0000704415-06-000108.txt : 20061113 0000704415-06-000108.hdr.sgml : 20061113 20061113170433 ACCESSION NUMBER: 0000704415-06-000108 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 16 CONFORMED PERIOD OF REPORT: 20060831 FILED AS OF DATE: 20061113 DATE AS OF CHANGE: 20061113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-19364 FILM NUMBER: 061209854 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 HEALTHWAYS INC DATE OF NAME CHANGE: 20000322 FORMER COMPANY: FORMER CONFORMED NAME: AMERICAN HEALTHCORP INC /DE DATE OF NAME CHANGE: 19940211 10-K 1 form10-k_083106.htm HEALTHWAYS, INC. FORM 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended August 31, 2006

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 000-19364

HEALTHWAYS, INC.

(Exact name of registrant as specified in its charter)

Delaware		62-1117144
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

	3841 Green Hills Village Drive, Nashville, TN 37215
	(Address of principal executive offices) (Zip code)

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

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Name of each exchange on which registered

Common Stock - $.001 par value, and

The NASDAQ Stock Market LLC

related Preferred Stock Purchase Rights

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes x No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.

Yes o No x

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 12 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 o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o No x

As of February 28, 2006, the last business day of the Registrant’s most recently completed second fiscal quarter, the aggregate market value of the shares held by non-affiliates of the registrant was approximately $1.4 billion based on the closing bid price reported for such date on The NASDAQ Stock Market.

As of November 7, 2006, 34,662,334 shares of Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held February 2, 2007 are incorporated by reference into Part III of this Form 10-K.

Healthways, Inc.

Form 10-K

Table of Contents

			Page
Part I
	Item 1.	Business	4
	Item 1A.	Risk Factors	9
	Item 1B.	Unresolved Staff Comments	14
	Item 2.	Properties	14
	Item 3.	Legal Proceedings	15
	Item 4.	Submission of Matters to a Vote of Security Holders	15
Part II
	Item 5.	Market for Registrant’s Common Equity, Related Stockholder
		Matters and Issuer Purchases of Equity Securities	18
	Item 6.	Selected Financial Data	19
	Item 7.	Management’s Discussion and Analysis of Financial Condition and
		Results of Operation	20
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	32
	Item 8.	Financial Statements and Supplementary Data	33
	Item 9.	Changes in and Disagreements with Accountants on Accounting and
		Financial Disclosure	54
	Item 9A.	Controls and Procedures	54
	Item 9B.	Other Information	57
Part III
	Item 10.	Directors and Executive Officers of the Registrant	58
	Item 11.	Executive Compensation	58
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	58
	Item 13.	Certain Relationships and Related Transactions	58
	Item 14.	Principal Accounting Fees and Services	58
Part IV
	Item 15.	Exhibits, Financial Statement Schedules	59

PART I.

Item 1. Business

Founded in 1981, Healthways, Inc. (formerly American Healthways, Inc.) (the “Company”) provides specialized, comprehensive Health and Care Support^SM programs and services, including disease management, high-risk care management, and Outcomes Driven Wellness^SM programs to health plans, governments, employers, and hospitals in all 50 states, the District of Columbia, Puerto Rico, and Guam. These services include, but are not limited to:

•

providing members with educational materials and personal interactions with highly trained nurses and other health-care professionals designed to create and sustain healthier behaviors;

•

incorporating current evidence-based clinical guidelines in interventions to optimize patient care;

•

developing care support plans and motivating members to set attainable goals for themselves;

•

providing local market resources to address acute episode interventions;

•

coordinating members’ care with local health-care providers; and

•

fostering wellness and prevention through total population screening, health risk assessments, and supportive interventions.

Our integrated Health and Care Support programs serve entire customer populations through member and physician Health and Care Support interventions, advanced neural network predictive modeling, and a confidential, secure Internet-based application that provides patients and physicians with individualized health information. Our programs enable our customers to develop relationships with all of their members, not just the chronically ill, and to identify those at highest risk for a health problem, allowing for early interventions.

Our programs are designed to help people lead healthier lives by making sure they understand and follow doctors’ orders including medication compliance, are aware of and can recognize early warning signs associated with a major health episode, and are setting achievable goals for themselves to improve their current health status.

We believe that our patient and physician support regimens, delivered and/or supervised by a multi-disciplinary team, have demonstrated that they assist in providing more effective care for the enrollee populations diagnosed with one or more diseases or conditions, which will improve the health status of the enrollee populations with the disease or condition and reduce both the short-term and long-term health-care costs for these enrollees. In addition, our consumer-directed health support services enable health plans and employers to reach and engage everyone in their covered populations through interventions which are sensitive and specific to each individual’s health risks and needs, thereby motivating behavior change and generating measurable cost savings.

Our integrated Health and Care Support product line includes programs for people with diabetes, coronary artery disease, heart failure, asthma, chronic obstructive pulmonary disease, end-stage renal disease, cancer, chronic kidney disease, depression, tobacco addiction, high-risk obesity, acid-related stomach disorders, atrial fibrillation, decubitus ulcer, fibromyalgia, hepatitis C, inflammatory bowel disease, irritable bowel syndrome, low-back pain, osteoarthritis, osteoporosis, and urinary incontinence. We also provide high-risk care management and population health support. We design our programs 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 designed to optimize member care and are based on the most up-to-date, evidence-based clinical guidelines.

The flexibility of our programs allows customers to enter the Health and Care Support market at the level they deem appropriate for their organization. Customers may select a single chronic disease or a total-

population approach, in which all members of the customer’s population receive the benefit of our programs at a single cost.

Customer Contracts

Contract Terms

We generally determine our contract fees by multiplying a contractually negotiated rate per member per month (“PMPM”) by the number of members covered by our services during the month. We set the PMPM rates during contract negotiations with customers based on the value we expect our programs to create and a sharing of that value between the customer and the Company. In some contracts, the PMPM rates may differ between a customer’s lines of business [e.g. Preferred Provider Organizations (“PPO”), Health Maintenance Organizations (“HMO”), Medicare Advantage]. Contracts with health plans generally range from three to seven years with provisions for subsequent renewal; contracts between our health plan customers and their self-insured employer accounts typically have one-year terms. Some contracts allow the customer to terminate early under certain conditions.

Some contracts provide that a portion (up to 100%) of our fees may be refundable to the customer (“performance-based”) if our programs do not achieve, when compared to a baseline year, a targeted percentage reduction in the customer’s health-care costs and selected clinical and/or other criteria that focus on improving the health of the members. Approximately 10% of revenues recorded during fiscal 2006 were performance-based and were subject to final reconciliation as of August 31, 2006. We anticipate that this percentage will fluctuate due to the level of performance-based fees in new contracts, revenue recognition associated with performance-based fees, and the timing of data reconciliation, which varies according to contract terms. A limited number of contracts also provide opportunities for us to receive incentive bonuses in excess of the contractual PMPM rate if we exceed contractual performance targets.

We are participating in two Medicare Health Support (“MHS”) pilots awarded under the Chronic Care Improvement Program authorized by the Medicare Modernization Act of 2003. The pilots will operate for 36 months and may be terminated by either party with six months written notice. We began operating one pilot in August 2005 to serve 20,000 Medicare fee-for-service beneficiaries in Maryland and the District of Columbia. All fees under this pilot are performance-based. In addition, in September 2005 we began serving 20,000 beneficiaries in Georgia in collaboration with CIGNA HealthCare, Inc. The majority of our fees under our contract with CIGNA are performance-based. Both of the pilots are for complex diabetes and congestive heart failure disease management services and are operationally similar to our programs for commercial and Medicare Advantage health plan populations.

In June 2006, we signed an amendment to our cooperative agreement with the Centers for Medicare & Medicaid Services (“CMS”) for our MHS stand-alone pilot in Maryland and the District of Columbia, which, among other things, enabled us to provide congestive heart failure programs to approximately 4,500 additional Medicare fee-for-service beneficiaries for two years beginning on August 1, 2006 (the “refresh population”). All fees for the refresh population are performance-based.

Information Systems

Our contracts require sophisticated management information systems to help us manage the care of large populations with targeted chronic diseases or other medical conditions and to report the impact of our programs on clinical and financial outcomes. We have developed and are continually expanding and improving our proprietary clinical, data management, and reporting systems, to continue to meet our information management needs for our Health and Care Support services. Due to the anticipated expansion and improvement in our information management systems, we expect to continue making significant investments in our information technology software and hardware and in our information technology staff.

Actual Lives under Management

We measure the volume of participation in our programs by the actual number of people who are benefiting from our services, which is reported as “actual lives under management.” Backlog represents the estimated annualized revenue at target performance associated with signed contracts at August 31, 2006 for which we have not yet begun providing services. The number of actual lives under management and annualized revenue in backlog are shown below at August 31, 2006, 2005 and 2004.

At August 31,	2006		2005		2004


(In 000s)
Actual lives under management		2,426		1,883		1,335
Annualized revenue in backlog	$	6,625	$	32,578	$	15,200

We have seen increasing demand for our Health and Care Support services from self-insured employer accounts, most of which are contracted through the Administrative Services Only (ASO) line of business with our health plan customers and for which our health plan customers do not assume medical cost risk but provide primarily administrative claim and health network access services. Signed contracts between these self-insured employers and our health plan customers are incorporated in our contracts with our 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, as appropriate.

Business Strategy

Our primary strategy is to create value for health plans, governments, employers, and hospitals through Health and Care Support programs and services that improve the quality and affordability of health-care. We plan to use our scalable state-of-the-art care enhancement centers, medical information content, and proprietary technologies to gain a competitive advantage in delivering our Health and Care Support services.

We expect to continue adding services to our product mix that extend our programs beyond a chronic disease focus and provide services to individuals who currently have, or face the risk of developing, one or more additional medical conditions. We believe that we can achieve improvements in care and significant cost savings by addressing care and treatment requirements for these additional selected diseases and conditions, which will enable us to address an increasingly larger percentage of a customer’s population and total health-care costs. As discussed in more detail below, in October 2006, we entered into a stock purchase agreement to acquire Axia Health Management, Inc. (“Axia”), a national provider of preventive health and wellness programs, which we expect to close during December 2006.

In May 2006 we entered into a strategic partnership with Medco, Inc., a pharmacy benefit management company, to distribute existing programs and to develop and distribute integrated medical and pharmaceutical management programs. We expect to continue developing proprietary, proactive health support products and services for whole populations across the continuum of care, including next generation integrated disease management and wellness solutions.

We anticipate that we will incur significant costs during fiscal 2007 to enhance and expand our clinical programs and data and financial reporting systems, pursue opportunities in international markets, enhance our information technology support, integrate the operations of Axia, and open additional or expand current care enhancement centers as needed. We may add some of these new capabilities and technologies through internal development, strategic alliances with other entities, and/or through selective acquisitions.

Competition

The health-care industry is highly competitive and subject to continual change in the manner in which services are provided. Other entities, whose financial, research, staff, and marketing resources may exceed our resources, are marketing a variety of care support, health support, and other care management services to health plans and self-insured employers, or have announced an intention to offer such services. These entities include disease management companies, major pharmaceutical companies, health plans, health-care organizations, providers, pharmacy benefit management companies, and other entities that provide services to health plans and self-insured employers.

We believe we have advantages over our competitors because of our state-of-the-art care enhancement center technology linked to our proprietary medical information technology, predictive modeling capabilities, behavior-change techniques, the comprehensive recruitment, pre-testing and training of our clinical colleagues, the comprehensive clinical nature of our product offerings, our established reputation for providing care to members with chronic diseases, and the proven financial and clinical outcomes of our programs; however, we cannot assure you that we can compete effectively with these companies.

Consolidation has been, and may continue to be, an important factor in all aspects of the health-care industry, including the Health and Care Support sector. While we believe the size of our membership base provides us with the economies of scale to compete even in a consolidating market, we cannot assure you that we can effectively compete with companies formed as a result of industry consolidation or that we can retain existing health plan customers if they are acquired by other health plans which already have or are not interested in Health and Care Support programs.

Governmental Regulation

Governmental regulation impacts us in a number of ways in addition to those regulatory risks presented under the “Risk Factors” below.

While many of the governmental and regulatory requirements affecting health-care delivery do not directly affect us, our customers must comply with a variety of regulations including the licensing and reimbursement requirements of federal, state and local agencies and the requirements of municipal building codes and health codes.

Certain of our professional health-care employees, such as nurses, must comply with individual licensing requirements. All of our health-care professionals who are subject to licensing requirements are licensed in the state in which they are physically present, such as the professionals located at a care enhancement center. Multiple state licensing requirements for health-care professionals who provide services telephonically over state lines may require us to license some of our health-care professionals in more than one state. We continually monitor legislative, regulatory and judicial developments in telemedicine; however, new agency interpretations, federal or state legislation or regulations, or judicial decisions could increase the requirement for multi-state licensing of all care enhancement center health professionals, which would increase our costs of services.

Changes in laws governing reimbursement to health plans providing services under governmental programs such as Medicare and Medicaid may affect us. Legislative and regulatory bodies may continue to reduce the funding of the Medicare and Medicaid programs in an effort to reduce overall federal health-care spending. In recent years, federal legislation has reduced or significantly altered Medicare and Medicaid reimbursements to most hospitals. These changes, future legislative initiatives or government regulation could adversely affect our operations or reduce the demand for our services.

Federal privacy regulations issued pursuant to the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) extensively restrict the use and disclosure of individually-identifiable health information by health plans, most health-care providers, and certain other entities (collectively, “covered entities”). We are contractually required to comply with certain aspects of the privacy regulations. Federal security regulations issued pursuant to HIPAA require covered entities to implement and maintain administrative, physical and technical safeguards to protect the confidentiality, integrity and availability of electronic individually-identifiable health information. We are contractually required to comply with certain aspects of the security regulations. In addition, we are contractually obligated to comply with any applicable state laws or regulations related to privacy that are more restrictive than the federal privacy regulations. We may also be directly subject to state requirements related to the confidentiality and security of confidential personal information.

Various federal and state laws regulate the relationships among providers of health-care services, other health-care businesses and physicians. The "fraud and abuse" provisions of the Social Security Act provide civil and criminal penalties and potential exclusion from the Medicare and Medicaid programs for persons or businesses who offer, pay, solicit or receive remuneration in order to induce referrals of patients covered by federal health-care programs (which include Medicare, Medicaid, TriCare and other federally funded health programs). While we believe that our business arrangements with our customers comply with these statutes, these fraud and abuse provisions are broadly written, and we do not yet know the full extent of their application. Therefore, we are unable to predict the effect, if any, of broad enforcement interpretation of these fraud and abuse provisions.

Further, the health-care industry is highly regulated at the federal and state levels. For example, federal law contains various prohibitions related to false statements and false claims, some of which apply to private payors as well as federal programs. Our participation in the MHS program being administered by CMS may subject us directly to various laws and regulations applicable to entities contracting to provide services to federal programs, including but not limited to provisions related to billing and reimbursement and the False Claims Act. Violations of the False Claims Act are punishable by treble damages and penalties of up to $11,000 per false claim. Actions may be brought under the False Claims Act by the government as well as by private individuals, known as “whistleblowers,” who are permitted to share in any settlement or judgment.

When a private party brings an action under the whistleblower provisions of the False Claims Act, the defendant will generally not be aware of the lawsuit until the government makes a determination whether it will intervene and take a lead in the litigation. There are many potential bases for liability under the False Claims Act. Although liability under the False Claims Act arises when an entity knowingly submits a false claim for reimbursement to the federal government, the False Claims Act defines the term “knowingly” broadly. Thus, although simple negligence generally will not give rise to liability under the False Claims Act, submitting a claim with reckless disregard for its truth or falsity can constitute “knowingly” submitting a claim. In some cases, whistleblowers, the federal government, and some courts have taken the position that entities who allegedly have violated other statutes, such as the “fraud and abuse” provisions of the Social Security Act, have thereby submitted false claims under the False Claims Act. From time to time, participants in the health care industry, including our company, may be subject to actions under the False Claims Act, and it is not possible to predict the impact of such actions.

Insurance

We maintain the following types of insurance for all of our locations and operations: professional liability (including errors and omissions), directors and officers, and general liability. While we believe our insurance coverage is adequate for our current operations, it might not be sufficient to cover all future claims. In recent years, the cost of liability and other forms of insurance has increased significantly. Such insurance might not continue to be available in adequate amounts or at a reasonable cost. We maintain property insurance with commercial carriers for each of our locations. These policies contain relatively standard

commercial terms and conditions. We also maintain workers compensation insurance through a large deductible policy where we retain a significant amount of the risk for claims.

Employees

As of October 17, 2006, we had 2,855 employees. Our employees are not subject to any collective bargaining agreements. We believe we have a good relationship with our employees.

Recent Developments

On September 30, 2006, we terminated an Agreement and Plan of Merger dated May 30, 2006 with LifeMasters Supported SelfCare, Inc. (“LifeMasters”) and entered into a Merger Termination and Release Agreement which provides for, among other things, a mutual release of claims and a payment of $1.5 million from LifeMasters to reimburse us for certain of our expenses.

In October 2006, we entered into a stock purchase agreement with Axia, a national provider of preventive health and wellness programs, to purchase all of Axia’s outstanding shares of capital stock for approximately $450 million, subject to adjustment for Axia’s indebtedness, working capital, and cash balance at closing. Of the purchase price, $35 million will be held in escrow until December 31, 2007 to satisfy any potential indemnification claims. An additional $9 million of the purchase price will be held in escrow to satisfy a portion of certain potential earnout obligations. We expect the acquisition to close during December 2006, subject to satisfaction of the closing conditions in the stock purchase agreement, including receipt of required regulatory approvals. We currently anticipate that the acquisition will be financed through a combination of cash on hand and committed bank debt.

Available Information

Our Internet address is www.healthways.com. We make available free of charge on or through our Internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

Item 1A. Risk Factors

In the execution of our business strategy, our operations and financial condition are subject to certain risks. A summary of certain material risks is provided below, and you should take such risks into account in evaluating any investment decision involving our company. This section does not describe all risks applicable to us and is intended only as a summary of certain material factors that could impact our operations in the industry in which we operate. Other sections of this Annual Report on Form 10-K (“Form 10-K”) contain additional information concerning these and other risks.

We depend on payments from customers, and cost reduction pressure on these entities may adversely affect our business and results of operations.

The health-care industry in which we operate currently faces significant cost reduction pressures as a result of constrained revenues from governmental and private revenue sources and increasing underlying medical care costs. We believe that these pressures will continue and possibly intensify.

We believe that our programs are geared specifically to assist our customers in controlling the high costs associated with the treatment of chronic diseases and in fostering wellness and prevention through total population screening, health risk assessments, and supportive interventions; however, the pressures to reduce

costs in the short term may negatively affect our ability to sign and/or retain contracts. In addition, this focus on cost reduction may cause our customers to focus on contract restructurings that reduce the fees we receive for our services. These financial pressures could have a negative impact on our results of operations.

A significant percentage of our revenues is derived from health plan customers.

A significant percentage of our revenues is derived from health plan customers. The health plan industry continues to undergo a period of consolidation, and we cannot assure you that we will be able to retain health plan customers if they are acquired by other health plans which already have or are not interested in Health and Care Support programs. In addition, a reduction in the number of covered lives enrolled with our health plan customers could adversely affect our results of operations.

We currently derive a large percentage of our revenues from two customers. The loss of, or the restructuring of a contract with, one or both of these customers could have a material adverse effect on our business and results of operations.

Because of the size of their membership and the number of programs purchased from us, we have a significant concentration of our revenues represented by contracts with two customers - Blue Cross and Blue Shield of Minnesota and CIGNA HealthCare, Inc. - each of which comprised over 10% of revenues in fiscal 2006 and collectively accounted for 38% of revenues. Although we believe that the full-year impact of other contracts signed in 2006, new contracts anticipated to be signed in 2007, and the expected increased revenues associated with the Axia acquisition will reduce our current revenue concentration, our results of operations, cash flows, and financial condition could be negatively and materially impacted by the loss or restructuring of a contract with a single large customer.

In fiscal 2005 and 2004, these same two contracts each comprised more than 10% of revenues for the year, comprising in the aggregate approximately 38% and 44% of such revenues, respectively.

The Health and Care Support industry is a relatively new segment of the health-care industry.

The rapidly growing Health and Care Support industry is a relatively new segment of the overall health-care industry with many entrants marketing various services and products labeled as Health and Care Support. Companies have used the generic label of health and/or care support to characterize a wide range of activities, from the sale of medical supplies and drugs to demand management services. Because the industry is somewhat new, purchasers of these services have not had significant experience purchasing, evaluating or monitoring such services, which generally results in a lengthy sales cycle for new contracts. As the industry matures, the number of programs that customers have been purchasing has generally expanded from one or two programs to a more comprehensive suite of programs, while also typically increasing the terms from three years to five years. These changes result in a more sizable contract commitment that generally requires approval from the customer’s executive management and frequently the customer’s board of directors.

Our business strategy includes developing new and additional products to complement our existing Health and Care Support services, as well as establishing additional distribution channels through which we may offer our products and services.

Our growth strategy focuses on developing new Health and Care Support programs to address chronic diseases and medical conditions as well as the overall health of all members. While we have considerable experience in Health and Care Support programs with a broad range of medical conditions, any new or modified programs will involve inherent risks of execution, such as our ability to implement our Health and Care Support programs within expected cost estimates; our ability to obtain adequate financing to provide the capital that may be necessary to support the growth of our operations; and our ability to deliver outcomes on any new products or services. In addition, as part of our business strategy, we expect to enter into

relationships, such as our strategic relationship with Medco, to establish additional distribution channels through which we may offer our products and services. As we begin to offer new products through new or alternative distribution channels, we may face difficulties, such as potential customer overlap that may lead to pricing conflicts, which may adversely affect our business.

If we do not manage our growth successfully, our growth and profitability may slow or decline.

We have expanded and expect to continue to expand our products and services as well as our overall operations, both organically and through the acquisition of businesses and technologies that complement our Health and Care Support services. This expansion has created significant demands on our administrative, operational and financial personnel and other resources. The inability to obtain and/or properly allocate sufficient resources or personnel to manage our growth may have an adverse effect on our growth and profitability.

Our inability to perform well under our contracted Health and Care Support programs could have a material adverse effect on our business and results of operations.

Our ability to continue to grow and expand our business is contingent upon our ability to continue to achieve desired savings performance under our existing contracts and to favorably resolve contract billing and interpretation issues with our customers. Unusual and unforeseen patterns of health care utilization by individuals with diabetes, cardiac, respiratory and/or other diseases or conditions for which we provide services could adversely affect our ability to achieve desired savings and clinical outcomes.

We depend on the timely receipt of accurate data from our customers and our accurate analysis of such data.

Identifying which members are eligible to receive our services and measuring our performance under our contracts are highly dependent upon the timely receipt of accurate data from our customers and our accurate analysis of such data. Data acquisition, data quality control and data analysis are complex processes that carry a risk of untimely, incomplete or inaccurate data from our customers or flawed analysis of such data, which could have a material adverse impact on our ability to recognize revenues.

Our MHS pilots and certain other customer contracts are performance-based and a portion (up to 100%) of our fees may be refundable if certain performance targets are not achieved.

Our cooperative agreements with CMS for the MHS pilots and certain other customer contracts provide that a portion of our fees (up to 100%) may be refundable to the customer if our programs do not achieve targeted savings performance. There is no guarantee that we will effect the necessary cost savings and clinical outcomes improvements under our contracts within the time frames contemplated and reach mutual agreement with customers with respect to cost savings. In addition, our ability to provide financial guidance with respect to performance-based contracts is contingent upon our ability to accurately forecast performance and the timing of revenue recognition under the terms of our contracts ahead of data collection and reconciliation.

We are currently pursuing opportunities to expand our Health and Care Support services in international markets.

We have incurred and expect to continue to incur costs in connection with pursuing business opportunities in international markets. Our success in the international markets will depend in part on our ability to anticipate the rate of market acceptance of Health and Care Support solutions and the individual market dynamics in potential international markets. The failure to accurately forecast the costs necessary to implement our strategy of establishing a presence in these markets could have an adverse effect on our business. In addition, as a result of doing business in foreign markets, we are exposed to the potential adverse effects of currency fluctuations as well as any changes in tax laws.

The anticipated benefits of the pending acquisition of Axia may not be realized.

We anticipate our pending acquisition of Axia will result in benefits including, among other things, enhanced revenues and a strong market position in providing health support for whole populations across the continuum of care. Specified conditions set forth in the Axia stock purchase agreement must be satisfied or waived to complete the acquisition, including receipt of all necessary regulatory approvals. If all of the conditions are not satisfied or waived, the acquisition either will not occur or will be delayed, and we may lose some or all of the intended benefits of the acquisition.

Achieving the anticipated benefits of the Axia acquisition is subject to a number of uncertainties, including whether we integrate Axia in an efficient and effective manner, and general competitive factors in the marketplace. Failure to achieve these anticipated benefits could result in increased costs, decreases in the amount of expected revenues, and diversion of management’s time and energy and could materially impact our business, financial condition and operating results.

We may experience difficulties associated with the integration of acquired businesses or technologies.

We may face substantial difficulties, costs and delays in effectively integrating any businesses and technologies that may be acquired as part of our overall growth strategy into our Health and Care Support platform. Integrating newly acquired organizations and technologies could be costly and time-consuming and may strain our resources. Consequently, we may not be successful in integrating these acquired businesses or technologies and may not achieve anticipated revenue and cost benefits.

We expect to incur additional leverage to finance the pending Axia acquisition.

We expect to finance the purchase price for the pending Axia acquisition with a combination of cash on hand and by incurring additional indebtedness. Our ability to secure the debt financing is contingent upon us satisfying all of the necessary conditions of our financing commitment. While we anticipate that the additional indebtedness will be on terms similar to our existing Second Amended and Restated Revolving Credit Loan Agreement, dated September 19, 2005 (the “Second Amended Credit Agreement”), the new indebtedness may impose further restrictions on us, which could limit, among other things, our ability to incur additional debt, pay dividends, repurchase shares of our common stock, make acquisitions or pursue available business opportunities. Our ability to service our indebtedness following the completion of the acquisition will depend on our ability to generate cash in the future. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available in an amount sufficient to enable us to service our indebtedness or to fund other liquidity needs.

A failure of our information systems could adversely affect our business.

Our ability to deliver Health and Care Support industry depends on effectively using information technology. We believe that our state-of-the-art electronic medical record and care enhancement center technology provides us with a competitive advantage in the industry; however, we expect to continually invest in updating and expanding technology. In some cases, we may have to make systems investments before we generate revenues from contracts with new customers. In addition, these system requirements expose us to technology obsolescence risks.

Our revenues are subject to seasonal pressure from the disenrollment processes of employer customers of our contracted health plans. In addition, some of our outcomes-driven wellness programs are contracted directly with employers and are one year in length, often beginning on January 1.

Employers typically make decisions on which health insurance carriers they will offer to their employees and also may allow employees to switch between health plans on an annual basis. These annual

membership disenrollment and re-enrollment processes of employers (whose employees are the health plan members) from health plans can result in a seasonal reduction in actual lives under management during our second fiscal quarter.

Historically, we have found that a majority of employers and employees make these decisions effective December 31 of each year. An employer’s change in health plans or employees’ changes in health plan elections may cause a decrease in our actual lives under management for existing contracts as of January 1. Although these decisions may also cause a gain in enrollees as new employers sign on with our customers, the identification of new members eligible to participate in our programs is based on the submission of health-care claims, which lags enrollment by an indeterminate period.

As a result, historically, actual lives under management for existing contracts have decreased between 6% and 8% on January 1 and have not been restored through new member identification until later in the fiscal year, thereby negatively affecting our revenues on existing contracts in our second fiscal quarter. However, the increasing demand for our Health and Care Support services from self-insured employer accounts, which generally begin their benefit year on January 1, has typically resulted in a net increase in actual lives under management on January 1.

Another seasonal impact on actual lives could occur if a health plan decided to withdraw coverage altogether for a specific line of business, such as Medicare Advantage, or in a specific geographic area, thereby automatically disenrolling previously covered members. Historically, we have experienced minimal covered life disenrollment from such decisions.

We face competition for staffing, which may increase our labor costs and reduce profitability.

We compete with other health-care and services providers in recruiting qualified management and staff personnel for the day-to-day operations of our business and care enhancement centers, including nurses and other health-care professionals. In some markets, the scarcity of nurses and other medical support personnel has become a significant operating issue to health-care businesses. This shortage may require us to enhance wages and benefits to recruit and retain qualified nurses and other health-care professionals.

Because a significant percentage of our existing contracts consist of a fixed fee per disease member, we have a limited ability to pass along increased labor costs to existing customers. A failure to recruit and retain qualified management, nurses and other health-care professionals, or to control labor costs, could have a material adverse effect on profitability.

We may face costly litigation that could force us to pay damages and/or harm our reputation.

In the course of our business, we are subject to lawsuits, which may involve large claims and significant defense costs (see Item 3, “Legal Proceedings”). Any of these claims, whether with or without merit, could result in costly litigation, and divert the time, attention, and resources of our management. Although we currently maintain liability insurance intended to cover such claims, there can be no assurance that the coverage limits of such insurance policies will be adequate or that all such claims will be covered by insurance. Although we believe that we have conducted our operations in full compliance with applicable statutory requirements and that we have meritorious defenses to outstanding claims, it is possible that resolution of these legal matters could have a material adverse effect on our consolidated results of operations in a particular financial reporting period. In addition, legal expenses associated with the defense of these matters may be material to our consolidated results of operations in a particular financial reporting period.

Compliance with new federal and state legislative and regulatory initiatives could adversely affect our results of operations or may require us to spend substantial amounts acquiring and implementing new information systems or modifying existing systems.

Our customers are subject to considerable state and federal government regulation. Many of these regulations are vaguely written and subject to differing interpretations that may, in certain cases, result in unintended consequences that could impact our ability to effectively deliver services. The current focus on regulatory and legislative efforts to protect the confidentiality and security of individually-identifiable health information, as evidenced by HIPAA, is one such example.

We believe that federal regulations governing the confidentiality of individually-identifiable health information permit us to obtain individually-identifiable health information for Health and Care Support purposes from a health plan customer; however, state legislation or regulation could preempt federal legislation if it is more restrictive. Our customers must comply with federal regulations governing the security of electronic individually-identifiable health information. As discussed below, we are contractually required to comply with certain aspects of these confidentiality and security regulations.

Although we continually monitor the extent to which specific state legislation or regulations may govern our operations, new federal or state legislation or regulation in this area that restricts our ability to obtain and handle individually-identifiable health information would have a material negative impact on our operations.

Government regulators may interpret current regulations governing our operations in a manner that negatively impacts our ability to provide services.

Broadly written Medicare fraud and abuse laws and regulations that are subject to varying interpretations may expose us to potential civil and criminal litigation regarding the structure of current and past contracts entered into with our customers, such as the civil lawsuit filed against us in 1994 as discussed under Item 3, “Legal Proceedings.” We believe that our operations have not violated and do not violate the provisions of the fraud and abuse statutes and regulations; however, private individuals acting on behalf of the United States government, or government enforcement agencies themselves, could pursue a claim against us under a new or differing interpretation of these statutes and regulations.

In addition, expanding the Health and Care Support industry to Medicare fee-for-service beneficiaries in the MHS pilots awarded under the Medicare Modernization Act of 2003 and to Medicare beneficiaries enrolled in Medicare Advantage plans could lead to increased direct regulation of Health and Care Support services. Further, our participation in the MHS program and providing services to Medicare Advantage beneficiaries may result in our being subject directly to various federal laws and regulations, including provisions related to fraud and abuse, false claims and billing and reimbursement for services, and the False Claims Act.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

Our corporate offices located in the Nashville, Tennessee area contain approximately 150,000 square feet of office space, which we lease pursuant to agreements that expire from August 2007 to May 2009. Our support and training offices for StatusOne Health Systems, LLC (“StatusOne”) located in San Diego, California, Aliso Viejo, California, and Westborough, Massachusetts, contain approximately 23,000 square feet of space in aggregate and have terms ranging from two to five years. In May 2006, we entered into an office lease agreement for our new corporate headquarters to be located near Nashville, Tennessee, containing approximately 255,000 square feet of rentable area, which we expect to occupy by March 1, 2008.

As of August 31, 2006, we also leased office space for our ten care enhancement center locations in Phoenix, Arizona; Franklin, Tennessee; Pittsburgh, Pennsylvania; Kapolei, Hawaii; Eagan, Minnesota; St. Louis, Missouri; Columbia, Maryland (two locations); Bellevue, Washington; and Raleigh, North Carolina for an aggregate of approximately 253,000 square feet of space with initial terms of approximately five to eleven years.

Item 3. Legal Proceedings

In June 1994, a former employee whom we dismissed in February 1994 filed a “whistle blower” action on behalf of the United States government. Subsequent to its review of this case, the federal government determined not to intervene in the litigation. The employee sued Healthways, Inc. and our wholly-owned subsidiary, 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.

Healthways, Inc. has since been dismissed as a defendant; however, the case is still pending against AHSI before the United States District Court for the District of Columbia. In addition, WPMC has settled claims filed against it as part of a larger settlement agreement that WPMC’s parent organization, HCA Inc., 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. In February 2006, WPMC filed an arbitration claim seeking indemnification from us for certain costs and expenses incurred by it in connection with the case.

In the action by the former employee, discovery is substantially complete but no trial date has been set. The parties have had initial discussions regarding their respective positions in the case; however, no resolution of this case has been reached or can be assured prior to the case proceeding to trial. In the action by WPMC, initial arbitration proceedings were commenced during the third quarter of fiscal 2006.

We believe that we have conducted our operations in full compliance with applicable statutory requirements and that we have meritorious defenses to the claims made in the case and the related arbitration proceeding, and intend to contest the claims vigorously. Nevertheless, it is possible that resolution of these legal matters could have a material adverse effect on our consolidated results of operations in a particular financial reporting period. We believe that we will continue to incur legal expenses associated with the defense of these matters which may be material to our consolidated results of operations in a particular financial reporting period. However, we believe that any resolution of this case and all related matters will not have a material effect on our liquidity or financial condition.

We are also subject to other claims and suits that arise from time to time in the ordinary course of our business. While management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact on our financial position, our results of operations, or our cash flows, these matters are subject to inherent uncertainties, and management’s view of these matters may change in the future.

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

Not applicable.

Executive Officers of the Registrant

The following table sets forth certain information regarding our executive officers as of August 31, 2006. Executive officers of the Company serve at the pleasure of the Board of Directors.

Officer	Age	Position

Thomas G. Cigarran	64	Chairman of the Company since September 1988, a director since 1981, President September 1981 until June 2001, Chief Executive Officer September 1988 until September 2003. Chairman of AmSurg Corp.

Ben R. Leedle, Jr.	45	Chief Executive Officer and director of the Company since September 2003, President since May 2002, Executive Vice President and Chief Operating Officer of the Health Plan Group from 2000 until May 2002. Senior Vice President from 1996 until 2000.

Mary A. Chaput	56	Executive Vice President, Chief Financial Officer and Secretary of the Company since October 2001. Co-founder and Chief Financial Officer of Paragon Ventures Group, Inc. from November 1998 until October 2001. Ms. Chaput is the spouse of the Company’s Executive Vice President and Chief Information Officer, Robert L. Chaput.

Robert L. Chaput	56	Executive Vice President and Chief Information Officer of the Company since December 2005. Founder and CEO of American Technology Group from July 2002 to December 2005. Co-founder and Chief Executive Officer of Paragon Ventures Group, Inc. from November 1998 until July 2002. Mr. Chaput is the spouse of the Company’s Executive Vice President and Chief Financial Officer, Mary A. Chaput.

Mary D. Hunter	61	Executive Vice President of the Company since 2001. Chief Operating Officer of the Hospital Group from 2001 until July 2003. Senior Vice President from 1994 until 2001.

Matthew E. Kelliher	51	Executive Vice President, International Business, of the Company since September 2004. Executive Vice President since September 2003. President of StatusOne from November 1997 until September 2003.

Alfred Lumsdaine	41	Senior Vice President of the Company since February 2003. Controller and Chief Accounting Officer from February 2002 to present. Treasurer and Corporate Controller of LOGISCO, Inc. from 2000 to 2001.

James E. Pope	53	Executive Vice President and Chief Operating Officer of the Company since May 2006. Executive Vice President and Chief Medical Officer of the Company from October 2003 until May 2006. Member of Medical Advisory Committee since February 1999.


Robert E. Stone	60	Executive Vice President and Chief Strategy Officer of the Company since 2005. Executive Vice President from 1999 to 2005. Senior Vice President from 1981 until 1999. President of Disease Management Association of America from October 2002 to October 2003.

Donald B. Taylor	48	Executive Vice President Alliances of the Company since May 2006. Chief Operating Officer of the Company from December 2003 until May 2006. Executive Vice President since February 2002. President of FISI Madison Financial and Benefit Consultants, Inc. (a subsidiary of Cendant Corporation) from September 1997 until June 2001. Consultant and Advisory Board Member of Brentwood Capital Advisors from July 2001 to present.

PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(a) Market Information

Our common stock is traded over-the-counter on The NASDAQ Stock Market (“NASDAQ”) under the symbol HWAY.

The following table sets forth the high and low sales prices per share of common stock as reported by NASDAQ for the relevant periods.

	High		Low


Year ended August 31, 2006
First quarter	$	46.77	$	36.99
Second quarter		48.39		42.28
Third quarter		54.63		39.26
Fourth quarter		54.98		46.08

Year ended August 31, 2005
First quarter	$	34.42	$	25.70
Second quarter		35.50		29.56
Third quarter		41.94		29.79
Fourth quarter		45.65		38.01

We did not repurchase any shares of our Common Stock during the quarter ended August 31, 2006.

(b) Holders

At November 6, 2006, there were approximately 39,200 holders of our Common Stock, including 150 stockholders of record.

We have never declared or paid a cash dividend on our Common Stock. We intend to retain our earnings to finance the growth and development of our business and do not expect to declare or pay any cash dividends in the foreseeable future. The Board of Directors will review our dividend policy from time to time and may declare dividends at its discretion. Our Second Amended and Restated Revolving Credit Loan Agreement, dated September 19, 2005 (the “Second Amended Credit Agreement”), restricts the payment of dividends. For further discussion of the Second Amended Credit Agreement, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources”.

Item 6. Selected Financial Data

Year ended and at August 31,	2006 (4) (5)		2005 (4)		2004 (4)		(2003)		(2002)


	(In thousands, except per share data)

Operating Results: (1)
Revenues	$	412,308	$	312,504	$	245,410	$	165,471	$	122,762
Cost of services		281,161		205,253		156,462		106,130		84,845

Gross margin		131,147		107,251		88,948		59,341		37,917

Selling, general and administrative expenses		44,417		28,418		23,686		16,511		12,726
Depreciation and amortization		24,517		22,408		18,450		10,950		7,271
Interest		1,053		1,630		3,509		569		370

		69,987		52,456		45,645		28,030		20,367


Income before income taxes		61,160		54,795		43,303		31,311		17,550
Income tax expense		24,009		21,711		17,245		12,837		7,195

Net income	$	37,151	$	33,084	$	26,058	$	18,474	$	10,355


Basic income per share: (2)	$	1.08	$	1.00	$	0.81	$	0.60	$	0.35


Diluted income per share: (2)	$	1.02	$	0.93	$	0.75	$	0.56	$	0.32


Weighted average common shares and
equivalents: (2)
Basic		34,348		33,241		32,264		31,048		29,945
Diluted		36,379		35,691		34,632		33,010		32,188

Balance Sheet Data: (1)
Cash and cash equivalents	$	154,792	$	63,467	$	45,147	$	35,956	$	23,924
Working capital		124,469		70,644		55,462		47,047		24,295
Total assets		382,386		270,954		253,449		140,013		118,017
Long-term debt		236		416		36,562		109		514
Other long-term liabilities		10,853		9,055		7,694		4,662		3,568
Stockholders’ equity		274,873		206,930		155,435		112,431		88,809

Other Operating Data:
Actual lives under management (3)		2,426		1,883		1,335		852		579
Annualized revenue in backlog	$	6,625	$	32,578	$	15,200	$	12,200	$	27,600

(1)	Certain items in prior periods have been reclassified to conform to current classifications.

(2)	Restated to reflect the effect of the December 2003 two-for-one stock split.

(3)	Restated to include the Company’s hospital-based diabetes patients.

(4)	Includes operating results, balance sheet data, and other operating data of StatusOne since the date of the acquisition, which was September 5, 2003.

(5)

Includes $15.3 million of costs related to equity-based awards expensed under Statement of Financial Accounting Standards (“SFAS”) No. 123(R) and cash-based awards issued in lieu of equity-based awards that were historically granted to certain levels of management. These cash-based awards are a result of changes in the design of the Company’s long-term incentive compensation program in preparation for adopting SFAS No. 123(R) on September 1, 2005.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

Overview

Founded in 1981, Healthways, Inc. (formerly American Healthways, Inc.) (the “Company”) provides specialized, comprehensive Health and Care Support^SMprograms and services, including disease management, high-risk care management, and Outcomes Driven Wellness^SM programs to health plans, governments, employers, and hospitals in all 50 states, the District of Columbia, Puerto Rico, and Guam. These services include, but are not limited to:

•

providing members with educational materials and personal interactions with highly trained nurses and other health-care professionals designed to create and sustain healthier behaviors;

•

incorporating current evidence-based clinical guidelines in interventions to optimize patient care;

•

developing care support plans and motivating members to set attainable goals for themselves;

•

providing local market resources to address acute episode interventions;

•

coordinating members’ care with local health-care providers; and

•

fostering wellness and prevention through total population screening, health risk assessments, and supportive interventions.

Our integrated Health and Care Support programs serve entire customer populations through member and physician Health and Care Support interventions, advanced neural network predictive modeling, and a confidential, secure Internet-based application that provides patients and physicians with individualized health information. Our programs enable our customers to develop relationships with all of their members and to identify those at highest risk for a health problem, allowing for early interventions.

population approach, in which all members of the customer’s population receive the benefit of our programs at a single cost.

In October 2006, we entered into a stock purchase agreement with Axia Health Management, Inc. (“Axia”), a national provider of preventive health and wellness programs, to purchase all of Axia’s outstanding shares of capital stock for approximately $450 million, subject to adjustment for Axia’s indebtedness, working capital, and cash balance at closing. Of the purchase price, $35 million will be held in escrow until December 31, 2007 to satisfy any potential indemnification claims. An additional $9 million of the purchase price will be held in escrow to satisfy a portion of certain potential earnout obligations. We expect the acquisition to close during December 2006, subject to satisfaction of the closing conditions in the stock purchase agreement, including receipt of required regulatory approvals. We currently anticipate that the acquisition will be financed through a combination of cash on hand and committed bank debt.

We have seen increasing demand for our Health and Care Support services from self-insured employer accounts, most of which are contracted through the Administrative Services Only (ASO) line of business with our health plan customers and for which our health plan customers do not assume medical cost risk but provide primarily administrative claim and health network access services. Signed contracts between these self-insured employers and our health plan customers are incorporated in our contracts with our health plan customers, and these program-eligible members are included in actual lives under management or annualized revenue in backlog, as appropriate.

Highlights of Fiscal 2006 Performance

•

Revenues increased 31.9% over fiscal 2005.

•

Net income for fiscal 2006, which included $15.3 million of costs related to share-based compensation expensed under SFAS No. 123(R) as well as cash-based awards issued in lieu of share-based compensation that was historically granted to certain levels of management, increased 12.3% over fiscal 2005, which included share-based compensation costs of $0.5 million.

•

Actual lives under management increased 28.8% from the end of fiscal 2005 to the end of fiscal 2006, which included a 48.8% increase in self-insured employer actual lives under management to 954,000 at the end of fiscal 2006 from 641,000 at the end of fiscal 2005.

Forward-Looking Statements

Management’s Discussion and Analysis of Financial Condition and Results of Operation contains forward-looking statements, which are based upon current expectations and involve a number of risks and uncertainties. Forward-looking statements include all statements that do not relate solely to historical or current facts, and can be identified by the use of words like “may,” “believe,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan,” or “continue.” In order for us to use the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we caution you that the following important factors, among others, may affect these forward-looking statements. Consequently, actual operations and results may differ materially from those expressed in the forward-looking statements. The important factors include but are not limited to:

•

our ability to sign and implement new contracts for Health and Care Support services;

•

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

•

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

•

our ability to anticipate the rate of market acceptance of Health and Care Support solutions and the individual market dynamics in potential international markets and our ability to accurately forecast the costs necessary to implement our strategy of establishing a presence in these markets;

•

our ability to effectively manage any growth that we might experience;

•

our ability to retain existing health plan customers if they decide to take programs in-house or are acquired by other health plans which already have or are not interested in Health and Care Support programs;

•

the risks associated with a significant concentration of our revenues with a limited number of customers;

•

our ability to effect cost savings and clinical outcomes improvements under Health and Care Support 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 us;

•

our ability to collect contractually earned performance incentive bonuses;

•

the ability of our customers to provide timely and accurate data that is essential to the operation and measurement of our performance under the terms of our contracts;

•

our ability to favorably resolve contract billing and interpretation issues with our customers;

•

our ability to satisfy the closing conditions in the Axia stock purchase agreement, including receipt of required regulatory approvals, and to satisfy the conditions of our financing commitment;

•

increased leverage expected to be incurred in conjunction with the anticipated acquisition of Axia;

•

our ability to integrate the operations of Axia and other acquired businesses or technologies into our business and to achieve the results provided in our guidance with respect to Axia;

•

our ability to develop new products and deliver outcomes on those products, including those anticipated from our strategic relationship with Medco, Inc.;

•

our ability to effectively integrate new technologies and approaches, such as those encompassed in our Health and Care Support initiatives or otherwise licensed or acquired by us, into our Health and Care Support platform;

•

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

•

our ability to implement our Health and Care Support strategy within expected cost estimates;

•

our ability to obtain adequate financing to provide the capital that may be necessary to support the growth of our operations and to support or guarantee our performance under new contracts;

•

unusual and unforeseen patterns of health care utilization by individuals with diabetes, cardiac, respiratory and/or other diseases or conditions for which we provide services;

•

the ability of our customers to maintain the number of covered lives enrolled in the plans during the terms of our agreements;

•

our ability to attract and/or retain and effectively manage the employees required to implement our agreements;

•

the impact of litigation involving us and/or our subsidiaries;

•

the impact of future state and federal health care and other applicable legislation and regulations on our ability to deliver our services and on the financial health of our customers and their willingness to purchase our 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 this Annual Report on Form 10-K, including those risk factors set forth in Item 1A of Part I.

We undertake no obligation to update or revise any such forward-looking statements.

Critical Accounting Policies

We describe our accounting policies in Note 1 of the Notes to the Consolidated Financial Statements. We prepare the consolidated financial statements in conformity with U.S. generally accepted accounting principles, which require us 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.

We believe the following accounting policies are the most critical in understanding the estimates and judgments that are involved in preparing our financial statements and the uncertainties that could impact our results of operations, financial condition and cash flows.

Revenue Recognition

We generally determine our contract fees by multiplying a contractually negotiated rate per member per month (“PMPM”) by the number of members covered by our services during the month. We set the PMPM rates during contract negotiations with customers based on the value we expect our programs to create and a sharing of that value between the customer and the Company. In some contracts, the PMPM rates may differ between a customer’s lines of business (e.g., PPO, HMO, Medicare Advantage). Contracts with health plans generally range from three to seven years with provisions for subsequent renewal; contracts between our health plan customers and their self-insured employer accounts typically have one-year terms.

We bill our 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, that is performance-based and may be subject to refund should we not meet performance targets. Contractually, we cannot bill for any incentive bonus until after contract settlement.

We recognize revenue as follows: 1) we recognize the fixed portion of the monthly fees as revenue during the period we perform our services; 2) we recognize the performance-based portion of the monthly fees based on the most recent assessment of our performance, which represents the amount that the customer would legally be obligated to pay if the contract were terminated as of the latest balance sheet date; and 3) we recognize additional incentive bonuses based on the most recent assessment of our performance, to the extent we consider such amounts collectible.

We assess our level of performance for our contracts based on medical claims and other data that the customer is contractually required to supply. A minimum of four to six months’ data is typically required for us to measure performance. In assessing our performance, we may include estimates such as medical claims incurred but not reported and a medical cost trend compared to a baseline year. In addition, we may also provide contractual reserves, when appropriate, for billing adjustments at contract reconciliation.

Substantially all of the fees under both the MHS pilots and the refresh population in which we are participating are performance-based. The pilots require that, by the end of the third year, we achieve a cumulative net savings (total savings for the intervention population as compared to the control group less fees received from CMS) of five percent. The cumulative net savings targets are lower at the beginning of the pilots and increase in gradual increments, ending with a cumulative net savings target of five percent at the end of the pilots. Under the amendment of our stand-alone MHS pilot in Maryland and the District of Columbia, the refresh population will be a separate cohort served for two years, by the end of which the program is expected to achieve a 2.5% cumulative net savings when compared to a new control cohort. Under the stand-alone pilot, savings in excess of target achieved in either the original cohort or the refresh cohort can be applied against any savings deficit that might occur in the other cohort. Although we receive the medical claims and other data associated with the intervention group under these pilots on a monthly basis, we assess our performance against the control group under these pilots based on quarterly performance reports received from CMS’ financial reconciliation contractor.

If data is insufficient or incomplete to measure performance, or interim performance measures indicate that we are not meeting performance targets, we do not recognize performance-based fees subject to refund as revenues but instead record them in a current liability account “contract billings in excess of earned revenue.” Only in the event we do not meet performance levels by the end of the measurement period, typically one year, are we contractually obligated to refund some or all of the performance-based fees. We would only reverse revenues that we had already recognized if performance to date in the measurement period, previously above targeted levels, subsequently dropped below targeted levels. Historically, any such adjustments have been immaterial to our financial condition and results of operations.

During the settlement process under a contract, which generally occurs six to eight months after the end of a contract year, we settle any performance-based fees and reconcile health-care claims and clinical data. As of August 31, 2006, performance-based fees that have not yet been settled with our customers but that have been recognized as revenue in the current and prior years, including performance-based fees recognized as revenue under the MHS pilots, which will not be settled with the customer until the end of the pilots, totaled approximately $54.3 million. Of this amount, $19.9 million was based on calculations which include estimates such as medical claims incurred but not reported and/or the customer’s medical cost trend compared to a baseline year, while $34.4 million was based entirely on actual data received from our customers. Data reconciliation differences, for which we provide contractual allowances until we reach agreement with respect to identified issues, can arise between the customer and us due to customer data deficiencies, omissions, and/or data discrepancies.

fiscal year. During fiscal 2006, we recognized a net increase in revenue of $1.6 million that related to services provided prior to fiscal 2006.

Impairment of Intangible Assets and Goodwill

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

If we determine that the carrying value of goodwill is impaired based upon an impairment review, we calculate any impairment using a fair-value-based goodwill impairment test as required by 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. We estimate fair value 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.

We amortize other identifiable intangible assets, such as acquired technologies and customer contracts, 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. We review intangible assets not subject to amortization on an annual basis or more frequently whenever events or circumstances indicate that the assets might be impaired. We assess the potential impairment of intangible assets subject to amortization whenever events or changes in circumstances indicate that the carrying values may not be recoverable.

If we determine that the carrying value of other identifiable intangible assets may not be recoverable, we calculate any impairment 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 us to conclude that impairment indicators exist and that goodwill and/or other intangible assets associated with our acquired businesses are impaired. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

Share-Based Compensation

On September 1, 2005, we adopted SFAS No. 123(R), “Share-Based Payment,” which requires us to measure and recognize compensation expense for all share-based payment awards based on estimated fair values at the date of grant. Determining the fair value of share-based awards at the grant date requires judgment in developing assumptions, which involve a number of variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, and expected stock option exercise behavior. In addition, we also use judgment in estimating the number of share-based awards that are expected to be forfeited. We contract with a third party to assist in developing the assumptions used in estimating the fair values of stock options.

Business Strategy

savings by addressing care and treatment requirements for these additional selected diseases and conditions, which will enable us to address an increasingly larger percentage of a customer’s population and total health-care costs. As discussed above, in October 2006, we entered into a stock purchase agreement to acquire Axia, a national provider of preventive health and wellness programs, which we expect to close during December 2006.

In May 2006 we entered into a strategic partnership with Medco, Inc., a leading pharmacy benefit management company, to distribute existing programs and to develop integrated medical and pharmaceutical management programs. We expect to continue developing proprietary, proactive health support products and services for whole populations across the continuum of care, including next generation integrated disease management and wellness solutions.

Results of Operations

The following table shows the components of the statements of operations for the fiscal years ended August 31, 2006, 2005 and 2004 expressed as a percentage of revenues.

	Year ended August 31,

	2006			2005			2004

Revenues		100.0	%		100.0	%		100.0	%

Cost of services		68.2	%		65.7	%		63.8	%

Gross margin		31.8	%		34.3	%		36.2	%

Selling, general and administrative expenses		10.8	%		9.1	%		9.7	%
Depreciation and amortization		5.9	%		7.2	%		7.5	%
Interest expense		0.3	%		0.5	%		1.4	%


Income before income taxes		14.8	%		17.5	%		17.6	%
Income tax expense		5.8	%		6.9	%		7.0	%


Net income		9.0	%		10.6	%		10.6	%

Revenues

Revenues for fiscal 2006 and fiscal 2005 increased 31.9% and 27.3%, respectively, over the prior fiscal years. Fiscal 2006 revenues increased over fiscal 2005 revenues primarily due to the following:

•

existing customers adding or expanding 25 programs since the beginning of fiscal 2005;

•

an increase in self-insured employer actual lives under management from 641,000 at August 31, 2005 to 954,000 at August 31, 2006;

•

the commencement of 9 new contracts since the beginning of fiscal 2005;

•

increased membership in customers’ existing programs; and

•

increased revenues from the MHS pilots of $11.0 million during fiscal 2006 compared to fiscal 2005.

Fiscal 2005 revenues increased over fiscal 2004 revenues primarily due to the following:

•

an increase in self-insured employer actual lives under management from 361,000 at August 31, 2004 to 641,000 at August 31, 2005;

•

existing customers adding or expanding 29 programs since the beginning of fiscal 2004;

•

the commencement of 10 new contracts since the beginning of fiscal 2004; and

•

increased membership in customers’ existing programs.

We anticipate that fiscal 2007 revenues will increase over fiscal 2006 revenues primarily due to the expansion of existing contracts, increasing demand for our Health and Care Support services from self-insured employers who contract with our health plan customers or with Medco, anticipated new health plan contracts, increased revenues from MHS pilots, and the pending acquisition of Axia,.

Cost of Services

Cost of services as a percentage of revenues increased to 68.2% for fiscal 2006 compared to 65.7% for fiscal 2005. This increase is primarily related to the following:

•

revenues and costs related to the two MHS pilots, which began in August and September of 2005, respectively. A significant portion of the performance-based fees under these three-year pilots has not yet been recognized as revenue because the contracts are in their early stages and we have not yet achieved 100% of the cumulative net savings target. During fiscal 2006, we recorded revenues of $11.2 million and costs of $21.3 million attributable to the MHS pilots compared to $0.2 million of revenues and $4.8 million of costs during fiscal 2005; and

•

long-term incentive compensation costs of $7.5 million incurred during fiscal 2006, including share-based compensation expensed under SFAS No. 123(R) and cash-based awards issued in lieu of share-based awards that were historically granted to certain levels of management, compared to no share-based compensation costs during fiscal 2005.

Excluding the revenues and costs associated with the MHS pilots and the long-term incentive compensation costs noted above, cost of services as a percentage of revenues decreased to 62.9% from 64.2% for fiscal 2006 and 2005, respectively, primarily due to increased capacity utilization, economies of scale, and productivity enhancements during fiscal 2006 compared to fiscal 2005.

Cost of services as a percentage of revenues increased to 65.7% for fiscal 2005 compared to 63.8% for fiscal 2004. Excluding contract performance incentive bonus revenues, which totaled $2.5 million for fiscal 2004 compared to $0.2 million for fiscal 2005, cost of services as a percentage of revenues increased to 65.7% from 64.4% for fiscal 2005 and 2004, respectively, primarily as a result of the following:

•

an increase in accrued employee bonuses; and

•

increased expenses related to securing and preparing for MHS pilots during fiscal 2005 compared to fiscal 2004.

These increases were partially offset by decreases attributable to initial operating costs in fiscal 2004 related to the opening of two new care enhancement centers in January 2004 and March 2004 and increased capacity utilization, economies of scale, and productivity enhancements during fiscal 2005 compared to fiscal 2004.

We anticipate that fiscal 2007 cost of services will increase over fiscal 2006 primarily as a result of increases in operating staff required for expected increases in demand for our services, increases in indirect staff costs associated with the continuing development and implementation of our Health and Care Support

services, increases in information technology and other support staff and costs, and the incremental cost of services attributable to Axia,.

Selling, General and Administrative Expenses

Selling, general and administrative expenses as a percentage of revenues increased to 10.8% for fiscal 2006 compared to 9.1% for fiscal 2005, primarily related to the following costs:

•

costs attributable to pursuing opportunities in international markets, which totaled $3.2 million and $0.7 million for fiscal 2006 and 2005, respectively; and

•

long-term incentive compensation costs of $7.8 million during fiscal 2006, which consisted of share-based compensation expensed under SFAS No. 123(R) and cash-based awards issued in lieu of share-based awards that were historically granted to certain levels of management, compared to $0.5 million of share-based compensation costs during fiscal 2005.

Excluding the costs above, selling, general and administrative expenses as a percentage of revenues decreased to 8.1% for fiscal 2006 compared to 8.7% for fiscal 2005, primarily due to our ability to more effectively leverage our selling, general and administrative expenses as a result of growth in our operations.

Selling, general and administrative expenses as a percentage of revenues decreased to 9.1% for fiscal 2005 compared to 9.7% for fiscal 2004, primarily due to our ability to more effectively leverage our selling, general and administrative expenses as a result of growth in our operations. These decreases were partially offset by an increase in accrued employee bonuses and increased expenses related to securing and preparing for MHS pilots during fiscal 2005 compared to fiscal 2004.

We anticipate that selling, general and administrative expenses for fiscal 2007 will increase over fiscal 2006 primarily due to anticipated investments in international initiatives, increases in selling and general administrative costs in support of our existing and anticipated new and expanded contracts, incremental selling, general and administrative costs attributable to Axia, and costs related to the integration of Axia.

Depreciation and Amortization

Depreciation and amortization expense for fiscal 2006 increased 9.4% compared to fiscal 2005 and 21.5% for fiscal 2005 compared to fiscal 2004, primarily due to increased depreciation expense associated with capital expenditures to enhance our information technology capabilities and expand our corporate office and calling capacity at existing care enhancement centers.

We anticipate that depreciation and amortization expense for fiscal 2007 will increase over fiscal 2006 primarily as a result of 1) anticipated amortization expense associated with the estimated identifiable intangible assets expected to be recorded upon completion of the Axia acquisition, and 2) additional capital expenditures associated with expected increases in demand for our services and growth and improvement in our information technology capabilities.

Interest Expense

Interest expense for fiscal 2006 decreased 35.4% compared to fiscal 2005 primarily because we had no bank debt outstanding during fiscal 2006.

Interest expense for fiscal 2005 decreased 53.5% compared to fiscal 2004 primarily due to a reduction in our long-term debt balance resulting from net repayments of $48.0 million of revolving debt during fiscal 2005, as well as lower interest rates under the First Amended and Restated Revolving Credit Loan Agreement dated October 29, 2004 (“the First Amended Credit Agreement”) compared to the Revolving Credit and Term

Loan Agreement dated September 5, 2003 (the “Former Credit Agreement”) (described more fully in “Liquidity and Capital Resources” below).

We anticipate that interest expense for fiscal 2007 will increase over fiscal 2006 primarily as a result of anticipated financing costs attributable to borrowings expected to be incurred in conjunction with the Axia acquisition.

Income Tax Expense

Our effective tax rate decreased to 39.3% for fiscal 2006 compared to 39.6% and 39.8% for fiscal 2005 and 2004, respectively, primarily as a result of changes in our geographic mix of earnings, which impacts our average state income tax rate, and other factors. The differences between the statutory federal income tax rate of 35.0% and our effective tax rate are due primarily to the impact of state income taxes and certain non-deductible expenses for income tax purposes. We anticipate that our effective tax rate for fiscal 2007 will increase over fiscal 2006 primarily as a result of an expected increase in costs related to international initiatives in fiscal 2007.

Liquidity and Capital Resources

Cash and cash equivalents increased $91.3 million during fiscal 2006 to $154.8 million at August 31, 2006 from $63.5 million at August 31, 2005. The increase was primarily due to cash flow from operations and the exercise of stock options, partially offset by capital expenditures.

Operating activities for fiscal 2006 generated cash of $99.8 million compared to $75.2 million for fiscal 2005. The increase in operating cash flow of $24.6 million resulted primarily from 1) an increase in cash collections recorded to contract billings in excess of earned revenue for fiscal 2006 compared to fiscal 2005, primarily related to the MHS pilots; and 2) payments during fiscal 2005 related to accounts payable accrued at August 31, 2004 associated with capital expenditures for upgrades to hardware in support of core business functions. These increases to cash were partially offset by 1) an increase in accounts receivable primarily resulting from increased revenues due to growth in our business; 2) a higher employee bonus payment during fiscal 2006 compared to fiscal 2005; and 3) the reclassification of the tax benefit of stock option exercises from operating cash flows during fiscal 2005 to financing cash flows during fiscal 2006, as required by SFAS No. 123(R).

Investing activities during fiscal 2006 used $27.5 million in cash which consisted almost entirely of investments in property and equipment, primarily associated with the addition of information technology hardware and software, the opening of a new care enhancement center, and expansions at existing care enhancement centers.

Financing activities for fiscal 2006 provided $19.0 million in cash primarily due to proceeds from the exercise of stock options and the related tax benefit. In addition, we received from escrow $3.8 million that was previously classified as restricted cash due to contractual requirements with a customer and was reclassified to cash and cash equivalents as our first-year results were validated with the customer.

On September 19, 2005, we amended and restated the First Amended Credit Agreement and entered into the Second Amended Credit Agreement, which provides us with a $250.0 million revolving credit facility, including a swingline sub facility of $10.0 million and a $75.0 million sub facility for letters of credit, together with an uncommitted incremental accordion facility of $50.0 million, and expires on September 19, 2010. As of August 31, 2006, our available line of credit totaled $249.3 million.

at our option, at LIBOR plus a spread of 0.875% to 1.5%, which is dependent on the ratio of total funded debt to EBITDA, or at the prime rate. The Second Amended Credit Agreement also provides for a fee ranging between 0.175% and 0.3% of unused commitments. The Second Amended Credit Agreement is secured by guarantees from our active domestic subsidiaries and by security interests in substantially all of our and our subsidiaries’ assets.

The First Amended Credit Agreement provided us with up to $150.0 million in borrowing capacity and contained various financial covenants, which required us to maintain, as defined, ratios or levels of (i) total funded debt to EBITDA, (ii) interest coverage, (iii) fixed charge coverage, and (iv) net worth. The Second Amended Credit Agreement contains similar financial covenants with the exclusion of the interest coverage ratio. Both agreements restrict the payment of dividends and limit the amount of repurchases of the Company’s common stock. As of August 31, 2006, we were in compliance with all of the covenant requirements of the Second Amended Credit Agreement.

As of August 31, 2006, there were letters of credit outstanding under the Second Amended Credit Agreement totaling $0.7 million primarily to support our requirement to repay fees under one health plan contract in the event we do not perform at established target levels and do not repay the fees due in accordance with the terms of the contract.

We believe that cash flow from operating activities, our available cash, and our expected available credit under committed bank debt will continue to enable us to meet our contractual obligations and to fund the current level of growth in our operations for the foreseeable future. However, if expanding our operations requires significant additional financing resources, such as capital expenditures for technology improvements, additional care enhancement centers and/or letters of credit or other forms of financial assurance to guarantee our performance under the terms of new contracts, or if we are required to refund performance-based fees pursuant to contract terms, we may need to raise additional capital by expanding our existing credit facility and/or issuing debt or equity. If we face a limited ability to arrange such financing, it may restrict our ability to expand our operations.

As discussed above, in October 2006, we entered into a stock purchase agreement to acquire Axia. We currently anticipate that the acquisition will be financed through a combination of cash on hand and committed bank debt. In connection with the acquisition, we entered into a commitment letter with respect to credit facilities under which we may borrow up to $600.0 million, including a revolving credit facility of up to $400.0 million and a term loan facility of $200.0 million, consisting of a term loan B. Pursuant to the commitment letter, our ability to borrow under the credit facilities is subject to various conditions that are customary for a transaction of this type.

If contract development accelerates or acquisition opportunities arise that would expand our operations, we may need to issue additional debt or equity to provide the funding for these increased growth opportunities. We may also issue equity in connection with future acquisitions or strategic alliances. We cannot assure you that we would be able to issue additional debt or equity on terms that would be acceptable to us.

Contractual Obligations

The following schedule summarizes our contractual cash obligations by the indicated period as of August 31, 2006:

	Payments Due By Year Ended August 31,

(In $000s)	2007		2008 - 2009		2010 - 2011		2012 and After		Total

Capital lease obligations	$	214	$	251	$	—	$	—	$	465
Deferred compensation
plan payments		1,442		2,175		550		3,971		8,138
Operating lease obligations (1)		8,054		17,795		18,889		72,005		116,743
Other contractual cash obligations (2)		2,400		4,075		1,500		—		7,975

Total Contractual Cash
Obligations	$	12,110	$	24,296	$	20,939	$	75,976	$	133,321

(1) In May 2006, we entered into an office lease agreement for our new corporate headquarters containing approximately 255,000 square feet of rentable area. The term of the lease is 15 years and will commence on the date that the premises are ready for occupancy, which is expected to be before March 1, 2008. The base rent for the initial 15-year term will be based on the actual construction costs of the building and is expected to range from $16.38 per square foot to $24.88 per square foot over the term.

(2) Other commitments represent cash payments in connection with our strategic alliance agreements and exclude certain variable costs related to one strategic alliance that are based on the number of future eligible members.

Recently Issued Accounting Standards

Accounting for Uncertainty in Income Taxes

In June 2006 the FASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.” FIN No. 48 creates a single model to address uncertainty in income tax positions by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. It is effective for fiscal years beginning after December 15, 2006. We do not yet know the impact that the adoption of FIN No. 48 will have on our financial position or results of operations.

Fair Value Measurement

In September 2006 the FASB issued SFAS No. 157, “Fair Value Measurement,” which provides guidance for using fair value to measure assets and liabilities, including a fair value hierarchy that prioritizes the information used to develop fair value assumptions. It also requires expanded disclosure about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value and does not expand the use of fair value in any new circumstances.

SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not expect the adoption of SFAS No. 157 to have a material impact on our financial position or results of operations.

Effect of Prior Year Misstatements on Current Year Misstatements

In September 2006 the Securities and Exchange Commission staff published Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which requires that companies quantify errors under both the “rollover” and “iron curtain” methods and evaluate the misstatement of the current year financial statements calculated under each approach. The rollover method quantifies a misstatement based on the effects of correcting the misstatement existing in the current period income statement, while the iron curtain method quantifies a misstatement based on the effects of correcting the misstatement existing in the balance sheet at the end of the current period, regardless of the misstatement’s period(s) of origin. After considering all relevant quantitative and qualitative factors, if either approach results in a misstatement that is material, a company must adjust its financial statements.

SAB No. 108 is effective for fiscal years ending after November 15, 2006. We do not expect the adoption of SAB No. 108 to have a material impact on our financial position or results of operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risk related to interest rate changes, primarily as a result of the Second Amended Credit Agreement, the First Amended Credit Agreement, and the Former Credit Agreement, which bear interest based on floating rates. Borrowings under the First Amended Credit Agreement bore interest, at our option, at the prime rate plus a spread of 0.0% to 1.0% or LIBOR plus a spread of 1.25% to 2.25%, which was dependent on the ratio of total funded debt to EBITDA, or a combination thereof. Borrowings under the Second Amended Credit Agreement generally bear interest, at our option, at LIBOR plus a spread of 0.875% to 1.5%, which is dependent on the ratio of total funded debt to EBITDA, or at the prime rate. As of August 31, 2006, we do not execute transactions or hold derivative financial instruments for trading purposes.

Because there was no variable rate debt outstanding during fiscal 2006, a one-point interest rate change would not have caused interest expense to fluctuate for fiscal 2006.

Item 8. Financial Statements and Supplementary Data

HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS

At August 31,	2006			2005



Current assets:
Cash and cash equivalents	$	154,792		$	63,467
Restricted cash		—			3,811
Accounts receivable, net		52,978			40,697
Prepaid expenses and other current assets		9,397			5,681
Deferred tax asset		3,726			3,305


Total current assets		220,893			116,961


Property and equipment:
Leasehold improvements		16,009			12,836
Computer equipment and related software		75,524			61,772
Furniture and office equipment		18,542			16,294

		110,075			90,902
Less accumulated depreciation		(63,525	)		(51,114	)

Net property and equipment		46,550			39,788

Long-term deferred tax asset		2,557			—

Other assets		4,052			2,065

Intangible assets, net		12,199			16,120

Goodwill, net		96,135			96,020


Total assets	$	382,386		$	270,954

See accompanying notes to the consolidated financial statements.

HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

LIABILITIES AND STOCKHOLDERS’ EQUITY

At August 31,	2006		2005



Current liabilities:
Accounts payable	$	9,221	$	3,622
Accrued salaries and benefits		36,007		26,845
Accrued liabilities		5,748		5,006
Contract billings in excess of earned revenue		35,013		8,037
Income taxes payable		7,906		660
Current portion of long-term debt		180		163
Current portion of long-term liabilities		2,349		1,984


Total current liabilities		96,424		46,317


Long-term debt		236		416

Long-term deferred tax liability		—		8,236

Other long-term liabilities		10,853		9,055


Stockholders’ equity
Preferred stock
$.001 par value, 5,000,000 shares authorized,
none outstanding		—		—
Common stock
$.001 par value, 75,000,000 shares authorized,
34,597,748 and 33,808,518 shares outstanding		35		34
Additional paid-in capital		140,216		109,425
Retained earnings		134,622		97,471


Total stockholders’ equity		274,873		206,930


Total liabilities and stockholders’ equity	$	382,386	$	270,954

See accompanying notes to the consolidated financial statements.

HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except earnings per share data)

Year ended August 31,	2006		2005		2004



Revenues	$	412,308	$	312,504	$	245,410
Cost of services		281,161		205,253		156,462

Gross margin		131,147		107,251		88,948

Selling, general and administrative expenses		44,417		28,418		23,686
Depreciation and amortization		24,517		22,408		18,450
Interest expense		1,053		1,630		3,509


Income before income taxes		61,160		54,795		43,303
Income tax expense		24,009		21,711		17,245


Net income	$	37,151	$	33,084	$	26,058


Earnings per share:
Basic	$	1.08	$	1.00	$	0.81


Diluted	$	1.02	$	0.93	$	0.75



Weighted average common shares and equivalents
Basic		34,348		33,241		32,264
Diluted		36,379		35,691		34,632

See accompanying notes to the consolidated financial statements.

HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(In thousands)

	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		—		—		—		26,058		—			26,058

Net change in fair value of interest rate
swap, net of income taxes of $23		—		—		—		—		35			35


Total comprehensive income													26,093

Exercise of stock options and other		—		1		5,085		—		—			5,086

Tax benefit of option exercises		—		—		10,013		—		—			10,013

Issuance of stock in conjunction with
strategic alliance		—		—		1,812		—		—			1,812


Balance, August 31, 2004	$	—	$	33	$	90,980	$	64,387	$	35		$	155,435

Net income		—		—		—		33,084		—			33,084

Termination of interest rate swap		—		—		—		—		(35	)		(35	)


Total comprehensive income													33,049

Exercise of stock options and other		—		1		5,229		—		—			5,230

Tax benefit of option exercises		—		—		11,672		—		—			11,672

Issuance of stock in conjunction with
Health IQ acquisition		—		—		1,544		—		—			1,544


Balance, August 31, 2005	$	—	$	34	$	109,425	$	97,471	$	—		$	206,930

Net income		—		—		—		37,151		—			37,151

Exercise of stock options and other		—		1		5,342		—		—			5,343

Tax benefit of option exercises		—		—		11,467		—		—			11,467

Share-based employee
compensation expense		—		—		13,982		—		—			13,982


Balance, August 31, 2006	$	—	$	35	$	140,216	$	134,622	$	—		$	274,873

See accompanying notes to the consolidated financial statements.

HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Year ended August 31,	2006			2005			2004



Cash flows from operating activities:
Net income	$	37,151		$	33,084		$	26,058
Adjustments to reconcile net income to net cash provided by
operating activities, net of business acquisitions:
Depreciation and amortization		24,517			22,408			18,450
Amortization of deferred loan costs		476			488			768
Share-based employee compensation expense		13,982			494			820
Excess tax benefits from share-based payment arrangements		(10,936	)		11,672			10,013
Increase in accounts receivable, net		(12,281	)		(6,485	)		(7,174	)
(Increase) decrease in other current assets		(3,716	)		1,098			(1,425	)
Increase (decrease) in accounts payable		5,599			(3,562	)		4,824
Increase (decrease) in accrued salaries and benefits		9,162			18,880			(3,959	)
Increase in other current liabilities		46,434			820			3,040
Deferred income taxes		(11,217	)		(5,456	)		(468	)
Other		3,621			2,003			3,841
(Increase) decrease in other assets		(1,539	)		633			231
Payments on other long-term liabilities		(1,445	)		(872	)		(371	)

Net cash flows provided by operating activities		99,808			75,205			54,648


Cash flows from investing activities:
Acquisition of property and equipment		(27,356	)		(16,161	)		(26,189	)
Purchases of investments		—			(2,000	)		(6,000	)
Proceeds on sale of investments		—			9,040			70
Business acquisitions, net of cash acquired		(115	)		(1,120	)		(60,223	)

Net cash flows used in investing activities		(27,471	)		(10,241	)		(92,342	)


Cash flows from financing activities:
Decrease (increase) in restricted cash		3,811			(2,287	)		(1,524	)
Proceeds from issuance of long-term debt		—			48,000			60,000
Deferred loan costs		(924	)		(730	)		(2,315	)
Excess tax benefits from share-based payment arrangements		10,936			—			—
Exercise of stock options		5,328			4,599			4,258
Payments of long-term debt		(163	)		(96,226	)		(12,424	)

Net cash flows provided by (used in) financing activities		18,988			(46,644	)		47,995


Net increase in cash and cash equivalents		91,325			18,320			10,301

Cash and cash equivalents, beginning of period		63,467			45,147			34,846


Cash and cash equivalents, end of period	$	154,792		$	63,467		$	45,147


Supplemental disclosure of cash flow information:
Cash paid during the year for interest	$	548		$	1,099		$	2,749

Cash paid during the year for income taxes	$	16,415		$	18,198		$	6,367



Noncash Activities:
Issuance of unregistered common stock associated with
Health IQ acquisition	$	—		$	1,544		$	—


Issuance of unregistered common stock associated with
Outcomes Verification Program	$	—		$	—		$	1,812

See accompanying notes to the consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years Ended August 31, 2006, 2005 and 2004

1.	Summary of Significant Accounting Policies

Healthways, Inc. (formerly American Healthways, Inc.) and its wholly-owned subsidiaries provide specialized, comprehensive Health and Care Support programs and services to health plans, governments, employers, and hospitals in all 50 states, the District of Columbia, Puerto Rico and Guam.

We have reclassified certain items in prior periods to conform to current classifications.

a. Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. We have eliminated all intercompany profits, transactions and balances.

b. Cash and Cash Equivalents - Cash and cash equivalents primarily include tax-exempt debt instruments, repurchase agreements, commercial paper, and other short-term investments with original maturities of less than three months. We also include in cash and cash equivalents any accrued interest related to these items.

c. Restricted Cash – Restricted cash at August 31, 2005 represented funds held in escrow in connection with a contractual requirement with a customer. In accordance with the terms of the contract, in January 2006 the entire $3.8 million was released from escrow and reclassified to cash and cash equivalents as our first-year results were validated with the customer.

d. Accounts Receivable - Billed receivables primarily represent fees that are contractually due in the ordinary course of providing our services, net of contractual adjustments. Unbilled receivables primarily represent fees that have been earned but that cannot be billed for until a contractually specified time, typically less than one year. Historically, we have experienced minimal instances of customer non-payment and therefore consider our accounts receivable to be collectible, but we may provide reserves, when appropriate, for billing adjustments at contract reconciliation.

e. Property and Equipment - Property and equipment is carried at cost and includes expenditures that increase value or extend useful lives. We recognize depreciation using the straight-line method over useful lives of three years for computer software and hardware and five to seven years for furniture and other office equipment. Leasehold improvements are depreciated over the shorter of the estimated life of the asset or the life of the lease, which ranges from two to eleven years. Depreciation expense for the years ended August 31, 2006, 2005, and 2004 was $20.6 million, $18.5 million, and $14.2 million, respectively, including amortization of assets recorded under capital leases.

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

g. Intangible Assets - Intangible assets subject to amortization primarily include acquired technology and customer contracts, which we amortize on a straight-line basis over a five-year estimated useful life. We assess 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 consist of a trade name of $4.3 million. We review intangible assets not subject to amortization on an annual basis or more frequently whenever events or circumstances indicate that the assets might be impaired. See Note 4 for further information on intangible assets.

h. Goodwill – We recognize goodwill for the excess of the purchase price over the fair value of tangible and identifiable intangible net assets of businesses that we acquire. The change in the carrying amount of goodwill for fiscal 2006 primarily relates to an earn-out agreement under which we are obligated to pay the former stockholders of Health IQ Diagnostics, LLC (“Health IQ”) additional purchase price equal to a percentage of revenues recognized from Health IQ’s programs in each of the fiscal quarters during the three-year period ending August 31, 2008 (see Note 3). Accumulated amortization of goodwill at August 31, 2006 and 2005 was $5.1 million.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” we review goodwill at least annually for impairment. We completed our annual impairment test as of June 30, 2006 as required by SFAS No. 142 and concluded that no impairment of goodwill exists. In connection with the adoption of SFAS No. 142, we also reassessed the useful lives and the classification of our identifiable intangible assets and determined that they continue to be appropriate.

i. Contract Billings in Excess of Earned Revenue - Contract billings in excess of earned revenue primarily represent performance-based fees subject to refund that we have not recognized as revenues because either 1) data from the customer is insufficient or incomplete to measure performance; or 2) interim performance measures indicate that we are not meeting performance targets.

j. Income Taxes - We file a consolidated federal income tax return that includes all of our domestic wholly-owned subsidiaries. We compute our income tax provision under SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 generally requires that we record deferred income taxes for the tax effect of differences between the book and tax bases of our assets and liabilities.

k. Revenue Recognition - We generally determine our contract fees by multiplying a contractually negotiated rate per member per month (“PMPM”) by the number of members covered by our services during the month. We set the PMPM rates during contract negotiations with customers based on the value we expect our programs to create and a sharing of that value between the customer and the Company.

among other things, enabled us to provide congestive heart failure programs to approximately 4,500 additional Medicare fee-for-service beneficiaries for two years beginning on August 1, 2006 (the “refresh population”). All fees for the refresh population are performance-based.

We bill our customers each month for the entire amount of our fees contractually due for the prior month’s enrollment, which typically includes the amount, if any, that is performance-based and may be subject to refund should we not meet performance targets. Contractually, we cannot bill for any incentive bonus until after contract settlement.

Substantially all of the fees under both the MHS pilots and the refresh population in which we are participating are performance-based. The pilots require that, by the end of the third year, we achieve a cumulative net savings (total savings for the intervention population as compared to the control group less fees received from CMS) of five percent. The cumulative net savings targets are lower at the beginning of the pilots and increase in gradual increments, ending with a cumulative net savings target of five percent at the end of the pilots. Under the amendment of our stand-alone MHS pilot in Maryland and the District of Columbia, the refresh population will be a separate cohort served for two years, by the end of which the program is expected to achieve a 2.5% cumulative net savings when compared to a new control cohort. Under the stand-alone pilot, savings in excess of target achieved in either the original cohort or the refresh cohort can be applied against any savings deficit that might occur in the other cohort. Although we receive the medical claims and other data associated with the intervention group under these pilots on a monthly or more frequent basis, we assess our performance against the control group under these pilots based on quarterly performance reports received from CMS’ financial reconciliation contractor.

If data is insufficient or incomplete to measure performance, or interim performance measures indicate that we are not meeting performance targets, we do not recognize performance-based fees subject to refund as revenues but instead record them in a current liability account “contract billings in excess of earned revenue”. Only in the event we do not meet performance levels by the end of the measurement period, typically one year, are we contractually obligated to refund some or all of the performance-based fees. We would only reverse revenues that we had already recognized if performance to date in the measurement period, previously above targeted levels, subsequently dropped below targeted levels. Historically, any such adjustments have been immaterial to our financial condition and results of operations.

to a baseline year, while $34.4 million was based entirely on actual data received from our customers. Data reconciliation differences, for which we provide contractual allowances until we reach agreement with respect to identified issues, can arise between the customer and us due to customer data deficiencies, omissions, and/or data discrepancies.

Performance-related adjustments (including any amounts recorded as revenue that were ultimately refunded), changes in estimates, data reconciliation differences, or adjustments to incentive bonuses may cause us to recognize or reverse revenue in a current fiscal year that pertains to services provided in the prior fiscal year. During fiscal 2006, we recognized a net increase in revenue of $1.6 million that related to services provided prior to fiscal 2006.

l. Earnings Per Share – We report earnings per share under SFAS No. 128 “Earnings per Share”. We calculate basic earnings per share using weighted average common shares outstanding during the period. We calculate diluted earnings per share using weighted average common shares outstanding during the period plus the effect of all dilutive potential common shares outstanding during the period.

m. Share-Based Compensation – We account for share-based compensation in accordance with SFAS No. 123(R), “Share-Based Payment” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R) supersedes Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and requires that all share-based payments to employees, including grants of employee stock options, be recognized in the income statement based on their fair values.

As permitted by SFAS No. 123, prior to September 1, 2005 we accounted for share-based payments to employees and outside directors using APB No. 25’s intrinsic value method and adopted the disclosure requirements of SFAS No. 123 and SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123.” As such, we generally recognized no compensation cost for employee stock options prior to fiscal 2006.

See Note 9 for further information on share-based compensation.

n. Management Estimates – In preparing our consolidated financial statements in conformity with generally accepted accounting principles, management must make estimates and assumptions that affect: 1) the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements; and 2) the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

2.	Recently Issued Accounting Standards

Accounting for Uncertainty in Income Taxes

Fair Value Measurement

the information used to develop fair value assumptions. It also requires expanded disclosure about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value and does not expand the use of fair value in any new circumstances.

Effect of Prior Year Misstatements on Current Year Misstatements

SAB No. 108 is effective for fiscal years ending after November 15, 2006. We do not expect the adoption of SAB No. 108 to have a material impact on our financial position or results of operations.

3.	Goodwill

The change in carrying amount of goodwill during the years ended August 31, 2006 and 2005 is shown below:

(In $000s)
Balance, August 31, 2004	$	93,574
Health IQ acquisition and related costs		3,622
StatusOne purchase price adjustments		(1,176	)

Balance, August 31, 2005	$	96,020
Health IQ purchase price adjustment		115

Balance, August 31, 2006	$	96,135

The Health IQ acquisition and related costs of $3.6 million during fiscal 2005 relate to the acquisition of Health IQ in June 2005. The StatusOne purchase price adjustments during fiscal 2005 primarily relate to $1.3 million that we received from escrow during the first quarter of fiscal 2005 after the termination of the StatusOne Health Systems, LLC (“StatusOne”) escrow agreement. The Health IQ purchase price adjustment of $0.1 million during fiscal 2006 primarily relates to an earn-out agreement under which we are obligated to pay the former stockholders of Health IQ additional purchase price equal to a percentage of revenues recognized from Health IQ’s programs in each of the fiscal quarters during the three-year period ending August 31, 2008.

4.	Intangible Assets

Intangible assets subject to amortization at August 31, 2006 consist of the following:

	Gross Carrying Amount		Accumulated Amortization		Net

(In $000s)
Acquired technology	$	10,163	$	6,098	$	4,065
Customer contracts		9,179		5,519		3,660
Other		200		70		130

Total	$	19,542	$	11,687	$	7,855

Intangible assets subject to amortization at August 31, 2005 consisted of the following:

	Gross Carrying Amount		Accumulated Amortization		Net

(In $000s)
Acquired technology	$	10,163	$	4,065	$	6,098
Customer contracts		9,233		3,725		5,508
Other		200		30		170

Total	$	19,596	$	7,820	$	11,776

Acquired technology, customer contracts, and other intangible assets are being amortized on a straight-line basis over a five-year estimated useful life. Total amortization expense for the years ended August 31, 2006 and 2005 was $3.9 million. Estimated amortization expense is $3.9 million for each of the next two fiscal years and $40,000, $10,000 and zero for the three fiscal years thereafter, respectively.

Intangible assets not subject to amortization at August 31, 2006 and 2005 consist of a trade name associated with the StatusOne acquisition of $4.3 million.

5.	Income Taxes

Income tax expense is comprised of the following:

Year ended August 31, (in $000s)	2006			2005			2004


Current taxes
Federal	$	29,247		$	22,750		$	14,729
State		5,977			4,416			3,016
Deferred taxes
Federal		(9,312	)		(4,941	)		(165	)
State		(1,903	)		(514	)		(335	)

Total	$	24,009		$	21,711		$	17,245

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following table shows the significant components of our net deferred tax asset (liability) for the fiscal years ended August 31, 2006 and 2005:

At August 31, (in $000s)	2006			2005


Deferred tax assets:
Accruals and reserves	$	2,681		$	2,375
Spin-off stock option adjustment		13			21
Deferred compensation		5,111			4,370
Share based payments		5,523			—
Capital loss carryforward		97			97

		13,425			6,863
Valuation allowance		(97	)		(97	)

		13,328			6,766

Deferred tax liability:
Tax over book depreciation		2,312			5,465
Tax over book amortization		4,733			6,232

		7,045			11,697

Net deferred tax asset (liability)	$	6,283		$	(4,931	)


Net current deferred tax assets	$	3,726		$	3,305
Net long-term deferred tax asset (liability)		2,557			(8,236	)

	$	6,283		$	(4,931	)

We recorded a valuation allowance totaling approximately $97,000 against deferred tax assets as of August 31, 2006 and 2005 because management believes it is more likely than not that the net deferred tax asset related to a capital loss carryforward will not be realized in future tax periods. The capital loss carryforward will expire if unused by August 31, 2007. For fiscal 2006 and 2005, the tax benefit of stock option compensation, excluding tax benefit either relieving the deferred tax asset described as “Spin-off stock option adjustment” or related to the deferred tax asset for share-based payments subject to SFAS No. 123(R), is recorded as additional paid-in capital.

The difference between income tax expense computed using the effective tax rate and the statutory federal income tax rate follows:

Year ended August 31, (in $000s)	2006		2005		2004


Statutory federal income tax	$	21,406	$	19,178	$	15,156
State income taxes, less federal income tax benefit		2,495		2,249		1,743
Other		108		284		346

Income tax expense	$	24,009	$	21,711	$	17,245

6.	Long-Term Debt

On September 19, 2005, we entered into a Second Amended and Restated Revolving Credit Loan Agreement (the “Second Amended Credit Agreement”). The Second Amended Credit Agreement provides us with a $250.0 million revolving credit facility, including a swingline sub facility of $10.0 million and a $75.0 million sub facility for letters of credit, together with an uncommitted incremental accordion facility of $50.0 million, and expires on September 19, 2010. As of August 31, 2006, our available line of credit totaled $249.3 million.

The Second Amended Credit Agreement requires us to repay the principal on any loans at the maturity date of September 19, 2010. Borrowings under the Second Amended Credit Agreement generally bear interest, at our option, at LIBOR plus a spread of 0.875% to 1.5%, which is dependent on the ratio of total funded debt

to EBITDA, or at the prime rate. The Second Amended Credit Agreement also provides for a fee ranging between 0.175% and 0.3% of unused commitments. The Second Amended Credit Agreement is secured by guarantees from our active domestic subsidiaries and by security interests in substantially all of our and our subsidiaries’ assets.

The Second Amended Credit Agreement contains various financial covenants, which require us to maintain, as defined, ratios or levels of (i) total funded debt to EBITDA, (ii) fixed charge coverage, and (iii) net worth. It also restricts the payment of dividends and limits the amount of repurchases of the Company’s common stock. As of August 31, 2006, we were in compliance with all of the covenant requirements of the Second Amended Credit Agreement.

As of August 31, 2006, there were letters of credit outstanding under the Second Amended Credit Agreement for $0.7 million primarily to support our requirement to repay fees under one health plan contract in the event we do not perform at established target levels and do not repay the fees due in accordance with the terms of the contract.

To meet the reporting requirements of SFAS No. 107, “Disclosures About Fair Value of Financial Instruments,” we calculate the estimated fair value of financial instruments using quoted market prices of similar instruments or discounted cash flow techniques. At August 31, 2006 and 2005, there were no material differences between the carrying amount and the fair value of our debt.

7.	Other Long-Term Liabilities

We have a non-qualified deferred compensation plan under which our officers may defer a portion of their salaries and receive a Company matching contribution plus a contribution based on our performance. Company contributions vest at 25% per year. We do not fund the plan and carry it as an unsecured obligation. Participants in the plan elect payout dates for their account balances, which can be no earlier than four years from the period of the deferral.

As of August 31, 2006 and 2005, other long-term liabilities included vested amounts under the plan of $6.7 million and $5.4 million, respectively, net of the current portion of $1.4 million. For the next five fiscal years, we must make plan payments of $1.4 million for the first two fiscal years, and $0.8 million, $0.3 million, and $0.2 million, for the next three fiscal years, respectively.

8.	Leases

We maintain operating lease agreements principally for our corporate office space and our ten care enhancement centers. Our corporate office leases cover approximately 150,000 square feet and expire from August 2007 to May 2009. Our support and training offices for StatusOne contain approximately 23,000 square feet of space in aggregate and have initial terms ranging from two to five years. The care enhancement center leases cover approximately 15,000 to 33,000 square feet each and have initial terms of approximately five to eleven years.

In May 2006, we entered into an office lease agreement for our new corporate headquarters to be located near Nashville, Tennessee containing approximately 255,000 square feet of rentable area. The term of the lease is 15 years and will commence on the date that the premises are ready for occupancy, which is expected to be before March 1, 2008. The lease also provides for two renewal options of five years each at then prevailing market rates. The base rent for the initial 15-year term will be based on the actual construction costs of the building and is expected to range from $16.38 per square foot to $24.88 per square foot over the term.

Most of our operating leases include escalation clauses, some of which are fixed amounts, and some of which reflect changes in price indices. Certain operating leases contain renewal options to extend the lease for additional periods. Our capital lease obligation contains an option to purchase the leased property for a specified amount at the end of the lease term. For the years ended August 31, 2006, 2005 and 2004, rent expense under lease agreements was approximately $7.7 million, $6.0 million, and $4.9 million, respectively.

The following table summarizes our future minimum lease payments, net of sublease income, under all capital leases and non-cancelable operating leases for each of the next five fiscal years:

(In $000s) Year ending August 31,	Capital Leases			Operating Leases


2007	$	214		$	8,054
2008		214			8,116
2009		37			9,679
2010		—			9,808
2011		—			9,081
2012 and thereafter		—			72,005

Total minimum lease payments		465		$	116,743

Less amount representing interest		(49	)

Present value of net minimum lease payments		416
Less current portion		(180	)

	$	236

9.	Share-Based Compensation

We have several shareholder-approved stock incentive plans for employees and directors. We currently have three types of share-based awards outstanding under these plans: stock options, restricted stock, and restricted stock units. We believe that such awards align the interests of our employees and directors with those of our stockholders. Prior to September 1, 2005, we accounted for these plans under the recognition and measurement provisions of APB No. 25 and related interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.”

For the years ended August 31, 2005 and 2004, we recorded compensation expense under APB No. 25 of approximately $0.5 million and $0.8 million, respectively. This expense resulted primarily from the grant, which was subject to stockholder approval, of stock options to two new directors of the Company in June 2003. We obtained such approval at the Annual Meeting of Stockholders in January 2004, at which time we issued the options. We also recognized a total income tax benefit in the statement of operations for share-based compensation arrangements of $0.2 million and $0.3 million for the years ended August 31, 2005 and 2004, respectively. We generally recognize compensation expense related to fixed award stock options with graded vesting on a straight-line basis over the vesting period.

Effective September 1, 2005, we adopted SFAS No. 123(R) using the modified prospective transition method. Under the modified prospective transition method, recognized compensation cost for the year ended August 31, 2006 includes 1) compensation cost for all share-based payments granted prior to, but not yet vested as of, September 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123; and 2) compensation cost for all share-based payments granted on or after September 1, 2005, based on the grant date fair value estimated in accordance with SFAS No. 123(R). In accordance with the modified prospective method, we have not restated prior period results.

For the year ended August 31, 2006, we recognized share-based compensation costs of $14.0 million, which consisted of $6.6 million in cost of services and $7.4 million in selling, general and administrative expenses. We also recognized a total income tax benefit in the statement of operations for share-based compensation arrangements of $5.5 million for the year ended August 31, 2006. We did not capitalize any share-based compensation costs during fiscal 2006, 2005, or 2004.

As a result of adopting SFAS No. 123(R), income before income taxes and net income for the year ended August 31, 2006 were $14.0 million and $8.4 million lower, respectively, than if we had continued to account for share-based compensation under APB 25. The effect of adopting SFAS No. 123(R) on both basic and diluted earnings per share for the year ended August 31, 2006 was $0.25 and $0.23 per share, respectively.

Prior to adopting SFAS No. 123(R), we presented the tax benefit of stock option exercises as operating cash flows. SFAS No. 123(R) requires that tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options be classified as financing cash flows.

SFAS No. 123(R) also requires companies to calculate an initial “pool” of excess tax benefits available at the adoption date to absorb any tax deficiencies that may be recognized under SFAS No.123(R). The pool includes the net excess tax benefits that would have been recognized if the company had adopted SFAS No. 123 for recognition purposes on its effective date.

We have elected to calculate the pool of excess tax benefits under the alternative transition method described in FASB Staff Position (“FSP”) No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards,” which also specifies the method we must use to calculate excess tax benefits reported on the statement of cash flows. The excess tax benefits from share-based payment arrangements classified as a financing cash inflow for the year ended August 31, 2006 of $10.9 million would not have been materially different if we had not adopted SFAS No. 123(R); however, they would have been classified as an operating cash inflow rather than as a financing cash inflow.

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation for the years ended August 31, 2005 and 2004:

	Year ended August 31,

(In $000s, except per share data)	2005			2004

Net income, as reported	$	33,084		$	26,058

Add: Stock-based employee compensation
expense included in reported net
income, net of related tax effects		299			493
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects		(6,709	)		(5,097	)

Pro forma net income	$	26,674		$	21,454


Earnings per share:
Basic - as reported	$	1.00		$	0.81
Basic - pro forma	$	0.80		$	0.66

Diluted - as reported	$	0.93		$	0.75
Diluted - pro forma	$	0.75		$	0.62

As noted above, we have several stockholder-approved stock incentive plans for employees and directors under which we have granted non-qualified stock options, restricted stock, and restricted stock units. We grant options under these plans at market value on the date of grant. The options generally vest over or at the end of four years. Options granted on or after August 24, 2005 expire seven years from the date of grant, while options granted before August 24, 2005 expire ten years from the date of grant. Restricted share awards generally vest at the end of four years. Certain option and restricted share awards provide for accelerated vesting upon a change in control or normal or early retirement (as defined in the plans). At August 31, 2006, we have reserved approximately 546,000 shares for future equity grants under our stock incentive plans.

As of August 31, 2006, there was $26.7 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the stock incentive plans. That cost is expected to be recognized over a weighted average period of 2.4 years.

Stock Options

In June 2005, we changed from the Black-Scholes option valuation model (“Black-Scholes model”) to a lattice-based binomial option valuation model (“lattice binomial model”), which we consider preferable to the Black-Scholes model because the lattice binomial model considers characteristics of fair value option pricing, such as an option’s contractual term and the probability of exercise before the end of the contractual term, that are not available under the Black-Scholes model. For the year ended August 31, 2006, we contracted with a third party to assist in developing the assumptions, noted in the table below, used in estimating the fair values of stock options. During fiscal 2006, we based expected volatility on both historical volatility and implied volatility from traded options on the Company’s stock. The expected term of options granted was derived from the output of the lattice binomial model and represents the period of time that options granted are expected to be outstanding. We used historical data to estimate expected option exercise and post-vesting employment termination behavior within the lattice binomial model.

For the years ended August 31, 2005 and 2004, we estimated the fair value of each option award on the date of grant using the Black-Scholes model. We based expected volatility on historical volatility. We estimated the expected term of stock options using historical exercise and employee termination experience.

The following table shows the weighted average grant-date fair values of options and the weighted average assumptions we used to develop the fair value estimates under each of the option valuation models for the years ended August 31, 2006, 2005, and 2004:

Year ended August 31,	2006			2005			2004


Weighted average grant-date fair value of options	$	22.61		$	20.02		$	15.64

Assumptions:
Expected volatility		47.7	%		49.8	%		60.0	%
Expected dividends		—			—			—
Expected term (in years)		5.3			5.7			7.4
Risk-free rate		3.8	%		3.8	%		3.8	%

A summary of option activity as of August 31, 2006 and changes during the year then ended is presented below:

Options

Outstanding at September 1, 2005	6,485		$16.53
Granted	215		47.52
Exercised	(782	)	6.85
Forfeited or expired	(82	)	23.69

Outstanding at August 31, 2006	5,836		18.87	6.3	$191,337

Exercisable at August 31, 2006	3,486		10.86	5.7	$142,076

The total intrinsic value, which represents the difference between the underlying stock’s market price and the option’s exercise price, of options exercised during fiscal 2006, 2005, and 2004 was $29.0 million, $29.8 million, and $25.4 million, respectively.

Cash received from option exercises under all share-based payment arrangements during fiscal 2006 and 2005 was $5.3 million and $4.6 million, respectively. The actual tax benefit realized for the tax deductions from option exercise of the share-based payment arrangements totaled $11.5 million and $11.8 million for the years ended August 31, 2006 and 2005, respectively. We issue new shares of common stock upon exercise of stock options.

Restricted Stock and Restricted Stock Units

The fair value of restricted stock and restricted stock units (“nonvested shares”) is determined based on the closing bid price of the Company’s common stock on the grant date. The weighted average grant-date fair value of nonvested shares granted during the years ended August 31, 2006 and 2005 was $47.40 and $42.51, respectively. Nonvested shares were not granted during the year ended August 31, 2004.

The following table shows a summary of our nonvested shares as of August 31, 2006 as well as activity during the year then ended. The total fair value of shares vested during fiscal 2006, 2005, and 2004 was $0.4 million, $16,000, and $40,000, respectively.

Nonvested Shares	Shares (000s)		Weighted Average Grant- Date Fair Value

Nonvested at September 1, 2005	135		$42.57
Granted	38		47.40
Vested	(10	)	40.67
Forfeited	(3	)	43.44

Nonvested at August 31, 2006	160		43.82

10.

Comprehensive Income

Comprehensive income, net of income taxes, was $37.2 million, $33.0 million, and $26.1 million for the years ended August 31, 2006, 2005, and 2004, respectively.

11.

Stockholder Rights Plan

On June 19, 2000, the Board of Directors adopted a stockholder rights plan under which holders of common stock as of June 30, 2000 received preferred stock purchase rights as a dividend at the rate of one right per share. As amended in June 2004 and July 2006, each right initially entitles its holder to purchase one one-hundredth of a Series A preferred share at $175.00, subject to adjustment. Upon becoming exercisable, each right will allow the holder (other than the person or group whose actions have triggered the exercisability of the rights), under alternative circumstances, to buy either securities of the Company or securities of the acquiring company (depending on the form of the transaction) having a value of twice the then current exercise price of the rights.

With certain exceptions, each right will become exercisable only when a person or group acquires, or commences a tender or exchange offer for, 15% or more of our outstanding common stock. Rights will also become exercisable in the event of certain mergers or asset sales involving more than 50% of our assets or earning power. The rights will expire on June 15, 2014. The Board of Directors of the Company will review the plan at least once every three years to determine if the maintenance and continuance of the plan is still in the best interests of the Company and its stockholders.

12.

Employee Benefits

We have a 401(k) Retirement Savings Plan (the “Plan”) available to substantially all of our employees. Employees can contribute up to a certain percentage of their base compensation as defined in the Plan. The Company matching contributions are subject to vesting requirements. Company contributions under the Plan totaled $2.5 million, $2.3 million, and $2.0 million for the years ended August 31, 2006, 2005 and 2004, respectively.

13.

Commitments and Contingencies

Pursuant to an earn-out agreement executed in connection with the acquisition of certain assets of Health IQ in June 2005, we are obligated to pay the former stockholders of Health IQ additional purchase price equal to a percentage of revenues recognized from Health IQ’s programs in each of the fiscal quarters during the three-year period ending August 31, 2008.

14.

Segment Disclosures

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, we distinguished operating and reportable segments based upon the types of customers, hospitals or health plans, that contract for our services. In order to improve operational efficiency, in December 2003 we merged our operations into a single operating segment for purposes of presenting financial information and evaluating performance.

Our integrated Health and Care Support product line includes programs for various diseases, conditions, and wellness programs. It is impracticable for us to report revenues by program. Further, we

report revenues from our external customers on a consolidated basis since Health and Care Support services are the only service that we provide.

We derived approximately 38% of our fiscal 2006 revenues from two contracts that each comprised more than 10% of our revenues for the year. Revenues from each of these contracts individually totaled approximately 27% and 11%, respectively, of fiscal 2006 revenues. In fiscal 2005 and 2004, these same two contracts each comprised more than 10% of revenues for the year, comprising in the aggregate approximately 38% and 44%, respectively, of our fiscal 2005 and fiscal 2004 revenues.

15.

Subsequent Event

On October 11, 2006, we entered into a stock purchase agreement with Axia, a national provider of preventive health and wellness programs, to purchase all of Axia’s outstanding shares of capital stock for approximately $450 million, subject to adjustment for Axia’s indebtedness, working capital, and cash balance at closing. Of the purchase price, $35 million will be held in escrow until December 31, 2007 to satisfy any potential indemnification claims. An additional $9 million of the purchase price will be held in escrow to satisfy a portion of certain potential earnout obligations. We expect the acquisition to close during December 2006, subject to satisfaction of the closing conditions in the stock purchase agreement, including receipt of required regulatory approvals. We currently anticipate that the acquisition will be financed through a combination of cash on hand and committed bank debt.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of Healthways, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Healthways, Inc. and Subsidiaries (the Company) as of August 31, 2006 and 2005, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended August 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Healthways, Inc. and Subsidiaries at August 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended August 31, 2006, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 1 and Note 9 to the consolidated financial statements, the Company adopted SFAS 123(R), Share-Based Payment, effective September 1, 2005.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Healthways, Inc. and Subsidiaries’ internal control over financial reporting as of August 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 13, 2006 expressed an unqualified opinion thereon.

/s/Ernst & Young LLP

Nashville, Tennessee

November 13, 2006

Quarterly Financial Information (unaudited):
(In thousands, except per share data)

Fiscal 2006	First		Second		Third		Fourth


Revenues	$	90,592	$	100,021	$	106,820	$	114,876

Gross margin	$	26,747	$	29,162	$	33,238	$	42,000
Income before income taxes	$	10,706	$	12,161	$	15,481	$	22,811
Net income	$	6,456	$	7,333	$	9,335	$	14,027

Basic earnings per share (1)	$	0.19	$	0.21	$	0.27	$	0.41
Diluted earnings per share (1)	$	0.18	$	0.20	$	0.26	$	0.38

Fiscal 2005	First		Second		Third		Fourth


Revenues	$	71,186	$	75,337	$	78,357	$	87,624

Gross margin	$	25,214	$	27,205	$	27,426	$	27,406
Income before income taxes	$	12,937	$	13,953	$	14,111	$	13,793
Net income	$	7,762	$	8,441	$	8,536	$	8,344

Basic earnings per share (1)	$	0.24	$	0.26	$	0.26	$	0.25
Diluted earnings per share (1)	$	0.22	$	0.24	$	0.24	$	0.23

(1)

We calculated earnings per share for each of the quarters based on the weighted average number of shares and dilutive options outstanding for each period. Accordingly, the sum of the quarters may not necessarily be equal to the full year income per share.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

Item 9A. Controls and Procedures

Management’s Annual Report on Internal Control over Financial Reporting

Management, including the principal executive officer and principal financial officer, is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

Management has performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of August 31, 2006 based on criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), Internal Controls - Integrated Framework, and believes that the COSO framework is a suitable framework for such an evaluation. Management has concluded that the Company’s internal control over financial reporting was effective as of August 31, 2006.

Ernst & Young LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements for the year ended August 31, 2006, has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting which is included in this Annual Report on Form 10-K.

We have performed an evaluation as of the end of the period covered by this report of the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 ), under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer. Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

There have been no changes in our internal controls over financial reporting during the quarter ended August 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Healthways, Inc. and Subsidiaries

We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting, that Healthways, Inc. and Subsidiaries maintained effective internal control over financial reporting as of August 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Healthways, Inc. and Subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

In our opinion, management’s assessment that Healthways, Inc. and Subsidiaries maintained effective internal control over financial reporting as of August 31, 2006 is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Healthways, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of August 31, 2006, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Healthways, Inc. and Subsidiaries as of August 31, 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended August 31, 2006 and our report dated November 13, 2006 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Nashville, Tennessee

November 13, 2006

Item 9B. Other Information

Not applicable.

PART III

Item 10. Directors and Executive Officers of the Registrant

Information concerning our directors, audit committee financial experts, code of ethics, and compliance with Section 16(a) of the Exchange Act will be included in our Proxy Statement for the Annual Meeting of Stockholders to be held February 2, 2007, to be filed with the Securities and Exchange Commission pursuant to Rule 14a-6(c), and is incorporated herein by reference.

Pursuant to General Instruction G(3), information concerning our executive officers is included in Part I, under the caption “Executive Officers of the Registrant” of this Form 10-K.

Item 11. Executive Compensation

Information required by this item will be contained in our Proxy Statement for the Annual Meeting of Stockholders to be held February 2, 2007, to be filed with the Securities and Exchange Commission pursuant to Rule 14a-6(c), and is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Item 13. Certain Relationships and Related Transactions

Item 14. Principal Accounting Fees and Services

PART IV

Item 15. Exhibits, Financial Statement Schedules

(a)	The following documents are filed as part of this Annual Report on Form 10-K:

1. The financial statements filed as part of this report are included in Part II, Item 8 of this Annual Report on Form 10-K.

2. We have omitted all Financial Statement Schedules because they are not required under the instructions to the applicable accounting regulations of the Securities and Exchange Commission or the information to be set forth therein is included in the financial statements or in the notes thereto.

3.	Exhibits

3.1

Restated Certificate of Incorporation for Healthways, Inc., as amended

3.2

Bylaws, as amended [incorporated by reference to Exhibit 3.1 to Form 10-Q of the Company’s fiscal quarter ended February 29, 2004]

4.1

Article IV of the Company's Restated Certificate of Incorporation (included in Exhibit 3.1)

4.2

Rights Agreement, dated June 19, 2000, between American Healthways, Inc. and SunTrust Bank, including the Form of Rights Certificate (Exhibit A), the Form of Summary of Rights (Exhibit B) and the Form of Certificate of Amendment to the Restated Certificate of Incorporation of American Healthways, Inc. (Exhibit C) [incorporated herein by reference to Exhibit 4 to the Company’s Current Report on Form 8-K dated June 21, 2000]

4.3

Amendment No. 1 to Rights Agreement, dated June 15, 2004, between American Healthways, Inc. and SunTrust Bank [incorporated herein by reference to Exhibit 4 to the Company’s Current Report on Form 8-K dated June 17, 2004]

4.4

Amendment No. 2 to Rights Agreement, dated July 19, 2006, between Healthways, Inc. and SunTrust Bank [incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K dated July 19, 2006]

10.1

Second Amended and Restated Revolving Credit Loan Agreement between the Company and SunTrust Bank as Administrative Agent, Regions Bank and Bank of America, N.A. as Co-Documentation Agents, and National City Bank and U.S. Bank, N.A. as Co-Syndication Agents dated September 15, 2005 including Form Revolving Credit Note, Form Swingline Note, and Form Subsidiary Guarantee Agreement [incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K of the Company dated September 22, 2005]

10.2

Agreement and Plan of Merger by and among American Healthways, Inc., AH Mergersub, Inc., StatusOne Health Systems, Inc., and certain stockholders of StatusOne Health Systems, Inc. dated as of September 5, 2003 [incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K filed on September 9, 2003]

10.3

Office Lease by and between Healthways, Inc. and Highwoods/Tennessee Holdings, L.P., dated as of May 4, 2006 [incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated May 5, 2006]

10.4

Merger Termination and Release Agreement by and among Healthways, Inc., Lime Acquisition Corp., and LifeMasters Supported SelfCare, Inc., dated as of September 30, 2006 [incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated October 3, 2006]

Management Contracts and Compensatory Plans

10.5

Employment Agreement dated February 1, 2006 between the Company and Thomas G. Cigarran [incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K dated February 1, 2006]

10.6

Employment Agreement dated February 1, 2006 between the Company and Robert E. Stone [incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K dated February 1, 2006]

10.7

Employment Agreement dated February 1, 2006 between the Company and Ben R. Leedle [incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K dated February 1, 2006]

10.8

Employment Agreement dated February 1, 2006 between the Company and Mary D. Hunter [incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K dated February 1, 2006]

10.9

Employment Agreement dated February 1, 2006 between the Company and Mary A. Chaput [incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated February 1, 2006]

10.10

Employment Agreement dated November 20, 2001 between the Company and Henry D. Herr, [incorporated by reference to Exhibit 10.1 to Form 10-Q of the Company’s fiscal quarter ended November 30, 2001]

10.11

Amendment to Employment Agreement dated October 7, 2005 between the Company and Henry D. Herr [incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K of the Company dated October 12, 2005]

10.12

Employment Agreement dated February 1, 2006 between the Company and Donald B. Taylor [incorporated by reference to Exhibit 10.8 to the Company’s Current Report on Form 8-K dated February 1, 2006]

10.13

Employment Agreement dated February 1, 2006 between the Company and James Pope, MD [incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K dated February 1, 2006]

10.14

Employment Agreement dated September 5, 2003 between the Company and Matthew Kelliher [incorporated by reference to Exhibit 10.1 to Form 10-Q of the Company’s fiscal quarter ended November 30, 2003]

10.15

Employment Agreement dated February 1, 2006 between the Company and Robert L. Chaput [incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K dated February 1, 2006]

10.16

Capital Accumulation Plan, as amended and restated [incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated November 15, 2005]

10.17

1991 Employee Stock Incentive Plan, as amended [incorporated by reference to Exhibit 10.10 to Form 10-K of the Company for its fiscal year ended August 31, 1992]

10.18

Amendment to 1991 Employee Stock Incentive Plan

10.19

Form of Indemnification Agreement by and among the Company and the Company's directors [incorporated by reference to Exhibit 10.15 to Registration Statement on Form S-1 (Registration No. 33-41119)]

10.20

1996 Stock Incentive Plan, as amended

10.21

2001 Amended and Restated Stock Option Plan

10.22

Form of Non-Qualified Stock Option Agreement under the Company’s 1996 Stock Incentive Plan, as amended

10.23

Form of Non-Qualified Stock Option Agreement under the Company’s Amended and Restated 2001 Stock Option Plan

10.24

Form of Restricted Stock Unit Award Agreement under the Company’s 1996 Stock Incentive Plan, as amended

10.25

Form of Non-Qualified Stock Option Agreement (for Directors) under the Company’s 1996 Stock Incentive Plan, as amended

Earnings Per Share Reconciliation

Subsidiary List

Consent of Ernst & Young LLP

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)

Exhibits

Refer to Item 15(a)(3) above.

(c)	Not applicable

SIGNATURES

Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

HEALTHWAYS, INC.

November 13, 2006

By: /s/ Ben R. Leedle, Jr.

Ben R. Leedle, Jr.

President and

Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature	Title	Date

/s/ Ben R. Leedle, Jr.	President, Chief Executive	November 13, 2006
Ben R. Leedle, Jr.	Officer, and Director (Principal Executive Officer)
/s/ Mary A. Chaput	Executive Vice President and Chief	November 13, 2006
Mary A. Chaput	Financial Officer (Principal Financial Officer)
/s/ Alfred Lumsdaine	Senior Vice President and Corporate	November 13, 2006
Alfred Lumsdaine /s/ Thomas G. Cigarran	Controller (Principal Accounting Officer) Chairman of the Board and Director	November 13, 2006
Thomas G. Cigarran

/s/ Frank A. Ehmann	Director	November 13, 2006
Frank A. Ehmann

/s/ Henry D. Herr	Director	November 13, 2006
Henry D. Herr

/s/ C. Warren Neel	Director	November 13, 2006
C. Warren Neel

/s/ William C. O’Neil, Jr.	Director	November 13, 2006
William C. O'Neil, Jr.
/s/ Jay C. Bisgard	Director	November 13, 2006
Jay C. Bisgard
/s/ John W. Ballantine	Director	November 13, 2006
John W. Ballantine
/s/ Mary Jane England, M.D.	Director	November 13, 2006
Mary Jane England

/s/ Alison Taunton-Rigby	Director	November 13, 2006
Alison Taunton-Rigby

GRAPHIC 2 img1.jpg GRAPHIC begin 644 img1.jpg M_]C_X``02D9)1@`!`0$`8`!@``#_VP!#``H'!P@'!@H("`@+"@H+#A@0#@T- M#AT5%A$8(Q\E)"(?(B$F*S7J#A(6&AXB)BI*3E)66EYB9FJ*CI*6FIZBIJK*SM+6VM[BYNL+#Q,7& MQ\C)RM+3U-76U]C9VN'BX^3EYN?HZ>KQ\O/T]?;W^/GZ_\0`'P$``P$!`0$! M`0$!`0````````$"`P0%!@<("0H+_\0`M1$``@$"!`0#!`<%!`0``0)W``$" M`Q$$!2$Q!A)!40=A<1,B,H$(%$*1H;'!"2,S4O`58G+1"A8D-.$E\1<8&1HF M)R@I*C4V-S@Y.D-$149'2$E*4U155E=865IC9&5F9VAI:G-T=79W>'EZ@H.$ MA8:'B(F*DI.4E9:7F)F:HJ.DI::GJ*FJLK.TM;:WN+FZPL/$Q<;'R,G*TM/4 MU=;7V-G:XN/DY>;GZ.GJ\O/T]?;W^/GZ_]H`#`,!``(1`Q$`/P#V:BBB@`HH MHH`****`"BBLW7]:AT#29+Z52[`A(HAUD<]%%!48NIJ7PMJ5QKMI-K,C,MM);".18[U9]/9SA?M<1C4G_>^[^M:P(8`@@@\@BN>.H>1XJD\/ZCMGMM0A,] MJ9`#T^_&?4=Q['%4IFD\$ZA`5=GT"[D$91B3]B<],'^X?3M1)..XX0C5TAH^ MW?T.OHI.M+2,`HHHH`****`"BBB@`HHHH`****`"BBB@`KC_`!!_I_C_`$#3 M7YAA62[9>Q89V_EBNPKC_%'_`!+/%^@ZV_%ON:TF;LN\?*3^9_*DSJPG\1VW ML[>MF:_B\RCP?JQASO\`LDF,?3G]*Y'0_&UCX=^'FBR/!)<.X:'9&0,%#SDG MZC\Z]$EB2:)XI%#(ZE64]P>HKR(6]KX#OM0L-9%GJ.C.WG6MNS!YC)VPO\/' M#$X'`Z]*Z(+GIN"WW.>FX1J)U%>/4V/$.K1:GX[\&O9;LN//P1@A']?P!KL_ M%%DFH^&=1MI`"&MV(]B!D?J!7&^`M%OM4U^X\6ZS&L,K+LM;8<&)2,`[?X0% MX`]R:ZWQ?J*:9X6OYV/S-$8HQW9F^4`?G2K65H]D51NZJY.^@G@V]DU#PCIM MQ*=SF$*Q/&-/LI!B2.$;QZ,>2/S-:U8H=9Q=67+M=A1 M1109!1110`4444`%%%%`!1110`4444`%4]5TRUUG39K"\3=#,N#CJ#V(]P:N M44#BW%W6YQC+%;Q1Z1XPB,D<7R6VI!F6.5>P=E(V-]>#6IIG@[PO8RK>6.EV MQ<\K,293]06)K==%D0HZAE88((R#68WAG1BY9;!(B>ODLT8_)2*I2DE9,UE* MG-\S5GY?UH9.I^'/!NFSOJ5];QP32,69A/(&D8^BALL?;%)9Z3/KU_:WE[:M M9Z38G=964GWY&[22#M[#\ZW;/1-+L)/-MK&%)?\`GIMR_P#WT>:OTG*4MV., MXT_X>_?_`""BBBD8!1110`4444`%%%%`#)2RPNR_>"DCZUS_`($UB^UWPQ%? MZBZ/.\LBDHFT8#8'%;\YQ!(?13_*O.?`'A:QU7PK%>376H1N\L@*P7CQKPQ_ MA!Q6T%%P;?E^I+W.E\-ZS?ZCXC\0V5TZ-!87"1P!4P0"">3WK.MK_P`3:QXH MUS3[/5K>S@TZ1%C#V@D)##/7(]*9X`M8['Q!XIM8GD=(KN-0TKEV/RGJ3R:J MZ5HT&L^.O%(ENKR#RY80/LMRT6N.O2M+14I>B_01WMHD\=I"EU*LTZH!) M(J[0S8Y(';Z5RNC^,)=0\=7VD2*%LBA^Q/MQYC1G;)@]^<_]\UJ^(M1.@^&9 M'MF9[C:MO:[FRSR-\J\]SGG\#7$Z[H&M^&-*TO6&O+6Y3074A(;_'ZU?Z!X::^TYT2<3(F73<,$X/%;5VEY/IC)9W"6] MTZ#9*\>]5/KM[UR?Q+N8KOP"MS"P>*>:!T;U!((KM$P$4>PJ&K03\W^@^IPH MO/%Q\7GP]_;MID6GVGS_`+`/7&,;OZUH^+M6UCPYX1@N8[J*2^$T4MW4]CX>OK MN!@)X+9Y$)7(#!2>E87]KZU<_#--9MI8QJ?V07!/E@JV.2-OTS57Q!X,TZT\ M-ZA<)>:HS16SN`]_(RDA3U!."*V/!B))X&TJ-@&1K-01Z@CFHM%0NM=1ZW*U MUXHE'P[77K?#74ULGE`+G,S87&._S'I1I?BAKGX>?\)!,R^?%:NTF!@>8N1C M'N1T]ZY?PD)9-5A\(R!BFBZA-ILZ'KNI1^+=2\/:W+&[JHGLI50)YD7?ZD?T-,3Q/?1:)K7B255DT^ M$L-/A"X+JOR[R?1FZ>U4OBC91FRTW48Y'@NH[M;<2QG#>7)D,,UUES;:9;:* M;.Z2*/3UB$+(_"!3A0/Y"A\ME*V_Z?YAJ96EKXDE;3[Y]6L[RTN5W7$2VX4( MI7(V,#D\X'-=)7G4NAW'@;Q#I/\`8FHW#V&HW8@DT^9]X`(R67Z"O1:BHEHU ML-#7171D895A@CVJKIFE6.C62V6G6ZV]NI)"*20">3UJQ,)3$1`Z))V+KN'Y M9%<];Z_>K%875VHDBN;62=X[:$Y7;L]3VR:E)M:`;%GI-AI]W=W5K;K%->.' MG<$GS&]3GZUGW7@KP[>WLUY<:<'GN&W2N)7&X_@:M1Z_I\MTMO'(6+.L88#C M<5W`>O3';'-!U81:Q]6[NTM[^TEM+J(2P3*4D0]&!ZBLBR\3VTMG;/=?+-+ M%')($'RIO.%ZG/7ZX[U+?:T%2:*W#1W$+P[A(H(*O(%R,'Z^]%IWU#0?/X:T M>YT:+1IK)7L(B"D)=L#'3G.>]-T[PKHNDWHO+&S\J<*4W>:[<'KP215=O$4@ MN8G-I.L`^TB1%0,Q\I@-PYZ=:ENM;D^UV\%DJ.+EDC1W!P&92Y)^B+G'JPI^ M_M<-"Z-'T\:P=7%LOVXQ^49LG.STQG%&J:38:U:BUU&W6XA5PX1B1\PZ'BF7 M%Z^EVLD]\WFQID[XDV[5`R<@GZ]/RJ.7Q!9Q2R1LLOR2K"&VX5G8!@H)/H"ZWR2Q;/,DBA(0;R`HY)YYHM* MU@+%OI&GVNI7.HP6J)=W8`FE&'9-6-JZE"+R1*2M$L_M;QS)&LC1R;E`,;!MIR,^O MIFBTMT&A-J6D6&L6\=OJ%N)XXY!(JLQ&&'0\&I;ZPM=3LI;.]@6>WE&'C?H1 M5,Z_:+.\31S@(TB>88_E+(NY@/P!/X4Q?$EB5&]9HW8QA$D0*7W@E2.<8PK= M>F#1:0:":;X6TC2KE;FVMW,R*51YI7E,:^B[B=OX5L5EV&J?VAJ3B%LVQMDD M4%<$-O=6S_WS5ZW6X4-]HD1^?EVKC`I2O?W@1+6>FB6<<$,*^9L@@>W3Y^=C M8S^/`K1HI)M#*%KI%O93&2W>1`V"R;AM8A0N3QG.`/RJPEG%'>S7:[O-F14; MGC"YQQ_P(U/11=L#-M="M+)HVMFECV1K&<-G>JYVYR.V3R,5'#XYN)E1D90[C@HP8=!SR M!UJO<>'+&X9RS3+OW[MK]=[!C].0.E:U%/F:"QGOHMHX(;S.9))/O?Q.I5OT M)ILFA6 EX-3.(I) 3 ex3-1_111306.htm RESTATED CERTIFICATE OF INCORPORATION

Exhibit 3.1

RESTATED CERTIFICATE OF INCORPORATION, AS AMENDED OF

HEALTHWAYS, INC.

(Originally incorporated on September 2, 1981)

FIRST: The name of the corporation (hereinafter called the "Corporation") is Healthways, Inc.

SECOND: The address of the registered office of the Corporation in the State of Delaware is 1209 Orange Street, City of Wilmington, County of New Castle. The name of the registered agent of the Corporation at such address is The Corporation Trust Company.

THIRD: The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware.

FOURTH: The aggregate number of shares of capital stock the Corporation is authorized to issue is 80,000,000 shares, of which 75,000,000 shares shall be Common Stock, par value $.001 per share (the "Common Stock"), and 5,000,000 shares shall be preferred stock, par value $.001 per share (the "Preferred Stock"), of which 750,000 shares are designated as Series A Preferred Stock (the "Series A Preferred Stock").

The designations and the powers, preferences and relative, participating, optional or other rights of the capital stock and the qualifications, limitations or restrictions thereof are as follows:

A.	COMMON STOCK PROVISIONS

Voting Rights.

Except as otherwise required by law or expressly provided herein, the holder of each share of Common Stock shall have one vote on each matter submitted to a vote of the stockholders of the Corporation.

Dividend Rights.

Subject to the provisions of law, the holders of the Common Stock shall be entitled to receive dividends at such times and in such amounts as may be determined by the Board of Directors of the Corporation.

Liquidation Rights.

In the event of any liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, after payment or provision for payment of the debts and other liabilities of the Corporation and the preferential amounts to which the holders of any outstanding shares of

Preferred Stock shall be entitled upon dissolution, liquidation, or winding up, the holders of the Common Stock shall be entitled to share ratably in the remaining assets of the Corporation.

B.	PREFERRED STOCK PROVISIONS

Designation.

The Board of Directors is authorized, subject to any limitations prescribed by law, to provide for the issuance of the shares of Preferred Stock in series, and by filing a certificate pursuant to the applicable law of the State of Delaware, to establish from time to time the number of shares to be included in each such series, and to fix the designation, powers, preferences, and rights of the shares of each such series and any qualifications, limitations or restrictions thereof. The number of authorized shares of Preferred Stock may be increased or decreased (but not below the number of shares thereof then outstanding) by the affirmative vote of the holders of a majority of the Common Stock without a vote of the holders of the Preferred Stock, or of any series thereof, unless a vote of any such holders is required pursuant to the certificate or certificates establishing the series of Preferred Stock.

Liquidation Rights.

If upon any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the assets available for distribution to holders of shares of Preferred Stock of all series shall be insufficient to pay such holders the full preferential amount to which they are entitled, then such assets shall be distributed ratably among the shares of all series of Preferred Stock in accordance with the respective preferential amounts payable with respect thereto.

Series A Preferred Stock.

Pursuant to the authority vested in the Board of Directors in accordance with the provisions of this Article Fourth of the Restated Certificate of Incorporation, the Board of Directors does hereby create, authorize and provide for the issuance of the Series A Preferred Stock out of the class of 5,000,000 shares of Preferred Stock, having the voting powers, designation, relative, participating, optional and other special rights, preferences, and qualifications, limitations and restrictions thereof that are set forth as follows:

(a) Designation and Amount. The shares of such series shall be designated as Series A Preferred Stock ("Series A Preferred Stock") and the number of shares constituting such series shall be 750,000. Such number of shares may be adjusted by appropriate action of the Board of Directors.

(b) Dividends and Distributions. Subject to the prior and superior rights of the holders of any shares of any other series of Preferred Stock or any other shares of Preferred Stock of the Corporation ranking prior and superior to the shares of Series A Preferred Stock with respect to dividends, each holder of one one-hundredth (1/100) of a share (a "Unit") of Series A Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for that purpose, dividends at the same rate as dividends

are paid with respect to the Common Stock. In the event that the Corporation shall at any time after June 19, 2000 (the "Rights Dividend Declaration Date") (i) declare or pay any dividend on outstanding shares of Common Stock payable in shares of Common Stock; (ii) subdivide outstanding shares of Common Stock; or (iii) combine outstanding shares of Common Stock into a smaller number of shares, then in each such case the amount to which the holder of a Unit of Series A Preferred Stock was entitled immediately prior to such event pursuant to the preceding sentence shall be adjusted by multiplying such amount by a fraction the numerator of which shall be the number of shares of Common Stock that are outstanding immediately after such event and the denominator of which shall be the number of shares of Common Stock that were outstanding immediately prior to such event.

(i) Subject to the provision for adjustment hereinafter set forth, each Unit of Series A Preferred Stock shall entitle the holder thereof to one vote on all matters submitted to a vote of the stockholders of the Corporation. In the event the Corporation shall at any time after the Rights Dividend Declaration Date (i) declare any dividend on outstanding shares of Common Stock payable in shares of Common Stock; (ii) subdivide outstanding shares of Common Stock; or (iii) combine the outstanding shares of Common Stock into a smaller number of shares, then in each such case the number of votes per Unit to which holders of Units of Series A Preferred Stock were entitled immediately prior to such event shall be adjusted by multiplying such number by a fraction the numerator of which shall be the number of shares of Common Stock that are outstanding immediately after such event and the denominator of which shall be the number of shares of Common Stock that were outstanding immediately prior to such event.

(ii) Except as otherwise provided herein or by law, the holders of Units of Series A Preferred Stock and the holders of shares of Common Stock shall vote together as one class on all matters submitted to a vote of stockholders of the Corporation.

(iii) Except as set forth herein or required by law, holders of Units of Series A Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of shares of Common Stock as set forth herein) for the taking of any corporate action.

(d) Reacquired Shares. Any Units of Series A Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and cancelled promptly after the acquisition thereof. All such Units shall, upon their cancellation, become authorized but unissued Units of Series A Preferred Stock to be created by resolution or resolutions of the Board of Directors, subject to the conditions and restrictions on issuance set forth herein.

(e) Liquidation. Upon any liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, the holders of Units of SeriesA Preferred Stock shall be entitled to share in any assets remaining ratably with the holders of the Common Stock. In the

event the Corporation shall at any time after the Rights Dividend Declaration Date (i) increase by way of stock split or similar transaction the number of outstanding shares of Common Stock; (ii) subdivide the outstanding shares of Common Stock; or (iii) combine the outstanding shares of Common Stock into a smaller number of shares, then in each such case the aggregate amount to which holders of Units of Series A Preferred Stock were entitled prior to such event shall be adjusted by multiplying such amount by a fraction, the numerator of which shall be the number of shares of Common Stock that are outstanding immediately after such event and the denominator of which shall be the number of shares of Common Stock that were outstanding immediately prior to such event.

(f) Share Exchange, Merger, Etc. In case the Corporation shall enter into any share exchange, merger, combination or other transaction in which the shares of Common Stock are exchanged for or converted into other stock or securities, cash and/or any other property, then in any such case Units of Series A Preferred Stock shall at the same time be similarly exchanged for or converted into an amount per Unit (subject to the provision for adjustment hereinafter set forth) equal to the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is converted or exchanged. In the event the Corporation shall at any time after the Rights Dividend Declaration Date (i) declare any dividend on outstanding shares of Common Stock payable in shares of Common Stock; (ii) subdivide outstanding shares of Common Stock; or (iii) combine outstanding shares of Common Stock into a smaller number of shares, then in each such case the amount set forth in the immediately preceding sentence with respect to the exchange or conversion of Units of Series A Preferred Stock shall be adjusted by multiplying such amount by a fraction the numerator of which shall be the number of shares of Common Stock that are outstanding immediately after such event and the denominator of which shall be the number of shares of Common Stock that were outstanding immediately prior to such event.

(g) Redemption. The Units of Series A Preferred Stock shall not be redeemable at the option of the Corporation or any holder thereof. Notwithstanding the foregoing sentence of this Section, the Corporation may acquire Units of Series A Preferred Stock in any other manner permitted by law and the Certificate of Incorporation or Bylaws of the Corporation.

(h) Ranking. The Units of Series A Preferred Stock shall rank junior to all other series of the Preferred Stock and to any other class of Preferred Stock that hereafter may be issued by the Corporation as to the payment of dividends and the distribution of assets, unless the terms of any such series or class shall provide otherwise.

(i) Amendment. The Certificate of Incorporation, including without limitation the provisions hereof, shall not hereafter be amended, either directly or indirectly, or through merger or share exchange with another corporation, in any manner that would alter or change the powers, preferences or special rights of the Series A Preferred Stock so as to affect the holders thereof adversely without the affirmative vote of the holders of a majority or more of the outstanding Units of Series A Preferred Stock, voting separately as a class.

(j) Fractional Shares. The Series A Preferred Stock may be issued in Units or other fractions of a share, which Units or fractions shall entitle the holder, in proportion to such

holder’s fractional shares, to exercise voting rights, receive dividends, participate in distributions and to have the benefit of all other rights of holders of Series A Preferred Stock.

FIFTH:

(a) The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors. Except as otherwise fixed by or pursuant to the provisions of Article FOURTH hereof relating to the rights of the holders of any class or series of stock having a preference over the Common Stock as to dividends or upon liquidation to elect additional directors under specified circumstances, the number of directors shall be fixed by or in the manner provided in the by-laws of the Corporation.

(b) The directors, other than those who may be elected by the holders of any class or series of stock having a preference over the Common Stock as to dividends or upon liquidation, shall be divided into three classes, designated Class I, Class II and Class III. Each class shall consist, as nearly equal in number as possible, of one-third of the total number of directors constituting the entire Board of Directors. At each annual meeting of stockholders, successors to the class of directors whose term expires at that annual meeting shall be elected for a three-year term. If the number of directors is changed, any increase or decrease shall be apportioned among the classes so as to maintain the number of directors in each class as nearly equal as possible.

(c) A director shall hold office until the annual meeting of stockholders for the year in which his or her term expires and until his or her successor shall be elected and shall qualify, subject, however, to prior death, resignation, retirement, disqualification or removal from office. Any additional director of any class appointed or elected to fill a vacancy resulting from an increase in such class shall hold office for a term that shall coincide with the remaining term of that class, but in no case will a decrease in the number of directors shorten the term of any incumbent director.

(d) Elections of directors need not be by written ballot unless the by-laws of the Corporation so provide.

SIXTH: In furtherance and not in limitation of the powers conferred by statute and unless otherwise provided herein, the Board of Directors, by a majority vote taken at any meeting at which a quorum is present, is expressly authorized to make, alter or repeal the by-laws of the Corporation.

SEVENTH: No director of the Corporation shall be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided, however, that this provision shall not eliminate or limit the liability of a director (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (ii)for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii)under Section 174 of the Delaware General Corporation Law or (iv)for any transaction from which the director derived an improper personal benefit.

EIGHTH:

(a) Right to Indemnification. Each person who was or is made a party or is threatened to be made a party to or is otherwise involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative (hereinafter a "proceeding"), by reason of the fact that he or she is or was a director or an officer of the Corporation or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise, including service with respect to an employee benefit plan (hereinafter an "indemnitee"), whether the basis of such proceeding is alleged action in an official capacity as a director, officer, employee or agent or in any other capacity while serving as a director, officer, employee or agent, shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Delaware General Corporation Law, as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Corporation to provide broader indemnification rights than such law permitted the Corporation to provide prior to such amendment), against all expense, liability and loss (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid in settlement) reasonably incurred or suffered by such indemnitee in connection therewith; provided, however, that, except as provided in Section (c) of this Article EIGHTH with respect to proceedings to enforce rights to indemnification, the Corporation shall indemnify any such indemnitee in connection with a proceeding (or part thereof) initiated by such indemnitee only if such proceeding (or part thereof) was authorized by the Board of Directors of the Corporation.

(b) Right to Advancement of Expenses. The right to indemnification conferred in Section (a) of this Article EIGHTH shall include the right to be paid by the Corporation the expenses (including attorneys' fees) incurred in defending any such proceeding in advance of its final disposition (hereinafter an "advancement of expenses"); provided, however, that, if the Delaware General Corporation Law requires, an advancement of expenses incurred by an indemnitee in his or her capacity as a director or officer (and not in any other capacity in which service was or is rendered by such indemnitee, including, without limitation, service to an employee benefit plan) shall be made only upon delivery to the Corporation of an undertaking (hereinafter an "undertaking"), by or on behalf of such indemnitee, to repay all amounts so advanced if it shall ultimately be determined by final judicial decision from which there is no further right to appeal (hereinafter a "final adjudication") that such indemnitee is not entitled to be indemnified for such expenses under this Section (b) or otherwise. The rights to indemnification and to the advancement of expenses conferred in Sections (a) and (b) of this Article EIGHTH shall be contract rights and such rights shall continue as to an indemnitee who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the indemnitee's heirs, executors and administrators.

(c) Right of Indemnitee to Bring Suit. If a claim under Section (a) or (b) of this Article EIGHTH is not paid in full by the Corporation within sixty (60) days after a written claim has been received by the Corporation, except in the case of a claim for an advancement of expenses, in which case the applicable period shall be twenty (20) days, the indemnitee may at

any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim. If successful in whole or in part in any such suit, or in a suit brought by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking, the indemnitee shall be entitled to be paid also the expense of prosecuting or defending such suit. In (i) any suit brought by the indemnitee to enforce a right to indemnification hereunder (but not in a suit brought by the indemnitee to enforce a right to an advancement of expenses) it shall be a defense that, and (ii) in any suit brought by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking, the Corporation shall be entitled to recover such expenses upon a final adjudication that, the indemnitee has not met any applicable standard for indemnification set forth in the Delaware General Corporation Law. Neither the failure of the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) to have made a determination prior to the commencement of such suit that indemnification of the indemnitee is proper in the circumstances because the indemnitee has met the applicable standard of conduct set forth in the Delaware General Corporation Law, nor an actual determination by the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) that the indemnitee has not met such applicable standard of conduct, shall create a presumption that the indemnitee has not met the applicable standard of conduct or, in the case of such a suit brought by the indemnitee, be a defense to such suit. In any suit brought by the indemnitee to enforce a right to indemnification or to an advancement of expenses hereunder, or brought by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking, the burden of proving that the indemnitee is not entitled to be indemnified, or to such advancement of expenses, under this Article EIGHTH or otherwise shall be on the Corporation.

(d) Non-Exclusivity of Rights. The rights to indemnification and to the advancement of expenses conferred in this Article EIGHTH shall not be exclusive of any other right which any person may have or hereafter acquire under any statute, the Corporation's Restated Certificate of Incorporation, by-laws, agreement, vote of stockholders or disinterested directors or otherwise.

(e) Insurance. The Corporation may maintain insurance, at its expense, to protect itself and any director, officer, employee or agent of the Corporation or another corporation, partnership, joint venture, trust or other enterprise against any expense, liability or loss, whether or not the Corporation would have the power to indemnify such person against such expense, liability or loss under the Delaware General Corporation Law.

(f) Indemnification of Employees and Agents of the Corporation. The Corporation may, to the extent authorized from time to time by the Board of Directors, grant rights to indemnification and to the advancement of expenses to any employee or agent of the Corporation to the fullest extent of the provisions of this Article EIGHTH with respect to the indemnification and advancement of expenses of directors and officers of the Corporation.

NINTH: No amendment to or repeal of Article SEVENTH or EIGHTH of this Restated Certificate of Incorporation shall apply to or have any effect on the rights of any individual referred to in Article SEVENTH or EIGHTH for or with respect to acts or omissions of such individual occurring prior to such amendment or repeal.

TENTH:

Vote Required For Certain Business Combinations

1. In addition to any affirmative vote required by law or this Restated Certificate of Incorporation, and except as otherwise expressly provided in Section B of this Article TENTH:

(a) any merger or consolidation of the Corporation or any Subsidiary (as hereinafter defined) with (i) any Interested Stockholder (as hereinafter defined) or (ii) any other corporation (whether or not itself an Interested Stockholder) which is, or after such merger or consolidation would be, an Affiliate (as hereinafter defined) of an Interested Stockholder; or

(b) any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or a series of transactions) to or with any Interested Stockholder or any Affiliate of any Interested Stockholder of any assets of the Corporation or any Subsidiary having an aggregate Fair Market Value of $30,000,000 or more; or

(c) the issuance or transfer by the Corporation or any Subsidiary (in one transaction or a series of transactions) of any securities of the Corporation or any Subsidiary to any Interested Stockholder or any Affiliate of any Interested Stockholder in exchange for cash, securities or other property (or a combination thereof) having an aggregate Fair Market Value of $10,000,000 or more; or

(d) the adoption of any plan or proposal for the liquidation or dissolution of the Corporation proposed by or on behalf of an Interested Stockholder or any Affiliate of any Interested Stockholder; or

(e) any reclassification of securities (including any reverse stock split), or recapitalization of the Corporation, or any merger or consolidation of the Corporation with any of its Subsidiaries or any other transaction (whether or not with or into or otherwise involving an Interested Stockholder) which has the effect, directly or indirectly, of increasing the proportionate share of the outstanding shares of any class of equity or convertible securities of the Corporation or any Subsidiary which is directly or indirectly owned by any Interested Stockholder or any Affiliate of any Interested Stockholder;

shall require the affirmative vote of the holders of at least 80% of the voting power of the then outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (the "Voting Stock"), excluding shares held by the Interested Stockholder, voting together as a single class (it being understood that for purposes of this Article TENTH, each share of the Voting Stock shall have the number of votes granted to it pursuant to Article FOURTH of this Restated Certificate of Incorporation). Such affirmative vote shall be required notwithstanding the fact that no vote may be required, or that a lesser percentage may be specified, by law or in any agreement with any national securities exchange or otherwise.

2. The term "Business Combination" as used in this Article TENTH shall mean any transaction which is referred to in any one or more of subparagraphs (a) through (e) of paragraph 1 of this Section A.

B. When Higher Vote Is Not Required. The provisions of Section A of this Article TENTH shall not be applicable to any particular Business Combination, and such Business Combination shall require only such affirmative vote as is required by law and any other provision of this Restated Certificate of Incorporation, if all of the conditions specified in either of the following paragraphs 1 or 2 are met:

1. The Business Combination shall have been approved by a majority of the Disinterested Directors (as hereinafter defined).

All of the following conditions shall have been met:

(a) The aggregate amount of the cash and the Fair Market Value (as hereinafter defined) as of the date of the consummation of the Business Combination of consideration other than cash to be received per share by holders of Common Stock in such Business Combination shall be at least equal to the higher of the following:

I. (if applicable) the Highest Per Share Price (as hereinafter defined) (including the brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Stockholder for any shares of Common Stock acquired by it (X) within the two year period immediately prior to the first public announcement of the proposal of the Business Combination (the "Announcement Date") or (Y) in the transaction in which it became an Interested Stockholder, whichever is higher; and

II. the Fair Market Value per share of Common Stock on the Announcement Date or on the date on which the Interested Stockholder became an Interested Stockholder (such latter date is referred to in this Article TENTH as the "Determination Date"), whichever is higher.

(b) The aggregate amount of the cash and the Fair Market Value as of the date of the consummation of the Business Combination of consideration other than cash to be received per share by holders of shares of any class of outstanding Voting Stock other than Common Stock shall be at least equal to the highest of the following (it being intended that the requirements of this subparagraph (b) shall be required to be met with respect to every such class of outstanding Voting Stock, whether or not the Interested Stockholder has previously acquired any shares of a particular class of Voting Stock):

I. (if applicable) the Highest Per Share Price (as hereinafter defined) (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Stockholder for any shares of such class of Voting Stock acquired by it (X) within the two-year period immediately prior to the Announcement Date or (Y) in the transaction in which it became an Interested Stockholder, whichever is higher;

II. (if applicable) the highest preferential amount per share to which the holders of shares of such class of Voting Stock are entitled in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation; and

III. the Fair Market Value per share of such class of Voting Stock on the Announcement Date or on the Determination Date, whichever is higher.

(c) The consideration to be received by holders of a particular class of outstanding Voting Stock (including Common Stock) shall be in cash or in the same form as the Interested Stockholder has previously paid for shares of such class of Voting Stock. If the Interested Stockholder has paid for shares of any class of Voting Stock with varying forms of consideration, the form of consideration for such class of Voting Stock shall be either cash or the form used to acquire the largest number of shares of such class of Voting Stock previously acquired by it.

(d) After such Interested Stockholder has become an Interested Stockholder and prior to the consummation of such Business Combination: (i) except as approved by a majority of the Disinterested Directors, there shall have been no failure to declare and pay at the regular date therefor any full quarterly dividends (whether or not cumulative) on any outstanding Preferred Stock; (ii) there shall have been (x) no reduction in the annual rate of dividends paid on the Common Stock (except as necessary to reflect any subdivision of the Common Stock), except as approved by a majority of the Disinterested Directors, and (y) an increase in such annual rate of dividends as necessary to reflect any reclassification (including any reverse stock split), recapitalization, reorganization or any similar transaction which has the effect of reducing the number of outstanding shares of the Common Stock, unless the failure so to increase such annual rate is approved by a majority of the Disinterested Directors; and (iii) such Interested Stockholder shall have not become the beneficial owner of any additional shares of Voting Stock except as part of the transaction which results in such Interested Stockholder becoming an Interested Stockholder.

(e) After such Interested Stockholder has become an Interested Stockholder, such Interested Stockholder shall not have received the benefit, directly or indirectly (except proportionately as a stockholder), of any loans, advances, guarantees, pledges or other financial assistance or any tax credits or other tax advantages provided by the Corporation, whether in anticipation of or in connection with such Business Combination or otherwise.

(f) A proxy or information statement describing the proposed Business Combination and complying with the requirements of the Securities Exchange Act of 1934, as amended ("Exchange Act"), and the rules and regulations thereunder (or any subsequent provisions replacing the Exchange Act, rules or regulations) shall be mailed to public stockholders of the Corporation at least 30 days prior to the consummation of such Business Combination (whether or not such proxy or information statement is required to be mailed pursuant to the Exchange Act or subsequent provisions).

Certain Definitions. For the purposes of this Article TENTH:

A "person" shall mean any individual, firm, corporation or other entity.

2. "Interested Stockholder" shall mean any person (other than the Corporation or any Subsidiary) who or which:

(a) is the beneficial owner, directly or indirectly, of more than 20% of the voting power of the outstanding Voting Stock; or

(b) is an Affiliate of the Corporation and at any time within the two-year period immediately prior to the date in question was the beneficial owner, directly or indirectly, within the meaning of Rule13d-3 under the Exchange Act, of 20% or more of the voting power of the then outstanding Voting Stock; or

(c) is an assignee of or has otherwise succeeded to any shares of Voting Stock which were at any time within the two-year period immediately prior to the date in question beneficially owned by any Interested Stockholder, if such assignment or succession shall have occurred in the course of a transaction or series of transactions not involving a public offering within the meaning of the Securities Act of 1933.

A person shall be a "beneficial owner" of any Voting Stock:

(a) which such person or any of its Affiliates or Associates (as hereinafter defined) beneficially owns, directly or indirectly, within the meaning of Rule13d-3 under the Exchange Act; or

(b) which such person or any of its Affiliates or Associates has (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise, or (ii) the right to vote pursuant to any agreement, arrangement or understanding (but neither such person nor any such Affiliate or Associate shall be deemed to be the beneficial owner of any shares of Voting Stock solely by reason of a revocable proxy granted for a particular meeting of stockholders, pursuant to a public solicitation of proxies for such meeting, and with respect to which shares neither such person nor any such Affiliate or Associate is otherwise deemed the beneficial owner); or

(c) which are beneficially owned, directly or indirectly, within the meaning of Rule13d-3 under the Exchange Act, by any other person with which such person or any of its Affiliates or Associates has any agreement, arrangement or understanding for the purposes of acquiring, holding, voting (other than solely by reason of a revocable proxy as described in subparagraph (b) of this paragraph (3)) or disposing of any shares of Voting Stock;

provided, however, that in the case of any employee stock ownership or similar plan of the Corporation or of any Subsidiary in which the beneficiaries thereof possess the right to vote any

shares of Voting Stock held by such plan, no such plan nor any trustee with respect thereto (nor any Affiliate of such trustee), solely by reason of such capacity of such trustee, shall be deemed, for any purposes hereof, to beneficially own any shares of Voting Stock held under any such plan.

4. For the purposes of determining whether a person is an Interested Stockholder pursuant to paragraph 2 of this Section C, the number of shares of Voting Stock deemed to be outstanding shall include shares deemed owned by such person through application of paragraph 3 of this Section C but shall not include any other shares of Voting Stock which may be issuable pursuant to any agreement, arrangement or understanding, or upon exercise of conversion rights, warrants or options, or otherwise.

5. "Affiliate" or "Associate" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Exchange Act.

6. "Subsidiary" means any corporation of which a majority of any class of equity security is owned, directly or indirectly, by the Corporation; provided, however, that for the purposes of the definition of Interested Stockholder set forth in paragraph 2 of this Section C, the term "Subsidiary" shall mean only a corporation of which a majority of each class of equity security is owned, directly or indirectly, by the Corporation.

7. "Disinterested Director" means any member of the Board of Directors who is unaffiliated with the Interested Stockholder and was a member of the Board of Directors prior to the time that the Interested Stockholder became an Interested Stockholder, and any successor of a Disinterested Director who is unaffiliated with the Interested Stockholder and is recommended to succeed a Disinterested Director by a majority of Disinterested Directors then on the Board of Directors.

8. "Fair Market Value" means: (a) in the case of stock, the highest closing sale price during the 30-day period immediately preceding the date in question of a share of such stock on the Composite Tape for New York Stock Exchange-Listed Stocks, or, if such stock is not quoted on the Composite Tape, on the New York Stock Exchange, or, if such stock is not listed on such Exchange, on the principal United States securities exchange registered under the Exchange Act on which such stock is listed, or, if such stock is not listed on any such exchange, the highest closing bid quotation with respect to a share of such stock during the 30-day period preceding the date in question on the National Association of Securities Dealers Automated Quotation System or any system then in use, or if no such quotations are available, the fair market value on the date in question of a share of such stock as determined by the Board of Directors in good faith, in each case with respect to any class of stock, appropriately adjusted for any dividend or distribution in shares of such stock or any stock split or reclassification of outstanding shares of such stock into a greater number of shares of such stock or any combination or reclassification of outstanding shares of such stock into a smaller number of shares of such stock; and (b) in the case of property other than cash or stock, the fair market value of such property on the date in question as determined by the Board of Directors in good faith.

9. References to "Highest Per Share Price" shall in each case with respect to any class of stock reflect an appropriate adjustment for any dividend or distribution in shares of such stock or any stock split or reclassification of outstanding shares of such stock into a greater number of shares of such stock or any combination or reclassification of outstanding shares of such stock into a smaller number of shares of such stock.

10. In the event of any Business Combination in which the Corporation survives, the phrase "consideration other than cash" as used in subparagraphs (a) and (b) of paragraph 2 of Section B of this Article TENTH shall include the shares of Common Stock and/or the shares of any other class of outstanding Voting Stock retained by the holders of such shares.

D. Powers of the Board of Directors. A majority of the directors of the Corporation shall have the power and duty to determine for the purposes of this Article TENTH, on the basis of information known to them after reasonable inquiry, (a) whether a person is an Interested Stockholder, (b) the number of shares of Voting Stock beneficially owned by any person, (c) whether a person is an Affiliate or Associate of another and (d) whether the assets which are the subject of any Business Combination have, an aggregate Fair Market Value of $30,000,000 or more, or the consideration to be received for the issuance or transfer of securities by the Corporation or any Subsidiary in any Business Combination has, an aggregate Fair Market Value of $10,000,000 or more.

E. No Effect on Fiduciary Obligations of Interested Stockholders. Nothing contained in this Article TENTH shall be construed to relieve any Interested Stockholder from any fiduciary obligation imposed by law.

F. Amendment or Repeal. Notwithstanding any other provisions of this Restated Certificate of Incorporation or the by-laws of the Corporation (and notwithstanding the fact that a lesser percentage may be specified by law, this Restated Certificate of Incorporation or the by-laws of the Corporation), the affirmative vote of the holders of 80% or more of the outstanding Voting Stock, excluding shares held by an Interested Stockholder, voting together as a single class, shall be required to amend or repeal, or adopt any provisions inconsistent with this Article TENTH.

ELEVENTH: No action required to be taken or which may be taken at any annual or special meeting of stockholders of the Corporation may be taken without a meeting, and the power of stockholders to consent, in writing, without a meeting, to the taking of any action is specifically denied.

TWELFTH: The Corporation shall not be governed by the provisions of Section203 of the General Corporation Law of the State of Delaware.

IN WITNESS WHEREOF, this Restated Certificate of Incorporation which restates, integrates and amends the provisions of the Certificate of Incorporation of the Corporation, and which has been duly adopted in accordance with Section 242 of the General Corporation Law of the State of Delaware, has been executed by its President and attested by its Secretary, this 20th day of August, 1991.

HEALTHWAYS, INC.

By: /s/ Thomas G. Cigarran

Thomas G. Cigarran

President

ATTEST:

/s/ Henry D. Herr

Henry D. Herr

Secretary

EX-10 4 ex10-18_111306.htm AMENDMENT TO 1991 PLAN

Exhibit 10.18

Amendment to the 1991 Employee Stock Incentive Plan

The third paragraph of Section 3 of the 1991 Plan is deleted in its entirety and replaced with the following:

In the event of any merger, reorganization, consolidation, recapitalization, extraordinary cash dividend, Stock dividend, Stock split or other change in corporate structure affecting the Common Stock, the Committee shall make an equitable and proportionate substitution or adjustment 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 and purchase price of shares subject to outstanding Stock Purchase Rights under the Plan, and in the number of shares subject to other outstanding awards granted under the Plan, 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.

EX-10 5 ex10-20_111306.htm 1996 STOCK INCENTIVE PLAN

Exhibit 10.20

HEALTHWAYS, INC.

1996 STOCK INCENTIVE PLAN

SECTION 1. Purpose; Definitions.

The purpose of the Healthways, Inc. 1996 Stock Incentive Plan (the "Plan") is to enable 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.

"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.

"Committee" means the Committee referred to in Section 2 of the Plan.

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

G. "Covered Officer" shall mean at any date (i) any individual who, with respect to the previous taxable year of the Company, was a "covered employee" of the Company within the meaning of Section 162(m) of the Code; provided, however, that the term "Covered Officer" shall not include any such individual who is designated by the Committee, in its discretion, at the time of any award under the Plan or at any subsequent time, as reasonably expected not to be such a "covered employee" with respect to the current taxable year of the Company and (ii) any individual who is designated by the Committee, in its discretion, at the time of any award or at any subsequent time, as reasonably expected to be such a "covered employee" with respect to the current taxable year of the Company or with respect to the taxable year of the Company in which any applicable award hereunder will be paid.

H. "Disability" means disability as determined under the Corporation's long-term disability insurance policy.

I. "Early Retirement" for purposes of this Plan, shall be deemed to have occurred if (i) the sum of the participant's age plus years of employment at the Company as of the proposed early retirement date is equal to or greater than 70, (ii) the participant has given written notice to the company at least one year prior to the proposed early retirement date of his or her intent to retire and (iii) the Chief Executive Officer shall have approved in writing such early retirement request prior to the proposed early retirement date, provided that in the event the Chief Executive Officer does not approve the request for early retirement or the Chief Executive Officer is the participant giving notice of his or her intent to retire, then in both cases, the Board of Directors shall make the determination of whether to approve or disapprove such request.

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

N. "Non-Qualified Stock Option" means any Stock Option that is not an Incentive Stock Option.

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

P. "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.

Q. "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.

"Outside Director Restricted Stock" shall have the meaning provided in Section 9.

S. "Participant" shall mean any person who is eligible under Section 4 of the Plan and who receives an award under the Plan.

T. "Performance Award" shall mean any Award granted under Section 8(C) of the Plan.

U. "Plan" means this Healthways, Inc. 1996 Stock Incentive Plan, as amended from time to time.

V. "Restricted Stock" means an award of shares of Stock that is subject to restrictions under Section 7 below.

W. "Restricted Stock Unit" shall mean any unit granted under Section 7(E) of the Plan.

"Restriction Period" shall have the meaning provided in Section 7.

"Retirement" means Normal or Early Retirement.

"Stock" means the Common Stock.

AA. "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).

BB. "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.

CC. "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 one or more committees of Non-Employee Directors who shall also be independent directors, as defined by applicable rules and regulations of the Commission and the Nasdaq Stock Market or such other exchange or market on which the Corporation’s Stock is traded, and “Outside Directors” as defined in the Code for purposes of Section 162(m) thereof, designated from time to time by the Board (individually and collectively, the “Committee”).

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;

(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. Subject to the terms of the Plan and applicable law, the Committee may delegate to one or more officers or managers of the Company or of any Subsidiary or Affiliate, or to a committee of such officers or managers, the authority, subject to such terms and limitations as the Committee shall determine, to grant awards under the Plan to, or to cancel, modify or waive rights with respect to, or to alter, discontinue, suspend, or terminate such awards

held by Participants who are not officers or directors of the Company for purposes of Section 16 of the Exchange Act or who are otherwise not subject to such provision of law.

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 9,040,000 shares. Any number of shares of Stock may be awarded so long as the total shares of Stock awarded does not exceed 9,040,000 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, the Committee shall make an equitable and proportionate substitution or adjustment 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, 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 and Section 8(c) of this Plan will be equitably and proportionately 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 and Restricted Stock Units.

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.

E. Restricted Stock Units. Subject to the provisions of the Plan, the Committee shall have sole and complete authority to determine the Participants to whom Restricted Stock Units shall be granted, the number of Restricted Stock Units to be granted to each Participant, the duration of the period during which, and the conditions under which, the Restricted Stock Units may be forfeited to the Company, and the other terms and conditions of such awards. The Restricted Stock Unit awards shall be evidenced by award agreements in such form as the Committee shall from time to time approve, which agreements shall comply with and be subject to the terms and conditions provided hereunder and any additional terms and conditions determined by the Committee that are consistent with the terms of the Plan.

Each Restricted Stock Unit award made under the Plan shall be for such number of shares of Stock as shall be determined by the Committee and set forth in the award agreement containing the terms of such Restricted Stock Unit award. The agreement shall set forth a period of time during which the grantee must remain in the continuous employment of the Company in order for the forfeiture and transfer restrictions to lapse. The Award Agreement may, in the discretion of the Committee, set forth performance or other conditions that will subject the Restricted Stock Units to forfeiture and transfer restrictions. The Committee may, in its discretion, waive all or any part of the restrictions applicable to any or all outstanding Restricted Stock Unit awards.

Each Restricted Stock Unit shall have a value equal to the Fair Market Value of a share of Stock. Restricted Stock Units shall be paid in cash, shares of Stock, other securities or other property, as determined in the sole discretion of the Committee, upon the lapse of the restrictions applicable thereto, or otherwise in accordance with the applicable award agreement. A Participant shall be credited with dividend equivalents on any vested Restricted Stock Units credited to the Participant's account at the time of any payment of dividends to shareholders on shares of Stock. The amount of any such dividend equivalents shall equal the amount that would have been payable to the Participant as a shareholder in respect of a number of shares of Stock equal to the number of vested Restricted Stock Units then credited to the Participant. Any such dividend equivalents shall be credited to the Participant's account as of the date on which such dividend would have been payable and shall be converted into additional Restricted Stock Units (which shall be immediately vested) based upon the Fair Market Value of a share of Stock on the date of such crediting. No dividend equivalents shall be paid in respect of Restricted Stock Units that are not yet vested. Except as otherwise determined by the Committee at or after grant, and subject to the “retirement” exceptions, Restricted Stock Units may not be sold, assigned, transferred, pledged, hypothecated or otherwise encumbered or disposed of, and all Restricted Stock Units and all rights of the grantee to such Restricted Stock Units shall terminate, without further obligation on the part of the Company, unless the grantee remains in continuous employment of the Company for the entire restricted period in relation to which such Restricted

Stock Units were granted and unless any other restrictive conditions relating to the Restricted Stock Unit Award are met.

SECTION 8. Other Stock-Based Awards and Performance 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.

C. Performance Awards. The Committee shall have sole and complete authority to determine the participants who shall receive a Performance Award, which shall consist of a right that is (i) denominated in cash or shares of Stock, (ii) valued, as determined by the Committee, in accordance with the achievement of such performance goals during such performance periods as the Committee shall establish, and (iii) payable at such time and in such form as the Committee shall determine. Notwithstanding anything in the Plan to the contrary, Performance Awards shall be subject to the terms and provisions of this Section 8(C).

The Committee may grant Performance Awards to Covered Officers based solely upon the attainment of performance targets related to one or more performance goals selected by the Committee from among the goals specified below. For the purposes of this Section 8(C), performance goals shall be limited to one or more of the following Corporation, Subsidiary, operating unit or division financial performance measures:

(i)

earnings before interest, taxes, depreciation and/or amortization;

(ii)

operating income or profit;

(iii)

operating efficiencies;

(iv)

return on equity, assets, capital, capital employed, or investment;

(v)

after tax operating income;

(vi)

net income;

(vii)

earnings or book value per share;

(viii)

cash flow(s);

(ix)

total sales or revenues or sales or revenues per employee;

(x)

production;

(xi)

stock price or total shareholder return;

(xii)

dividends;

(xiii)

strategic business objectives, consisting of one or more objectives based on meeting specified cost targets, business expansion goals, and goals relating to acquisitions or divestitures;

or any combination thereof. Each goal may be expressed on an absolute and/or relative basis, may be based on or otherwise employ comparisons based on internal targets, the past

performance of the Corporation or any Subsidiary, operating unit or division of the Corporation and/or the past or current performance of other companies, and in the case of earnings-based measures, may use or employ comparisons relating to capital, shareholders' equity and/or shares of Stock outstanding, or to assets or net assets.

With respect to any Covered Officer, the aggregate maximum number of shares of Stock in respect of which all Performance Awards and Stock Options may be granted under Sections 5 and 8(C) of the Plan in each year of the performance period is 450,000, and the maximum amount of the aggregate Performance Awards denominated in cash is $1,000,000 in each year of the performance period.

To the extent necessary to comply with Section 162(m) of the Code, with respect to grants of Performance Awards to Covered Officers, no later than 90 days following the commencement of each performance period (or such other time as may be required or permitted by Section 162(m) of the Code), the Committee shall, in writing, (1) select the performance goal or goals applicable to the performance period, (2) establish the various targets and bonus amounts which may be earned for such performance period, and (3) specify the relationship between performance goals and targets and the amounts to be earned by each Covered Officer for such performance period. Following the completion of each performance period, the Committee shall certify in writing whether the applicable performance targets have been achieved and the amounts, if any, payable to Covered Officers for such performance period. In determining the amount earned by a Covered Officer for a given performance period, subject to any applicable Performance Award agreement, the Committee shall have the right to reduce the amount payable at a given level of performance to take into account additional factors that the Committee may deem relevant to the assessment of individual or corporate performance for the performance period.

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.

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 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 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. With respect to Non-Qualified Stock Options granted prior to December 31, 2004:

(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.

With respect to Non-Qualified Stock Options granted on or after January 1, 2005, 100% 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 may vest and be exercisable following the termination or expiration of the Optionee's position as a director 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 removal by the stockholders for cause and if the Optionee has (x) (a) served at least two full three-year terms as a director, or (b) served at least two terms as a director of the Corporation (the first of which may be a partial term and the last of which shall be a full three-year term) and offered to resign from the Board on or after such Optionee’s 70^th birthday, which offer to resign has been accepted by the Corporation, and (y) in the event of the Optionee’s retirement from the Board, given the Corporation at least nine months’ prior written notice of the Optionee’s intent not to stand for re-election at the end of the Optionee’s then-current term, each Non-Qualified Stock Option granted to Optionee shall vest and become immediately exercisable at the end of the Optionee’s then-current term and may be exercised by the Optionee for a period of one year from the end of such term or until the expiration of the stated term of the Option, whichever period is 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 without meeting the requirements of subsection Q(i) above, 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

If the Optionee shall cease to be a director of the Corporation for any reason (including removal by the stockholders for cause) other than retirement, Disability, or death without meeting the requirements of subsection Q(i) above , the Optionee may exercise the Non-Qualified Stock Option, to the extent it was exercisable on the date of such cessation. 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.

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.

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

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, except as otherwise set forth in subsection 9(T) 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-10 6 ex10-21_111306.htm AMENDED AND RESTATED 2001 STOCK OPTION PLAN

Exhibit 10.21

HEALTHWAYS, INC.

AMENDED AND RESTATED 2001 STOCK OPTION PLAN

SECTION 1.

Purpose; Definitions.

The purpose of the Healthways, Inc. Amended and Restated 2001 Stock Option Plan (the “Plan”) is to enable Healthways, Inc. (the “Corporation”) to attract, retain and reward key employees of and consultants to the Corporation and its Subsidiaries and Affiliates, and strengthen the mutuality of interests between such key employees and consultants by awarding such key employees and consultants equity-based incentives in the Corporation. 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.

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

“Cause” has the meaning provided in Section 5(j) of the Plan.

D. “Change in Control” has the meaning provided in Section 6(b) of the Plan.

E. “Change in Control Price” has the meaning provided in Section 6(d) of the Plan.

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

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

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

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

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

K. “Early Retirement” for purposes of this Plan, shall be deemed to have occurred if (i) the sum of the participant's age plus years of employment at the Company as of the proposed early retirement date is equal to or greater than 70, (ii) the participant has given written notice to the company at least one year prior to the proposed early retirement date of his or her intent to retire and (iii) the Chief Executive Officer shall have approved in writing such early retirement request prior to the proposed early retirement date, provided that in the event the Chief Executive Officer does not approve the request for early retirement or the Chief Executive Officer is the participant giving notice of his or her intent to retire, then in both cases, the Board of Directors shall make the determination of whether to approve or disapprove such request.

L. “Effective Date” has the meaning provided in Section 10 of the Plan.

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

N. “Fair Market Value” means with respect to the Common 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 Common Stock on Nasdaq or such other market or exchange as is the principal trading market for the Common Stock, or, if no such sale of a share of Common Stock is reported on Nasdaq or other exchange or principal trading market on such date, the fair market value of a share of Common Stock as determined by the Committee in good faith.

O. “Immediate Family” means 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.

“Nasdaq" means The Nasdaq National Stock Market.

Q. “Non-Qualified Stock Option” means any stock option that is not an incentive stock option within the meaning of Section 422 of the Code granted pursuant to Section 5 hereof.

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

S. “Plan” means this Healthways, Inc. Amended and Restated 2001 Stock Option Plan, as amended from time to time.

“Retirement” means Normal or Early Retirement.

U. “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.

SECTION 2.

Administration.

The Plan shall be administered by a Committee of not less than two non-employee directors, 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 non-employee directors. 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, Non-Qualified Stock Options to officers and other key employees of and consultants to the Corporation.

In particular, the Committee, or the Board, as the case may be, 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 Non-Qualified Stock Options, may from time to time be granted hereunder;

(b) to determine whether and to what extent Non-Qualified Stock Options are to be granted hereunder to one or more eligible persons;

(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 Non-Qualified Stock Option and/or the shares of Common 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 7 hereof;

(e) to determine whether and under what circumstances a Non-Qualified Stock Option may be settled in Common Stock instead of cash;

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

(g) to determine whether, to what extent, and under what circumstances shares of Common 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);

(h) to determine whether to require payment of tax withholding requirements in shares of Common Stock subject to the award; and

(i) to impose any holding period required to satisfy Section 16 under the Exchange Act.

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.

SECTION 3.

Shares of Common Stock Subject to Plan.

(a) As of the Effective Date, the aggregate number of shares of Common Stock that may be issued under the Plan shall be 1,800,000 shares. The shares of Common Stock issuable under the Plan may consist, in whole or in part, of authorized and unissued shares or treasury shares.

(b) If any shares of Common Stock that have been optioned cease to be subject to a Non-Qualified Stock Option or any such award otherwise terminates without a payment being made to the participant in the form of Common Stock, such shares shall again be available for distribution in connection with future awards under the Plan.

(c) In the event of any merger, reorganization, consolidation, recapitalization, extraordinary cash dividend, stock dividend, stock split or other change in corporate structure affecting the Common Stock, the Committee shall make an equitable and proportionate substitution or adjustment in the maximum number of shares that may be awarded under the Plan and in the number and option price of shares subject to outstanding Non-Qualified Options granted under the Plan, provided that the number of shares subject to any award shall always be a whole number. The maximum number of shares that may be awarded to any

officer or key employee under Section 4 of this Plan will be equitably and proportionately adjusted in the same manner as the number of shares subject to outstanding Non-Qualified Stock 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) 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 under this Plan in excess of 450,000 shares during any calendar year.

SECTION 5.

Non-Qualified Stock Options.

Non-Qualified Stock Options may be granted alone, in addition to, or in tandem with cash awards made outside of the Plan. Any Non-Qualified Stock Option granted under the Plan shall be in such form as the Committee may from time to time approve. All stock options granted under the Plan shall be Non-Qualified Stock Options. The Committee shall have the authority to grant to any optionee Non-Qualified Stock Options.

Non-Qualified Stock 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 Common Stock purchasable under a Non-Qualified 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 Common Stock at grant.

(b) Option Term. The term of each Non-Qualified Stock Option shall be fixed by the Committee but shall not exceed ten years after the date the Non-Qualified Stock Option is granted.

(c) Exercisability. Non-Qualified 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 6, unless otherwise determined by the Committee at or after grant, no Non-Qualified Stock Option shall be exercisable prior to the first anniversary date of the granting of the Non-Qualified Option. The Committee may provide that a Non-Qualified Stock Option shall vest over a period of future service at a rate specified at the time of grant, or that the Non-Qualified Stock Option is exercisable only in installments. If the

Committee provides, in its sole discretion, that any Non-Qualified 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 Non-Qualified 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), Non-Qualified 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 cash, check, or such other instrument as the Committee may accept. As determined by the Committee, in its sole discretion, at or after grant, payment in full or in part may also be made in the form of shares of Common Stock already owned by the optionee for at least six months prior to the date of exercise valued at the Fair Market Value of the Common Stock on the date the Non-Qualified Stock Option is exercised. If payment of the exercise price is made in part or in full with Common Stock, the Committee may award to the employee a new Non-Qualified Stock Option to replace the Common Stock which was surrendered. No shares of Common 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 shareholder with respect to shares subject to the Non-Qualified Stock 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 9(a).

(e) Transferability of Options. No Non-Qualified Stock Option shall be transferable by the optionee 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 the optionee or a member of his or her Immediate Family, or (ii) transfers by will or by the laws of descent and distribution.

(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 Non-Qualified 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. If an optionee’s employment by the Corporation and any Subsidiary or Affiliate terminates by reason of death, any Non-Qualified Stock Option held by such optionee may thereafter be exercised, to

the extent such option was exercisable at the time of death or on such accelerated basis as the Committee may determine at or after grant (or 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 Non-Qualified Stock Option, whichever period is the shorter.

(h) Termination by Reason of Disability. If an optionee’s employment by the Corporation and any Subsidiary or Affiliate terminates by reason of Disability, any Non-Qualified 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 on such accelerated basis as the Committee may determine at or after grant (or as may be determined in accordance with procedures established by the Committee), for a period of 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 Non-Qualified Stock Option, whichever period is the shorter, provided however, that, if the optionee dies within the period specified 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 Non-Qualified Stock Option, whichever period is shorter.

(i) Termination by Reason of Retirement. If an optionee’s employment by the Corporation and any Subsidiary or Affiliate terminates by reason of Normal or Early Retirement, any Non-Qualified 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 on such accelerated basis as the Committee may determine at or after grant or, as may be determined in accordance with procedures established by the Committee, for a period of 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 Non-Qualified Stock Option, whichever period is the shorter; provided however, that, if the optionee dies within the period specified 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 Non-Qualified Stock Option, whichever period is shorter.

(j) Other Termination. Unless otherwise determined by the Committee (or pursuant to procedures established by the Committee) at or after grant, if an optionee’s employment by the Corporation and any Subsidiary or Affiliate is involuntarily terminated for any reason other than death, Disability or

Normal or Early Retirement, or if optionee voluntarily terminates employment, the Non-Qualified Stock Option shall thereupon terminate, except that such Non-Qualified Stock Option may be exercised, to the extent otherwise then exercisable, for the lesser of three months or the balance of such Non-Qualified 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 Affiliate (except for Disability, Normal or Early Retirement), the Non-Qualified Stock Option shall thereupon terminate; provided, however, that the Committee at grant or thereafter may extend the exercise period in this situation for the lesser of three months or the balance of such Non-Qualified Stock Option’s term.

SECTION 6.

Change in Control Provisions.

(a)

Impact of Event. In the event of:

(1) a “Change in Control” as defined in Section 6(b); or

(2) a “Potential Change in Control” as defined in Section 6(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),

Subject to the limitations set forth below in this Section 6(a), the following acceleration provision shall apply:

(i) Any Non-Qualified Stock Option awarded under the Plan not previously exercisable and vested shall become fully exercisable and vested.

(ii) Subject to the limitations set forth below in this Section 6(a), the value of all outstanding Non-Qualified Stock Options to the extent vested, shall, unless otherwise determined by the Board or by the Committee in its sole discretion prior to any Change in Control, be cashed out on the basis of the “Change in Control Price” as defined in Section 6(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 Board or Committee may determine prior to the Change in Control.

(iii) The Board or the Committee may impose additional conditions on the acceleration or valuation of any option in the option agreement.

(b) Definition of Change in Control. For purposes of Section 6(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 shareholders, 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 6(a), a “Potential Change in Control” means the happening of any one of the following:

(i) The approval by shareholders of an agreement by the Corporation, the consummation of which would result in a Change in Control of the Corporation as defined in Section 6(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 6, “Change in Control Price” means the highest price per share paid in any transaction reported on Nasdaq or such other exchange or market as is the principal trading market for the Common 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.

SECTION 7.

Amendments and Termination.

The Board may at any time 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 Non-Qualified Stock Option theretofore granted, without the 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

The Committee may amend the terms of any Non-Qualified Stock Option or other award theretofore granted, prospectively or retroactively, but, subject to Section 2 above, no such amendment shall impair the rights of any holder without the holder’s consent. The Committee may also substitute new Non-Qualified Stock Options for previously granted Non-Qualified Stock Options (on a one for one or other basis), provided that the

Committee may not modify any outstanding Non-Qualified Stock Option so as to specify a lower exercise price or accept the surrender of an outstanding Non-Qualified Stock Option and authorize the granting of a new Non-Qualified 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 8.

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 Common Stock or payments in lieu of 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 9.

General Provisions.

(a) The Committee may require each person purchasing shares pursuant to a Non-Qualified Stock Option 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 Common Stock or other securities delivered under the Plan shall be subject to such stop-transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations, and other requirements of the Commission, any stock exchange upon which the Common 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 shareholder 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 Common Stock, including Common 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 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.

(f) 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.

(g) The Committee may, at or after grant, condition the receipt of any payment in respect of any award or the transfer of any shares subject to an award on the satisfaction of a six-month holding period, if such holding period is required for compliance with Section 16 under the Exchange Act.

SECTION 10.

Effective Date of Plan.

The Plan shall be effective April 19, 2001 (the “Effective Date”).

SECTION 11.

Term of Plan.

No Non-Qualified Stock Option shall be granted pursuant to the Plan on or after the tenth anniversary of the Effective Date of the Plan, but awards granted prior to such tenth anniversary may be extended beyond that date.

EX-10 7 ex10-22_111306.htm NON-QUALIFIED STOCK OPTION AGREEMENT, 1996 PLAN

Exhibit 10.22

HEALTHWAYS, INC.

NON-QUALIFIED STOCK OPTION AGREEMENT

THIS STOCK OPTION AGREEMENT is made and entered into this «Day1st» day of «Month», «Year», by and between HEALTHWAYS, INC., a Delaware corporation (the "Corporation") including its subsidiary corporations, and «First_Name» «Last_Name» (the "Colleague").

WHEREAS, the Corporation desires to afford the Colleague an opportunity to purchase shares of Common Stock, $.001 par value per share ("Common Stock") of the Corporation, in accordance with the provisions of the Healthways, Inc. 1996 Employee Stock Incentive Plan, as amended (the "Plan").

NOW, THEREFORE, In consideration of the mutual covenants set forth in this Agreement and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows:

1. Grant of Option. Corporation hereby grants to Colleague the option (the "Option"), exercisable in whole or in part to purchase «TotalShares_» shares of the Corporation's Common Stock, for a price of $ «AmountPerShare» per share.

2. Option Plan. This Option is granted as a non-qualified stock option under the Plan, and is not intended to qualify as an incentive stock option, as that term is used in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). This means that, at the time Colleague exercises all or any portion of this Option, Colleague will have taxable income equal to any positive difference between the market value of the Common Stock at the date of the exercise and the option exercise price paid for the Common Stock under this Option as shown in Section 1 of this Agreement.

This Option is subject to the terms and conditions set forth in the Plan. In the event any of the provisions in this Agreement conflict with or are inconsistent with the provisions of the Plan, the provisions of the Plan shall be controlling.

3. Timing of Exercise. Colleague may exercise this Option with respect to the percentage of shares set forth below from and after the dates specified below:

Percentage Vested

Date of Vesting

Options Exercisable

100%

«MoDayYrPlus4»

«TotalShares_»

This Option will expire seven (7) years from the date of grant of this Option.

4. Manner of Exercise. This Option shall be exercised by the Colleague (or other party entitled to exercise the Option under Section 5 of this Agreement) by delivering written notice to the Corporation stating the number of shares of Common Stock to be purchased, the person or persons in whose name the shares are to be registered and each such person's address and social security number. Such notice shall not be effective unless accompanied by the full purchase price for all shares so purchased. The purchase price shall be payable in cash and shall be calculated as the number of shares to be purchased times the option exercise price per share as shown in Section 1 of this Agreement. Payment in currency or by certified check, cashier's check or postal money order shall be considered payment in cash. The Corporation shall have the right to require the Colleague to remit to the Corporation an amount sufficient to satisfy any federal, state and local withholding tax requirements prior to the delivery of any certificate for such shares.

5. Nontransferability of Option. This Option shall not be transferable by the Colleague otherwise than by will or by the laws of descent and distribution, and is exercisable during Colleague's lifetime only by the Colleague. The terms of this Option shall be binding on the executors, administrators, heirs and successors of the Colleague.

Termination of Employment.

(a) Termination by Death. If the Colleague's employment by the Corporation terminates by reason of death, this Option may thereafter be exercised, to the extent the Option was exercisable at the time of death, by the legal representative of the estate or by the legatee of the Colleague under the will of the Colleague, for a period of one year from the date of such death or until the expiration of the stated term of the Option, whichever period is the shorter.

(b) Termination by Reason of Disability. If the Colleague's employment by the Corporation terminates by reason of Disability (as that term is defined under the Corporation's long-term disability insurance policy), this Option may thereafter be exercised by the Colleague, to the extent it was exercisable at the time of termination, for a period of three years from the date of such termination of employment or until the expiration of the stated term of the Option, whichever period is shorter, provided, however, that if the Colleague dies within such three-year period, the Option 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 the Option, whichever period is shorter.

(c) Retirement. If the Colleague’s employment by the Corporation terminates by reason of retirement as defined in the Plan, the shares subject to the Option granted hereunder not previously exercisable and vested shall become fully exercisable and vested upon the date of such termination of employment and this option may be exercised for a period of one

year from the date of such termination of employment or until the expiration of the stated term of the Option, whichever period is shorter.

(d) Other Termination. If the Colleague's employment by the Corporation is involuntarily terminated for any reason other than Death, Disability, or Retirement, or if the Colleague voluntarily terminates employment, this Option shall thereupon terminate, except that this Option may be exercised by the Colleague, to the extent otherwise then exercisable, for a period of three months from the date of such termination of employment or the expiration of the Option's term, whichever period is the shorter if the involuntary termination is without Cause. If the Colleague’s employment by the Company is terminated for Cause, this Option shall immediately terminate.

7. Restrictions on Purchase and Sale of Shares. The Corporation shall be obligated to sell or issue shares pursuant to the exercise of this Option only in the event that the shares are at that time effectively registered or otherwise exempt from registration under the Securities Act of 1933, as amended (“the 1933 Act”). In the event that the shares are not registered under the 1933 Act, the Colleague hereby agrees that, as a further condition to the exercise of this Option, the Colleague (or his successor under Section 5 of this Agreement), if the Corporation so requests, will execute an agreement in form satisfactory to the Corporation in which the Colleague represents that he or she is purchasing the shares for investment purposes, and not with a view to resale or distribution. The Colleague further agrees that if the shares of Common Stock to be issued upon the exercise of this Option are not subject to an effective registration statement filed with the Securities and Exchange Commission pursuant to the requirements of the 1933 Act, such shares shall bear an appropriate restrictive legend.

8. Adjustment. In the event of any merger, reorganization, consolidation, recapitalization, extraordinary cash dividend, stock dividend, stock split or other change in corporate structure affecting the Common Stock, the number of shares of Common Stock of the Corporation subject to this Option and the price per share of such shares shall be equitably and proportionately adjusted by the Committee in accordance with the Plan.

9. Change in Control. Upon a Change in Control, and if and to the extent so determined by the Committee or the Board upon a Potential Change in Control, the shares subject to the Option granted hereunder not previously exercisable and vested shall become fully exercisable and vested.

10. No Rights Until Exercise. The Colleague shall have no rights hereunder as a stockholder with respect to any shares subject to this Option until the date of the issuance of a stock certificate to him or her for such shares upon due exercise of this Option.

11. Confidentiality, Non-solicitation and Non-Compete. It is the interest of all Colleagues to protect and preserve the assets of the Corporation. In this regard, in consideration for granting this Option and as conditions of Colleagues' ability to exercise this option, Colleague acknowledges and agrees that:

(a) Confidentiality. In the course of Colleague's employment, Colleague will have access to trade secrets and other confidential information of the Corporation and its clients. Accordingly, Colleague agrees that, without the prior written consent of the Corporation, Colleague will not, other than in the normal conduct of the Corporation's business affairs, divulge, furnish, publish or use for personal benefit or for the direct or indirect benefit of any other person or business entity, whether or not for monetary gain, any trade secrets or confidential or proprietary information of the Corporation or its clients, including without limitation, any information relating to any business methods, marketing and business plans, financial data, systems, customers, suppliers, policies, procedures, techniques or research developed for the benefit of the Corporation or its clients. Proprietary information includes, but is not limited to, information developed by the Colleague for the Corporation while employed by the Corporation. The obligations of the Colleague under this paragraph will continue after the Colleague has left the employment of the Corporation. Colleague agrees that upon leaving the employment of the Corporation, Colleague will return to the Corporation all property and confidential information in the Colleague's possession and agrees not to copy or otherwise record in any way such information.

(b) Non-Solicitation. While employed by the Corporation and for a period of two years thereafter, Colleague shall not, upon Colleague's own behalf or on behalf of any other person or entity, directly or indirectly,

- hire or solicit to leave the employ of the Corporation any person employed by or under contract as an independent contractor to the Corporation; or

- contact, solicit, entice away, or divert any disease management business from any person or entity who is a client or with whom the Corporation was engaged in discussions as a potential client within one year prior to the date of termination of Colleague.

(c) Non-Compete. While employed by Corporation and continuing during the period while any amounts are being paid to Colleague and for a period of 18 months thereafter, Colleague will not own or be employed by or assist anyone else in the conduct of any business (i) which is in competition with any business conducted by the Corporation or (ii) which Colleague knows the Corporation was actively evaluating for possible entry, in either case in the United States or in any other jurisdiction in which the Corporation is engaged in business or has been engaged in business during Colleague’s employment by the Corporation, or in such jurisdictions where Colleague knows the Corporation is actively pursuing business opportunities at the time of Colleague’s termination of employment with the Corporation; provided that ownership of five percent (5%) or less of the voting stock of any public corporation shall not constitute a violation hereof.

In the event Colleague breaches any provisions of this Section 11, this Option shall immediately expire and may not be exercised, and the Corporation shall be entitled to seek other appropriate remedies it may have available to limit its damages from such breach

12. Amendment. The Committee may amend the terms of this Option, prospectively or retroactively, but, subject to Section 8 above, no such amendment shall impair the rights of the Colleague hereunder without the Colleague's consent.

13. Notices. All notices required to be given under this Option shall be deemed to be received if delivered or mailed as provided for herein, to the parties at the following addresses, or to such other address as either party may provide in writing from time to time.

To the Corporation:

Healthways, Inc.

3841 Green Hills Village Drive

Nashville, TN 37215

To the Colleague:

(colleague name and address)

___________________________________

14. Severability. If any provision of this Agreement is, or becomes, or is deemed to be invalid, illegal, or unenforceable in any jurisdiction or as to any person or the award of the Option, or would disqualify the Plan or the Option under any laws deemed applicable by the Committee, such provision shall be construed or deemed amended to conform to the applicable laws, or if it cannot be construed or deemed amended without, in the determination of the Committee, materially altering the intent of the Plan or the Option, such provision shall be stricken as to such jurisdiction, person or Option, and the remainder of the Plan and Option shall remain in full force and effect.

15. Governing Law. The validity, construction and effect of this Agreement shall be determined in accordance with the laws of the State of Delaware without giving effect to conflicts of laws principles.

16. Resolution of Disputes. Any dispute or disagreement which may arise under, or as a result of, or in any way related to, the interpretation, construction or application of this Agreement shall be determined by the Committee. Any determination made hereunder shall be final, binding and conclusive on the Optionee and the Corporation for all purposes.

IN WITNESS WHEREOF, the parties have caused the Stock Option Agreement to be duly executed as of the day and year first above written.

HEALTHWAYS, INC.:

Name: Ben R. Leedle, Jr.

Title: President & CEO

COLLEAGUE:

EX-10 8 ex10-23_111306.htm NON-QUALIFIED STOCK OPTION AGREEMENT, 2001 PLAN

Exhibit 10.23

NON-QUALIFIED STOCK OPTION AGREEMENT

UNDER THE HEALTHWAYS, INC.

AMENDED AND RESTATED 2001 STOCK OPTION PLAN

THIS STOCK OPTION AGREEMENT is made and entered into this «Day1st» day of «Month», «Year», by and between Healthways, Inc., a Delaware corporation (the "Company"), and «First_Name» «Last_Name» (the "Optionee"). Capitalized terms not otherwise defined herein shall have the meaning ascribed to such terms in the Healthways, Inc. Amended and Restated 2001 Stock Option Plan.

WHEREAS, the Company has adopted the Healthways, Inc. Amended and Restated 2001 Stock Option Plan (the "Plan"), pursuant to which the Company is authorized to grant options to purchase shares of the Company’s Common Stock, par value $.001 per share (the "Common Stock"), to Colleagues of the Company;

WHEREAS, the Company desires to afford the Optionee an opportunity to purchase Common Stock as hereinafter provided in accordance with the provisions of the Plan.

NOW, THEREFORE, in consideration of the mutual covenants hereinafter set forth and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound hereby, agree as follows:

1. Grant of Option. The Company hereby grants to Optionee a Non-Qualified Stock Option (the "Option"), exercisable in whole or in part, to purchase «totalshares» shares of the Company's Common Stock, for an exercise price of $«AmountPerShare» per share.

2. Option Plan. This Option is granted under the Plan and is subject to the terms and conditions set forth in the Plan. In the event any of the provisions hereof conflict with or are inconsistent with the provisions of the Plan, the provisions of the Plan shall be controlling.

3. Timing of Exercise. Optionee may exercise this Option with respect to the percentage of shares set forth below from and after the dates specified below:

Percentage Vested

Date of Vesting

Options Exercisable

100%

«MoDayYrPlus4»

«totalshares»

This Option will expire seven (7) years from the date of grant of this Option.

4. Manner of Exercise. This Option shall be exercised by the Optionee (or other party entitled to exercise the Option under Section 5 of this Agreement) by delivering written notice to the Corporation stating the number of shares of Common Stock to be purchased, the person or persons in whose name the shares are to be registered and each such person's address

and social security number. Such notice shall not be effective unless accompanied by the full purchase price for all shares so purchased. The purchase price shall be payable in cash and shall be calculated as the number of shares to be purchased times the option exercise price per share as shown in Section 1 of this Agreement. Payment in currency or by certified check, cashier's check or postal money order shall be considered payment in cash. The Company shall have the right to require the Optionee to remit to the Company an amount sufficient to satisfy any federal, state and local withholding tax requirements prior to the delivery of any certificate for such shares.

5. Nontransferability of Option. This Option shall not be transferable by the Optionee otherwise than (i) by will or by the laws of descent and distribution, or (ii) transfers by the Optionee to a member of his or her Immediate Family or a trust for the benefit of the Optionee or a member of his or her Immediate Family. The terms of this Option shall be binding on the executors, administrators, heirs and successors of the Optionee.

Termination of Employment.

(a) Termination by Death. If the Optionee's employment by the Company terminates by reason of death, this Option may thereafter be exercised, to the extent the Option was exercisable at the time of death, 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 from the date of such death or until the expiration of the stated term of the Option, whichever period is the shorter.

(b) Termination by Reason of Disability. If the Optionee's employment by the Company terminates by reason of Disability (as that term is defined under the Company's long-term disability insurance policy), this Option may thereafter be exercised by the Optionee, to the extent it was exercisable at the time of termination, for a period of one year from the date of such termination of employment or until the expiration of the stated term of the Option, whichever period is shorter, provided, however, that if the Optionee dies within such one-year period, the Option 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 the Option, whichever period is shorter.

(c) Retirement. If the Optionee’s employment by the Company terminates by reason of Retirement (as defined in the Plan), the shares subject to the Option granted hereunder not previously exercisable and vested shall become fully exercisable and vested upon the date of such termination of employment and this Option may be exercised for a period of one year from the date of such termination of employment or until the expiration of the stated term of the Option, whichever period is shorter.

(d) Other Termination. If the Optionee's employment by the Company is involuntarily terminated for any reason other than death, Disability, or Retirement, of if Optionee voluntarily terminates employment, this Option shall thereupon terminate, except that this Option may be exercised by the Optionee, to the extent otherwise then exercisable, for a period of three months from the date of such termination of employment or the expiration of the Option's term, whichever period is the shorter if the involuntary termination is without Cause (as

defined in the Plan). If the Optionee’s employment by the Company is terminated for Cause, this Option shall immediately terminate.

7. Restrictions on Purchase and Sale of Shares. The Company shall be obligated to sell or issue shares pursuant to the exercise of this Option only in the event that the shares are at that time effectively registered or otherwise exempt from registration under the Securities Act of 1933, as amended (“the 1933 Act”). In the event that the shares are not registered under the 1933 Act, the Optionee hereby agrees that, as a further condition to the exercise of this Option, the Optionee (or his successor under Section 5 of this Agreement), if the Company so requests, will execute an agreement in form satisfactory to the Company in which the Optionee represents that he or she is purchasing the shares for investment purposes, and not with a view to resale or distribution. The Optionee further agrees that if the shares of Common Stock to be issued upon the exercise of this Option are not subject to an effective registration statement filed with the Securities and Exchange Commission pursuant to the requirements of the 1933 Act, such shares shall bear an appropriate restrictive legend.

8. Adjustment. In the event of any merger, reorganization, consolidation, recapitalization, extraordinary cash dividend, stock dividend, stock split or other change in corporate structure affecting the Common Stock, the number of shares of Common Stock of the Company subject to this Option and the price per share of such shares shall be equitably and proportionately adjusted by the Committee in accordance with the Plan.

9. Change in Control. Upon a Change in Control, and if and to the extent so determined by the Committee or the Board upon a Potential Change in Control, the shares subject to the Option granted hereunder not previously exercisable and vested shall become fully exercisable and vested.

10. No Rights Until Exercise. The Optionee shall have no rights hereunder as a stockholder with respect to any shares subject to this Option until the date of the issuance of a stock certificate to him or her for such shares upon due exercise of this Option.

11. Confidentiality, Non-solicitation and Non-Compete. It is the interest of all Optionees to protect and preserve the assets of the Company. In this regard, in consideration for granting this Option and as conditions of Optionee’s ability to exercise this option, Optionee acknowledges and agrees that:

(a) Confidentiality. In the course of Optionee's employment, Optionee will have access to trade secrets and other confidential information of the Company and its clients. Accordingly, Optionee agrees that, without the prior written consent of the Company, Optionee will not, other than in the normal conduct of the Company's business affairs, divulge, furnish, publish or use for personal benefit or for the direct or indirect benefit of any other person or business entity, whether or not for monetary gain, any trade secrets or confidential or proprietary information of the Company or its clients, including without limitation, any information relating to any business methods, marketing and business plans, financial data, systems, customers, suppliers, policies, procedures, techniques or research developed for the benefit of the Company or its clients. Proprietary information includes, but is not limited to, information developed by

the Optionee for the Company while employed by the Company. The obligations of the Optionee under this paragraph will continue after the Optionee has left the employment of the Company. Optionee agrees that upon leaving the employment of the Company, Optionee will return to the Company all property and confidential information in the Optionee's possession and agrees not to copy or otherwise record in any way such information.

(b) Non-Solicitation. While employed by the Company and for a period of two years thereafter, Optionee shall not, upon Optionee's own behalf or on behalf of any other person or entity, directly or indirectly,

- hire or solicit to leave the employ of the Company any person employed by or under contract as an independent contractor to the Company; or

- contact, solicit, entice away, or divert any disease management business from any person or entity who is a client or with whom the Company was engaged in discussions as a potential client within one year prior to the date of termination of Optionee.

(c) Non-Competition. While employed by the Company and continuing during the period while any amounts are being paid to Optionee and for a period of 18 months thereafter, Optionee will not own or be employed by or assist anyone else in conduct of any business (i) which is in completion with any business conducted by the Company or (ii) which Optionee knows the Company was actively evaluating for possible entry, knows the Company was actively evaluating for possible entry, in either case in the United States or in any other jurisdiction in which the Company is engaged in business or has been engaged in business during Optionee’s employment by the Company, or in such jurisdiction where Optionee knows the Company is actively pursuing business opportunities at the time of termination of employment; provided that ownership of five percent (5%) or less of the voting stock of any public corporation shall not constitute a violation hereof.

In the event Optionee breaches any provisions of this Section 11, this Option shall immediately expire and may not be exercised, and the Company shall be entitled to seek other appropriate remedies it may have available to limit its damages from such breach.

12. Amendment. The Committee may amend the terms of this Option, prospectively or retroactively, but, subject to Section 8 above, no such amendment shall impair the rights of the Optionee hereunder without the Optionee's consent.

13. Notices. All notices required to be given under this Option shall be deemed to be received if delivered or mailed as provided for herein, to the parties at the following addresses, or to such other address as either party may provide in writing from time to time.

To the Company:

Healthways, Inc.

3841 Green Hills Village Drive

Nashville, TN 37215

To the Optionee:

(name and address)

14. Severability. If any provision of this Agreement is, or becomes, or is deemed to be invalid, illegal, or unenforceable in any jurisdiction or as to any person or the award of this Option, or would disqualify the Plan or the Option under any laws deemed applicable by the Committee, such provision shall be construed or deemed amended to conform to the applicable laws, or if it cannot be construed or deemed amended without, in the determination of the Committee, materially altering the intent of the Plan or the Option, such provision shall be stricken as to such jurisdiction, person or Option, and the remainder of the Plan and Option shall remain in full force and effect.

15. Governing Law. The validity, construction and effect of this Agreement shall be determined in accordance with the laws of the State of Delaware without giving effect to conflicts of laws principles.

16. Resolution of Disputes. Any dispute or disagreement which may arise under, or as a result of, or in any way related to, the interpretation, construction or application of this Agreement shall be determined by the Committee and the Company for all purposes.

IN WITNESS WHEREOF, the parties have caused the Stock Option Agreement to be duly executed as of the day and year first above written.

HEALTHWAYS, INC.:

_________________________________

Name: Ben R. Leedle, Jr.

Title: President & CEO

OPTIONEE:

___________________________________

EX-10 9 ex10-24_111306.htm 1996 PLAN RSU AWARD AGREEMENT

Exhibit 10.24

HEALTHWAYS, INC.

1996 STOCK INCENTIVE PLAN

RESTRICTED STOCK UNIT AWARD AGREEMENT

This RESTRICTED STOCK UNIT AWARD AGREEMENT (the "Agreement"), dated this «Day1st» day of «Month» «Year», is by and between Healthways, Inc., a Delaware Company (the "Company"), and «First_Name» «Last_Name» (the "Grantee"), under the Company's 1996 Stock Incentive Plan (the "Plan").

Section 1. Restricted Stock Unit Award. The Grantee is hereby granted «TotalShares» restricted stock units (the "Restricted Stock Units"). Each Restricted Stock Unit represents the right to receive one share of the Company's Common Stock, $.001 par value (the "Stock"), subject to the terms and conditions of this Agreement and the Plan.

Section 2. Vesting of the Award. Except as otherwise provided in Section 3 below, the Restricted Stock Units will vest at such times (the "Vesting Date") and in the percentages set forth below, as long as the Grantee is serving as an employee of the Company on the Vesting Date.

Vesting Date		Award Percentage of Restricted Stock Units
«MoDayYrPlus4»		100%

The Company shall issue one share of the Stock to the Grantee for each vested Restricted Stock Unit (the “Distributed Shares”) at the time the Restricted Stock Unit vests. The Distributed Shares shall be represented by a certificate.

Section 3. Forfeiture on Termination of Employment. If the Grantee ceases to be employed by the Company for any reason, all Restricted Stock Units that have not vested prior to the date of termination of Grantee's employment will be forfeited and the Grantee shall have no further rights with respect to such Restricted Stock Units; provided, however, that if the Grantee’s employment by the Company terminates by reason of Retirement (as defined in the Plan), the Restricted Stock Units granted hereunder shall immediately vest.

Section 4. Voting Rights and Dividends. Prior to the Vesting Date, the Grantee shall have no rights to any dividends declared and paid in respect of the Stock underlying the Restricted Stock Units. The Grantee shall not have any voting rights with respect to the shares of Stock underlying the Restricted Stock Units prior to the vesting of the Restricted Stock Units and the issuance of the shares of Stock as set forth in Section 2. A holder of Distributed Shares shall have full dividend and voting rights as a holder of Stock.

Section 5.

Restrictions on Transfer.

5.1 General Restrictions. The Restricted Stock Units shall not be transferable by the Grantee (or his or her personal representative or estate) other than by will or by the laws of descent and distribution. The terms of this Agreement shall be binding on the executors, administrators, heirs and successors of the Grantee.

5.2 Change in Control. All restrictions imposed on the Restricted Stock Units shall expire automatically and the Restricted Stock United granted hereby shall be deemed fully vested upon a Change in Control, as such term is defined in the Plan, and the Company shall issue the shares of Stock underlying the Restricted Stock Units.

Section 6. Restrictive Agreement. As a condition to the receipt of any Distributed Shares, the Grantee (or his or her legal representative or estate or any third party transferee), if the Company so requests, will execute an agreement in form satisfactory to the Company in which the Grantee or such other recipient of the shares represents that he or she is purchasing the shares for investment purposes, and not with a view to resale or distribution.

Section 7. Adjustment. 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, the number of Restricted Stock Units subject to this Agreement shall be equitably and proportionately adjusted by the Committee in accordance with the Plan.

Section 8. Tax Withholding. The Company shall withhold from any distribution of Stock an amount of Stock equal to such federal, state or local taxes as shall be required to be withheld pursuant to any applicable law or regulation.

Section 9. Governing Provisions. This Agreement is made under and subject to the provisions of the Plan, and all of the provisions of the Plan are also provisions of this Agreement. If there is a difference or conflict between the provisions of this Agreement and the provisions of the Plan, the provisions of the Plan will govern. By signing this Agreement, the Grantee confirms that he or she has received a copy of the Plan.

Section 10. Confidentiality, Non-Solicitation and Non-Compete. It is in the interest of all Colleagues to protect and preserve the assets of the Company. In this regard, in consideration for granting these Restricted Stock Units and as conditions of Grantee’s ability to receive the Distributed Shares, Grantee acknowledges and agrees that:

(a) Confidentiality. In the course of Grantee's employment, Grantee will have access to trade secrets and other confidential information of the Company and its clients. Accordingly, Grantee agrees that, without the prior written consent of the Company, Grantee will not, other than in the normal conduct of the Company's business affairs, divulge, furnish, publish or use for personal benefit or for the direct or indirect benefit of any other person or business entity, whether or not for monetary gain, any trade secrets or confidential or proprietary information of the Company or its clients, including without limitation, any

information relating to any business methods, marketing and business plans, financial data, systems, customers, suppliers, policies, procedures, techniques or research developed for the benefit of the Company or its clients. Proprietary information includes, but is not limited to, information developed by the Grantee for the Company while employed by the Company. The obligations of the Grantee under this paragraph will continue after the Grantee has left the employment of the Company. Grantee agrees that upon leaving the employment of the Company, Grantee will return to the Company all property and confidential information in the Grantee's possession and agrees not to copy or otherwise record in any way such information.

(b) Non-Solicitation. While employed by the Company and for a period of two years thereafter, Grantee shall not, upon Grantee's own behalf or on behalf of any other person or entity, directly or indirectly,

- hire or solicit to leave the employ of the Company any person employed by or under contract as an independent contractor to the Company; or

(c) Non-Compete. While employed by the Company and continuing during the period while any amounts are being paid to Grantee and for a period of 18 months thereafter, Grantee will not own or be employed by or assist anyone else in the conduct of any business (i) which is in competition with any business conducted by the Company or (ii) which Grantee knows the Company was actively evaluating for possible entry, in either case in the United States or in any other jurisdiction in which the Company is engaged in business or has been engaged in business during Grantee’s employment by the Company, or in such jurisdictions where Grantee knows the Company is actively pursuing business opportunities at the time of Grantee’s termination of employment with the corporation; provided that ownership of five percent (5%) or less of the voting stock of any public corporation shall not constitute a violation hereof.

In the event Grantee breaches any provisions of this Section 10, these Restricted Stock Units shall immediately expire, and the Company shall be entitled to seek other appropriate remedies it may have available to limit its damages from such breach.

Section 11.

Miscellaneous.

11.1 Entire Agreement. This Agreement and the Plan contain the entire understanding and agreement between the Company and the Grantee concerning the Restricted Stock Units granted hereby, and supersede any prior or contemporaneous negotiations and understandings. The Company and the Grantee have made no promises, agreements, conditions, or understandings relating to the Restricted Stock Units, either orally or in writing, that are not included in this Agreement or the Plan.

11.2 Employment. By establishing the Plan, granting awards under the Plan, and entering into this Agreement, the Company does not give the Grantee any right to continue to be employed by the Company or to be entitled to any remuneration or benefits not set forth in this Agreement or the Plan.

11.3 Captions. The captions and section numbers appearing in this Agreement are inserted only as a matter of convenience. They do not define, limit, construe, or describe the scope or intent of the provisions of this Agreement.

11.4 Counterparts. This Agreement may be executed in counterparts, each of which when signed by the Company and the Grantee will be deemed an original and all of which together will be deemed the same Agreement.

11.5 Notice. Any notice or communication having to do with this Agreement must be given by personal delivery or by certified mail, return receipt requested, addressed, if to the Company, to the principal office of the Company and, if to the Grantee, to the Grantee's address set forth below or any address of which the Grantee subsequently notifies the Company.

11.6 Amendment. The Chairman of the Board or the Board of Directors of the Company may amend the terms of this Agreement, but no such amendment shall impair the rights of the Grantee hereunder without the Grantee's consent.

11.7 Governing Law. This Agreement shall be governed and construed exclusively in accordance with the law of the State of Delaware applicable to agreements to be performed in the State of Delaware to the extent it may apply.

11.8 Validity; Severability. If, for any reason, any provision hereof shall be determined to be invalid or unenforceable, the validity and effect of the other provisions hereof shall not be affected thereby. Whenever possible, each provision of this Agreement will be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability will not affect any other provision or any other jurisdiction, but this Agreement will be reformed, construed and enforced in such jurisdiction as if such invalid, illegal or unenforceable provision had never been contained herein. If any court determines that any provision of Section 10 or any other provision hereof is unenforceable but has the power to reduce the scope or duration of such provision, as the case may be, such provision, in its reduced form, shall then be enforceable.

IN WITNESS WHEREOF, the Company and the Grantee have executed this Agreement to be effective as of «Day1st» day of «Month» «Year».

HEALTHWAYS, INC

By:

Title: Ben R. Leedle, Jr., President and CEO

Grantee Signature:

_______________________________________

EX-10 10 ex10-25_111306.htm NON-QUALIFIED STOCK OPTION AGREEMENT FOR DIRECTORS

Exhibit 10.25

HEALTHWAYS, INC.

NON-QUALIFIED STOCK OPTION AGREEMENT

THIS STOCK OPTION AGREEMENT is made and entered into this «Day1st» day of «Month», «Year», by and between HEALTHWAYS, INC., a Delaware corporation (the "Corporation") including its subsidiary corporations, and «First_Name» «Last_Name» (the "Director").

WHEREAS, the Corporation desires to afford the Director an opportunity to purchase shares of Common Stock, $.001 par value per share ("Common Stock") of the Corporation, in accordance with the provisions of the Healthways, Inc. 1996 Stock Incentive Plan, as amended (the "Plan").

1. Grant of Option. Corporation hereby grants to Director the option (the "Option"), exercisable in whole or in part to purchase «TotalShares» shares of the Corporation's Common Stock, for a price of $ «AmountPerShare» per share.

2. Option Plan. This Option is granted as a non-qualified stock option under the Plan, and is not intended to qualify as an incentive stock option, as that term is used in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). This means that, at the time Director exercises all or any portion of this Option, Director will have taxable income equal to any positive difference between the market value of the Common Stock at the date of the exercise and the option exercise price paid for the Common Stock under this Option as shown in Section 1 of this Agreement.

3. Timing of Exercise. Director may exercise this Option with respect to the percentage of shares set forth below from and after the dates specified below, provided that Director is still serving as a director of the Corporation on such date except as set forth in Section 6 hereof:

Percentage Vested		Date of Vesting		Cumulative Options Exercisable
100%		«MoDayYrPlus4»		«TotalShares»

This Option will expire ten (10) years from the date of grant of this Option.

4. Manner of Exercise. This Option shall be exercised by the Director (or other party entitled to exercise the Option under Section 5 of this Agreement) by delivering written notice to the Corporation stating the number of shares of Common Stock to be purchased, the person or persons in whose name the shares are to be registered and each such person's address and social security number. Such notice shall not be effective unless accompanied by the full purchase price for all shares so purchased. The purchase price shall be payable in cash and shall be calculated as the number of shares to be purchased times the option exercise price per share as shown in Section 1 of this Agreement. Payment in currency or by certified check, cashier's check or postal money order shall be considered payment in cash. The Corporation shall have the right to require the Director to remit to the Corporation an amount sufficient to satisfy any federal, state and local withholding tax requirements prior to the delivery of any certificate for such shares.

5. Nontransferability of Option. This Option shall not be transferable by the Director without the prior written consent of the Board of Directors otherwise than (i) transfers by the Director to a member of the Director’s Immediate Family or a trust for the benefit of Director or a member of such Director’s Immediate Family, or (ii) transfers by will or by the laws of descent and distribution. The terms of this Option shall be binding on the executors, administrators, heirs and successors of the Director.

Termination or Expiration of Director's Position on the Board of Directors.

(a) Termination or Resignation from Board Following Two Terms as a Director. If the Director shall cease to serve as a director of the Corporation for any reason other than involuntary removal by the stockholders for cause and if the Director has (x) (a) served at least two full three-year terms as a director, or (b) served at least two terms as a director of the Corporation (the first of which may be a partial term and the last of which shall be a full three-year term) and offered to resign from the Board on or after such Director’s 70^th birthday, which offer to resign has been accepted by the Corporation, and (y) in the event of the Director’s retirement from the Board, given the Corporation at least nine months’ prior written notice of the Director’s intent not to stand for re-election at the end of the Director’s then-current term, the shares subject to the Option granted hereunder not previously exercisable and vested shall become vest and become immediately exercisable at the end of the Director’s then-current term and this Option may be exercised for a period of one year from the end of such term or until the expiration of the stated term of the Option, whichever period is shorter (the “Exercise Period”); provided, however, that if the Director dies within the Exercise Period, the Option shall thereafter be exercisable to the extent to which it was exercisable at the time of death for a period of three years from the date of such death or until the expiration of the stated term of the Option, whichever period is shorter.

(b) Termination by Reason of Retirement or Disability. If the Director shall cease to be a director of the Corporation by reason of retirement or Disability (as that term is defined under the Corporation's long-term disability insurance policy) without meeting the requirements of section 6(a) above, this Option may thereafter be exercised by the Director, to the extent it was exercisable at the time of such cessation, for a period of one year from the date

of such cessation or until the expiration of the stated term of the Option, whichever period is shorter; provided, however, that if the Director dies within such one-year period, the Option shall thereafter be exercisable to the extent to which it was exercisable at the time of death for a period of three years from the date of such death or until the expiration of the stated term of the Option, whichever period is shorter.

(c) Termination by Death. If the Director shall cease to be a director of the Corporation by reason of death, the shares subject to the Option granted hereunder not previously exercisable and vested shall vest and become immediately exercisable and may thereafter be exercised, by the legal representative of the estate or by the legatee of the Director under the will of the Director, for a period of three years from the date of such death or until the expiration of the stated term of the Option, whichever period is the shorter.

(d) Termination for any Other Reason. If the Director shall cease to be a director of the Corporation for any reason (including removal by the stockholders for cause) other than retirement, death or Disability without meeting the requirements of section 6(a) above, this Option may be exercised by the Director, to the extent otherwise then exercisable on the date of such cessation, for a period of three months from the date of such cessation or the expiration of the Option's term, whichever period is the shorter.

7. Restrictions on Purchase and Sale of Shares. The Corporation shall be obligated to sell or issue shares pursuant to the exercise of this Option only in the event that the shares are at that time effectively registered or otherwise exempt from registration under the Securities Act of 1933, as amended (“the 1933 Act”). In the event that the shares are not registered under the 1933 Act, the Director hereby agrees that, as a further condition to the exercise of this Option, the Director (or his successor under Section 5 of this Agreement), if the Corporation so requests, will execute an agreement in form satisfactory to the Corporation in which the Director represents that he or she is purchasing the shares for investment purposes, and not with a view to resale or distribution. The Director further agrees that if the shares of Common Stock to be issued upon the exercise of this Option are not subject to an effective registration statement filed with the Securities and Exchange Commission pursuant to the requirements of the 1933 Act, such shares shall bear an appropriate restrictive legend.

8. Adjustment. In the event of any merger, reorganization, consolidation, recapitalization, extraordinary cash dividend, stock dividend, stock split or other change in corporate structure affecting the Common Stock, the number of shares of Common Stock of the Corporation subject to this Option and the price per share of such shares shall be equitably and proportionately adjusted by the Committee in accordance with the Plan.

9. Change in Control. Upon a Change in Control, and if and to the extent so determined by the Board of Directors upon a Potential Change in Control, the shares subject to the Option granted hereunder not previously exercisable and vested shall become fully exercisable and vested.

10. No Rights Until Exercise. The Director shall have no rights hereunder as a stockholder with respect to any shares subject to this Option until the date of the issuance of a stock certificate to him or her for such shares upon due exercise of this Option.

11. Amendment. The Board of Directors may amend the terms of this Option, prospectively or retroactively, but, subject to Section 8 above, no such amendment shall impair the rights of the Director hereunder without the Director's consent.

12. Notices. All notices required to be given under this Option shall be deemed to be received if delivered or mailed as provided for herein, to the parties at the following addresses, or to such other address as either party may provide in writing from time to time.

To the Corporation:

Healthways, Inc.

3841 Green Hills Village Drive

Nashville, Tennessee 37215

To the Director:

(Directorname and address)

13. Severability. If any provision of this Agreement is, or becomes, or is deemed to be invalid, illegal, or unenforceable in any jurisdiction or as to any person or the award of the Option, or would disqualify the Plan or the Option under any laws deemed applicable by the Committee, such provision shall be construed or deemed amended to conform to the applicable laws, or if it cannot be construed or deemed amended without, in the determination of the Committee, materially altering the intent of the Plan or the Option, such provision shall be stricken as to such jurisdiction, person or Option, and the remainder of the Plan and Option shall remain in full force and effect.

14. Governing Law. The validity, construction and effect of this Agreement shall be determined in accordance with the laws of the State of Delaware without giving effect to conflicts of laws principles.

15. Resolution of Disputes. Any dispute or disagreement which may arise under, or as a result of, or in any way related to, the interpretation, construction or application of this Agreement shall be determined by the Board of Directors. Any determination made hereunder shall be final, binding and conclusive on the Director and the Corporation for all purposes.

IN WITNESS WHEREOF, the parties have caused the Stock Option Agreement to be duly executed as of the day and year first above written.

HEALTHWAYS, INC.:

_________________________________

Name: Ben R. Leedle, Jr.

Title: President & CEO

DIRECTOR:

___________________________________

EX-11 11 ex11_111306.htm EX-11, EARNINGS PER SHARE RECONCILIATION

Exhibit 11

Healthways, Inc.

Earnings Per Share Reconciliation

August 31, 2006

(In thousands, except earnings per share data)

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

Year Ended August 31,	2006		2005		2004


Numerator:
Net income - numerator for basic earnings per share	$	37,151	$	33,084	$	26,058
Effect of dilutive securities		—		—		—
Numerator for diluted earnings per share	$	37,151	$	33,084	$	26,058

Denominator:
Shares used for basic earnings per share		34,348		33,241		32,264
Effect of dilutive stock options outstanding		2,031		2,450		2,368
Shares used for diluted earnings per share		36,379		35,691		34,632

Earnings per share:
Basic	$	1.08	$	1.00	$	0.81
Diluted	$	1.02	$	0.93	$	0.75

EX-21 12 ex21_111306.htm EX-21, SUBSIDIARY LIST

Exhibit 21

SUBSIDIARY LIST

AS OF NOVEMBER 13, 2006

STATE OR

JURISDICTION OF

OWNERSHIP

NAME OF SUBSIDIARY

ORGANIZATION

OWNED BY

PERCENTAGE

American Healthways Services, Inc.

Healthways, Inc.

100%

American Healthways Government

Services, Inc.

Healthways, Inc.

100%

Healthways International, Inc.

Healthways, Inc.

100%

CareSteps.com, Inc.

Healthways, Inc.

100%

Axonal Information Solutions, Inc.

CareSteps.com, Inc.

100%

StatusOne Health Systems, LLC

American Healthways Services, Inc.

100%

Population Health Support, LLC

American Healthways Services, Inc.

100%

Healthways International Limited

England and

Healthways International, S.a.r.l.

100%

Wales

Healthways International, S.a.r.l.

Luxembourg

Healthways International, Inc.

100%

Healthways International GmbH

Germany

Healthways International, S.a.r.l.

100%

EX-23 13 ex23_111306.htm EX-23, CONSENT OF ERNST & YOUNG

Exhibit 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statements (Forms S-8 No. 33-42895, No. 33-42899, No. 33-42908, No. 33-42909, No. 333-04615, No. 333-33336, No. 333-70948, No. 333-103510, No. 333-113149, and No. 333-122881) of Healthways, Inc. of our reports dated November 13, 2006, with respect to the consolidated financial statements of Healthways, Inc. and Subsidiaries, Healthways, Inc. and Subsidiaries management’s assessment of the effectiveness of internal control over financial reporting, and the effectiveness of internal control over financial reporting of Healthways, Inc. and Subsidiaries, included in the Annual Report (Form 10-K) for the year ended August 31, 2006.

/s/Ernst & Young LLP

Nashville, Tennessee

November 13, 2006

EX-31 14 ex31-1_111306.htm EX-31.1, SECTION 302 CEO CERTIFICATION

Exhibit 31.1

CERTIFICATION

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

1.	I have reviewed this annual report on Form 10-K of 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 officer(s) 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) 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

(d) 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 (the registrant’s fourth fiscal quarter in the case of an annual report) 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 officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, 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: November 13, 2006

/s/ Ben R. Leedle, Jr.

Ben R. Leedle, Jr.

President and Chief Executive Officer

EX-31 15 ex31-2_111306.htm EX-31.2, SECTION 302 CFO CERTIFICATION

Exhibit 31.2

CERTIFICATION

I, Mary A. Chaput, certify that:

1.	I have reviewed this annual report on Form 10-K of Healthways, Inc.;

(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: November 13, 2006

/s/ Mary A. Chaput

Mary A. Chaput

Executive Vice President and Chief Financial Officer

EX-32 16 ex32_111306.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 Annual Report of Healthways, Inc. (the "Company") on Form 10-K for the period ending August 31, 2006, 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

November 13, 2006

/s/ Mary A. Chaput

Mary A. Chaput

Executive Vice President and Chief Financial Officer

November 13, 2006