[Newton Juhng:]

Okay great. I was just wondering can you tell me how quickly you can get a program up and running so that it begins to provide meaningful revenue?

[Ben Leedle:]

Yeah sure. Obviously there are a pretty broad array of programs and services that we can deliver. Typically on the care support side of our business those programs would be implemented in a 90-120 day time frame. If it includes a step wise growth of a call center in a scenario where a particular client wanted to have a dedicated call center operation those are more in the order of 150-180 days and then probably 90 day time frames for the bulk of our health and wellness programs to be implemented. So that kind of gives you a range of 90-150 days pretty consistently in terms of implementation. When we shared with you backlog in the past you know that is our estimated annualized revenues from an agreement at target performance and typically Mary would tell you take that number and half for the forward-looking year in order to be able to see those revenues in through the way you are looking at the business.

[Newton Juhng:]

I see. So 6-1/2 months into the year here in the fiscal year we should be looking at your visibility of what you need to get to your numbers as being very high and otherwise considering the 90-120 day time frame as kind of being on the shorter end is what you would need to do in order to get a program to bringing in revenue you are pretty much already at that point.

[Mary Chaput:]

Why don’t I help you walk through that. If you took the fourth quarter run rate from our fiscal 2007, I think it was about $170 million and if you multiply that by about four to annualize it you come up with about $680. Then if you remember at the end of our fourth quarter we had a backlog of about $40 million and I think that is what Ben was referring to – if you take about half of that…and why you take half it is when is the start date or how much revenue would be at risk or would defer or delay the recognition of that you would add $20 million to that so you are now at $700 million. Since the beginning of the fiscal year we have signed about $97 million worth of new business. At this point I guess I would recommend you take about 1/3 of it so maybe $30 million would come in a year. I’m just giving you some rules of thumb that you could use. Then remember I talked in my opening remarks about the decline in the second half of the year over the first half for a variety of things, ASO customers that were lost, some terminated contracts because of financial insolvency or lass of critical mass and those three things added up to about $10 million. So you go through those machinations and you are down to about $720 million for the commercial business. And I think our guidance is $708 to $726. So that will give you…then if you wanted to add international in at $8-10 million you’d be comparable to the $720-740. You’d probably be in the middle of that range.

[Newton Juhng:]

Gotcha. I’ll definitely work through that off line. Let me ask you one more question. On the Fleury contract here when I hear fixed fee sometimes that gets me excited and sometimes it gets me a little scared. What I wanted to know was just around if there is greater adoption than you were expecting in the first three years considering you are on a fixed fee…I would assume beyond that it would be considered a good thing but in the short-term the kind of mid-term, those first three years, how would we be looking at that?

[Ben Leedle:]

There’s protection in the agreement over the first three years that if for whatever reason there was a dramatic ramp up to the positive then we wouldn’t be sitting in a position of being penalized for that. What it does do is it guarantees us a minimum as the business ramps up across those first three years and then really converts over to more of a PMPM type arrangement related to the participation so that it will float and move with the success in the marketplace.

[Newton Juhng:]

Ben can you remind me. Is the recruitment here of people in this contract going to be something that Fleury is going to be taking on and is it more of an optic in to some sort of program that they are trying to push?

[Ben Leedle:]

Yes.

[Newton Juhng:]

Thank you very much.

[Operator:]

We’ll go next to Ryan Daniels with William Blair and Co.

[Ryan Daniels:]

Yeah good afternoon guys. A couple of quick follow-ups. First on the $97 million in new revenue I think you mentioned in your prepared comments that is a record in regards to a full year basis let alone for six months. Can you give a feel maybe a year ago period what that metric was so we can see the growth rate?

[Ben Leedle:]

Great question. We’re going to have to follow-up with you on that.

[Mary Chaput:]

I have a sense but I really wouldn’t want to put it out there unless I was sure it was right.

[Ryan Daniels:]

That’s fine. I can take that off line. In regards to the Cigna contract I don’t know how much you can provide on this but obviously they have done a recent acquisition of Great West and one of your competitors [Matry] indicated that Great West is going to put growth with them on pause. Is there opportunity to capture that business? Was that part of the discussion about that expansion? You kind of hinted Ben that as they grow hopefully this business grows, that is certainly one way their fully insured lives are going to grow pretty substantially over the next couple of years. Is that business you think you could capture?

[Ben Leedle:]

I think we’ve got a good shot at that. I think it obviously will make sense for Cigna to have a common approach for their business and obviously we are across I guess 10 of their 20 million lives as it is and have been there for 11 years. So I’ll never say that there is a guarantee or anything associated with that but I think we are in a position to have the opportunity to service that population in the future.

[Ryan Daniels:]

Fair enough. And then going back to an earlier question and maybe asking it a little bit differently…not about the economy but what we have seen out of the managed care plans over the last really 10 days or so with some of the problems they are having with medical cost trends and Medicare Advantage pricing on the PDP, things like that. If you look at that, I just want to get your color on it. Is that really enhancing the longer term opportunity for you and in turn does it maybe diminish the nearer term pipeline, i.e. are plans a little more hesitant to go out and buy things today even though they may need it more in the future because of what is going on? What are you seeing there and what do you see in the pipeline because of what has happened.

[Ben Leedle:]

I would tell you our pipeline as I commented earlier is as strong as it has ever been . The activity is for deeply integrated solutions that are either coming from health plans visa vie their ASO demand from their customers or directly from employers for that. I do not see the recent issues for the MCO’s to in any way curtail that or step back from it. I think we see it as likelihood that it gets amplified because there is only so much they can do to lower administrative costs in their business and the demand is to drive value from the other part of the healthcare dollar which is the majority of the healthcare dollar that they have taken on the responsibility to manage either directly in their fully insured books or on behalf of their employer customer. So I think it puts more pressure on the health plans to show their relevancy to do just that. So I think it is going to press them, as we’ve said for a long, long time, that at the end of the day it will be about outcome and that the market will pursue at a higher rate of expectation that you can deliver and improve those outcomes and scale so I think we are in a good position to continue to help our current clients and potentially also benefit from an urgency that is going to get created around doing that.

[Ryan Daniels:]

That’s great color. The last question I have and I’ll hop off and follow-up with you guys off line, given the recent activity we’ve seen in the market with a lot of your DM competitors, have you seen a lot of opening up in the pipeline again on an RFP basis where industry consultants, health plans, employers, are maybe a little more hesitant to give business to somebody who has recently been acquired, could be acquired, is undergoing acquisition talks and things of that nature…is that actually opening up business for you as you look forward to 2009 starts?

[Ben Leedle:]

I would tell you that we think there is great opportunity. While it is intriguing around the kind of business models that are being put to test here in the near-term based on that MNA activity you are talking about. In the meantime people have to make progress and I do think they do hesitate around that MNA type of activity to try to understand what is the strategic value for why those organizations are coming together and then they put some kind of do-ability factor around the relative integration and the benefit that will be claimed from those combinations. I think in the meantime we stand pretty clear and pretty open with our capabilities to help people right now with what they are looking for. I think it will provide us maybe with a slightly disproportionate edge during this time frame.

[Ryan Daniels:]

Thanks.

[Operator:]

We’ll go next to Brooks O’Neil with Dougherty and Co.

[[Depak Chala:]

Just a follow-up on the Fleury contract. Ben you commented that the expenses not for you guys but for Fleury…are there any kind of expenses that we should be thinking about when you roll on with the contract?

[Ben Leedle:]

I think you can think of it as largely account relationship and obviously some degree of management support to that effort. I was trying to point out in my prepared remarks that you should not expect to see the kind of cost intensity that you would typically see associated when we are completely responsible for all of the infrastructure, technology, facilities and people and would be part of the model and you probably became knowledgeable about in following us over time. So you really need to think of this as the kind of business model that would yield economics that would be consistent with either consulting or licensing type arrangements.

[[Depak Chala:]

That is very helpful. Do you still provide numbers for Axia or is that integrated now with you?

[Mary Chaput:]

We don’t. They are so intertwined at this point with integrated solutions that it is just an exercise in allocation.

[Operator:]

We’ll take our next question from Daryn Miller with Goldman Sachs.

[Daryn Miller:]

Thanks. I was wondering Mary if you can spike out in the first and the second quarter the costs that you incurred for bringing the call centers on line that were falling I guess in the cost to service line?

[Mary Chaput:]

Yeah sure. First quarter those new centers, and some of them are health and care support, some of them are just health support and some are just care support, we are about 4 cents. So that is about $2.5 to $2.8 million. In the second quarter we spent another penny on those call centers, and about a penny on the headquarters at that point as well. Remember pre-tax $625,000 now is a penny. Third quarter I think I mentioned that the headquarters is going to be about 6 cents plus 2 ongoing so about 8 cents in total and nothing more on the call centers. Then the fourth quarter another 2 cents which will be ongoing.

[Daryn Miller:]

Great. Then you also gave some interesting statistics on capacity utilization. How do you guys measure that?

[Mary Chaput:]

It’s not easy. Meaning we have seats and available space with desks and people in their desks and then we have capacity where there are desks available but not yet filled and then there is the percent of time that it is used. We have call centers that are dedicated to specific customers that have excess capacity and then some that are shared. Our target is to reach 85% capacity. What we do is we kind of add up the available seats and the numbers that are filled and we get improved margins. Anything above the 85%. I think I talked previously of sometimes heading as high as 90-92%. So we run the first half of the year around 68% capacity that is when the pressure is around the margin. At this point I would say we’re running probably in the non-customer specific centers at about 65% non-dedicated and the customer specific about 75%. So that’s where we get the approximately 68% capacity utilization when you look at the numbers.

[Daryn Miller:]

And you think you’ll be at 85% by the end of the year and if that is the case does that mean that next year we’ll see more call centers come on?

[Mary Chaput:]

Well our target is to get to that 85% and we’ll give you 2009 guidance when we get to the end of this year.

[Daryn Miller:]

Great. One more. On the large ASO employers you reference in relation to the $10 million in declining revenue? What is going on there?

[Ben Leedle:]

I listened to Mary’s prepared comments and it could have been interpreted as those were our contracts that we lost. Those were employer accounts that left the health plan completely. So obviously when we talk ASO those are employer relationships that are customers of the health plan and the health plan contracts with us to bring health improvement programs like the deep management wellness to those employers. If that employer changes their health benefits administration relationship and no longer offers that health plan those drop out of our queue on January 1 typically and a lot of our health plans will then also add new clients in and then typically come back to some level of either negative or positive turn associated with those clients. Then Mary commented there was opportunity because those ASO account go somewhere and we have a pretty significant foot print and relationship with other health plans and typically have had the chance to recover those relationships through other health plans and also be able to re-identify new membership that has replaced those ASO accounts in existing health plans later in the year because it is a claims based process. So I wanted to make sure we did have the opportunity to clarify that. I don’t know if that helps answer your question or not.

[Daryn Miller:]

Yes it does thank you. One last question. Are you guys willing to break out Silver Sneakers revenue?

[Ben Leedle:]

No.

[Operator:]

We’ll go next with Lynn [Pedalsky] with Piper Jaffray.

[Lynn [Pedalsky]:]

Hi guys thanks for taking the question. There is obviously going to be some spillover costs into fiscal 2009 as Medicare winds down. Can you give us an estimate of what those might be for the first couple of quarters?

[Mary Chaput:]

Absolutely. There will not be wide count cuts because it really ends at the end of July so there may be some small spill into August but that will be it.

[Lynn [Pedalsky]:]

But nothing in fiscal 2009.

[Mary Chaput:]

That’s correct.

[Operator:]

That is the end of the question-and-answer session. At this time I’d like to turn the call over to Mr. Leedle for any closing or additional comments.

[Ben Leedle:]

Just want to thank you for your time today. Obviously Mary and I and the team will be available for any other questions or conversation you’d like to have. Just so you know Mary and I are traveling to the Lehman Brothers Conference in Miami tomorrow and Thursday so we’ll actually have a web cast of our investor presentation and will be hopefully seeing some of you down there where the weather is warmer.