-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AgIdMvRGTgCCQ1NLXa09+y/HgugmHw3C/GRtWMVkXF7iypXebpzmPrpS8mdCS4RT a80fyVzhEDyz1SD3ASDMqA== 0000704415-04-000015.txt : 20040714 0000704415-04-000015.hdr.sgml : 20040714 20040714171128 ACCESSION NUMBER: 0000704415-04-000015 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20040531 FILED AS OF DATE: 20040714 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN HEALTHWAYS INC CENTRAL INDEX KEY: 0000704415 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MISC HEALTH & ALLIED SERVICES, NEC [8090] IRS NUMBER: 621117144 STATE OF INCORPORATION: DE FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-19364 FILM NUMBER: 04914392 BUSINESS ADDRESS: STREET 1: 3841 GREEN HILLS VILLAGE DRIVE CITY: NASHVILLE STATE: TN ZIP: 37215 BUSINESS PHONE: 6156651122 MAIL ADDRESS: STREET 1: 3841 GREEN HILLS VILLAGE DRIVE CITY: NASHVILLE STATE: TN ZIP: 37215 FORMER COMPANY: FORMER CONFORMED NAME: AMERICAN HEALTHCORP INC /DE DATE OF NAME CHANGE: 19940211 10-Q 1 form10-q_053104.htm AMERICAN HEALTHWAYS, INC. FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Quarterly Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the Quarterly Period Ended May 31, 2004

Commission File Number 000-19364

AMERICAN HEALTHWAYS, INC.

(Exact Name of Registrant as Specified in its Charter)


Delaware (State or Other Jurisdiction of Incorporation)		62-1117144 (I.R.S. Employer Identification No.)


3841 Green Hills Village Drive Nashville, Tennessee (Address of Principal Executive Offices)		37215 (Zip Code)

Registrant’s telephone number, including area code: (615) 665-1122

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes [X] No [ ]

As of July 12, 2004 there were outstanding 32,764,354 shares of the Registrant’s Common Stock, par value $.001 per share.


Part I Item 1. Financial Statements CONSOLIDATED BALANCE SHEETS - ASSETS CONSOLIDATED BALANCE SHEETS - LIABILITIES AND STOCKHOLDERS' EQUITY CONSOLIDATED STATEMENT OF OPERATIONS CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY CONSOLIDATED STATEMENTS OF CASH FLOWS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk Item 4. Controls and Procedures Part II Item 1. Legal Proceedings Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities Item 3. Defaults Upon Senior Securities Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K SIGNATURES Ex-10.2 1996 Stock Incentive Plan, as amended Ex-11 Earnings Per Share Reconciliation Ex-31.1 Section 302 CEO Certification Ex-31.2 Section 302 CFO Certification Ex-32 Section 906 CEO and CFO Certification

Part I

Item 1. Financial Statements

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS


	(Unaudited) May 31, 2004			August 31, 2003
Current assets:
Cash and cash equivalents	$	44,450		$	35,956
Restricted cash		585			--
Accounts receivable, net
Billed		24,969			18,526
Unbilled		4,552			7,971
Other current assets		6,062			4,267
Income taxes receivable		1,125			--
Deferred tax asset		923			758


Total current assets		82,666			67,478
Property and equipment:
Leasehold improvements		7,771			5,045
Computer equipment and related software		48,626			38,214
Furniture and office equipment		13,792			9,558


		70,189			52,817
Less accumulated depreciation		(35,525	)		(25,166	)


		34,664			27,651
Long-term deferred tax asset		67			--
Other assets		2,800			182
Intangible assets, net		20,834			264
Goodwill, net		93,520			44,438


	$	234,551		$	140,013


See accompanying notes to the consolidated financial statements.

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

LIABILITIES AND STOCKHOLDERS’ EQUITY

	(Unaudited) May 31, 2004		August 31, 2003
Current liabilities:
Accounts payable	$	5,003	$	4,067
Accrued salaries and benefits		4,285		9,162
Accrued liabilities		3,496		2,790
Contract billings in excess of earned revenue		8,392		3,272
Income taxes payable		--		391
Current portion of long-term debt		12,324		389
Current portion of long-term liabilities		995		360


Total current liabilities		34,495		20,431
Long-term debt		39,599		109
Long-term deferred tax liability		11,838		2,380
Other long-term liabilities		5,558		4,662
Stockholders' equity:
Preferred stock
$.001 par value, 5,000,000 shares
authorized, none outstanding		--		--
Common stock
$.001 par value, 75,000,000 and 40,000,000
shares authorized, 32,664,545 and 31,593,464
shares outstanding		33		32
Additional paid-in capital		87,814		74,070
Retained earnings		55,094		38,329
Accumulated other comprehensive income		120		--

Total stockholders' equity		143,061		112,431


	$	234,551	$	140,013


See accompanying notes to the consolidated financial statements.

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except earnings per share data)

(Unaudited)

	Three Months Ended May 31,				Nine Months Ended May 31,
	2004		2003		2004		2003
Revenues	$	65,354	$	41,822	$	173,555	$	119,461
Cost of services		41,413		26,738		112,577		76,170


Gross margin		23,941		15,084		60,978		43,291
Selling, general & administrative expenses		5,842		4,519		17,006		12,230
Depreciation and amortization		4,784		2,722		13,354		7,923
Interest		841		132		2,676		438


Income before income taxes		12,474		7,711		27,942		22,700
Income tax expense		4,990		3,161		11,177		9,307


Net income	$	7,484	$	4,550	$	16,765	$	13,393


Basic income per share:	$	0.23	$	0.15	$	0.52	$	0.43


Diluted income per share:	$	0.22	$	0.14	$	0.48	$	0.41


Weighted average common shares
and equivalents:
Basic		32,442		31,083		32,094		30,920
Diluted		34,803		32,974		34,607		32,810

See accompanying notes to the consolidated financial statements.

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

For the Nine Months Ended May 31, 2004

(In thousands)

(Unaudited)

	Preferred Stock		Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Income		Total

Balance, August 31, 2003	$	--	$	32	$	74,070	$	38,329	$	--	$	112,431
Net income		--		--		--		16,765		--		16,765
Net change in fair value of interest
rate swap, net of income taxes of $80		--		--		--		--		120		120


Total comprehensive income												16,885
Exercise of stock options and other		--		1		3,773		--		--		3,774
Tax benefit of option exercises		--		--		8,159		--		--		8,159
Stock issued in conjunction
with strategic alliance		--		--		1,812		--		--		1,812


Balance, May 31, 2004	$	--	$	33	$	87,814	$	55,094	$	120	$	143,061



See accompanying notes to the consolidated financial statements.

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended May 31,
	2004			2003
Cash flows from operating activities:
Net income	$	16,765		$	13,393
Adjustments to reconcile net income to net cash provided by
operating activities, net of business acquisitions:
Depreciation and amortization		13,354			7,923
Amortization of deferred loan costs		576			207
Tax benefit of stock option exercises		8,159			1,527
Increase in accounts receivable, net		(2,595	)		(3,609	)
Increase in other current assets		(1,696	)		(476	)
Increase (decrease) in accounts payable		394			(2,194	)
Decrease in accrued salaries and benefits		(5,261	)		(4,684	)
Increase in other current liabilities		1,987			15,125
Other		2,003			851
Decrease in other assets		204			169
Payments of other long-term liabilities		(300	)		(332	)


Net cash flows provided by operating activities		33,590			27,900


Cash flows from investing activities:
Acquisition of property and equipment		(15,734	)		(11,760	)
Business acquisitions, net of cash acquired		(60,223	)		--


Net cash flows used in investing activities		(75,957	)		(11,760	)


Cash flows from financing activities:
Increase in restricted cash		(585	)		(6,000	)
Proceeds from issuance of long-term debt, net of deferred loan costs		57,685			--
Payments of long term-debt		(9,329	)		(285	)
Exercise of stock options		3,090			823


Net cash flows provided by (used in) financing activities		50,861			(5,462	)


Net increase in cash and cash equivalents		8,494			10,678
Cash and cash equivalents, beginning of period		35,956			23,924


Cash and cash equivalents, end of period	$	44,450		$	34,602




See accompanying notes to the consolidated financial statements.

AMERICAN HEALTHWAYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Interim Financial Reporting

The accompanying consolidated financial statements of American Healthways, Inc. and its subsidiaries (the “Company”) for the three and nine months ended May 31, 2004 and May 31, 2003 are unaudited. However, in the opinion of the Company, all adjustments consisting of normal, recurring accruals necessary for a fair presentation have been reflected therein. Certain items in prior periods have been reclassified to conform to current classifications.

Certain financial information, which is normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States, but which is not required for interim reporting purposes, has been omitted. The accompanying consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2003.

(2) Segment Disclosures

Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures About Segments of an Enterprise and Related Information,” establishes disclosure standards for segments of a company based on a management approach to defining operating segments. Through November 2003, the Company distinguished operating and reportable segments based upon the types of customers (hospitals or health plans) that contract for the Company’s services. In order to improve operational efficiency, in December 2003 the Company merged its operations into a single operating segment for purposes of presenting financial information and evaluating performance.

(3) Recently Issued Accounting Standards

Consolidation of Variable Interest Entities
In 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest Entities.” FIN No. 46 requires consolidation of variable interest entities (“VIE”) if certain conditions are met and generally applies to periods ending after March 15, 2004. The adoption of FIN No. 46 did not have a material impact on the Company’s financial position or results of operations.

Derivative Instruments and Hedging Activities
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities that fall within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 amends SFAS No. 133 regarding implementation issues raised in relation to the application of the definition of a derivative. The amendments set forth in SFAS No. 149 require that contracts with comparable characteristics be accounted for similarly. This Statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material impact on the Company’s financial position or results of operations.

(4) Restricted Cash

Restricted cash represents funds held in escrow in connection with contractual requirements (see Note 9).

(5) Stock-Based Compensation

The Company measures compensation for stock options issued to its employees and outside directors pursuant to Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and has adopted the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an Amendment of FASB Statement No. 123.” Compensation expense recorded under APB No. 25 for the three and nine months ended May 31, 2004 was approximately $145,000 and $675,000, respectively. This expense resulted primarily from the grant, subject to stockholder approval, of stock options to two new directors of the Company in June 2003. Such approval was obtained at the Annual Meeting of Stockholders in January 2004, at which time the options were issued. The Company recognizes compensation expense related to fixed award stock options on a straight-line basis over the vesting period.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.

	Three Months Ended May 31,						Nine Months Ended May 31,
	2004			2003			2004			2003
(In $000s, except per share data)
Net income, as reported	$	7,484		$	4,550		$	16,765		$	13,393
Add: Stock-based employee compensation
expense included in reported net
income, net of related tax effects		90			--			419			--
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects		(1,339	)		(804	)		(3,876	)		(2,412	)


Pro forma net income	$	6,235		$	3,746		$	13,308		$	10,981


Earnings per share:
Basic - as reported	$	0.23		$	0.15		$	0.52		$	0.43
Basic - pro forma	$	0.19		$	0.12		$	0.41		$	0.36

Diluted - as reported	$	0.22		$	0.14		$	0.48		$	0.41
Diluted - pro forma	$	0.18		$	0.11		$	0.38		$	0.33

(6) Business Acquisitions

On September 5, 2003, the Company completed the acquisition of StatusOne Health Systems, Inc. (“StatusOne”) through the merger of a wholly-owned subsidiary of the Company with and into StatusOne in accordance with the terms of an Agreement and Plan of Merger (the “Merger Agreement”). The addition of StatusOne expands the Company’s product offerings and provides for additional opportunities for initiating and expanding total-population care management programs with health plans.

The aggregate purchase price paid by the Company was approximately $65.7 million, which was funded through a $60.0 million term loan and cash of $5.7 million, including acquisition costs of approximately $0.7 million. In addition, pursuant to an earn-out agreement (the “Earn-Out Agreement”), the Company is obligated to pay the former stockholders of StatusOne up to $12.5 million in additional purchase price, payable either in cash or common stock at the Company’s discretion, if StatusOne achieves certain revenue targets during the one-year period immediately following the acquisition (the “Earn-Out Period”). At the closing, the Company delivered $5.0 million of the purchase price into an escrow account under the terms and conditions of a separate escrow agreement to secure certain obligations of the former stockholders under the terms of the Merger Agreement.

The allocation of the StatusOne purchase price, shown below, is preliminary and subject to adjustments, primarily related to any additional purchase price attributable to StatusOne’s results during the Earn-Out Period.


(In $000s)
Fair value of current net tangible assets acquired	$	1,776
Fair value of long-term net tangible liabilities assumed		(8,850	)
Intangible assets:
Acquired technology		10,163
Customer contracts		9,137
Trade name		4,344
Goodwill		49,082

Total purchase price	$	65,652

The results of operations of StatusOne were consolidated with those of the Company beginning September 5, 2003. The unaudited pro forma results of operations as if the transaction had occurred on September 1, 2002 are as follows:

	Three Months Ended May 31, 2003		Nine Months Ended May 31, 2003
(In $000s, except per share data)
Revenues	$	47,792	$	135,568
Net income	$	4,344	$	12,663
Earnings per share:
Basic	$	0.14	$	0.41
Diluted	$	0.13	$	0.39

(7) Intangible and Other Assets

Intangible assets subject to amortization at May 31, 2004 consist of the following:

	Gross Carrying Amount		Accumulated Amortization		Net
(In $000s)
Acquired technology	$	10,163	$	1,524	$	8,639
Customer contracts		9,313		1,462		7,851

Total	$	19,476	$	2,986	$	16,490

Acquired technology and customer contracts are being amortized on a straight-line basis over a five-year estimated useful life. Total amortization expense for the nine months ended May 31, 2004 was $3,237,000. Estimated amortization expense for the remainder of fiscal 2004 and the following four fiscal years thereafter is $980,000, $3,904,000, $3,881,000, $3,865,000 and $3,860,000, respectively. The Company assesses the potential impairment of intangible assets subject to amortization whenever events or changes in circumstances indicate that the carrying values may not be recoverable.

Intangible assets not subject to amortization at May 31, 2004 consist of the trade name associated with the StatusOne acquisition of $4,344,000. The Company reviews intangible assets not subject to amortization on an annual basis or more frequently whenever events or circumstances indicate that the assets might be impaired.

Other assets consist primarily of deferred loan costs net of accumulated amortization.

(8) Long-Term Debt

On September 5, 2003, in conjunction with the acquisition of StatusOne, the Company entered into a new revolving credit and term loan agreement (the “Credit Agreement”) with eight financial institutions that replaced its previous credit agreement dated November 22, 2002. The Credit Agreement provides the Company with up to $100.0 million in borrowing capacity, including a $60.0 million term loan (the “Term Loan”) and a $40.0 million revolving line of credit, under a credit facility that expires on August 31, 2006. The $40.0 million revolving line of credit provides the Company with the ability to issue up to $40.0 million of letters of credit, provided the aggregate amounts outstanding under the revolving line of credit do not exceed $40.0 million.

The Company is required to make principal installment payments of $3.0 million at the end of each fiscal quarter beginning on November 30, 2003 and ending with a $27.0 million balloon payment due on August 31, 2006. Borrowings under the Credit Agreement bear interest, at the Company’s option, at the prime rate plus a spread of 0.5% to 1.25% or LIBOR plus a spread of 2.0% to 2.75%, or a combination thereof. The Credit Agreement also provides for a fee ranging between 0.375% and 0.5% of unused commitments. Substantially all of the Company’s and its subsidiaries’ assets are pledged as collateral for any borrowings under the Credit Agreement.

The Credit Agreement contains various financial covenants, which require the Company to maintain, as defined, minimum ratios or levels of (i) consolidated total funded debt to consolidated EBITDA, (ii) interest coverage, (iii) fixed charge coverage, and (iv) consolidated net worth. The Credit Agreement also prohibits the payment of dividends and limits the amount of repurchases of the Company’s common stock. As of May 31, 2004, the Company was in compliance with all of the financial covenant requirements of the Credit Agreement.

On September 16, 2003, the Company entered into an interest rate swap agreement to reduce its exposure to interest rate fluctuations. By entering into the interest rate swap agreement the Company effectively converted $40.0 million of floating rate debt to a fixed obligation with an interest rate of 4.99%. The Company currently believes that it meets and will continue to meet the criteria for the “shortcut” method under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” in accounting for the interest rate swap agreement, which allows for an assumption of no hedge ineffectiveness. As such, there is no income statement impact from changes in the fair value of the interest rate swap. The interest rate swap agreement is marked to market each reporting period, and the change in the fair value, net of income taxes, of the interest rate swap agreement is reported through other comprehensive income in the consolidated statement of changes in stockholders’ equity.

(9) Commitments and Contingencies

During the three months ended May 31, 2004, in conjunction with contractual requirements under one contract beginning on March 1, 2004, the Company funded an escrow account in the amount of approximately $0.6 million. The Company is required to deposit a percentage of all fees received from this customer during the first year of the contract into the escrow account to be used to repay fees under the contract in the event the Company does not perform at established target levels.

In June 1994, a civil “whistle blower” action was filed on behalf of the United States government by a former employee dismissed by the Company in February 1994. Subsequent to its review of this case, the federal government determined not to intervene in the litigation. The employee sued American Healthways, Inc. (“AMHC”) and a wholly-owned subsidiary of AMHC, American Healthways Services, Inc. (“AHSI”), as well as certain named and unnamed medical directors and one named client hospital, West Paces Medical Center (“WPMC”), and other unnamed client hospitals. AMHC has since been dismissed as a defendant; however, the case is still pending against AHSI. In addition, WPMC has agreed to settle the claims filed against it subject to the court’s approval as part of a larger settlement agreement that WPMC’s parent organization, HCA Inc., has reached with the United States government. The complaint alleges that AHSI, the client hospitals and the medical directors violated the federal False Claims Act by entering into certain arrangements that allegedly violated the federal anti-kickback statute and provisions of the Social Security Act prohibiting physician self-referrals. Although no specific monetary damage has been claimed, the plaintiff, on behalf of the federal government, seeks treble damages plus civil penalties and attorneys’ fees. The plaintiff also has requested an award of 30% of any judgment plus expenses. The case is still in the discovery stage and has not yet been set for trial.

The Company believes that its operations have been conducted in full compliance with applicable statutory requirements. Although there can be no assurance, the Company currently believes that the resolution of issues, if any, which may be raised by the government and the resolution of the civil litigation would not have a material adverse effect on the Company’s financial position or results of operations except to the extent that the Company incurs material legal expenses associated with its defense of this matter and the civil suit; provided, however, that any unanticipated developments in these matters could materially adversely affect the Company’s results of operations, financial condition, or cash flows.

(10) Stockholders’ Equity

In December 2001, the Company established an industry-wide Outcomes Evaluation Program with Johns Hopkins University and Health System (“Johns Hopkins”) to independently evaluate the effectiveness of clinical interventions, and their clinical and financial results, produced by the Company as well as other members of the disease management and care enhancement industry. In addition to a five-year funding commitment by the Company that began December 1, 2001, additional funding may be provided for this program through research sponsored by other outcomes-based health-care organizations. Pursuant to the terms of the funding commitment, amended in December 2003, the Company will provide Johns Hopkins compensation of $0.7 million annually for the remaining three years of the commitment. The Company issued 150,000 unregistered shares of common stock to Johns Hopkins on December 31, 2001. One half of the 150,000 shares vested immediately, and the remaining 75,000 shares vested on December 1, 2003.

On November 17, 2003, the Company’s Board of Directors approved a two-for-one stock split effected in the form of a 100% stock dividend which was distributed on December 19, 2003 to stockholders of record at the close of business on December 5, 2003. The consolidated financial statements and notes and exhibits hereto have been restated to give effect to the stock split.

(11) Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income,” requires that changes in the amounts of certain items, including changes in the fair value of interest rate swap agreements, be shown in the financial statements. The Company displays comprehensive income, which includes net income and net changes in the fair value of the interest rate swap agreement, in the consolidated statement of changes in stockholders’ equity. Comprehensive income, net of income taxes, was $7,781,000 and $16,885,000, respectively, for the three and nine months ended May 31, 2004.

(12) Subsequent Event

On June 15, 2004, the Company’s Board of Directors voted to amend its shareholder rights agreement, dated as of June 19, 2000 (the “Rights Agreement”), between the Company and SunTrust Bank, to, among other things, (i) increase the purchase price for each preferred stock unit under the Rights Agreement, (ii) extend the final expiration date of the Rights issued thereunder to the close of business on June 15, 2014, and (iii) provide that the Board of Directors of the Company will review the Rights Agreement at least once every three years to determine if the maintenance and continuance of the Rights Agreement is still in the best interests of the Company and its stockholders.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Founded in 1981, American Healthways, Inc. (the “Company”) provides specialized, comprehensive care enhancement and disease management services to individuals in all 50 states, the District of Columbia, Puerto Rico, and Guam. The Company’s integrated care enhancement programs serve entire health plan populations through member and physician care support interventions, advanced neural network predictive modeling, and confidential, secure Internet-based applications that provide patients and physicians with individualized health information and data. The Company’s integrated care enhancement programs enable health plans to develop relationships with all of their members, not just the chronically ill, and to identify those at highest risk for a future adverse health event, allowing for early interventions.

The Company’s integrated care enhancement product line includes programs for health plan members with diabetes, coronary artery disease, heart failure, asthma, chronic obstructive pulmonary disease, end-stage renal disease, cancer, chronic kidney disease, acid-related stomach disorders, atrial fibrillation, decubitus ulcer, fibromyalgia, hepatitis C, inflammatory bowel disease, irritable bowel syndrome, low-back pain, osteoarthritis, osteoporosis, urinary incontinence, and high-risk population management. The programs are designed to create and maintain key desired behaviors of each program member and of the providers who care for them in order to improve member health status, thereby reducing health-care costs. The programs incorporate interventions necessary to optimize member care and are based on the most current, evidence-based clinical guidelines as approved and/or adopted by the nation’s leading nonprofit health organizations.

The flexibility of the Company’s programs allows health plans to enter the disease management and care enhancement market at the level they deem appropriate for their organization, including the management of a single chronic disease, multiple chronic diseases or total-population in which all members receive the benefit of multiple programs.

On September 5, 2003, the Company completed the acquisition of StatusOne Health Systems, Inc. (“StatusOne”), a provider of health management services for high-risk populations of health plans and integrated medical systems nationwide. The addition of StatusOne expands the Company’s product offerings and provides for additional opportunities for initiating and expanding total-population care management programs with health plans.

As of May 31, 2004, the Company had contracts with 41 health plans to provide 108 disease management and care enhancement program services, and also had 51 contracts to provide its services at 69 hospitals.

Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements, which are based upon current expectations and involve a number of risks and uncertainties. In order for the Company to utilize the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, investors are hereby cautioned that these statements may be affected by the important factors, among others, set forth below, and consequently, actual operations and results may differ materially from those expressed in these forward-looking statements. The important factors include:

•

the Company’s ability to sign and implement new contracts for disease management and care enhancement services

•

the timing of implementation, and the effect, of regulatory rules and interpretations relating to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003;

•

the risks associated with a significant concentration of the Company’s revenues with a limited number of customers;

•

the Company’s ability to effect cost savings and clinical outcomes improvements under disease management and care enhancement contracts and reach mutual agreement with customers with respect to cost savings, or to effect such savings and improvements within the time frames contemplated by the Company;

•

the Company’s ability to accurately forecast performance and the timing of revenue recognition under the terms of its contracts ahead of data collection and reconciliation in order to provide forward-looking guidance;

•

the Company’s ability to collect contractually earned performance incentive bonuses;

•

the ability of the Company’s customers to provide timely and accurate data that is essential to the operation and measurement of the Company’s performance under the terms of its health plan contracts;

•

the Company’s ability to resolve favorably contract billing and interpretation issues with its customers;

•

the Company’s ability to integrate the operations of StatusOne and other acquired businesses or technologies into the Company's business;

•

the Company’s ability to achieve the expected financial results for StatusOne;

•

the Company’s ability to service its debt and make principal and interest payments as those payments become due;

•

the ability of the Company to develop new products and deliver outcomes on those products;

•

the ability of the Company to effectively integrate new technologies and approaches, such as those encompassed in its care enhancement initiatives or otherwise licensed or acquired by the Company, into the Company's care enhancement platform;

•

the Company’s ability to renew and/or maintain contracts with its customers under existing terms or restructure these contracts on terms that would not have a material negative impact on the Company’s results of operations;

•

the Company’s ability to implement its care enhancement strategy within expected cost estimates;

•

the ability of the Company to obtain adequate financing to provide the capital that may be needed to support the growth of the Company’s operations and to support or guarantee the Company’s performance under new contracts;

•

unusual and unforeseen patterns of healthcare utilization by individuals with diabetes, cardiac, respiratory and/or other diseases or conditions for which the Company provides services, in the health plans with which the Company has executed a disease management contract;

•

the ability of the health plans to maintain the number of covered lives enrolled in the plans during the terms of the agreements between the health plans and the Company;

•

the Company’s ability to attract and/or retain and effectively manage the employees required to implement its agreements;

•

the impact of litigation involving the Company;

•

the impact of future state and federal healthcare and other applicable legislation and regulations on the ability of the Company to deliver its services and on the financial health of the Company’s customers and their willingness to purchase the Company’s services;

•

current geopolitical turmoil and the continuing threat of domestic or international terrorism;

•

general worldwide and domestic economic conditions and stock market volatility; and

•

other risks detailed in the Company’s annual, quarterly or other filings with the Securities and Exchange Commission.

The Company undertakes no obligation to update or revise any such forward-looking statements.

Customer Contracts

The Company’s disease management and care enhancement services range from telephone and mail contacts directed primarily to health plan members with targeted diseases or who are at high risk for a future adverse health event to services that include providing local market resources to address acute episode interventions and coordination of care with local health-care providers. Calls are primarily made from one of the Company’s care enhancement centers.

Fees under the Company’s contracts are generally determined by multiplying the contractually negotiated rate per health plan member per month (“PMPM”) by the number of health plan members covered by the Company’s services during the month. PMPM rates are set during contract negotiations with customers based on the expected value to be created by the Company’s programs and a sharing of that value between the customer and the Company. In some contracts, the PMPM rates may differ between the health plan’s lines of business (e.g. Preferred Provider Organizations (“PPO”), Health Maintenance Organizations (“HMO”), Medicare+Choice). Contracts are generally for terms of three to seven years with provisions for subsequent renewal and may provide that some portion (up to 100%) of the Company’s fees may be refundable to the health plan (“performance-based”) if a targeted percentage reduction in the health plan’s health-care costs and clinical and/or other criteria that focus on improving the health of the members, compared to a baseline year, are not achieved. Approximately 10% of the Company’s revenues recorded during the nine months ended May 31, 2004 were performance-based and are subject to final reconciliation. The Company anticipates that this percentage will continue to fluctuate due to the timing of data reconciliation, which varies according to contract terms, and revenue recognition associated with performance-based fees. A limited number of contracts also provide opportunities for the Company to receive incentive bonuses in excess of the contractual PMPM rate if the Company is able to exceed contractual performance targets.

Disease management and care enhancement contracts require sophisticated management information systems to enable the Company to manage the care of large populations of health plan members with targeted chronic diseases or other medical conditions and to report clinical and financial outcomes before and after the implementation of the Company’s programs. The Company has developed and is continually expanding and enhancing its clinical and data management and reporting systems, which it believes meet its information management needs for its disease management and care enhancement services. The anticipated expansion and enhancement in its information management systems will continue to require significant investments by the Company in information technology software, hardware and its information technology staff.

The Company’s contract revenues are dependent upon the contractual relationships it establishes and maintains with health plans to provide disease management and care enhancement services to their members. Some contracts provide for early termination by the health plan under certain conditions. No assurances can be given that the results of contract restructurings and possible terminations at or prior to renewal would not have a material negative impact on the Company’s results of operations and financial condition.

Approximately 43% and 46% of the Company’s revenues for the three and nine months ended May 31, 2004, respectively, were derived from two contracts that each comprised more than 10% of the Company’s revenues for the period. The loss of either of these contracts or any other large health plan contract or a reduction in the profitability of any of these contracts would have a material negative impact on the Company’s results of operations, cash flows, and financial condition.

Of the four health plan contracts scheduled to expire in fiscal 2004, representing in aggregate approximately 3% of the Company’s revenues for the nine months ended May 31, 2004, one contract, comprising less than 1% of such revenues, has been renewed; one contract, representing 1% of such revenues, has been renewed and expanded; and one contract, representing less than 1% of such revenues, has been terminated. As of May 31, 2004, twenty-three of the Company’s health plan contracts, which represent approximately 25% of the Company’s revenues for the nine months ended May 31, 2004, allow for early termination. The average length of time the Company has been providing services under these 23 contracts is over three years. During the nine months ended May 31, 2004, one of the Company’s customers, representing less than 1% of revenues for the nine months ended May 31, 2004, terminated its contract with the Company early. No assurance can be given that unscheduled contract terminations or renegotiations would not have a material negative impact on the Company’s results of operations, cash flows, and financial condition.

The Company’s 51 hospital contracts represent hospital-based diabetes treatment centers located in and operated under contracts with general acute-care hospitals. The primary goal of each center is to create a center of excellence for the treatment of diabetes in the community in which it is located, thereby increasing the hospital’s market share of diabetes patients and lowering the hospital’s cost of providing services while enhancing the quality of care to this population. For the nine months ended May 31, 2004, revenues from the Company’s hospital contracts accounted for approximately 6% of the Company’s total revenues.

Actual Lives under Management

The Company measures the volume of participation in its programs by the actual number of health plan members and hospital patients who are benefiting from the Company’s services, which is reported as “actual lives under management.” At May 31, 2004, the Company had contracts with 41 health plans to provide 108 disease management and care enhancement program services and 51 contracts to provide its services at 69 hospitals. Annualized revenue in backlog represents the estimated annualized revenue at target performance associated with signed contracts at May 31, 2004 for which the Company has not yet begun to provide services. The number of actual lives under management and annualized revenue in backlog are shown below at May 31, 2004 and May 31, 2003.

At May 31,	2004		2003
Actual lives under management		1,211,000		752,000	⁽¹⁾
Annualized revenue in backlog (in $000s)	$	13,507	$	20,880

⁽¹⁾Restated to include the Company's hospital-based diabetes program
patients

The annual membership enrollment and disenrollment processes of employers (whose employees are health plan members) from health plans can result in a seasonal reduction in actual lives under management during the Company’s second fiscal quarter. Employers typically make decisions on which health insurance carriers they will offer to their employees and may also allow employees to switch between health plans on an annual basis. Historically, the Company has found that a majority of these decisions are made effective December 31 of each year. An employer’s change in health plans or employees’ changes in health plan elections may result in the Company’s loss of actual lives under management as of January 1. Although these decisions may also result in a gain in enrollees as new employers sign up with the Company’s customers, the process of identifying new members eligible to participate in the Company’s programs is dependent on the submission of health-care claims, which lags enrollment by an indeterminate period. As a result, historically the Company has experienced a loss of actual lives under management from existing customers of between 5% and 7% on January 1 that is not restored through new member identification until later in the fiscal year, thereby negatively affecting the Company’s revenues on existing contracts in its second fiscal quarter.

The Company has experienced increasing demand for its care enhancement and disease management services from health plans’ administrative services only (“ASO”) customers. ASO customers are typically self-insured employers for which the Company’s health plan customers do not assume risk but provide primarily administrative claim and health network access services. Signed contracts between these self-insured employers and the Company’s health plan customers are incorporated in the Company’s contracts with its health plan customers, and these program-eligible members are included in the lives under management or the annualized revenue in backlog reported in the table above, when appropriate.

Business Acquisitions

On September 5, 2003, the Company completed the acquisition of StatusOne. The addition of StatusOne expands the Company’s product offerings and provides for additional opportunities for initiating and expanding total-population care management programs with health plans.

The aggregate purchase price paid by the Company was approximately $65.7 million, which was funded through a $60.0 million term loan and cash of $5.7 million, including acquisition costs of approximately $0.7 million. Pursuant to an earn-out agreement executed in connection the acquisition of StatusOne (the “Earn-Out Agreement”), the Company is obligated to pay the former stockholders of StatusOne up to $12.5 million in additional purchase price, payable either in cash or common stock at the Company’s discretion, if StatusOne achieves certain revenue targets during the one-year period immediately following the acquisition (the “Earn-Out Period”). At the closing, the Company delivered $5.0 million of the purchase price into an escrow account under the terms and conditions of a separate escrow agreement to secure certain obligations of the former stockholders under the terms of an Agreement and Plan of Merger.

The purchase price was preliminarily allocated to the related assets acquired and liabilities assumed based upon their respective fair values. The purchase price paid in excess of the fair value of identifiable net assets was $49.1 million. The allocation of the StatusOne purchase price is preliminary and subject to adjustments, primarily related to any additional purchase price attributable to StatusOne’s results during the Earn-Out Period.

Business Strategy

The Company’s primary strategy is to develop new and to expand existing relationships with health plans to provide disease management and care enhancement services, including assisting these health plans in creating value for their large self-insured customers. The Company anticipates that it will utilize its scaleable state-of-the-art care enhancement centers and medical information content and technologies to gain a competitive advantage in delivering its disease management and care enhancement services. In addition, the Company will continue to add services to its product mix that extend the Company’s programs for health plans beyond a chronic disease focus and provide care enhancement services to members identified with one or more additional conditions or who are at risk for developing these diseases or conditions. The Company believes that improvements in care, and therefore significant cost savings, can result from providing care enhancement programs to members with these additional selected diseases and conditions, which will enable the Company to address a much larger percentage of a health plan’s population and total health-care costs. The Company anticipates that significant costs will be incurred during the remainder of fiscal 2004 for the enhancement and expansion of clinical programs and data reporting systems, the enhancement of information technology support, and the integration of StatusOne. The Company also recognizes the possibility that some of these new capabilities and technologies may be added through strategic alliances with other entities and that the Company may choose to make minority interest investments in or acquire for stock or cash one or more of these entities.

Critical Accounting Policies

The Company’s accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2003. The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosures at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.

The Company believes the following accounting policies to be the most critical in understanding the judgments that are involved in preparing its financial statements and the uncertainties that could impact its results of operations, financial condition and cash flows.

Revenue Recognition

Fees under the Company’s contracts are generally determined by multiplying a contractually negotiated PMPM rate by the number of health plan members covered by the Company’s services during the month. In some contracts, the PMPM rates may differ between the health plan’s lines of business (e.g. PPO, HMO, Medicare+Choice). These contracts are generally for terms of three to seven years with provisions for subsequent renewal and may provide that some portion (up to 100%) of the Company’s fees may be refundable to the health plan (“performance-based”) if a targeted percentage reduction in the health plan’s health-care costs and clinical and/or other criteria that focus on improving the health of the members, compared to a baseline year, are not achieved. Approximately 10% of the Company’s revenues recorded during the nine months ended May 31, 2004 were performance-based and are subject to final reconciliation. The Company anticipates that this percentage will continue to fluctuate due to the timing of data reconciliation, which varies according to contract terms, and revenue recognition associated with performance-based fees. A limited number of contracts also provide opportunities for the Company to receive incentive bonuses in excess of the contractual PMPM rate if the Company is able to exceed contractual performance targets.

The Company bills its customers each month for the entire amount of the fees contractually due for the prior month’s enrollment, which typically includes the amount, if any, which is performance-based and may be subject to refund should performance targets not be met. The monthly billing does not include any potential incentive bonuses which, if earned, are not due until after contract settlement. The Company recognizes revenue during the period the services are performed as follows: the fixed portion of the monthly fees is recognized as revenue during the period the services are performed; the performance-based portion of the monthly fees is recognized based on performance to date in the contract year; and additional incentive bonuses are recognized based on performance to date in the contract year to the extent such amounts are considered collectible.

The Company assesses its level of performance based on medical claims and other data contractually required to be supplied monthly by the health plan customer. A minimum of four to six months’ data is typically required before performance can be measured. Estimates that may be included in the Company’s assessment of performance include medical claims incurred but not reported and a health plan’s medical cost trend compared to a baseline year. In addition, the Company may also provide reserves, when appropriate, for billing adjustments at contract reconciliation (“contractual reserves”). In the event data from the health plan is insufficient or incomplete to measure performance, or interim performance measures indicate that performance targets are not being met, fees subject to refund are not recognized as revenues but rather are recorded in a current liability account “contract billings in excess of earned revenue.” In the event that performance levels are not met by the end of the contract year, the Company is contractually obligated to refund some or all of the performance-based fees. The Company would reverse revenues previously recognized if performance to date in the contract year, previously above targeted levels, dropped below targeted levels due to subsequent adverse performance and/or adjustments in contractual reserves.

The settlement process under a contract, which generally is not completed until six to eight months after the end of a contract year, involves reconciliation of both health-care claims and clinical data and includes the settlement of any performance-based fees. Data reconciliation differences between the Company and the customer can arise due to health plan data deficiencies, omissions and/or data discrepancies, for which the Company provides contractual reserves until agreement is reached with respect to identified issues.

Impairment of Intangible Assets and Goodwill

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” goodwill is reviewed for impairment on an annual basis or more frequently whenever events or circumstances indicate that the carrying value may not be recoverable.

In the event the Company determines that the carrying value of goodwill is impaired based upon an impairment review, the measurement of any impairment is calculated using a fair-value-based goodwill impairment test as required under the provisions of SFAS No. 142. Fair value is the amount at which the asset could be bought or sold in a current transaction between two willing parties and may be estimated using a number of techniques, including quoted market prices or valuations by third parties, present value techniques based on estimates of cash flows, or multiples of earnings or revenues performance measures.

The Company’s other identifiable intangible assets, such as acquired technology and customer contracts, are amortized on the straight-line method over their estimated useful lives, except for trade names, which have an indefinite life and are not subject to amortization. The Company reviews intangible assets not subject to amortization on an annual basis or more frequently whenever events or circumstances indicate that the assets might be impaired. The Company assesses the potential impairment of intangible assets subject to amortization whenever events or changes in circumstances indicate that the carrying values may not be recoverable.

In the event the Company determines that the carrying value of other identifiable intangible assets may not be recoverable, the measurement of any impairment is calculated using an estimate of the asset’s fair value based on the projected net cash flows expected to result from that asset, including eventual disposition.

Future events could cause the Company to conclude that impairment indicators exist and that goodwill and/or other intangible assets associated with its acquired businesses are impaired. Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations.

Results of Operations

The following table shows the components of the statements of operations for the three and nine months ended May 31, 2004 and May 31, 2003 expressed as a percentage of revenues.

	Three Months Ended May 31,				Nine Months Ended May 31,
	2004		2003		2004		2003
Revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of services	63.4	%	63.9	%	64.9	%	63.8	%

Gross margin	36.6	%	36.1	%	35.1	%	36.2	%
Selling, general and administrative expenses	8.9	%	10.8	%	9.8	%	10.2	%
Depreciation and amortization	7.3	%	6.5	%	7.7	%	6.6	%
Interest expense	1.3	%	0.3	%	1.5	%	0.4	%

Income before income taxes	19.1	%	18.5	%	16.1	%	19.0	%
Income tax expense	7.6	%	7.6	%	6.4	%	7.8	%

Net income	11.5	%	10.9	%	9.7	%	11.2	%

Revenues

Revenues for the three months ended May 31, 2004 increased 56.3% over the three months ended May 31, 2003, primarily due to an increase in average actual lives under management. The average number of actual lives under management increased from approximately 722,000 for the three months ended May 31, 2003 to 1,173,000 for the three months ended May 31, 2004. The increase in average actual lives under management was primarily due to the signing of new health plan contracts during fiscal 2003 and 2004, the acquisition of StatusOne on September 5, 2003, existing health plan customers adding new programs, an increase in the ASO/PPO actual lives under management resulting from increasing demand for the Company’s care enhancement services from self-insured employers who contract with the Company’s health plan customers, and increased enrollment in customers’ existing programs.

Revenues for the nine months ended May 31, 2004 increased 45.3% over the nine months ended May 31, 2003, primarily due to an increase in average actual lives under management. The average number of actual lives under management increased from approximately 675,000 lives for the nine months ended May 31, 2003 to 1,070,000 lives for the nine months ended May 31, 2004. The increase in average actual lives under management was primarily due to the signing of new health plan contracts during fiscal 2003 and 2004, the acquisition of StatusOne on September 5, 2003, existing health plan customers adding new programs, an increase in the ASO/PPO actual lives under management resulting from increasing demand for the Company’s care enhancement services from self-insured employers who contract with the Company’s health plan customers, and increased enrollment in customers’ existing programs. In addition, the increase in revenues for the nine months ended May 31, 2004 compared to the same period in fiscal 2003 was also partially attributable to the renegotiation of one contract at the beginning of fiscal 2004 for which the Company did not recognize any revenue in fiscal 2003 because it was unable to measure performance due to contracting terms and outcomes measurement provisions unique to this contract.

The Company anticipates that total revenues for the remainder of fiscal 2004 will increase over fiscal 2003 revenues primarily as a result of additional revenues from its existing and anticipated new and expanded health plan contracts, the acquisition of StatusOne, and the timing of revenue recognition from contracts which have performance-based fees.

Cost of Services

Cost of services as a percentage of revenues decreased to 63.4% for the three months ended May 31, 2004 compared to 63.9% for the same period in fiscal 2003. Excluding contract performance incentive bonus revenues, which increased $1.4 million for the three months ended May 31, 2004 compared to the same period in fiscal 2003, cost of services as a percentage of revenues would have increased to 65.1% from 64.4% for the three months ended May 31, 2004 and 2003, respectively, primarily as a result of the incremental costs of preparing for and servicing new contracts that have not yet begun or which have performance-based fees that have not been recognized as revenue because data is insufficient to determine performance.

Cost of services as a percentage of revenues increased to 64.9% for the nine months ended May 31, 2004 compared to 63.8% for the same period in fiscal 2003. Excluding contract performance incentive bonus revenues, which decreased $0.4 million for the nine months ended May 31, 2004, cost of services as a percentage of revenues would have increased to 65.8% from 65.3% for the nine months ended May 31, 2004 and 2003, respectively, due to the incremental costs of preparing for and servicing new contracts that have not yet begun or which have performance-based fees that have not been recognized as revenue because data is insufficient to determine performance.

The Company anticipates that cost of services for the remainder of fiscal 2004 will increase over fiscal 2003 primarily as a result of increased operating staff required for expected increases in demand for the Company’s services, the incremental cost of services attributable to StatusOne, increased indirect staff costs associated with the continuing development and implementation of its care enhancement services, and increases in information technology and other support staff and costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses as a percentage of revenues decreased to 8.9% for the three months ended May 31, 2004 compared to 10.8% for the same period in fiscal 2003, primarily due to a decrease in costs related to marketing and branding campaigns and a $1.4 million increase in contract performance incentive bonus revenues recognized during the third quarter of fiscal 2004.

Selling, general and administrative expenses as a percentage of revenues decreased to 9.8% for the nine months ended May 31, 2004 compared to 10.2% for the same period in fiscal 2003, primarily due to a decrease in costs related to marketing and branding campaigns, partially offset by a $0.4 million decrease in contract performance incentive bonus revenues recognized during the nine months ended May 31, 2004 and a $0.7 million increase in stock-based compensation expense resulting from the grant, subject to stockholder approval, of stock options to two new directors of the Company in June 2003. Such approval was obtained at the Annual Meeting of Stockholders in January 2004, at which time the options were issued.

The Company anticipates that selling, general and administrative expenses for the remainder of fiscal 2004 will increase over fiscal 2003 primarily as a result of increased indirect support costs for the Company’s existing and anticipated new and expanded health plan contracts and the incremental selling, general and administrative expenses attributable to StatusOne.

Depreciation and Amortization

Depreciation and amortization expense for the three and nine months ended May 31, 2004 increased 75.8% and 68.5%, respectively, over the same periods in fiscal 2003 primarily due to amortization on intangible assets related to the acquisition of StatusOne and an increase in depreciation and amortization expense associated with equipment, software development, leasehold improvements, and computer-related capital expenditures. These capital expenditures were related to enhancements in the Company’s health plan information technology capabilities, the opening of two new care enhancement centers, and the expansion of three existing care enhancement centers and the corporate office since May 31, 2003.

The Company anticipates that depreciation and amortization expense for the remainder of fiscal 2004 will increase over fiscal 2003 primarily as a result of the additional amortization associated with intangible assets related to the StatusOne acquisition, additional capital expenditures associated with expected increases in demand for the Company’s services, and growth and improvement in the Company’s information technology capabilities.

Interest Expense

Interest expense for the three and nine months ended May 31, 2004 increased $0.7 million and $2.2 million, respectively, compared to the same periods in fiscal 2003. The increase in interest expense was primarily attributable to interest costs related to a $60.0 million term loan (the “Term Loan”) incurred in connection with the Company’s acquisition of StatusOne (described more fully in “Liquidity and Capital Resources” below), offset slightly by decreased fees associated with a reduction in outstanding letters of credit to support certain contractual requirements to repay fees in the event the Company does not perform at target levels and does not repay the fees due in accordance with the contract terms.

The Company anticipates that interest expense for the remainder of fiscal 2004 will increase over fiscal 2003 primarily as a result of interest costs related to the Company’s Term Loan.

Income Tax Expense

The Company’s effective tax rate decreased to 40% for the three and nine months ended May 31, 2004 compared to 41% for the three and nine months ended May 31, 2003, primarily as a result of the Company’s geographic mix of earnings, which involves the impact of state income taxes, and other factors. The differences between the statutory federal income tax rate of 35% and the Company’s effective tax rate are due primarily to the impact of state income taxes and certain non-deductible expenses for income tax purposes.

Liquidity and Capital Resources

Operating activities for the nine months ended May 31, 2004 generated $33.6 million in cash flow from operations compared to $27.9 million for the nine months ended May 31, 2003. The increase in operating cash flow resulted primarily from an increase in net income as well as increased adjustments to net income attributable to stock option exercise tax benefits and increases in depreciation and amortization expense. These increases to cash flow from operations were offset by a decrease in cash collections recorded to contract billings in excess of earned revenue for the nine months ended May 31, 2004 primarily attributable to one contract for which the Company did not recognize any revenue during fiscal 2003 because it was unable to measure performance due to contracting terms and outcomes measurement provisions unique to this contract. Investing activities during the nine months ended May 31, 2004 used $76.0 million in cash, which consisted of the acquisition of StatusOne and the investment in property and equipment. The purchase of property and equipment was primarily associated with enhancements in the Company’s information technology capabilities and the opening of two care enhancement centers in fiscal 2004. Financing activities for the nine months ended May 31, 2004 provided $50.9 million in cash primarily due to net proceeds from the issuance of debt related to the acquisition of StatusOne and the exercise of stock options, offset by payments on long-term debt and debt issuance costs.

On September 5, 2003, in conjunction with the acquisition of StatusOne, the Company entered into a new revolving credit and term loan agreement (the “Credit Agreement”) with eight financial institutions that replaced its previous credit agreement dated November 22, 2002. The Credit Agreement provides the Company with up to $100.0 million in borrowing capacity, including the Term Loan and a $40.0 million revolving line of credit, under a credit facility that expires on August 31, 2006. The $40.0 million revolving line of credit provides the Company with the ability to issue up to $40.0 million of letters of credit, provided the aggregate amounts outstanding under the revolving line of credit do not exceed $40.0 million. As of May 31, 2004, the Company’s available line of credit totaled $39.6 million.

On September 16, 2003, the Company entered into an interest rate swap agreement for the management of interest rate exposure. By entering into the interest rate swap agreement the Company effectively converted $40.0 million of floating rate debt to a fixed obligation with an interest rate of 4.99%.

As of May 31, 2004, there was one letter of credit outstanding under the Credit Agreement for $0.4 million to support the Company’s requirement to repay fees under one health plan contract in the event the Company does not perform at established target levels and does not repay the fees due in accordance with the terms of the contract. The Company has never had a draw under an outstanding letter of credit.

The Company believes that cash flow from operating activities and its available cash and available credit under its Credit Agreement will continue to enable the Company to meet its contractual obligations, including the $12.5 million contingent consideration under the StatusOne Earn-Out Agreement, and to fund the current level of growth in its operations for the foreseeable future. However, to the extent that the expansion of the Company’s operations requires significant additional financing resources, such as capital expenditures for technology improvements, additional care enhancement centers and/or the issuance of letters of credit or other forms of financial assurance to guarantee the Company’s performance under the terms of new contracts, or to the extent the Company is required to refund performance-based fees pursuant to contract terms, the Company may need to raise additional capital through an expansion of the Company’s existing credit facility and/or issuance of debt or equity. The Company’s ability to arrange such financing may be limited and, accordingly, the Company’s ability to expand its operations could be restricted. In addition, should contract development accelerate or should acquisition opportunities arise that would enhance the Company’s planned expansion of its operations, the Company may need to issue additional debt or equity to provide the funding for these increased growth opportunities or may issue equity in connection with future acquisitions or strategic alliances. No assurance can be given that the Company would be able to issue additional debt or equity on terms that would be acceptable to the Company.

Material Commitments

The following schedule summarizes the Company’s contractual cash obligations at May 31, 2004. It does not include the $12.5 million contingent consideration under the StatusOne Earn-Out Agreement.

	Twelve Months Ended May 31,
(In $000s)	2005	2006 – 2007	2008 – 2009	2010 and After	Total
Long-term debt ⁽¹⁾	$12,324	$39,330	$ 269	$ --	$51,923
Deferred compensation
plan payments	714	1,812	698	1,958	5,182
Operating lease obligations	5,401	9,774	5,925	5,083	26,183
Other contractual cash
obligations ⁽²⁾	700	1,050	--	--	1,750

Total contractual cash
obligations	$19,139	$51,966	$6,892	$7,041	$85,038



⁽¹⁾ Long-term debt consists of principal payments due under the Credit Agreement and capital lease obligations, including the current portion, and does not include future cash obligations for interest associated with the Company’s outstanding indebtedness.
⁽²⁾ Other contractual cash obligations represent cash payments in connection with the Company’s funding of the industry-wide Outcomes Evaluation Program independently evaluated by Johns Hopkins University and Health System.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is subject to market risk related to interest rate changes, primarily as a result of its Credit Agreement, which bears interest based on floating rates. Borrowings under the Credit Agreement bear interest, at the Company’s option, at the prime rate plus a spread of 0.5% to 1.25% or LIBOR plus a spread of 2.0% to 2.75%, or a combination thereof. In order to manage its interest rate exposure, as described under “Liquidity and Capital Resources” in Item 2, the Company entered into an interest rate swap agreement, effectively converting $40.0 million of floating rate debt to a fixed obligation with an interest rate of 4.99%. The Company does not anticipate any material changes in its primary market risk exposures or how those exposures are managed in fiscal 2004. The Company does not execute transactions or hold derivative financial instruments for trading purposes.

A one-point interest rate change on the variable rate debt outstanding at May 31, 2004 would have resulted in interest expense fluctuating approximately $0.1 million for the nine months ended May 31, 2004.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s chief executive officer and chief financial officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of May 31, 2004. Based on that evaluation, the chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures effectively and timely provide them with material information relating to the Company and its consolidated subsidiaries required to be disclosed in the reports the Company files or submits under the Exchange Act.

During the period covered by this report, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. The design of a control system is based in part upon certain assumptions of the likelihood of certain future events, and there can be no assurance that any design will succeed in achieving its goals under all possible future conditions. Because of inherent limitations in any control system, misstatements due to error or fraud may occur and not be detected.

Part II

Item 1. Legal Proceedings.

The Company believes that its operations have been conducted in full compliance with applicable statutory requirements. Although there can be no assurance, the Company currently believes that the resolution of issues, if any, which may be raised by the government and the resolution of the civil litigation would not have a material adverse effect on the Company’s financial position or results of operations except to the extent that the Company incurs material legal expenses associated with its defense of this matter and the civil suit; provided, however that any unanticipated developments in these matters could materially adversely affect the Company’s results of operations, financial condition, or cash flows.

Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities.

On June 15, 2004, the Company amended that certain Rights Agreement, dated as of June 19, 2000 (the “Rights Agreement”), between the Company and SunTrust Bank, to, among other things, (i) increase the purchase price for each preferred stock unit under the Rights Agreement, (ii) extend the final expiration date of the Rights issued thereunder to the close of business on June 15, 2014, and (iii) provide that the Board of Directors of the Company will review the Rights Agreement at least once every three years to determine if the maintenance and continuance of the Rights Agreement is still in the best interests of the Company and its stockholders.

Item 3. Defaults Upon Senior Securities.

Not Applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

Not Applicable.

Item 5. Other Information.

Not Applicable.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits


4.1	Rights Agreement between the Company and SunTrust Bank as Rights Agent [incorporated by reference to Exhibit 4 to Current Report on Form 8-K filed June 21, 2000]
4.2	Amendment No. 1 to Rights Agreement between the Company and SunTrust Bank as Rights Agent [incorporated by reference to Exhibit 4 to Current Report on Form 8-K filed June 17, 2004]
10.2	1996 Stock Incentive Plan, as amended
11	Earnings Per Share Reconciliation
31.1	Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Ben R. Leedle, Jr., President and Chief Executive Officer
31.2	Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Mary A. Chaput, Executive Vice President and Chief Financial Officer
32.1	Certification Pursuant to 18 U.S.C section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 made by Ben R. Leedle, Jr., President and Chief Executive Officer and Mary A. Chaput, Executive Vice President and Chief Financial Officer

(b) Reports on Form 8-K

No Current Reports on Form 8-K were filed with the SEC during the quarter ended May 31, 2004. However, the following Current Reports on Form 8-K were furnished to the SEC during the quarter ended May 31, 2004.

A Current Report on Form 8-K was furnished on March 4, 2004 reporting the Company’s participation in the Seventh Annual Global Healthcare Conference hosted by Lehman Brothers and the related live broadcast on the Internet of the Company’s presentation.

A Current Report on Form 8-K was furnished on March 15, 2004 reporting a live broadcast on the Internet of the second quarter conference call to analysts.

A Current Report on Form 8-K was furnished on March 22, 2004 reporting earnings results for the second quarter ended February 29, 2004.

A Current Report on Form 8-K was furnished on May 18, 2004 reporting the Company’s participation in the 33rd Annual Institutional Investor Conference hosted by SunTrust Robinson Humphrey and the related live broadcast on the Internet of the Company’s presentation.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.


		American Healthways, Inc. (Registrant)
Date July 14, 2004	By	/s/ Mary A. Chaput Mary A. Chaput Executive Vice President Chief Financial Officer (Principal Financial Officer)
Date July 14, 2004	By	/s/ Alfred Lumsdaine Alfred Lumsdaine Senior Vice President and Controller (Principal Accounting Officer)

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AMERICAN HEALTHWAYS, INC.

1996 STOCK INCENTIVE PLAN

SECTION 1. Purpose; Definitions.

        The purpose of the American Healthways, Inc. 1996 Stock Incentive Plan (the “Plan”) is to enable American Healthways, Inc. (the “Corporation”) to attract, retain and reward key employees of and consultants to the Corporation and its Subsidiaries and Affiliates, and directors who are not also employees of the Corporation, and strengthen the mutuality of interests between such key employees, consultants and directors by awarding such key employees, consultants and directors performance-based stock incentives and/or other equity interests or equity-based incentives in the Corporation, as well as performance-based incentives payable in cash. The creation of the Plan shall not diminish or prejudice other compensation programs approved from time to time by the Board.

        For purposes of the Plan, the following terms shall be defined as set forth below:

    A.            “Affiliate” means any entity other than the Corporation and its Subsidiaries that is designated by the Board as a participating employer under the Plan, provided that the Corporation directly or indirectly owns at least 20% of the combined voting power of all classes of stock of such entity or at least 20% of the ownership interests in such entity.

    B.            “Board” means the Board of Directors of the Corporation.

    C.            “Common Stock” means the Corporation’s Common Stock, par value $.001 per share.

    D.            “Code” means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto.

    E.            “Committee” means the Committee referred to in Section 2 of the Plan.

    F.            “Corporation” means American Healthways, Inc., a corporation organized under the laws of the State of Delaware or any successor corporation.

    G.            “Disability” means disability as determined under the Corporation’s long-term disability insurance policy.

    H.            “Disinterested Person” shall have the meaning set forth in Rule 16b-3(c)(2)(i) as promulgated by the Securities and Exchange Commission (“Commission”) under the Securities Exchange Act of 1934, as amended, or any successor definition adopted by the Commission.

    I.            “Early Retirement” means retirement, for purposes of this Plan with the express consent of the Corporation at or before the time of such retirement, from active employment with the Corporation and any Subsidiary or Affiliate prior to age 65, in accordance with any applicable early retirement policy of the Corporation then in effect or as may be approved by the Committee.

    J.            “Exchange Act” means the Securities Exchange Act of 1934, as amended from time to time, and any successor thereto.

    K.            “Fair Market Value” means with respect to the Stock, as of any given date or dates, unless otherwise determined by the Committee in good faith, the reported closing price of a share of such class of Stock on The Nasdaq Stock Market (“Nasdaq Stock Market”) or such other exchange or market as is the principal trading market for such class of Stock, or, if no such sale of a share of such class of Stock is reported on the Nasdaq Stock Market or other exchange or principal trading market on such date, the fair market value of a share of such class of Stock as determined by the Committee in good faith.

    L.            “Incentive Stock Option” means any Stock Option intended to be and designated as an “Incentive Stock Option” within the meaning of Section 422 of the Code.

    M.            “Non-Qualified Stock Option” means any Stock Option that is not an Incentive Stock Option.

    N.            “Normal Retirement” means retirement from active employment with the Corporation and any Subsidiary or Affiliate on or after age 65.

    O.            “Other Stock-Based Award” means an award under Section 8 below that is valued in whole or in part by reference to, or is otherwise based on, Stock.

    P.            “Outside Director” means a member of the Board who is not an officer or employee of the Corporation or any Subsidiary or Affiliate of the Corporation.

    Q.            “Outside Director Restricted Stock” shall have the meaning provided in Section 9.

    R.            “Plan” means this American Healthways, Inc. 1996 Stock Incentive Plan, as amended from time to time.

    S.            “Restricted Stock” means an award of shares of Stock that is subject to restrictions under Section 7 below.

    T.            “Restriction Period” shall have the meaning provided in Section 7.

    U.            “Retirement” means Normal or Early Retirement.

    V.            “Stock” means the Common Stock.

    W.            “Stock Appreciation Right” means the right pursuant to an award granted under Section 6 below to surrender to the Corporation all (or a portion) of a Stock Option in exchange for an amount equal to the difference between (i) the Fair Market Value, as of the date such Stock Option (or such portion thereof) is surrendered, of the shares of Stock covered by such Stock Option (or such portion thereof), subject, where applicable, to the pricing provisions in Section 6(b)(ii), and (ii) the aggregate exercise price of such Stock Option (or such portion thereof).

    X.            “Stock Option” or “Option” means any option to purchase shares of Stock (including Restricted Stock, if the Committee so determines) granted pursuant to Section 5 or Section 9 below.

    Y.            “Subsidiary” means any corporation (other than the Corporation) in an unbroken chain of corporations beginning with the Corporation if each of the corporations (other than the last corporation in the unbroken chain) owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in the chain.

        In addition, the terms “Change in Control,” “Potential Change in Control” and “Change in Control Price” shall have the meanings set forth, respectively in Sections 10(b), (c) and (d) below and the term “Cause” shall have the meaning set forth in Section 5(j) below.

SECTION 2. Administration.

        The Plan shall be administered by a Committee of not less than two Disinterested Persons, who shall be appointed by the Board and who shall serve at the pleasure of the Board. The functions of the Committee specified in the Plan may be exercised by an existing Committee of the Board composed exclusively of Disinterested Persons. The initial Committee shall be the Compensation Committee of the Board.

        The Committee shall have authority to grant, pursuant to the terms of the Plan, to officers, other key employees and consultants eligible under Section 4: (i) Stock Options, (ii) Stock Appreciation Rights, (iii) Restricted Stock, and/or (iv) Other Stock-Based Awards.

        In particular, the Committee shall have the authority, consistent with the terms of the Plan:

    (a) to select the officers and other key employees of and consultants to the Corporation and its Subsidiaries and Affiliates to whom Stock Options, Stock Appreciation Rights, Restricted Stock, and/or Other Stock-Based Awards may from time to time be granted hereunder;

    (b) to determine whether and to what extent Incentive Stock Options, Non-Qualified Stock Options, Stock Appreciation Rights, Restricted Stock, and/or Other Stock-Based Awards, or any combination thereof, are to be granted hereunder to one or more eligible employees;

    (c) to determine the number of shares to be covered by each such award granted hereunder;

    (d) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder (including, but not limited to, the share price and any restriction or limitation, or any vesting acceleration or waiver of forfeiture restrictions regarding any Stock Option or other award and/or the shares of Stock relating thereto, based in each case on such factors as the Committee shall determine, in its sole discretion); and to amend or waive any such terms and conditions to the extent permitted by Section 11 hereof;

    (e) to determine whether and under what circumstances a Stock Option may be settled in cash or Restricted Stock under Section 5(m) or (n), as applicable, instead of Stock;

    (f) to determine whether, to what extent and under what circumstances Option grants and/or other awards under the Plan are to be made, and operate, on a tandem basis vis-a-vis other awards under the Plan and/or cash awards made outside of the Plan;

    (g) to determine whether, to what extent and under what circumstances Stock and other amounts payable with respect to an award under this Plan shall be deferred either automatically or at the election of the participant (including providing for and determining the amount (if any) of any deemed earnings on any deferred amount during any deferral period); and

    (h) to determine whether to require payment withholding requirements in shares of Stock.

        The Committee shall have the authority to adopt, alter and repeal such rules, guidelines and practices governing the Plan as it shall, from time to time, deem advisable; to interpret the terms and provisions of the Plan and any award issued under the Plan (and any agreements relating thereto); and to otherwise supervise the administration of the Plan.

        All decisions made by the Committee pursuant to the provisions of the Plan shall be made in the Committee’s sole discretion and shall be final and binding on all persons, including the Corporation and Plan participants.

        Notwithstanding the foregoing, the Committee shall have no authority to determine the terms or conditions of awards to Outside Directors, which shall be governed solely by Section 9 hereof.

SECTION 3. Shares of Stock Subject to Plan.

        The aggregate number of shares of Stock reserved and available for distribution under the Plan shall not exceed 7,740,000 shares. Any number of shares of Stock may be awarded so long as the total shares of Stock awarded does not exceed 7,740,000 shares. Such shares of Common Stock may consist, in whole or in part, of authorized and unissued shares or treasury shares.

        If any shares of Stock that have been optioned cease to be subject to a Stock Option, or if any shares of Stock that are subject to any Restricted Stock or Other Stock-Based Award granted hereunder are forfeited prior to the payment of any dividends, if applicable, with respect to such shares of Stock, or any such award otherwise terminates without a payment being made to the participant in the form of Stock, such shares shall again be available for distribution in connection with future awards under the Plan.

        In the event of any merger, reorganization, consolidation, recapitalization, extraordinary cash dividend, Stock dividend, Stock split or other change in corporate structure affecting the Stock, an appropriate substitution or adjustment shall be made in the aggregate number of shares reserved for issuance under the Plan, in the number and option price of shares subject to outstanding Options granted under the Plan, in the number of Non-Qualified Stock Options granted to Outside Directors pursuant to Section 9 of the Plan and in the number of shares subject to other outstanding awards granted under the Plan as may be determined to be appropriate by the Committee, in its sole discretion, provided that the number of shares subject to any award shall always be a whole number. Such adjusted option price shall also be used to determine the amount payable by the Corporation upon the exercise of any Stock Appreciation Right associated with any Stock Option. The maximum number of shares that may be awarded to any participant under Section 4 of this Plan will be adjusted in the same manner as the number of shares subject to outstanding Options.

SECTION 4. Eligibility.

        Officers and other key employees of and consultants to the Corporation and its Subsidiaries and Affiliates (but excluding members of the Committee and any person who serves only as a director, except as otherwise provided in Section 9) who are responsible for or contribute to the management, growth and/or profitability of the business of the Corporation and/or its Subsidiaries and Affiliates are eligible to be granted awards under the Plan. No officer or key employee shall be eligible to receive awards relative to shares of Stock which exceed 450,000 shares during any year.

SECTION 5. Stock Options.

        Stock Options may be granted alone, in addition to or in tandem with other awards granted under the Plan and/or cash awards made outside of the Plan. Any Stock Option granted under the Plan shall be in such form as the Committee may from time to time approve.

        Stock Options granted under the Plan may be of two types: (i) Incentive Stock Options and (ii) Non-Qualified Stock Options. Incentive Stock Options may be granted only to individuals who are employees of the Corporation or any Subsidiary of the Corporation.

        The Committee shall have the authority to grant to any optionee Incentive Stock Options, Non-Qualified Stock Options, or both types of Stock Options (in each case with or without Stock Appreciation Rights).

        Options granted to officers, key employees and consultants under the Plan shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee shall deem desirable.

    (a)       Option Price. The option price per share of Stock purchasable under a Stock Option shall be determined by the Committee at the time of grant but shall be not less than 100% of the Fair Market Value of the Stock at grant, in the case of both Incentive Stock Options and Non-Qualified Stock Options (or, in the case of any employee who owns stock possessing more than 10% of the total combined voting power of all classes of stock of the Corporation or of any of its Subsidiaries, not less than 110% of the Fair Market Value of the Stock at grant in the case of Incentive Stock Options).

    (b)       Option Term. The term of each Stock Option shall be fixed by the Committee, but no Incentive Stock Option or Non-Qualified Stock Option shall be exercisable more than ten years after the date the Option is granted (or, in the case of an employee who owns stock possessing more than 10% of the total combined voting power of all classes of stock of the Corporation or any of its Subsidiaries or parent corporations, more than five years after the date the Option is granted in the case of Incentive Stock Options).

    (c)       Exercisability. Stock Options shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee at or after grant; provided, however, that except as provided in Section 5(g) and (h) and Section 10, unless otherwise determined by the Committee at or after grant, no Stock Option shall be exercisable prior to the first anniversary date of the granting of the Option. The Committee may provide that a Stock Option shall vest over a period of future service at a rate specified at the time of grant, or that the Stock Option is exercisable only in installments. If the Committee provides, in its sole discretion, that any Stock Option is exercisable only in installments, the Committee may waive such installment exercise provisions at any time at or after grant in whole or in part, based on such factors as the Committee shall determine, in its sole discretion. The Committee may establish performance conditions or other conditions to the exercisability of any Stock Options, as determined by the Committee in its sole discretion, which conditions may be waived by the Committee in its sole discretion.

    (d)       Method of Exercise. Subject to whatever installment exercise restrictions apply under Section 5(c), Stock Options may be exercised in whole or in part at any time during the option period, by giving written notice of exercise to the Corporation specifying the number of shares to be purchased.

        Such notice shall be accompanied by payment in full of the purchase price, either by check, note or such other instrument as the Committee may accept. As determined by the Committee, in its sole discretion, at or (except in the case of an Incentive Stock Option) after grant, payment in full or in part may also be made in the form of unrestricted Stock already owned by the optionee or, in the case of the exercise of a Non-Qualified Stock Option or Restricted Stock, subject to an award hereunder (valued at the Fair Market Value of the Stock on the date the option is exercised, as determined by the Committee). If payment of the exercise price is made in part or in full with Stock, the Committee may award to the employee a new Stock Option to replace the Stock which was surrendered.

        If payment of the option exercise price of a Non-Qualified Stock Option is made in whole or in part in the form of Restricted Stock, such Restricted Stock (and any replacement shares relating thereto) shall remain (or be) restricted in accordance with the original terms of the Restricted Stock award in question, and any additional Stock received upon the exercise shall be subject to the same forfeiture restrictions, unless otherwise determined by the Committee, in its sole discretion, at or after grant.

        No shares of Stock shall be issued until full payment therefor has been made. An optionee shall generally have the rights to dividends or other rights of a stockholder with respect to shares subject to the Option when the optionee has given written notice of exercise, has paid in full for such shares, and, if requested, has given the representation described in Section 13(a).

    (e)       Non-Transferability of Options. No Stock Option shall be transferable by the optionee otherwise than by will or by the laws of descent and distribution, and all Stock Options shall be exercisable, during the optionee’s lifetime, only by the optionee.

    (f)       Bonus for Taxes. In the case of a Non-Qualified Stock Option, the Committee in its discretion may award at the time of grant or thereafter the right to receive upon exercise of such Stock Option a cash bonus calculated to pay part or all of the federal and state, if any, income tax incurred by the optionee upon such exercise.

    (g)       Termination by Death. Subject to Section 5(k), if an optionee’s employment by the Corporation and any Subsidiary or (except in the case of an Incentive Stock Option) Affiliate terminates by reason of death, any Stock Option held by such optionee may thereafter be exercised, to the extent such option was exercisable at the time of death or (except in the case of an Incentive Stock Option) on such accelerated basis as the Committee may determine at or after grant (or except in the case of an Incentive Stock Option, as may be determined in accordance with procedures established by the Committee) by the legal representative of the estate or by the legatee of the optionee under the will of the optionee, for a period of one year (or such other period as the Committee may specify at or after grant) from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter.

    (h)       Termination by Reason of Disability. Subject to Section 5(k), if an optionee’s employment by the Corporation and any Subsidiary or (except in the case of an Incentive Stock Option) Affiliate terminates by reason of Disability, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the time of termination or (except in the case of an Incentive Stock Option) on such accelerated basis as the Committee may determine at or after grant (or, except in the case of an Incentive Stock Option, as may be determined in accordance with procedures established by the Committee), for a period of (i) three years (or such other period as the Committee may specify at or after grant) from the date of such termination of employment or until the expiration of the stated term of such Stock Option, whichever period is the shorter, in the case of a Non-Qualified Stock Option and (ii) one year from the date of termination of employment or until the expiration of the stated term of such Stock Option, whichever period is shorter, in the case of an Incentive Stock Option; provided however, that, if the optionee dies within the period specified in (i) above (or other such period as the committee shall specify at or after grant), any unexercised Non-Qualified Stock Option held by such optionee shall thereafter be exercisable to the extent to which it was exercisable at the time of death for a period of twelve months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is shorter. In the event of termination of employment by reason of Disability, if an Incentive Stock Option is exercised after the expiration of the exercise period applicable to Incentive Stock Options, but before the expiration of any period that would apply if such Stock Option were a Non-Qualified Stock Option, such Stock Option will thereafter be treated as a Non-Qualified Stock Option.

    (i)       Termination by Reason of Retirement. Subject to Section 5(k), if an optionee’s employment by the Corporation and any Subsidiary or (except in the case of an Incentive Stock Option) Affiliate terminates by reason of Normal or Early Retirement, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the time of such Retirement or (except in the case of an Incentive Stock Option) on such accelerated basis as the Committee may determine at or after grant (or, except in the case of an Incentive Stock Option, as may be determined in accordance with procedures established by the Committee), for a period of (i) three years (or such other period as the Committee may specify at or after grant) from the date of such termination of employment or the expiration of the stated term of such Stock Option, whichever period is the shorter, in the case of a Non-Qualified Stock Option and (ii) three months from the date of such termination of employment or the expiration of the stated term of such Stock Option, whichever period is the shorter, in the event of an Incentive Stock Option; provided however, that, if the optionee dies within the period specified in (i) above (or other such period as the Committee shall specify at or after grant), any unexercised Non-Qualified Stock Option held by such optionee shall thereafter be exercisable to the extent to which it was exercisable at the time of death for a period of twelve months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is shorter. In the event of termination of employment by reason of Retirement, if an Incentive Stock Option is exercised after the expiration of the exercise period applicable to Incentive Stock Options, but before the expiration of the period that would apply if such Stock Option were a Non-Qualified Stock Option, the option will thereafter be treated as a Non-Qualified Stock Option.

    (j)       Other Termination. Subject to Section 5(k), unless otherwise determined by the Committee (or pursuant to procedures established by the Committee) at or (except in the case of an Incentive Stock Option) after grant, if an optionee’s employment by the Corporation and any Subsidiary or (except in the case of an Incentive Stock Option) Affiliate is involuntarily terminated for any reason other than death, Disability or Normal or Early Retirement, the Stock Option shall thereupon terminate, except that such Stock Option may be exercised, to the extent otherwise then exercisable, for the lesser of three months or the balance of such Stock Option’s term if the involuntary termination is without Cause. For purposes of this Plan, “Cause” means (i) a felony conviction of a participant or the failure of a participant to contest prosecution for a felony, or (ii) a participant’s willful misconduct or dishonesty, which is directly and materially harmful to the business or reputation of the Corporation or any Subsidiary or Affiliate. If an optionee voluntarily terminates employment with the Corporation and any Subsidiary or (except in the case of an Incentive Stock Option) Affiliate (except for Disability, Normal or Early Retirement), the Stock Option shall thereupon terminate; provided, however, that the Committee at grant or (except in the case of an Incentive Stock Option) thereafter may extend the exercise period in this situation for the lesser of three months or the balance of such Stock Option’s term.

    (k)       Incentive Stock Options. Anything in the Plan to the contrary notwithstanding, no term of this Plan relating to Incentive Stock Options shall be interpreted, amended or altered, nor shall any discretion or authority granted under the Plan be so exercised, so as to disqualify the Plan under Section 422 of the Code, or, without the consent of the optionee(s) affected, to disqualify any Incentive Stock Option under such Section 422.

        No Incentive Stock Option shall be granted to any participant under the Plan if such grant would cause the aggregate Fair Market Value (as of the date the Incentive Stock Option is granted) of the Stock with respect to which all Incentive Stock Options issued after December 31, 1986 are exercisable for the first time by such participant during any calendar year (under all such plans of the Company and any Subsidiary) to exceed $100,000.

        To the extent permitted under Section 422 of the Code or the applicable regulations thereunder or any applicable Internal Revenue Service pronouncement:

    (ii)       if (x) a participant’s employment is terminated by reason of death, Disability or Retirement and (y) the portion of any Incentive Stock Option that is otherwise exercisable during the post-termination period specified under Section 5(g), (h) or (i), applied without regard to the $100,000 limitation contained in Section 422(d) of the Code, is greater than the portion of such Option that is immediately exercisable as an “Incentive Stock Option” during such post-termination period under Section 422, such excess shall be treated as a Non-Qualified Stock Option; and

    (iii)       if the exercise of an Incentive Stock Option is accelerated by reason of a Change in Control, any portion of such Option that is not exercisable as an Incentive Stock Option by reason of the $100,000 limitation contained in Section 422(d) of the Code shall be treated as a Non-Qualified Stock Option.

    (l)       Buyout Provisions. The Committee may at any time offer to buy out for a payment in cash, Stock or Restricted Stock an Option previously granted, based on such terms and conditions as the Committee shall establish and communicate to the optionee at the time that such offer is made.

    (m)       Settlement Provisions. If the option agreement so provides at grant or (except in the case of an Incentive Stock Option) is amended after grant and prior to exercise to so provide (with the optionee’s consent), the Committee may require that all or part of the shares to be issued with respect to the spread value of an exercised Option take the form of Restricted Stock, which shall be valued on the date of exercise on the basis of the Fair Market Value (as determined by the Committee) of such Restricted Stock determined without regards to the forfeiture restrictions involved.

    (n)       Performance and Other Conditions. The Committee may condition the exercise of any Option upon the attainment of specified performance goals or other factors as the Committee may determine, in its sole discretion. Unless specifically provided in the option agreement, any such conditional Option shall vest immediately prior to its expiration if the conditions to exercise have not theretofore been satisfied. The shares of Common Stock acquired pursuant to any conditional Option shall not be transferable by an Optionee subject to Section 16(a) of the Exchange Act within six months of the date such Option first becomes exercisable.

SECTION 6. Stock Appreciation Rights.

        A.    Grant and Exercise. Stock Appreciation Rights may be granted in conjunction with all or part of any Stock Option granted under the Plan. In the case of a Non-Qualified Stock Option, such rights may be granted either at or after the time of the grant of such Stock Option. In the case of an Incentive Stock Option, such rights may be granted only at the time of the grant of such Stock Option.

        A Stock Appreciation Right or applicable portion thereof granted with respect to a given Stock Option shall terminate and no longer be exercisable upon the termination or exercise of the related Stock Option, subject to such provisions as the Committee may specify at grant where a Stock Appreciation Right is granted with respect to less than the full number of shares covered by a related Stock Option.

        A Stock Appreciation Right may be exercised by an optionee, subject to Section 6(b), in accordance with the procedures established by the Committee for such purpose. Upon such exercise, the optionee shall be entitled to receive an amount determined in the manner prescribed in Section 6(b). Stock Options relating to exercised Stock Appreciation Rights shall no longer be exercisable to the extent that the related Stock Appreciation Rights have been exercised.

        B.    Terms and Conditions. Stock Appreciation Rights shall be subject to such terms and conditions, not inconsistent with the provisions of the Plan, as shall be determined from time to time by the Committee, including the following:

    (i)       Stock Appreciation Rights shall be exercisable only at such time or times and to the extent that the Stock Options to which they relate shall be exercisable in accordance with the provisions of Section 5 and this Section 6 of the Plan; provided, however, that any Stock Appreciation Right granted to an optionee subject to Section 16(a) of the Exchange Act subsequent to the grant of the related Stock Option shall not be exercisable during the first six months of its term. The exercise of Stock Appreciation Rights held by optionees who are subject to Section 16(a) of the Exchange Act shall comply with Rule 16b-3(e) thereunder, to the extent applicable. In particular, such Stock Appreciation Rights shall be exercisable only pursuant to an irrevocable election made at least six months prior to the date of exercise or within the applicable ten business day “window” periods specified in Rule 16b-3(e)(3).

    (ii)       Upon the exercise of a Stock Appreciation Right, an optionee shall be entitled to receive an amount in cash and/or shares of Stock equal in value to the excess of the Fair Market Value of one share of Stock over the option price per share specified in the related Stock Option multiplied by the number of shares in respect of which the Stock Appreciation Right shall have been exercised, with the Committee having the right to determine the form of payment. When payment is to be made in shares, the number of shares to be paid shall be calculated on the basis of the Fair Market Value of the shares on the date of exercise. When payment is to be made in cash, such amount shall be calculated on the basis of the average of the highest and lowest quoted selling price, regular way, of the Stock on the Nasdaq Stock Market or such other exchange or market as is the principal trading market for the Stock, or, if no such sale of Stock is reported on such date, the fair market value of the Stock as determined by the Committee in good faith.

    (iii)       Stock Appreciation Rights shall be transferable only when and to the extent that the underlying Stock Option would be transferable under Section 5(e) of the Plan.

    (iv)       Upon the exercise of a Stock Appreciation Right, the Stock Option or part thereof to which such Stock Appreciation Right is related shall be deemed to have been exercised for the purpose of the limitation set forth in Section 3 of the Plan on the number of shares of Stock to be issued under the Plan.

    (v)       The Committee, in its sole discretion, may also provide that, in the event of a Change in Control and/or a Potential Change in Control, the amount to be paid upon the exercise of a Stock Appreciation Right shall be based on the Change in Control Price, subject to such terms and conditions as the Committee may specify at grant.

    (vi)       The Committee may condition the exercise of any Stock Appreciation Right upon the attainment of specified performance goals or other factors as the Committee may determine, in its sole discretion. Unless specifically provided in the applicable award agreement, any such conditional Stock Appreciation Right held by a grantee subject to Section 16(a) of the Exchange Act shall not be exercisable until the expiration of six months following the satisfaction of the condition giving rise to such Stock Appreciation Right.

SECTION 7. Restricted Stock.

        A.    Administration. Shares of Restricted Stock may be issued either alone, in addition to or in tandem with other awards granted under the Plan and/or cash awards made outside the Plan. The Committee shall determine the eligible persons to whom, and the time or times at which, grants of Restricted Stock will be made, the number of shares of Restricted Stock to be awarded to any person, the price (if any) to be paid by the recipient of Restricted Stock (subject to Section 7(b)), the time or times within which such awards may be subject to forfeiture, and the other terms, restrictions and conditions of the awards in addition to those set forth in Section 7(c).

        The Committee may condition the grant of Restricted Stock upon the attainment of specified performance goals or such other factors as the Committee may determine, in its sole discretion.

        The provisions of Restricted Stock awards need not be the same with respect to each recipient.

        B.    Awards and Certificates. The prospective recipient of a Restricted Stock award shall not have any rights with respect to such award, unless and until such recipient has executed an agreement evidencing the award and has delivered a fully executed copy thereof to the Corporation, and has otherwise complied with the applicable terms and conditions of such award.

    (i)       The purchase price for shares of Restricted Stock shall be established by the Committee and may be zero.

    (ii)       Awards of Restricted Stock must be accepted within a period of 60 days (or such shorter period as the Committee may specify at grant) after the award date, by executing a Restricted Stock Award Agreement and paying whatever price (if any) is required under Section 7(b)(i).

    (iii)       Each participant receiving a Restricted Stock award shall be issued a stock certificate in respect of such shares of Restricted Stock. Such certificate shall be registered in the name of such participant, and shall bear an appropriate legend referring to the terms, conditions, and restrictions applicable to such award.

    (iv)       The Committee shall require that the stock certificates evidencing such shares be held in custody by the Corporation until the restrictions thereon shall have lapsed, and that, as a condition of any Restricted Stock award, the participant shall have delivered a stock power, endorsed in blank, relating to the Stock covered by such award.

        C.    Restrictions and Conditions. The shares of Restricted Stock awarded pursuant to this Section 7 shall be subject to the following restrictions and conditions:

    (i)       In accordance with the provisions of this Plan and the award agreement, during a period set by the Committee commencing with the date of such award (the “Restriction Period”), the participant shall not be permitted to sell, transfer, pledge, assign or otherwise encumber shares of Restricted Stock awarded under the Plan. Within these limits, the Committee, in its sole discretion, may provide for the lapse of such restrictions in installments and may accelerate or waive such restrictions in whole or in part, based on service, performance and/or such other factors or criteria as the Committee may determine, in its sole discretion.

    (ii)       Except as provided in this paragraph (ii) and Section 7(c)(i), the participant shall have, with respect to the shares of Restricted Stock, all of the rights of a stockholder of the Corporation, including the right to vote the shares, and the right to receive any cash dividends. The Committee, in its sole discretion, as determined at the time of award, may permit or require the payment of cash dividends to be deferred and, if the Committee so determines, reinvested, subject to Section 14(e), in additional Restricted Stock to the extent shares are available under Section 3, or otherwise reinvested. Pursuant to Section 3 above, Stock dividends issued with respect to Restricted Stock shall be treated as additional shares of Restricted Stock that are subject to the same restrictions and other terms and conditions that apply to the shares with respect to which such dividends are issued. If the Committee so determines, the award agreement may also impose restrictions on the right to vote and the right to receive dividends.

    (iii)       Subject to the applicable provisions of the award agreement and this Section 7, upon termination of a participant’s employment with the Corporation and any Subsidiary or Affiliate for any reason during the Restriction Period, all shares still subject to restriction will vest, or be forfeited, in accordance with the terms and conditions established by the Committee at or after grant.

    (iv)       If and when the Restriction Period expires without a prior forfeiture of the Restricted Stock subject to such Restriction Period, certificates for an appropriate number of unrestricted shares shall be delivered to the participant promptly.

        D.    Minimum Value Provisions. In order to better ensure that award payments actually reflect the performance of the Corporation and service of the participant, the Committee may provide, in its sole discretion, for a tandem performance-based or other award designed to guarantee a minimum value, payable in cash or Stock to the recipient of a restricted stock award, subject to such performance, future service, deferral and other terms and conditions as may be specified by the Committee.

SECTION 8. Other Stock-Based Awards.

        A.    Administration. Other Stock-Based Awards, including, without limitation, performance shares, convertible preferred stock, convertible debentures, exchangeable securities and Stock awards or options valued by reference to earnings per share or Subsidiary performance, may be granted either alone or in addition to or in tandem with Stock Options, Stock Appreciation Rights or Restricted Stock granted under the Plan and/or cash awards made outside of the Plan; provided that no such Other Stock-Based Awards may be granted in tandem with Incentive Stock Options if that would cause such Stock Options not to qualify as Incentive Stock Options pursuant to Section 422 of the Code.

        Subject to the provisions of the Plan, the Committee shall have authority to determine the persons to whom and the time or times at which such awards shall be made, the number of shares of Stock to be awarded pursuant to such awards, and all other conditions of the awards; provided that for Other Stock-Based Awards that do not contain a three-year restriction period on vesting, the number of shares of Common Stock to which such Other Stock-Based Awards relate shall not exceed 10% of the total number of shares of Common Stock authorized for issuance under the Plan. The Committee may also provide for the grant of Stock upon the completion of a specified performance period.

        The provisions of Other Stock-Based Awards need not be the same with respect to each recipient.

        B.    Terms and Conditions. Other Stock-Based Awards made pursuant to this Section 8 shall be subject to the following terms and conditions:

    (i)       Shares subject to awards under this Section 8 and the award agreement referred to in Section 8(b)(v) below, may not be sold, assigned, transferred, pledged or otherwise encumbered prior to the date on which the shares are issued, or, if later, the date on which any applicable restriction, performance or deferral period lapses.

    (ii)       Subject to the provisions of this Plan and the award agreement and unless otherwise determined by the Committee at grant, the recipient of an award under this Section 8 shall be entitled to receive, currently or on a deferred basis, interest or dividends or interest or dividend equivalents with respect to the number of shares covered by the award, as determined at the time of the award by the Committee, in its sole discretion, and the Committee may provide that such amounts (if any) shall be deemed to have been reinvested in additional Stock or otherwise reinvested.

    (iii)       Any award under Section 8 and any Stock covered by any such award shall vest or be forfeited to the extent so provided in the award agreement, as determined by the Committee, in its sole discretion.

    (iv)       In the event of the participant’s Retirement, Disability or death, or in cases of special circumstances, the Committee may, in its sole discretion, waive in whole or in part any or all of the remaining limitations imposed hereunder (if any) with respect to any or all of an award under this Section 8.

    (v)       Each award under this Section 8 shall be confirmed by, and subject to the terms of, an agreement or other instrument by the Corporation and the participant.

    (vi)       Stock (including securities convertible into Stock) issued on a bonus basis under this Section 8 may be issued for no cash consideration. Stock (including securities convertible into Stock) purchased pursuant to a purchase right awarded under this Section 8 shall be priced at least 85% of the Fair Market Value of the Stock on the date of grant.

SECTION 9. Awards to Outside Directors.

        A.    General. The provisions of this Section 9 shall apply only to awards to Outside Directors in accordance with this Section 9. The Committee shall have no authority to determine the timing of or the terms or conditions of any award under this Section 9. On and after the date of the Corporation’s 2004 Annual Meeting of Stockholders, no grants shall be made to Outside Directors pursuant to Sections 9(B) through 9(I) hereof, but awards to Outside Directors shall only be made pursuant to Sections 9(J) through 9(T) hereof.

        B.     On the date of each Annual Meeting of Stockholders of the Corporation, commencing with the 1996 Annual Meeting of Stockholders, each Outside Director will receive an automatic grant of restricted stock pursuant to this Section 9 (the “Outside Directors Restricted Stock”) in a number of shares of stock which will be determined by dividing:

    (i)       $10,000 by

    (ii)       the average of the daily closing bid price of the Stock for the first five (5) trading days of the month in which the Annual Meeting is held (as reported in The Wall Street Journal), rounding up or down any fractional share of Stock to the nearest whole share.

The Outside Director Restricted Stock award shall be adjusted annually on the date of the Annual Meeting of Stockholders by the percentage change from the previous year in the Consumer Price Index, Urban Wage Earners and Clerical Workers (1982-1984 = 100), All Cities Average; provided, however, that such annual increase shall not exceed six percent.

        C.     The Outside Director Restricted Stock shall vest as follows:

    (i)       Of the aggregate number of shares of Outside Director Restricted Stock granted on the date of each Annual Meeting of Stockholders, one-third of the Outside Director Restricted Stock shall immediately vest on the date of grant;

    (ii)       At the first Annual Meeting of Stockholders following the Annual Meeting at which the Outside Director Restricted Stock was granted, if the grantee is still serving as a director of the Corporation, the Outside Director Restricted Stock shall vest with respect to one-half of the remaining shares of the Outside Director Restricted Stock; and

    (iii)       At the second Annual Meeting of Stockholders following the Annual Meeting at which the Outside Director Restricted Stock was granted, if the director is still serving as a director of the Corporation, the Outside Director Restricted Stock shall vest with respect to the remaining shares of the Outside Director Restricted Stock.

        D.     Until the earlier of (i) five years from the date of grant and (ii) the date on which the Outside Director ceases to serve as a director of the Corporation (the”Outside Director Period of Restriction), no Outside Director Restricted Stock may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, otherwise than by will or by the laws of descent and distribution.

        Each certificate representing Outside Director Restricted Stock granted pursuant to this Section 9 shall bear the following legend:

“The sale or other transfer of the shares represented by this certificate, whether voluntary, involuntary, or by operation of law, is subject to certain restrictions on transfer set forth in the American Healthways, Inc. 1996 Stock Incentive Plan (the “Plan”), and rules of administration adopted pursuant to such Plan. A copy of the Plan and the rules of such Plan may be obtained from the Secretary of American Healthways, Inc.”

Once the Outside Director Period of Restriction has lapsed, the grantee shall be entitled to have the legend required by this Section 9 removed from such stock certificate(s); provided however, that such certificate shall be subject to any legend required by applicable state or federal law.

        E.     From the date on which the Outside Director Restricted Stock is granted, grantees awarded such Stock may exercise full voting rights with respect to the Outside Director Restricted Stock.

        F.     Grantees holding Outside Director Restricted Stock that has vested in accordance with Section 9(c) hereof, shall be entitled to receive all dividends and other distributions paid with respect to such shares of Stock while they are so held. If any such dividends, or distributions are paid in Stock, such shares of Stock shall be subject to the same restrictions on transferability as the shares of Outside Director Restricted Stock with respect to which they were paid.

        G.     Grantees of Outside Director Restricted Stock shall enter into a Restricted Stock Award Agreement with the Corporation setting forth the restrictions imposed on the Stock granted to him or her.

        H.      All restrictions imposed on the Outside Director Restricted Stock shall expire automatically upon a Change in Control, but shall not otherwise be subject to Section 10 hereof.

        I.     All shares of Outside Director Restricted Stock which have not vested in accordance with Section 9(c) hereof, at the time of a grantee’s resignation, removal or failure to be elected as a member of the Board of Directors shall be forfeited and such forfeited shares shall again be available for award hereunder.

        J.     The Board may not amend or alter this Section 9, except as provided in Section 11, without the approval of the holders of a majority of the issued and outstanding shares of Common Stock, and in no event shall this Section 9 be amended more than once every six months, other than to comply with changes in the Exchange Act, Code or the Employee Retirement Income Security Act of 1974, as amended, or the regulations thereunder.

        K.    Grant of Stock Options. Non-Qualified Stock Options will be awarded under this Plan pursuant to the following formula:

    (i)       On the date of his or her initial election to the Board, whether such election is by the Board or by the Corporation’s stockholders, each Outside Director shall be granted a Non-Qualified Stock Option (an “Initial Option”) to purchase up to 15,000 shares of the Corporation’s Common Stock, the amount of shares to be determined by the Board, subject to adjustment as provided in Section 3, provided that such Optionee has not received an Initial Option on any previous date.

    (ii)       Commencing with the 2004 Annual Meeting of Stockholders and continuing in effect for each subsequent Annual Meeting, each Outside Director who has served as a director of the Corporation for at least twelve (12) months will be automatically granted on the date of each such Annual Meeting a Non-Qualified Stock Option to purchase up to 5,000 shares of the Corporation’s Common Stock, the amount of shares to be determined by the Board, subject to adjustment as provided in Section 3.

    (iii)       Each Outside Director, other than directors elected to the Board in 2003, will be granted on the date of the 2004 Annual Meeting of Stockholders a Non-Qualified Stock Option (the “2003 Option”) to purchase 5,000 shares of the Corporation’s Common Stock, subject to adjustment as provided in Section 3, at an exercise price of $35.77 per share (the closing price of the Corporation’s Common Stock on September 2, 2003).

        L.    Stock Option Price. Except for the 2003 Options granted pursuant to subsection (k)(iii) above, each Non-Qualified Stock Option granted pursuant to this Section 9 shall represent the right to purchase the shares of Common Stock represented thereby at the Fair Market Value on the date the Non-Qualified Stock Option is granted.

        M.    Stock Option Agreement. The grant of any Non-Qualified Stock Option shall be evidenced by a written Stock Option Agreement executed by the Corporation and the Optionee. The Stock Option Agreement shall contain the number of shares of Common Stock subject to the Non-Qualified Stock Option evidenced thereby, the other essential terms of the Non-Qualified Stock Option determined in accordance with Section 9 hereof, and other terms that are not inconsistent with requirements of this Plan.

        N.    Exercisability.

    (i)       One-third of the Non-Qualified Stock Options granted pursuant to Section 9(k) shall vest immediately as of the date of grant.

    (ii)       One-third of the Non-Qualified Stock Options granted pursuant to Section 9(k) shall vest on the first anniversary of the date of grant, provided that the grantee is still serving as a director of the Corporation on such date.

    (iii)       The remaining one-third of the Non-Qualified Stock Options granted pursuant to Section 9(k) shall vest on the second anniversary of the date of grant, provided that the grantee is still serving as a director of the Corporation on such date.

        O.    Term. All Non-Qualified Stock Options shall have a term of ten years from the date of grant, subject to earlier termination as hereinafter provided.

        P.    Forfeiture. Non-Qualified Stock Options that have not become exercisable on the date the Optionee ceases to serve as a director of the Corporation for any reason shall be forfeited and terminated immediately upon termination of service.

        Q.    Termination of Stock Options. Non-Qualified Stock Options that have become exercisable on the date the termination or expiration of the Optionee’s position as a director may be exercised as follows:

    (i)       Termination or Resignation from Board following Two Terms as a Director

        If the Optionee shall cease to be a director of the Corporation for any reason other than involuntary termination by the Corporation for Cause and if the Optionee has served at least two full terms as a director of the Corporation, each Non-Qualified Stock Option granted to Optionee shall immediately vest and become fully exercisable and may be exercised by the Optionee for a period of one year from the date of such termination or cessation or until the expiration of the stated term of the Option, whichever period is the shorter (the “Exercise Period”); provided, however, that if the Optionee dies during the Exercise Period, any unexercised Non-Qualified Stock Option held by such Optionee shall thereafter be exercisable for a period of three years from the date of such death or until the expiration of the stated term of the Option, whichever is shorter.

    (ii)        Retirement or Disability

    If the Optionee shall cease to be a director of the Corporation by reason of retirement or Disability before the Optionee serves two full terms as a director of the Corporation, the Optionee may exercise the Non-Qualified Stock Option if and to the extent it was exercisable on the date of such cessation. Such Non-Qualified Stock Option may be exercised for a period of one year from the date of such cessation or until the expiration of the stated term of such Non-Qualified Stock Option, whichever period is shorter.

    (iii)        Death

    If the Optionee shall cease to be a director of the Corporation by reason of death at any time, the Non-Qualified Stock Option shall vest and become immediately exercisable. Such Non-Qualified Stock Option may be exercised for a period of three years from the date of such death or until the expiration of the stated term of such Non-Qualified Stock Option, whichever period is shorter.

    (iv)           Termination for any other reason other than Cause

    If the Optionee shall cease to be a director of the Corporation for any reason other than retirement, Disability, or death before the Optionee serves two full terms as a director of the Corporation, the Optionee may exercise the Non-Qualified Stock Option, to the extent it was exercisable on the date of such cessation, if the Optionee’s position as a director was involuntarily terminated by the Corporation without Cause (as defined in Section 5(j)). Such Non-Qualified Stock Options, if exercised, must be exercised within the lesser of three months from the date of cessation or until the expiration of the stated term of the Non-Qualified Stock Option, whichever period is shorter.

    (v)        Termination for Cause

    If the Corporation terminates the Optionee’s position as a director of the Corporation for Cause, the Non-Qualified Stock Option shall immediately terminate.

        R.    Method of Exercise. A Non-Qualified Stock Option shall be exercised by delivering to the Corporate Secretary of the Corporation a written notice of exercise in the form prescribed by the Corporate Secretary for use from time to time. Such notice of exercise shall indicate the number of shares for which the Non-Qualified Stock Option is exercised and shall be accompanied by the full exercise price for the Non-Qualified Stock Options exercised.

        S.    Payment of Exercise Price. The exercise price may be paid in cash (including certified or cashier’s check, bank draft or money order), Common Stock, or a combination of Common Stock and cash. The Common Stock so delivered shall be valued at the Fair Market Value of the Common Stock on the date of exercise. No shares of Common Stock shall be issued or delivered until full payment has been made.

        T.    Transferability. Non-Qualified Stock Options shall not be transferable without the prior written consent of the Committee other than (i) transfers by the Optionee to a member of his or her Immediate Family or a trust for the benefit of Optionee or a member of his or her Immediate Family, or (ii) transfers by will or by the laws of descent and distribution. For purposes of this Section 9(t), “Immediate Family” shall mean any child, stepchild, grandchild, parent, stepparent, grandparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law, and shall include adoptive relationships.

SECTION 10. Change in Control Provisions.

        A. Impact of Event. In the event of:

        (1) a “Change in Control” as defined in Section 10(b) or

        (2) a “Potential Change in Control” as defined in Section 10(c), but only if and to the extent so determined by the Committee or the Board at or after grant (subject to any right of approval expressly reserved by the Committee or the Board at the time of such determination),

the following acceleration and valuation provisions shall apply if so determined by the Board in its sole discretion:

    (i)       Any Stock Appreciation Rights (including, without limitation, any Limited Stock Appreciation Rights) outstanding for at least six months and any Stock Option awarded under the Plan not previously exercisable and vested shall become fully exercisable and vested.

    (ii)       The restrictions applicable to any Restricted Stock and Other Stock-Based Awards, in each case to the extent not already vested under the Plan, shall lapse and such shares and awards shall be deemed fully vested.

    (iii)       Except as otherwise provided in Section 10(a)(iv) below, the value of all outstanding Stock Options, Stock Appreciation Rights, Restricted Stock and Other Stock-Based Awards, in each case to the extent vested, shall, unless otherwise determined by the Committee in its sole discretion at or (except in the case of an Incentive Stock Option) after grant but prior to any Change in Control, be cashed out on the basis of the “Change in Control Price” as defined in Section 10(d) as of the date such Change in Control or such Potential Change in Control is determined to have occurred or such other date as the Committee may determine prior to the Change in Control.

    (iv)       In the case of any Stock Options, Stock Appreciation Rights, Restricted Stock and Other Stock-Based Awards held by any person subject to Section 16(a) of the Exchange Act, the value of all such Stock Options, Stock Appreciation Rights, Restricted Stock or Other Stock-Based Awards, in each case to the extent that they are vested and have been held for at least six months, shall (unless otherwise determined by the Committee in its sole discretion) be cashed out on the basis of the “Change in Control Price” as defined in Section 10(d) as of the date of such Change in Control or such Potential Change in Control is determined to have occurred, but only if the Change in Control or Potential Change in Control is outside the control of the grantee for purposes of Rule 16b-3(e)(3) under the Exchange Act, or any successor provision promulgated by the Securities and Exchange Commission.

        B.    Definition of Change in Control. For purposes of Section 10(a), a “Change in Control” means the happening of any of the following:

    (i)       any person or entity, including a “group” as defined in Section 13(d)(3) of the Exchange Act, other than the Corporation or a wholly-owned subsidiary thereof or any employee benefit plan of the Corporation or any of its Subsidiaries, becomes the beneficial owner of the Corporation’s securities having 35% or more of the combined voting power of the then outstanding securities of the Corporation that may be cast for the election of directors of the Corporation (other than as a result of an issuance of securities initiated by the Corporation in the ordinary course of business); or

    (ii)       as the result of, or in connection with, any cash tender or exchange offer, merger or other business combination, sales of assets or contested election, or any combination of the foregoing transactions, less than a majority of the combined voting power of the then outstanding securities of the Corporation or any successor corporation or entity entitled to vote generally in the election of the directors of the Corporation or such other corporation or entity after such transaction are held in the aggregate by the holders of the Corporation’s securities entitled to vote generally in the election of directors of the Corporation immediately prior to such transaction; or

    (iii)       during any period of two consecutive years, individuals who at the beginning of any such period constitute the Board cease for any reason to constitute at least a majority thereof, unless the election, or the nomination for election by the Corporation’s stockholders, of each director of the Corporation first elected during such period was approved by a vote of at least two-thirds of the directors of the Corporation then still in office who were directors of the Corporation at the beginning of any such period.

        C.    Definition of Potential Change in Control. For purposes of Section 10(a), a “Potential Change in Control” means the happening of any one of the following:

    (i)       The approval by stockholders of an agreement by the Corporation, the consummation of which would result in a Change in Control of the Corporation as defined in Section 10(b); or

    (ii)       The acquisition of beneficial ownership, directly or indirectly, by any entity, person or group (other than the Corporation or a Subsidiary or any Corporation employee benefit plan (including any trustee of such plan acting as such trustee)) of securities of the Corporation representing 5% or more of the combined voting power of the Corporation’s outstanding securities and the adoption by the Committee of a resolution to the effect that a Potential Change in Control of the Corporation has occurred for purposes of this Plan.

        D.    Change in Control Price. For purposes of this Section 10, “Change in Control Price” means the highest price per share paid in any transaction reported on the Nasdaq Stock Market or such other exchange or market as is the principal trading market for the Stock, or paid or offered in any bona fide transaction related to a Potential or actual Change in Control of the Corporation at any time during the 60 day period immediately preceding the occurrence of the Change in Control (or, where applicable, the occurrence of the Potential Change in Control event), in each case as determined by the Committee except that, in the case of Incentive Stock Options and Stock Appreciation Rights relating to Incentive Stock Options, such price shall be based only on transactions reported for the date on which the optionee exercises such Stock Appreciation Rights or, where applicable, the date on which a cash out occurs under Section 10(a)(iii).

SECTION 11. Amendments and Termination.

        The Board may amend, alter, or discontinue the Plan, but no amendment, alteration, or discontinuation shall be made which would impair the rights of an optionee or participant under a Stock Option, Stock Appreciation Right, Restricted Stock, Other Stock-Based Award or Outside Director Restricted Stock theretofore granted, without the optionee’s or participant’s consent or which, without the approval of the Corporation’s stockholders, would:

    (a)       except as expressly provided in this Plan, increase the total number of shares reserved for the purpose of the Plan;

    (b)       materially increase the benefits accruing to participants under the Plan; or

    (c)       materially modify the requirements as to eligibility for participation in the Plan.

        The Committee may amend the terms of any Stock Option or other award theretofore granted, prospectively or retroactively, but, subject to Section 3 above, no such amendment shall impair the rights of any holder without the holder’s consent. The Committee may also substitute new Stock Options for previously granted Stock Options (on a one for one or another basis), provided that the Committee may not modify any outstanding Stock Option so as to specify a lower exercise price or accept the surrender of an outstanding Stock Option and authorize the granting of a new Stock Option in substitution therefor specifying a lower exercise price. Subject to the above provisions, the Board shall have broad authority to amend the Plan to take into account changes in applicable securities and tax laws and accounting rules, as well as other developments.

SECTION 12. Unfunded Status of Plan.

        The Plan is intended to constitute an “unfunded” plan for incentive and deferred compensation. With respect to any payments not yet made to a participant or optionee by the Corporation, nothing contained herein shall give any such participant or optionee any rights that are greater than those of a general creditor of the Corporation. In its sole discretion, the Committee may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver Stock or payments in lieu of or with respect to awards hereunder; provided, however, that, unless the Committee otherwise determines with the consent of the affected participant, the existence of such trusts or other arrangements is consistent with the “unfunded” status of the Plan.

SECTION 13. General Provisions.

        A.     The Committee may require each person purchasing shares pursuant to a Stock Option or other award under the Plan to represent to and agree with the Corporation in writing that the optionee or participant is acquiring the shares without a view to distribution thereof. The certificates for such shares may include any legend which the Committee deems appropriate to reflect any restrictions on transfer.

        All certificates for shares of Stock or other securities delivered under the Plan shall be subject to such stock-transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations, and other requirements of the Securities and Exchange Commission, any stock exchange upon which the Stock is then listed, and any applicable Federal or state securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions.

        B.     Nothing contained in this Plan shall prevent the Board from adopting other or additional compensation arrangements, subject to stockholder approval if such approval is required; and such arrangements may be either generally applicable or applicable only in specific cases.

        C.     The adoption of the Plan shall not confer upon any employee of the Corporation or any Subsidiary or Affiliate any right to continued employment with the Corporation or a Subsidiary or Affiliate, as the case may be, nor shall it interfere in any way with the right of the Corporation or a Subsidiary or Affiliate to terminate the employment of any of its employees at any time.

        D.     No later than the date as of which an amount first becomes includible in the gross income of the participant for Federal income tax purposes with respect to any award under the Plan, the participant shall pay to the Corporation, or make arrangements satisfactory to the Committee regarding the payment of, any Federal, state, or local taxes of any kind required by law to be withheld with respect to such amount. The Committee may require withholding obligations to be settled with Stock, including Stock that is part of the award that gives rise to the withholding requirement. The obligations of the Corporation under the Plan shall be conditional on such payment or arrangements and the Corporation and its Subsidiaries or Affiliates shall, to the extent permitted by law, have the right to deduct any such taxes from any payment of any kind otherwise due to the participant.

        E.     The actual or deemed reinvestment of dividends or dividend equivalents in additional Restricted Stock (or other types of Plan awards) at the time of any dividend payment shall only be permissible if sufficient shares of Stock are available under Section 3 for such reinvestment (taking into account then outstanding Stock Options and other Plan awards).

        F.     The Plan and all awards made and actions taken thereunder shall be governed by and construed in accordance with the laws of the State of Delaware.

        G.     The members of the Committee and the Board shall not be liable to any employee or other person with respect to any determination made hereunder in a manner that is not inconsistent with their legal obligations as members of the Board. In addition to such other rights of indemnification as they may have as directors or as members of the Committee, the members of the Committee shall be indemnified by the Corporation against the reasonable expenses, including attorneys’ fees actually and necessarily incurred in connection with the defense of any action, suit or proceeding, or in connection with any appeal therein, to which they or any of them may be a party by reason of any action taken or failure to act under or in connection with the Plan or any option granted thereunder, and against all amounts paid by them in settlement thereof (provided such settlement is approved by independent legal counsel selected by the Corporation) or paid by them in satisfaction of a judgment in any such action, suit or proceeding, except in relation to matters as to which it shall be adjudged in such action, suit or proceeding that such Committee member is liable for negligence or misconduct in the performance of his duties; provided that within 60 days after institution of any such action, suit or proceeding, the Committee member shall in writing offer the Corporation the opportunity, at its own expense, to handle and defend the same.

        H.     In addition to any other restrictions on transfer that may be applicable under the terms of this Plan or the applicable award agreement, no Option, Stock Appreciation Right, Restricted Stock award, or Other Stock-Based Award or other right issued under this Plan is transferable by the participant other than by will or the laws of descent and distribution or pursuant to a qualified domestic relations order as defined under the Code or Title I of the Employee Retirement Income Security Act of 1974, as amended. The designation of a beneficiary will not constitute a transfer.

SECTION 14. Effective Date of Plan.

        The Plan shall be effective as of the date of approval of the Plan by a majority of the votes cast by the holders of the Corporation’s Stock.

SECTION 15. Term of Plan.

        No Stock Option, Stock Appreciation Right, Restricted Stock award, Other Stock-Based Award or Outside Director Restricted Stock award shall be granted pursuant to the Plan on or after October 25, 2011, but awards granted prior to October 25, 2011 may be extended beyond that date.
EX-11 4 ex-11_053104.htm EARNINGS PER SHARE RECONCILIATION
Exhibit 11

American Healthways, Inc.
Earnings Per Share Reconciliation
May 31, 2004
(Unaudited)
(In thousands, except earnings per share data)

        The following is a reconciliation of the numerator and denominator of basic and diluted earnings per share:

Three Months Ended
May 31,
Nine Months Ended
May 31,

2004
2003
2004
2003

Numerator:

    Net income - numerator for basic earnings per share $  7,484 $  4,550 $16,765 $13,393

    Effect of dilutive securities -- -- -- --

    Numerator for diluted earnings per share $  7,484 $  4,550 $16,765 $13,393

Denominator:

   Shares used for basic earnings per share 32,442 31,083 32,094 30,920

   Effect of dilutive stock options outstanding 2,361 1,891 2,513 1,890

   Shares used for diluted earnings per share 34,803 32,974 34,607 32,810

Earnings per share:

    Basic $    0.23 $    0.15 $    0.52 $    0.43

    Diluted $    0.22 $    0.14 $    0.48 $    0.41

EX-31 5 ex-311_053104.htm SECTION 302 CEO CERTIFICATION
Exhibit 31.1

I, Ben R. Leedle, Jr. certify that:

1.     I have reviewed this quarterly report on Form 10-Q of American Healthways, Inc.;

2.     Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.     Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

        a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

        b)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

        c)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

        a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

        b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: July 14, 2004

/s/ Ben R. Leedle, Jr.
Ben R. Leedle, Jr.
President and Chief Executive Officer

EX-31 6 ex-312_053104.htm SECTION 302 CFO CERTIFICATION
Exhibit 31.2

I, Mary A. Chaput, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of American Healthways, Inc.;

2.     Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.     Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

        a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

        b)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

        c)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

        a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

        b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: July 14, 2004

/s/ Mary A. Chaput
Mary A. Chaput
Executive Vice President and Chief Financial Officer

EX-32 7 ex-32_053104.htm SECTION 906 CEO AND CFO CERTIFICATION
Exhibit 32

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of American Healthways, Inc. (the “Company”) on Form 10-Q for the period ended May 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Ben R. Leedle, Jr., President and Chief Executive Officer of the Company, and Mary A. Chaput, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

    (1)        The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

    (2)        The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Ben R. Leedle, Jr.
Ben R. Leedle, Jr.
President and Chief Executive Officer
July 14, 2004

/s/ Mary A. Chaput
Mary A. Chaput
Executive Vice President and Chief Financial Officer
July 14, 2004

-----END PRIVACY-ENHANCED MESSAGE-----

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-Q

AMERICAN HEALTHWAYS, INC.

Part I

Item 1. Financial Statements

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

LIABILITIES AND STOCKHOLDERS’ EQUITY

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except earnings per share data)

(Unaudited)

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

For the Nine Months Ended May 31, 2004

(In thousands)

(Unaudited)

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

AMERICAN HEALTHWAYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Interim Financial Reporting

(2) Segment Disclosures

(3) Recently Issued Accounting Standards

(4) Restricted Cash

(5) Stock-Based Compensation

(6) Business Acquisitions

(7) Intangible and Other Assets

(8) Long-Term Debt

(9) Commitments and Contingencies

(10) Stockholders’ Equity

(11) Comprehensive Income

(12) Subsequent Event

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Customer Contracts

Actual Lives under Management

Business Acquisitions

Business Strategy

Critical Accounting Policies

Results of Operations

Revenues

Cost of Services

Selling, General and Administrative Expenses

Depreciation and Amortization

Interest Expense

Income Tax Expense

Liquidity and Capital Resources

Material Commitments

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Part II

Item 1. Legal Proceedings.

Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities.

Item 3. Defaults Upon Senior Securities.

Item 4. Submission of Matters to a Vote of Security Holders.

Item 5. Other Information.

Item 6. Exhibits and Reports on Form 8-K.

SIGNATURES

AMERICAN HEALTHWAYS, INC.

1996 STOCK INCENTIVE PLAN

SECTION 1. Purpose; Definitions.

SECTION 2. Administration.

SECTION 3. Shares of Stock Subject to Plan.

SECTION 4. Eligibility.

SECTION 5. Stock Options.

SECTION 6. Stock Appreciation Rights.

SECTION 7. Restricted Stock.

SECTION 8. Other Stock-Based Awards.

SECTION 9. Awards to Outside Directors.

SECTION 10. Change in Control Provisions.

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

American Healthways, Inc.
Earnings Per Share Reconciliation
May 31, 2004
(Unaudited)
(In thousands, except earnings per share data)