Note From Edward Hemmelgarn

Patience is a virtue, especially in today's market environment. Many investors cling to the 1990s ideal of a rapidly rewarding and consistently upward-moving stock market, but that was the exception, not the rule. Conversely, investors are overly pessimistic when equities fail to deliver significant, immediate returns. It's prudent to remember that equities are long term investments, and despite periods of meteoric gains and painful declines, they usually deliver attractive returns over time.

The up and down pattern of today's markets is likely to be repeated often in the coming years. As for the remainder of this year, we believe that the Fed will slow the pace of its rate hikes prior to the end of summer, which should inspire a rebound in equities. At this time, it may be prudent to avoid stocks that are most vulnerable to rate hikes, higher energy prices and slower global growth rates.

In the meantime, we continue to look for sound growth companies which possess the characteristics to produce significant growth. A prime example is American Healthways, the nation's leading disease management firm, and one of our holdings. In this issue of our newsletter, we interview Mary Chaput, the company's chief financial officer, about how American Healthways has achieved significant cost savings for health care providers. Additionally, Karen Mroz-Bremner, Ph.D, one of our Healthcare analysts, provides insights as to why disease management continues to gain favor within the healthcare establishment.

Improving Health while Curbing Medical Spending
By Karen Mroz-Bremner, Ph.D - Healthcare Analyst

Far more attempts have been made to fix healthcare problems than to prevent them, and healthcare costs have continued to skyrocket. Fortunately, that approach is starting to change. Those paying for healthcare costs (employers sponsoring health insurance, individuals paying premiums, and the government underwriting Medicare) have begun to focus on achieving a pound of cure by spending an ounce on prevention.

Much of the focus is on disease management. Half of US healthcare expenditures are spent on a mere 5% of the US population, most of whom have chronic health problems. Helping these individuals improve their quality of life and prevent further complications provides a win-win situation for both the payors (whose costs are reduced) and the patients (whose quality of life is improved).

Disease management programs help individuals with chronic conditions improve their health through behavior modification, care coordination, and by ensuring that patients receive the scientifically validated best standard of care. These programs often use knowledgeable call center nurses, who encourage patients to set goals and discuss concerns with their physicians. The health insurer pays the disease management company fees for their services. These costs are recouped, generally in less than 9 months, due to reduced spending on hospital visits, prescription medications, and other services. The payors save money, although in my opinion the real winners are the individuals who take a more proactive interest in their own healthcare and enjoy a healthier, higher quality life.

The Federal government has recognized the wisdom of Ben Franklin's advice, and is moving towards disease management programs as a way to control Medicare expenditures. A year and a half ago Congress mandated that Medicare implement 3 year-long pilot programs in 2005, and that all Medicare HMO plans have Disease Management programs in place by 2006. Since 20% of seniors have 5 or more chronic conditions and account for 2/3 of the money the Federal government spends on Medicare, disease management programs offer tremendous potential for cost savings, improved quality of life for seniors, and an opportunity for disease management providers.

In this issue, we highlight the leading independent disease management company and one of the newest holdings in our portfolio, American Healthways, Inc. (NASDAQ: AMHC). American Healthways manages over 1.4 million diseased lives. The company has demonstrated cost savings for health plan customers such as Blue Cross and Blue Shield of Minnesota, who have reported savings of at least $2.90 for every $1 invested for total population healthcare management. This translated to a 2-3% reduction in overall medical expenses for the entire health plan.

Last December, American Healthways was awarded 2 of Medicare's 9 Chronic Care Improvement Projects (1 in conjunction with longtime partner Cigna). The fees that the government pays for these 20,000 patient pilot programs are refundable to the government if the program fails to realize 5% savings when compared to a control group. Because of the nature of these fees, American Healthways will not be able to record the revenue until there is sufficient data to be assured that 5% savings were achieved. Within the next month or two, American Healthways should announce the programs' start dates and detail the costs. We expect that this announcement will lower the EPS estimates for the next 3-4 quarters, but that within 4 or 5 quarters the company will be able to recognize the revenue, which should prompt a large jump in EPS. Although this may cause headline risk in the short term, cash flow growth and annual EPS growth should continue to be strong.

Executive Insights
Mary Chaput, Executive Vice President and Chief Financial Officer
American Healthways[NASDAQ: AMHC]

Q: Why have so many initiatives to control healthcare costs fallen short expectations?
A: Healthcare costs have experienced doubledigit, annual increases for quite some time the U.S., and now represent a major financial burden to consumers, corporations, and the government. Traditional initiatives to control costs have primarily focused on utilization review and utilization management. These approaches have sought to limit access healthcare, which has actually served to drive up healthcare costs. At first that may sound paradoxical, but reducing routine checkups and medical maintenance opens the door more serious medical conditions, which are highly expensive to treat.

Q: How does American Healthways control healthcare costs through disease management?
A: We work closely with patients to address their personal health needs and by taking steps to enhance their care - rather than limit it. When you can provide people with greater control over their health through improved care and better education that tends to reduce healthcare costs.

Q: Do you expect your role in disease management to increase?
A: Yes, because no other alternative to disease management has demonstrated an ability reduce healthcare costs long-term. As result of some of our programs, Blue Cross and Blue Shield of Minnesota reported 18% drop in emergency room visits and 14% drop in hospital admissions. Ernst Young verified savings of up to 29% in total health care costs for congestive heart failure. Hawaii's largest health plan enjoyed 2-to-1 financial return on its investment our diabetes program. All of these numbers are third-party-validated and peer-reviewed. We've seen no other published cost control initiatives in the healthcare arena that have approached results of this magnitude.

Q: What is the competitive landscape in disease management?
A: Our competition includes a mix of public and private companies, many of which sell directly to employers. We sell almost exclusively to health management organizations, and believe this is advantageous for a number of reasons. Health plans aggregate data that can be sent to us in a predetermined format, and this enables us to enjoy great efficiencies. The health plans also have strong sales forces with existing employer relationships. We leverage our small sales force to teach their large sales teams to introduce our disease management products to self-insured employers.

Q: How does American Healthways expect to remain the industry leader?
A: We believe our share of the outsourced disease management market today hovers around 50%, and we believe that we're wellpositioned to maintain and even increase this dominant industry position. Since 1981, when we were formed, we have become extremely adept at scaling this business via our technology and call centers. We have approximately 1,300 nurses delivering services to nearly 1.5 million members in all 50 states, the District of Columbia, Puerto Rico, and Guam. Despite our growth, we have remained nimble, and we excel at bringing products to market quickly.

Q: Is there much differentiation between your products and competitors' products?
A: Absolutely. American Healthways has one of the broadest offerings of disease management, care enhancement, and highrisk health management services of any disease management company in the country. Some of our competitors simply send out educational materials, some provide informed decision support. Our product delivery is far more sophisticated. We run medical healthcare claims and lab and pharmacy data through our systems, stratify this data, and then create predictive models that enable us to effectively structure our interventions. Our goal is always to create a human connection between our call center nurses and patients, in order to modify a patient's behavior. That requires ongoing support and education, which is why we devote as much time as it takes to each patient call. 90% of our calls are outbound, in contrast to some of ourcompetitors, whose models are almost totally driven by inbound calls.

Q:Does American Healthways look to globally expand its services, given that other developed nations are experiencing growing healthcare costs?
A: We have a team focused on creating a presence in selected countries across Europe, Asia and South America. Some of these countries have national healthcare systems, which is a different model than what we're accustomed to in the U.S.

Q: American Healthways has recently expanded its product line to include programs for high-risk patients, depression, tobacco cessation, kidney disease, cancer, and a number of other health conditions. Do you expect to build new products internally or through acquisitions?
A: If we can find an acquisition that fills a product need, is accretive and the acquisition candidate is driven to provide improved outcomes, we will consider a purchase. However, if a customer is looking for a program that we don't have, we'll build it quickly through our rapid cycle development process.

Q: Are there other benefits to disease management programs beyond lowering healthcare costs?
A: Yes. Employers are well-aware that absenteeism due to non-chronic ailments such as low back pain, osteoporosis, ulcers, and arthritis can seriously hamper productivity. Our ability to help employees lead a healthier life can reduce absenteeism and generate significant -soft- savings. Indeed, some employers indicate that their soft savings are greater than those achieved on the medical cost side.