0000704415-07-000046.txt : 20070409 0000704415-07-000046.hdr.sgml : 20070409 20070409163552 ACCESSION NUMBER: 0000704415-07-000046 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20070228 FILED AS OF DATE: 20070409 DATE AS OF CHANGE: 20070409 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-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-19364 FILM NUMBER: 07756665 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-Q 1 form10-q_022807.htm HEALTHWAYS, INC. FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended February 28, 2007

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

For the transition period from _____ to _____

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)

(Former name, former address and former fiscal year, if changed since last report)

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 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. (Check one):

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 Exchange Act).

Yes o No x

As of April 5, 2007 there were outstanding 35,055,589 shares of the Registrant’s Common Stock, par value $.001 per share.

Healthways, Inc.

Form 10-Q

Table of Contents

			Page
Part I
	Item 1.	Financial Statements	4
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
	Item 4.	Controls and Procedures	29
Part II
	Item 1.	Legal Proceedings	30
	Item 1A.	Risk Factors	30
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31
	Item 3.	Defaults Upon Senior Securities	31
	Item 4.	Submission of Matters to a Vote of Security Holders	31
	Item 5.	Other Information	32
	Item 6.	Exhibits	32

Part I

Item 1.

Financial Statements

HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

ASSETS

	February 28,			August 31,
	2007			2006
Current assets:
Cash and cash equivalents	$	52,377		$	154,792
Accounts receivable, net		92,234			52,978
Prepaid expenses and other current assets		13,787			9,397
Income taxes receivable		915			—
Deferred tax asset		7,047			3,726
Total current assets		166,360			220,893

Property and equipment:
Leasehold improvements		19,076			16,009
Computer equipment and related software		86,100			75,524
Furniture and office equipment		20,565			18,542
		125,741			110,075
Less accumulated depreciation		(75,430	)		(63,525	)
		50,311			46,550

Long-term deferred tax asset		—			2,557

Other assets		6,202			4,052

Intangible assets, net		104,417			12,199

Goodwill, net		472,449			96,135

Total assets	$	799,739		$	382,386

See accompanying notes to the consolidated financial statements.

HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

LIABILITIES AND STOCKHOLDERS’ EQUITY

		February 28,			August 31,
		2007			2006
Current liabilities:
Accounts payable	$	16,582		$	9,221
Accrued salaries and benefits		22,968			36,007
Accrued liabilities		15,227			5,429
Deferred revenue		8,286			319
Contract billings in excess of earned revenue		53,487			35,013
Income taxes payable		—			7,906
Current portion of long-term debt		2,189			180
Current portion of long-term liabilities		2,700			2,349
Total current liabilities		121,439			96,424

Long-term debt		328,169			236
Long-term deferred tax liability		20,712			—
Other long-term liabilities		11,478			10,853

Stockholders’ equity:
Preferred stock
$.001 par value, 5,000,000 shares
authorized, none outstanding		—			—
Common stock
$.001 par value, 75,000,000 shares authorized,
35,040,414 and 34,597,748 shares outstanding		35			35
Additional paid-in capital		160,431			140,200
Retained earnings		157,480			134,622
Accumulated other comprehensive income (loss)		(5	)		16
Total stockholders’ equity		317,941			274,873

Total liabilities and stockholders’ equity	$	799,739		$	382,386

See accompanying notes to the consolidated financial statements.

HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except earnings per share data)

(Unaudited)

	Three Months Ended				Six Months Ended
	February 28,				February 28,
	2007		2006		2007		2006

Revenues	$	160,281	$	100,021	$	277,336	$	190,612
Cost of services (exclusive of depreciation and amortization of $7,458, $4,815, $13,093, and $9,245, respectively, included below)		105,939		70,859		183,488		134,703
Selling, general & administrative expenses		19,557		10,919		32,140		21,042
Depreciation and amortization		10,268		5,825		17,085		11,488

Operating income		24,517		12,418		44,623		23,379
Interest expense		6,251		257		6,547		512

Income before income taxes		18,266		12,161		38,076		22,867
Income tax expense		7,242		4,828		15,218		9,078

Net income	$	11,024	$	7,333	$	22,858	$	13,789

Earnings per share:
Basic	$	0.32	$	0.21	$	0.66	$	0.40

Diluted	$	0.30	$	0.20	$	0.62	$	0.38

Weighted average common shares
and equivalents:
Basic		34,958		34,321		34,792		34,140
Diluted		36,935		36,300		36,763		36,136

See accompanying notes to the consolidated financial statements.

HEALTHWAYS, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

For the Six Months Ended February 28, 2007

(In thousands)

(Unaudited)

									Accumulated
					Additional				Other
	Preferred		Common		Paid-in		Retained		Comprehensive
	Stock		Stock		Capital		Earnings		Income (Loss)			Total
Balance, August 31, 2006		$—		$35		$140,200		$134,622		$16			$274,873

Comprehensive Income:

Net income		—		—		—		22,858		—			22,858

Net change in fair value of interest rate
swap, net of income tax benefit of $41		—		—		—		—		(62	)		(62	)

Foreign currency translation adjustment		—		—		—		—		41			41

Total comprehensive income													22,837

Sale of unregistered common stock		—		—		5,000		—		—			5,000

Exercise of stock options and other		—		—		2,632		—		—			2,632

Tax benefit of option exercises		—		—		4,395		—		—			4,395

Share-based employee compensation expense		—		—		8,204		—		—			8,204

Balance, February 28, 2007		$—		$35		$160,431		$157,480		$ (5	)		$317,941

See accompanying notes to the consolidated financial statements.

HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Six Months Ended
	February 28,
	2007			2006
Cash flows from operating activities:
Net income	$	22,858		$	13,789
Adjustments to reconcile net income to net cash provided by
operating activities, net of business acquisitions:
Depreciation and amortization		17,085			11,488
Amortization of deferred loan costs		405			237
Share-based employee compensation expense		8,204			6,557
Excess tax benefits from share-based payment arrangements		(4,117	)		(8,935	)
Increase in accounts receivable, net		(15,653	)		(7,797	)
Increase in other current assets		(85	)		(3,372	)
(Decrease) increase in accounts payable		(1,156	)		836
(Decrease) increase in accrued salaries and benefits		(17,414	)		1,581
Increase in other current liabilities		17,617			22,269
Deferred income taxes		(5,708	)		(5,762	)
Other		1,990			2,051
Decrease in other assets		1,768			206
Payments on other long-term liabilities		(1,154	)		(1,221	)
Net cash flows provided by operating activities		24,640			31,927

Cash flows from investing activities:
Acquisition of property and equipment		(7,620	)		(10,108	)
Business acquisitions, net of cash acquired		(456,725	)		(70	)
Other, net		(13	)		—
Net cash flows used in investing activities		(464,358	)		(10,178	)

Cash flows from financing activities:
Decrease in restricted cash		—			3,811
Proceeds from issuance of long-term debt		350,000			—
Deferred loan costs		(4,357	)		(581	)
Proceeds from sale of unregistered common stock		5,000			—
Excess tax benefits from share-based payment arrangements		4,117			8,935
Payments of long-term debt		(20,089	)		(79	)
Exercise of stock options		2,632			4,479
Net cash flows provided by financing activities		337,303			16,565

Net (decrease) increase in cash and cash equivalents		(102,415	)		38,314

Cash and cash equivalents, beginning of period		154,792			63,467

Cash and cash equivalents, end of period	$	52,377		$	101,781

See accompanying notes to the consolidated financial statements.

HEALTHWAYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1)

Interim Financial Reporting

The accompanying consolidated financial statements of Healthways, Inc. and its wholly-owned subsidiaries for the three and six months ended February 28, 2007 and 2006 are unaudited. However, in our opinion, the financial statements reflect all adjustments consisting of normal, recurring accruals necessary for a fair presentation. We have reclassified certain items in prior periods to conform to current classifications.

We have omitted certain financial information that is normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States but that is not required for interim reporting purposes. You should read the accompanying consolidated financial statements in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended August 31, 2006.

(2)

Recently Issued Accounting Standards

In February 2007, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.” SFAS No. 159 provides entities with the one-time option to measure financial instruments and certain other items at fair value, with changes in fair value recognized in earnings as they occur. The fair value option may be applied instrument by instrument (with a few exceptions), is irrevocable, and must be applied to entire instruments and not to portions of an instrument. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We have not yet completed our analysis of the impact that the implementation of SFAS No. 159 will have on our results of operations or financial condition, but we do not expect it to have a material impact.

(3)

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. We account for share-based compensation in accordance with SFAS No. 123(R), “Share-Based Payment.” For the three and six months ended February 28, 2007, we recognized share-based compensation costs of $4.2 million and $8.2 million, respectively. For the three and six months ended February 28, 2006, we recognized share-based compensation costs of $3.3 million and $6.6 million, respectively.

In October 2006, we granted annual equity awards, including stock options and restricted stock units, for fiscal 2006 performance. A summary of our stock options as of February 28, 2007 and changes during the six months then ended is presented below:

Options	Shares (000s)		Weighted-Average Exercise Price			Weighted-Average Remaining Contractual Term			Aggregate Intrinsic Value ($000s)
Outstanding at September 1, 2006	5,836		$	18.87
Granted	312			42.84
Exercised	(120	)		11.81
Forfeited or expired	(13	)		22.89
Outstanding at November 30, 2006	6,015		$	20.24
Granted	93			45.31
Exercised	(197	)		6.10
Forfeited or expired	(13	)		29.42
Outstanding at February 28, 2007	5,898		$	21.09	5.92		$	133,377
Exercisable at February 28, 2007	3,367		$	11.71	5.30		$	107,029

The weighted-average grant-date fair value of options granted during the three and six months ended February 28, 2007 was $24.48 and $22.02, respectively.

The following table shows a summary of our restricted stock and restricted stock units (“nonvested shares”) as of February 28, 2007 as well as activity during the six months then ended.

Nonvested Shares	Shares (000s)		Weighted-Average Grant Date Fair Value
Nonvested at September 1, 2006	160		$	43.82
Granted	167			43.04
Vested	(3	)		38.11
Forfeited	—			—
Nonvested at November 30, 2006	324		$	43.44
Granted	26			45.25
Vested	—			—
Forfeited	(2	)		42.16
Nonvested at February 28, 2007	348		$	43.58

(4)

Business Acquisitions

On December 1, 2006, we acquired Axia Health Management, Inc. (“Axia”), a national provider of preventive health and wellness programs. The addition of Axia furthers our continuing strategy to provide a full spectrum of integrated, personalized, and evidence-based interventions to maintain or improve health and productivity.

We paid an aggregate of $456.1 million for Axia, including transaction-related costs of $5.1 million, which was funded through the use of approximately $106.1 million in available cash and $350.0 million in borrowings under a $600.0 million credit facility, as discussed in Note 8 below. At the closing, we deposited $35.0 million of the purchase price to be held in escrow until approximately December 31, 2007 to satisfy any potential indemnification claims. We also deposited an additional $9.0 million of the purchase price to be held in escrow to satisfy a portion of certain pre-existing potential earnout obligations (the “Earnout Obligations”).

At the close of the acquisition, L. Ben Lytle, who served as the chief executive officer of Axia prior to the acquisition, purchased for $5.0 million 123,305 shares of Healthways common stock under the terms of a Subscription Agreement dated October 11, 2006.

The total preliminary purchase price was allocated to Axia’s net tangible and identifiable intangible assets based on their estimated fair values. The estimated fair values of certain assets and liabilities were determined with the assistance of independent third-party valuation firms, and such firms’ preliminary work and our estimates and assumptions are subject to change upon the finalization of the valuations. The total preliminary purchase price was allocated as follows (excluding debt and cash acquired) and is subject to adjustments, primarily related to the finalization of the third-party valuations, a working capital adjustment, and the potential Earnout Obligations:

(In 000s)
Net tangible assets	$	9,369
Identifiable intangible assets		96,698
Goodwill		375,719
Net deferred tax liability		(25,656	)
Total preliminary purchase price	$	456,130

The results of operations of Axia were consolidated with those of the Company beginning on December 1, 2006. The unaudited pro forma combined results of operations as if the transaction had occurred on September 1, 2005 are as follows:

	Six Months Ended		Three Months Ended		Six Months Ended
(In $000s except per share amounts)	February 28, 2007		February 28, 2006		February 28, 2006
Revenues		$316,253		$128,934		$240,125
Net income		20,707		5,495		8,262
Earnings per share:
Basic		0.60		0.16		0.24
Diluted		0.56		0.15		0.23

The unaudited pro forma combined results of operations shown above include certain pro forma adjustments described in our Current Report on Form 8-K/A filed with the Securities and Exchange Commission on February 7, 2007.

(5)

Goodwill

The change in the carrying amount of goodwill during the six months ended February 28, 2007 is shown below:

(In $000s)
Balance, August 31, 2006	$	96,135
Purchase of Axia		375,719
Health IQ purchase price adjustment		595
Balance, February 28, 2007	$	472,449

The Health IQ Diagnostics, LLC (“Health IQ”) purchase price adjustment 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.

(6)

Intangible and Other Assets

Intangible assets subject to amortization at February 28, 2007 consist of the following:

	Gross Carrying		Accumulated
(In $000s)	Amount		Amortization		Net
Acquired technology	$	22,525	$	7,744	$	14,781
Customer contracts		58,196		7,957		50,239
Distributor and provider networks		8,709		298		8,411
Other		1,945		157		1,788
Total	$	91,375	$	16,156	$	75,219

Acquired technology, customer contracts, distributor and provider networks, and other intangible assets are being amortized on a straight-line basis over estimated useful lives ranging from four to ten years. Total amortization expense for the three months ended February 28, 2007 and 2006 was $3.5 million and $1.0 million, respectively. Total amortization expense for the six months ended February 28, 2007 and 2006 was $4.5 million and $2.0 million, respectively. Estimated amortization expense is $7.0 million for the remainder of fiscal 2007, $14.0 million for fiscal 2008, and $10.2 million, $10.1 million, and $9.2 million for the three fiscal years thereafter, respectively.

Intangible assets not subject to amortization at February 28, 2007 and 2006 consist of trade names of $29.2 million and $4.3 million, respectively. Other assets consist primarily of deferred loan costs net of accumulated amortization.

(7)

Derivative Investments and Hedging Activities

SFAS No. 133, “Accounting for Derivative Investments and Hedging Activities,” as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires companies to record all derivatives at estimated fair value as either assets or liabilities on the balance sheet and to recognize the unrealized gains and losses, the treatment of which depends on whether the derivative is designated as a hedging instrument.

As a result of our investment in international initiatives, we are exposed to foreign currency exchange rate risks. A significant portion of these risks is economically hedged with currency options and forwards contracts in order to minimize our exposure to fluctuations in foreign currency exchange rates. Principal currencies hedged include the Euro and British pound. These derivative instruments serve as economic hedges and do not qualify for hedge accounting treatment under SFAS No. 133. Accordingly, they require current period mark-to-market accounting, with any change in fair value being recorded each period in the statement of operations. We record the fair market value of our derivatives, based on information provided by reliable third parties, as other current assets and accrued liabilities. We routinely monitor our foreign currency exposures to maximize the overall effectiveness of our foreign currency hedge positions.

On December 21, 2006, we entered into an amortizing fixed interest rate swap agreement to reduce our exposure to interest rate fluctuations on our floating rate debt commitments. Under this interest rate swap agreement, the interest rate is fixed with respect to specified amounts of notional principal. We designated this swap agreement at its inception as a qualifying cash flow hedge. The fair

value of the swap at February 28, 2007 of $0.1 million has been reported in “accrued liabilities” with an offset, net of tax, included in “accumulated other comprehensive loss” in the balance sheet.

(8)

Long-Term Debt

On December 1, 2006, we entered into a Third Amended and Restated Revolving Credit and Term Loan Agreement (the “Third Amended Credit Agreement”). The Third Amended Credit Agreement provides us with a $400.0 million revolving credit facility, including a swingline sub facility of $10.0 million and a $75.0 million sub facility for letters of credit, a $200.0 million term loan facility, and an uncommitted incremental accordion facility of $200.0 million. As of February 28, 2007, availability under our line of credit totaled $268.9 million.

Revolving advances under the Third Amended Credit Agreement generally bear interest, at our option, at 1) LIBOR plus a spread of 0.875% to 1.750% or 2) the greater of the federal funds rate plus 0.5%, or the prime rate, plus a spread of 0.000% to 0.250%. In February 2007, we amended the Third Amended Credit Agreement such that term loan borrowings generally bear interest, at our option, at 1) LIBOR plus 1.50% or 2) the greater of the federal funds rate plus 0.5%, or the prime rate. The Third Amended Credit Agreement also provides for a fee ranging between 0.150% and 0.300% of unused commitments. The Third Amended Credit Agreement is secured by guarantees from most of the Company’s domestic subsidiaries and by security interests in substantially all of the Company’s and such subsidiaries’ assets.

We are required to repay outstanding revolving loans on the revolving commitment termination date, which is December 1, 2011. We are required to repay term loans in quarterly principal installments aggregating $0.5 million each, commencing on March 31, 2007, and the entire unpaid principal balance of the term loans is due and payable at maturity on December 1, 2013.

The Third 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. On December 21, 2006, we entered into an amortizing fixed interest rate swap agreement for the management of interest rate exposure. By entering into this interest rate swap agreement we effectively converted $230.0 million of floating rate debt to a fixed obligation with an interest rate of 4.995%. The principal value of the swap arrangement amortizes over a 39-month period and terminates on March 31, 2010. We currently believe that we meet the hedge accounting criteria under SFAS No. 133 in accounting for the interest rate swap agreement.

(9)

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.

In connection with the acquisition of Axia, we assumed certain potential Earnout Obligations up to an aggregate amount of $18.0 million. As discussed above, we deposited $9.0 million of the purchase price in escrow to satisfy a portion of these Earnout Obligations. Under the terms of the stock purchase agreement, we are responsible for payment of one-half of the total Earnout Obligations, with the other one-half being paid through the $9.0 million held in escrow.

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. The plaintiff recently agreed to dismiss its claims against the medical directors with prejudice, and on February 7, 2007 the court granted the plaintiff’s motion and dismissed all claims against all named medical directors.

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 a related matter, 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 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.

(10)

Comprehensive Income

Comprehensive income, net of income taxes, was $11.0 million and $7.3 million for the three months ended February 28, 2007 and 2006, respectively, and $22.8 million and $13.8 million for the six months ended February 28, 2007 and 2006, respectively.

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

Overview

Founded in 1981, Healthways, Inc. (the “Company”) provides specialized, comprehensive Health and Care Support^SM solutions to help people maintain or improve their health and, as a result, reduce overall healthcare costs.

Designed to provide highly specific and personalized interventions for each individual in a population, irrespective of health status, age, or payor, Healthways’ evidenced-based services are made available to consumers by phone, mail, internet, and face-to-face interactions. To expand our Health Support offerings, on December 1, 2006 we acquired Axia Health Management, Inc. (“Axia”), a national provider of preventive health and wellness programs, for approximately $456.1 million in cash.

We deliver our programs to customers, which include health plans, governments, employers, and hospitals, in all 50 states, the District of Columbia, Puerto Rico, and Guam. These services include:

	•	fostering wellness and prevention through total population screening, health risk assessments, and supportive interventions;
	•	providing access to health improvement activities such as physical activity programs, weight management, complementary and alternative medicine and smoking cessation;
	•	promoting the reduction of lifestyle behaviors that lead to poor health or chronic conditions;
	•	providing educational materials and personal interactions with highly trained nurses and other healthcare professionals that are designed to create and sustain healthier behaviors to members with chronic conditions;
	•	incorporating current evidence-based clinical guidelines in interventions to optimize patient health outcomes;
	•	developing Care Support plans and motivating members to set attainable goals for themselves;
	•	providing local market resources to address acute episode interventions; and
	•	coordinating members’ care with local healthcare providers.

Our programs focus on prevention, education, health coaching, behavior change and evidence-based medicine to drive adherence to proven standards of care, medications and physicians’ plans of care. The programs are designed to support better health and assist in providing more effective care, which we believe will improve the health status of member populations and reduce both the short-term and long-term healthcare costs for members.

Health and Care Support services enable health plans and employers to reach and engage everyone in their covered populations through interventions that are both sensitive to and specific to each individual’s health risks and needs. Health Support products are designed to motivate people to make positive lifestyle changes and accomplish individual goals, such as becoming more physically active through SilverSneakers®, staying fit using My ePHIT® and quitting smoking through the world’s largest on-line community via QuitNet®. The Care Support product line includes programs for people with chronic diseases or conditions, including diabetes, coronary artery disease, heart failure, asthma, chronic obstructive pulmonary disease, end-stage renal disease, cancer, chronic kidney disease, depression, high-risk obesity, metabolic syndrome, 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 for members at risk for hospitalization due to complex conditions. We believe that creating real and sustainable behavior change generates measurable long-term cost savings.

Predicated on the fundamental belief that healthier people cost less, Healthways’ programs are designed to help keep healthy individuals healthy, mitigate and delay the progression to disease associated with family or lifestyle risk factors and promote the best possible health for those who are already affected by disease. At the same time, we recognize that each individual plays a variety of roles in his or her pursuit of health, often simultaneously. By providing the full spectrum of Health and Care Support services to meet each individual’s needs, we believe that our interventions can be delivered both at scale and in a manner that reflects the unique needs of each consumer over time. Further, Healthways’ extensive and fully accredited complementary and alternative provider network offers convenient access to the significant number of individuals who seek health services outside of the traditional healthcare system.

Recent Developments

As noted above, on December 1, 2006 we acquired Axia for approximately $456.1 million. At the closing of the acquisition, we deposited $35.0 million of the purchase price to be held in escrow until approximately December 31, 2007, to satisfy any potential indemnification claims. We also deposited an additional $9.0 million of the purchase price to be held in escrow to satisfy a portion of certain pre-existing potential earnout obligations. We financed the acquisition through a combination of cash on hand and borrowings under the Third Amended Credit Agreement.

Highlights of Performance for the Three Months Ended February 28, 2007

•

Revenues increased 60.2% for the three months ended February 28, 2007 over the three months ended February 28, 2006.

•

Net income for the three months ended February 28, 2007 increased 50.3% over the three months ended February 28, 2006.

•

Available lives and billed lives increased to 184.8 million and 26.4 million, respectively, at February 28, 2007 compared to 49.4 million and 2.0 million, respectively, at February 28, 2006.

Forward-Looking Statements

Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements, which are based upon current expectations and involve a number of risks and uncertainties. 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 and/or our cooperative agreement with CMS ahead of data collection and reconciliation in order to provide forward-looking guidance;

•

our ability to agree with CMS to make certain modifications to our cooperative agreement at a time and on terms acceptable to us;

•

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;

•

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;

•

the risks associated with foreign currency exchange rate fluctuations and our ability to hedge against such fluctuations;

•

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;

•

increased leverage incurred in conjunction with the acquisition of Axia and our ability to service our debt and make principal and interest payments as those payments become due;

•

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;

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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 our other filings with the Securities and Exchange Commission.

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

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 typically 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]. In addition, some of our services are billed on a fee for service basis.

Contracts generally range from three to five 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.

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 healthcare costs and selected clinical and/or other criteria that focus on improving the health of the members. Approximately 6% of revenues recorded during the six months ended February 28, 2007 were performance-based and were subject to final reconciliation as of February 28, 2007. 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 are scheduled to operate for 36 months but 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 (“CIGNA”). 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, although modified for the special needs and conditions of this population.

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.

Technology

Our customer contracts require sophisticated analytical, data management, Internet and computer-telephony solutions based on state-of-the-art technology. These solutions help us deliver Health and Care Support services to large populations within our government, health plan and employer customers. Our predictive modeling capabilities allow us to identify our customers’ health and wellness requirements. We incorporate behavior-change science with consumer-friendly web portals to facilitate

consumer preferences for engagement and convenience. Sophisticated data analytical and reporting solutions are used to validate the impact of our programs on clinical and financial outcomes. We continue to invest heavily in technology and are continually expanding and improving our proprietary clinical, data management, and reporting systems to continue to meet the information management requirements of our Health and Care Support services.

Contract Revenues

Our contract revenues depend on the contractual terms we establish and maintain with customers to provide Health and Care Support services to their members. Some contracts allow the customer to terminate early. Restructurings and possible terminations at or prior to renewal could have a material negative impact on our results of operations and financial condition.

Approximately 20% and 23% of our revenues for the three and six months ended February 28, 2007, respectively, were derived from one customer. The loss of this customer or any other large customer or a reduction in the profitability of a contract with any large customer would have a material negative impact on our results of operations, cash flows, and financial condition.

Billed Lives and Available Lives

Following the acquisition of Axia on December 1, 2006, we introduced new metrics to replace the “actual lives under management” metric traditionally used to measure our Care Support business. The first new metric is “billed lives”, which is the total number of lives for which we receive fees under our contracts. The second new metric is “available lives”, which measures the entire population of our health plan and employer commercial customers. The number of available lives and billed lives as of February 28, 2007 and February 28, 2006 were as follows:

	February 28,	February 28,
(In 000s)	2007	2006
Available lives	184,800	49,400
Billed lives	26,400	2,027

Backlog

Backlog represents the estimated annualized revenue at target performance associated with signed contracts at February 28, 2007 for which we have not yet begun providing services. Annualized revenue in backlog as of February 28, 2007 and February 28, 2006 was as follows:

	February 28,		February 28,
(In 000s)	2007		2006
Annualized revenue in backlog	$	8,383	$	5,215

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 available and billed lives or in the annualized revenue in backlog reported in the tables above, as appropriate.

Business Strategy

Our primary strategy is to improve the health of populations as well as the quality and affordability of healthcare through Health and Care Support programs and services both domestically and internationally, thereby creating value for health plans, governments, employers, and hospitals. We plan to continue using our scaleable state-of-the-art care enhancement centers, medical information content, web services, health provider networks 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 reach and support entire populations. 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.

We deliver programs that engage consumers in their health. We believe that we can achieve health improvements and generate significant cost savings by addressing consumer and customer needs for effective programs that support the individual across his or her lifetime.

We anticipate that we will incur significant costs during the remainder of fiscal 2007 to enhance and expand our Health and Care Support capabilities, pursue opportunities in international markets, enhance our information technology support, integrate the operations of Axia, and open additional or expand current capacity 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 or investments.

Critical Accounting Policies

We describe our accounting policies in Note 1 of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended August 31, 2006. 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 typically 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). In addition, some of our services are billed on a fee for service basis.

Contracts with health plans generally range from three to five years with provisions for subsequent renewal; contracts between our health plan customers and their self-insured employer accounts typically have one-year terms.

We generally 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. Fees for service are typically billed in the month after the services are provided.

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 5.0%. 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 5.0% 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 healthcare claims and clinical data. As of February 28, 2007, 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 totaled approximately $60.0 million. Of this amount, $25.7 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 $34.3 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 during the prior fiscal year. During the six months ended February 28, 2007, we recognized a net decrease in revenue of $1.9 million that related to services provided prior to fiscal 2007.

Impairment of Intangible Assets and Goodwill

In accordance with 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

In accordance with SFAS No. 123(R), we 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.

Results of Operations

The following table shows the components of the statements of operations for the three and six months ended February 28, 2007 and 2006 expressed as a percentage of revenues.

	Three Months Ended				Six Months Ended
	February 28,				February 28,
	2007		2006		2007		2006

Revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of services (exclusive of depreciation
and amortization included below)	66.1	%	70.8	%	66.2	%	70.7	%
Selling, general and administrative expenses	12.2	%	10.9	%	11.6	%	11.0	%
Depreciation and amortization	6.4	%	5.8	%	6.2	%	6.0	%
Operating income	15.3	%	12.5	%	16.1	%	12.3	%

Interest expense	3.9	%	0.3	%	2.4	%	0.3	%

Income before income taxes	11.4	%	12.2	%	13.7	%	12.0	%
Income tax expense	4.5	%	4.9	%	5.5	%	4.8	%

Net income	6.9	%	7.3	%	8.2	%	7.2	%

Revenues

Revenues for the three months ended February 28, 2007 increased 60.2% over revenues for the three months ended February 28, 2006, primarily due to the following:

•

revenues of $43.6 million related to the acquisition of Axia on December 1, 2006;

•

an increase in the number of self-insured employer billed lives on behalf of our health plan customers from 811,000 at February 28, 2006 to 1,059,000 at February 28, 2007;

•

the addition of new programs or expansion into additional populations with eight existing customers since the beginning of the second quarter of fiscal 2006; and

•

the commencement of seven new contracts since the beginning of the second quarter of fiscal 2006.

as a higher cumulative net savings target, which increases in gradual increments over the term of the pilots.

Revenues for the six months ended February 28, 2007 increased 45.5% over revenues for the six months ended February 28, 2006, primarily due to the following:

•

revenues of $43.6 million related to the acquisition of Axia on December 1, 2006;

•

an increase in the number of self-insured employer billed lives on behalf of our health plan customers from 811,000 at February 28, 2006 to 1,059,000 at February 28, 2007;

•

the addition of new programs or expansion into additional populations with eight existing customers since the beginning of fiscal 2006; and

•

the commencement of eight new contracts since the beginning of fiscal 2006.

These increases were slightly offset by decreased revenues associated with the MHS pilots due to a decline in the cumulative net savings in the intervention population compared to the control group as well as a higher cumulative net savings target, which increases in gradual increments over the term of the pilots.

We anticipate that revenues for the remainder of fiscal 2007 will increase over fiscal 2006 primarily due to the expansion of existing contracts, increasing demand for our Health and Care Support services from self-insured employers, anticipated new contracts, signed contracts since the end of the second quarter of fiscal 2007, and the acquisition of Axia. Due to the decline in the cumulative net savings in the intervention group compared to the control group, we have been actively engaged with CMS in mutual and intensive analysis of intervention and control group data in order to better understand the factors associated with CMS reported performance and to identify mutually acceptable modifications to the pilots. We expect that CMS will complete its evaluation of the suggested pilot modifications by the middle of calendar 2007. Until this evaluation is completed and a decision is reached, we do not yet know the impact on fiscal 2007 revenues from the MHS pilots.

Cost of Services

Cost of services (excluding depreciation and amortization) as a percentage of revenues for the three months ended February 28, 2007 decreased to 66.1% compared to 70.8% for the same period in fiscal 2006, primarily due to the following:

•

a decrease in the level of employee bonus provision; and

•

decreased professional consulting fees related to information technology strategy and initiatives.

These decreases were partially offset by increases in cost of services as a percentage of revenues for the three months ended February 28, 2007 compared to the three months ended February 28, 2006 related to the following:

•

increased salaries and benefits and temporary staffing expense, primarily related to organizational design changes in our field support and operations structure and enhanced client reporting initiatives; and

•

increased costs related to the MHS pilots, primarily due to 1) enhanced interventions to focus on the special needs of this population, such as the increased use of heart monitors; and 2) additional costs related to the refresh population, which we began serving on August 1, 2006.

Cost of services (excluding depreciation and amortization) as a percentage of revenues for the six months ended February 28, 2007 decreased to 66.2% compared to 70.7% for the same period in fiscal 2006, primarily due to a decrease in the level of employee bonus provision during the six months ended February 28, 2007 compared to the six months ended February 28, 2006. This decrease was partially offset by increases in cost of services as a percentage of revenues for the three months ended February 28, 2007 compared to the three months ended February 28, 2006 related to the following:

•

increased salaries and benefits, primarily related to organizational design changes in our field support and operations structure and enhanced client reporting initiatives;

•

increased volume in mailings of educational materials to participants due to timing of new contracts and an increase in domestic postage rates; and

•

increased costs related to the MHS pilots, primarily due to 1) additional costs related to the timing of the pilot in Georgia in collaboration with CIGNA, which did not begin until the middle of the first quarter of fiscal 2006; 2) enhanced interventions to focus on the special needs of this population, such as the increased use of heart monitors; and 3) additional costs related to the refresh population, which we began serving on August 1, 2006.

We anticipate that cost of services for the remainder of fiscal 2007 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, including related operational integration expenses.

Selling, General and Administrative Expenses

Selling, general and administrative expenses as a percentage of revenues increased to 12.2% and 11.6% for the three and six months ended February 28, 2007, respectively, from 10.9% and 11.0% for the same periods in fiscal 2006 primarily due to the following:

•

an increase in salaries and benefits related to changes in our infrastructure to support future strategic and operational growth; and

•

the acquisition of Axia, which has slightly higher selling, general and administrative expenses as a percentage of revenues due to the nature of Health Support services, as well as the related integration costs.

These increases were somewhat offset by decreases in selling, general and administrative expenses as a percentage of revenues related to the following:

•

a decrease in the level of employee bonus provision during the three and six months ended February 28, 2007 compared to the three and six months ended February 28, 2006; and

•

a decrease in legal fees during the three and six months ended February 28, 2007 compared to the three and six months ended February 28, 2006.

We anticipate that selling, general and administrative expenses for the remainder of 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 the three and six months ended February 28, 2007 increased 76.3% and 48.7% compared to the same periods in fiscal 2006 primarily due to the following:

•

depreciation and amortization expense associated with the depreciable assets and preliminary identifiable intangible assets recorded in connection with the Axia acquisition on December 1, 2006; and

•

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 the remainder of fiscal 2007 will increase over fiscal 2006 primarily as a result of 1) depreciation and amortization expense associated with the depreciable assets and preliminary identifiable intangible assets recorded in connection with 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 the three and six months ended February 28, 2007 increased $6.0 million compared to the three and six months ended February 28, 2006, primarily due to borrowings under the Third Amended Credit Agreement related to the acquisition of Axia on December 1, 2006.

We anticipate that interest expense for the remainder of fiscal 2007 will increase over fiscal 2006 primarily as a result of the outstanding borrowings under the Third Amended Credit Agreement.

Income Tax Expense

Our effective tax rate was 39.6% and 40.0% for the three and six months ended February 28, 2007, respectively, compared to 39.7% for the three and six months ended February 28, 2006. Changes in our effective tax rate are primarily a result of costs of international initiatives incurred in foreign jurisdictions and changes in our domestic United States geographic mix of earnings, which impacts our average state income tax rate. 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, the lack of tax benefit on certain expenses incurred in international initiatives, and certain non-deductible expenses for income tax purposes. We anticipate that our effective tax rate for the remainder of fiscal 2007 will not change significantly compared to fiscal 2006 or fiscal 2007 to date; however, we continue to evaluate the impact of the Axia acquisition on our geographic mix of earnings and overall state tax rate.

Liquidity and Capital Resources

Operating activities for the six months ended February 28, 2007 generated cash of $24.6 million compared to $31.9 million for the same period in fiscal 2006. The decrease in operating cash flow resulted primarily from 1) increased payments of employee bonuses that were accrued at the end of the previous fiscal year; 2) an increase in days sales in receivables to 53 days at February 28, 2007 from 44 days at February 28, 2006; and 3) an increase in income tax payments, primarily due to an increase in final tax payments pertaining to the previous fiscal year as well as a lower level of employee stock option exercises. These decreases to cash were partially offset by an increase in net income.

Investing activities during the six months ended February 28, 2007 used $464.4 million in cash and consisted primarily of payments related to the acquisition of Axia on December 1, 2006.

Financing activities for the six months ended February 28, 2007 provided $337.3 million in cash primarily from the proceeds of borrowings under the Third Amended Credit Agreement, slightly offset by principal payments on these borrowings.

On December 1, 2006, we entered into the Third Amended Credit Agreement. The Third Amended Credit Agreement provides us with a $400.0 million revolving credit facility, including a swingline sub facility of $10.0 million and a $75.0 million sub facility for letters of credit, a $200.0 million term loan facility, and an uncommitted incremental accordion facility of $200.0 million. As of February 28, 2007, availability under our line of credit totaled $268.9 million.

The Third Amended Credit Agreement replaced the Second Amended Credit Agreement, which provided 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. The Second Amended Credit Agreement contained various financial covenants, which required us to maintain, as defined, ratios or levels of (i) total funded debt to EBITDA, (ii) fixed charge coverage, and (iii) net worth. The Third Amended Credit Agreement contains similar financial covenants. Both agreements restrict the payment of dividends and limit the amount of repurchases of the Company’s common stock. As of February 28, 2007, we were in compliance with all of the covenant requirements of the Third Amended Credit Agreement.

On December 21, 2006, we entered into an amortizing fixed interest rate swap agreement for the management of interest rate exposure. By entering into this interest rate swap agreement we effectively converted $230.0 million of floating rate debt to a fixed obligation with an interest rate of 4.995%. The principal value of the swap arrangement amortizes over a 39-month period and terminates on March 31, 2010. We currently believe that we meet the hedge accounting criteria under SFAS No. 133 in accounting for the interest rate swap agreement.

We believe that cash flow from operating activities, our available cash, and our expected available credit under the Third Amended Credit Agreement 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.

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.

Recently Issued Accounting Standards

Fair Value Option for Financial Assets and Financial Liabilities

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.” SFAS No. 159 provides entities with the one-time option to measure financial instruments and certain other items at fair value, with changes in fair value recognized in earnings as they occur. The fair value option may be applied instrument by instrument (with a few exceptions), is irrevocable, and must be applied to entire instruments and not to portions of an instrument. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We have not yet completed our analysis of the impact that the implementation of SFAS No. 159 will have on our results of operations or financial condition, but we do not expect it to have a material impact.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risk related to interest rate changes, primarily as a result of the Third Amended Credit Agreement, which bears interest based on floating rates. Revolving advances under the Third Amended Credit Agreement generally bear interest, at our option, at 1) LIBOR plus a spread of 0.875% to 1.750% or 2) the greater of the federal funds rate plus 0.5%, or the prime rate, plus a spread of 0.000% to 0.250%. In February 2007, we amended the Third Amended Credit Agreement such that term loan borrowings generally bear interest, at our option, at 1) LIBOR plus 1.50% or 2) the greater of the federal funds rate plus 0.5%, or the prime rate.

In order to manage our interest rate exposure under the Third Amended Credit Agreement, we entered into an amortizing fixed interest rate swap agreement in December 2006, effectively converting $230.0 million of floating rate debt to a fixed obligation with an interest rate of 4.995%.

A one-point interest rate change would have resulted in interest expense fluctuating approximately $0.5 million for the six months ended February 28, 2007.

As of February 28, 2007, as a result of our investment in international initiatives, we are also exposed to foreign currency exchange rate risks. Because a significant portion of these risks is economically hedged with currency options and forwards contracts and because our international initiatives are not yet material to our consolidated results of operations, a 10% change in foreign currency exchange rates would not have had a material impact on our results of operations or financial position for the six months ended February 28, 2007. We do not execute transactions or hold derivative financial instruments for trading purposes.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our chief executive officer and chief financial officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of February 28, 2007. Based on that evaluation, the chief executive officer and chief financial officer have concluded that our disclosure controls and procedures effectively and timely provide them with material information relating to the Company and its consolidated subsidiaries required to be disclosed in the reports the Company files or submits under the Exchange Act.

Changes in Internal Control over Financial Reporting

On December 1, 2006, we acquired Axia, whose revenues represent approximately 27.2% of our consolidated revenues for the quarter ended February 28, 2007. Excluding the Axia acquisition, there have been no changes in our internal controls over financial reporting during the quarter ended February 28, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II

Item 1. Legal Proceedings

Item 1A. Risk Factors

Not Applicable.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On October 11, 2006, we entered into a Subscription Agreement with L. Ben Lytle in connection with the acquisition of Axia, for whom Mr. Lytle served as chief executive officer. Under the Subscription Agreement, on December 1, 2006, Mr. Lytle purchased 123,305 unregistered shares of our common stock, $.001 par value, for $5.0 million. The issuance of the shares was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, because it was a transaction not involving a public offering.

Item 3. Defaults Upon Senior Securities

Not Applicable.

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

(a) The Annual Meeting of Stockholders of Healthways, Inc. was held on February 2, 2007.

(c)

The following proposals were voted upon at the Annual Meeting of Stockholders:

(i)

Nominations to elect William C. O’Neil, Jr., Ben R. Leedle, Jr., Alison Taunton-Rigby, John A. Wickens and L. Ben Lytle as Directors of the Company. The results of the election of the above-mentioned nominees were as follows:

	For	Withheld
William C. O'Neil, Jr.	30,711,408	2,317,559
Ben R. Leedle, Jr.	30,992,458	2,036,509
Alison Taunton-Rigby	32,424,804	604,163
John A. Wickens	32,644,105	384,862
L. Ben Lytle	30,744,852	2,284,115

(ii)

Adoption of a new 2007 Stock Incentive Plan. The voting results of the above-mentioned Plan were as follows:

For				Against				Abstain from Voting
18,740,950				9,266,843				42,149

(iii)

Ratification of the appointment of Ernst & Young LLP as the Company’s independent registered public accounting firm for fiscal 2007. The voting results were as follows:

For				Against				Abstain from Voting
32,969,820				40,192				18,955

Item 5. Other Information

Not applicable.

Item 6. Exhibits

(a)

Exhibits

10.1		First Amendment to Third Amended and Restated Revolving Credit and Term Loan Agreement dated February 20, 2007 by and among Healthways, Inc., various lenders, and SunTrust Bank, as Administrative Agent, Issuing Bank and Swingline Lender

10.2		Long-Term Performance Award Agreement for Matthew E. Kelliher. Confidential treatment requested for certain portions of this Exhibit pursuant to Rule 406 promulgated under the Securities Act and Rule 24b-2 promulgated under the Securities Exchange Act, which portions are omitted and filed separately with the Securities and Exchange Commission.

11		Earnings Per Share Reconciliation

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended

32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

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

			Healthways, Inc.
			(Registrant)




Date	April 9, 2007	By	/s/ Mary A. Chaput
			Mary A. Chaput
			Executive Vice President
			Chief Financial Officer
			(Principal Financial Officer)




Date	April 9, 2007	By	/s/ Alfred Lumsdaine
			Alfred Lumsdaine
			Senior Vice President and
			Controller
			(Principal Accounting Officer)

GRAPHIC 2 logo.jpg GRAPHIC begin 644 logo.jpg M_]C_X``02D9)1@`!`0$`8`!@``#__@`<4V]F='=A'P\?_$`!@!`0$!`0$````````` M```````!`@0#_\0`)Q$``@(!`P,#!0$```````````$"$1(#,4$3(6$BH;%1 M@9'!\.'_W0`$`"C_V@`,`P$``A$#$0`_`/9J4I0"E*4`I2E`*P==;9;4ZZM+ M:$#*E*.`!W)K.JBUG6-_DAX[K+;'?#2U^S)>',J[I3VH>NGIYVWV2W)9O4`F M@JM<%^8V/[\X::/LI7/W`-;#/NR,%=G2H'HU+25?0$`?QJ)ODXS-6VO3#:MC M"VU2I03PWH3]U'L2./H,5)ZHCN.Z?E/1W"S*B(+\=P&U\ MDHR*D:KD9,37&DX4Y:2P\ZV'&G MFSA<=T<"4GT(^HK;I6\2+E%D1+@`+C;W2Q)QR6>BQZ$5AIITS3A&4,X<;K^X M)ZE*4/$4I2@%*4H!2E*`4I2@%*4H!2E*`Q7N\-6W[V#CWJJ_#;'ZI)!_$$ET M.]]V[^F*ME5+"M'7V3(6D_H6Y.>(MP#(BO'F5=DJ[]*AU:/JTY::W=->:OM[ MD-K1YS36OK1J9:5&$XV8SZ@,[.?_``<_NFHZZ76^Z?L=S0XYDY]GBYNJ8CTQT M;8T6%O4MY?89Z=STK;I>RO6J&\_.4E=QG.E^4I/(*/)(]`.%C2 ME)\JE^4_T3E*4J',*4I0"E*4`I2E`*5R7:2[#M$R4R$EUAA;B`H9&0DD9KDT MOXMVFU M29[@W!E!(2.:E<@D>I.!]:C-&W][4%D\:8VEF^S7=?RK$I+7RC,)+Z5!)W[B0.)SC'/I6S4;U^A M1Y,^W2H*(T:.IQ3;["EK4I()."%#'3I5P=I?46;T:>9B*)MDJ1;P3GPFE!36 M?\"@0/IBLS;;BL;7+V^$]?#9;2?SP:X-+3+_`'6%$N<^1!,64QXG@LL*2M)/ M+S%1!_*LM-7R9=KG?(TI+01;YA8:V)()3Z\>='IM7X/7K2>_PB2@66#;W5/M M-J.59_*DM M.4;LS=DS2JI9-8*NFKIUI<:"(P1O@NX_&""4N'/7S`X]C6UR_P`^W:W:M%Q2 MR+?/;)A/I20?$'-"CG&>WTJ].2=?<6BS4JMIU')(O5S\)"K3;D*2UM'G?<0, MK(/+:#Y>7,&EEFW^Y,V^Y"3;7X]?$ MK;)*$*22!G:#R%>BFU&D2NY4/ACM1HQ0`*0F4_P/0;J@-`NZ59M$1V?);;N: M9*RE*GE@YWG;Y0<=NE>H!(`P``/2L?#;`^XG\A6NK>7DE%8U`ER_:BB6"/)7 M'1%2)TEU"02"#AI/$$<\JX]A49#9>TAK]#3\MV5%OZ#N=<2E.)">6=H`X@X^ MM7S`!)P,GK6)+:EA!*2L#(2>>.]1:E+&NQ:*,NZP+7\5[@]/E-QFS;6T!;AP M"=V2^PY#>VK1Q"O*1_.ID!IS*@$*XX)&#Q'2F6D@(R@ M!7(<.-'--IUL*(71']BK1_E4<_:JUIJPVN]Z@U.]/B%Y2+DI*"5J3@8]"*]! M``&`,"@`&<`#/.BU&LFN111],V^):_B3?(D)DM,IB,D)R5<3Q/$^]:-8S6*EMA6%*2"!GB>(]:G4M*UL6CSS4.FY>E[;;[W#N,B8;&M.UE;:$_8 MD@+&4@$_7/6I3XA&+J[3>Z)1%,+@V?23:ULGY-B("MM*-Q*=O'AUS5-1!M$+4=JD: M)GG=*D#YJ)'=*V?!QE2E)_9QZ]37I'*M;:&&G%(;2VA:AN4$@`GUJ1U,;\E: M-M*Q2M*_NJ"O8YI7D4__T/6[I'$JUR6?"#JE-*V)(!\V#C&>M0HMTZ*XEZ$T MIA2(<9.U"4X6H+5O!]@?XU9:5I2:5$HB+5^E%2%&>LC&\*;\/RYW>4I5VV_] MUPN6VX&UR4`K\UP+@9VC)1XX5G/MQJRTJY][%%?;@R3[URKBW=]M#[J'TOAA*%K;PE9`?!(_T#/K5JI5S\"BN,Q[M$<5 M\N'=C[TC*5!.U&Y?D7WZDUN@P4PGY3,J&J0%N@L.;`L>&`D)3Z8(/\^M3M*F M;%%>#E[?=<"42([;BFN>TEO[0AS!QC[F#_*NJW"Z&E%3*`ZV4%_ M+I;"DD;AX6,<^':I^E,_`HA[4F>9[CLQ+R`N,V`A2]R`H*7GH..-I^OI6B'$ M6U;G8TN&MV:5.DO[`H+)*L*"NG`@8Z%"1&V2'$>"PE*@4Y: M5L5NY#B`0D8]>U;6#?%J9>=4ZD@QPMO:D).1]KGV_P#E3]*9^!16A^L+;#:M M[JRMMM3VY* EX-10 3 ex10-1_022807.htm EX-10.1, FIRST AMENDMENT TO CREDIT AGREEMENT

Exhibit 10.1

FIRST AMENDMENT TO THIRD AMENDED AND RESTATED

REVOLVING CREDIT AND TERM LOAN AGREEMENT

THIS FIRST AMENDMENT TO THIRD AMENDED AND RESTATED REVOLVING CREDIT AND TERM LOAN AGREEMENT (this “Amendment”), is made and entered into as of February 20, 2007, by and among HEALTHWAYS, INC., a Delaware corporation (the “Borrower”), the several banks and other financial institutions from time to time party hereto (collectively, the “Lenders”) and SUNTRUST BANK, in its capacity as Administrative Agent for the Lenders (the “Administrative Agent”), and as the Issuing Bank and the Swingline Lender.

W I T N E S S E T H:

WHEREAS, the Borrower, the Lenders and the Administrative Agent are parties to a certain Third Amended and Restated Revolving Credit and Term Loan Agreement, dated as of December 1, 2006 (as amended, restated, supplemented or otherwise modified from time to time, the “Credit Agreement”; capitalized terms used herein and not otherwise defined shall have the meanings assigned to such terms in the Credit Agreement), pursuant to which the Lenders have made certain financial accommodations available to the Borrower;

WHEREAS, the Borrower has requested that the Lenders and the Administrative Agent amend certain provisions of the Credit Agreement, and subject to the terms and conditions hereof, the Lenders are willing to do so;

NOW, THEREFORE, for good and valuable consideration, the sufficiency and receipt of all of which are acknowledged, the Borrower, the Lenders, the Issuing Bank and the Administrative Agent agree as follows:

Amendment.

Section 1.1 of the Credit Agreement is hereby amended by replacing clause (x) of the definition of “Applicable Margin” in its entirety with the following:

(x) with respect to all Term Loans outstanding on any date, a Base Rate Margin of 0.00% per annum and a Eurodollar Rate Margin of 1.50% per annum,

2. Conditions to Effectiveness of this Amendment. Notwithstanding any other provision of this Amendment and without affecting in any manner the rights of the Lenders hereunder, it is understood and agreed that this Amendment shall not become effective, and the Borrower shall have no rights under this Amendment, until the Administrative Agent shall have received executed counterparts of this Amendment from the Borrower, each of the Guarantors and the applicable Lenders.

3. Representations and Warranties. To induce the Lenders and the Administrative Agent to enter into this Amendment, each Loan Party hereby represents and warrants to the Lenders and the Administrative Agent:

(a) The Borrower and each of its Subsidiaries (i) is duly organized, validly existing and in good standing as a corporation, partnership or limited liability company, as applicable, under the laws of the jurisdiction of its organization, (ii) has all requisite power and authority to carry on its business as now conducted, and (iii) is duly qualified to do business, and is in good standing, in each jurisdiction where such qualification is required, except where a failure to be so qualified would not reasonably be expected to result in a Material Adverse Effect;

(b) The execution, delivery and performance of this Amendment by each Loan Party are within such Loan Party’s organizational powers and have been duly authorized by all necessary organizational, and if required, shareholder, partner or member, action;

(c) The execution, delivery and performance of this Amendment by each Loan Party (i) do not require any consent or approval of, registration or filing with, or any action by, any Governmental Authority, except those as have been obtained or made and are in full force and effect or where a failure to do so, individually or in the aggregate, could not reasonably be expected to have a Material Adverse Effect, (ii) will not violate any applicable law or regulation or the charter, by-laws or other organizational documents of the Borrower or any of its Subsidiaries or any order of any Governmental Authority, (iii) will not violate or result in a default under any indenture, material agreement or other material instrument binding on the Borrower or any of its Subsidiaries or any of its material assets or give rise to a right thereunder to require any payment to be made by the Borrower or any of its Subsidiaries and (iv) will not result in the creation or imposition of any Lien on any material asset of the Borrower or any of its Subsidiaries, except Liens (if any) created under the Loan Documents;

(d) This Amendment has been duly executed and delivered by or on behalf of each Loan Party and constitutes a legal, valid and binding obligation of each Loan Party, enforceable against such Loan Party in accordance with its terms except as the enforceability hereof may be limited by bankruptcy, insolvency, reorganization, moratorium and other similar laws affecting creditors’ rights and remedies in general and by general principles of equity; and

(e) After giving effect to this Amendment and any changes in facts and circumstances that are not prohibited by the terms of the Credit Agreement, the representations and warranties contained in the Credit Agreement and the other Loan Documents are true and correct in all material respects (subject to the limitation that representations and warranties effective as of a specified date are true and correct as of such specified date), and no Default or Event of Default exists as of the date hereof.

Reaffirmations and Acknowledgments.

(a) Reaffirmation of Guaranty. Each Subsidiary Loan Party consents to the execution and delivery by the Borrower of this Amendment and jointly and severally ratifies and confirms

the terms of the Subsidiary Guarantee Agreement with respect to the indebtedness now or hereafter outstanding under the Credit Agreement as amended hereby and all promissory notes issued thereunder. Each Subsidiary Loan Party acknowledges that, notwithstanding anything to the contrary contained herein or in any other document evidencing any indebtedness of the Borrower to the Lenders or any other obligation of the Borrower, or any actions now or hereafter taken by the Lenders with respect to any obligation of the Borrower, the Subsidiary Guarantee Agreement (i) is and shall continue to be a primary obligation of the Subsidiary Loan Parties, (ii) is and shall continue to be an absolute, unconditional, joint and several, continuing and irrevocable guaranty of payment, and (iii) is and shall continue to be in full force and effect in accordance with its terms. Nothing contained herein to the contrary shall release, discharge, modify, change or affect the original liability of the Subsidiary Loan Parties under the Subsidiary Guarantee Agreement.

(b) Acknowledgment of Perfection of Security Interest. Each Loan Party hereby acknowledges that, as of the date hereof, the security interests and liens granted to the Administrative Agent and the Lenders under the Credit Agreement and the other Loan Documents are in full force and effect, are properly perfected and are enforceable in accordance with the terms of the Credit Agreement and the other Loan Documents.

5. Effect of Amendment. Except as set forth expressly herein, all terms of the Credit Agreement, as amended hereby, and the other Loan Documents shall be and remain in full force and effect and shall constitute the legal, valid, binding and enforceable obligations of the Borrower to the Lenders and the Administrative Agent. The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of the Lenders under the Credit Agreement, nor constitute a waiver of any provision of the Credit Agreement. This Amendment shall constitute a Loan Document for all purposes of the Credit Agreement.

6. Governing Law. This Amendment shall be governed by, and construed in accordance with, the internal laws of the State of New York and all applicable federal laws of the United States of America.

7. No Novation. This Amendment is not intended by the parties to be, and shall not be construed to be, a novation of the Credit Agreement or an accord and satisfaction in regard thereto.

8. Costs and Expenses. The Borrower agrees to pay on demand all reasonable out-of-pocket costs and expenses of the Administrative Agent in connection with the preparation, execution and delivery of this Amendment, including, without limitation, the reasonable fees and out-of-pocket expenses of outside counsel for the Administrative Agent with respect thereto.

9. Counterparts. This Amendment may be executed by one or more of the parties hereto in any number of separate counterparts, each of which shall be deemed an original and all of which, taken together, shall be deemed to constitute one and the same instrument. Delivery of an executed counterpart of this Amendment by facsimile transmission or by electronic mail in pdf form shall be as effective as delivery of a manually executed counterpart hereof.

10. Binding Nature. This Amendment shall be binding upon and inure to the benefit of the parties hereto, their respective successors, successors-in-titles, and assigns.

11. Entire Understanding. This Amendment sets forth the entire understanding of the parties with respect to the matters set forth herein, and shall supersede any prior negotiations or agreements, whether written or oral, with respect thereto.

[Signature Pages To Follow]

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed, under seal in the case of the Borrower and the Guarantors, by their respective authorized officers as of the day and year first above written.

BORROWER:

HEALTHWAYS, INC.

By: /s/ Alfred Lumsdaine

Name: Alfred Lumsdaine

Title: Senior Vice President and Controller

LENDERS:

SUNTRUST BANK, as Administrative Agent, as Issuing Bank, as Swingline Lender and as a Lender

By: /s/ William D. Priester

Name: William D. Priester

Title: Director

[SIGNATURE PAGE TO FIRST AMENDMENT TO THIRD AMENDED AND RESTATED REVOLVING CREDIT AND TERM LOAN AGREEMENT]

EX-10 4 ex10-2_022807.htm EX-10.2, LONG-TERM PERFORMANCE AWARD AGREEMENT

* CONFIDENTIAL INFORMATION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION

September 28, 2006

Matthew E. Kelliher

3841 Green Hills Village Drive

Nashville, TN 37215

RE:	Long Term Performance Award

Dear Matt:

This letter agreement sets forth the material terms of your Long Term Performance Award being entered into by American Healthways, Inc. (the “Company”) with you on September 29, 2006. You may evidence your execution of this agreement by countersigning the signature page below. The Company’s obligations set forth in this agreement are subject to formal approval by the Company’s Compensation Committee (the “Committee”).

1. General. Your Long Term Performance Award shall be based upon achieving certain targets described below with respect to the Company’s international business operations during the four year performance period beginning on September 1, 2006 and ending on August 31, 2010 (the “Performance Period”). You may earn a bonus with respect to each fiscal year within the Performance Period (each, a “Performance Year”) for Signed Contracts (as defined below) under paragraph 2, net revenue under paragraph 3, Adjusted Operating Margin under paragraph 4 and expanded business relationships under paragraph 5. Earned amounts shall be subject to an annual $1 million limit as described under paragraph 6 and shall be subject to the vesting requirement under paragraph 7. Earned and vested bonus amounts will be paid in cash (U.S. Dollars) at such times as set forth in paragraph 8. Your rights under this letter shall be in addition to your rights as a corporate executive under the Company’s other incentive compensation plans and any rights under your employment agreement as currently in effect (the “Employment Agreement”). Your Long Term Performance Award will be granted under, and to the extent not contrary to the terms of this letter, shall be subject to all of the terms and conditions imposed upon such awards granted under the American Healthways, Inc. 1996 Stock

* CONFIDENTIAL INFORMATION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION

Incentive Plan (the “Plan”). All dollar amounts set forth in this letter are denominated in U.S. dollars.

2.	Signed Contracts.

(a)

You will earn while you are employed as head of the Company’s international business operations (an “Eligible Employee”) a special, one-time $100,000 bonus for each “Signed Contract” (as defined below) entered into with an entity primarily doing business in a new foreign country and having annualized net revenues in excess of [___]*, as determined by the fourth quarter run-rate for the Company’s then current fiscal year determined in accordance with generally accepted accounting principles ("GAAP"). The Company has absolute discretion as to whether to enter into a Signed Contract that is eligible for compensation under the Long Term Performance Award.

(b)

A “Signed Contract” for purposes of this letter shall mean a definitive legal agreement entered into by the Company or one of its affiliates (each, a “Healthways Entity”) to provide disease management, care enhancement and/or high-risk health management services to a third party unrelated to a Healthways Entity if either (1) the services under such agreement will be provided with respect to individuals residing in a foreign country, (2) such agreement is entered into with a foreign country or a political subdivision thereof; or (3) such agreement is entered into with an entity with business operations in the United States that is controlled by an entity domiciled outside of the United States that was identified and solicited by Healthways International.

(c)

An entity shall be considered to be “primarily doing business in a new foreign country” if more than half of its revenues are attributable to a foreign country in which a Healthways Entity does not have a previously Signed Contract, as reasonably determined by the Committee. For this purpose, a foreign country will be a new foreign country if the Company does not have, prior to the execution of a Signed Contract, another “Signed Contract” with respect to that country qualifying for a bonus under this Section 2(a).

3. Net Revenue. You will earn while you are employed as an Eligible Employee an annual bonus equal to two percent of the net revenue determined in accordance with GAAP that is directly attributable to all Signed Contracts for each Performance Year.

4.	Adjusted Operating Margin.

(a)

You will earn while you are employed as an Eligible Employee an annual bonus for each Performance Year with respect to each Signed Contract that meets the following requirements as of the end of the then current Performance Year: (1) the Signed Contract is in existence for more than 12 months, (2) net revenues as determined under GAAP with respect to the Signed Contract exceed [____]*, and (3) the pre-tax operating profit margin, as determined under GAAP and

- 2 -

* CONFIDENTIAL INFORMATION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION

disregarding corporate headquarters allocations (the “Adjusted Operating Margin”), is at least [____]*.

(b)

The bonus that may be earned under this paragraph 4 with respect to an eligible Signed Contract as described in (a) above for a Performance Year is equal to [____]* for each [____]* of Adjusted Operating Margin above [____]*. In determining the Adjusted Operating Margin, all percentages shall be rounded down to the nearest one-tenth of a percent. For example, you would earn a bonus of [____]* with respect to an eligible Signed Contract for the fiscal year ending August 31, 2008 if the Adjusted Operating Margin for that Performance Year is [____]*.

(c)

Once you earn a bonus under this paragraph 4 with respect to an eligible Signed Contract, no further bonus may be earned thereunder based on Adjusted Operating Margin in a later Performance Year unless (1) the Signed Contract retains its eligibility as described above for that year, and (2) the Adjusted Operating Margin for that year exceeds the Adjusted Operating Margin for the immediately preceding Performance Year. In that event, the additional bonus that may be earned equals [____]* for each [____]* of Adjusted Operating Margin above [____]* less the bonus earned for all prior Performance Periods with respect to that eligible Signed Contract (but in no event less than zero).

(d)

Notwithstanding anything to the contrary in this paragraph 4, a bonus may only be earned for a Performance Year with respect to the two most valuable eligible Signed Contracts, as determined at the end of a Performance Period based upon total Adjusted Operating Margin. In the event that the two most valuable eligible Signed Contracts change from one Performance Year to the next, the Committee shall make equitable adjustments for purposes of (c) above to take into account previously earned bonus amounts.

5. Expanded Business Relationship. You will earn while you are employed as an Eligible Employee a bonus equal to $500,000 with respect to an expanded Signed Contract if (a) the annualized net revenue for a Performance Period based on the fourth quarter run-rate for the Company’s then current fiscal year, as determined in accordance with GAAP, increases by more than [____]* the annualized net revenue for such contract with respect to the most recent prior Performance Year, based on the fourth quarter run-rate for the Company’s immediately preceding fiscal year, as determined in accordance with GAAP, and (b) the remaining term of such Signed Contract as of the quarter that the revenue run-rate requirement in (a) above is first satisfied is at least three years. Only one $500,000 bonus may be earned with respect to any one expanded Signed Contract under this paragraph 5.

6. Section 162(m) Limitation. Notwithstanding anything to the contrary in paragraphs 2 through 5, the maximum bonus that may be earned with respect to any single Performance Year may not exceed $1 million. Otherwise earned bonuses during a Performance Year shall be reduced in the following order until the total earned bonuses for that year are reduced to $1 million: (a) the Adjusted Operating Margin bonus under paragraph 4, and then if necessary (b) the expanded business relationship bonus under paragraph 5, and then if necessary (c) the run-

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* CONFIDENTIAL INFORMATION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION

rate revenue bonus under paragraph 4, and then if necessary (d) the Signed Contract bonus under paragraph 3, and then if necessary (e) any “restoration amount” (as defined below) attributable to a prior Performance Year. Any earned bonus for a Performance Year shall be eligible to be earned in the following Performance Year provided that there is no erosion in the financial results for that bonus. For example, if Adjusted Operating Margin for the 2008 Performance Year is [____]* and the earned amount is reduced by [____]* due to the $1 million limitation, the [____]* will again be earned for the 2009 Performance Year so long as the Adjusted Operating Margin is at least [____]*. Any amount restored under this paragraph 6 shall be referred to as a “restoration amount.”

7. Vesting. Any earned bonus must be vested in order to become payable. The following rules shall apply in determining your earned and vested benefit:

(a)

You must remain employed with the Company or its affiliates until the end of the Performance Period in order to fully vest in your earned bonus amounts.

(b)

In the event that you terminate employment in a manner that entitles you to severance benefits under your Employment Agreement or you die or become disabled (as defined under your Employment Agreement) or you remain employed by the Company other than as an Eligible Employee until the end of the Performance Period, (1) you will vest in any bonus previously earned for Performance Years prior to the Performance Year of employment termination or loss of status as an Eligible Employee, as the case may be, and (2) you will vest in a pro-rata share of any bonus calculated under paragraphs 2 through 5 above with respect to the Performance Year in which such event occurred.

(c)

In the event that there is a Change in Control of the Company (as defined under the Plan) or a sale of the Company’s international business operations while you are employed as an Eligible Employee, then you shall earn a vested pro-rata bonus for the Performance Year of such event based on performance up until the date of such event, as reasonably determined by the Committee in its sole discretion, and all previously earned bonus amounts shall immediately be vested on such event.

(d)

Notwithstanding the foregoing, if you engage in any activity or fail to act during the Performance Period in a manner that constitutes “Cause” as defined under your Employment Agreement, and your employment is subsequently terminated, or you resign from employment with the Company before the end of the Performance Period and any event described in paragraph 7(c) above (regarding Change in Control and a sale of the Company’s international business), then you shall immediately forfeit all rights to all bonus amounts under this letter.

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8. Payments. You (or in the event of your death, your beneficiary) will receive a cash lump-sum payment equal to the dollar value of the earned and vested bonus amounts as determined above as soon as practicable following completion of the Company’s audited financial statements on a consolidated basis, but in no event later than March 15th of the calendar year immediately following the end of the Performance Period. No interest will be paid on the bonus amounts. Notwithstanding the foregoing, if there is a Change in Control of the Company (as defined under the Plan) or a sale of the Company’s international business operations while you are employed as an Eligible Employee, then all earned and vested bonus amounts shall be payable within 15 days after the closing of such event.

9. Repayment of Certain Amounts. If any of the Company's financial statements are required to be restated, resulting from errors, omissions, or fraud, and if, as a result, it is determined that any amount paid to you as described in Section 8 above was greater than (the excess an “Excess Payment”) or less (the shortfall an “Underpayment”) than the amount that should otherwise have been accrued and payable hereunder, then the Company shall be entitled to recover the Excess Payment, if any, and you shall be entitled to an additional payment in the amount of the Underpayment, if any.

10. Non-Compete/Non-Solicitation/Confidentiality. You and the Company hereby acknowledge that that Company has elected to provide you with this Long Term Performance Award in its discretion, and not as a result of or pursuant to any pre-existing agreement or obligation binding on the Company. Accordingly, in consideration for the considerable and valuable benefits to be made available to you hereunder, you hereby agree to the covenants regarding non-competition, non-solicitation and confidentiality set forth on Exhibit A hereto. If at any time prior the end of the earlier of the Performance Period or an event described in paragraph 7(c) above, you materially breach any of the provisions of Exhibit A after being given notice by the Company of the action(s) or inaction(s) constituting such breach and a reasonable opportunity to cure such breach given the facts and circumstances, your rights to receive any payment under the terms hereunder shall be forfeited and cancelled. Notwithstanding the foregoing, the Company shall not be required to provide you with any such notice and shall be entitled to immediately forfeit and cancel your rights under this letter if you commit such material breach and either (a) such breach by its nature cannot reasonably be expected to be cured or (b) you failed, at the time you commenced the employment or substantial services leading to the breach, to notify the Company of the commencement of such employment or such services. Nothing in this paragraph 10 shall diminish, negate or otherwise affect any of the Company’s rights or remedies under Exhibit A. Notice must be in writing and shall be deemed to have been duly given on the date of delivery if delivered by hand, on the date of transmission, if delivered by confirmed facsimile, on the first business day following the date of deposit if delivered by guaranteed overnight delivery service, or on the fourth business day following the date delivered or mailed by United States registered or certified mail, return receipt requested, postage prepaid, addressed as follows: if to you, at the address (or facsimile number) shown on the Company’s records, and if the Company, at the address for the Company’s headquarters to the attention of the Chief Financial Officer, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt.

11. Taxes. The Company and its affiliates may withhold from any amounts payable under this letter or otherwise such federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation. You shall be responsible for all taxes on the payments you receive under this letter.

12. Section 409A. To the extent applicable, it is intended that this letter comply with the provisions of Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”). This letter shall be administered in a manner consistent with this intent, and any provision that would cause the letter to fail to satisfy Section 409A of the Code shall have no force and effect until amended to comply with Section 409A of the Code (which amendment may be retroactive to the extent permitted by Section 409A of the Code and may be made by the Company without your consent).

13. Assignment. You may not pledge, assign, or transfer any of your rights under the Long Term Performance Award (or this letter) prior to payment, except by will or the laws of descent and distribution.

14. No Rights to Future Employment. This letter shall not be construed to grant you the right to be retained as an employee of the Company or its affiliates.

15. Unfunded Obligation. All payments to be made under this letter shall be paid from the general funds of the Company and no special or separate fund shall be established and no segregation of assets shall be made to assure payment of such amounts. You will not have a right, title, or interest whatsoever in or to any investments which the Company may make to aid it in meeting its obligations under this letter.

16. Compliance with Law. The Company shall make reasonable efforts to comply with all applicable laws; provided, however, that notwithstanding any other provision of this letter, cash will not be paid with respect to your vested performance units if doing so would result in a violation of any such law.

17. Entire Agreement: Modification. This letter contains the entire agreement between you, the Company and its affiliates concerning the matters set forth herein and supersedes any other discussions, agreements, representations or warranties of any kind with regard to these matters. If for any reason any provision of this letter shall be held invalid, that invalidity will not affect the remainder of this letter.

18. Successors and Assigns. The provisions of this letter shall inure to the benefit of, and be binding upon, your successors, administrators, heirs, legal representatives and assigns, and the successors and assigns of the Company.

19. Acknowledgment. You acknowledge that you have had an opportunity to fully discuss and review the terms of this letter with an attorney of your own choosing. You further

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acknowledge that you have carefully read this letter, understand its contents and freely and voluntarily assent to all of its terms and conditions, and sign your name of your own free act.

20. Governing Law. The interpretation, performance, and enforcement of this letter shall be governed by the laws of the state of Tennessee, without giving effect to the principles of conflict of laws thereof.

Please review this letter carefully and, if it correctly states our agreement, sign and return to me the enclosed copy.

Best regards,

/s/ Mary A. Chaput

Healthways, Inc.

Read, accepted and agreed to this 29th day of September, 2006.

/s/ M.E. Kelliher

Matthew Kelliher

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Exhibit A

COVENANTS REGARDING

CONFIDENTIALITY, NON-COMPETITION, NON-SOLICITATION.

In consideration for the benefits provided under this Long Term Performance Award, you hereby acknowledge and agree that:

1. Confidentiality.

The business of providing any care support services, health support services or “wellness” services (including without limitation, any in-person, telephonic, web-based or home monitoring program, service, application or device which is intended to improve the health or welfare of participants or users) in which the Company is engaged (the “Business”) is intensely competitive and your employment by the Company requires that you have access to and knowledge of confidential information of the Company (which, for purposes of this Exhibit A, shall be construed to include the Company, its subsidiaries and their respective affiliates) relating to its business plans, financial data, marketing programs, client information, contracts and other trade secrets, in each case other than as and to the extent such information is generally known or publicly available through no violation of this Agreement by you;

The use or disclosure of such information other than in furtherance of the Business may place the Company at a competitive disadvantage and may do damage, monetary or otherwise, to the Business; and

Your engaging in any of the activities prohibited by this Exhibit A shall constitute improper appropriation and/or use of such information. You expressly acknowledge the trade secret status of the Company’s confidential information and that the confidential information constitutes a protectable business interest of the Company. Other than as may be required in the performance of your duties, you expressly agree not to divulge such confidential information to anyone outside the Company without prior permission.

2. Non-Competition. During your employment and for a period equal to two (2) years after the date of termination of your employment by the Company for any reason, you shall not:

Engage in Competition, as defined below, with the Company or its subsidiaries within any market where the Company is conducting the Business at the time of termination of your employment. For purposes of this Exhibit A, “Competition” by you shall mean your directly or indirectly being employed by or acting as a consultant, advisor or lender to, or being a director, officer, employee, principal, agent, stockholder, member, owner or partner of, or permitting your name to be used in connection with the activities of any entity engaged in the Business, provided that, it shall not be a violation of this sub-paragraph for you to become the registered or beneficial owner of less than five percent (5%) of any class of the capital stock of any one or more competing corporations

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registered under the 1934 Act, provided that, you do not participate in the business of such corporation until such time as this covenant expires; and

Directly or indirectly, for your benefit or for the benefit of any other person or entity, do any of the following:

solicit from any customer, doing business with the Company as of your termination, business of the same or of a similar nature to the Business of the Company with such customer;

ii.

solicit from any known potential customer of the Company business of the same or of a similar nature to that which, to your knowledge, has been the subject of a written or oral bid, offer or proposal by the Company, or of substantial preparation with a view to making such a bid, proposal or offer, within sixteen (16) months prior to your termination; or

iii.

recruit or solicit the employment or services of any person who was employed by the Company upon termination of your employment and is employed by the Company at the time of such recruitment or solicitation.

3. General.

You acknowledge that the services to be rendered by you to the Company are of a special and unique character, which causes the agreements you have made in this Exhibit A to be of significant value to the Company, the loss of which may not be reasonably or adequately compensated for by damages in an action at law, and that a breach or threatened breach by you of any of the provisions contained in this Exhibit A will cause the Company irreparable injury. You therefore agree that the Company will be entitled, in addition to any other right or remedy, to a temporary, preliminary and permanent injunction, without the necessity of proving the inadequacy of monetary damages or the posting of any bond or security, enjoining or restraining you from any such violation or threatened violations. You acknowledge that the terms of this Exhibit A and its obligations are reasonable and will not prohibit you from being employed or employable in the health care industry.

The time periods described in Section 2 above shall be tolled at any time in you are in breach of the agreements you have made in this Exhibit A. If any restriction set forth in Section 2 above, or in this Exhibit A generally, is found by any court of competent jurisdiction to be unenforceable because it extends for too long a period of time or over too great a range of activities or in too broad a geographic area, then such restriction shall be interpreted to extend only over the maximum period of time, range of activities or geographic areas as to which it may be enforceable.

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EX-11 5 ex11_022807.htm EX-11, EARNINGS PER SHARE RECONCILIATION

Exhibit 11

Healthways, Inc.

Earnings Per Share Reconciliation

February 28, 2007

(Unaudited)

(In thousands, except earnings per share data)

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

	Three Months Ended				Six Months Ended
	February 28,				February 28,
	2007		2006		2007		2006

Numerator:
Net income - numerator for basic earnings per share	$	11,024	$	7,333	$	22,858	$	13,789
Effect of dilutive securities		—		—		—		—
Numerator for diluted earnings per share	$	11,024	$	7,333	$	22,858	$	13,789

Denominator:
Shares used for basic earnings per share		34,958		34,321		34,792		34,140
Effect of dilutive stock options outstanding		1,977		1,979		1,971		1,996
Shares used for diluted earnings per share		36,935		36,300		36,763		36,136

Earnings per share:
Basic	$	0.32	$	0.21	$	0.66	$	0.40
Diluted	$	0.30	$	0.20	$	0.62	$	0.38

EX-31 6 ex31-1_022807.htm EX-31.1, SECTION 302 CEO CERTIFICATION

Exhibit 31.1

CERTIFICATION

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

1. I have reviewed this quarterly report on Form 10-Q 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 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: April 9, 2007

/s/ Ben R. Leedle, Jr.

Ben R. Leedle, Jr.

President and Chief Executive Officer

EX-31 7 ex31-2_022807.htm EX-31.2, SECTION 302 CFO CERTIFICATION

Exhibit 31.2

CERTIFICATION

I, Mary A. Chaput, certify that:

1. I have reviewed this quarterly report on Form 10-Q 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: April 9, 2007

/s/ Mary A. Chaput

Mary A. Chaput

Executive Vice President and Chief Financial Officer

EX-32 8 ex32_022807.htm EX-32, SECTION 906 CEO AND CFO CERTIFICATION

Exhibit 32

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Healthways, Inc. (the "Company") on Form 10-Q for the period ended February 28, 2007, 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

April 9, 2007

/s/ Mary A. Chaput

Mary A. Chaput

Executive Vice President and Chief Financial Officer

April 9, 2007