We rate Healthways ( HWAY) a HOLD. Our rating is supported by the company's top-line growth and higher earnings countered by its weak cash and liquidity position. Although the margins and returns are improving, rising expenses along with mounting debt may negatively impact the company's performance in the upcoming quarters.

HIGHLIGHTS

-- Top-line growth. Healthways Inc.'s Q1 FY09 revenue grew 5.5% to $185.40 million from $175.82 million in the prior year's quarter due to contributions from the commencement of new contracts, increase in the recognition of performance-based fees and growth in the number of self-insured employers on behalf of its health plan customers. Domestic commercial available lives and domestic commercial billed lives advanced 6.3% and 22.5%, respectively.

-- Higher earnings. During Q1 FY09, earnings increased on the back of higher revenue growth. Net income for the quarter swelled 12.5% to $12.58 million or $0.37 per share compared to $11.18 million or $0.30 per share in the prior year's quarter attributed to higher revenue.

-- Improving margins and returns. During the quarter, gross profit margin widened 103 basis points to 30.40% from 29.37% and operating margin increased 31 basis points to 14.15% from 13.84%. Moreover, return on assets and return on equity increased 123 basis points and 377 basis points to 6.37% and 15.33% respectively.

-- Weak cash and liquidity position. Healthways' cash and cash equivalents plunged 92.0% to $4.35 million from $54.53 million while net operating cash flow declined 15.0% to $21.65 million when compared to the same quarter last year. Moreover, the company has a quick ratio of 0.75 which shows its inability to meet short-term cash requirements.

-- Rising expenses and debt. The cost of services increased 3.9% to $129.05 million from $124.19 million while selling, general and administrative expenses edged up 6.5% to $17.95 million from $16.85 million. Furthermore, total debt for the quarter spiked 6.4% to $307.10 million from $288.72 million deteriorating the debt-to-equity ratio to 0.84 from 0.75.

FINANCIAL ANALYSIS

Healthways Inc.'s Q1 FY09 revenue grew 5.5% to $185.40 million from $175.82 million in the prior year's quarter due to contributions from the commencement of new contracts, increase in the recognition of performance-based fees and growth in the number of self-insured employers on behalf of its health plan customers. Geographically, international revenue totaled $3.80 million and domestic revenue totaled $181.60 million. Moreover, domestic commercial available lives increased 6.3% to 195.00 million from 183.40 million while domestic commercial billed lives advanced 22.5% to 32.70 million from 26.70 million in Q1 FY08 attributed to signing of new contracts, expansion or extension of contracts with health plans and employers. Furthermore, the annualized revenue in backlog stood at $31.90 million compared to $51.00 million a year ago.

During the quarter, gross profit margin widened 103 basis points to 30.40% from 29.37% a year ago despite a 3.9% increase in cost of services. Cost of services stood at $129.05 million compared to $124.19 million. Selling, general, and administrative expenses edged up 6.5% to $17.95 million from $16.85 million. Operating margin increased 31 basis points to 14.15% from 13.84%. Interest expenses declined 4.5% to $5.10 million from $5.34 million there by improving the interest coverage ratio to 5.15 from 4.55 a year ago. Finally, net income for the quarter swelled 12.5% to $12.58 million or $0.37 per share compared to $11.18 million or $0.30 per share in the prior year's quarter attributed to higher revenue.

Healthways' cash and cash equivalents plunged 92.0% to $4.35 million from $54.53 million. Net operating cash flow declined 15.0% to $21.65 million when compared to the same quarter last year. Return on assets increased 123 basis points to 6.37% from 5.14%. Similarly, return on equity advanced 377 basis points to 15.33% from 11.56% a year ago. Total debt for the quarter spiked 6.4% to $307.10 million from $288.72 million. Stockholders' equity declined 4.7% to $366.75 million from $384.66 million. Therefore, the debt-to-equity ratio deteriorated to 0.84 from 0.75. Moreover, the company has a quick ratio of 0.75 which shows its inability to meet short-term cash requirements.

During the quarter under review, Healthways signed a new agreement wit a Fortune 100 company to provide comprehensive Health and Care Support solution for more than 90,000 employees and dependents. Also, the company launched new senior solution for the Medicare Advantage population of a large Blue Cross Blue Shield Plan. The company also announced the appointment of Mr. Brueckner to serve as President and Chief Operating Officer.

Recently, the company signed a five-year agreement with the Hospitals Contribution Fund of Australia Limited (HCF) to offer comprehensive Health and Care Support solution.

Looking forward to FY09, the company expects run rate revenue to decline by approximately $90.00 million to $100.00 million over FY08 which would in turn lead to an increase in cost of services and/or selling, general and administrative expenses as a percentage of revenue. In addition, the company also anticipates higher legal expenses.

This article was written by a staff member of TheStreet.com Ratings.