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

701 Cool Springs Boulevard, Franklin, TN 37067

(Address of Principal Executive Offices) (Zip Code)

615-614-4929

(Registrant’s Telephone Number, Including Area Code)

3841 Green Hills Village Drive, Nashville, TN 37215

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

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2

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			Page
Part I
	Item 1.	Financial Statements	4
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
	Item 4.	Controls and Procedures	32
Part II
	Item 1.	Legal Proceedings	34
	Item 1A.	Risk Factors	35
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35
	Item 3.	Defaults Upon Senior Securities	36
	Item 4.	Submission of Matters to a Vote of Security Holders	36
	Item 5.	Other Information	36
	Item 6.	Exhibits	36

 

 

3

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Item 1.

Financial Statements

		May 31,					August 31,
		2008					2007
Current assets:
Cash and cash equivalents		$	17,836				$	47,655
Accounts receivable, net			121,412					80,201
Prepaid expenses			9,115					10,370
Other current assets			4,813					4,319
Income taxes receivable			—					1,741
Deferred tax asset			7,554					7,145
Total current assets			160,730					151,431
Property and equipment:
Leasehold improvements			34,422					19,268
Computer equipment and related software			127,909					87,843
Furniture and office equipment			28,036					20,435
Capital projects in process			14,266					12,336
			204,633					139,882
Less accumulated depreciation			(94,952	)				(81,160	)
			109,681					58,722
Long-term deferred tax asset			8,045					—
Other assets			17,995					15,609
Customer contracts, net			36,333					41,777
Other intangible assets, net			73,635					77,722
Goodwill, net			484,178					483,584
Total assets		$	890,597				$	828,845
See accompanying notes to the consolidated financial statements.

 

 

4

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		May 31,				August 31,
		2008				2007
Current liabilities:
Accounts payable	$	13,942			$	13,630
Accrued salaries and benefits		27,616				18,960
Accrued liabilities		23,499				22,146
Deferred revenue		8,032				7,918
Contract billings in excess of earned revenue		74,873				72,829
Income taxes payable		17,692				—
Current portion of long-term debt		3,446				2,213
Current portion of long-term liabilities		3,901				2,943
Total current liabilities		173,001				140,639
Long-term debt		350,905				297,059
Long-term deferred tax liability		—				14,009
Other long-term liabilities		33,973				14,388
Stockholders’ equity:
Preferred stock
$.001 par value, 5,000,000 shares
authorized, none outstanding		—				—
Common stock
$.001 par value, 120,000,000 and 75,000,000 shares authorized,
33,571,928 and 35,606,482 shares outstanding		34				35
Additional paid-in capital		202,884				188,126
Retained earnings		130,568				174,641
Accumulated other comprehensive loss		(768	)			(52	)
Total stockholders’ equity		332,718				362,750
Total liabilities and stockholders’ equity	$	890,597			$	828,845
See accompanying notes to the consolidated financial statements.

 

 

5

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6

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																Accumulated
									Additional							Other
		Preferred			Common				Paid-in			Retained				Comprehensive
		Stock			Stock				Capital			Earnings				Loss					Total
Balance, August 31, 2007			$—				$35			$188,126			$174,641					$(52	)			$362,750
Cumulative effect of change in accounting
principle – adoption of FIN 48			—				—			—			(687	)				—				(687	)
Comprehensive income:
Net income			—				—			—			37,611					—				37,611
Net change in fair value of interest rate
swaps, net of income taxes of $845			—				—			—			—					(1,203	)			(1,203	)
Foreign currency translation adjustment			—				—			—			—					487				487
Total comprehensive income																						36,895
Exercise of stock options			—				1			6,151			—					—				6,152
Repurchases of common stock			—				(2)			(13,341	)		(80,997	)				—				(94,340	)
Tax benefit of option exercises			—				—			9,747			—					—				9,747
Share-based employee compensation expense			—				—			12,201			—					—				12,201
Balance, May 31, 2008			$—				$34			$202,884			$130,568					$(768	)			$332,718

 

 

7

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		Nine Months Ended May 31,
		2008					2007
Cash flows from operating activities:
Net income		$	37,611				$	33,650
Adjustments to reconcile net income to net cash provided by
operating activities, net of business acquisitions:
Depreciation and amortization			34,053					27,225
Amortization of deferred loan costs			874					697
Share-based employee compensation expense			12,201					12,546
Excess tax benefits from share-based payment arrangements			(9,367	)				(7,257	)
Increase in accounts receivable, net			(41,230	)				(7,641	)
Decrease (increase) in other current assets			4,266					(4,841	)
Decrease in accounts payable			(1,869	)				(212	)
Increase (decrease) in accrued salaries and benefits			8,656					(18,007	)
Increase in other current liabilities			24,568					37,690
Deferred income taxes			(11,068	)				(8,157	)
Other			13,902					4,071
(Increase) decrease in other assets			(1,356	)				1,732
Payments on other long-term liabilities			(1,972	)				(1, 247	)
Net cash flows provided by operating activities			69,269					70,249
Cash flows from investing activities:
Acquisition of property and equipment			(70,682	)				(19,864	)
Acquisitions, net of cash acquired			(358	)				(466,979	)
Purchase of investment			—					(9,047	)
Other, net			(2,439	)				(13	)
Net cash flows used in investing activities			(73,479	)				(495,903	)
Cash flows from financing activities:
Proceeds from issuance of long-term debt			85,420					350,000
Deferred loan costs			—					(4,357	)
Proceeds from sale of unregistered common stock			—					5,000
Repurchases of common stock			(94,340	)				—
Excess tax benefits from share-based payment arrangements			9,367					7,257
Payments of long-term debt			(32,208	)				(30,641	)
Exercise of stock options			6,152					5,224
Net cash flows (used in) provided by financing activities			(25,609	)				332,483
Net decrease in cash and cash equivalents			(29,819	)				(93,171	)
Cash and cash equivalents, beginning of period			47,655					154,792
Cash and cash equivalents, end of period		$	17,836				$	61,621

 

 

8

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(1)	Interim Financial Reporting

(2)	Recently Issued Accounting Standards

 

 

9

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(3)	Share-Based Compensation

Options				Shares (000s)			Weighted-Average Exercise Price							Weighted-Average Remaining Contractual Term								Aggregate Intrinsic Value ($000s)
Outstanding at September 1, 2007				5,245			$	22.46
Granted				592				49.96
Exercised				(580	)			10.98
Forfeited or expired				(148	)			38.71
Outstanding at May 31, 2008				5,109			$	26.49					5.06						$	53,837
Exercisable at May 31, 2008				2,563			$	13.29					4.40						$	49,158

 

 

10

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Nonvested Shares				Shares (000s)			Weighted-Average Grant Date Fair Value
Nonvested at September 1, 2007				364			$	43.76
Granted				168				51.81
Vested				(1	)			34.84
Forfeited				(31	)			46.73
Nonvested at May 31, 2008				500			$	46.31

(4)	Income Taxes

(5)	Derivative Investments and Hedging Activities

 

 

11

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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 foreign currency derivatives as other current assets or accrued liabilities. We routinely monitor our foreign currency exposures to maximize the overall effectiveness of our foreign currency hedge positions.

We currently maintain six interest rate swap agreements to reduce our exposure to interest rate fluctuations on our floating rate debt commitments. Under these interest rate swap agreements, the interest rate is fixed with respect to specified amounts of notional principal. The swaps are accounted for in accordance with SFAS No. 133 and were designated at their inception as qualifying cash flow hedges; thus, they are recorded at estimated fair value in the balance sheet, with changes in fair value being reported in other comprehensive income. The fair values of the swaps at May 31, 2008 of $1.9 million and ($4.3) million have been reported in other assets and other long-term liabilities, respectively, with an offset, net of tax, included in accumulated other comprehensive loss in the consolidated balance sheet.

 

 

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 May 31, 2008, availability under our revolving credit facility totaled $242.9 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%. Term loan borrowings 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, which commenced 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. As of May 31, 2008, we are currently a party to the following interest rate swap agreements for which we receive a variable rate of interest based on the three-month LIBOR and for which we pay the following fixed rates of interest plus a spread of 0.875% to 1.750% on revolving advances and a spread of 1.50% on term loan borrowings:

 

 

 

 

 

 

(1) The principal value of this swap agreement amortizes over a 39-month period.

(2) This swap agreement becomes effective April 1, 2009.

(3) This swap agreement becomes effective October 1, 2009.

(4) This swap agreement becomes effective January 2, 2010.

 

We currently believe that we meet the hedge accounting criteria under SFAS No. 133 in accounting for these interest rate swap agreements.

 

 

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 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 plaintiff has also dismissed 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.

 

The complaint alleges that AHSI, the client hospitals and the medical directors violated the federal False Claims Act by entering into certain arrangements that allegedly violated the federal anti-kickback statute and provisions of the Social Security Act prohibiting physician self-referrals. Although no specific monetary damage has been claimed, the plaintiff, on behalf of the federal government, seeks treble damages plus civil penalties and attorneys’ fees. The plaintiff also has requested an award of 30% of any judgment plus expenses.

 

In the action by the former employee, discovery is 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. During September 2007, the parties to this matter agreed to place the arbitration on hold for an indefinite period.

 

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. As these matters are subject to inherent uncertainties, management’s view of these matters may change in the future.

 

We are also subject to other claims and suits that arise from time to time in the ordinary course of our business.

 

 

Comprehensive income, net of income taxes, was $16.2 million and $11.5 million for the three months ended May 31, 2008 and 2007, respectively, and $36.9 million and $34.3 million for the nine months ended May 31, 2008 and 2007, respectively.

 

 

The following table contains information for shares of our Common Stock that we repurchased during the third quarter of fiscal 2008:

 

 

 

 

 

 

The following is a reconciliation of the numerator and denominator of basic and diluted earnings per share for the three and nine months ended May 31, 2008 and 2007:

 

 

 

 

Beginning on June 5, 2008, Healthways and its Chairman, Chief Executive Officer and Chief Financial Officer (collectively, the “Class Action Defendants”) were named as defendants in two purported class actions filed in the U.S. District Court for the Middle District of Tennessee, Nashville Division (the “Class Action Complaints”).   The Class Action Complaints seek monetary damages on behalf of persons who purchased the Company’s common stock between October 17, 2007 and February 26, 2008 (the “Proposed Class Period”).  These suits allege claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 related to certain disclosures made by Healthways during the Proposed Class Period regarding its results of operations, business and prospects. Discovery in these cases has not yet commenced and no trial dates have been set.

 

Also, on June 27, 2008, a shareholder filed a shareholder's derivative action purportedly on behalf of Healthways in the Chancery Court for the State of Tennessee, Twentieth Judicial District, Davidson County, against all of Healthways’ directors and certain of its officers. This action is based upon substantially the same facts alleged in the Class Action Complaint described above. The plaintiff shareholder is seeking to recover damages in an unspecified amount and equitable and/or injunctive relief. Discovery in the case has not yet commenced and no trial date has been set.

 

 

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 both direct healthcare costs and the costs of health-related lost productivity.

 

Designed to provide highly specific and personalized interventions for each individual in a population, irrespective of health status, age, or payor, our evidence-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 health and wellness programs.

 

We deliver our programs to customers, which include health plans, governments, employers, and hospitals, in all 50 states, the District of Columbia, and Puerto Rico. We began delivering our Health and Care Support programs in Germany and Brazil in January 2008 and June 2008, respectively. Our services include:

 

 

Our programs focus on prevention, education, physical fitness, health coaching, behavior change and evidence-based interventions to drive adherence to proven standards of care, medication regimens and physicians’ plans of care. The programs are designed to support better health and assist in providing more effective care, which we believe will optimize the health status of member populations and reduce both the short-term and long-term direct healthcare costs for participants, including the costs of health-related lost productivity.

 

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 the Healthways SilverSneakers® Fitness Program, staying fit using on-line tools and a vast network of fitness centers, and quitting smoking through an on-line

 

smoking cessation community, QuitNet®. The Care Support product line includes programs for people with chronic diseases or persistent 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 through our StatusOne® product 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 and are more productive, 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 habits 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.        

 

Highlights of Performance for the Three and Nine Months Ended May 31, 2008

 

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 usethe “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:

 

 

 

 

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

 

Our contracts with health plans generally range from three to five years with provisions for subsequent renewal; contracts with self-insured employers, either directly or through their health plans, typically have one-year terms. Some contracts allow the customer to terminate early.

 

Some of our 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 4% of revenues recorded during the nine months ended May 31, 2008 were performance-based and were subject to final reconciliation as of May 31, 2008. 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 currently participating in a Medicare Health Support pilot awarded under the Chronic Care Improvement Program authorized by the Medicare Modernization Act of 2003. The

 

pilot is scheduled to terminate on July 31, 2008. We began operating this 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. The pilot is for complex diabetes and congestive heart failure disease management services and, while operationally similar to our programs for commercial and Medicare Advantage health plan populations, has been modified for the special needs and conditions of this population. In addition, we began serving 20,000 beneficiaries in Georgia in September 2005 in collaboration with CIGNA HealthCare, Inc (“CIGNA”). CIGNA terminated its Chronic Care Improvement Program Cooperative Agreement with CMS effective January 14, 2008. The majority of our fees under our contract with CIGNA were performance-based.

 

In June 2006, we signed an amendment to our cooperative agreement with CMS for our Medicare Health Support 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 customer base. Our predictive modeling capabilities allow us to identify and stratify those participants who are most at risk for an adverse health event. We incorporate behavior-change science with consumer-friendly interactions such as face-to-face, telephonic, print materials and web portals to facilitate consumer preferences for engagement and convenience. We use sophisticated data analytical and reporting solutions 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 19% and 20% of our revenues for the three and nine months ended May 31, 2008 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.

 

Domestic Commercial Billed Lives and Domestic Commercial Available Lives

 

The number of domestic commercial available lives and domestic commercial billed lives as of May 31, 2008 and 2007 were as follows:

 

		May 31,		May 31,
(In 000s)		2008		2007
Domestic commercial available lives(1)		189,400		187,400
Domestic commercial billed lives		28,900		27,100

⁽¹⁾ Estimated based on the Atlantic Information Services, Inc. (AIS) Directory of Health Plans and publicly available information.

 

Backlog

 

Backlog represents the estimated annualized revenue at target performance for business awarded but not yet started at May 31, 2008. Annualized revenue in backlog as of May 31, 2008 and 2007 was as follows:

 

 

 

Our Health and Care support services with self-insured employer accounts are primarily contracted through the Administrative Services Only (ASO) line of business with our health plan customers, in which our health plan customers do not assume medical cost risk but provide, among other services, 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 domestic commercial available and billed lives or in the annualized revenue in backlog reported in the table above, as appropriate.

 

Business Strategy

 

Our primary strategy is to optimize the health of entire populations, as well as the quality and affordability of healthcare, through our Health and Care Support solutions both domestically and internationally, thereby creating value for individuals, health plans, governments, and employers. We plan to continue using our scalable state-of-the-art call centers, medical information content, behavior change processes and techniques, strategic relationships, health provider networks and proprietary technologies to gain a competitive advantage in delivering our Health and Care Support services.

 

We continue to see increasing demand for integrated Health and Care Support solutions from self-insured employers. As a result, we expect to continue adding and enhancing solutions to extend our reach and effectiveness for entire populations. The flexibility of our programs allows customers to enter the Health and Care Support market at the level of services that they deem appropriate for their organization. Customers may select from a single Health or Care Support program to a total-population approach, in which all members of the customer’s population are eligible to 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 and productivity improvements by addressing consumer and customer needs for effective programs that support the individual throughout his or her lifetime.

 

We anticipate that we will continue to enhance, expand and further integrate our Health and Care Support capabilities, pursue opportunities in domestic government and international markets, and enhance our information technology support. 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 1of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended August 31, 2007. 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 addition, some of our services are billed on a fee for service basis.

 

Some of our 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 4% of revenues recorded during the nine months ended May 31, 2008 were performance-based and were subject to final reconciliation as of May 31, 2008. 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 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. Deferred revenues can arise from contracts which permit upfront billing and collection of fees covering the entire contractual service period, generally 12 months. 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 PMPM fees and fees for service as revenue during the period we perform our services; 2) we recognizethe performance-based portion of the monthly feesbased 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 recognizeadditional incentive bonuses based on the most recent assessment of ourperformance, to the extent we considersuch 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’ of 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.

 

All of the fees under the Medicare Health Support pilot in which we are currently participating are performance-based. Our original cooperative agreement required 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%. Under an amendment to our agreement, we began serving a “refresh population” of approximately 4,500 beneficiaries on August 1, 2006, which is measured as a separate cohort for two years, by the end of which the program is required to achieve a 2.5% cumulative net savings when compared to a new control cohort. In April 2008, we signed an amendment to our Medicare Health Support protocol with CMS, which changed the financial performance target for both the initial cohort and the refresh population to budget neutrality from 5.0% net savings and 2.5% net savings, respectively. 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 summary performance reports received from CMS’ independent financial reconciliation contractor. As of May 31, 2008, contract billings in excess of earned revenue related to the Medicare Health Support pilots totaled $60.8 million.

 

Ifdata is insufficient or incomplete to measure performance, or interim performance measures indicate that we are not meetingperformance targets, we do not recognize performance-based fees subject to refund as revenues but instead record them in a current liability account entitled “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 May 31, 2008, 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 $44.9 million. Of this amount, $5.3 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 $39.6 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 a prior fiscal year. During the nine months ended May 31, 2008, we recognized a net increase in revenue of approximately $1.4 million that related to services provided prior to fiscal 2008.

 

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 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 calculateany impairmentusing 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 ouracquired 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.

 

Results of Operations

 

The following table shows the components of the statements of operations for the three and nine months ended May 31, 2008 and 2007 expressed as a percentage of revenues.

 

				Three Months Ended						Nine Months Ended
				May 31,						May 31,
				2008		2007				2008		2007
Revenues				100.0	%	100.0	%			100.0	%	100.0	%
Cost of services (exclusive of depreciation
and amortization included below)				67.4	%	68.9	%			69.3	%	67.9	%
Selling, general and administrative expenses				10.7	%	11.3	%			9.9	%	10.8	%
Depreciation and amortization				6.8	%	6.0	%			6.2	%	6.1	%
Operating income (1)				15.1	%	13.8	%			14.5	%	15.2	%
Interest expense				2.7	%	3.6	%			2.9	%	2.8	%
Income before income taxes (1)				12.4	%	10.2	%			11.7	%	12.4	%
Income tax expense				5.1	%	3.8	%			4.8	%	4.8	%
Net income				7.3	%	6.4	%			6.9	%	7.6	%

 

⁽¹⁾ Figures may not add due to rounding.

 

Revenues

 

Revenues for the three months ended May 31, 2008 increased $23.5 million, or 14.0%, over revenues for the three months ended May 31, 2007, primarily due to the following:

 

 

These increases were partially offset by decreases in revenues of $6.9 million primarily due to contract terminations with certain customers as well as incentive bonus revenues related to one customer that were recognized during the three months ended May 31, 2007.

 

Revenues for the nine months ended May 31, 2008 increased $101.0 million, or 22.7%, over revenues for the nine months ended May 31, 2007 primarily due to the acquisition of Axia on December 1, 2006. The remainder of the increase is primarily due to the following:

 

 

These increases were partially offset by decreases in revenues of $20.1 million related to the following: contract terminations with certain customers, a decline in participation associated with a change in the delivery model for one customer, and a reduction in the scope of our services with one customer.

 

We anticipate that, despite the aforementioned contract terminations and contract scope reductions, revenues for the remainder of fiscal 2008 will increase over fiscal 2007 revenues primarily due to contracts with new customers, additional or expanded programs with existing customers, and increased membership in customers’ existing programs since the end of fiscal 2007, as noted above. We further anticipate that our ability to continue to increase revenues year over year will largely depend on our ability to add revenues in a manner and in a timeframe that will

 

more than offset revenue declines from any contract terminations or reductions in scope of services, such as those noted above.

 

Cost of Services

 

Cost of services (excluding depreciation and amortization) as a percentage of revenues decreased to 67.4% for the three months ended May 31, 2008 compared to 68.9% for the three months ended May 31, 2007. The decrease is primarily due to the following:

 

 

These decreases were partially offset by the following increases in cost of services as a percentage of revenues:

 

 

Cost of services (excluding depreciation and amortization) as a percentage of revenues for the nine months ended May 31, 2008 increased to 69.3% compared to 67.9% for the nine months ended May 31, 2007. The increase is primarily due to the following:

 

 

These increases were partially offset by decreases in cost of services as a percentage of revenues for the nine months ended May 31, 2008 compared to the nine months ended May 31, 2007, primarily due to decreased costs related to the Medicare Health Support pilot in which we participated in collaboration with CIGNA, which CIGNA terminated effective January 14, 2008.

 

We anticipate that cost of services for the remainder offiscal 2008 will increase over fiscal 2007 primarily as a result of expenses associated with increases in operating staff required for the increase in demand for our services in fiscal 2008, increases in indirect staff costs associated with the continuing development and implementation of our Health and Care Support services, and increases in information technology and other support staff and costs.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses as a percentage of revenues decreased to 10.7% for the three months ended May 31, 2008 compared to 11.3% for the three months ended May 31, 2007, primarily due to the following:

 

 

These decreases were somewhat offset by increases in selling, general and administrative expenses as a percentage of revenues related to relocating to and operating our new corporate headquarters during the three months ended May 31, 2008.

 

Selling, general and administrative expenses as a percentage of revenues decreased to 9.9% for the nine months ended May 31, 2008 compared to 10.8% for the nine months ended May 31, 2007, primarily due to the following:

 

 

These decreases were partially offset by increases in selling, general and administrative expenses as a percentage of revenues related to relocating to and operating our new corporate headquarters during the three months ended May 31, 2008.

 

We anticipate that selling, general and administrative expenses for the remainder of fiscal 2008 will decrease slightly over fiscal 2007 primarily due to efficiencies from the integration of Axia and certain cost management initiatives.

 

Depreciation and Amortization

 

Depreciation and amortization expense increased 28.1% for the three months ended May 31, 2008 compared to the three months ended May 31, 2007, primarily due to increased depreciation expense resulting from capital expenditures on computer software, which we made to enhance our information technology capabilities, and increased amortization expense associated with patents which were acquired in August 2007.

 

Depreciation and amortization expense increased 25.1% for the nine months ended May 31, 2008 compared to the nine months ended May 31, 2007, primarily due to the following:

 

 

We anticipate that depreciation and amortization expense for the remainder of fiscal 2008 will increase over fiscal 2007 primarily as a result of additional capital expenditures made during fiscal 2008 associated with our new corporate headquarters, the opening of four new call centers, and growth and improvement in our information technology capabilities.

 

Interest Expense

 

Interest expense for the three months ended May 31, 2008 decreased $0.8 million compared to the three months ended May 31, 2007, primarily as a result of a decrease in interest rates on outstanding borrowings under the Third Amended Credit Agreement. 

 

Interest expense for the nine months ended May 31, 2008 increased $3.0 million compared to the nine months ended May 31, 2007, primarily related to increased interest expense during the three months ended November 30, 2007 compared to the three months ended November 30, 2006 due to borrowings under the Third Amended Credit Agreement related to the acquisition of Axia on December 1, 2006. This increase was somewhat offset by a decrease in interest expense due to a lower average level of outstanding borrowings during the nine months ended May 31, 2008 compared to the nine months ended May 31, 2007 due to repayments of revolving debt since December 1, 2006. 

 

We anticipate that interest expense for the remainder of fiscal 2008 will decrease slightly over fiscal 2007 primarily as a result of lower interest rates, somewhat offset by a higher level of outstanding borrowings under the Third Amended Credit Agreement.

 

Income Tax Expense

 

Our effective tax rate was 41.1% for both the three and nine months ended May 31, 2008 compared to 37.1% and 39.1% for the three and nine months ended May 31, 2007. The tax rate for the three and nine months ended May 31, 2008 includes the impact of interest accruals related to unrecognized tax benefits included in our income tax provision. The tax rate for the three and nine months ended May 31, 2007 was favorably impacted by a lower than anticipated state 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, tax interest accruals, and certain non-deductible expenses for income tax purposes.

 

We anticipate that our effective tax rate for the remainder of fiscal 2008 will not change significantly; however, we continue to evaluate the impact of changes in our operating profile both in the United States and abroad on our geographic mix of earnings.

 

Liquidity and Capital Resources

 

Operating activities for the nine months ended May 31, 2008 generated cash of $69.3 million compared to $70.2 million for the same period in fiscal 2007. The decrease in operating cash flow resulted primarily from an increase in days’ sales outstanding in accounts receivable to 59 days at May 31, 2008 from 47 days at May 31, 2007 primarily due to timing of cash receipts from several large customers.

 

This decrease was somewhat offset by an increase in operating cash flow during the nine months ended May 31, 2008 compared to the nine months ended May 31, 2007, primarily due to the following:

 

 

 

Investing activities during the nine months ended May 31, 2008 used $73.5 million in cash, which primarily consisted of purchases of property and equipment associated with our new corporate headquarters, information technology hardware and software, and new call centers.

 

Financing activities during the nine months ended May 31, 2008 used $25.6 million in cash, primarily from repurchases of our common stock and repayments on borrowings under the Third Amended Credit Agreement. These uses were somewhat offset by additional borrowings under the Third Amended Credit Agreement.

 

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 May 31, 2008, availability under our revolving credit facility totaled $242.9 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%. Term loan borrowings 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, which commenced 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. The Third Amended Credit Agreement also restricts the payment of dividends and limits the amount of repurchases of the Company’s common stock. As of May 31, 2008, we were in compliance with all of the covenant requirements of the Third Amended Credit Agreement.

 

As of May 31, 2008, we are currently a party to the following interest rate swap agreements for which we receive a variable rate of interest based on the three-month LIBOR and for which we pay the following fixed rates of interest plus a spread of 0.875% to 1.750% on revolving advances and a spread of 1.50% on term loan borrowings:

 

 

(1) The principal value of this swap agreement amortizes over a 39-month period.

(2) This swap agreement becomes effective April 1, 2009.

(3) This swap agreement becomes effective October 1, 2009.

(4) This swap agreement becomes effective January 2, 2010.

 

We currently believe that we meet the hedge accounting criteria under SFAS No. 133 in accounting for these interest rate swap agreements.

 

We believe that cash flows 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 call 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.

 

In July 2007, our Board of Directors authorized a share repurchase program which allows for the repurchase of up to $100 million of our common stock from time to time in the open market or in privately negotiated transactions through July 5, 2009. As of May 31, 2008, we had repurchased the full $100 million of our common stock authorized under the share repurchase program.

 

Contractual Obligations

 

There were no material changes outside the ordinary course of our business in our contractual obligations from those reported at August 31, 2007 in our Annual Report on Form 10-K, except for a new perpetual license agreement and 25-year strategic relationship agreement that we entered into during the second quarter of fiscal 2008. We have total contractual cash obligations of $45.0 million related to these agreements, $25.0 million of which will occur ratably

 

during the first five years of the agreements, and the remaining $20.0 million of which will occur ratably over the last 20 years of the agreements.

 

In addition to the above and as discussed in Note 4, we adopted the provisions of FIN No. 48 on September 1, 2007.  Total unrecognized tax benefits as of September 1, 2007 were $11.1 million.  We expect $8.0 million of these unrecognized tax benefits to be paid in fiscal 2008 and have classified them as a current liability in the consolidated balance sheet.  We have classified the remaining $3.1 million of these unrecognized tax benefits as a long-term liability in the consolidated balance sheet and are currently unable to determine when they will result in obligations requiring future cash payments due to the uncertainties related to these tax positions.

 

Recently Issued Accounting Standards

 

Fair Value Measurement

 

In September 2006 the FASB issued SFAS No. 157, “Fair Value Measurement,” which provides guidance for using fair value to measure assets and liabilities, including a fair value hierarchy that prioritizes the information used to develop fair value assumptions.  It also requires expanded disclosure about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings.  The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value and does not expand the use of fair value in any new circumstances.  SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.

 

In February 2008, the FASB issued FSP FAS No. 157-2, “Effective Date of FASB Statement No. 157”, which defers by one year the effective date of the provisions of SFAS No. 157 for non-recurring, nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. We do not expect the adoption of SFAS No. 157 to have a material impact on our financial position or results of operations.

 

Business Combinations

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”. This statement expands the definition of a business and a business combination and generally requires the acquiring entity to recognize all of the assets and liabilities of the acquired business, regardless of the percentage ownership acquired, at their fair values. It also requires that contingent consideration and certain acquired contingencies be recorded at fair value on the acquisition date and that acquisition costs generally be expensed as incurred.

SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008. We have not yet completed our analysis of the impact that the implementation of SFAS No. 141(R) will have on our results of operations or financial condition.

Accounting for Uncertainty in Income Taxes

On September 1, 2007, we adopted the provisions of FIN No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (see Note 4). FIN No. 48 creates a single model to address uncertainty in income tax positions by prescribing the

 

minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. As a result of the adoption of FIN No. 48, we recorded a $0.7 million decrease to the beginning balance of retained earnings as a cumulative effect of a change in accounting principle.

 

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%. Term loan borrowings 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 have entered into six interest rate swap agreements effectively converting our floating rate debt to fixed obligations with interest rates ranging from 3.433% to 4.995%.

 

A one-point interest rate change would have resulted in interest expense fluctuating approximately $0.7 million for the nine months ended May 31, 2008.

 

As a result of our investment in international initiatives, as of May 31, 2008 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 nine months ended May 31, 2008. 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 May 31, 2008. 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 completed our acquisition of Axia. We continue to evaluate additional processes, information technology systems and other components of internal control over financial reporting resulting from the acquisition of Axia, and such evaluation will be

 

reported in management’s annual assessment of internal control over financial reporting in our 2008 Annual Report on Form 10-K.

 

Excluding Axia, there have been no changes in our internal controls over financial reporting during the quarter ended May 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Part II

 

 

Former Employee Action

 

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 directorsand 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 plaintiff has also dismissed 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.

 

The complaint alleges that AHSI, the client hospitals and the medical directors violated the federal False Claims Act by entering into certain arrangements that allegedly violated the federal anti-kickback statute and provisions of the Social Security Act prohibiting physician self-referrals. Although no specific monetary damage has been claimed, the plaintiff, on behalf of the federal government, seeks treble damages plus civil penalties and attorneys’ fees. The plaintiff also has requested an award of 30% of any judgment plus expenses.

 

In the action by the former employee, discovery is 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. During September 2007, the parties to this matter agreed to place the arbitration on hold for an indefinite period.

 

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.

 

Securities Class Action Litigation

 

Beginning on June 5, 2008, Healthways and its Chairman, Chief Executive Officer and Chief Financial Officer (collectively, the “Class Action Defendants”) were named as defendants in two purported class actions filed in the U.S. District Court for the Middle District of Tennessee, Nashville Division (the “Class Action Complaints”).   The Class Action Complaints seek monetary damages on behalf of persons who purchased the Company’s common stock between October 17, 2007 and February 26, 2008 (the “Proposed Class Period”).  These suits allege claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 related to certain disclosures

 

made by Healthways during the Proposed Class Period regarding its results of operations, business and prospects. Discovery in these cases has not yet commenced and no trial dates have been set.

 

Shareholder Derivative Lawsuit  

 

On June 27, 2008, a shareholder filed a shareholder's derivative action purportedly on behalf of Healthways in the Chancery Court for the State of Tennessee, Twentieth Judicial District, Davidson County, against all of Healthways’ directors and certain of its officers. This action is based upon substantially the same facts alleged in the Class Action Complaint described above. The plaintiff shareholder is seeking to recover damages in an unspecified amount and equitable and/or injunctive relief. Discovery in the case has not yet commenced and no trial date has been set.

 

General Liability and Other Claims

 

We are also subject to other claims and suits that arise from time to time in the ordinary course of our business.

 

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 these legal matters will not have a material adverse impact on our liquidity or financial condition. As these matters are subject to inherent uncertainties, management’s view of these matters may change in the future.

 

Item 1A. Risk Factors

 

 

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

 

The following table contains information for shares of our Common Stock that we repurchased during the third quarter of fiscal 2008:

 

 

 

 

 

 

Item 3. Defaults Upon Senior Securities

 

 

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

 

 

Item 5. Other Information

 

 

Item 6. Exhibits

 

 

 

 

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.