FACTORING: ‘Margin for error is small’

Tuesday, December 31, 2002

CHICAGO - The recent Chapter 11 bankruptcy of National Century Financial Enterprises and subsequent filings by several of its clients has spawned discussion in HME circles about whether the reward is worth the risk with a financial strategy called factoring.

In Dublin, Ohio-based NCFE’s case, the consequences to providers look severe, with Andover, Mass.-based Med Diversified filing for Chapter 11 bankruptcy along with its home health subsidiary, Tender Loving Care Health Services of Lake Success, N.Y. Other casualties include Durham, N.C.-based PhyAmerica Physician Group and Doctors Community Healthcare Corp., Scottsdale, Ariz.

At press time in early December, NCFE founder Lance K. Paulsen had resigned as chief executive officer and the firm reportedly put its corporate headquarters up for sale in order to satisfy creditors. In the week following NCFE’s mid-November bankruptcy filing, the scope of a federal investigation into the firm’s financial practices broadened to include the FBI, the U.S. Department of Health and Human Services, the U.S. Securities and Exchange Commission and the U.S. Attorney’s Office in Louisville, Kentucky.

“It’s a problem that will continue to pop up,” said an industry source who specializes in healthcare financial issues. “A lot of companies are doing [factoring] and it amounts to issuing junk bonds. The ripple effect from this will be much bigger than it shows right now.”

Factoring – which has the reputation of being a last-ditch option for providers needing cash flow assistance – is where providers sell their accounts receivable in exchange for a cash advance. Typically, the factoring company will pay the provider between 75% and 90% of the A/R collectible value.

Doug Crana, president of Consolidated Medical, a Newburgh, New York-based HME provider, said it seemed like a fair exchange when he began using a factoring company’s services in early 1999. But over the better part of that year, Crana noticed that the cash-flow improvement system wasn’t easing the pinch.

“It looked good at first, but ultimately it didn’t work out,” he said. “Even though we were getting cash on a monthly basis, we were still behind and couldn’t catch up.”

Crana determined that his company could work out its cash flow problems internally by exerting more discipline and “becoming more proactive” with its A/R. “It has worked out pretty well so far,” he said.

NCFE’s difficulties appear to be related to its cash reserves, specifically whether it can cover $3.35 billion in bonds it issued to investors. And although he has no official confirmation, HME accounting expert Wallace Weeks believes a reserve deficit is at the heart of the problem.

Reserves are supposed to come from the difference between the A/R purchase price and the amount of receivables collected, said Weeks, president of The Weeks Group, Melbourne, Fla. For example, if a factoring company buys $4 billion in A/R and advances 80% to its clients, the $800 million difference is supposed to be placed in reserve release, he said.

“In all likelihood, there are more than one month’s worth of reserves that can’t be released,” he said. “It has probably built up over time.”

VGM Leasing President Jim Phillips speculated that if NCFE did mismanage the back end of its finances, “lenders are probably going to turn up the microscope a notch – not good for an industry on the brink of competitive bidding.”

Phillips said the Waterloo, Iowa-based provider organization once considered offering factoring services, but ultimately decided against it.

“The dollars get so big and you need too many efficiencies,” he said. “The margin of error is very small.”

Despite the potential pitfalls, Weeks says, factoring companies can offer advantages to small businesses.

“They have served the agriculture and textile industries for years,” he said. “They serve a good purpose.” HME