UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

For the Quarterly Period Ended February 29, 2004

Commission File Number 000-19364

AMERICAN HEALTHWAYS, INC.

3841 Green Hills Village Drive, Nashville, TN 37215

615-665-1122

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

Yes     [X]         No   [   ]   

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

Yes     [X]         No   [   ]   

As of April 9, 2004 there were outstanding 32,563,660 shares of the Registrant’s Common Stock, par value $.001 per share.

Part I

Item 1. Financial Statements

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS

(Unaudited)

See accompanying notes to the consolidated financial statements.

2

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

LIABILITIES AND STOCKHOLDERS’ EQUITY

(Unaudited)

See accompanying notes to the consolidated financial statements.

3

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except earnings per share data)

(Unaudited)

See accompanying notes to the consolidated financial statements.

4

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

For the Six Months Ended February 29, 2004

(In thousands)

(Unaudited)

See accompanying notes to the consolidated financial statements.

5

AMERICAN HEALTHWAYS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes to the consolidated financial statements.

6

AMERICAN HEALTHWAYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1)

Interim Financial Reporting

     The accompanying consolidated financial statements of American Healthways, Inc. and its subsidiaries (the “Company”) for the three and six months ended February 29, 2004 and February 28, 2003 are unaudited. However, in the opinion of the Company, all adjustments consisting of normal, recurring accruals necessary for a fair presentation have been reflected therein. Certain items in prior periods have been reclassified to conform to current classifications.

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

(2)

Segment Disclosures

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

(3)		Recently Issued Accounting Standards
		Consolidation of Variable Interest Entities

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

Derivative Instruments and Hedging Activities

      In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities that fall within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 amends SFAS No. 133 regarding implementation issues raised in relation to the application of the definition of a derivative. The amendments set forth in SFAS No. 149 require that contracts with comparable characteristics be accounted for similarly. This Statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging

7

relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material impact on the Company’s financial position or results of operations.

(4)

Stock-Based Compensation

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an Amendment of FASB Statement No. 123.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for annual and interim periods beginning after December 15, 2002. The adoption of SFAS No. 148 did not have a material impact on the Company’s financial position or results of operations.

     The Company has elected to continue to measure compensation for stock options issued to its employees and outside directors pursuant to Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and has adopted the disclosure requirements of SFAS No. 123 and SFAS No. 148. Compensation expense recorded under APB No. 25 for the three and six months ended February 29, 2004 was approximately $530,000. This expense resulted primarily from the grant, subject to stockholder approval, of stock options to two new directors of the Company in June 2003. Such approval was obtained at the Annual Meeting of Stockholders in January 2004, at which time the options were issued. The Company recognizes compensation expense related to fixed award stock options on a straight-line basis.

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

8

(5)

Business Acquisitions

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

     The aggregate purchase price paid by the Company was approximately $65.7 million, which was funded through a $60 million term loan and cash of $5.7 million, including acquisition costs of approximately $0.7 million. In addition, pursuant to an earn-out agreement (the “Earn-Out Agreement”), the Company is obligated to pay the former stockholders of StatusOne up to $12.5 million in additional purchase price, payable either in cash or common stock at the Company’s discretion, if StatusOne achieves certain revenue targets during the one-year period immediately following the acquisition (the “Earn-Out Period”). At the closing, the Company delivered $5 million of the purchase price into an escrow account under the terms and conditions of a separate escrow agreement to secure certain obligations of the former stockholders under the terms of the Merger Agreement.

9

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

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

(6)

Intangible and Other Assets

     Intangible assets subject to amortization at February 29, 2004 consist of the following:

     Acquired technology and customer contracts are being amortized on a straight-line basis over a five-year estimated useful life. Other intangible assets included in the table above are being amortized on

10

a straight-line basis over their estimated useful lives (one to three years) and consist primarily of non-competition agreements associated with business acquisitions. Total amortization expense for the six months ended February 29, 2004 was $2,162,000. Estimated amortization expense for the remainder of fiscal 2004 and the following four fiscal years thereafter is $2,047,000, $3,888,000, $3,873,000, $3,865,000 and $3,859,000, respectively. The Company assesses the potential impairment of intangible assets subject to amortization whenever events or changes in circumstances indicate that the carrying values may not be recoverable.

     Intangible assets not subject to amortization at February 29, 2004 consist of the trade name associated with the StatusOne acquisition of $4,344,000. The Company reviews intangible assets not subject to amortization on an annual basis or more frequently whenever events or circumstances indicate that the assets might be impaired.

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

(7)

Long-Term Debt

     On September 5, 2003, in conjunction with the acquisition of StatusOne, the Company entered into a new revolving credit and term loan agreement (the “Credit Agreement”) with eight financial institutions that replaced its previous credit agreement dated November 22, 2002. The Credit Agreement provides the Company with up to $100 million in borrowing capacity, including a $60 million term loan (the “Term Loan”) and a $40 million revolving line of credit, under a credit facility that expires on August 31, 2006. The Company is required to make principal installment payments of $3 million at the end of each fiscal quarter beginning on November 30, 2003 and ending with a $27 million balloon payment due on August 31, 2006. Borrowings under the Credit Agreement bear interest, at the Company’s option, at the prime rate plus a spread of 0.5% to 1.25% or LIBOR plus a spread of 2.0% to 2.75%, or a combination thereof. Substantially all of the Company’s and its subsidiaries’ assets are pledged as collateral for any borrowings under the credit facility. The Credit Agreement also contains various financial covenants, provides for a fee ranging between 0.375% and 0.5% of unused commitments, prohibits the payment of dividends, and limits the amount of repurchases of the Company’s common stock. On September 16, 2003, the Company entered into an interest rate swap agreement to reduce the exposure to interest rate fluctuations. By entering into the interest rate swap agreement the Company effectively converted $40 million of floating rate debt to a fixed obligation with an interest rate of 4.99%. The Company currently believes that it meets and will continue to meet the criteria for the “shortcut” method under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” in accounting for the interest rate swap agreement, which allows for an assumption of no hedge ineffectiveness. As such, there is no income statement impact from changes in the fair value of the interest rate swap. The interest rate swap agreement is marked to market each reporting period, and the change in the fair value, net of income taxes, of the interest rate swap agreement is reported through other comprehensive income (loss) in the consolidated statement of changes in stockholders’ equity.

(8)

Commitments and Contingencies

     In June 1994, a “whistle blower” action was filed on behalf of the United States government by a former employee dismissed by the Company in February 1994. The case is currently pending before the United States District Court for the District of Columbia. The employee sued American Healthways, Inc. (“AMHC”) and a wholly-owned subsidiary of AMHC, American Healthways Services, Inc. (“AHSI”), as well as certain named and unnamed medical directors and one named client hospital, West Paces Medical Center (“WPMC”), and other unnamed client hospitals. AMHC has since been dismissed as a defendant; however, the case is still pending against AHSI. In addition, WPMC has agreed to settle the claims filed

11

against it subject to the court’s approval as part of a larger settlement agreement that WPMC’s parent organization, HCA Inc., has reached with the United States government. The complaint alleges that AHSI, the client hospitals and the medical directors violated the federal False Claims Act by entering into certain arrangements that allegedly violated the federal anti-kickback statute and provisions of the Social Security Act prohibiting physician self-referrals. Although no specific monetary damage has been claimed, the plaintiff, on behalf of the federal government, seeks treble damages plus civil penalties and attorneys’ fees. The plaintiff also has requested an award of 30% of any judgment plus expenses. The Office of the Inspector General of the Department of Health and Human Services determined not to intervene in the litigation, and the complaint was unsealed in February 1995. The case is still in the discovery stage and has not yet been set for trial.

     The Company believes that its operations have been conducted in full compliance with applicable statutory requirements. Although there can be no assurance that the results of the matter would not have a material adverse impact on the Company, nor can an estimate of possible loss be made, the Company believes that the resolution of issues, if any, which may be raised by the government and the resolution of the civil litigation would not have a material adverse effect on the Company’s financial position or results of operations except to the extent that the Company incurs material legal expenses associated with its defense of this matter and the civil suit.

(9)

Stockholders’ Equity

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

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

(10)

Comprehensive Income

     SFAS No. 130, “Reporting Comprehensive Income,” requires that changes in the amounts of certain items, including changes in the fair value of interest rate swap agreements, be shown in the financial statements. The Company displays comprehensive income, which includes net income and net changes in the fair value of the interest rate swap agreement, in the consolidated statement of changes in stockholders’ equity. Comprehensive income, net of income taxes, was $5,128,000 and $9,104,000, respectively, for the three and six months ended February 29, 2004.

12

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

Overview

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

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

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

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

     As of February 29, 2004, the Company had contracts with 38 health plans to provide 89 disease management and care enhancement program services, and also had 49 contracts to provide its services at 67 hospitals.

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

•

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

13

•		the risks associated with a significant concentration of the Company’s revenues with a limited number of customers;
•		the Company’s ability to effect cost savings and clinical outcomes improvements under disease management and care enhancement contracts and reach mutual agreement with customers with respect to cost savings, or to effect such savings and improvements within the time frames contemplated by the Company;
•		the ability of the Company to accurately forecast performance and the timing of revenue recognition under the terms of its contracts ahead of data collection and reconciliation;
•		the Company’s ability to collect contractually earned performance incentive bonuses;
•		the ability of the Company’s customers to provide timely and accurate data that is essential to the operation and measurement of the Company’s performance under the terms of its health plan contracts;
•		the Company’s ability to resolve favorably contract billing and interpretation issues with its customers;
•		the Company’s ability to integrate the operations of StatusOne into the Company’s business;
•		the Company’s ability to achieve the expected financial results for StatusOne;
•		the Company’s ability to service its debt and make principal and interest payments as those payments become due;
•		the ability of the Company to develop new products and deliver outcomes on those products;
•		the ability of the Company to effectively integrate new technologies and approaches, such as those encompassed in its care enhancement initiatives, into the Company’s care enhancement platform;
•		the Company’s ability to renew and/or maintain contracts with its customers under existing terms or restructure these contracts on terms that would not have a material negative impact on the Company’s results of operations;
•		the Company’s ability to implement its care enhancement strategy within expected cost estimates;
•		the ability of the Company to obtain adequate financing to provide the capital that may be needed to support the growth of the Company’s operations and to support or guarantee the Company’s performance under new contracts;
•		unusual and unforeseen patterns of healthcare utilization by individuals with diabetes, cardiac, respiratory and/or other diseases or conditions for which the Company provides services, in the health plans with which the Company has executed a disease management contract;
•		the ability of the health plans to maintain the number of covered lives enrolled in the plans during the terms of the agreements between the health plans and the Company;
•		the Company’s ability to attract and/or retain and effectively manage the employees required to implement its agreements;
•		the impact of litigation involving the Company;
•		the impact of future state and federal healthcare legislation and regulations on the ability of the Company to deliver its services and on the financial health of the Company’s customers and their willingness to purchase the Company’s services; and
•		general economic conditions.

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

14

Customer Contracts

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

     Fees under the Company’s contracts are generally determined by multiplying the contractually negotiated rate per health plan member per month (“PMPM”) by the number of health plan members covered by the Company’s services during the month. PMPM rates are set during contract negotiations with customers regarding the value to be created by the Company’s programs and a sharing of that value between the customer and the Company. In some contracts, the PMPM rate may differ between the health plan’s lines of business (e.g. PPO, HMO, Medicare). Contracts are generally for terms of three to seven years with provisions for subsequent renewal and may provide that some portion (up to 100%) of the Company’s fees may be refundable to the health plan (“performance-based”) if a targeted percentage reduction in the health plan’s health-care costs and clinical and/or other criteria that focus on improving the health of the members, compared to a baseline year, are not achieved. Approximately 8% of the Company’s revenues recorded during the six months ended February 29, 2004 were performance-based and are subject to final reconciliation. The Company anticipates that this percentage will fluctuate due to the timing of data reconciliation, which varies according to contract terms, and revenue recognition associated with performance-based fees. A limited number of contracts also provide opportunities for the Company to receive incentive bonuses in excess of the contractual PMPM rate if the Company is able to exceed contractual performance targets.

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

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

     Approximately 58% of the Company’s revenues for the three and six months ended February 29, 2004 were derived from three contracts that each comprised more than 10% of the Company’s revenue for the period. The loss of any of these contracts or any other large health plan contract or a reduction in the profitability of any of these contracts would have a material negative impact on the Company’s results of operations, cash flows, and financial condition.

     Of the four health plan contracts scheduled to expire in fiscal 2004, representing in aggregate approximately 4% of the Company’s revenues for the six months ended February 29, 2004, one contract,

15

comprising less than 1% of revenues, has been renewed; one contract, representing 2% of revenues, has been renewed and expanded; and one contract, representing less than 1% of revenues for the six months ended February 29, 2004, has been terminated. As of February 29, 2004, twenty-four of the Company’s health plan contracts, which represent approximately 27% of the Company’s revenues for the six months ended February 29, 2004, allow for early termination. The average length of time the Company has been providing services for this group of 24 contracts is three years. No assurance can be given that unscheduled contract terminations or renegotiations would not have a material negative impact on the Company’s results of operations, cash flows, and financial condition.

     The Company’s 49 hospital contracts represent hospital-based diabetes treatment centers located in and operated under contracts with general acute-care hospitals. The primary goal of each center is to create a center of excellence for the treatment of diabetes in the community in which it is located, thereby increasing the hospital’s market share of diabetes patients and lowering the hospital’s cost of providing services while enhancing the quality of care to this population. For the six months ended February 29, 2004, revenues from the Company’s hospital contracts accounted for