form10-q_033111.htm

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 March 31, 2011

or

[  ] 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.)

701 Cool Springs Boulevard, Franklin, TN  37067
(Address of Principal Executive Offices) (Zip Code)

615-614-4929
(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   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 
 

 

Yes   ¨   No   ¨

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

Large accelerated filer ¨                                           Accelerated filer x

Non-accelerated filer ¨
(Do not check if a smaller reporting company)
Smaller reporting company ¨

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

Yes   ¨   No  x

As of May 4, 2011 there were outstanding 33,960,952 shares of the Registrant’s Common Stock, par value $.001 per share.

 
2

 


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
 
18
 
   
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
30
 
   
Item 4.
Controls and Procedures
31
 
 
Part II
       
   
Item 1.
Legal Proceedings
32
 
   
Item 1A.
Risk Factors
33
 
   
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
34
 
   
Item 3.
Defaults Upon Senior Securities
34
 
   
Item 4.
Removed and Reserved
34
 
   
Item 5.
Other Information
34
 
   
Item 6.
Exhibits
34
 


 
3

 

Part I

Item 1.
Financial Statements
 

HEALTHWAYS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

ASSETS

     
March 31,
     
December 31,
     
     
2011
     
2010
     
 
Current assets:
                   
 
Cash and cash equivalents
 
$
4,336
     
$
1,064
   
 
Accounts receivable, net
   
87,261
       
89,108
   
 
Prepaid expenses
   
9,387
       
12,577
   
 
Other current assets
   
2,694
       
3,064
   
 
Income taxes receivable
   
4,100
       
8,695
   
 
Deferred tax asset
   
11,625
       
11,272
   
 
  Total current assets
   
119,403
       
125,780
   
                       
 
Property and equipment:
                   
 
Leasehold improvements
   
40,775
       
40,662
   
 
Computer equipment and related software
   
214,511
       
207,077
   
 
Furniture and office equipment
   
27,443
       
27,328
   
 
Capital projects in process
   
10,116
       
10,117
   
       
292,845
       
285,184
   
 
Less accumulated depreciation
   
(163,767
)
     
(154,528
)
 
       
129,078
       
130,656
   
                       
 
Other assets
   
13,684
       
14,733
   
                       
 
Intangible assets, net
   
92,836
       
94,255
   
 
Goodwill, net
   
496,265
       
496,265
   
                       
 
Total assets
 
$
851,266
     
$
861,689
   
                       
 
See accompanying notes to the consolidated financial statements.
                   





 
4

 

HEALTHWAYS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)

LIABILITIES AND STOCKHOLDERS’ EQUITY

     
March 31,
     
December 31,
 
     
2011
     
2010
 
 
Current liabilities:
             
 
Accounts payable
$
16,297
   
$
22,555
 
 
Accrued salaries and benefits
 
34,851
     
39,157
 
 
Accrued liabilities
 
36,108
     
31,532
 
 
Deferred revenue
 
5,568
     
5,931
 
 
Contract billings in excess of earned revenue
 
20,617
     
18,814
 
 
Current portion of long-term debt
 
2,999
     
3,935
 
 
Current portion of long-term liabilities
 
3,759
     
3,309
 
 
Total current liabilities
 
120,199
     
125,233
 
                 
 
Long-term debt
 
239,625
     
243,425
 
 
Long-term deferred tax liability
 
22,354
     
23,050
 
 
Other long-term liabilities
 
33,942
     
39,140
 
                 
 
Stockholders’ equity:
             
 
Preferred stock
             
 
      $.001 par value, 5,000,000 shares
             
 
authorized, none outstanding
 
 —
     
 —
 
 
Common stock
             
 
      $.001 par value, 120,000,000 shares authorized,
             
 
        33,987,051 and 34,018,706 shares outstanding
 
34
     
34
 
 
Additional paid-in capital
 
235,864
     
232,524
 
 
Retained earnings
 
210,345
     
206,210
 
 
Treasury stock, at cost, 728,547 and 429,654 shares in treasury
 
(8,362
)
   
(4,494
)
 
Accumulated other comprehensive loss
 
(2,735
)
   
(3,433
)
 
  Total stockholders’ equity
 
435,146
     
430,841
 
                 
 
Total liabilities and stockholders’ equity
$
851,266
   
$
861,689
 
                 

 
See accompanying notes to the consolidated financial statements.
 




 
5

 

HEALTHWAYS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except earnings per share data)
(Unaudited)

       
Three Months Ended
   
       
March 31,
   
     
2011
   
2010
   
                     
 
Revenues
 
$
162,969
   
$
178,999
   
 
Cost of services (exclusive of depreciation and amortization of $9,023 and $10,233, respectively, included below)
   
121,908
     
128,868
   
 
Selling, general & administrative expenses
   
17,842
     
17,235
   
 
Depreciation and amortization
   
12,433
     
13,554
   
                     
 
Operating income
   
10,786
     
19,342
   
 
 Interest expense
   
3,418
     
3,422
   
                     
 
Income before income taxes
   
7,368
     
15,920
   
 
Income tax expense
   
3,233
     
6,506
   
                     
 
Net income
 
$
4,135
   
$
9,414
   
                     
 
Earnings per share:
                 
 
  Basic
 
$
0.12
   
$
0.28
   
                     
 
  Diluted
 
$
0.12
   
$
0.27
   
                     
 
Weighted average common shares
                 
 
and equivalents:
                 
 
Basic
   
33,975
     
33,955
   
 
Diluted
   
34,690
     
34,919
   
                     

 
See accompanying notes to the consolidated financial statements.
 

 
6

 


HEALTHWAYS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
For the Three Months Ended March 31, 2011
(In thousands)
(Unaudited)

                       
Accumulated
     
           
Additional
         
Other
     
   
Preferred
 
Common
 
Paid-in
 
Retained
 
Treasury
 
Comprehensive
     
   
Stock
 
Stock
 
Capital
 
Earnings
 
Stock
 
Income (Loss)
 
Total
 
Balance, December 31, 2010
   
$—
   
$34 
   
$232,524
   
$206,210
   
$(4,494
)
 
 $(3,433
)
$430,841
   
                                             
Comprehensive income:
                                           
                                             
Net income
   
 —
   
 —
   
 —
   
4,135
   
   
 —
 
4,135
   
                                             
Net change in fair value of interest rate
                                           
swaps, net of income tax expense of $508
   
 —
   
 —
   
 —
   
 —
   
   
786
 
786
   
                                             
Foreign currency translation adjustment
   
 —
   
 —
   
 —
   
   
   
(88
)
(88
)
 
                                             
Total comprehensive income
                                     
4,833
   
                                             
Repurchases of common stock
   
   
   
   
   
(3,868
)
 
 
(3,868
)
 
                                             
Exercise of stock options and other
   
 —
   
   
1,885
   
 —
   
   
 — 
 
1,885
   
                                             
Tax effect of stock options and restricted
     stock units
   
 —
   
 —
   
(797
)
 
 — 
   
   
 — 
 
(797
)
 
                                             
Share-based employee compensation expense
   
 —
   
 —
   
2,252
   
 — 
   
   
 — 
 
2,252
   
                                             
Balance, March 31, 2011
   
$—
   
$34 
   
$235,864
   
$210,345
   
$(8,362
)
 
 $(2,735
)
$435,146
   


See accompanying notes to the consolidated financial statements.


 
7

 

HEALTHWAYS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
     
Three Months Ended
 
     
March 31,
 
     
2011
     
2010
 
 
Cash flows from operating activities:
                 
 
Net income
 
$
4,135
     
$
9,414
 
 
Adjustments to reconcile net income to net cash provided by
                 
 
(used in) operating activities, net of business acquisitions:
                 
 
Depreciation and amortization
   
12,433
       
13,554
 
 
Amortization of deferred loan costs
   
477
       
396
 
 
Share-based employee compensation expense
   
2,252
       
2,972
 
 
Excess tax benefits from share-based payment arrangements
   
(172
)
     
(401
)
 
Decrease (increase) in accounts receivable, net
   
1,909
       
(16,274
)
 
Decrease in other current assets
   
7,022
       
2,853
 
 
Decrease in accounts payable
   
(2,782
)
     
(6,744
)
 
Decrease in accrued salaries and benefits
   
(10,248
)
     
(25,322
)
 
Increase in other current liabilities
   
7,805
       
10,225
 
 
Deferred income taxes
   
(2,700
)
     
3,509
 
 
Other
   
928
       
1,892
 
 
Decrease (increase) in other assets
   
137
       
(1,034
)
 
Payments on other long-term liabilities
   
(358
)
     
(2,313
)
 
Net cash flows provided by (used in) operating activities
   
20,838
       
(7,273
)
                     
 
Cash flows from investing activities:
                 
 
Change in restricted cash
   
469
       
 
 
Acquisition of property and equipment
   
(9,787
)
     
(12,638
)
 
Other
   
(1,796
)
     
(1,412
)
 
Net cash flows used in investing activities
   
(11,114
)
     
(14,050
)
                     
 
Cash flows from financing activities:
                 
 
Proceeds from issuance of long-term debt
   
119,918
       
281,250
 
 
Payments of long-term debt
   
(123,445
)
     
(256,922
)
 
Deferred loan costs
   
(40
)
     
(2,963
)
 
Excess tax benefits from share-based payment arrangements
   
172
       
401
 
 
Exercise of stock options
   
1,862
       
393
 
 
Repurchases of common stock
   
(3,868
)
     
 
 
Change in outstanding checks and other
   
(1,320
)
     
(1,817
)
 
Net cash flows (used in) provided by financing activities
   
(6,721
)
     
20,342
 
                     
 
Effect of exchange rate changes on cash
   
269
       
(86
)
                     
 
Net increase (decrease) in cash and cash equivalents
   
3,272
       
(1,067
)
                     
 
Cash and cash equivalents, beginning of period
   
1,064
       
2,356
 
                     
 
Cash and cash equivalents, end of period
 
$
4,336
     
$
1,289
 
 
See accompanying notes to the consolidated financial statements.
   

 
8

 

HEALTHWAYS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1)
Basis of Presentation
 

Our financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).  In our opinion, the accompanying consolidated financial statements of Healthways, Inc. and its wholly-owned subsidiaries 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 U.S. GAAP 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 December 31, 2010.

(2)
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 units, and restricted stock.  We believe that such awards align the interests of our employees and directors with those of our stockholders.

For the three months ended March 31, 2011 and 2010, we recognized share-based compensation costs of $2.3 million and $3.0 million, respectively.
 
 
A summary of our stock options as of March 31, 2011 and changes during the three months then ended is presented below:

             
Weighted-
         
             
Average
         
         
Weighted-
 
Remaining
   
Aggregate
   
     
Shares
 
Average
 
Contractual
   
Intrinsic
   
 
Options
 
(000s)
 
Exercise Price
 
Term (years)
   
Value ($000s)
   
 
Outstanding at January 1, 2011
 
6,208
 
$
17.12
             
 
Granted
 
259
   
14.16
             
 
Exercised
 
(157
)
 
11.44
             
 
Forfeited or expired
 
(50
)
 
18.10
             
 
Outstanding at March 31, 2011
 
6,260
   
17.14
 
5.48
   
$16,440
   
 
Exercisable at March 31, 2011
 
3,760
   
19.26
 
3.42
   
8,483
   

The weighted-average grant-date fair value of options granted during the three months ended March 31, 2011 was $8.02.
 
The following table shows a summary of our restricted stock and restricted stock units (“nonvested shares”) as of March 31, 2011 as well as activity during the three months then ended:
 
 
9

 


           
Weighted-
 
           
Average
 
     
Shares
   
Grant Date
 
 
Nonvested Shares
 
(000s)
   
Fair Value
 
 
Nonvested at January 1, 2011
 
1,153
   
$
15.29
 
 
Granted
 
126
     
14.16
 
 
Vested
 
(156
)
   
14.45
 
 
Forfeited
 
(16
)
   
15.90
 
 
Nonvested at March 31, 2011
 
1,107
     
15.28
 

(3)
Income Taxes
 

Our effective tax rate increased to 43.9% for the three months ended March 31, 2011 compared to 40.9% for the three months ended March 31, 2010, primarily due to an increase in the level of certain expenses related to international operations for which we currently are not able to recognize a tax benefit.

We file income tax returns in the U.S. Federal jurisdiction and in various state and foreign jurisdictions.  Tax years remaining subject to examination in these jurisdictions include 2007 to present.

(4)
Derivative Investments and Hedging Activities
 

We use derivative instruments to manage risks related to interest rates and foreign currencies.  We record all derivatives at estimated fair value as either assets or liabilities on the balance sheet and recognize the unrealized gains and losses in either the balance sheet or statement of operations, depending on whether the derivative is designated as a hedging instrument.  As permitted under our master netting arrangements, the fair value amounts of our derivative instruments are presented on a net basis by counterparty in the consolidated balance sheets.

Interest Rate

In order to reduce our exposure to interest rate fluctuations on our floating rate debt commitments, we maintain interest rate swap agreements with original notional amounts of $335.0 million ($145.0 million of which will become effective in January 2012 and $30.0 million of which will become effective in January 2013) and termination dates ranging from December 30, 2011 to December 31, 2013.  These interest rate swap agreements effectively modify our exposure to interest rate risk by converting a portion of our floating rate debt to fixed obligations with interest rates ranging from 0.580% to 3.855%, thus reducing the impact of interest rate changes on future interest expense.  Under these agreements, we receive a variable rate of interest based on LIBOR, and we pay a fixed rate of interest.  We have designated these interest rate swap agreements as qualifying cash flow hedges.  We currently meet the hedge accounting criteria under U.S. GAAP in accounting for these interest rate swap agreements.

Foreign Currency

We enter into foreign currency options and/or forward contracts in order to minimize our earnings exposure to fluctuations in foreign currency exchange rates.  Our foreign currency exchange contracts do not qualify for hedge accounting treatment under U.S. GAAP.  We routinely monitor our foreign currency exposures to maximize the overall effectiveness of our foreign currency hedge positions.  We do not execute transactions or hold derivative financial instruments for trading or other purposes.

 
10

 

 
 
Fair Values of Derivative Instruments

The estimated gross fair values of derivative instruments at March 31, 2011 and December 31, 2010, excluding the impact of netting derivative assets and liabilities when a legally enforceable master netting agreement exists, were as follows:

     
March 31, 2011
 
December 31, 2010
   
 
(In $000s)
 
Foreign currency exchange contracts
Interest rate swap agreements
 
Foreign currency exchange contracts
Interest rate swap agreements
   
 
Assets:
               
                   
 
  Derivatives not designated as hedging instruments:
               
 
     Other current assets
 
$56
$—
 
$136
$—
   
                   
 
  Derivatives designated as hedging instruments:
               
 
     Other assets
 
25
 
   
 
Total assets
 
$56
$25
 
$136
$—
   
                   
 
 Liabilities:
               
 
  Derivatives not designated as hedging instruments:
               
 
     Accrued liabilities
 
$192
$—
 
$245
$—
   
 
 
               
 
  Derivatives designated as hedging instruments:
               
 
     Accrued liabilities
 
3,261
 
4,465
   
 
     Other long-term liabilities
 
2,528
 
2,593
   
 
Total liabilities
 
$192
$5,789
 
$245
$7,058
   
                   

See also Note 6.

Cash Flow Hedges

Derivative instruments that are designated and qualify as cash flow hedges are recorded at estimated fair value in the balance sheet, with the effective portion of the gains and losses being reported in accumulated other comprehensive income or loss (“accumulated OCI”).  These gains and losses are reclassified into earnings in the same period during which the hedged transaction affects earnings or the period in which all or a portion of the hedge becomes ineffective.  As of March 31, 2011, we expect to reclassify $4.1 million of net losses on interest rate swap agreements from accumulated OCI to interest expense within the next 12 months due to the scheduled payment of interest associated with our debt.

Gains and losses representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.  The following table shows the effect of our cash flow hedges on the consolidated statement of operations (or when applicable, the consolidated balance sheet) during the three months ended March 31, 2011 and March 31, 2010:

 
11

 



         
Amount of Gain (Loss) Recognized in OCI on Derivatives (Effective Portion)
For the Three Months Ended
       
 
Derivatives in Cash Flow Hedging Relationships
     
March 31, 2011
 
March 31, 2010
       
 
Interest rate swap agreements, gross of tax effect
     
$1,294
 
$(642)
       

During the three months ended March 31, 2011 and 2010, there were no gains or losses on cash flow hedges recognized in income resulting from hedge ineffectiveness.

Derivative Instruments Not Designated as Hedging Instruments

Our foreign currency exchange contracts require current period mark-to-market accounting, with any change in fair value being recorded each period in the statement of operations in selling, general and administrative expenses.  At March 31, 2011, we had forward contracts with notional amounts of $9.4 million to exchange foreign currencies, primarily the Australian dollar and Euro, that were entered into to hedge forecasted foreign net income (loss) and intercompany debt.

These forward contracts did not have a material effect on our consolidated statements of operations during the three months ended March 31, 2011 and 2010.

(5)
Fair Value Measurements
 

We account for certain assets and liabilities at fair value.  Fair value is defined as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date, assuming the transaction occurs in the principal or most advantageous market for that asset or liability.
 
Fair Value Hierarchy

The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:
 
 
Level 1:  Quoted prices in active markets for identical assets or liabilities;
 
 
 
Level 2:  Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-based valuation techniques in which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
 
 
 
Level 3:  Unobservable inputs that are supported by little or no market activity and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.
 


 
12

 


Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents our assets and liabilities measured at fair value on a recurring basis at March 31, 2011 and December 31, 2010:

 
(In 000s)
March 31, 2011
   
 
 
 
Level 2
   
 
Gross Fair Value
   
 
 
 
Netting (1)
   
 
 
Net Fair Value
     
 
Assets:
                             
 
Foreign currency exchange contracts
 
$
56
 
$
56
 
$
(50
)
$
6
     
 
Interest rate swap agreements
   
25
 
$
25
   
(25
)
 
     
 
Liabilities:
                             
 
Foreign currency exchange contracts
 
$
192
 
$
192
 
$
(50
)
$
142
     
 
Interest rate swap agreements
   
5,789
   
5,789
   
(25
)
 
5,764
     

 
(In 000s)
December 31, 2010
   
 
 
 
Level 2
   
 
Gross Fair Value
   
 
 
 
Netting (1)
   
 
 
Net Fair Value
     
 
Assets:
                             
 
Foreign currency exchange contracts
 
$
136
 
$
136
 
$
(116
)
$
20
     
 
Liabilities:
                             
 
Foreign currency exchange contracts
 
$
245
 
$
245
 
$
(116
)
$
129
     
 
Interest rate swap agreements
   
7,058
   
7,058
   
   
7,058
     


(1) This column reflects the impact of netting derivative assets and liabilities by counterparty when a legally enforceable master netting agreement exists.

The fair values of forward foreign currency exchange contracts are valued using broker quotations of similar assets or liabilities in active markets.  The fair values of interest rate swap agreements are primarily determined based on the present value of future cash flows using internal models and third-party pricing services with observable inputs, including interest rates, yield curves and applicable credit spreads.

Fair Value of Other Financial Instruments

In addition to foreign currency exchange contracts and interest rate swap agreements, the estimated fair values of which are disclosed above, the estimated fair value of each class of financial instruments at March 31, 2011 was as follows:
 
 
·
Cash and cash equivalents – The carrying amount of $4.3 million approximates fair value because of the short maturity of those instruments (less than three months).
 
 
·
Long-term debt –The estimated fair value of outstanding borrowings under our credit agreement is based on the average of the prices set by the issuing bank given current market conditions and is not necessarily indicative of the amount we could realize in a current market exchange. The estimated fair value and carrying amount of outstanding borrowings under the Fourth Amended Credit Agreement (see Note 6) at March 31, 2011 are $227.7 million and $238.7 million, respectively.

 
13

 

 
 
(6)
Long-Term Debt
 

On March 30, 2010, we entered into the Fourth Amended and Restated Credit Agreement (the “Fourth Amended Credit Agreement”).  The Fourth Amended Credit Agreement provides us with a $55.0 million revolving credit facility from March 30, 2010 to December 1, 2011 (the “2011 Revolving Credit Facility”) and a $345.0 million revolving credit facility from March 30, 2010 to December 1, 2013 (the “2013 Revolving Credit Facility”), including a swingline sub facility of $20.0 million and a $75.0 million sub facility for letters of credit.  The Fourth Amended Credit Agreement also provides a continuation of the term loan facility provided pursuant to the Third Amended and Restated Credit Agreement, of which $191.5 million remained outstanding on March 31, 2011, and an uncommitted incremental accordion facility of $200.0 million.

Revolving advances under the Fourth Amended Credit Agreement are drawn first under the 2013 Revolving Credit Facility, with any advances in excess of $345.0 million being drawn under the 2011 Revolving Credit Facility.  Revolving advances under the 2013 Revolving Credit Facility generally bear interest, at our option, at 1) LIBOR plus a spread of 1.875% to 2.750% or 2) the greater of the federal funds rate plus 0.5%, or the prime rate, plus a spread of 0.375% to 1.250%.  Revolving advances under the 2011 Revolving Credit Facility 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.  See Note 5 for a description of our interest rate swap agreements.  The Fourth Amended Credit Agreement also provides for a fee ranging between 0.150% and 0.300% of the unused commitments under the 2011 Revolving Credit Facility and 0.275% and 0.425% of the unused commitments under the 2013 Revolving Credit Facility.  The Fourth 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 applicable commitment termination date, which is December 1, 2011 for the 2011 Revolving Credit Facility and December 1, 2013 for the 2013 Revolving Credit Facility. We are required to repay term loans in quarterly principal installments aggregating $0.5 million each, which commenced on March 31, 2007.  The entire unpaid principal balance of the term loans is due and payable at maturity on December 1, 2013.

The Fourth Amended Credit Agreement contains various financial covenants, which require us to maintain, as defined, ratios or levels of 1) total funded debt to EBITDA, 2) fixed charge coverage, and 3) net worth.  The Fourth Amended Credit Agreement also restricts the payment of dividends and limits the amount of repurchases of the Company’s common stock.  As of March 31, 2011, we were in compliance with all of the covenant requirements of the Fourth Amended Credit Agreement.

As described in Note 5 above, as of March 31, 2011, we are a party to interest rate swap agreements for which we receive a variable rate of interest based on LIBOR and for which we pay a fixed rate of interest.


(7)
Restructuring and Related Charges and Impairment Loss
 

In November 2010, we began a restructuring of the Company primarily focused on aligning resources with current and emerging markets and consolidating operating capacity, which was largely completed by the end of fiscal 2010.  We do not expect to incur significant additional costs or adjustments related to this restructuring.  The change in accrued restructuring and related charges related to the November 2010 restructuring activities during the three months ended March 31, 2011 was as follows:

 
14

 


 
(In 000s)
       
           
 
Accrued restructuring and related charges at January 1, 2011
$
7,607
   
 
Additions
 
   
 
Payments
 
(1,615
)
 
 
Adjustments
 
(234
)
 
 
Accrued restructuring and related charges at March 31, 2011
$
5,758
   
           

(8)
Commitments and Contingencies
 

Shareholder Derivative Lawsuits

On June 27, 2008 and July 24, 2008, respectively, two shareholders filed putative derivative actions purportedly on behalf of Healthways in the Chancery Court for the State of Tennessee, Twentieth Judicial District, Davidson County, against certain directors and officers of the Company.  These actions are based on facts substantially similar to those previously made in the recently settled securities class action, including: (a) allegations of individual violations of the Securities Exchange Act of 1934 (the “Act”), including Section 10(b), and (b) allegations that misleading statements were made and material information omitted from public communications regarding (i) the purported loss or restructuring of certain contracts with customers, (ii) the Company’s participation in the Medicare Health Support (“MHS”) pilot program for the Centers for Medicare & Medicaid Services, and (iii) the Company’s guidance for fiscal year 2008.  The plaintiffs sought to recover damages in an unspecified amount and equitable and/or injunctive relief. 

On August 13, 2008, the Court consolidated these two lawsuits and appointed lead counsel.  On October 3, 2008, the Court ordered that the consolidated action be stayed until the motion to dismiss in the securities class action had been resolved by the District Court.  By stipulation of the parties, the plaintiffs filed their consolidated complaint on May 9, 2009.  On June 19, 2009, the defendants filed a motion to dismiss the consolidated complaint.  The Court granted the defendants’ motion to dismiss on October 14, 2009.  The plaintiffs filed a notice of appeal on November 12, 2009.  The Tennessee Court of Appeals heard argument on the appeal on October 13, 2010 and affirmed the trial court’s dismissal on March 14, 2011.

ERISA Lawsuits

On July 31, 2008, a purported class action alleging violations of the Employee Retirement Income Security Act (“ERISA”) was filed in the U.S. District Court for the Middle District of Tennessee, Nashville Division against Healthways, Inc. and certain of its directors and officers alleging breaches of fiduciary duties to participants in the Company’s 401(k) plan.  The central allegation is that Company stock was an imprudent investment option for the 401(k) plan. 

An amended complaint was filed on September 29, 2008, naming as defendants the Company, the Board of Directors, certain officers, and members of the Investment Committee charged with administering the 401(k) plan.  The amended complaint alleged that the defendants violated ERISA by failing to remove the Company stock fund from the 401(k) plan when it allegedly became an imprudent investment, by failing to disclose adequately the risks and results of the MHS pilot program to 401(k) plan participants, and by failing to seek independent advice as to whether to continue to permit the plan to hold Company stock.  It further alleged that the Company and its directors should have been more closely monitoring the Investment Committee and other plan fiduciaries.  The amended complaint sought damages in an undisclosed amount and other equitable relief.  The defendants filed a motion to dismiss on October 29, 2008.   On January 28, 2009, the Court granted

 
15

 

the defendants’ motion to dismiss the plaintiff’s claims for breach of the duty to disclose with regard to any non-public information and information beyond the specific disclosure requirements of ERISA and denied Defendants’ motion to dismiss as to the remainder of the plaintiff’s claims.  A period of discovery ensued.

 On May 12, 2009, the plaintiff filed a motion for class certification.  After the plaintiff failed, without explanation, to appear for his scheduled deposition, the Court issued an Order on July 10, 2009 warning the plaintiff that his failure to participate in the lawsuit could result in sanctions, including but not limited to dismissal.  After the plaintiff’s failure to participate continued, on July 23, 2009, the defendants filed a motion to dismiss for failure to prosecute the action.  On August 6, 2009, the parties filed a stipulation of dismissal with prejudice as to the named plaintiff but otherwise without prejudice, and the Court entered an Order to that effect on the same date.  

On February 1, 2010, a new named plaintiff filed another putative class action complaint in the United States District Court for the Middle District of Tennessee, Nashville Division, alleging ERISA violations in the administration of the Company’s 401(k) plan.  The new complaint is identical to the original complaint, including the allegations and the requests for relief.  Defendants’ answer to this complaint was filed on March 22, 2010.  A scheduling order was entered on April 1, 2010, and discovery commenced thereafter.  On April 30, 2010, Plaintiff filed a motion for class certification.  On June 23, 2010, the parties reached an agreement in principle to settle this matter for $1.3 million, with such settlement being funded by the Company’s fiduciary liability insurance carrier.  The District Court gave preliminary approval of the settlement on December 1, 2010, and granted final approval following a fairness hearing held April 25, 2011.   Due to the Company’s insurance coverage, this settlement is not expected to result in any charge to the Company.

Contract Dispute

We currently are involved in a contractual dispute with Blue Cross Blue Shield of Minnesota regarding fees paid to us as part of a former contractual relationship.  In 2010, we received a notice of arbitration under the terms of our agreement alleging a violation of certain contract provisions.  An arbitration hearing has been scheduled for July 11, 2011.  We believe we performed our services in compliance with the terms of our agreement and that the assertions made in the arbitration notice are without merit.  We are not able to reasonably estimate a range of potential losses, if any.

Outlook

We are also subject to other contractual disputes, claims and legal proceedings that arise from time to time in the ordinary course of our business.  While we are unable to estimate a range of potential losses, we do not believe that any of the legal proceedings pending against us as of the date of this report will have a material adverse effect on our liquidity or financial condition; however, we may settle disputes and/or claims, sustain judgments or incur expenses relating to these matters in a particular fiscal quarter which may adversely affect our results of operations.  As these matters are subject to inherent uncertainties, our view of these matters may change in the future.

(9)
Share Repurchases
 

The following table contains information for shares of our Common Stock that we repurchased during the first quarter of 2011:

 
16

 


Period
   
Total Number of Shares Purchased
     
Average Price Paid per Share
     
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)
     
Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1)
 
                                     
January 1 through 31
   
137,600
       
$11.03
     
 567,254
       
$53,987,364
 
February 1 through 28
   
16,000
       
$11.89
     
583,254
       
$53,797,124
 
March 1 through 31
   
145,293
       
$14.87
     
728,547
       
$51,636,617
 
                                     
Total
   
298,893
                             

(1)  All share repurchases between January 1, 2011 and March 31, 2011 were made pursuant to a share repurchase program authorized by the Company’s Board of Directors and publicly announced on October 21, 2010, which allows for the repurchase of up to $60 million of our common stock from time to time in the open market or in privately negotiated transactions through October 19, 2012.

(10)
Comprehensive Income
 

Comprehensive income, net of income taxes, was $4.8 million and $9.0 million for the three months ended March 31, 2011 and 2010, respectively.

(11)
Earnings Per Share
 

The following is a reconciliation of the numerator and denominator of basic and diluted earnings per share for the three months ended March 31, 2011 and 2010:

 
(In 000s, except per share data)
 
Three Months Ended
March 31,
       
     
2011
 
2010
 
 
 
 
Numerator:
                 
 
Net income - numerator for basic earnings per share
 
$
4,135
 
$
9,414
     
                     
 
Denominator:
                 
 
Shares used for basic earnings per share
   
33,975
   
33,955
     
 
Effect of dilutive securities outstanding:
                 
 
Non-qualified stock options
   
380
   
529
     
 
Restricted stock units
   
335
   
435
     
 
Shares used for diluted earnings per share
   
34,690
   
34,919
     
                     
 
Earnings per share:
                 
 
Basic
 
$
0.12
 
$
0.28
     
 
Diluted
 
$
0.12
 
$
0.27
     
                     
 
Dilutive securities outstanding not included in the computation of earnings per share because their effect is antidilutive:
                 
 
 Non-qualified stock options
   
4,441
   
3,370
     
 
        Restricted stock units
   
128
   
5
     


 
17

 


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

Overview

Founded in 1981, Healthways, Inc. provides specialized, comprehensive solutions to help people improve physical, emotional and social well-being, thereby reducing both direct healthcare costs and associated costs from the loss of employee productivity.

We provide highly specific and personalized interventions for each individual in a population, irrespective of health status, age or payor.  Our evidence-based health, prevention and well-being services are made available to consumers via phone, mobile devices, direct mail, the Internet, face-to-face consultations and venue-based interactions.

In North America, our customers include health plans, governments, employers, pharmacy benefit managers, and hospitals in all 50 states, the District of Columbia and Puerto Rico. We also provide health improvement programs and services in Brazil and Australia.  We operate care enhancement and coaching centers worldwide staffed with licensed health professionals.  Our fitness center network encompasses approximately 14,000 U.S. locations.  We also maintain an extensive network of over 39,000 complementary and alternative medicine and chiropractic practitioners, which offers convenient access to the significant number of individuals who seek health services outside of the traditional healthcare system.

Our guiding philosophy and approach to market is predicated on the fundamental belief that healthier people cost less and are more productive.  As described more fully below, our programs are designed to improve well-being by helping people to adopt or maintain healthy behaviors, reduce health-related risk factors, and optimize care for identified health conditions.

First, our programs are designed to help people adopt or maintain healthy behaviors by:

 
·
fostering wellness and disease prevention through total population screening, well-being assessments and supportive interventions; and
 
·
providing access to health improvement programs, such as fitness solutions, weight management, and complementary and alternative medicine.

Our prevention programs focus on education, physical fitness, health coaching, and behavior change techniques and support.  We believe this approach improves the well-being status of member populations and reduces the short- and long-term direct healthcare costs for participants, including associated costs from the loss of employee productivity.

Second, our programs are designed to help people reduce health-related risk factors by:

 
·
promoting the change and improvement of the lifestyle behaviors that lead to poor health or chronic conditions; and
 
·
providing educational materials and personal interactions with highly trained nurses and other healthcare professionals to create and sustain healthier behaviors for those individuals at-risk or in the early stages of chronic conditions.

 
18

 

We enable our customers to engage everyone in their covered populations through specific interventions that are sensitive to each individual’s health risks and needs. Our programs are designed to motivate people to make positive lifestyle changes and accomplish individual goals, such as increasing physical activity for seniors through the Healthways SilverSneakers® fitness solution or overcoming nicotine addiction through the QuitNet® on-line smoking cessation community.

Finally, our programs are designed to help people optimize care for identified health conditions by:

 
·
incorporating the latest, evidence-based clinical guidelines into 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 episodic interventions;
 
·
coordinating members’ care with their healthcare providers;
 
·
providing software licensing and management consulting in support of well-being improvement services; and
 
·
providing high-risk care management for members at risk for hospitalization due to complex conditions.

Our approach is to use proprietary, analytic models to identify individuals who are likely to incur future high costs, including those who have specific gaps in care, and through evidence-based interventions drive adherence to proven standards of care, medication regimens and physicians’ plans of care to reduce disease progression and related medical spending.

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 services to meet each individual’s needs, we believe our interventions can be delivered at scale and in a manner that reflects those unique needs over time.  We believe creating real and sustainable behavior change generates measurable, long-term cost savings and improved individual and business performance.

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 our solutions;
 
·
our ability to accurately forecast the costs required to fully implement new contracts;
 
·
our ability to retain existing customers and to renew 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 accurately forecast performance and the timing of revenue recognition under the terms of our customer contracts ahead of data collection and reconciliation in order to provide forward-looking guidance;

 
19

 
 
·
the impact of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, “PPACA”), on our operations and/or the demand for our services;
 
·
the impact of any new or proposed legislation, regulations and interpretations relating to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, including the potential expansion to Phase II for Medicare Health Support programs and any legislative or regulatory changes with respect to Medicare Advantage;
 
·
our ability to anticipate the rate of market acceptance of our solutions in potential international markets;
 
·
our ability to accurately forecast the costs necessary to implement our strategy of establishing a presence in international markets;
 
·
the risks associated with foreign currency exchange rate fluctuations and our ability to hedge against such fluctuations;
 
·
the risks associated with deriving a significant concentration of our revenues from a limited number of customers;
 
·
our ability to achieve the contractually required cost savings and clinical outcomes improvements and reach mutual agreement with customers with respect to cost savings, or to achieve such savings and improvements within the time frames contemplated by us;
 
·
our ability to achieve estimated annualized revenue in backlog in the manner and within the timeframe we expect, which is based on certain estimates regarding the implementation of our services;
 
·
our ability and/or the ability of our customers to enroll participants and to estimate their level of enrollment and participation in our programs in a manner and within the timeframe anticipated by us;
 
·
the ability of our customers to provide timely and accurate data that is essential to the operation and measurement of our performance under the terms of our contracts;
 
·
our ability to favorably resolve contract billing and interpretation issues with our customers;
 
·
our ability to service our debt and make principal and interest payments as those payments become due;
 
·
the risks associated with changes in macroeconomic conditions, which may reduce the demand and/or the timing of purchases for our services from customers or potential customers, reduce the number of covered lives of our existing customers, or restrict our ability to obtain additional financing;
 
·
counterparty risk associated with our interest rate swap agreements and foreign currency exchange contracts;
 
·
our ability to integrate acquired businesses or technologies into our business and to accurately forecast the related costs;
 
·
our ability to anticipate strategic changes and opportunities in our industry and/or business and to accurately forecast the related impact on our earnings;
 
·
the impact of any impairment of our goodwill or other intangible assets;
 
·
our ability to develop new products and deliver outcomes on those products;
 
·
our ability to implement our new integrated data and technology solutions platform within the required timeframe and expected cost estimates and to develop and enhance this platform and/or other technologies to meet evolving customer and market needs;
 
·
our ability to obtain adequate financing to provide the capital that may be necessary to support our operations and to support or guarantee our performance under new contracts;
 
·
unusual and unforeseen patterns of healthcare utilization by individuals with diseases or conditions for which we provide services;
 
·
the ability of our customers to maintain the number of covered lives enrolled in the plans during the terms of our agreements;
 
·
the impact of legal proceedings involving us and/or our subsidiaries;
 
·
the impact of future state, federal, and international legislation and regulations applicable to our business, including PPACA, on our ability to deliver our services and on the financial health of our customers and their willingness to purchase our services;

 
20

 


 
·
current geopolitical turmoil, the continuing threat of domestic or international terrorism, and the potential emergence of a health pandemic; and
 
·
other risks detailed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 and 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 addition, some of our services, such as the SilverSneakers fitness solution, include fees that are based upon member participation.

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 or pharmacy benefit manager, typically have one to three-year terms.  Some of our contracts allow the customer to terminate early.

Some of our contracts provide that a portion 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 3% of revenues recorded during the three months ended March 31, 2011 were performance-based and were subject to final reconciliation as of March 31, 2011.  We anticipate that this percentage will fluctuate due to the level of performance-based fees in new contracts and the timing and amount of revenue recognition associated with performance-based fees.  Some contracts also provide for additional fees for incentive bonuses in excess of the contractual PMPM rate if we meet or exceed contractual performance targets.

Contract Revenues

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

Approximately 18% of our revenues for the three months ended March 31, 2011 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 could have a material negative impact on our results of operations, cash flows, and financial condition.

Technology

Our solutions require sophisticated analytical, data management, Internet and computer-telephony solutions based on state-of-the-art technology. These solutions help us deliver our 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

 
21

 

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 services.  The behavior change techniques and predictive modeling incorporated in our technology identify an individual’s readiness to change and provide personalized support through appropriate messaging using any method desired, including venue-based face-to-face; print; phone; mobile and remote devices; on-line; emerging modalities; and any combination thereof to motivate and sustain healthy behaviors.

Business Strategy

 The World Health Organization defines health as “…not only the absence of infirmity and disease, but also a state of physical, mental, and social well-being.”

Our business strategy reflects our passion to enhance health and well-being, and as a result, reduce overall healthcare costs and improve workforce engagement, yielding better business performance for our customers.  Our programs are designed to improve well-being by helping people to:

 
·
adopt or maintain healthy behaviors;
 
·
reduce health-related risk factors; and
 
·
optimize care for identified health conditions.

Through our solutions, we work to optimize the health and well-being of entire populations, one person at a time, domestically and internationally, thereby creating value by reducing overall healthcare costs and improving productivity for individuals, families, health plans, governments, employers and communities.

We believe it is critical to impact an entire population’s underlying health status and well-being in a long-term, cost effective way.  Believing that what gets measured gets acted upon, in 2008, we entered into an exclusive, 25-year relationship with Gallup to provide a national, daily pulse of individual and collective well-being.  The Gallup-Healthways Well-Being IndexTM is the result of a unique partnership in well-being measurement and research that is based upon surveys of 1,000 Americans every day, with more than 1.2 million surveys completed to date.  Under the agreement, Gallup evaluates and reports on the well-being of individuals of countries, states and communities; Healthways provides similar services for companies, families and individuals.  This agreement was recently expanded with the launch of the Gallup-Healthways Well-Being Index in the United Kingdom, which we believe indicates the growing global interest in gaining clear insights for government and business leaders charged with shaping the policy responses necessary to improve health, increase individual and organizational performance, lower healthcare costs and achieve sustained economic growth.

To enhance health and well-being within their respective populations, our current and prospective customers require solutions that focus on the underlying drivers of healthcare demand, address worsening health status, reverse or slow unsustainable cost trends, foster healthy behaviors, mitigate health risk factors, and manage chronic conditions.  Our strategy is to deliver programs that engage individuals and help them enhance their health status and well-being regardless of their starting point.  We believe we can achieve health and well-being improvements in a population and generate significant cost savings and increases in productivity by providing effective programs that support the individual throughout his or her health journey.

We are adding and enhancing solutions to extend our reach and effectiveness and to meet increasing demand for integrated solutions.  The flexibility of our programs allows customers to provide a range of services they deem appropriate for their organizations.  Customers may select from certain single program options up to a total-population approach, in which all members of a customer’s population are eligible to receive our services.  Recently signed contracts have expanded both the level of integration and breadth of services provided
 
22

 

to major health plans as they develop and implement a number of patient centered medical home models.  Our services now extend beyond chronic care and wellness programs to include care management and pharmacy benefit management as well as health promotion, prevention and quality improvement solutions.

Our strategy includes as a priority the ongoing expansion of our value proposition through the introduction of our total population management solution.  This solution, in addition to improving individuals’health and reducing direct healthcare costs, targets a much larger improvement in employer profitability by reducing the impact of lost productivity for health-related reasons.  With the success of our total population management solution, we expect to gain an even greater competitive advantage in responding to employers’ needs for a healthier, higher-performing and less costly workforce.

Our strategy also includes the further enhancement and deployment of our proprietary next generation technology platform known as Embrace.  This platform, which is essential to our total population management solution, enables us to integrate data from the healthcare organizations and other entities interacting with an individual.  Embrace provides for the delivery of our integrated solutions and ongoing communications between the individual and his or her medical and health experts, using any method desired, including venue-based face-to-face; print; phone; mobile and remote devices; on-line; emerging modalities; and any combination thereof.

We plan to increase our competitive advantage in delivering our services by leveraging our scalable, state-of-the-art call centers, medical information content, behavior change processes and techniques, strategic relationships, health provider networks, fitness center relationships, and proprietary technologies and techniques.  We may add new capabilities and technologies through internal development, strategic alliances with other entities and/or through selective acquisitions or investments.

We anticipate continuing to enhance, expand and integrate additional capabilities with health plans and to pursue opportunities with domestic government entities and communities as well as the public and private sectors of healthcare in international markets.  In addition, the significant changes in government regulation of healthcare may afford us expanded opportunities to provide services to health plans and employers as well as collaborate with and/or directly provide solutions to integrated medical systems and provider groups in the post healthcare reform marketplace.

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 December 31, 2010.  We prepare the consolidated financial statements in conformity with U.S. GAAP, which requires 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, such as the SilverSneakers fitness solution, include fees that are based upon member participation.

 
23

 


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 or pharmacy benefit manager, typically have one to three-year terms. Some of our contracts allow the customer to terminate early.

Some of our contracts provide that a portion 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 3% of revenues recorded during the three months ended March 31, 2011 were performance-based and were subject to final reconciliation as of March 31, 2011.  We anticipate that this percentage will fluctuate due to the level of performance-based fees in new contracts and the timing and amount of revenue recognition associated with performance-based fees.  Some contracts also provide for additional fees for incentive bonuses in excess of the contractual PMPM rate if we meet or 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 arise from contracts which permit upfront billing and collection of fees covering the entire contractual service period, generally 12 months.  We typically bill for any incentive bonus after the contract is settled.  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 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 allowances for billing adjustments (such as data reconciliation differences) as appropriate.

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 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 March 31, 2011, 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 $36.0 million, all of which was based 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.

 
24

 


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 three months ended March 31, 2011, net performance-related adjustments to revenue that pertained to services provided prior to 2011 were not material.

Impairment of Intangible Assets and Goodwill

We review goodwill for impairment on an annual basis (during the fourth quarter of our fiscal year) or more frequently whenever events or circumstances indicate that the carrying value may not be recoverable.

We estimate the fair value of each reporting unit using a discounted cash flow model and reconcile the aggregate fair value of our reporting units to our consolidated market capitalization.  The discounted cash flow model requires significant judgments, including management’s estimate of future cash flows, which is dependent on internal forecasts, estimation of the long-term growth rate for our business, the useful life over which cash flows will occur, and determination of our weighted average cost of capital.  Changes in these estimates and assumptions could materially affect the estimate of fair value and goodwill impairment for each reporting unit.

If we determined that the carrying value of goodwill was impaired based upon an impairment review, we would calculate any impairment using a fair-value-based goodwill impairment test as required by U.S. GAAP.  The fair value of a reporting unit is the price that would be received to sell the unit as a whole in an orderly transaction between market participants at the measurement date.

Except for a certain trade name which has an indefinite life and is not subject to amortization, we amortize identifiable intangible assets, such as acquired technologies and customer contracts, using the straight-line method over their estimated useful lives.  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.

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 estimate the fair value of trade names using a present value technique, which requires management’s estimate of future revenues attributable to these trade names, estimation of the long-term growth rate for these revenues, and determination of our weighted average cost of capital.  Changes in these estimates and assumptions could materially affect the estimate of fair value for the trade names.

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 estimated price that would be received to sell the asset in an orderly transaction between market participants.

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.

Income Taxes

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.  Accounting for income taxes

 
25

 

requires significant judgment in determining income tax provisions, including determination of deferred tax assets, deferred tax liabilities, and any valuation allowances that might be required against deferred tax assets, and in evaluating tax positions.

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.  U.S. GAAP 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.  Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our financial position, results of operations, or cash flows.

Share-Based Compensation

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 months ended March 31, 2011 and 2010 expressed as a percentage of revenues.

       
Three Months Ended
           
       
March 31,
           
       
2011
 
2010
       
                     
 
Revenues
   
100.0
%
100.0
%
     
 
Cost of services (exclusive of depreciation
                 
 
and amortization included below)
   
74.8 
%
72.0
%
     
 
Selling, general and administrative expenses
   
10.9 
%
9.6
%
     
 
Depreciation and amortization
   
7.6 
%
7.6
%
     
 
Operating income (1)
   
6.6 
%
10.8
%
     
                     
 
Interest expense
   
2.1 
%
1.9
%
     
                     
 
Income before income taxes
   
4.5 
%
8.9
%
     
 
Income tax expense
   
2.0 
%
3.6
%
     
                     
 
Net income
   
2.5 
%
5.3
%
     

(1) Figures may not add due to rounding.

 
26

 



Revenues

Revenues decreased $16.0 million, or 9.0%, for the three months ended March 31, 2011 compared to the three months ended March 31, 2010, primarily due to contract and program terminations with certain customers and the loss by some of our health plan customers of certain of their administrative services only (“ASO”) employer accounts, somewhat offset by increased revenues from an increase in participation in our fitness solutions as well as in the number of members eligible to participate in such solutions.

Cost of Services

Cost of services (excluding depreciation and amortization) as a percentage of revenues increased to 74.8% for the three months ended March 31, 2011 compared to 72.0% for the three months ended March 31, 2010, primarily due to the following:

·  
costs associated with securing and implementing certain significant new and innovative contracts;
·  
an increased portion of our revenue generated by fitness solutions, which typically have a higher cost of services as a percentage of revenue than our other programs, somewhat offset by efficiencies gained in these solutions through economies of scale and cost management initiatives;
·  
certain costs that cannot reduced in the same proportion and/or timeframe as the decrease in revenues discussed above;
·  
an increase in consulting expenses primarily related to implementation of our Embrace platform; and
·  
changes in the contract structure of certain incentive-based wellness programs from a utilization model to a PMPM model as well as an increase in the number of members eligible for these programs and their utilization of such programs.

These increases were somewhat offset by a decrease in cost of services as a percentage of revenues primarily due to a decrease in the level of short-term incentive compensation based on the Company’s year-to-date financial performance against established internal targets for these periods.

Selling, General and Administrative Expenses

Selling, general and administrative expenses as a percentage of revenues increased to 10.9% for the three months ended March 31, 2010 compared to 9.6% for the three months ended March 31, 2010, primarily due to the following:

·  
costs involved in pursuing business in evolving markets such as domestic government, community, and certain international markets; and
·  
certain costs that cannot be reduced in the same proportion and/or timeframe as the decrease in revenues discussed above.

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

·  
a decrease in the level of short-term incentive compensation based on the Company’s year-to-date financial performance against established internal targets for these periods; and

 
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·  
cost savings realized from a restructuring of the Company that was largely completed during the fourth quarter of 2010.

Depreciation and Amortization

Depreciation and amortization expense decreased $1.1 million, or 8.3%, for the three months ended March 31, 2011 compared to the three months ended March 31, 2010, primarily related to certain computer software that has become fully depreciated since March 31, 2010 and that had a shorter useful life than our current Embrace platform, which was recently placed into service.

Interest Expense

Interest expense for the three months ended March 31, 2011 remained relatively consistent with the three months ended March 31, 2010.

Income Tax Expense

Our effective tax rate increased to 43.9% for the three months ended March 31, 2011 compared to 40.9% for the three months ended March 31, 2011, primarily due to an increase in the level of certain expenses related to international operations for which we currently are not able to recognize a tax benefit.

Outlook

We anticipate that quarterly revenues and earnings will improve for the remainder of 2011 compared to the three months ended March 31, 2011, primarily due to the following:

·  
upcoming start dates for certain significant new contracts;
·  
the recognition of performance-based revenues and other revenues based on achieving certain deliverables;
·  
a decrease in costs associated with securing and implementing certain significant new and innovative contracts;
·  
ramping member enrollment on certain contracts throughout the year; and
·  
a decrease in incentive costs related to member utilization of certain incentive-based wellness programs, which tends to be higher earlier in the year.

We anticipate depreciation and amortization expense for fiscal 2011 will increase slightly compared to the three months ended March 31, 2011 primarily due to new projects expected to be placed into service.

As discussed in “Liquidity and Capital Resources” below, a significant portion of our long-term debt is subject to fixed interest rate swap agreements; however, we cannot predict the potential for changes in interest rates, which would impact our variable rate debt.  We anticipate that our effective tax rate for the remainder of 2011 will decrease slightly as compared to the three months ended March 31, 2011; however, we will continue to monitor and adjust the rate based upon changes in the geographic mix of our earnings, adjustments to uncertain tax positions, and consideration of other tax issues affecting the company.

Liquidity and Capital Resources

Operating activities for the three months ended March 31, 2011 provided cash of $20.8 million compared to a use of cash of $7.3 million for the three months ended March 31, 2010.  The increase in operating

 
28

 

cash flow is primarily due to a lower short-term incentive compensation payment during the three months ended March 31, 2011 compared to the three months ended March 31, 2010.  These amounts are paid following the year in which they are earned.

Investing activities during the three months ended March 31, 2011 used $11.1 million in cash, which primarily consisted of capital expenditures associated with our Embrace platform.

Financing activities during the three months ended March 31, 2011 used $6.7 million in cash, primarily due to net repayments on borrowings under our credit agreement and repurchases of our common stock.

On March 30, 2010, we entered into the Fourth Amended and Restated Credit Agreement (the “Fourth Amended Credit Agreement”).  The Fourth Amended Credit Agreement provides us with a $55.0 million revolving credit facility from March 30, 2010 to December 1, 2011 (the “2011 Revolving Credit Facility”) and a $345.0 million revolving credit facility from March 30, 2010 to December 1, 2013 (the “2013 Revolving Credit Facility”), including a swingline sub facility of $20.0 million and a $75.0 million sub facility for letters of credit.  The Fourth Amended Credit Agreement also provides a continuation of the term loan facility provided pursuant to the Third Amended and Restated Credit Agreement, of which $191.5 million remained outstanding on March 31, 2011, and an uncommitted incremental accordion facility of $200.0 million.  As of March 31, 2011, availability under our revolving credit facility totaled $266.1 million as calculated under the most restrictive covenant.

Revolving advances under the Fourth Amended Credit Agreement are drawn first under the 2013 Revolving Credit Facility, with any advances in excess of $345.0 million being drawn under the 2011 Revolving Credit Facility.  Revolving advances under the 2013 Revolving Credit Facility generally bear interest, at our option, at 1) LIBOR plus a spread of 1.875% to 2.750% or 2) the greater of the federal funds rate plus 0.5%, or the prime rate, plus a spread of 0.375% to 1.250%.  Revolving advances under the 2011 Revolving Credit Facility 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.  See below for a description of our interest rate swap agreements.  The Fourth Amended Credit Agreement also provides for a fee ranging between 0.150% and 0.300% of the unused commitments under the 2011 Revolving Credit Facility and 0.275% and 0.425% of the unused commitments under the 2013 Revolving Credit Facility.  The Fourth 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 applicable commitment termination date, which is December 1, 2011 for the 2011 Revolving Credit Facility and December 1, 2013 for the 2013 Revolving Credit Facility. We are required to repay term loans in quarterly principal installments aggregating $0.5 million each, which commenced on March 31, 2007.  The entire unpaid principal balance of the term loans is due and payable at maturity on December 1, 2013.

The Fourth Amended Credit Agreement contains various financial covenants, which require us to maintain, as defined, ratios or levels of 1) total funded debt to EBITDA, 2) fixed charge coverage, and 3) net worth.  The Fourth Amended Credit Agreement also restricts the payment of dividends and limits the amount of repurchases of the Company’s common stock.  As of March 31, 2011, we were in compliance with all of the covenant requirements of the Fourth Amended Credit Agreement.

In order to reduce our exposure to interest rate fluctuations on our floating rate debt commitments, we maintain interest rate swap agreements with original notional amounts of $335.0 million ($145.0 million of

 
29

 

which will become effective in January 2012 and $30.0 million of which will become effective in January 2013) and termination dates ranging from December 30, 2011 to December 31, 2013.  These interest rate swap agreements effectively modify our exposure to interest rate risk by converting a portion of our floating rate debt to fixed obligations with interest rates ranging from 0.580% to 3.855%, thus reducing the impact of interest rate changes on future interest expense.  Under these agreements, we receive a variable rate of interest based on LIBOR, and we pay a fixed rate of interest.

We currently meet the hedge accounting criteria under U.S. GAAP in accounting for these interest rate swap agreements.

In October 2010, our Board of Directors authorized a share repurchase program which allows for the repurchase over a two-year period of up to $60 million of our common stock from time to time in the open market or in privately negotiated transactions.  As of March 31, 2011, $51.6 million of our common stock is still subject to repurchase under this program.

We believe that cash flows from operating activities, our available cash, and our expected available credit under the Fourth Amended Credit Agreement will continue to enable us to meet our contractual obligations, to effect the share repurchase program, and to fund our current operations for the foreseeable future.  However, if our operations require significant additional financing resources, such as capital expenditures for technology improvements or additional call centers, 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 effectively operate our business.  We cannot assure you that we would always be able to secure additional financing if needed and, if such funds were available, whether the terms or conditions would be acceptable to us.
 
 
If contract development accelerates or acquisition opportunities arise, 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.

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 Fourth Amended Credit Agreement, which bears interest based on floating rates. Revolving advances under the 2013 Revolving Credit Facility generally bear interest, at our option, at 1) LIBOR plus a spread of 1.875% to 2.750% or 2) the greater of the federal funds rate plus 0.5%, or the prime rate, plus a spread of 0.375% to 1.250%.  Revolving advances under the 2011 Revolving Credit Facility 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 Fourth Amended Credit Agreement, we have entered into interest rate swap agreements effectively converting our floating rate debt to fixed obligations with interest rates ranging from 0.580% to 3.855%.

A one-point interest rate change would have resulted in a change in interest expense of approximately $0.2 million for the three months ended March 31, 2011.

As a result of our investment in international initiatives, as of March 31, 2011 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

 
30

 

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 three months ended March 31, 2011.  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 Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of March 31, 2011.  Based on that evaluation, the chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are effective.  They are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms and to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal controls over financial reporting during the three months ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 
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Part II

Item 1.
Legal Proceedings
 

Shareholder Derivative Lawsuits

On June 27, 2008 and July 24, 2008, respectively, two shareholders filed putative derivative actions purportedly on behalf of Healthways in the Chancery Court for the State of Tennessee, Twentieth Judicial District, Davidson County, against certain directors and officers of the Company.  These actions are based on facts substantially similar to those previously made in the recently settled securities class action, including: (a) allegations of individual violations of the Securities Exchange Act of 1934 (the “Act”), including Section 10(b), and (b) allegations that misleading statements were made and material information omitted from public communications regarding (i) the purported loss or restructuring of certain contracts with customers, (ii) the Company’s participation in the Medicare Health Support (“MHS”) pilot program for the Centers for Medicare & Medicaid Services, and (iii) the Company’s guidance for fiscal year 2008.  The plaintiffs sought to recover damages in an unspecified amount and equitable and/or injunctive relief. 

On August 13, 2008, the Court consolidated these two lawsuits and appointed lead counsel.  On October 3, 2008, the Court ordered that the consolidated action be stayed until the motion to dismiss in the securities class action had been resolved by the District Court.  By stipulation of the parties, the plaintiffs filed their consolidated complaint on May 9, 2009.  On June 19, 2009, the defendants filed a motion to dismiss the consolidated complaint.  The Court granted the defendants’ motion to dismiss on October 14, 2009.  The plaintiffs filed a notice of appeal on November 12, 2009.  The Tennessee Court of Appeals heard argument on the appeal on October 13, 2010 and affirmed the trial court’s dismissal on March 14, 2011.

ERISA Lawsuits

On July 31, 2008, a purported class action alleging violations of the Employee Retirement Income Security Act (“ERISA”) was filed in the U.S. District Court for the Middle District of Tennessee, Nashville Division against Healthways, Inc. and certain of its directors and officers alleging breaches of fiduciary duties to participants in the Company’s 401(k) plan.  The central allegation is that Company stock was an imprudent investment option for the 401(k) plan. 

An amended complaint was filed on September 29, 2008, naming as defendants the Company, the Board of Directors, certain officers, and members of the Investment Committee charged with administering the 401(k) plan.  The amended complaint alleged that the defendants violated ERISA by failing to remove the Company stock fund from the 401(k) plan when it allegedly became an imprudent investment, by failing to disclose adequately the risks and results of the MHS pilot program to 401(k) plan participants, and by failing to seek independent advice as to whether to continue to permit the plan to hold Company stock.  It further alleged that the Company and its directors should have been more closely monitoring the Investment Committee and other plan fiduciaries.  The amended complaint sought damages in an undisclosed amount and other equitable relief.  The defendants filed a motion to dismiss on October 29, 2008.   On January 28, 2009, the Court granted the defendants’ motion to dismiss the plaintiff’s claims for breach of the duty to disclose with regard to any non-public information and information beyond the specific disclosure requirements of ERISA and denied Defendants’ motion to dismiss as to the remainder of the plaintiff’s claims.  A period of discovery ensued.

 On May 12, 2009, the plaintiff filed a motion for class certification.  After the plaintiff failed, without explanation, to appear for his scheduled deposition, the Court issued an Order on July 10, 2009 warning the plaintiff that his failure to participate in the lawsuit could result in sanctions, including but not limited to dismissal.  After the plaintiff’s failure to participate continued, on July 23, 2009, the defendants filed a motion to dismiss for failure to prosecute the action.  On August 6, 2009, the parties filed a stipulation of dismissal with

 
32

 

prejudice as to the named plaintiff but otherwise without prejudice, and the Court entered an Order to that effect on the same date.  

On February 1, 2010, a new named plaintiff filed another putative class action complaint in the United States District Court for the Middle District of Tennessee, Nashville Division, alleging ERISA violations in the administration of the Company’s 401(k) plan.  The new complaint is identical to the original complaint, including the allegations and the requests for relief.  Defendants’ answer to this complaint was filed on March 22, 2010.  A scheduling order was entered on April 1, 2010, and discovery commenced thereafter.  On April 30, 2010, Plaintiff filed a motion for class certification.  On June 23, 2010, the parties reached an agreement in principle to settle this matter for $1.3 million, with such settlement being funded by the Company’s fiduciary liability insurance carrier.  The District Court gave preliminary approval of the settlement on December 1, 2010, and granted final approval following a fairness hearing held April 25, 2011.   Due to the Company’s insurance coverage, this settlement is not expected to result in any charge to the Company.

Contract Dispute

We currently are involved in a contractual dispute with Blue Cross Blue Shield of Minnesota regarding fees paid to us as part of a former contractual relationship.  In 2010, we received a notice of arbitration under the terms of our agreement alleging a violation of certain contract provisions.  An arbitration hearing has been scheduled for July 11, 2011.  We believe we performed our services in compliance with the terms of our agreement and that the assertions made in the arbitration notice are without merit.  We are not able to reasonably estimate a range of potential losses, if any.

Outlook

We are also subject to other contractual disputes, claims and legal proceedings that arise from time to time in the ordinary course of our business.  While we are unable to estimate a range of potential losses, we do not believe that any of the legal proceedings pending against us as of the date of this report will have a material adverse effect on our liquidity or financial condition; however, we may settle disputes and/or claims, sustain judgments or incur expenses relating to these matters in a particular fiscal quarter which may adversely affect our results of operations.  As these matters are subject to inherent uncertainties, our view of these matters may change in the future.

Item 1A.
Risk Factors
 

In addition to the other information set forth in this report, you should carefully consider the risks and uncertainties previously reported under the caption “Part I — Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, the occurrence of which could materially and adversely affect our business, prospects, financial condition and operating results. The risks previously reported and described in the Annual Report on Form 10-K for the fiscal year ended December 31, 2010 and in this report are not the only risks facing our business. Additional risks and uncertainties not currently known to us or those we currently deem to be immaterial may also materially and adversely affect our business operations.

There have been no material changes to our risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

 
33

 



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 first quarter of 2011:

Period
   
Total Number of Shares Purchased
     
Average Price Paid per Share
     
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)
     
Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1)
 
                                     
January 1 through 31
   
137,600
       
$11.03
     
 567,254
       
$53,987,364
 
February 1 through 28
   
16,000
       
$11.89
     
583,254
       
$53,797,124
 
March 1 through 31
   
145,293
       
$14.87
     
728,547
       
$51,636,617
 
                                     
Total
   
298,893
                             

(1)  All share repurchases between January 1, 2011 and March 31, 2011 were made pursuant to a share repurchase program authorized by the Company’s Board of Directors and publicly announced on October 21, 2010, which allows for the repurchase of up to $60 million of our common stock from time to time in the open market or in privately negotiated transactions through October 19, 2012.

Item 3.
Defaults Upon Senior Securities
 

 
Not Applicable.
 

Item 4.
Removed and Reserved
 


Item 5.
Other Information
 

 
Not Applicable.
 

Item 6.
Exhibits
 

 
(a)
Exhibits

     
10.1
 
Amendment to Employment Agreement dated April 6, 2011 between the Company and Alfred Lumsdaine
     
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

 
34

 

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
May 9, 2011
 
By
/s/ Alfred Lumsdaine
       
Alfred Lumsdaine
       
Chief Financial Officer
       
(Principal Financial Officer)




 
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