Receivables? What Receivables? Oh -- Those Receivables!

Shared Medical Systems (SMS) is one of the biggest companies in the business of supplying computer systems to healthcare companies for managing information. But some analysts think the information the company supplies about itself could be improved -- particularly when you look at its receivables.

The Malvern, Pa.-based company, which supplies software used to track a wide range of healthcare operations -- everything from a hospital's finances to those of a pharmacy or radiology lab -- has drawn the attention of short-sellers, accounting watchdogs and analysts, including the Center for Financial Research and Analysis and Off Wall Street Consulting.

The issue for Shared Medical is that while its sales are certainly growing, the total amounts due as accounts receivable are growing even faster, often a sign of deteriorating financial health. SMS also extends credit to customers for major purchases of its software and systems, an unusual practice in the health-care information industry.

In particular, some analysts criticize the way SMS accounts for these credit sales: They say Shared Medical reveals a key statistic only once a year, depriving investors of the ability to track the company's progress in collecting these amounts due on a timely basis.

"I do think there's some merit to the accounting issues at the company," says Stephen DeNelsky, vice president at ING Baring Furman Selz. "In Shared Medical's case, the accounting is telling a story that the overall business is not as strong as they'd like to believe it is." DeNelsky, whose firm does not have an underwriting relationship with SMS, rates the stock a hold.

Growth in receivables, particularly the kind of long-term receivables found on SMS' balance sheet, can serve as a warning sign to investors. It may mean that a company is aggressive in recognizing revenue before it collects cash. It may mean that demand for its products is slowing, thus requiring more favorable terms in order to maintain its pace of sales. Or it may mean that SMS is completing the installations of its software and services at a slower rate than intended.

As DeNelsky says, "You might not know the answer, but it's certainly not a positive sign." The company's spokesman didn't respond to repeated requests for an interview.

In an April report, and in a follow-up note released last month, CFRA took SMS to task for two issues related to its receivables. SMS classified the money it is owed through its long-term credit arrangements with customers as one of its "other assets" on its balance sheet, CFRA complained. But SMS disclosed the exact amount only once a year.

Additionally, CFRA said that in its accounts-receivable figures, SMS didn't distinguish between billed and unbilled receivables -- those the company has recognized as revenue, but for which customers haven't been billed. As with the long-term financing, SMS disclosed the unbilled receivables figure only once a year.

The problem with this practice, CFRA reported, is that by failing to fully disclose information on receivables, Shared Medical "creates an impediment in recognizing a possible deterioration in SMS' business." The solution, CFRA said, was for the company to disclose those balances quarterly.

Those figures can be extremely useful to investors. In its April report, for example, CFRA compares SMS' results for the fourth quarter of 1997 with the fourth quarter of 1996. Over that period, revenue rose 11.5%. But at the same time, unbilled receivables jumped 26% and long-term receivables rocketed 78% higher. Based on the buildup in both long-term and unbilled receivables, "CFRA believes that SMS may be recognizing revenue in an increasingly aggressive manner," CFRA states. (Italics in the original.)

More recently, in its note covering SMS' earnings for the second quarter of 1998, CFRA noted that system and services fees, the core of SMS' revenue, rose only 3% from the first quarter, while accounts receivable remained flat. But long-term financing receivables jumped 18%. CFRA found the weak revenue growth "particularly disturbing" in light of the jump in long-term financing receivables.

CFRA isn't the only company looking closely at those receivables.

DeNelsky calculated a different figure for days' sales outstanding in accounts receivable than one would surmise from looking at the company's unadjusted revenue figures. DSO, or accounts receivable divided by average daily sales rate, is a yardstick of the credit that a company extends to its customers and of how quickly customers pay.

Looking only at accounts receivable, DSOs increased 5.3% from the second quarter of 1997 to the second quarter of 1998, according to DeNelsky's calculations. But adding back the money owed the company that's classified as long-term financing, DSOs have jumped more than 15%, he says.

Slicing the DSO numbers a different way, DeNelsky calculates that at the close of Shared Medical's most recent quarter, days' sales outstanding amount to 99 if you look only at the accounts-receivable figure that SMS itemizes. But if you take into account long-term financing arrangements, DSOs jump to 128, DeNelsky says.

Since average DSOs in the healthcare information services industry range from 110 to 120, the new data takes SMS from slightly better than the industry average to a bit worse. "It certainly should be reflected in anyone's valuation," he said.

Since CFRA's April report, Shared Medical has become a little more forthcoming, but not much. Analysts learned in a conference call covering second-quarter results that long-term receivables had grown $11 million from the end of the first quarter. Shared Medical didn't report that information in its 10-Q, though, so investors with no access to analysts' reports may never get that information.

One sell-side analyst who is bullish on the company acknowledges that Shared Medical could improve its financial disclosure. "The company has done what I would call a spotty job in dealing with those issues," said Richard Jacobs, technology analyst at Janney Montgomery Scott. "In the second-quarter conference call, they weren't prepared. All you have to do is look at the chart."

But, he said, "They've satisfied me that they understand the issues." Jacobs, whose firm doesn't have an underwriting relationship with SMS, rates it a buy and says the stock can rise to 80. Shared Medical closed Wednesday at 55 7/8.

Another analyst who discounts receivables problems is Dave Francis, a managing director at Volpe Brown Whelan. "As an issue, it's been overdone," said Francis, who has a buy on SMS and a price target above 100. "They're still getting paid. . . We don't see any major risk of a write-off or anything like that." Volpe Brown Whelan hasn't done underwriting for SMS.

DeNelsky points out Shared Medical's strengths, too. "They're a leader," he said. "They're probably the best systems integrators of any company. They also have a loyal customer base." But he said the degree customers will accept the company's new product, called Novius, is still unclear.

Soothing some of investor concerns about receivables, Shared Medical is apparently getting out of the business of long-term financing. SMS told analysts recently that it had reached an agreement under which IBM Credit will supply customer financing.

That was an uncommon sideline for a healthcare information services company, according to DeNelsky, who said the only other company in the field he knows of that finances customer purchases is Imnet Systems (IMNT). (The Georgia-based healthcare document-management company has a definitive agreement to be acquired by industry leader HBO & Co. (HBOC).)

DeNelsky is hopeful that outsourcing the financing function will go a long way toward easing investors' concerns about receivables. "It should [go away] as long as they offsource this to IBM Credit," DeNelsky said.

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