**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   **September
                  30, 2007**
 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 **0-20619**
  
 **MATRIA
        HEALTHCARE, INC.**
 (Exact
        name of registrant as specified in its charter)
 
 **Delaware**
              **20-2091331**(State
                  or other jurisdiction of
                incorporation
                  or organization)
              (I.R.S.
                  Employer
                Identification
                  No.)**1850
                  Parkway Place**
                **Marietta,
                  Georgia****30067**
              **(770)
                  767-4500**(Address
                  of principal executive offices) (Zip Code)
              (Registrant’s
                  telephone number, including area
                  code)
 
 
 
 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.
 Yesx                  No ̈
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer (as defined by Rule 12b-2 of
        the
        Exchange Act).
 Large
        accelerated filer ̈                                                        Accelerated
        filer x                                                                                Non-accelerated
        filer ̈
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act).
 Yes ̈                  Nox
 
 
 The
        number of shares outstanding of the issuer’s only class of common stock, $.01
        par value, as of November 1, 2007, was 21,415,777.
  
  **MATRIA
        HEALTHCARE, INC.**
 **QUARTERLY
        REPORT ON FORM 10-Q**
 **SEPTEMBER
        30, 2007**
 
 **TABLE
        OF CONTENTS**
 
 
 **PART
                  I - FINANCIAL INFORMATION**Item
                  1.
              Financial
                  Statements
              3Item
                  2.
              Management’s
                  Discussion and Analysis of FinancialCondition
                  and Results of Operations
              14Item
                  3.
              Quantitative
                  and Qualitative Disclosures About Market Risk
              26Item
                  4.
              Controls
                  and Procedures
              26**PART
                  II - OTHER INFORMATION**Item
                  1.
              Legal
                  Proceedings
              27Item
                  1A.
              Risk
                  Factors
              27Item
                  6.
              Exhibits
              27**SIGNATURES**
              28
  2
  **PART
        I - FINANCIAL INFORMATION**
 
 **Item
        1.  Financial Statements**
 
 **Matria
        Healthcare, Inc. and Subsidiaries**
 **Consolidated
        Condensed Balance Sheets**
 (Amounts
        in thousands, except per share amounts)
 (Unaudited)
 
 **September
                    30,**
                
                
                **December
                    31,****ASSETS**
                
                **2007**
                
                
                **2006**Current
                    assets:Cash
                    and cash equivalents
                
                $
                11,262
                
                
                $
                19,839Restricted
                    cash
                
                
                -
                
                
                
                1,372Trade
                    accounts receivable, less allowances of $3,771 and$4,397
                    at September 30,  2007 and December 31, 2006,
                    respectively
                
                
                53,231
                
                
                
                52,985Prepaid
                    expenses and other current assets
                
                
                11,613
                
                
                
                14,234Deferred
                    income taxes
                
                
                18,839
                
                
                
                8,087Total current assets
                
                
                94,945
                
                
                
                96,517Property
                    and equipment, net
                
                
                40,348
                
                
                
                38,950Goodwill,
                    net
                
                
                495,459
                
                
                
                500,830Other
                    intangibles, net
                
                
                50,533
                
                
                
                55,891Deferred
                    income taxes
                
                
                -
                
                
                
                5,564Other
                    assets
                
                
                10,976
                
                
                
                13,621$
                692,261
                
                
                $
                711,373**LIABILITIES
                    AND SHAREHOLDERS' EQUITY**Current
                    liabilities:Accounts
                    payable, principally trade
                
                $
                8,199
                
                
                $
                13,846Current
                    installments of long-term debt
                
                
                29,494
                
                
                
                4,197Unearned
                    revenues
                
                
                11,068
                
                
                
                13,493Acquisition
                    contingent consideration
                
                
                -
                
                
                
                54,223Accrued
                    liabilities
                
                
                16,551
                
                
                
                22,661Total
                    current liabilities
                
                
                65,312
                
                
                
                108,420Long-term
                    debt, excluding current installments
                
                
                266,260
                
                
                
                275,938Deferred
                    tax liability
                
                
                8,896
                
                
                
                -Other
                    long-term liabilities
                
                
                6,611
                
                
                
                8,039Total liabilities
                
                
                347,079
                
                
                
                392,397Shareholders'
                    equity:Preferred
                    stock, $.01 par value.  Authorized 50,000
                    shares;none outstanding at September 30, 2007 and December 31,
                    2006
                
                
                -
                
                
                
                -Common
                    stock, $.01 par value.   Authorized 50,000
                    shares;issued and outstanding 21,385 and 21,255 at September 30,
                    2007and December 31, 2006, respectively
                
                
                214
                
                
                
                213Additional
                    paid-in capital
                
                
                427,318
                
                
                
                415,950Accumulated
                    deficit
                
                
                (81,223
                )
                
                
                (97,149
                )Accumulated
                    other comprehensive earnings
                
                
                (1,127
                )
                
                
                (38
                )Total
                    shareholders' equity
                
                
                345,182
                
                
                
                318,976$
                692,261
                
                
                $
                711,373
  See
        accompanying notes to consolidated condensed financial statements.
   3
 **Matria
        Healthcare, Inc. and Subsidiaries**
 **Consolidated
        Condensed Statements of Operations**
 (Amounts
        in thousands, except per share amounts)
 (Unaudited)
 
  **Three
                    Months Ended**
                
                
                **Nine
                    Months Ended****September
                    30,**
                
                
                **September
                    30,****2007**
                
                
                **2006**
                
                
                **2007**
                
                
                **2006**Revenues
                
                $
                89,604
                
                
                $
                84,186
                
                
                $
                263,748
                
                
                $
                247,719Cost
                    of revenues
                
                
                26,850
                
                
                
                27,243
                
                
                
                80,062
                
                
                
                80,104Selling
                    and administrative expenses
                
                
                43,506
                
                
                
                40,027
                
                
                
                131,551
                
                
                
                118,845Provision
                    for doubtful accounts
                
                
                1,464
                
                
                
                1,021
                
                
                
                3,866
                
                
                
                2,785Amortization
                    of intangible assets
                
                
                1,786
                
                
                
                1,786
                
                
                
                5,358
                
                
                
                5,358Total
                    costs and operating expenses
                
                
                73,606
                
                
                
                70,077
                
                
                
                220,837
                
                
                
                207,092Operating
                    earnings from continuing operations
                
                
                15,998
                
                
                
                14,109
                
                
                
                42,911
                
                
                
                40,627Interest
                    income
                
                
                456
                
                
                
                434
                
                
                
                1,368
                
                
                
                1,165Interest
                    expense
                
                
                (6,382
                )
                
                
                (7,136
                )
                
                
                (18,047
                )
                
                
                (20,699
                )Other
                    income, net
                
                
                4
                
                
                
                310
                
                
                
                331
                
                
                
                879Earnings
                    from continuing operations before income taxes
                
                
                10,076
                
                
                
                7,717
                
                
                
                26,563
                
                
                
                21,972Income
                    tax expense
                
                
                (4,182
                )
                
                
                (3,185
                )
                
                
                (10,793
                )
                
                
                (9,190
                )Earnings
                    from continuing operations
                
                
                5,894
                
                
                
                4,532
                
                
                
                15,770
                
                
                
                12,782Discontinued
                    Operations:Earnings
                    (loss) from discontinued operations, net of income taxes
                
                
                13
                
                
                
                1,261
                
                
                
                (147
                )
                
                
                5,159Gain
                    on disposal of discontinued operation, net of income taxes
                
                
                971
                
                
                
                24,244
                
                
                
                971
                
                
                
                24,244Earnings
                    from discontinued operations
                
                
                984
                
                
                
                25,505
                
                
                
                824
                
                
                
                29,403Net
                    earnings
                
                $
                6,878
                
                
                $
                30,037
                
                
                $
                16,594
                
                
                $
                42,185Net
                    earnings per common share:Basic:Continuing
                    operations
                
                $
                0.28
                
                
                $
                0.22
                
                
                $
                0.74
                
                
                $
                0.61Discontinued
                    operations
                
                
                0.04
                
                
                
                1.21
                
                
                
                0.04
                
                
                
                1.40$
                0.32
                
                
                $
                1.43
                
                
                $
                0.78
                
                
                $
                2.01Diluted:Continuing
                    operations
                
                $
                0.27
                
                
                $
                0.21
                
                
                $
                0.72
                
                
                $
                0.59Discontinued
                    operations
                
                
                0.04
                
                
                
                1.18
                
                
                
                0.04
                
                
                
                1.36$
                0.31
                
                
                $
                1.39
                
                
                $
                0.76
                
                
                $
                1.95Weighted
                    average shares outstanding:Basic
                
                
                21,378
                
                
                
                21,041
                
                
                
                21,344
                
                
                
                20,957Diluted
                
                
                21,864
                
                
                
                21,554
                
                
                
                21,828
                
                
                
                21,664
  See
        accompanying notes to consolidated
        condensed financial statements.
  4
  **Matria
        Healthcare, Inc. and Subsidiaries**
 **Consolidated
        Condensed Statements of Cash Flows**
 (Amounts
        in thousands)
 (Unaudited)
  **Nine
                    Months Ended****September
                    30,****2007**
                
                
                **2006**Cash
                    Flows from Operating Activities:Net
                    earnings
                
                $
                16,594
                
                
                $
                42,185Less
                    earnings from discontinued operations, net of income taxes
                
                
                824
                
                
                
                29,403Earnings
                    from continuing operations
                
                
                15,770
                
                
                
                12,782Adjustments
                    to reconcile earnings from continuing operations tonet
                    cash provided by operating activities:Depreciation
                    and amortization (including debt discount and expenses)
                
                
                16,237
                
                
                
                15,670Provision
                    for doubtful accounts
                
                
                3,866
                
                
                
                2,785Deferred
                    income taxes
                
                
                5,823
                
                
                
                9,190Share-based
                    compensation
                
                
                9,471
                
                
                
                5,131Excess
                    tax benefit - share-based compensation
                
                
                (150
                )
                
                
                -Imputed
                    interest on acquisition consideration
                
                
                -
                
                
                
                1,747Changes
                    in assets and liabilities:Trade
                    accounts receivable
                
                
                (4,111
                )
                
                
                (10,472
                )Prepaid
                    expenses and other current assets
                
                
                2,523
                
                
                
                2,331Noncurrent
                    assets
                
                
                (366
                )
                
                
                (421
                )Accounts
                    payable
                
                
                (5,647
                )
                
                
                (4,348
                )Accrued
                    and other liabilities
                
                
                (8,732
                )
                
                
                (23,230
                )Net
                    cash provided by continuing operations
                
                
                34,684
                
                
                
                11,165Net
                    cash used in discontinued operations
                
                
                (1,465
                )
                
                
                (3,847
                )Net
                    cash provided by operating activities
                
                
                33,219
                
                
                
                7,318Cash
                    Flows from Investing Activities:Purchases
                    of property and equipment
                
                
                (10,022
                )
                
                
                (8,478
                )Payment
                    of acquisition-related obligations
                
                
                (50,745
                )
                
                
                (1,677
                )Purchase
                    price adjustment for acquisition
                
                
                1,623
                
                
                
                -Decrease
                    in restricted cash
                
                
                1,372
                
                
                
                261Purchases
                    of property and equipment related to discontinued
                    operations
                
                
                -
                
                
                
                (379
                )Acquisition
                    of business, net of cash received
                
                
                -
                
                
                
                (434,727
                )Proceeds
                    from the sale of business, net of transaction costs
                
                
                -
                
                
                
                121,598Net
                    cash used in investing activities
                
                
                (57,772
                )
                
                
                (323,402
                )Cash
                    Flows from Financing Activities:Proceeds
                    from the issuance of long-term debt, net of transaction
                    costs
                
                
                -
                
                
                
                443,977Proceeds
                    from short-term borrowings
                
                
                41,799
                
                
                
                2,556Principal
                    repayments of debt
                
                
                (27,873
                )
                
                
                (129,012
                )Proceeds
                    from issuance of common stock
                
                
                1,900
                
                
                
                3,479Excess
                    tax benefit - share-based compensation
                
                
                150
                
                
                
                -Net
                    cash provided by financing activities
                
                
                15,976
                
                
                
                321,000Effect
                    of exchange rate changes on cash and cash equivalents
                
                
                -
                
                
                
                504Net
                    increase (decrease) in cash and cash equivalents
                
                
                (8,577
                )
                
                
                5,420Cash
                    and cash equivalents at beginning of year
                
                
                19,839
                
                
                
                22,758Cash
                    and cash equivalents at end of period
                
                $
                11,262
                
                
                $
                28,178Supplemental
                    disclosure of cash paid for:Interest
                
                $
                16,166
                
                
                $
                23,933Income
                    taxes
                
                $
                3,061
                
                
                $
                4,665
 See
        accompanying notes to consolidated condensed financial
        statements.
  5
  **Notes
        to Consolidated Condensed Financial Statements**
 (Unaudited)
 
 **1.  General**
  The
        consolidated condensed financial statements as of September 30, 2007, and
        for
        the three-month and nine-month periods ended September 30, 2007 and 2006,
        respectively, are unaudited.  The consolidated condensed balance sheet
        as of December 31, 2006, was derived from audited financial statements, but
        does
        not include all disclosures required by accounting principles generally accepted
        in the United States.  In preparing financial statements, it is
        necessary for management to make assumptions and estimates affecting the
        amounts
        reported in the consolidated financial statements and related
        notes.  These estimates and assumptions are developed based upon all
        information available.  Actual results could differ from estimated
        amounts.  In the opinion of management, all adjustments, consisting of
        normal recurring accruals, necessary for fair presentation of the consolidated
        condensed financial position and results of operations for the periods presented
        have been included.  The results for the three and nine months ended
        September 30, 2007, are not necessarily indicative of the results that may
        be
        expected for the full year ending December 31, 2007.
 
 The
        consolidated condensed financial statements should be read in conjunction
        with
        the consolidated financial statements and related notes included in our Annual
        Report on Form 10-K for the year ended December 31, 2006. References herein
        to
“we,” “us,” “our,” the “Company,” and “Matria” refer to Matria Healthcare, Inc.
        and its consolidated subsidiaries.
 
 
 **2.  Recently
        Issued and Recently Adopted Accounting Standards**
  ***Accounting
        for Uncertainty in Income Taxes.***We adopted the provisions of FASB
        Interpretation No. 48, *Accounting for Uncertainty in Income Taxes, an
        interpretation of FASB Statement No. 109* (“FIN 48” or “Interpretation”) on
        January 1, 2007.  FIN 48 prescribes a recognition threshold and
        measurement attribute for the financial statement recognition and measurement
        of
        a tax position taken or expected to be taken in a tax return.  FIN 48
        also provides guidance on derecognition, classification, interest and penalties,
        accounting in interim periods, disclosure and transition. See Note 5, Income
        Taxes.
  ***Fair Value Option*****.**  In February 2007,
        the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159,
*The Fair Value Option for Financial Assets and Financial Liabilities
–
Including an Amendment of FASB Statement No. 115* (“SFAS 159”), which
        permits entities to choose to measure many financial instruments and certain
        other items at fair value. Entities that elect the fair value option will
        report
        unrealized gains and losses in earnings at each subsequent reporting
        date.  The fair value option may be elected on an
        instrument-by-instrument basis with a few exceptions.  SFAS 159 also
        establishes presentation and disclosure requirements to facilitate comparisons
        between companies that choose different measurement attributes for similar
        assets and liabilities.  The requirements of SFAS 159 are effective
        for our fiscal year beginning January 1, 2008.  We are currently
        assessing the potential impact of implementing this
        standard.  However, we do not expect the implementation to have a
        material adverse effect on our results of operations or financial
        position.
 
 **3.           Acquisitions**
  ***CorSolutions
        Medical, Inc.***  Pursuant to the merger agreement pursuant
        to which we acquired CorSolutions, we pursued a claim before a
        contractually-designated settlement accountant for certain post-closing
        adjustments, including a $4.0 million claim relating to a liability resulting
        from CorSolutions’ pre-closing performance under a customer
        contract.  The existence of the $4.0 million liability had not been
        disclosed by the sellers.  On September 20, 2007, the settlement
        accountant awarded us $3.9 million related to the undisclosed liability
        described above.  That award was offset by $1.3 million related to
        certain payroll taxes arising from the deemed exercise of options by employees
        of the sellers who subsequently became
 6
 
  employees
          of the Company, resulting in a net award of $2.6 million.  These
          amounts when included in the post-closing adjustment mechanism pursuant
          to the
          merger agreement resulted in the Company receiving $1.6 million plus $199,000
          of
          interest. We decreased goodwill by $1.6 million in the third quarter of
          2007 for
          the consideration received.
 
 ***Other
        Acquisitions.***In connection with Matria’s acquisitions
        of WinningHabits, Inc. (“WinningHabits”) on October 1, 2005, and Miavita LLC
        (“Miavita”) on April 1, 2005, we were required to pay additional consideration
        in future periods, based upon the financial performance of these businesses
        in
        specified post-closing periods.
 
 The
        additional consideration for the WinningHabits acquisition was based on the
        acquired company’s 2006 financial performance.  At March 31, 2007, we
        computed the additional consideration pursuant to the terms of our earn-out
        agreement to be $27.9 million.  On May 1, 2007, the sellers filed a
        notice of objection, objecting to certain aspects of the calculation. The
        sellers agreed to accept $28.7 million of additional consideration, which
        we
        paid on June 8, 2007.
 
 The
        second earn-out period for the Miavita acquisition ended March 31, 2007.
        On
        November 6, 2006, the Company and the seller entered into a Settlement Agreement
        and Release that effectively amended the terms of the original acquisition
        agreement to fix the amount payable for the second earn-out period at $20.0
        million plus 3.575 times net revenues from certain new customers between
        November 6, 2006, and March 31, 2007, provided that no payment was payable
        in
        respect of the second earn-out period unless payments received from such
        new
        customers between November 6, 2006, and May 1, 2007, were at least $500,000.
        The
        $500,000 threshold was met, and the Company paid a total of $22.0 million
        during
        the second quarter of 2007 with respect to the second earn-out
        period.  Additional earn-out payments will be payable in future
        periods based on a percentage of specified revenues pertaining to certain
        customer agreements.
 
 We
        decreased goodwill by $3.4 million in the first nine months of 2007 for the
        change in additional consideration payable under the earn-out agreements
        noted
        above.
 
 
 **4.           Comprehensive
        Earnings**
  Comprehensive
        earnings generally include all changes in equity during a period except those
        resulting from investments by owners and distributions to
        owners.  Comprehensive earnings consist of net earnings, foreign
        currency translation adjustments (net of income taxes) and net unrealized
        gains
        and losses on derivative instruments.  Comprehensive earnings for the
        three-month and nine-month periods ended September 30, 2007, were $5.6 million
        and $15.5 million, respectively, and for the corresponding periods in 2006
        were
        $21.6 million and $35.5 million, respectively.
 
 
 
 **5.           Income
          Taxes**
 As
        required, we adopted FIN 48 on January 1, 2007. As a result of implementing
        this
        Interpretation, we derecognized $524,000 in income tax benefits for certain
        tax
        positions for which there is uncertainty and recognized $145,000 of related
        interest and penalties. These adjustments resulted in increases of $669,000
        to
        beginning Accumulated deficit and to Other long-term liabilities. As of January
        1, 2007, and September 30, 2007, the amount of unrecognized tax benefits
        was
        $524,000, which, if recognized, would favorably affect the effective income
        tax
        rate in future periods. During the first nine months of 2007, we recorded
        interest and penalties of approximately $51,000.  It is our policy to
        classify interest and penalties recognized on underpayment of income taxes
        as
        Interest expense and Other income, net, respectively.
 
 7
  At
        this
        time, we do not believe that it is reasonably possible that there will be
        a
        material change in the estimated unrecognized tax benefits within the next
        twelve months.
 
 The
        Company and its subsidiaries file income tax returns in the U.S. Federal
        jurisdiction and in various states. Tax years that remain subject to examination
        for federal and various state jurisdictions are from 1996 to
        present.
 
 
 **6.           Earnings
        Per Share**
  The
        computations for basic and diluted net earnings per common share are as follows
        (in thousands, except per share amounts):
 **Three
                    Months Ended**
                
                
                **Nine
                    Months Ended****September
                    30,**
                
                
                **September
                    30,****2007**
                
                
                **2006**
                
                
                **2007**
                
                
                **2006****Net
                    earnings - basic and diluted:**Continuing
                    operations
                
                $
                5,894
                
                
                $
                4,532
                
                
                $
                15,770
                
                
                $
                12,782Discontinued
                    operations
                
                
                984
                
                
                
                25,505
                
                
                
                824
                
                
                
                29,403Net
                    earnings available to common shareholders
                
                $
                6,878
                
                
                $
                30,037
                
                
                $
                16,594
                
                
                $
                42,185**Shares:**Weighted
                    average common shares outstanding - basic
                
                
                21,378
                
                
                
                21,041
                
                
                
                21,344
                
                
                
                20,957Dilutive
                    effect of:Stock
                    options and employee stock purchase plan
                
                
                465
                
                
                
                498
                
                
                
                471
                
                
                
                684Unvested
                    restricted stock awards
                
                
                21
                
                
                
                15
                
                
                
                13
                
                
                
                23Weighted
                    average common shares outstanding - diluted
                
                
                21,864
                
                
                
                21,554
                
                
                
                21,828
                
                
                
                21,664**Basic:**Continuing
                    operations
                
                $
                0.28
                
                
                $
                0.22
                
                
                $
                0.74
                
                
                $
                0.61Discontinued
                    operations
                
                
                0.04
                
                
                
                1.21
                
                
                
                0.04
                
                
                
                1.40$
                0.32
                
                
                $
                1.43
                
                
                $
                0.78
                
                
                $
                2.01**Diluted:**Continuing
                    operations
                
                $
                0.27
                
                
                $
                0.21
                
                
                $
                0.72
                
                
                $
                0.59Discontinued
                    operations
                
                
                0.04
                
                
                
                1.18
                
                
                
                0.04
                
                
                
                1.36$
                0.31
                
                
                $
                1.39
                
                
                $
                0.76
                
                
                $
                1.95
 The
        calculation of diluted earnings per share excludes the antidilutive effect
        of
        1.2 million shares for stock options in both the three-month and nine-month
        periods ended September 30, 2007, and 1.3 million and 1.2 million shares,
        respectively, in the corresponding periods of 2006.  In the
        three-month and nine-month periods of 2007, the computation excludes 500,000
        shares of unvested restricted stock awards because the performance conditions
        as
        defined in the restricted stock agreements were not met.
 
  **7.   Share
        -Based Compensation**
  The
        Company’s Long-Term Stock Incentive Plan (the “LTIP”) and 2005 Directors’
Non-Qualified Stock Option Plan provide for the issuance of stock options,
        restricted stock units and other share-based awards to employees and to
        non-employee directors. At September 30, 2007, the plans permit the granting
        of
        share-based awards of up to approximately 852,000 shares of common
        stock.  The options are granted with an exercise price equal to the
        fair market value of the Company’s common stock on the date of grant and vest
        monthly over 12 months from the date of grant under the 2005 Director’s
        Non-Qualified Stock Option Plan and over a period of years (generally three
        to
        five) under the LTIP, subject to eligibility status as specified in the
        individual option agreement.  The term of each stock option is ten
        years from the date of grant. Restricted stock vests over a period of years
        (generally three), subject to eligibility status and, in some cases,
        satisfactory
 8
 
  achievement
          of performance goals, in each case as specified in the individual restricted
          stock agreement.
 
 The
        Company also has options and shares available for grant under various other
        plans, the provisions of which are similar to the plans described
        above.  Due to forfeitures of previously issued grants, at September
        30, 2007, there were approximately 8,000 options and shares available for
        grant
        under these plans.
 
 Our
        Employee Stock Purchase Plan (the “Purchase Plan”) allows employees to purchase
        the Company’s common stock at the lower of 85% of the fair market value per
        share on either the first or last
 business
          day of the quarter, limited to a maximum of the lesser of 10% of the employee’s
          compensation or 375 shares of common stock per quarter.  During the
          nine months ended September 30, 2007 and 2006, we issued approximately
          51,000
          and 41,000 shares, respectively, under the Purchase Plan.  At
          September 30, 2007, approximately 59,000 shares were reserved for purchase
          under
          the Purchase Plan.
 
 The
        fair
        value of each option award is estimated on the date of grant using the
        Black-Scholes option pricing model. The weighted average fair values of stock
        options granted during the nine months ended September 30, 2007 and 2006,
        were
        $13.22 and $15.96, respectively.  We did not grant any option awards
        during the third quarter of 2007. The following assumptions were used for
        calculating the fair value of our option awards:
  **Three
                    Months Ended**
                
                
                **Nine
                    Months Ended****September
                    30,**
                
                
                **September
                    30,****2007**
                
                
                **2006**
                
                
                **2007**
                
                
                **2006**Risk-free
                    interest rates
                
                ****
                **-**
                
                
                
                4.58
                %
                
                
                4.95
                %
                
                
                4.80
                %Expected
                    lives (in years)
                
                ****
                **-**
                
                
                
                4
                
                
                
                4
                
                
                
                4Dividend
                    yield
                
                NA
                
                
                NA
                
                
                NA
                
                
                NAExpected
                    volatility
                
                ****
                **-**
                
                
                
                52.1
                %
                
                
                46.4
                %
                
                
                55.0
                %
 The
        following table summarizes our stock option activity during the nine months
        ended September 30, 2007 (shares and value in thousands):
 
 **Weighted****Average****Remaining****Contractual**
              
              
              **Aggregate****Exercise**
              
              
              **Term**
              
              
              **Intrinsic****Shares**
              
              
              **Price**
              
              
              **(Years)**
              
              
              **Value**Outstanding
                  at January 1, 2007
              
              
              2,487
              
              
              $
              22.26Granted
              
              
              42
              
              
              $
              31.41Exercised
              
              
              (70
              )
              
              $
              11.91Forfeited/expired/cancelled
              
              
              (91
              )
              
              $
              28.68Outstanding
                  at September 30, 2007
              
              
              2,368
              
              
              $
              22.48
              
              
              
              6.5
              
              
              $
              15,453Options
                  exercisable at September 30, 2007
              
              
              1,353
              
              
              $
              18.34
              
              
              
              5.6
              
              
              $
              12,976




The
      total aggregate
      intrinsic value of options exercised during the nine-month period ended
      September 30, 2007, was $1.1 million. 
 9


The
        following table summarizes information regarding our stock options outstanding
        at September 30, 2007 (shares in thousands):
 **Outstanding**
                
                
                **Exercisable****Range
                    of Exercise Prices**
                
                
                **Shares
                    Outstanding**
                
                
                **Weighted
                    Average Remaining Contractual Life (years)**
                
                
                **Weighted
                    Average Exercise Price**
                
                
                **Shares
                    Exercisable**
                
                
                **Weighted
                    Average Exercise Price**$
                4.57
                    - $12.37
                
                
                
                632
                
                
                
                4.0
                
                
                $
                9.71
                
                
                
                593
                
                
                $
                9.88$
                12.61
                    - $28.03
                
                
                
                680
                
                
                
                6.5
                
                
                $
                19.07
                
                
                
                346
                
                
                $
                16.58$
                28.16
                    - $34.11
                
                
                
                626
                
                
                
                8.0
                
                
                $
                29.94
                
                
                
                265
                
                
                $
                29.76$
                34.47
                    - $40.33
                
                
                
                430
                
                
                
                8.1
                
                
                $
                35.80
                
                
                
                149
                
                
                $
                35.752,368
                
                
                
                6.5
                
                
                $
                22.48
                
                
                
                1,353
                
                
                $
                18.34
  The
        following table summarizes our restricted stock award activity for the
        nine-month period ended September 30, 2007 (shares in thousands):
 **Weighted****Average****Grant
                    Date****Fair
                    Value****Shares**
                
                
                **Per
                    Share**Nonvested
                    at January 1, 2007
                
                
                221
                
                
                $
                28.10Granted
                
                
                466
                
                
                $
                27.89Vested
                
                
                (11
                )
                
                $
                28.16Forfeited
                
                
                (48
                )
                
                $
                28.07Nonvested
                    at September 30, 2007
                
                
                628
                
                
                $
                27.94
 For
        the
        three months and nine months ended September 30, 2007, we recorded share-based
        compensation expense of $3.6 million ($2.3 million net of income tax, or
        $0.11
        per diluted share) and $9.5 million ($6.2 million net of income tax, or $0.28
        per diluted share), respectively.  For the corresponding periods in
        2006, we recorded share-based compensation expense of $1.9 million ($1.3
        million
        net of income tax, or $0.06 per diluted share) and $5.1 million ($3.5 million
        net of income tax, or $0.16 per diluted share), respectively.  The
        expense is included in Selling and administrative expenses on the consolidated
        condensed statement of operations.  We did not capitalize any
        share-based compensation costs in any period.  Cash received from
        option exercises and shares issued under all share-based payment arrangements
        for the nine months ended September 30, 2007 and 2006, was $1.9 million and
        $3.5
        million, respectively.
 
 At
        September 30, 2007, total compensation expense related to unvested share-based
        awards granted to employees under stock option plans but not yet recognized
        was
        approximately $20.3 million, after estimating forfeitures and before income
        taxes.  The expense of all unvested share-based awards is expected to
        be recognized over an estimated weighted average period of approximately
        2.8
        years. Our restricted stock awards are performance-based and
        service-based.  Expense for restricted stock awards is recognized
        using the tranche method (performance-based awards) or the straight line
        method
        (service-based awards) over the vesting period. The remaining unrecognized
        compensation expense for the performance-based restricted stock awards may
        vary
        each reporting period based on changes in the expected achievement of
        performance measures.
 
 
 **8.           Long-Term
        Debt**
  On
        January 19, 2006, in connection with our acquisition of CorSolutions, we
        entered
        into a $485.0 million credit agreement and a second lien term loan facility
        with
        Bank of America, N.A., as administrative
 10
 
  and
          collateral agent (the “Credit Facilities”).  Amounts borrowed under
          the Credit Facilities, as amended, accrue interest at a variable spread
          over
          LIBOR, with the applicable spread determined by the Company’s consolidated
          leverage ratio, as described in the applicable credit
          agreement.  Interest rates for the Credit Facilities are reset
          quarterly. Amounts borrowed are fully and unconditionally guaranteed on
          a joint
          and several basis by substantially all of our subsidiaries. The Credit
          Facilities mature on January 19, 2012. As of September 30, 2007, the outstanding
          balance under the Credit Facilities was $267.7 million, excluding the Revolving
          Credit Facility noted below.
 
 The
        Credit Facilities also provide for a Revolving Credit
        Facility.  Amounts borrowed under the Revolving Credit Facility accrue
        interest at a variable spread over LIBOR or the prime rate, at our option,
        with
        the applicable spread determined by reference to our consolidated leverage
        ratio, as described in the credit agreement.  On February 23, 2007, we
        entered into a third amendment to the Credit Facilities, the terms of which
        increased our borrowing capacity under the Revolving Credit Facility from
        $30.0
        million to $50.0 million.  All
        other terms of the Credit Facilities, as amended, remain
        unchanged.  At September 30, 2007, there was $25.0 million outstanding
        under the Revolving Credit Facility, and the available balance was $23.6
        million.
 
 
 The
        Credit Facilities contain, among other things, various representations,
        warranties and affirmative, negative and financial covenants customary for
        financings of this type. The negative covenants include, without limitation,
        certain limitations on transactions with affiliates, liens, making investments,
        the incurrence of debt, sales of assets, and changes in business. The financial
        covenants contained in the Credit Facilities include a consolidated leverage
        ratio and a consolidated fixed charges coverage ratio. At September 30, 2007,
        we
        were in compliance with all covenants of the Credit Facilities.
 
 The
        weighted average interest rates, including amortization of debt discount
        and
        expense, on all outstanding indebtedness were 8.43% and 8.22% for the
        three-month and nine-month periods ended September 30, 2007, respectively,
        and
        9.41% and 9.24% for the corresponding periods in 2006.
 
 
 **9.  Derivative
        Financial Instruments**
  In
        February and May 2006, we entered into two interest rate swap agreements,
        each
        with a notional amount of $100.0 million, to hedge exposure to fluctuations
        in
        interest rates related to our Credit Facilities.  The agreements,
        which have two-year terms, have the economic effect of converting $200.0
        million
        of floating-rate debt under the Credit Facilities to fixed-rate
        debt.  The provisions of the agreements provide that we pay the bank
        fixed base rates of 5.065% and 5.350%, respectively, and the bank will pay
        us
        floating rates based on three-month LIBOR (5.495% and 5.198%, respectively,
        at
        September 30, 2007). The variable rates are reset quarterly.
 
 In
        August
        2007, we entered into two additional interest rate swap agreements, each
        with
        notional amounts of $100.0 million.  The terms of these agreements are
        scheduled to become effective after the termination of the swaps noted above
        (February and May 2008). These agreements also have two-year terms and have
        the
        economic effect of converting $200.0 of floating-rate debt to fixed-rate
        debt.  We will pay the bank fixed base rates of 4.890% and 4.910%,
        respectively, under these swap arrangements, and the bank will pay us floating
        rates based on three-month LIBOR.
 
 On
        the
        dates the interest rate swap derivative contracts were entered into, we
        designated the derivatives as hedges of the variability of cash flow to be
        paid
        (“cash flow” hedge).  Under cash flow hedge accounting, changes in the
        fair value of a derivative that is qualified, designated and highly effective
        as
        a cash flow hedge are recorded in other comprehensive income until earnings
        are
        affected by the variability of cash flows.  We reflected the interest
        rate swap agreements on the consolidated condensed balance sheets at fair
 11
 
  value
          ($1.8 million and $62,000 payable at September 30, 2007, and December 31,
          2006,
          respectively), which was based upon the estimated amount we would pay upon
          settlement of the agreements taking into account interest rates on those
          dates.  For the three-month and nine-month periods ended September 30,
          2007, we recognized net gains of $92,000 and $245,000, respectively, from
          the
          cash flow hedges.  We recognized a net gain of $74,000 and a net loss
          of $7,000 for the corresponding periods in 2006.  These amounts are
          included in Interest expense in the consolidated condensed statements of
          operations.
 
  **10.  Contingencies**
  We
        are
        pursuing claims for fraud and breach of contract in connection with the merger
        transaction in which we acquired CorSolutions before the American Arbitration
        Association in Chicago, Illinois, seeking damages in an unspecified
        amount.   There is no assurance that we will prevail in this
        proceeding.  However, if we do prevail, any resulting award will
        impact our goodwill and/or our pretax earnings.
 
 We
        are involved in various claims and legal actions arising in the ordinary
        course
        of business.  In the opinion of management, based in part on the
        advice of counsel, the ultimate disposition of these matters will not have
        a
        material adverse effect on the Company’s consolidated balance sheet, results of
        operations or liquidity.
 
  **11.  Divestitures**
  On
        September 1, 2006, and October 17, 2006, respectively, we completed the sales
        of
        Facet Technologies, LLC (“Facet”) for net cash proceeds of $121.6 million and
        our foreign diabetes services operations in Germany (“Dia Real”) for net cash
        proceeds of $33.3 million. As a result, the accompanying consolidated condensed
        financial statements reflect the operations of these divisions as discontinued
        operations for all periods presented.  The operating results of
        discontinued operations are as follows (in thousands):
 
 **Three
                    Months Ended**
                
                
                **Nine
                    Months Ended****September
                    30,**
                
                
                **September
                    30,****2007**
                
                
                **2006**
                
                
                **2007**
                
                
                **2006**Revenues
                
                $
                -
                
                
                $
                29,982
                
                
                $
                -
                
                
                $
                102,610Earnings
                    (loss) from discontinued operations
                
                $
                23
                
                
                $
                2,221
                
                
                $
                (241
                )
                
                $
                8,855Gain
                    on disposal of discontinued operation
                
                
                -
                
                
                
                27,075
                
                
                
                -
                
                
                
                27,075Income
                    tax benefit (expense)
                
                
                961
                
                
                
                (3,791
                )
                
                
                1,065
                
                
                
                (6,527
                )Discontinued
                    operations, net of tax
                
                $
                984
                
                
                $
                25,505
                
                
                $
                824
                
                
                $
                29,403
 The
        Facet
        sale resulted in a gain of $27.1 million, or $24.2 million net of income
        taxes,
        which was recorded in the third quarter of 2006. In the third quarter of
        2007,
        we recorded a tax benefit of $971,000 primarily related to the increased
        utilization of our foreign tax credits in our 2006 federal tax
        return.  Earnings from discontinued operations before income tax
        expense for the three-month and nine-month periods ended September 30, 2006,
        include charges of $2.2 million and $8.6 million, respectively, for interest
        expense and deferred financing fees related to our Credit Facilities. These
        amounts were allocated in accordance with Emerging Issues Task Force (“EITF”)
        Issue 87-24, *Allocation of Interest to Discontinued Operations*. Under
        EITF Issue 87-24, interest on debt that must be repaid upon disposal of
        discontinued operations must be allocated to discontinued
        operations.  In accordance with the terms of the Credit Facilities, we
        used the net proceeds from the sales of Facet and Dia Real to repay a portion
        of
        the outstanding indebtedness under our Credit Facilities.
 
 12
  In
        connection with the sales, we accrued $1.3 million for other liabilities
        related
        to the divestitures. A reconciliation of the accrued liability balance is
        as
        follows (in thousands):
  **Employee
                    Termination Benefits**
                
                
                **Lease
                    Obligations**
                
                
                **Other
                    Accruals**
                
                
                **Total**Balance
                    January 1, 2007
                
                $
                290
                
                
                
                872
                
                
                
                124
                
                
                $
                1,286Charges
                
                
                6
                
                
                
                -
                
                
                
                98
                
                
                
                104Payments
                
                
                (296
                )
                
                
                (872
                )
                
                
                (195
                )
                
                
                (1,363
                )Balance
                    at September 30, 2007
                
                $
                -
                
                
                
                -
                
                
                
                27
                
                
                $
                27
 **12.  Supplemental
        Disclosures Regarding Revenue**
  We
        have
        one reportable segment that includes our disease and condition management
        services, wellness programs and maternity management services. The following
        table summarizes our revenues for these services and programs (amounts in
        thousands):
 
 **Three
                    months ended**
                
                
                **Nine
                    months ended****September
                    30,**
                
                
                **September
                    30,****2007**
                
                
                **2006**
                
                
                **2007**
                
                
                **2006**Disease
                    and Condition Management
                
                $
                57,247
                
                
                $
                51,624
                
                
                $
                164,773
                
                
                $
                153,806Wellness
                
                
                6,536
                
                
                
                4,823
                
                
                
                20,567
                
                
                
                13,824Maternity
                    Management
                
                
                25,821
                
                
                
                27,739
                
                
                
                78,408
                
                
                
                80,089$
                89,604
                
                
                $
                84,186
                
                
                $
                263,748
                
                
                $
                247,719
 **13.  Variable
        Interest Entity**
  In
        September 2006, the Company entered
        into a Stock Purchase and Loan Agreement with Secured Independence, Inc.
        (“SI”),
        a privately-held business, forming a strategic alliance to address the needs
        of
        the long-term care insurance industry. Our initial investment of $552,500
        purchased 95 shares of SI’s common stock, which constituted a 19% equity
        investment in SI.  Under the terms of the agreement, the Company shall
        make working capital advances up to an aggregate of $1.9
        million.  Also, we are entitled to purchase additional shares of SI
        common stock, which when added to our initial investment would constitute
        up to
        100% of the shares SI common stock on a fully diluted basis. As of September
        30,
        2007, we have made working capital advances totaling $1.0 million.
 
 We
        evaluated our equity investment in
        SI and determined that SI is a variable interest entity under FASB
        Interpretation No. 46 (FIN-46R) (Revised December 2003), *Consolidation of
        Variable Interest Entities*.  We concluded that we are the primary
        beneficiary as defined by FIN-46R and, as a result, we are required to
        consolidate the assets, liabilities and results of operations of SI in our
        consolidated financial statements.  We therefore consolidated SI in
        our financial statements since the time of our initial investment in September
        2006.
  For the three-month and nine-month periods ended September 30, 2007, SI’s pretax
        losses totaled $361,000 and $1.0 million, respectively.
 13
  **Item
          2.  Management’s Discussion and Analysis of Financial Condition and
          Results of Operations**
 
 *The
        following discussion and analysis
        should be read in conjunction with the other financial information in this
        Report and the consolidated financial statements and related notes and other
        financial information in our Annual Report on Form 10-K for the year ended
        December 31, 2006, as filed with the Securities and Exchange Commission (the
        “Commission” or “SEC”).  The discussion contains forward-looking
        statements that involve risks and uncertainties.  Actual results could
        differ materially from those anticipated in the forward-looking statements
        as a
        result of a variety of factors, including those discussed in “Risk Factors” in
        the Annual Report.  The historical results of operations are not
        necessarily indicative of future results.*
 
 **Executive
        Overview**
 
 We
        are a leading provider of
        comprehensive, integrated programs and services focused on wellness, disease
        and
        condition management, productivity enhancement and informatics. This suite
        of
        services, which we call “Health Enhancement,” is designed to reduce
        health-related costs and enhance the health and quality of life of the
        individuals we serve. We provide services to self-insured employers, private
        and
        government-sponsored health plans, pharmaceutical companies and patients.
        Our
        employer clients are primarily Fortune 1000 companies that self-insure the
        medical benefits provided to their employees, dependents and
        retirees.  Our health plan customers are regional and national health
        plans, as well as government-sponsored health plans, such as state Medicaid
        programs.
 
 Our
        online, interactive wellness programs address issues such as: smoking cessation,
        weight loss, exercise, healthier diet, stress relief, healthy aging, and
        productivity enhancement. These programs are designed to help employees and
        health plan members live healthier and longer lives while reducing their
        healthcare costs and increasing their productivity.
 
 Our
        disease and condition management programs focus on the most costly medical
        conditions including, without limitation, diabetes, cardiovascular diseases,
        respiratory disorders, depression, chronic pain, hepatitis C, cancer and
        high-risk pregnancies.  We assist individuals to better manage their
        conditions by increasing their knowledge about their illnesses or conditions,
        potential complications and the importance of medication and treatment plan
        compliance. Depending on acuity, our specialized nurses proactively contact
        patients to monitor their progress and ensure they are following the plan
        of
        care set by their physician.
 
 14
  **Results
        of Operations**
  ***Three
        Months Ended September 30, 2007, Compared to Three Months Ended September
        30,
        2006***
  The
        following table summarizes key components in our financial statements for
        continuing operations for the three-month periods ended September 30, 2007
        and
        2006, respectively, expressed as a percentage of revenues. An explanation
        of the
        results follows the table.
  **Three
                    Months Ended****September
                    30,****2007**
                
                
                **2006**Revenues
                
                
                100.0
                %
                
                
                100.0
                %Cost
                    of revenues
                
                
                30.0
                %
                
                
                32.4
                %Gross
                    margin
                
                
                70.0
                %
                
                
                67.6
                %Selling
                    and administrative expenses
                
                
                48.6
                %
                
                
                47.5
                %Provision
                    for doubtful accounts
                
                
                1.6
                %
                
                
                1.2
                %Amortization
                    of intangible assets
                
                
                2.0
                %
                
                
                2.1
                %Operating
                    earnings
                
                
                17.9
                %
                
                
                16.8
                %Interest
                    expense, net
                
                
                -6.6
                %
                
                
                -8.0
                %Other
                    income, net
                
                
                0.0
                %
                
                
                0.4
                %Earnings
                    from continuing operations before income taxes
                
                
                11.2
                %
                
                
                9.2
                %Income
                    tax expense
                
                
                -4.7
                %
                
                
                -3.8
                %Earnings
                    from continuing operations (1)
                
                
                6.6
                %
                
                
                5.4
                %(1)
                    Amounts may not add due to rounding.
  Revenues
        increased by $5.4 million, or
        6.4%, to $89.6 million for the three months ended September 30, 2007, from
        $84.2
        million in the same period in 2006. This increase was due primarily to the
        implementation of new and expanded disease management and wellness contracts,
        net of attrition, and the favorable impact from achieving certain performance
        targets.  These increases were partially offset by a decrease in
        revenues from our maternity management services. Disease and condition
        management program revenues increased $5.6 million, or 10.9%, to $57.2 million
        for the three months ended September 30, 2007. Wellness program revenues
        were
        $6.5 million for the three months ended September 30, 2007, compared to $4.8
        million for the same period in 2006, increasing 35.5%. Maternity management
        program revenues decreased $1.9 million, or 6.9%, to $25.8 million for the
        three
        months ended September 30, 2007, primarily due to decreased preterm labor
        management revenues resulting from a decline in census and patient days,
        combined with decreased revenues from the effect of Zofran becoming generic,
        which is used for nausea and vomiting.  These decreases were partially offset
        by higher
        revenues from our MaternaLink®services, which include risk
        assessment and early intervention programs.
 
 Cost
          of
          revenues as a percentage of revenues decreased to 30.0% for the three months
          ended September 30, 2007, from 32.4% for the same period in
          2006.  This decrease was primarily due to: (i) an increase in our
          high-margin disease management and wellness revenues, and (ii) the availability
          of a lower cost generic drug for Zofran, which is used in our maternity
          management services.  These decreases were partially offset by
          increased costs of revenues as a percentage of revenues for certain clinical
          services for preterm labor management.
 
 Selling
        and administrative expenses increased $3.5 million to $43.5 million in the
        third
        quarter of 2007, compared to $40.0 million in the same period of 2006. We
        incurred increased costs primarily for salaries and other personnel-related
        expenses and increased depreciation and amortization expenses related to
        our
        technology investments. Share-based compensation expense increased $1.7 million
        due to an increase in expense related to our restricted stock awards, which
        are
        performance-based and service-based and have shorter vesting periods than
        certain stock options with grants dating back to 2003 that have expense
        continuing into 2007.  As a percentage of revenues, selling and
        administrative expenses increased to 48.6% in 2007 compared to 47.5% in
        2006.
 15
 
 The
        provision for doubtful accounts as a percentage of revenues was 1.6% for
        the
        three months ended September 30, 2007, compared to 1.2% for the same period
        in
        2006.  The provision, which is recorded primarily for our maternity
        management program revenues, is adjusted periodically based upon our quarterly
        evaluation of historical collection experience, recoveries of amounts previously
        provided, industry reimbursement trends and other relevant factors. The
        percentage increase results from an increase in bad debts for our disease
        and
        condition management and wellness revenues.
 
 Interest
        expense decreased to $6.4 million in 2007, from $7.1 million in 2006, due
        primarily to lower interest rates due to refinancing the Second Lien Facility
        of
        our Credit Facilities, combined with a lower outstanding balance of our Credit
        Facilities, which we entered into in January 2006 in conjunction with our
        acquisition of CorSolutions. In November 2006, we amended the terms of our
        Credit Facilities, effectively reducing the interest rate on outstanding
        indebtedness to LIBOR plus 2.0%, a 475 basis point reduction. The weighted
        average interest rates, including amortization of debt discount and expense,
        on
        all outstanding indebtedness were 8.43% and 9.41% for the three-month periods
        ended September 30, 2007 and 2006, respectively.
 
 Income
        tax expense was $4.2 million and $3.2 million for the three months ended
        September 30, 2007 and 2006, respectively.  The effective income tax
        rate is higher than the statutory federal tax rate due to state income taxes
        and
        certain non-deductible expenses for tax purposes.  Cash outflows for
        income taxes for continuing and discontinued operations in 2007 and 2006
        were
        $651,000 and $2.1 million, respectively, comprised of federal alternative
        minimum taxes, state income taxes and, in 2006, foreign taxes.  As of
        December 31, 2006, our remaining net operating loss carryforwards were $67.0
        million, which we expect will be available to offset future taxable income,
        subject to certain limitations. We expect to use approximately $22.0 million
        of
        our net operating loss carryforwards in 2007.
 
 Discontinued
        operations include the operations of Facet Technologies, LLC (“Facet”) and Dia
        Real, our foreign diabetes services operations in Germany. The earnings from
        discontinued operations in the third quarter of 2007 were $13,000, net of
        tax,
        compared to earnings of $1.3 million for the same period in 2006.  We
        completed the sale of Facet on September 1, 2006, for net cash proceeds of
        $121.6 million and recorded a gain on the sale of $27.1 million, or $24.2
        million, net of income taxes. In the third quarter of 2007, we recorded $971,000
        to Gain on disposal of discontinued operations, which primarily related to
        the
        increased utilization of foreign tax credits in our 2006 federal tax
        return.  Discontinued operations in 2006 include $2.5 million of
        interest expense and amortization expense of deferred financing fees related
        to
        the Credit Facilities, which was allocated to discontinued operations in
        accordance with Emerging Issues Task Force (“EITF”) Issue 87-24, *Allocation
        of Interest to Discontinued Operations*. EITF Issue 87-24 states that
        interest on debt that must be repaid when the disposal of discontinued
        operations occurs should be allocated to discontinued operations.  In
        accordance with the terms of the Credit Facilities, we used the net proceeds
        from the sales of Facet in the third quarter of 2006 and Dia Real in the
        fourth
        quarter of 2006 to repay a portion of the outstanding indebtedness under
        our
        Credit Facilities.
 
 16
  ***Nine
        Months Ended September 30, 2007, Compared to Nine Months Ended September
        30,
        2006***
  The
        following table summarizes key components in our financial statements for
        continuing operations for the nine-month periods ended September 30, 2007
        and
        2006, respectively, expressed as a percentage of revenues. An explanation
        of the
        results follows the table.
   **Nine
                    Months Ended****September
                    30,****2007**
                
                
                **2006**Revenues
                
                
                100.0
                %
                
                
                100.0
                %Cost
                    of revenues
                
                
                30.4
                %
                
                
                32.3
                %Gross
                    margin
                
                
                69.6
                %
                
                
                67.7
                %Selling
                    and administrative expenses
                
                
                49.9
                %
                
                
                48.0
                %Provision
                    for doubtful accounts
                
                
                1.5
                %
                
                
                1.1
                %Amortization
                    of intangible assets
                
                
                2.0
                %
                
                
                2.2
                %Operating
                    earnings
                
                
                16.3
                %
                
                
                16.4
                %Interest
                    expense, net
                
                
                -6.3
                %
                
                
                -7.9
                %Other
                    income, net
                
                
                0.1
                %
                
                
                0.4
                %Earnings
                    from continuing operations before income taxes
                
                
                10.1
                %
                
                
                8.9
                %Income
                    tax expense
                
                
                -4.1
                %
                
                
                -3.7
                %Earnings
                    from continuing operations (1)
                
                
                6.0
                %
                
                
                5.2
                %(1)
                    Amounts may not add due to rounding.
  Revenues
        increased by $16.0
        million, or 6.5%, to $263.7 million for the nine months ended September 30,
        2007, from $247.7 million for the same period in 2006. The increases were
        due
        primarily to the implementation of new and expanded disease management and
        wellness contracts, net of attrition, and the favorable impact of achieving
        certain performance targets.  Disease and condition management program
        revenues increased $11.0 million, or 7.1%, to $164.8 million for the nine-month
        period ended September 30, 2007. Wellness program revenues increased $6.7
        million, or 48.8%, to $20.6 million in 2007 from $13.8 million for the same
        period in 2006. Maternity management program revenues decreased $1.7 million,
        or
        2.1%, to $78.4 million for the nine months ended September 30, 2007, primarily
        due to decreased preterm labor management revenues resulting from a decline
        in
        census and patient days, partially offset by higher revenues
        from our
        MaternaLink®services.
 
 Cost
          of
          revenues as a percentage of revenues decreased to 30.4% for the nine months
          ended September 30, 2007, from 32.3% for the same period in
          2006.  This decrease was primarily due to (i) an increase in our
          high-margin disease management and wellness revenues, and (ii) the availability
          of a lower cost generic drug for Zofran, which is used for nausea and vomiting
          in our maternity management services. These decreases in cost of revenues
          as a
          percentage of revenue were partially offset by increases in cost as a percentage
          of revenues for certain clinical services for preterm labor
          management.
 
 Selling
        and administrative expenses increased $12.7 million, or 10.7%, to $131.6
        million
        in the nine months ended September 30, 2007, from $118.8 million in the same
        period of 2006. Selling and administrative expenses as a percentage of revenues
        increased to 49.9% in 2007 from 48.0% in 2006. As noted above, increased
        costs
        for salaries and other personnel-related expenses, as well as depreciation
        and
        amortization expenses, were major contributors to the increase. Our share-based
        compensation expense increased $4.3 million in the nine-month period ended
        September 30, 2007, due to the recognition of expense from our performance-based
        and service-based restricted stock awards, which have shorter vesting periods
        than certain stock options with grants dating back to 2003 that have expense
        continuing into 2007.
 
 The
        provision for doubtful accounts as a percentage of revenues was 1.5% for
        the
        nine months ended September 30, 2007, compared to 1.1% for the same period
        in
        2006 as a result of an increase in bad debts for our disease and condition
        management and wellness revenues.
 17
 
 Interest
        expense decreased $2.7 million to $18.0 million in 2007, from $20.7 million
        in
        2006 due primarily to lower interest rates and a lower outstanding balance
        of
        our Credit Facilities.  As noted above, we amended the terms of our
        Credit Facilities in November 2006, effectively reducing the interest rate
        on
        outstanding indebtedness. The weighted average interest rates, including
        amortization of debt discount and expense, on all outstanding indebtedness
        were
        8.22% and 9.24% for the nine months ended September 30, 2007 and 2006,
        respectively.
 
 Income
        tax expense was $10.8 million and $9.2 million for the nine months ended
        September 30, 2007 and 2006, respectively.  Our effective income tax
        rates were 40.6% in 2007 and 41.8% in 2006.  The effective income tax
        rate in 2007 is lower than the 2006 rate as a result of the reduced impact
        of
        certain non-deductible expenses in 2007 and our reduced utilization of incentive
        stock options as a component of our share-based compensation, which is generally
        not tax deductible. The effective income tax rate is higher than the statutory
        federal tax rate due to state income taxes and certain non-deductible expenses
        for tax purposes.  Cash outflows for income taxes for continuing and
        discontinued operations in 2007 and 2006 were $3.1 million and $4.7 million,
        respectively, comprised of federal alternative minimum taxes, state income
        taxes
        and, in 2006, foreign taxes.  As of December 31, 2006, our remaining
        net operating loss carryforwards were $67.0 million, which we expect will
        be
        available to offset future taxable income, subject to certain limitations.
        We
        expect to use approximately $22.0 million of our net operating loss
        carryforwards in 2007.
 
 Discontinued
        operations include the operations of Facet and Dia Real. The loss from
        discontinued operations for the nine-month period ended September 30, 2007,
        was
        $147,000, net of tax, compared to earnings of $5.2 million for the comparable
        period in 2006. We completed the sale of Facet on September 1, 2006, for
        net
        cash proceeds of $121.6 million and recorded a gain on the sale of $27.1
        million, or $24.2 million , net of income taxes.  In the third quarter
        of 2007, we recorded $971,000 to Gain on disposal of discontinued operations,
        which primarily related to the increased utilization of foreign tax credits
        in
        our 2006 federal tax return. Discontinued operations in 2006 include a pre-tax
        expense of $8.9 million for the allocation of interest and deferred financing
        fees related to the Credit Facilities as discussed above.
 
 
 **Liquidity
        and Capital Resources**
  ***Operating
        Activities***
 As
        of
        September 30, 2007, we had cash and cash equivalents of $11.3
        million.  In the first nine months of 2007, operating activities from
        continuing operations provided $34.7 million of cash, compared with $11.2
        million provided in the comparable period of 2006.  This increase was
        due primarily to decreases in accrued and other liabilities in the first
        nine
        months of 2006 for the payment of transaction-related expenses incurred in
        the
        CorSolutions acquisition and a decrease in our days’ sales outstanding, or DSO,
        to 53 days at September 30, 2007, from 60 days at September 30,
        2006.  Our DSO at December 31, 2006, was 54 days.
 
 Net
        cash
        used in discontinued operations was $1.5 million and $3.8 million for the
        nine-month periods ended September 30, 2007 and 2006, respectively, driven
        primarily by the payment of certain expenses related to the sale of Facet
        and
        Dia Real. The 2006 period reflects the allocation of $8.9 million in interest
        expense (before taxes) referenced above.
 
 ***Investing
        Activities***
 Net
        cash
        used in investing activities totaled $57.8 million and $323.4 million for
        the
        nine months ended September 30, 2007 and 2006, respectively.  During
        the second quarter of 2007, we paid $50.7 million of additional earn-out
        consideration for our acquisitions of Miavita LLC (April 2005) and
        WinningHabits, Inc. (October 2005).  In 2006, we paid $1.7 million of
        additional earn-out consideration for the first earn-out period of the Miavita
        acquisition.  These payments were recorded as additional goodwill.
        Additional earn-out
 18
 
  consideration
          may be payable in future periods based on a percentage of specified revenues
          from certain MiaVita customer agreements.
 
 We
        used
        $10.0 million and $8.5 million in 2007 and 2006, respectively, for capital
        expenditures for continuing operations.  Capital expenditures for both
        periods related to the replacement and enhancement of computer information
        systems and to the replacement of medical devices used in our maternity
        management programs.  We expect to expend a total of approximately
        $14.0 million for capital items in 2007, including capital expenditures made
        in
        the first nine months.
 
 In
        2006,
        we used $434.7 million, net of cash acquired, in connection with the acquisition
        of CorSolutions.  We completed the acquisition on January 19, 2006,
        and results of operations of this business have been included in our
        consolidated results of operations effective January 1, 2006.  In
        September 2007, we received $1.6 million for a purchase price adjustment
        for the
        CorSolutions acquisition.  On September 1, 2006, we completed the sale
        of Facet for $121.6 million, net of $646 of cash transaction costs paid during
        the third quarter.
 
 ***Financing
        Activities***
 Net
        cash
        provided by financing activities was $16.0 million and $321.0 million for
        the
        nine months ended September 30, 2007 and 2006, respectively.  During
        the second quarter of 2007, we borrowed $40.0 million under our Revolving
        Credit
        Facility (described below).  We repaid $27.9 million and $129.0
        million of short-term indebtedness and capital lease obligations during the
        nine-month periods ended September 30, 2007 and 2006,
        respectively.  Our 2007 repayments include $22.0 million for
        prepayment on our Credit Facilities and $2.0 million to redeem our remaining
        outstanding unsecured 11% Senior Notes, $120 million of which had been redeemed
        in June 2004. During the third quarter of 2006, we made prepayments of $125.0
        million toward the reduction of the Credit Facility, using $115.0 proceeds
        from
        the Facet divestiture and $10.0 million from operating cash flows.
 
 We
        received $1.9 million and $3.5 million from participants under our stock
        purchase and stock option plans in the nine-month periods ended September
        30,
        2007 and 2006, respectively.
 
 During
        2006, we used proceeds of $444.0 million, net of debt issuance costs of $11.0
        million, from our Credit Facilities described below to fund the acquisition
        of
        CorSolutions.
 
 Our
        Credit Facilities, which mature on January 19, 2012, include a $485.0 million
        credit agreement and a second lien term loan facility with Bank of America,
        N.A., as administrative and collateral agent.  Amounts borrowed under
        the Credit Facilities, as amended, accrue interest at a variable spread over
        LIBOR, with the applicable spread determined by the Company’s consolidated
        leverage ratio, as described in the applicable credit
        agreement.  Interest rates for the Credit Facilities are reset
        quarterly. Amounts borrowed are fully and unconditionally guaranteed on a
        joint
        and several basis by substantially all of our subsidiaries. As of September
        30,
        2007, the outstanding balance under the Credit Facilities was $267.7 million,
        excluding the Revolving Credit Facility noted below.
 
 The
        Credit Facilities also provide for a Revolving Credit
        Facility.  Amounts borrowed under the Revolving Credit Facility accrue
        interest at a variable spread over LIBOR or the prime rate, at our option,
        with
        the applicable spread determined by reference to our consolidated leverage
        ratio, as described in the credit agreement.  On February 23, 2007, we
        entered into a third amendment to the Credit Facilities, the terms of which
        increased our borrowing capacity under the Revolving Credit Facility from
        $30.0
        million to $50.0 million.  All other terms of the Credit Facilities,
        as amended, remain unchanged.  At September 30, 2007, $25.0 million
        was outstanding under the Revolving Credit Facility, and the available balance
        was $23.6 million.
 19
 
 The
        Credit Facilities contain, among other things, various representations,
        warranties and affirmative, negative and financial covenants customary for
        financings of this type. The negative covenants include, without limitation,
        certain limitations on transactions with affiliates, liens, making investments,
        the incurrence of debt, sales of assets, and changes in business. The financial
        covenants contained in the Credit Facilities include a consolidated leverage
        ratio and a consolidated fixed charges coverage ratio. At September 30, 2007,
        we
        were in compliance with all covenants of the Credit Facilities.
 
 In
        February and May 2006, we entered into two interest rate swap agreements
        totaling $200.0 million notional amount to hedge our exposure to fluctuations
        in
        interest rates related to the Credit Facilities.  The swap agreements
        had the economic effect of converting $200.0 million of our floating-rate
        debt
        under the Credit Facilities to fixed-rate debt.  Under the terms of
        the agreements, we will pay the bank fixed base rates of 5.065% and 5.350%,
        respectively, and the bank will pay us floating rates based on three-month
        LIBOR
        (5.495% and 5.198%, respectively, at September 30, 2007). We reflected the
        interest rate swap agreements on the consolidated condensed balance sheet
        at a
        fair value of $1.8 million and $62,000 at September 30, 2007 and December
        31,
        2006, respectively, based upon the estimated amount we would pay upon settlement
        of the agreements taking into account interest rates on those
        dates.  For the three-month and nine-month periods ended September 30,
        2007, we recognized net gains of $92,000 and $245,000, respectively, from
        the
        cash flow hedges.  We recognized a net gain of $74,000 and a net loss
        of $7,000 for the corresponding three-month and nine-month periods in
        2006.  These amounts are included in Interest expense in the
        consolidated condensed statements of operations.
 
 In
        August
        2007, we entered into two additional interest rate swap agreements, each
        with
        notional amounts of $100.0 million.  These swap agreements are
        scheduled to become effective after the termination of the swaps noted above
        (February and May 2008). These agreements also have two-year terms, and have
        the
        economic effect of converting $200.0 million of floating-rate debt to fixed-rate
        debt.  We will pay the bank fixed base rates of 4.890% and 4.910%,
        respectively, under these swap arrangements, and the bank will pay us floating
        rates based on three-month LIBOR.
 
 We
        believe that our cash, other liquid assets, operating cash flows and Credit
        Facilities, taken together, will provide adequate resources to fund ongoing
        operating requirements, planned capital expenditures and contractual obligations
        through at least the next twelve months.
 
 **Contractual
        Obligations, Commitments and Off-Balance Sheet
        Arrangements**
 We
        have
        various contractual obligations that are recorded as liabilities in our
        consolidated condensed financial statements. Certain other items, such as
        operating lease obligations, are not recognized as liabilities in our
        consolidated condensed financial statements but are required to be disclosed.
        The following sets forth our future minimum payments required under our
        contractual obligations as of September 30, 2007 (in thousands):
  **Payments
                    Due by Year****Total**
                
                
                **Less
                    than 1 Year**
                
                
                **1
                    - 3 Years**
                
                
                **3
                    - 5 Years**
                
                
                **More
                    than 5 Years**Long-term
                    debt obligations (1)
                
                $
                368,771
                
                
                $
                50,060
                
                
                $
                45,631
                
                
                $
                273,080
                
                
                $
                -Capital
                    lease obligations
                
                
                38
                
                
                
                38
                
                
                
                -
                
                
                
                -
                
                
                
                -Operating
                    lease obligations
                
                
                24,458
                
                
                
                8,097
                
                
                
                10,333
                
                
                
                3,222
                
                
                
                2,806Other
                    long-term obligations
                
                
                4,557
                
                
                
                743
                
                
                
                2,709
                
                
                
                1,105
                
                
                
                -$
                397,824
                
                
                $
                58,938
                
                
                $
                58,673
                
                
                $
                277,407
                
                
                $
                2,806
 (1)
              Includes
                  projected interest payments.
 
 20
  Principal
        and interest payments of $825,000 and $5.4 million, respectively, under the
        Credit Facilities are payable in the remaining three months of
        2007.  Capital expenditures of approximately $14.0 million, including
        capital expenditures made in the first nine months, are estimated in 2007
        as we
        continue to enhance our computer information systems.
 
 As
        of
        September 30, 2007, we did not have any significant off-balance sheet
        arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K, except
        for
        our indemnification obligations related to potential breaches of the
        representations and warranties contained in the definitive agreement to sell
        Dia
        Real, which obligations are capped at $9.9 million.
 
 
 ***Other
        Factors Affecting Liquidity***
 In
        connection with our acquisition of Miavita LLC, we will be required to pay
        additional earn-out consideration in future periods, based upon specified
        revenues pertaining to certain customer agreements.  In accordance
        with SFAS No. 141, *Business Combinations*, we accrue contingent
        consideration obligations upon attainment of the objectives. Additionally,
        any
        such payments would result in increases in goodwill.
 
 
 ***Uncertainties***
  We
        are subject to various legal claims
        and actions incidental to our business and the businesses of our predecessors,
        including product liability claims and professional liability
        claims.  We maintain insurance, including insurance covering
        professional and product liability claims, with customary deductible
        amounts.  There can be no assurance, however, that (i) lawsuits will
        not be filed against us in the future, (ii) our prior experience with respect
        to
        the disposition of litigation is representative of the results that will
        occur
        in pending or future cases or (iii) adequate insurance coverage will be
        available at acceptable prices, if at all, for incidents arising or claims
        made
        in the future.  There are no pending legal or governmental proceedings
        to which we are a party that we believe would, if adversely resolved, have
        a
        material adverse effect on our financial position or results of operations.
        For
        a discussion of other risks and uncertainties that may affect our business,
        see
“Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended
        December 31, 2006.
 
  **Critical
        Accounting Policies and Estimates**
  Critical
        accounting policies are those
        policies that require management to make the most challenging, subjective
        or
        complex judgments, often because they must estimate the effect of matters
        that
        are inherently uncertain and may change in subsequent
        periods.  Critical accounting policies involve judgments and
        uncertainties that are sufficiently sensitive to result in materially different
        results under different assumptions and conditions. We believe our most critical
        accounting policies are described below:
 
 ***Revenue
        Recognition and Allowances for Uncollectible
        Accounts.***  Our services are provided telephonically and
        through home-based nursing services through care centers located throughout
        the
        United States. In addition, our services are provided through access to our
        online health and wellness based tools. Revenues are recognized as the related
        services are rendered and are net of contractual allowances and related
        discounts.
 
 Our
        services are paid for primarily on the basis of (i) monthly fees for each
        employee or member enrolled in a health plan, (ii) each member identified
        with a
        particular chronic disease or condition under contract, (iii) each member
        enrolled in our programs, (iv) fee-for-service, or (v) a fixed rate per
        case.  Billings for certain services occur in advance of services
        being performed.  Such amounts are recorded as Unearned
 21
 
  revenues
          in the consolidated condensed balance sheets. Such amounts are subsequently
          recognized as revenue as services are performed.
 
 Some
        contracts provide that a portion of our fees are at-risk (i.e., refundable)
        if
        our programs do not achieve certain financial cost savings and clinical
        performance criteria. Revenues subject to refund are not recognized if (i)
        sufficient information is not available to calculate performance measurements,
        or (ii) interim performance measurements indicate that we are not meeting
        performance targets.  If either of these two conditions exists, we
        record the amounts as Unearned revenues in the consolidated condensed balance
        sheets.  If we do not meet performance targets by the end of the
        operations period under the contract, we are contractually obligated to refund
        some or all of the at-risk fees. Historically, such adjustments have been
        immaterial to our financial condition and results of operations.
 
 A
        significant portion of our revenues is billed to third-party reimbursement
        sources.  Therefore, the collectibility of all of our accounts
        receivable varies based on payor mix, general economic conditions and other
        factors. A provision for doubtful accounts is made for revenues estimated
        to be
        uncollectible and is adjusted periodically based upon our evaluation of current
        industry conditions, historical collection experience, recoveries of amounts
        previously provided, industry reimbursement trends and other relevant factors
        which, in the opinion of management, deserve recognition in estimating the
        allowance for uncollectible accounts.  The evaluation is performed at
        each reporting period for each operating unit with an overall assessment
        at the
        consolidated level.  The evaluation of the monthly estimates of
        revenues estimated to be uncollectible has not resulted in material adjustments
        in any recent period; however, special charges have resulted from certain
        specific circumstances affecting collectibility.  While estimates and
        judgments are involved and factors impacting collectibility may change,
        management believes adequate provision has been made for any adjustments
        that
        may result from final determination of amounts to be collected.
 
 ***Goodwill
        and Identifiable Intangible
        Assets*****.**  Goodwill represents the excess
        of cost over fair value of net assets acquired.  Goodwill arising from
        business combinations is accounted for under the provisions of SFAS No. 141,
        *Business Combinations*, and SFAS No. 142, *Goodwill and Other
        Intangible Assets*, and is not amortized. Our identifiable intangible assets
        are amortized over their respective estimated useful lives. As of September
        30,
        2007, we reported goodwill and identifiable intangible assets at net carrying
        amounts of $495.5 million and $50.5 million, respectively. The total of $546.0
        million represents approximately 79% of our total assets as of September
        30,
        2007.
 
 We
        review
        goodwill and identifiable intangibles for impairment annually as of December
        31
        and whenever events or changes in circumstances indicate that the carrying
        value
        may not be recoverable. In testing for impairment, we compare the book value
        of
        net assets to the fair value of the related reporting units that have goodwill
        and indefinite life intangibles assigned to them.  If the fair value
        is determined to be less than book value, a second step is performed to compute
        the amount of impairment.  We estimate the fair values of the
        reporting units based upon earnings multiples for similar precedent transactions
        as well as the present value of estimated future free cash flows. The approach
        utilized is dependent on a number of factors, including estimates of future
        revenues and operating costs, appropriate discount rates and other
        variables.  We base our estimates on assumptions that we believe to be
        reasonable, but which are unpredictable and inherently
        uncertain.  Therefore, future impairments could result if actual
        results differ from those estimates.  Based on our evaluation, we
        concluded that no impairment of recorded goodwill and intangibles existed
        at
        December 31, 2006.
 
 ***Accounting
        for Income
        Taxes.***  We account for income taxes using an asset and
        liability approach.  Deferred income taxes are recognized for the tax
        consequences of “temporary differences” by applying enacted statutory tax rates
        applicable to future years to differences between the financial statement
        carrying amounts and the tax bases of existing assets and liabilities and
        net
        operating loss and tax credit carryforwards.
 22
  Additionally,
        the effect on deferred taxes of a change in tax rates is recognized in earnings
        in the period that includes the enactment date.
 
 The
        income tax expense for continuing operations was $10.8 million and $9.2 million
        for the nine-month periods ended September 30, 2007 and 2006,
        respectively.  Reflected in each period were various non-deductible
        permanent differences between tax and financial reporting.  As of
        December 31, 2006, our remaining net operating loss carryforwards of $67.0
        million, the tax effect of which is reflected as an asset on the balance
        sheet
        in Deferred income taxes, will be available to offset future taxable income
        liabilities.  Based on projections of taxable income in 2007 and
        future years, we believe that it is more likely than not that we will fully
        realize the value of the recorded deferred income tax assets.  The
        amount of the deferred tax asset considered realizable, however, could be
        reduced if estimates of future taxable income during the carryforward period
        are
        reduced.  We expect to use approximately $21.7 million of our net
        operating loss carryforwards in 2007.
 
 We
        account for our income tax uncertainties in accordance with the provisions
        of
        FASB Interpretation No. 48, *Accounting for Uncertainty in Income Taxes, an
        interpretation of FASB Statement No. 109* (“FIN 48”), which we adopted on
        January 1, 2007.  See “Recently Issued and Recently Adopted Accounting
        Standards” below and Note 2 and Note 5 of our Notes to Consolidated Condensed
        Financial Statements.
 
 ***Share-Based
        Compensation.***   On January 1, 2006, we adopted
        Statement of Financial Accounting Standards No. 123 (revised 2004),
*Share-Based Payment* (“SFAS 123(R)”).  SFAS 123(R) establishes
        standards for the accounting for share-based payment transactions in which
        an
        enterprise receives employee services in exchange for either equity instruments
        of the enterprise or liabilities that are based on the fair value of the
        enterprise’s equity instruments or that may be settled by the issuance of such
        equity instruments. SFAS 123(R) eliminates the ability to account for
        share-based compensation transactions, as we formerly did, using the intrinsic
        value method as prescribed by Accounting Principles Board, (“APB”), Opinion No.
        25, Accounting for Stock Issued to Employees, and generally requires that
        such
        transactions be accounted for using a fair-value-based method. Changes in
        assumptions as to the employee forfeitures assumptions, expected stock option
        exercise terms and volatility could have a significant impact on the stock
        compensation fair value determinations. Additionally, our restricted stock
        awards are performance-based and service-based.  Expense for
        restricted stock awards is recognized using the tranche method
        (performance-based awards) or the straight line method (service-based awards)
        over the vesting period. The remaining unrecognized compensation costs for
        the
        performance-based restricted stock awards may vary each reporting period
        based
        on changes in the expected achievement of performance measures.
 
 The
        above
        listing is not intended to be a comprehensive list of all of our accounting
        policies.  In many cases, the accounting treatment of a particular
        transaction is specifically dictated by accounting principles generally accepted
        in the United States, with no need for management’s judgment in their
        application.  There are also areas in which management’s judgment in
        selecting any available alternative would not produce a materially different
        result.  See the Notes to Consolidated Financial Statements in our
        Annual Report on Form 10-K for the year ended December 31, 2006, which contain
        additional accounting policies and other disclosures required by accounting
        principles generally accepted in the United States.
 
 Our
        senior management has discussed the development and selection of our critical
        accounting estimates, and this disclosure, with the Audit Committee of our
        Board
        of Directors.
 
 
 **Recently
        Issued and Recently Adopted Accounting Standards**
  ***Accounting
        for Uncertainty in Income Taxes.***We adopted the provisions of FIN
        48 on January 1, 2007.  FIN 48 prescribes a recognition threshold and
        measurement attribute for the financial statement recognition and measurement
        of
        a tax position taken or expected to be taken in a tax return.  FIN 48
        also
 23
 
  provides
          guidance on derecognition, classification, interest and penalties, accounting
          in
          interim periods, disclosure and transition. We undertook a comprehensive
          review
          of our tax positions, and the cumulative effect of adopting the provisions
          of
          FIN 48 to all tax positions resulted in a cumulative effect adjustment
          to
          Accumulated deficit of $669,000. As of the date of adoption, the total
          amount of
          unrecognized tax benefits was $524,000, and interest and penalties were
          $145,000.
  ***Fair Value Option*****.**  In February 2007,
        the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159,
*The Fair Value Option for Financial Assets and Financial Liabilities
–
Including an Amendment of FASB Statement No. 115* (“SFAS 159”), which
        permits entities to choose to measure many financial instruments and certain
        other items at fair value. Entities that elect the fair value option will
        report
        unrealized gains and losses in earnings at each subsequent reporting
        date.  The fair value option may be elected on an
        instrument-by-instrument basis with a few exceptions.  SFAS 159 also
        establishes presentation and disclosure requirements to facilitate comparisons
        between companies that choose different measurement attributes for similar
        assets and liabilities.  The requirements SFAS 159 are effective for
        our fiscal year beginning January 1, 2008.  We are currently assessing
        the potential impact of implementing this standard.  However, we do
        not expect the implementation to have a material adverse effect on our results
        of operations or financial position.
 
 Our
        Annual Report on Form 10-K for the year ended December 31, 2006, as filed
        with
        the Commission, also contains a discussion of recently issued accounting
        standards and the expected impact on our financial statements.
 
 
 **Forward-Looking
        Information**
  This
        Form
        10-Q, including the information incorporated by reference herein, contains
        various forward-looking statements and information that are based on our
        beliefs
        and assumptions, as well as information currently available to
        us.  From time to time, the Company and its officers, directors or
        employees may make other oral or written statements (including statements
        in
        press releases or other announcements) that contain forward-looking statements
        and information.  Without limiting the generality of the foregoing,
        the words “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,”
“seek” and similar expressions, when used in this Form 10-Q and in such other
        statements, are intended to identify forward-looking statements, although
        some
        statements may use other phrasing.  All statements that express
        expectations and projections with respect to future matters, including, without
        limitation, statements relating to growth, new lines of business and general
        optimism about future operating results, are forward-looking
        statements.  All forward-looking statements and information in this
        Quarterly Report are forward-looking statements within the meaning of Section
        27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange
        Act, as amended, and are intended to be covered by the safe harbors created
        thereby.  Such forward-looking statements are not guarantees of future
        performance and are subject to risks, uncertainties and other factors that
        may
        cause the actual results, performance or achievements of the Company to differ
        materially from historical results or from any results expressed or implied
        by
        such forward-looking statements.  Such factors include, without
        limitation:
 (i)
              Changes
                  in reimbursement rates, policies or payment practices by third-party
                  payors, whether initiated by the payor or legislatively mandated,
                  or
                  uncollectible accounts in excess of current
                  estimates;
 (ii)
              The
                  loss of major payors or customers;
 (iii)
              Impairment
                  of the Company’s rights in intellectual
                  property;
 (iv)
              Increased
                  or more effective competition;
 (v)
              New
                  technologies that render obsolete or non-competitive products and
                  services
                  offered by the Company;
 (vi)
              Changes
                  in or new interpretations of laws or regulations applicable to
                  the
                  Company, its customers or referral sources or failure to comply
                  with
                  existing laws and regulations;
 24
  (vii)
              Increased
                  exposure to professional negligence
                  liability;
 (viii)
              Difficulties
                  in successfully integrating recently acquired businesses into the
                  Company’s operations and uncertainties related to the future performance
                  of such businesses;
 (ix)
              Changes
                  in company-wide or business unit
                  strategies;
 (x)
              The
                  effectiveness of the Company’s advertising, marketing and promotional
                  programs;
 (xi)
              Market
                  acceptance of the Company’s wellness and disease and condition management
                  programs and the Company’s ability to sign and implement new wellness and
                  disease and condition management
                  contracts;
 (xii)
              Inability
                  to successfully manage the Company’s
                  growth;
 (xiii)
              Acquisitions
                  that strain the Company’s financial and operational
                  resources;
 (xiv)
              Inability
                  to forecast accurately or effect cost savings and clinical outcomes
                  improvements or penalties for failure to meet the clinical or cost
                  savings
                  performance criteria under the Company’s disease management contracts or
                  inability to reach agreement with the Company’s disease management
                  customers with respect to the same;
 (xv)
              Inability
                  of the Company’s disease management customers to provide timely and
                  accurate data that is essential to the operation and measurement
                  of the
                  Company’s performance under its disease management
                  contracts;
 (xvi)
              Increases
                  in interest rates;
 (xvii)
              Changes
                  in the number of covered lives enrolled in the health plans with
                  which the
                  Company has agreements for payment;
 (xviii)
              The
                  availability of adequate financing and cash flows to fund the Company’s
                  capital and other anticipated
                  expenditures;
 (xix)
              Higher
                  than anticipated costs of doing business that cannot be passed
                  on to
                  customers;
 (xx)
              Pricing
                  pressures;
 (xxi)
              Information
                  technology failures or obsolescence or the inability to effectively
                  integrate new technologies;
 (xxii)
              The
                  outcome of legal proceedings or investigations involving the Company,
                  and
                  the adequacy of insurance coverage in the event of an adverse
                  judgment;
 (xxiii)
              Competition
                  for staff;
 (xxiv)
              Changes
                  in estimated payments of earn-out consideration;
                  and
 (xxv)
              The
                  risk factors discussed from time to time in the Company’s SEC reports,
                  including but not limited to, the Company’s Annual Report on Form 10-K for
                  the year ended December 31, 2006.
 
 These
        factors are not intended to be an all-encompassing list of risks and
        uncertainties that may affect the operations, performance, development and
        results of our business.  Many of such factors are beyond the
        Company’s ability to control or predict, and readers are cautioned not to put
        undue reliance on such forward-looking statements.  In providing
        forward-looking statements, the Company expressly disclaims any obligation
        to
        update these statements publicly or otherwise, whether as a result of new
        information, future events or otherwise, except as may be required by
        law.
 
  25
  
 **Item
        3.  Quantitative and Qualitative Disclosures About Market
        Risk**
  We
        are
        exposed to market risk from changes in interest rates on long-term
        debt.
 
 Our
        primary interest rate risk relates to the Credit Facilities and our interest
        rate swap facilities.  In February 2006 and May 2006, we entered into
        interest rate swap agreements with notional amounts totaling $200.0 million
        with
        a bank under which we pay the bank fixed base rates of interest of 5.065%
        and
        5.350%, respectively, and the bank pays us floating rates based on three-month
        LIBOR (5.495% and 5.198%, respectively, at September 30, 2007).  The
        agreements, which have a two-year term, have the economic effect of converting
        a
        portion of our floating rate debt to fixed rate debt.  Based upon the
        total amount outstanding at September 30, 2007, not covered by interest rate
        swaps, a hypothetical two percentage point increase in the interest rates
        for a
        duration of one year would result in additional interest expense of
        approximately $1.9 million.
 
 
  **Item
        4.  Controls and Procedures**
  **(a)  Evaluation
        of Disclosure Controls and Procedures**
   Our
        Chief Executive
        Officer and our Chief Financial Officer have evaluated the effectiveness
        of the
        design and operation of our disclosure controls and procedures (as such term
        is
        defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
        of
        1934, as amended (the “Exchange Act”)) as of September 30, 2007.  No
        process, no matter how well designed and operated, can provide absolute
        assurance that the objectives of the process are met in all
        cases.  However, our disclosure controls and procedures are designed
        to provide reasonable assurance that the certifying officers will be alerted
        on
        a timely basis to material information relating to the Company, including
        the
        Company’s consolidated subsidiaries, required to be included in our reports
        filed or submitted under the Exchange Act.
  Based
        on
        such evaluation, such officers have concluded that our disclosure controls
        and
        procedures were effective as of September 30, 2007, to provide reasonable
        assurance that the objectives of the disclosure controls and procedures were
        met.
  
  **(b)  Changes
        in Internal Control Over Financial Reporting**
  During
        the three months ended September 30, 2007, there were no significant changes
        in
        the Company’s internal control over financial reporting that have materially
        affected, or are reasonably likely to materially affect, the Company’s internal
        control over financial reporting.
 
 
  26
  **PART
        II3⁄4OTHER
        INFORMATION**
 
 **Item
        1.                      Legal
        Proceedings**
 
 As
        noted
        in our Form 10-K for the fiscal year ended December 31, 2006, pursuant to
        the
        merger agreement pursuant to which we acquired CorSolutions, we pursued a
        claim
        before a contractually-designated settlement accountant for certain post-closing
        adjustments, including a $4.0 million claim relating to a liability resulting
        from CorSolutions’ pre-closing performance under a customer
        contract.  The existence of the $4.0 million liability had not been
        disclosed by the sellers.  On September 20, 2007, the settlement
        accountant awarded us $3.9 million related to the undisclosed liability
        described above.  That award was offset by $1.3 million related to
        certain payroll taxes arising from the deemed exercise of options by employees
        of the sellers who subsequently became employees of the Company, resulting
        in a
        net award of $2.6 million.  These amounts when included in the
        post-closing adjustment mechanism pursuant to the merger agreement resulted
        in
        the Company receiving $1.8 million, which included $199,000 of
        interest.
 
 
 **Item
        1A.  Risk Factors**
 
 As
        of the date of the report, there
        have been no material changes to the risk factors included in Item 1A to
        our
        Annual Report on Form 10-K for the year ended December 31, 2006.
 
 
 **Item
                  6.  Exhibits****Exhibit**
                **Number                               Description**3.1
              Amended
                  Bylaws of Matria Healthcare, Inc. (incorporated by reference to
                  Exhibit
                  3.1 to the Company’s Current Report on Form 8-K dated July 24,
                  2007)10.1
              Matria
                  Healthcare, Inc. Board of Directors Corporate Governance and Nominating
                  Committee Charter, as amended July 24, 2007.31.1
              Rule
                  13a-14(a)/15d-14(a) Certification by Parker H. Petit31.2
              Rule
                  13a-14(a)/15d-14(a) Certification by Jeffrey L. Hinton32.1
              Section
                  1350 Certification by Parker H. Petit32.2
              Section
                  1350 Certification by Jeffrey L. Hinton
  27
  **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 thereunto
        duly authorized.
 
 
 MATRIA
        HEALTHCARE, INC.
 
 November
                  7, 2007
              By:  /s/  Parker
                  H. PetitParker
                  H. PetitChairman
                  of the Board andChief
                  Executive Officer
 
 
 /s/  Jeffrey
                  L. HintonJeffrey
                  L. HintonSenior
                  Vice President andChief
                  Financial Officer
 
 
  28