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Healthways Inc. (HWAY - Analyst Report) reported second-quarter 2013 loss per share of 3 cents, narrower than the Zacks Consensus Estimate and the company’s expectations of a loss of 5 cents per share. However, the result is worse than the year-ago earnings of 15 cents per share.

In the second quarter, net loss was $1.1 million versus net income of $5.1 million a year ago. The company’s results continue to reflect the loss of the Cigna Corp. (CI - Analyst Report) contract and one other contract.

Revenues

Revenues declined 4.7% year over year to $162.3 million in the quarter, trailing the Zacks Consensus Estimate of $171 million. However, upon exclusion of the two terminal contracts, revenues improved 11.7% from the prior-year quarter.
   
Margins

As gross profit dipped 29.6% to $28.8 million, gross margin contracted a massive 630 basis points (bps) year over year to 17.7% in the quarter. Selling, general and administrative expenses decreased 4.7% year over year to $14.3 million. Healthways witnessed operating margin contraction of 630 bps year over year to 8.9%.

Balance Sheet

Healthways ended the quarter with cash and cash equivalents of only $2.3 million compared with $1.8 million at the end of 2012. Long-term debt was almost $254 million compared with $278.5 million at the end of 2012.

Contract Activity

Healthways inked 25 new, expanded or extended contracts in the quarter. This count included 2 fresh contracts, 12 extended contracts and 11 expanded contracts. The company also renewed its contract with Australia’s largest not-for-profit health insurer Hospital Contributions Fund (HCF).

Outlook

The company affirmed its sales guidance for 2013. Healthways continues to expect sales in a band of $710-$750 million, reflecting growth of 5%-11% year over year. The current Zacks Consensus Estimate of $728 million lies within the outlook band.

The company expects higher revenues for 2013 despite a drop of $80 million on account of the termination of two contracts. Healthways forecasts higher sales in the second half of 2013 as fresh contracts inked in 2012 take off in the upcoming quarters.

However, the company tweaked its outlook for bottom line to reflect the effect of its cash convertible senior notes due 2018. Healthways expect earnings per share of about 18-28 cents compared with prior outlook of 25-35 cents for 2013. The current Zacks Consensus Estimate of 29 cents is pegged higher than the revised guidance.

Strategic Developments

Healthways disclosed an exclusive strategic partnership with Beacon Health System to strengthen its market position. The company’s collaboration with Beacon will assess market opportunities to deliver scalable solutions to improve population health and well-being.

On the other hand, Healthways revealed an exclusive partnership with Dr. Dean Ornish to operate and license the suite of Ornish Lifestyle Management Programs. The program is well-aligned with the company’s goal to help individuals cut down on health-related risk factors by encouraging them to change lifestyle behaviors that lead to chronic conditions. Notably, Dr. Ornish’s Program for Reversing Heart Disease is covered by Medicare as a branded program under a new benefit category.

Our Take

Although Healthways witnessed lower revenues and significant margin contraction in the quarter, we derive comfort from the better-than-the stated Zacks Consensus Estimate bottom line. While the company posted loss and reduced its earnings expectation for 2013, we are encouraged by management commentary to turn to profit in the third quarter.

Moreover, brisk contract activity was another material upside for Healthways. We believe that fresh contracts may enable the company to gradually get over the termination of the two contracts. We look forward to the new strategic alliances that should boost top line in the upcoming quarters.

Healthways has significant opportunities for growth in three key areas:  the commercial, Medicare, and international markets. Due to its unique scalable business model, the stock presents a compelling investment opportunity.

Healthways currently carries a Zacks Rank #1 (Strong Buy). Other Zacks Rank #1 stocks like WellPoint Inc. (WLP - Analyst Report) and MedAssets Inc. (MDAS - Snapshot Report) also appear impressive.

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