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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended DECEMBER 31, 1996
or
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-11618
HPSC, INC.
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(Exact name of registrant as specified in its charter)
Delaware 04-2560004
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(State or other jurisdiction of (IRS Employer Identification No.
incorporation or organization) 04-2560004)
60 STATE STREET, BOSTON, MASSACHUSETTS 02109
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (617) 720-3600
Securities registered pursuant to section 12(b) of the Act:
NONE
Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK-PAR VALUE $.01 PER SHARE
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(Title of class)
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.
YES /X/ NO / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any other
amendment to this Form 10-K.
YES / / NO /X/
The aggregate market value of the voting stock held by non-affiliates of the
registrant was $21,645,217 at February 28, 1997, representing 3,533,913 shares.
The number of shares of common stock, par value $.01 per share, outstanding
as of February 28, 1997 was 4,657,930.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held May 13, 1997 (the "1997 Proxy Statement") are incorporated by
reference into Part III of this annual report on Form 10-K.
The 1997 Proxy Statement, except for the parts therein which have been
specifically incorporated by reference, shall not be deemed "filed" as part of
this report on Form 10-K.
PART I
ITEM 1. BUSINESS
GENERAL
The Company is a specialty finance company engaged primarily in financing
healthcare providers throughout the United States. To date, the largest part
of the Company's revenues has been derived from its financing of healthcare
equipment. HPSC also finances the purchase of healthcare practices,
particularly dental practices. The Company has over 20 years of experience as
a provider of financing to dental professionals in the United States. Through
its subsidiary, ACFC, the Company also provides asset-based lending to a
variety of businesses in the northeastern United States.
HPSC provides financing for equipment and other practice-related expenses
to the dental, ophthalmic, general medical, chiropractic and veterinary
professions. On a consolidated basis, approximately 60.0% of the Company's
business arises from equipment financing, approximately 30.0% from related
financing, including practice finance, leasehold improvements, office
furniture, working capital and supplies, and approximately 10% from
asset-based lending. HPSC principally competes in the portion of the
healthcare finance market where the size of the transaction is $250,000 or
less, sometimes referred to as the "small-ticket" market. The average size of
the Company's financing transactions in 1996 has been approximately $25,000.
In connection with its equipment financings, the Company enters into
noncancellable installment sales and lease contracts, substantially all of
which provide for a full payout at a fixed interest rate over a term of one
to seven years. The Company markets its financing services to healthcare
providers in a number of ways, including direct marketing through trade
shows, conventions and advertising, through its sales staff with 14 offices
in nine states and through cooperative arrangements with equipment vendors.
At December 31, 1996, HPSC's outstanding leases and notes receivable
owned and managed were approximately $190 million, consisting of
approximately 11,100 active contracts. HPSC's financing contract originations
in 1996 were approximately $86.9 million compared to approximately $60.9
million in 1995, an increase of 42.7%, which compared to financing contract
originations of approximately $28.4 million in 1994, an increase of 114.4%.
The following table summarizes HPSC's financing contract originations for
fiscal years 1994, 1995 and 1996 (excluding ACFC originations).
HPSC Originations by Market (1)
YEAR ENDED DECEMBER 31,
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1994 1995 1996
-------------------------- -------------------------- --------------------------
DOLLAR PERCENTAGE OF DOLLAR PERCENTAGE OF DOLLAR PERCENTAGE OF
MARKET AMOUNT ORIGINATIONS AMOUNT ORIGINATIONS AMOUNT ORIGINATIONS
- ---------------------------------------------- --------- --------------- --------- --------------- --------- ---------------
(DOLLARS IN THOUSANDS)
Dental........................................ $ 19,000 67.0% $ 28,900 47.0% $ 45,900 53.0%
Other Medical (2)............................. 9,400 33.0% 32,000 53.0% 41,000 47.0%
--------- ----- --------- ----- --------- -----
Total......................................... $ 28,400 100.0% $ 60,900 100.0% $ 86,900 100.0%
--------- ----- --------- ----- --------- -----
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(1) Items financed include equipment (through leases and notes), leasehold
improvements, working capital, supplies, as well as practice finance.
(2) Includes financing contracts for the ophthalmic, general medical,
chiropractic and veterinary professions.
ACFC, the Company's wholly-owned subsidiary, provides asset-based
financing, principally in the northeastern United States, for companies which
cannot readily obtain traditional bank financing. The ACFC loan portfolio
generally provides the Company with a greater spread over its borrowing costs
than the Company can achieve in its healthcare financing business. The
Company anticipates that it will expand its asset-based financing business.
The following table summarizes ACFC's line of credit originations for fiscal
1994, 1995 and 1996.
ACFC ORIGINATIONS
YEAR ENDED DECEMBER 31,
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1994 1995 1996
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(DOLLARS IN THOUSANDS)
Amount of Originated Lines of Credit.............................................. $ 5,000 $ 12,100 $ 17,600
Balance Outstanding (period end).................................................. $ 4,000 $ 12,000 $ 18,700
Number of Lines of Credit Originated.............................................. 2 8 14
The continuing increase in the Company's originations of financing
contracts and lines of credit resulted in a 36.1% increase in the Company's
revenues for fiscal year 1996, as compared with fiscal year 1995, and an
10.7% increase in the Company's revenues for fiscal year 1995 compared with
fiscal year 1994. This percentage increase in revenues is lower than the
percentage increase in originations because revenues consist of earned income
on leases and notes, which is a function of the amount of net investment in
leases and notes and the level of interest rates, and is recognized over the
life of the financing contract, while originations are recognized at the time
of origination.
BUSINESS STRATEGY
The Company's strategy is to expand its business and enhance its
profitability by (i) increasing its share of the dental equipment financing
market, the Company's traditional market, as well as by expanding its
activities in other healthcare markets; (ii) diversifying the Company's
revenue stream through its practice finance and asset-based lending
businesses; (iii) emphasizing service to vendors and customers; (iv)
increasing its direct sales and other marketing efforts; (v) maintaining and
increasing its access to low-cost capital and managing interest rate risks;
(vi) continuing to manage effectively its credit risks; and (vii)
capitalizing on information technology to increase productivity and enable
the Company to manage a higher volume of financing transactions. Important
components of the Company's strategy include:
- Increase Healthcare Equipment Financing. The Company's goal is to increase
its share of the dental equipment financing market, as well as to expand
its activities in other healthcare markets, such as the ophthalmic,
general medical, chiropractic and veterinary professions. The Company is
pursuing this goal by hiring sales personnel with experience in financing
for those professions, through direct sales calls and advertising and by
applying the Company's experience in the dental profession to other
medical professions. The Company has increased its share of the dental
equipment financing market in each year since 1993 and believes that it
can increase its market share in other targeted professions through its
sales and marketing efforts and high level of service. The Company
believes that it has benefited and will continue to benefit from
technological advances which stimulate the demand for new and upgraded
healthcare equipment. The Company also believes that regulatory trends in
the healthcare professions have resulted in greater demand for outpatient
services, which may result in greater need for medical outpatient
equipment and supporting office equipment, including office automation
equipment. The Company intends to pursue these potential opportunities for
new financing business. This Note offering will increase the Company's
capital base, thereby permitting the Company to increase its financing
activity.
- Diversify Revenue Stream. In addition to retaining and increasing its
share of the healthcare equipment financing market, the Company plans to
expand its presence in the practice finance and asset-based lending
markets. In 1996, practice finance transactions accounted for
approximately 13.0% of HPSC's financing contract originations. HPSC has
originated approximately 260 practice finance loans aggregating
approximately $24.6 million over the past three years. In addition to this
business being profitable on a stand-alone basis, management believes that
practice finance earns HPSC substantial goodwill among healthcare
providers. Asset-based lending through ACFC accounts for approximately 10%
of the Company's revenues on a consolidated basis. ACFC has entered into
24 asset-based lending transactions since its inception in 1994, totaling
approximately $34.7 million in lines of credit, and currently has
approximately $18.7 million of loans outstanding. The Company anticipates
that it will expand its asset-based financing business.
- Emphasize Service to Vendors and Customers. The Company believes that
healthcare providers seek financing through the Company in large part due
to the high level of service it provides to both customers and vendors,
including the Company's familiarity with the specialized needs of dental
and medical professionals, the speed and convenience of financing
equipment through the Company and the Company's established relationships
with equipment vendors. The Company competes with other providers of
financing services for the business of vendors by ensuring that vendors in
approved equipment financing transactions are paid promptly for the
equipment, usually within one day of delivery to the customer. The Company
intends to continue to provide equipment vendors with timely,
convenient and competitive financing for their equipment sales and with a
variety of other value-added services that promote both the vendors'
equipment sales and the selection of the Company to provide financing,
and thereby expects to continue to obtain referrals for additional
financing transactions. The Company also will continue to emphasize
customer service, which includes the flexibility to customize financing
arrangements to the needs of individual healthcare providers. In most
cases, the Company's sales representatives work directly with the vendors'
potential purchasers, providing them with the guidance necessary to
complete the equipment financing transaction. The Company believes that
such "consultative financing" has enhanced, and will continue to enhance,
customer satisfaction and loyalty.
- Increase Direct Sales and Other Marketing Efforts. The Company currently
has sales and marketing personnel located in 14 offices across the United
States. The Company intends to open additional sales offices and to
continue to hire sales staff with significant prior experience in the
healthcare financing business. In addition to promoting its financing
services through its sales and marketing personnel, the Company relies on
various equipment financing referral sources and relationships with
vendors and manufacturers of dental, medical and other equipment and
intends to further leverage these relationships. Management believes that
this marketing approach is more effective than isolated solicitations of
equipment purchasers. The Company also expects to continue to broaden its
customer base through national advertising in trade journals and
magazines, by participation in trade shows and through the broad
dissemination of literature describing the Company's financing programs.
- Reduce Borrowing Costs and Manage Interest Rate Risks. In order to reduce
its borrowing costs and manage interest rate risks, the Company seeks to
match-fund its financing contracts through a variety of funding sources.
Currently the Company has access to funding through the $95 million
Revolver and the $100 million Bravo asset securitization facility, as well
as its asset sales to, and loans from, a number of savings banks. The
Company completed the Funding I and Bravo asset securitizations to take
advantage of the significantly lower cost of funds available under these
facilities, as compared with the Company's bank borrowings, with which to
finance its contract originations. The Company's recently completed
amendment to its Bravo asset securitization facility permits it to sell up
to $30 million of financing assets under that program on a limited
recourse basis. The Company will continue to seek advantageous sources of
credit, possibly including additional securitizations and asset sales, if
appropriate.
- Manage Credit Risk. The Company employs comprehensive credit review
procedures. The credit background of each potential customer is checked
with one or more commercial credit reporting agencies, including TRW Inc.,
Equifax Inc., Trans Union Corporation and Dun & Bradstreet Corporation.
Appropriate professional organizations may be consulted regarding the
customer's professional status. In addition to a customer's credit
profile, information such as the equipment type and vendor may be
considered in some circumstances. The delinquency rate (based on
contractual balances more than 60 days past due) of the Company's
equipment financing contract portfolio has declined from 11.0% in fiscal
year 1994 to 4.2% at December 31, 1996. The Company believes that its
delinquency rate has declined because of (i) the Company's comprehensive
on-line credit evaluation procedure to screen financing applications, (ii)
the Company's improved collection procedures and (iii) growth in the
Company's portfolio of financing contracts. Management believes that the
Company's credit and loss experience compares favorably with other
"small-ticket" equipment finance companies. The Company will continue its
thorough credit application screening process and will seek to maintain
the decline in its delinquency rate.
- Capitalize on Information Technology. The Company has developed automated
information systems and telecommunications capabilities tailored to
support all areas within the organization. Systems support is provided for
accounting, taxes, credit, collections, operations, sales, sales support
and marketing. The Company has invested a significant amount of time and
capital in computer hardware and proprietary customized software and has
developed a substantial database of information that enables the Company
to better target its sales and marketing activities. The Company's Boston
headquarters is linked electronically with all of the Company's other
offices. Each salesperson's laptop computer can also connect to the Boston
office, permitting a salesperson to respond promptly to a customer's
financing request. This capability also permits the Company to control the
speed, accuracy and quality of the credit application process. The
Company's centralized data processing system provides timely support for
the marketing and service efforts of the Company's salespeople and for
equipment manufacturers and dealers. The Company's computerized systems
also provide management with accurate, up-to-date customer data which it
uses to strengthen the Company's internal controls and forecasting. The
Company believes that its system is among the most advanced in the
small-ticket equipment financing industry and can accommodate
significantly greater financing volume, giving the Company
a competitive advantage based on the speed of its contract processing,
control over credit risk and high level of service.
INDUSTRY OVERVIEW
The equipment financing industry in the United States includes a wide
variety of sources for financing the purchase and leasing of equipment, ranging
from specialty financing companies, which concentrate on a particular industry
or financing vehicle, to large banking institutions, which offer a full array of
financial services. According to the Equipment Leasing Association of America
("ELA") 1995 Annual Survey of Industry Activity & Business Operations, the total
financing volume in the United States for all types of equipment (including
medical) was estimated to be approximately $160 billion in 1995, of which
medical equipment, according to responses to the ELA survey, accounted for 3.1%
(or approximately $5.0 billion) of 1995 total annual financing volume.
The medical equipment finance industry includes two distinct markets
which are generally differentiated based on equipment price and type of
healthcare provider. The first market, in which the Company currently does
not compete, is financing of equipment priced at over $250,000, which is
typically sold to hospitals and other institutional purchasers. Because of
the size of the purchase, long sales cycle, and number of financing
alternatives generally available to these types of customers, their choice
among financing alternatives tends to be based primarily on cost of
financing. The second market, in which the Company competes, is the financing
of lower-priced or "small-ticket" equipment, where the price of the financed
equipment is generally $250,000 or less. Much of this equipment is sold to
individual practitioners or small group practices, including dentists,
ophthalmologists, physicians, chiropractors, veterinarians and other
healthcare providers. The Company focuses on the small-ticket market because
it is able to respond in a prompt and flexible manner to the needs of
individual customers. Management believes that purchasers in the small-ticket
healthcare equipment market often seek the value-added sales support and
general ease of conducting business which the Company offers.
The Company believes that healthcare providers are increasingly choosing to
purchase rather than lease, equipment because of (i) the availability of a tax
deduction of up to $17,500 of the purchase price in the first year of equipment
use, (ii) changes in healthcare reimbursement methodologies that reduce
incentives to lease equipment for relatively short periods of time and (iii) a
reduced difference in financing costs between equipment purchases and equipment
leases, due to generally lower interest rates. Consistent with industry trends,
installment sales agreements (notes) now comprise 60% of the financing contracts
originated by the Company.
Although the Company has focused its business in the past on equipment
finance, it has expanded more recently into practice finance. Practice finance
is a specialized segment of the finance industry, in which the Company's primary
competitors are banks. Practice finance is a relatively new business opportunity
for financing companies such as HPSC that has developed as the sale of
healthcare professional practices has increased. The primary sources of
healthcare practice financing are banks; not all financing companies provide
this service. Typically, HPSC has financed approximately 70% of the cost of the
practice being purchased, although buyers are increasingly choosing to finance
the entire purchase price. Management believes that HPSC is a leading provider
of dental practice financing, due in large part to its active advertising
program to the dental profession and direct solicitation of dental healthcare
providers.
HEALTHCARE PROVIDER FINANCING
TERMS AND CONDITIONS
The Company's business consists primarily of the origination of equipment
financing contracts pursuant to which the Company finances the acquisition by
healthcare providers of various types of equipment as well as leasehold
improvements, working capital and supplies. The contracts are either installment
sales agreements (notes) or lease agreements and are noncancellable. The
installment sales agreements are full payout contracts and provide for scheduled
payments sufficient, in the aggregate, to cover the Company's borrowing costs
and the costs of the underlying equipment, and to provide the Company with an
appropriate profit margin. The majority of contracts originated by the Company
(approximately 60%) are installment sales agreements. The balance of the
equipment financing contracts originated by the Company are leases. The Company
provides its leasing customers with an option to purchase the equipment at the
end of the lease for 10% of its original cost. Since 1991, approximately 99% of
lessees have exercised this option. The average cost of financings by HPSC in
1996 was approximately $26,000. In that period, HPSC entered into approximately
3,740 new financing contracts, an increase of approximately 33.6% from 1995.
All of the Company's equipment financing contracts require the customer to:
(i) maintain, service and operate the equipment in accordance with the
manufacturer's and government-mandated procedures; (ii) maintain property and
public liability insurance for the equipment; (iii) pay all taxes associated
with the equipment; and (iv) make all scheduled contract payments regardless of
the performance of the equipment. Substantially all of the Company's financing
contracts provide for principal and interest payments due monthly for the term
of the contract. In the event of default by a customer, the financing contract
provides that the Company has the rights afforded creditors under law, including
the right to repossess the underlying
equipment and in the case of legal proceedings arising from a default, to
recover damages and attorneys' fees. The Company's equipment financing
contracts generally provide for late fees and service charges to be applied
on payments which are overdue. In 1996, the Company billed approximately $1.1
million in late fees and service charges on late payments, compared to
approximately $700,000 in 1995. This increase was due to growth in the
Company's portfolio and to the completion of the Company's implementation of
a modified late fee and service charge program, rather than to increased
delinquencies.
Although the customer has the full benefit of the equipment manufacturers'
warranties with respect to the equipment it finances, the Company makes no
warranties to its customers as to the equipment. In addition, the financing
contract obligates the customer to continue to make contract payments regardless
of any defects in the equipment. Under an installment sale contract (note), the
customer holds title to the equipment and the Company has a lien on the
equipment to secure the loan; under a lease, the Company retains title to the
equipment. The Company has the right to assign any financing contract without
the consent of the customer.
A practice finance transaction typically takes the form of a loan to a
healthcare provider purchasing a practice, which is secured by the assets of the
practice being financed and may be secured by one or more personal guarantees or
personal assets. The average size of a practice finance transaction is
approximately $100,000, with a typical contract term of 60 to 72 months.
The length of the Company's lease agreements and notes due in installments
range from 12 to 84 months, with a median term of 60 months and an average
initial term of 55 months, and an average implicit interest rate, before the
yield adjustment for deferred origination costs, of 13.0% for 1996 originations
(excluding ACFC).
CUSTOMERS
The primary customers for the Company's financing contracts are healthcare
providers, including dentists, ophthalmologists, other physicians, chiropractors
and veterinarians. The following table provides the general composition of the
Company's healthcare finance portfolio as of December 31, 1996 (excluding ACFC's
portfolio).
HPSC Leases and Notes Receivable (1)
NUMBER OF
DOLLARS PERCENTAGE CONTRACTS PERCENTAGE
---------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Dental........................................................... $ 130,910 69.0% 7,900 71.2%
Other Medical (2)................................................ $ 59,000 31.0% 3,200 28.8%
---------- ----- ----------- -----
Total............................................................ $ 189,910 100.0% 11,100 100.0%
---------- ----- ----------- -----
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(1) Includes receivables owned or managed
(2) Includes ophthalmic, general medical, chiropractic and veterinary providers.
As of December 31, 1996, no single customer (or group of affiliated
customers) accounted for more than 1% of the Company's healthcare finance
portfolio.
The Company's customers are located throughout the United States, but
primarily in heavily populated states such as California, Florida, Texas,
Illinois and New York.
REALIZATION OF RESIDUAL VALUES ON EQUIPMENT LEASES
Since 1994, the Company has realized over 99% of the residual value of
equipment covered by leases. The overall growth in the Company's equipment lease
portfolio in recent years has resulted in increases in the aggregate amount of
recorded residual values. Substantially all of the residual values on the
Company's balance sheet as of December 31, 1996 are attributable to leases which
will expire by the end of 2001. Realization of such values depends on factors
not within the Company's control, such as the condition of the equipment, the
cost of comparable new equipment and the technological or economic obsolescence
of equipment. Although the Company has received over 99% of recorded residual
values for leases which expired during the last three years, there can be no
assurance that this realization rate will be maintained.
PRACTICE FINANCE
The Company regularly provides financing to healthcare providers in
connection with the acquisition of professional practices. HPSC typically makes
a loan to the professional acquiring the practice, which is
secured by all of the assets of the practice and which may require a personal
guarantee and a pledge of personal assets by the professional who is
obtaining the financing. Through December 31, 1996, the Company has
originated a total of approximately 260 practice finance loans aggregating
approximately $24.6 million, with an average loan of approximately $100,000.
The term of such loans averages 60 to 84 months. In 1996, practice finance
generated approximately 13.0% of HPSC's financing contract originations.
Management believes that its practice finance business contributes to the
diversification of the Company's revenue sources and earns HPSC substantial
goodwill among healthcare providers. All practice finance inquiries received
at the Company's sales office, or by its salespersons in the field, are
referred to the Boston office for processing.
The Company solicits business for its practice finance services primarily by
advertising in trade magazines, attending healthcare conventions, and directly
approaching potential purchasers of healthcare practices. Over half of the
healthcare practices financed by the Company to date have been dental practices.
The Company has also financed the purchase of practices by chiropractors,
ophthalmologists, general medical practitioners and veterinarians.
The following table sets forth the estimated practice finance loan
originations for fiscal years 1994, 1995 and 1996.
PRACTICE FINANCE ORIGINATIONS
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Amount of Originations.............................................................. $ 3,200 $ 8,400 $ 13,000
Number of Contracts................................................................. 50 90 120
GOVERNMENT REGULATION AND HEALTHCARE TRENDS
The majority of the Company's present customers are healthcare providers.
The healthcare industry is subject to substantial federal, state and local
regulation. In particular, the federal and state governments have enacted laws
and regulations designed to control healthcare costs, including mandated
reductions in fees for the use of certain medical equipment and the enactment of
fixed-price reimbursement systems, where the rates of payment to healthcare
providers for particular types of care are fixed in advance of actual treatment.
The United States Congress is considering changes to the Medicare program. The
impact on the Company's business of any changes to the Medicare program which
may be adopted cannot be predicted.
Major changes have occurred in the United States healthcare delivery system,
including the formation of integrated patient care networks (often involving
joint ventures between hospitals and physician groups), as well as the grouping
of healthcare consumers into managed-care organizations sponsored by insurance
companies and other third parties. Moreover, state healthcare initiatives have
significantly affected the financing and structure of the healthcare delivery
system. These changes have not yet had a material effect on the Company's
business, but the effect of any changes on the Company's future business cannot
be predicted.
The Company believes that the trend toward managed healthcare through
health maintenance organizations may have a positive effect on the Company's
future operations. The Company believes that as primary care physicians
increasingly become "gatekeepers" to more specialized care, the Company will
be able to accelerate its marketing programs to family and general
practitioners. These physicians would require additional, cost-effective
equipment that emphasizes early diagnosis and screening as compared to the
more costly "big-ticket" medical equipment purchased by hospitals for
treatment purposes. Medicaid managed care programs also encourage the
increased availability of cost-effective "small-ticket" equipment such as
that financed by the Company. Furthermore, the various reform initiatives are
intended to result in a greater percentage of the population having access to
some type of health coverage, which would increase the likelihood that
healthcare providers will be reimbursed at some (perhaps lower) rate for
services provided to this expanded insured population, thereby improving the
credit quality of providers and increasing their ability to purchase and
finance new equipment.
ASSET-BASED LENDING
ACFC makes asset-based loans of $3 million or less, primarily secured by
accounts receivable, inventory and equipment. ACFC typically makes accounts
receivable loans to borrowers that cannot obtain traditional bank financing in a
variety of industries (none of which to date are medical). ACFC takes a security
interest in all of the borrower's assets and monitors collection of its
receivables. Advances on a revolving loan generally do not exceed 80% of the
borrower's eligible accounts receivable. ACFC also makes revolving and "term
like" inventory loans not exceeding 50% of the value of the customer's active
inventory, valued at the lower of cost or market rate. Finally, ACFC provides
term financing for equipment, which is secured by the machinery and equipment of
the borrower. Each of ACFC's officers has over ten years of experience providing
these types of financing on behalf of various finance companies.
The average ACFC loan is for a term of two to three years in an amount of $1
million. No single borrower accounts for more than 10% of ACFC's aggregate
portfolio, and no more than 25% of ACFC's portfolio is concentrated in any
single industry.
ACFC's loans are "fully followed," which means that ACFC receives daily
settlement statements of its borrowers' accounts receivable. ACFC participates
in the collection of its borrowers' accounts receivable and requires that
payments be made directly to an ACFC lock-box account. Availability under lines
of credit is usually calculated daily. ACFC's credit committee, which includes
members of the senior management of HPSC, must approve in advance all ACFC
loans. To date, ACFC has experienced no loan losses; however, there can be no
assurance that it will not experience losses in the future.
From its inception through December 31, 1996, ACFC has provided 24 lines of
credit totaling $34.7 million and currently has approximately $18.7 million of
loans outstanding to 18 borrowers. The annual dollar volume of originations of
lines of credit by ACFC has grown from $5.0 million in 1994 to $12.1 million in
1995 to $17.6 million in 1996. The Company anticipates that ACFC's asset-based
lending will continue to grow.
CREDIT AND ADMINISTRATIVE PROCEDURES
The Company processes all credit applications, and monitors all existing
contracts, at its corporate headquarters in Boston, Massachusetts (other than
ACFC applications and contracts, all of which are processed at ACFC's
headquarters in West Hartford, Connecticut). The Company's credit procedure
requires the review, verification and approval of a potential customer's
credit file, accurate and complete documentation, delivery of the equipment
and verification of installation by the customer, and correct invoicing by
the vendor. When a sales representative receives a credit application from a
potential customer, he or she enters it into the Company's computer system.
The Company's credit requirements usually include an acceptable personal
payment history and minimum credit rating scores on several credit reporting
agency models, and generally require that the borrower be a practicing
licensed medical professional. The credit of the potential customer is
checked with one or more commercial credit reporting agencies, including TRW
Inc., Equifax Inc., Trans Union Corporation and Dun & Bradstreet Corporation.
Appropriate professional organizations may be consulted regarding the
customer's professional status. In addition to a customer's credit profile,
information such as the equipment type and vendor may be considered. The type
and amount of information and time required for a credit decision varies
according to the nature, size and complexity of each transaction. In smaller,
less complicated transactions, a decision can often be reached within one
hour; more complicated transactions may require up to three or four days.
Once the equipment is shipped and installed, the vendor invoices the Company.
The Company verifies that the customer has received and accepted the
equipment and obtains the customer's authorization to pay the vendor.
Following this telephone verification, the file is forwarded to the contract
administration department for audit, booking and funding and to commence
automated billing and transaction accounting procedures.
Timely and accurate vendor payments are essential to the Company's business.
In order to maintain its relationships with existing vendors and attract new
vendors, the Company makes most payments to vendors for financed equipment
within one day of equipment delivery to the customer.
ACFC's underwriting procedures include an evaluation of the collectibility
of the borrower's receivables that are pledged to ACFC, including an evaluation
of the validity of such receivables and the creditworthiness of the payors of
such receivables. ACFC may also require its customers to pay for credit
insurance with respect to its loans. The Loan Administration Officer of ACFC is
responsible for maintaining its lending standards and for monitoring its loans
and underlying collateral. Before approving a loan, ACFC examines the
prospective customer's books and records, and continues to make such
examinations and to monitor its customers' operations as it deems necessary
during the term of the loan. Loan officers are required to rate the risk of each
loan made by ACFC, and to update the rating upon
receipt of any financial statement from the customer or when 90 days have
elapsed since the date of the last rating. Loan loss reserves are based on a
percentage of loans outstanding. An account will be placed in non-accrual
status when a customer is unable to service the debt and the collateral is
deteriorating.
The Company considers its finance portfolio assets to consist of two general
categories of assets based on such assets' relative risk.
The first category of assets consists of the Company's lease contracts and
notes receivable due in installments, which comprise approximately 87.7% of the
Company's net investment in leases and notes at December 31, 1996 (90.1% at
December 31, 1995). Substantially all of such contracts and notes are due from
licensed medical professionals, principally dentists, who practice in individual
or small group practices. Such contracts and notes are at fixed interest rates
and have terms ranging from 12 to 84 months. The Company believes that leases
and notes entered into with medical professionals are generally "small-ticket,"
homogeneous transactions with similar risk characteristics. Except for the
amounts described in the following paragraph related to asset-based lending, all
of the Company's historical provision for losses, charge offs, recoveries and
allowance for losses have related to its lease contracts and notes due in
installments.
The second category of assets consists of the Company's notes receivable,
which comprise approximately 12.3% of the Company's net investment in leases and
notes at December 31, 1996 (9.9% at December 31, 1995). Such notes receivable
consist of commercial, asset-based, revolving lines of credit to small and
medium size manufacturers and distributors, at variable interest rates, and
typically have terms of two years. The Company began commercial lending
activities in mid-1994. Through December 31, 1996, the Company has not had any
charge-offs of commercial notes receivable. The provision for losses related to
the commercial notes receivable was $146,000, $95,000 and $43,000 in 1996, 1995
and 1994, respectively. The amount of the allowance for losses related to the
commercial notes receivable was $284,000 and $138,000 at December 31, 1996 and
1995, respectively.
COLLECTION AND LOSS EXPERIENCE
The delinquency statistics for the Company's equipment financing contract
portfolio have improved every year since 1993. The delinquency rate (based on
contractual balances more than 60 days past due) of the Company's portfolio
has declined from 11.0% at December 31, 1994 to 4.2% at December 31, 1996.
The Company believes that the delinquency rate has declined because of (i)
the Company's comprehensive on-line credit evaluation procedure to screen
financing applications, (ii) the Company's improved collection procedures and
(iii) growth in the Company's portfolio of financing contracts. The Company
believes that its credit and loss experience compares favorably with other
"small-ticket" equipment finance companies.
The Company uses its own five-person in-house staff to collect late payments
from customers and manage accounts that are in litigation. When an account is 30
days past due, the Company begins collection procedures. The following table
illustrates HPSC's delinquent payment experience in fiscal 1994, 1995 and 1996
(excluding ACFC loans).
Delinquency Experience (1)
AS OF DECEMBER 31,
---------------------------------------------
1994 1995 1996
------------ ---------------- ------------
(DOLLARS IN THOUSANDS)
Total Portfolio Owned and Managed......................... $100,045 $130,066 $189,910
Contractual Delinquencies:
61-90 days.............................................. $1,925 $2,314 $2,134
Over 90 days............................................ 9,108 4,964 5,763
------------ ---------------- ------------
Total Contractual Delinquencies (over 60 days)............ $11,033 $7,278 $7,897
------------ ---------------- ------------
Contractual Delinquencies as a Percentage of Total
Portfolio Owned and Managed
61-90 days.............................................. 1.9% 1.8% 1.1%
Over 90 days............................................ 9.1 3.8 3.1
------------ ---------------- ------------
Total Contractual Delinquencies (over 60 days)............ 11.0% 5.6% 4.2%
------------ ---------------- -------------
Net charge-offs divided by Average Total Portfolio Owned
and Managed (2)......................................... 1.7% 1.2% 0.9%
- ------------------------
(1) Excludes ACFC. To date, ACFC has experienced no credit losses in its
asset-based lending portfolio.
(2) Excludes losses attributable to the Company's discontinued Canadian
operations.
ALLOWANCE FOR LOSSES; CHARGE-OFFS
The Company maintains an allowance for losses in connection with equipment
financing contracts and other loans held in the Company's portfolio at a level
which the Company deems sufficient to meet future estimated uncollectible
receivables, based on an analysis of delinquencies, problem accounts, and
overall risks and probable losses associated with such contracts, and a review
of the Company's historical loss experience. At December 31, 1996, this
allowance for losses was 2.7% of the Company's net investment in leases and
notes (before allowance). There can be no assurance that this allowance will
prove to be adequate. Failure of the Company's customers to make scheduled
payments under their financing contracts could require the Company to (i) make
payments in connection with the recourse portion of its borrowing relating to
such contract, (ii) forfeit its residual interest in any underlying equipment
and (iii) forfeit cash collateral pledged as security for the Company's asset
securitizations. In addition, although net charge-offs on the financing
contracts originated by the Company have been 1.1% of the Company's average net
investment in leases and notes (before allowance) for the year ended December
31, 1996, any increase in such losses or in the rate of payment defaults under
the financing contracts originated by the Company could adversely affect the
Company's ability to obtain additional funding, including its ability to
complete additional asset securitizations.
Accounts are normally charged off when future payment is deemed unlikely.
The following table illustrates the Company's historical allowance for losses
and charge-off experience.
CHARGE-OFFS AND ALLOWANCE FOR LOSSES
YEAR ENDED
-------------------------------------------------------------------
DEC. 26, DEC. 25, DEC. 31, DEC. 31, DEC. 31,
1992 1993 (1) 1994 1995 1996
--------------- -------------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Allowance for losses:
Balance at beginning of period .......................... $11,033 $ 9,216 $6,897 $ 4,595 $ 4,482
Additions(2)............................................. 4,307 15,104 754 1,266 1,114
Charge-offs.............................................. (6,179) (17,501) (3,350) (1,504) (1,609)
Recoveries............................................... 55 78 294 125 95
--------------- ----------- ------- -------- ----------
Balance at end of period................................. $ 9,216 $ 6,897 $4,595 $ 4,482 $ 4,082
--------------- ----------- -------- -------- ----------
Net investment in leases and notes (before allowance).....$ 166,274 $ 116,649 $95,788 $124,398 $ 153,304
Ending allowance divided by net investment in leases and
notes (before allowance)................................ 5.5% 5.9% 4.8% 3.6% 2.7%
Charge-offs divided by average net investment in leases and
notes (before allowance)................................ 3.5% 12.4% 3.2% 1.4% 1.2%
- ------------------------
(1) In 1993, the Company experienced a substantial decrease in originations,
increased selling, general and administrative costs and a substantial
adjustment to its allowance for losses, in each case largely as a result of
the bankruptcy of Healthco, which previously had referred to the Company
substantially all of the Company's business.
(2) In connection with the sale of leases and notes during 1996 and 1995, the
Company recognized estimated recourse liability of $450,000 and $30,000,
respectively.
The above table includes a provision for losses related to the commercial
notes receivable of $146,000, $95,000 and $43,000 in 1996, 1995 and 1994,
respectively. The amount of the allowance for losses related to the commercial
notes receivable was $284,000 and $138,000 at December 31, 1996 and 1995,
respectively.
FUNDING SOURCES
GENERAL
The Company's principal sources of funding for its financing transactions
have been: (i) a $95 million Revolver, (ii) a receivables-backed limited
recourse asset securitization transaction with Funding I in an original
amount of $70 million, (iii) a securitized limited recourse revolving credit
facility with Bravo, currently in the amount of $100 million, (iv) a defined
recourse fixed-term loan from and sales of financing contracts to savings
banks and other purchasers and (v) the Company's internally generated
revenues. In March 1997, the Company issued $20,000,000 principal amount 11%
unsecured senior subordinated notes due 2007, yielding approximately
$18,500,000 in net proceeds to the Company. Management believes that the
Company's liquidity is adequate to meet current obligations and future
projected levels of financings and to carry on normal operations.
The Revolver is a line of credit arrangement under which the Company may
borrow up to $95 million at any given time at variable rates. The Company is
subject to extensive borrowing covenants and certain restrictions on its
operations in connection with the Revolver. See "Description of Certain
Indebtedness."
The Company's securitization transactions provide funding for the
Company's financing transactions at more favorable interest rates than the
Company is able to obtain from conventional borrowing sources such as banks.
In a securitization, the Company sells or contributes financing contracts to
a special-purpose corporation ("SPC") wholly-owned by the Company. The SPC,
in turn, either itself or through a third-party trust to which the SPC has
pledged the financing contracts, issues securities representing an interest
in the financing contracts to outside investors (the securitization). The
offering proceeds from the securities are paid to the SPC, which then pays
the Company for the financing contracts or makes credit available to the
Company at favorable rates. Simultaneously, the Company and the SPC may
arrange for interest rate swaps with institutional lenders, such that any
credit extended to the Company by the SPC can be fixed at a lower rate of
interest than that being paid on the Company's financing contracts. The SPC
enlists the services of a credit organization to guarantee the issued
securities, and pays a fee to the Company to service the underlying contracts
(subject to the Company's compliance with certain financial and performance
covenants). As the financing contracts generate revenue from customers'
monthly payments, that revenue is used by the SPC or the trust to make
payments on the securities. The SPC is intended to be bankruptcy remote, with
assets entirely
separate from those of the Company. It is limited in its business activities
to owning the transferred financing contracts, completing the securitization
of those contracts and providing credit to the Company based on the
securitization. The SPC may incur indebtedness or other obligations only in
relation to the securitization. The Company has found that securitizations
are an effective means of obtaining credit on a limited recourse basis at
favorable interest rates.
Another funding source for the Company has been sales of its financing
contracts to, and borrowing against such contracts from, a variety of savings
banks. Each of these transactions is subject to certain covenants that may
require the Company to (i) repurchase financing contracts from the bank and
make payments under certain circumstances, including the delinquency of the
underlying debtor, and (ii) service the underlying financing contracts. The
Company carries a recourse reserve for each transaction in its allowance for
losses and recognizes a gain that is included for accounting purposes in
earned income for leases and notes for the year in which the transaction is
completed. Each of these transactions incorporates the covenants under the
Revolver as such covenants were in effect at the time the asset sale or loan
agreement was entered into. Any default under the Revolver may trigger a
default under the loan or asset sale agreements. The Company may enter into
additional asset sale agreements in the future in order to manage its
liquidity.
THE REVOLVER
The Company executed a Revolving Credit Agreement on June 23, 1994 with
The First National Bank of Boston, individually and as Agent, and another
bank, for borrowing up to $20 million. This agreement was amended and
restated in May 1995, increasing credit availability to $50 million and
adding additional lending banks. The agreement was next amended in December
1995 to increase availability to $60 million and extend the term to December
31, 1996, and amended again in July 1996 to increase availability to $75
million, and further amended in December 1996 to increase availability to $95
million. There are currently five banks providing the credit facility to the
Company under the Revolver Agreement. Under the Revolver Agreement, the
Company may borrow at variable rates of prime plus 0.25% to 0.50% and at
LIBOR plus 1.75% to 2.00%, depending upon certain performance covenants. At
December 31, 1996, the Company had approximately $40 million outstanding
under this facility. The Revolver is not currently hedged and is, therefore,
exposed to upward movements in interest rates. See "Description of Certain
Indebtedness." The Revolver is secured by a lien on the assets of HPSC and
ACFC (including a pledge of the capital stock of ACFC), including, without
limitation, Customer Receivables (as defined herein). Accordingly,
indebtedness under the Revolver constitutes Secured Portfolio Debt for
purposes of the Indenture, and is senior in right of payment to the Notes.
FUNDING I
In December 1993, in a one-time receivables-backed securitization
transaction, Funding I (a wholly-owned SPC of the Company) issued $70 million
of secured notes ("Funding I Notes") bearing interest at 5.01% to three
institutional investors, Travelers Insurance Company, Prudential Insurance
Company and the Principal Group. Under the terms of the securitization, the
Company sold or contributed certain of its financing contracts, equipment
residual rights and rights to the underlying equipment to Funding I as
collateral for the Funding I Notes (the "Collateral"). The Funding I Notes
are rated "AAA" by Standard & Poor's. The required monthly payments of
interest and principal to holders of the Funding I Notes are unconditionally
guaranteed by Municipal Bond Investor Assurance Corporation ("MBIA") pursuant
to the terms of a Note guarantee insurance policy. In connection with the
securitization, the Company made an investment in Funding I, some or all of
which may be required to fund payments to holders of the Funding I Notes if
certain default and delinquency ratios relating to the Collateral are not
met. As of December 31, 1996, Funding I had approximately $9.8 million of
gross receivables as collateral for the Funding I Notes. The securitization
agreement also imposes restrictions on cash balances of Funding I under
certain conditions; at December 31, 1996, this restricted cash amounted to
approximately $4.0 million. At December 31, 1996, the Funding I Notes had an
outstanding balance of approximately $7.0 million. Note payments to investors
for the years 1997 through 1999, based on projected cash flows from the
Collateral, are expected to be $5.3 million, $1.3 million and $226,000,
respectively. The Company is not permitted to sell or contribute additional
financing contracts to Funding I as long as the current investor notes are
outstanding.
In July and August of 1996, the level of delinquencies of the contracts
held in Funding I rose above certain levels, as defined in the operative
documents, and triggered a payment restriction event. This restriction had
the effect of "trapping" any cash distribution that the Company otherwise
would have been eligible to receive. The event was considered a technical
default under the Revolver, which default was waived by the lending banks. In
September 1996, delinquency levels improved and the payment restrictions were
removed. A payment restriction event is not unusual during the later stages
of a static pool securitization and may occur again before Funding I is fully
paid out. The default provisions of the Revolver Agreement were amended on
December 12, 1996 to conform to the default provisions of the Funding I
agreements. As a result, a payment restriction event under Funding I will not
constitute a default under the Revolver unless such event continues for at
least six months. There can be no assurance that any future defaults will be
waived by the lending banks. Under the terms of Funding I, when the principal
balance of the Funding I Notes equals the balance of the restricted cash in
the facility, Funding I must automatically pay the Funding I Notes and
terminate. This event is expected to occur during fiscal 1997. In the event
of an early termination, the Company could incur a non-cash, non-operating
charge against earnings representing the early recognition of certain
unamortized deferred transaction origination costs. At December 31, 1996,
these unamortized costs were approximately $400,000 and were amortizing at
approximately $17,000 per month. The Notes are effectively subordinated to
the Funding I Notes, which also constitute Secured Portfolio Debt. Funding I
has not guaranteed payment of the Notes.
BRAVO
In January 1995, the Company entered into a revolving credit
securitization facility (the "Facility") with another SPC, Bravo, structured
and guaranteed by CapMAC. Under the Facility, the Company sells certain
equipment financing contracts to Bravo which, along with the underlying
equipment, serve as collateral or consideration for cash advanced to Bravo by
Triple-A One Funding Corporation ("Triple-A"), a commercial paper conduit
entity. Bravo, in turn, makes cash advances to the Company in return for the
contracts. In November 1996, the Facility was amended to increase available
borrowing to up to $100 million and to allow up to $30 million of the
Facility to be used for sales of financing contracts to Triple-A from Bravo,
$7.0 million of which had been used for such sales at December 31, 1996.
Bravo incurs interest at variable rates in the commercial paper market and
enters into interest rate swap agreements to assure fixed rate funding.
Additional sales of financing contracts to Bravo from the Company may be made
subject to certain covenants regarding Bravo's portfolio performance and
borrowing base calculations. The Company's ability to make additional sales
under the Facility (and therefore to continue to draw advances at commercial
paper rates) will depend upon a number of factors, including general
conditions in the credit markets and the ability of the Company to originate
financing contracts which satisfy eligibility requirements set forth in the
Facility documents. There can be no assurance that the Company will continue
to originate eligible contracts.
In order to secure a AAA rating for its commercial paper, Triple-A has
established a liquidity line of credit with a group of liquidity banks, for
which The First National Bank of Boston serves as liquidity agent. Each
liquidity bank commits to make advances for a one-year term, which term may
be extended at the sole option of each liquidity bank. The Facility
terminates on the earlier of the termination of the liquidity banks'
commitment to make liquidity advances (currently December 1997) or October
28, 1999, or upon an event of default. Upon termination of the Facility, no
further advances will be made to either Bravo or the Company, and Bravo will
continue to pay principal, interest and "sale" payments until all advances
from Triple-A have been repaid in full. The Company had approximately $67.5
million outstanding under the Facility on December 31, 1996 and, in
connection with the Facility, had 14 separate interest rate swap agreements
with The First National Bank of Boston with a total notional value of
approximately $65.2 million. The weighted average cost of funds associated
with Bravo's borrowings under the Facility since January 1995 is
approximately 7.3%.
The Notes are effectively subordinated to Bravo's obligations to Triple-A,
which also constitute Secured Portfolio Debt. Bravo has not guaranteed payment
of the Notes.
SAVINGS BANK LOAN AND SALES OF FINANCING CONTRACTS
In April 1995, the Company entered into a secured, fixed rate, fixed term
loan agreement with Springfield Institution for Savings under which the Company
borrowed $3.5 million at 9.5% subject to certain recourse and performance
covenants. The Company had approximately $2.4 million outstanding under this
agreement at December 31, 1996. In addition, between November 1995 and December
1996, the Company sold an aggregate of $20.6 million net amount of financing
contracts to the following savings banks: Cambridge Savings Bank; Century Bank
and Trust Co.; First Essex Bank, FSB; and Springfield Institution for Savings.
The loan agreement and the agreements evidencing financing contract sales are
secured by the underlying Customer Receivables. In addition, under the recourse
provisions of the agreements evidencing the financing contract sales, the
Company has a contingent obligation to repurchase the Customer Receivables
securing such agreements and/or make payments on such receivables under certain
circumstances, including delinquencies of the underlying debtors. Upon the
occurrence of a triggering event under the recourse provisions of such
agreements, the Company's obligation to repurchase and/or make payments on the
Customer Receivables would constitute Secured Portfolio Debt.
INFORMATION TECHNOLOGY
The Company has developed automated information systems and
telecommunications capabilities to support all areas within the organization.
Systems support is provided for accounting, taxes, credit, collections,
operations, sales, sales support and marketing. The Company has invested a
significant amount of time and capital in computer hardware and proprietary
software. The Company's computerized systems provide management with accurate
and up-to-date customer data which strengthens its internal controls and
assists in forecasting.
The Company contracts with an outside consulting firm to provide
information technology services and has developed its own customized computer
software. The Company's Boston office is linked electronically with all of
the Company's other offices. Each salesperson's laptop computer may also be
linked to the computer systems in the Boston office, permitting a salesperson
to respond to a customer's financing request, or a vendor's informational
request, almost immediately. Management believes that its investment in
technology has positioned the Company to manage increased equipment financing
volume.
The Company's centralized data processing system provides timely support
for the marketing and service efforts of its salespeople and for equipment
manufacturers and dealers. The system permits the Company to generate
collection histories, vendor analyses, customer reports and credit histories
and other data
useful in servicing customers and equipment suppliers. The system is also
used for financial and tax reporting purposes, internal controls, personnel
training and management. The Company believes that its system is among the
most advanced in the small-ticket equipment financing industry, giving the
Company a competitive advantage based on the speed of its contract
processing, control over credit risk and high level of service.
SALES AND MARKETING
GENERAL
In addition to promoting its financing services through its sales and
marketing employees, most of whom work out of the Company's regional offices,
the Company relies on various equipment financing referral sources and
relationships with vendors and manufacturers of dental, medical and other
equipment for the marketing of its services. The Company's sales and
marketing staff focuses its efforts primarily on these vendors in an effort
to encourage them to recommend the Company as a preferred funding source to
purchasers of their equipment. The Company then enters into financing
contracts directly with the vendors' customers.
HPSC currently has 14 field sales and marketing personnel located in 14
offices throughout the United States, as well as eight sales representatives
at the Company's Boston headquarters. Sales personnel are assigned to a
particular region of the country or to a particular healthcare profession.
Sales personnel generally can obtain approval of a financing transaction
within 24 to 48 hours, and often within one hour, of completion of
documentation through use of the Company's computer system. Practice finance
sales and marketing is managed centrally from Boston, with leads referred to
Boston from the Company's sales offices. ACFC's employees are located in West
Hartford, Connecticut. Its business is presently conducted primarily in the
northeastern United States with all sales and marketing efforts managed from
its West Hartford office.
The Company's sales force emphasizes customer service, including
providing customized financing arrangements for individual healthcare
providers. In most cases, the Company's sales representatives work directly
with the vendors' potential purchasers, providing them with the guidance
necessary to complete the equipment financing transaction. The Company
believes that such "consultative financing" enhances customer satisfaction
and loyalty.
The Company also attempts to broaden its customer base through national
advertising in trade journals and magazines, by attending trade shows and
through the broad dissemination of literature describing the Company's
financing programs.
VENDORS
The Company's sales representatives establish formal and informal
relationships with equipment vendors and manufacturers. The primary objective
of these relationships is for the sales representative to support the
equipment manufacturer or vendor or their representatives in their sales
efforts by providing timely, convenient and competitive financing for their
equipment sales. In addition, the Company provides these vendors with a
variety of value-added services which simultaneously promote the vendors'
equipment sales as well as the selection of the Company for financing. These
services include consulting with the vendors on structuring financing
transactions which meet the needs of the vendor and the equipment purchaser;
training the vendor's sales and management staffs to understand and market
the Company's various financing products; customizing financing products to
encourage product sales; and, in most cases, working directly with the
vendors' potential purchasers to provide them with the guidance necessary to
complete the equipment financing transaction.
The Company believes this method of marketing is more effective than
isolated solicitations of equipment purchasers. During the year ended
December 31, 1996, the Company estimates that vendor relationships generated
a majority of the Company's financing contract originations, but no one
vendor's financing accounted for more than 13% of the Company's financing
contract originations. The top ten vendors in terms of the dollar volume of
the Company's financings for the year ended December 31, 1996, accounted for
approximately 35% of HPSC's originations during that period.
MARKETING PROGRAMS
The Company employs a number of marketing strategies to promote its
healthcare provider financing services. For example, the Company advertises
its services in national publications targeting dental, ophthalmic and other
healthcare professionals. Representatives of the Company attend approximately
80 healthcare conventions per year, as well as solicit business directly from
key manufacturers and distributors of equipment. From time to time, the
Company participates in special promotions with equipment vendors to
encourage both the purchase and financing of healthcare equipment. The
Company also distributes to its customers and others informational brochures,
which are produced by the Company and which describe the various financing
services provided by the Company, as well as quarterly outlook fliers and a
year-end tax advisory letter.
COMPETITION
Healthcare provider financing and asset-based lending are highly
competitive businesses. The Company competes for customers with a number of
national, regional and local finance companies, including those which, like
the Company, specialize in financing for healthcare providers. In addition,
the Company's competitors include those equipment manufacturers which finance
the sale or lease of their products themselves, conventional leasing
companies and other types of financial services companies such as commercial
banks and savings and loan associations. Although the Company believes that
it currently has a competitive advantage based on its customer-oriented
financing and value-added services, many of the Company's competitors and
potential competitors possess substantially greater financial, marketing and
operational resources than the Company. Moreover, the Company's future
profitability will be directly related to the Company's ability to obtain
capital funding at favorable rates as compared to the capital costs of its
competitors. The Company's competitors and potential competitors include many
larger, more established companies that have a lower cost of funds than the
Company and access to capital markets and to other funding sources which may
be unavailable to the Company. The Company's ability to compete effectively
for profitable equipment financing business will continue to depend upon its
ability to procure funding on attractive terms, to develop and maintain good
relations with new and existing equipment suppliers, and to attract
additional customers.
Historically, the Company's equipment finance business has concentrated
on leasing small-ticket dental, medical and office equipment. The Company may
in the future finance more expensive equipment than it has in the past. As it
does so, the Company's competition can be expected to increase. In addition,
the Company may face greater competition with its expansion into the practice
finance and asset-based lending markets.
EMPLOYEES
At December 31, 1996, the Company had 67 full-time employees, seven of
whom work for ACFC, and none of whom was represented by a labor union.
Approximately 13 of the Company's employees are engaged in credit,
collections and lease documentation, approximately 30 are in sales, marketing
and customer service, and 19 are engaged in general administration, tax and
accounting. Management believes that the Company's employee relations are
good.
ITEM 2 PROPERTY
The Company leases approximately 11,320 square feet of office space at 60
State Street, Boston, Massachusetts for approximately $24,000 per month. This
lease expires on May 31, 1999 with a five-year extension option. ACFC leases
approximately 2,431 square feet at 433 South Main Street, West Hartford,
Connecticut for approximately $4,000 per month. This lease expires on August
31, 1999 with a three-year extension option. The Company's total rent expense
for 1996 under all operating leases was $390,665. The Company also rents
space as required for its sales locations on a short-term basis. The Company
believes that its facilities are adequate for its current operations and for
the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
Although the Company is from time to time subject to actions or claims
for damages in the ordinary course of its business and engages in collection
proceedings with respect to delinquent accounts, the Company is aware of no
such actions, claims, or proceedings currently pending or threatened that are
expected to have a material adverse effect on the Company's business,
operating results or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1996.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The table below sets forth the representative high and low bid prices for
shares of the Common Stock in the over the counter market as reported by the
NASDAQ National Market System (Symbol: "HPSC") for the fiscal years 1996 and
1995:
1996 FISCAL YEAR HIGH LOW 1995 FISCAL YEAR HIGH LOW
- ------------------------------------- --------- --------- ------------------------------------- --------- ---------
First Quarter........................ $ 5 3/4 $ 4 1/2 First Quarter........................ $ 5 1/2 $ 3 5/8
Second Quarter....................... 7 3/8 4 1/2 Second Quarter....................... 5 4 3/8
Third Quarter........................ 7 3/16 5 3/4 Third Quarter........................ 5 1/8 4 1/2
Fourth Quarter....................... 6 3/4 5 7/8 Fourth Quarter....................... 5 1/4 4 1/2
The foregoing quotations represent prices between dealers, and do not
include retail markups, markdowns, or commissions.
HOLDERS
APPROXIMATE NUMBER OF HOLDERS OF RECORD
TITLE OF CLASS (AS OF FEBRUARY 28, 1997)
- -------------------------------------------------------------- --------------------------------------------
Common Stock, par value $.01 per share 95(1)
(1) This number does not reflect beneficial ownership of shares held in
"nominee" or "street" name.
DIVIDENDS
The Company has never paid any dividends and anticipates that for the
foreseeable future its earnings will be retained for use in its business.
RECENT SALES OF UNREGISTERED STOCK
The Company granted a non-qualified stock option to Lowell P. Weicker,
Jr., a director of the Company, on December 7, 1995 for the purchase of 4,000
shares of Common Stock of the Company at an exercise price of $4.75 per share
(the market price per share on the date of grant). Any shares purchased by
Mr. Weicker under this option will not be registered under the Securities
Act. Mr. Weicker's option will expire on December 7, 2005 unless terminated
earlier in accordance with the terms of the option agreement.
The Company granted a non-qualified stock option to Terry Lierman
effective April 9, 1996 for the purchase of 10,000 shares of Company Common
Stock at an exercise price of $4.50 per share, in recognition of Mr.
Lierman's agreement to assist the Company in obtaining certain financing
transactions. Any shares purchased by Mr. Lierman under this option will not
be registered under the Securities Act. Mr. Lierman's option will expire on
April 9, 2001 unless terminated earlier in accordance with the terms of the
option agreement.
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED
----------------------------------------------------------------
DEC. 26, DEC. 25, DEC. 31, DEC. 31, DEC. 31,
1992 1993 (1) 1994 (2) 1995 1996
---------------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Statement of Operations Data:
Earned income on leases and notes........... $ 21,734 $ 17,095 $ 11,630 $ 12,871 $ 17,515
Gain on sales of leases and notes........... -- -- -- 53 1,572
Provision for losses........................ (4,307) (15,104) (754) (1,296) (1,564)
---------------- ---------- ---------- ---------- ----------
Net revenues..................... 17,427 1,991 10,876 11,628 17,523
Selling, general and administrative
expenses.................................. 3,574 5,160 6,970 5,984 8,059
Interest expense............................ 10,663 9,057 3,514 5,339 8,146
Interest income............................. (54) (78) (358) (375) (261)
Loss on write-off of foreign currency
translation adjustment (3)................ -- -- -- 601 --
---------------- ---------- ---------- ---------- ----------
Income (loss) before income taxes........... 3,244 (12,148) 750 79 1,579
Provision (benefit) for income taxes........ 1,260 (4,870) 300 204 704
---------------- ---------- ---------- ---------- ----------
Net income (loss)........................... $ 1,984 $ (7,278) $ 450 $ (125) $ 875
---------------- ---------- ---------- ---------- ----------
Net income (loss) per share................. $ 0.40 $ (1.48) $ 0.09 $ (0.03) $ 0.22
---------------- ---------- ---------- ---------- ----------
Shares used to compute net income (loss) per
share..................................... 4,922,473 4,923,233 4,989,391 3,881,361 4,067,236
DEC. 26, DEC. 25, DEC. 31, DEC. 31, DEC. 31,
1992 1993 (1) 1994 1995 1996
------------------ --------- ------------------ ---------------- ---------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Balance Sheet Data:
Cash and cash
equivalents............. $ 625 $16,600 $ 419 $ 861 $ 2,176
Restricted cash........... -- -- 7,936 5,610 6,769
Net investment in leases
and notes............... 157,058 109,752 91,193 119,916 149,222
Total assets.............. 158,857 130,437 103,148 130,571 163,217
Revolving credit
borrowings.............. 24,584 7,130 16,500 39,000 40,000
Senior notes.............. 50,000 50,000 41,024 49,523 76,737
Senior Subordinated
Notes................... -- -- -- -- --
Subordinated debt......... 19,090 19,962 -- -- --
Total liabilities......... 113,816 92,816 70,326 97,410 128,885
Total stockholders'
equity.................. 45,041 37,621 32,822 33,161 34,332
- ------------------------
(1) In 1993, the Company experienced a substantial decrease in new business,
increased selling, general and administrative costs and a substantial
adjustment to its loan loss reserves, in each case largely as a result of
the bankruptcy of Healthco, which previously had referred to the Company
substantially all of the Company's business.
(2) For 1994 and prior years, the Company's fiscal year was the 52 or 53-week
period ending on the last Saturday of the calendar year. The 1994 fiscal
year covers the 53-week period from December 26, 1993 to December 31, 1994.
In fiscal year 1995, the Company changed its fiscal year-end to
December 31.
(3) Reflects a one-time, non-cash loss on write-off of cumulative foreign
currency translation adjustments related to the Company's discontinued
Canadian operations.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FISCAL YEARS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1995
Earned income from leases and notes for 1996 was $17,515,000 (including
$2,643,000 from ACFC) as compared to $12,871,000 ($1,316,000 from ACFC) for
1995. This increase of approximately 36.1% was due primarily to the increase
in the net investment in leases and notes from 1995 to 1996. The increase in
net investment in leases and notes resulted from an increase of approximately
41.4% in the Company's financing contract originations for fiscal 1996 to
approximately $97,000,000 (including approximately $10,000,000 in ACFC
originations, and excluding $3,800,000 of initial direct costs) from
$68,600,000 (including $7,600,000 in ACFC originations, and excluding
$3,000,000 of initial direct costs) for 1995. Gains on sales of leases and
notes increased to $1,572,000 in 1996 compared to $53,000 in 1995. This
increase was caused by higher levels of sales activity in 1996. Earned income
on leases and notes is a function of the amount of net investment in leases
and notes and the level of financing contract interest rates. Earned income
is recognized over the life of the net investment in leases and notes, using
the interest method.
Interest expense net of interest income on cash balances for 1996 was
$7,885,000 (45.0% of earned income) compared to $4,964,000 (38.6% of earned
income) for 1995, an increase of 58.8%. The increase in net interest expense
was due primarily to a 31.9% increase in debt levels from 1995 to 1996, which
resulted from borrowings to finance the Company's financing contract
originations. The increase as a percentage of earned income was due to higher
interest rates on debt in 1996 as compared to 1995.
Net financing margin (earned income less net interest expense) for fiscal
1996 was $9,630,000 (55.0% of earned income) as compared to $7,907,000 (61.4%
of earned income) for 1995. The increase in amount was due to higher earnings
on a higher balance of earning assets. The decline in percentage of earned
income was due to higher debt during 1996 as compared to 1995.
The provision for losses for fiscal 1996 was $1,564,000 (8.9% of earned
income) compared to approximately $1,296,000 (10.1% of earned income) for
1995. This increase in amount resulted from higher levels of new financings
in 1996 and the Company's continuing evaluation of its allowance for losses.
The allowance for losses at December 31, 1996 was $4,082,000 (2.7% of net
investment in leases and notes) as compared to $4,482,000 (3.7% of net
investment in leases and notes) at December 31, 1995. Net charge-offs were
$1,500,000 in 1996 compared to $1,400,000 in 1995.
Selling, general and administrative expenses for fiscal 1996 were
$8,059,000 (46.0% of earned income) as compared to $5,984,000 (46.5% of
earned income) for 1995. This increase resulted from increased staffing and
systems and support costs required by higher volumes of financing activity in
1996 and anticipated near-term growth.
In 1995, the Company incurred a loss on write-off of foreign currency
translation adjustment of approximately $601,000 in connection with
substantial liquidation of the Company's investment in its Canadian
subsidiary. The Company incurred no such loss in 1996.
The Company's income before income taxes for fiscal 1996 was $1,579,000
compared to $79,000 for 1995. The provision for income taxes was $704,000
(44.6% of income before tax) in 1996 compared to $204,000 (258.2%) in 1995.
The 1995 provision was affected by the $601,000 foreign currency translation
adjustment related to the Company's Canadian operations that was not
deductible.
The Company's net income for fiscal 1996 was $875,000 or $0.22 per share
compared to ($125,000) or ($0.03) per share for 1995. The increase in 1996
over 1995 was due to higher earned income from leases and notes and gains on
sales offset by increases in the provision for losses, higher selling,
general and administrative expenses, higher average debt levels and higher
average rates of interest on debt and a foreign currency translation
adjustment in 1995.
At December 31, 1996, the Company had approximately $47,500,000 of
customer applications which had been approved but had not resulted in a
completed transaction, compared to approximately $39,900,000 of such customer
applications at December 31, 1995. Not all approved applications will result
in completed financing transactions with the Company.
FISCAL YEARS ENDED DECEMBER 31, 1995 AND DECEMBER 31, 1994
Earned income from leases and notes for fiscal 1995 was $12,871,000
compared to $11,630,000 in 1994. This increase of 10.7% resulted primarily
from an increase of 31.5% in the net investment in leases and notes from 1994
to 1995. The Company financed new portfolio assets at a cost of $68,600,000
million in 1995 compared to $32,600,000 in 1994, a 110.4% increase in the
value of assets financed.
Interest expense net of interest income on cash balances for 1995 was
$4,964,000 (38.6% of earned income) compared to $3,156,000 (27.1% of earned
income) in 1994. The 57.3% increase in amount was due primarily to a 42.7%
increase in the level of debt required to support the increase in new
portfolio assets and higher average interest rates in 1995. The Company
funded its business in 1995 in part with fixed rate and revolving credit
arrangements. See "Liquidity and Capital Resources" and Note B to the
Company's Consolidated Financial Statements contained elsewhere in this
annual report on Form 10-K.
Net financing margin for fiscal 1995 was $7,907,000 (61.4% of earned
income), compared to approximately $8,474,000 (72.9% of earned income) in
fiscal 1994. The declines in both the amount of net interest margin and its
percentage of earned income were due to the Company's higher levels of debt
at higher average interest rates on debt in 1995 as compared to 1994.
The provision for losses was $1,296,000 (10.1% of earned income) in 1995
as compared to $754,000 (6.5% of earned income) in 1994. The allowance for
losses at December 31, 1995 was $4,482,000 (3.7% of net investment in leases
and notes), compared to approximately $4,595,000 (5.0% of net investment in
leases and notes) at December 31, 1994. Net charge-offs were approximately
$1,400,000 in 1995 compared to approximately $3,100,000 in 1994. The increase
in the provision for losses was due to the higher level of financing contract
originations and the Company's continuing adjustment of the provision for
losses to reflect the risks and diversification in its portfolio.
Selling, general and administrative expenses were $5,984,000 (46.5% of
earned income) in fiscal year 1995 compared to $6,970,000 (59.9% of earned
income) in fiscal year 1994. The decrease in amount was due to a reduction in
expenses related to the Company's discontinued Canadian operations in 1995
and the reversal of certain accruals related to the uncertain impact on the
Company of the bankruptcy of Healthco in 1993.
In 1994, the Company discontinued its Canadian operations as part of its
strategic plan to focus on its business in the United States. Consistent with
this strategy, and in an effort to begin to liquidate its Canadian
operations, the Company in 1994 sold a large portion of its Canadian
portfolio to Newcourt Credit Group, Inc. ("Newcourt") for approximately
$7,000,000 and used most of the proceeds to repay third party debt. Some of
the proceeds were repatriated to the Company. As part of the sale agreement,
the Company entered into a service agreement whereby Newcourt agreed to
manage certain accounts over the next two-year period ending June 30, 1996.
Since the Company no longer generated new business in Canada, these managed
accounts were written down to estimated net realizable value. As a result of
the transaction with Newcourt the Company's total investment in Canada
decreased from approximately $3,800,000 to approximately $2,100,000 at
December 31, 1994. In 1995, the Company continued to liquidate its Canadian
assets and repatriated another $700,000 to the United States. At December 31,
1995, after currency adjustments, the Company's investment in Canada was less
than $800,000. Accordingly, the Company was deemed to have substantially
liquidated its Canadian investment. Therefore, in accordance with Statement
of Financial Accounting Standards No. 52 ("Foreign Currency Translation"),
the Company recognized in earnings the cumulative translation losses incurred
in prior years that had been deferred as a separate component of equity.
The Company had income before income taxes in 1995 of $79,000 compared to
$750,000 in 1994. The provision for income taxes was $204,000 (258.2% of
income before tax) in 1995 compared to $300,000 (40%) in 1994. The provision
for income taxes in 1995 was 258.2% of income before income taxes, due to the
fact that the $601,000 foreign currency translation adjustment related to the
Company's Canadian operations was not deductible. In addition, the Company
had a $128,000 reduction in its tax provision for a 1995 Canadian provincial
refund of taxes from prior years.
The Company's net loss was $125,000 or $0.03 per share in 1995 compared
to net income of $450,000 or $0.09 per share in 1994. The decrease in 1995
was primarily caused by the recognition of a non-cash write-off of a
cumulative foreign currency translation adjustment of $601,000 related to the
Company's discontinued Canadian operations.
The earnings per share impact from the Company's repurchase and
retirement of treasury shares in 1995 was less than $0.01. Earnings per share
were unfavorably affected in 1995 by $0.16 per share due to the 1995
write-off of the Company's cumulative translation adjustment from the
substantial liquidation of its Canadian operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financing activities require substantial amounts of
capital, and its ability to originate new financing transactions is dependent
on the availability of cash and credit. The Company currently has access to
credit under the Revolver, its securitization transactions with Bravo, and a
loan secured by financing contracts. The Company obtains cash from sales of
its financing contracts to various savings banks and from lease and note
payments. Substantially all of the assets of HPSC and ACFC and the stock of
ACFC have been pledged to HPSC's lenders as security under HPSC's various
short and long-term credit arrangements. Borrowings under the securitizations
are secured by financing contracts, including the amounts receivable
thereunder and the assets securing the financing contracts. The
securitizations are limited recourse obligations of the Company, structured
so that the cash flow from the securitized financing contracts services the
debt. In these limited recourse transactions, the Company retains some risk
of loss because it shares in any losses incurred, and it may forfeit the
residual interest, if any, it has in the securitized financing contracts
should a default occur. The Company's borrowings under the Revolver are full
recourse obligations of HPSC. Most of the Company's borrowings under the
Revolver are used to temporarily fund new financing contracts entered into by
the Company and are repaid with the proceeds obtained from other full or
limited recourse financings and cash flow from the Company's financing
transactions.
At December 31, 1996, the Company had $8,945,000 in cash, cash
equivalents and restricted cash as compared to $6,471,000 at the end of 1995.
As described in Note D to the Company's Consolidated Financial Statements,
$6,769,000 of such cash was restricted pursuant to financing agreements as of
December 31, 1996, compared to $5,610,000 at December 31, 1995.
Cash provided by operating activities was $6,680,000 million for the year
ended December 31, 1996 compared to $4,514,000 in 1995 and cash used in
operating activities of $2,598,000 in 1994. The significant components of
cash provided for 1996 as compared to 1995 were an increase in net income in
1996 to $875,000 from a loss of $125,000 in 1995; an increase in the gain on
sales of leases and notes to $1,572,000 in 1996 from $53,000 in 1995, which
was caused by a higher level of sales activity in 1996; and an increase in
accounts payable and accrued liabilities of $2,379,000 in 1996 as compared to
1995, which was caused by a higher level of originations of lease contracts
and notes receivable in 1996 as compared to 1995.
Cash used in investing activities was $34,406,000 for the year ended
December 31, 1996 compared to $32,615,000 in 1995 and cash provided by
investing activities of $15,675,000 in 1994. The primary components of cash
used in investing activity for 1996 as compared to 1995 were an increase in
originations of lease contracts and notes receivable to $90,729,000 from
$63,945,000 in 1995, offset by an increase in proceeds from sales of lease
contracts and notes receivable to $24,344,000 in 1996 from $1,630,000 in 1995.
Cash provided by financing activities was $29,041,000 for the year ended
December 31, 1996 compared to cash provided by financing activities of
$28,543,000 for 1995 and cash used in financing activities of $29,258,000 in
1994. The significant components of cash provided by financing activity in
1996 as compared to 1995 were an increase in the proceeds from issuance of
senior notes in 1996 to $52,973,000 from $28,422,000 in 1995, offset by
repayments of senior notes in 1996 of $26,019,000 compared to $23,385,000 in
1995 and a decrease in net proceeds from demand and revolving notes payable
to banks to $1,000,000 in 1996 from $25,570,000 in 1995.
On December 27, 1993, the Company raised $70,000,000 through an asset
securitization transaction in which its wholly-owned subsidiary, Funding I,
issued senior secured notes (the "Funding I Notes") at a rate of 5.01%. The
Funding I Notes are secured by a portion of the Company's portfolio which it
sold in part and contributed in part to Funding I. Proceeds of this financing
were used to retire $50,000,000 of 10.125% senior notes due December 28,
1993, and $20,000,000 of 10% subordinated notes due January 15, 1994. The
Funding I Notes had an outstanding balance of $6,861,000 at December 31,
1996. In July and August of 1996, the level of delinquencies in Funding I
rose above specified levels and triggered a payment restriction event. This
restriction had the effect of "trapping" any cash distribution that the
Company otherwise would have been eligible to receive. The event was
considered a technical default under the Revolver Agreement, which default
was waived by the lending banks in September 1996. In September 1996,
delinquency levels improved and the payment restrictions were removed. A
payment restriction event is not unusual during the later stages of a static
pool securitization and may occur again before Funding I is fully paid out.
The Revolver Agreement was amended and restated on December 12, 1996,
amending the default provisions with respect to Funding I payment restriction
events to conform to the default provisions of the Funding I agreements. As a
result, a payment restriction event under Funding I will not constitute a
default under the Revolver Agreement unless such event continues for at least
six months. There can be no assurance that any future defaults will be waived
by the lending banks. Under the terms of the Funding I securitization, when
the principal balance of the Funding I Notes equals the balance of the
restricted cash in the facility, Funding I must automatically pay the Funding
I Notes and terminate. This event may occur during fiscal 1997, prior to the
scheduled termination of Funding I. In the event of an early termination, the
Company would incur a non-cash, non-operating charge against earnings
representing the early recognition of certain unamortized deferred
transaction origination costs. At December 31, 1996, these unamortized costs
were approximately $400,000 and were amortizing at approximately $17,000 per
month.
The Revolver Agreement, as amended and restated, increased the Company's
availability under the Revolver to $95,000,000. Under the Revolver Agreement,
the Company may borrow at variable rates of prime and at LIBOR plus 1.25% to
1.75%, dependent on certain performance covenants. At December 31, 1996, the
Company had $40,000,000 outstanding under this facility and $55,000,000
available for borrowing, subject to borrowing base limitations. The Revolver
Agreement currently is not hedged and is, therefore, exposed to upward
movements in interest rates.
As of January 31, 1995, the Company, along with its newly-formed,
wholly-owned, special-purpose subsidiary Bravo, established a $50,000,000
revolving credit facility structured and guaranteed by Capital Markets
Assurance Corporation ("CapMAC"). Under the terms of the facility, Bravo, to
which the Company has sold and may continue to sell or contribute certain of
its portfolio assets, pledges its interests in these assets to a
commercial-paper conduit entity. Bravo incurs interest at variable rates in
the commercial paper market and enters into interest rate swap agreements to
assure fixed rate funding. Monthly settlements of principal and interest
payments are made from the collection of payments on Bravo's portfolio. HPSC
may make additional sales to Bravo subject to certain covenants regarding
Bravo's portfolio performance and borrowing base calculations. The Company is
the servicer of the Bravo portfolio, subject to meeting certain covenants.
The required monthly payments of principal and interest to purchasers of the
commercial paper are guaranteed by CapMAC pursuant to the terms of the
agreement. The Company had $67,524,000 outstanding under the Bravo facility
at December 31, 1996, and, in connection with this facility, had 14 separate
interest rate swap agreements with The First National Bank of Boston with a
total notional value of $65,231,000. Effective November 5, 1996, the Bravo
facility was increased to $100,000,000 and amended to provide that up to
$30,000,000 of such facility may be used as sales of receivables from Bravo
for accounting purposes. The Company had $6,991,000 outstanding from sales of
receivables under this portion of the facility at December 31, 1996.
In April 1995, the Company entered into a fixed rate, fixed term loan
agreement with Springfield Institution for Savings ("SIS") under which the
Company borrowed $3,500,000 at 9.5% subject to certain recourse and
performance covenants. The Company had $2,352,000 outstanding under this
agreement at December 31, 1996. Also in fiscal 1995, the Company entered into
a sale agreement with SIS under which it sold approximately $1,700,000 of
financing contracts (which included a cash payment of $1,500,000 and
scheduled future payments of $200,000), subject to certain recourse covenants
and servicing of these contracts by the Company, and recognized a net gain of
approximately $53,000 in connection with the sale. Through December 31, 1996,
the Company had entered into several similar sale agreements with savings
banks and the Bravo securitization facility under which it received a total
of $24,344,000 during 1996 and recognized a net gain of $1,572,000.
Amortization of debt discount of $0, $0 and $38,000 in 1996, 1995 and
1994, respectively, is included in interest expense.
The Company's existing senior secured debt, issued in connection with
certain securitization transactions as shown on the balance sheet contained
in the Company's Consolidated Financial Statements appearing elsewhere,
reflect its approximate fair market value. The fair market value is estimated
based on the quoted market prices for the same or similar issues or on the
current rates offered to the Company for debt of the same maturity.
In March 1997, the Company issued $20,000,000 principal amount 11%
unsecured senior subordinated notes due 2007, yielding approximately
$18,500,000 in net proceeds to the Company (the "Note Offering"). The Company
used the net proceeds to repay, in part, amounts outstanding under the
Revolver.
Management believes that the Company's liquidity, resulting from the
availability of credit under the Revolver, the Bravo facility and the loan
from SIS, along with cash obtained from the sales of its financing contracts
and from internally generated revenues and the net proceeds of the Note
Offering, is adequate to meet current obligations and future projected levels
of financings and to carry on normal operations. In order to finance
adequately its anticipated growth, the Company will continue to seek to raise
additional capital from bank and non-bank sources, make selective use of
asset sale transactions in 1997 and use its current credit facilities. The
Company expects that it will be able to obtain additional capital at
competitive rates, but there can be no assurance it will be able to do so.
Inflation in the form of rising interest rates could have an adverse
impact on the interest rate margins of the Company and its ability to
maintain adequate earning spreads on its portfolio assets.
CERTAIN ACCOUNTING PRONOUNCEMENTS
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Current tax liabilities or assets are
recognized, through charges or credits to the current tax provision, for the
estimated taxes payable or refundable for the current year. Net deferred tax
liabilities or assets are recognized, through charges or credits to the
deferred tax provision, for the estimated future tax effects, based on
enacted tax rates, attributable to temporary differences. Deferred tax
liabilities are recognized for temporary differences that will result in
amounts taxable in the future, and deferred tax assets are recognized for
temporary differences and tax benefit carryforwards that will result in
amounts deductible or creditable in the future.
Effective January 1, 1995, the Company adopted prospectively Statement of
Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for
Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors
for Impairment of a Loan--Income Recognition and Disclosure." These
standards apply to the Company's practice acquisition loans and asset-based
lending. The standards require that a loan be classified and accounted for as
an impaired loan when it is probable that the Company will be unable to
collect all principal and interest due on the loan in accordance with the
loan's original contractual terms. Impaired loans are valued based on the
present value of expected future cash flows, using the interest rate in
effect at the time the loan was placed on nonaccrual status. A loan's
observable market value or collateral value may be used as an alternative
valuation technique. Impairment exists when the recorded investment in a loan
exceeds the value of the loan measured using the above-mentioned valuation
techniques. Such impairment is recognized as a valuation reserve, which is
included as a part of the Company's allowance for losses. The adoption of
these new standards did not have a material impact on the Company's allowance
for losses.
In October 1995, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123, "Accounting for Stock-Based Compensation." This standard was
effective January 1, 1996. The standard encourages, but does not require,
adoption of a fair value-based accounting method for stock-based compensation
arrangements and would supersede the provisions of Accounting Principles
Board Opinion No. 25 (APB No. 25), "Accounting for Stock Issued to
Employees." An entity may continue to apply APB No. 25 provided the entity
discloses its pro forma net income and earnings per share as if the fair
value-based method had been applied in measuring compensation cost. The
Company continues to apply APB No. 25 and to disclose the pro forma
information required by SFAS No. 123.
Statement of Financial Accounting Standards No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" (SFAS 125), effective for the Company on January 1, 1997,
provides new methods of accounting and reporting for transfers and servicing
of financial assets and extinguishments of liabilities. SFAS No. 127 has
delayed the effective date of certain sections of SFAS 125 until January 1,
1998. The Company's adoption of the appropriate sections of SFAS 125 is not
expected to have a material effect on the Company's financial position or
results of operations.
FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act. Discussions containing such
forward-looking statements may be found in the material set forth under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business," as well as within the annual report generally.
When used in this annual report, the words "believes," "anticipates,"
"expects," "plans," "intends," "estimates," "continue," "could," "may" or
"will" (or the negative of such words) and similar expressions are intended
to identify forward-looking statements. Such statements are subject to a
number of risks and uncertainties. Actual results in the future could differ
materially from those described in the forward-looking statements as a result
of the risk considerations set forth below and the matters set forth in this
annual report generally. HPSC cautions the reader, however, that such list of
considerations may not be exhaustive. HPSC undertakes no obligation to
release publicly the result of any revisions to these forward-looking
statements that may be made to reflect any future events or circumstances.
CERTAIN CONSIDERATIONS
Dependence on Funding Sources; Restrictive Covenants. The Company's
financing activities are capital intensive. The Company's revenues and
profitability are related directly to the volume of financing contracts it
originates. To generate new financing contracts, the Company requires access
to substantial short- and long-term credit. To date, the Company's principal
sources of funding for its financing transactions have been (i) a revolving
credit facility with The First National Bank of Boston, as Agent, for
borrowing up to $95.0 million (the "Revolver"), (ii) borrowings under a
receivables-backed limited recourse asset securitization transaction with
Funding I in an original amount of $70.0 million, (iii) a $100.0 million
limited recourse revolving credit facility with Bravo, (iv) a fixed-rate,
full recourse term loan from a savings bank, (v) specific recourse sales of
financing contracts to savings banks and other purchasers ((iv) and (v)
constitute "Savings Bank Indebtedness") and (vi) the Company's internally
generated revenues. There can be no assurance that the Company will be able
to negotiate a new revolving credit facility at the end of the current term
of the Revolver in December 1997, complete additional asset securitizations
or obtain other additional financing, when needed and on acceptable terms.
The Company would be adversely affected if it were unable to continue to
secure sufficient and timely funding on acceptable terms. The agreement
governing the Revolver (the "Revolver Agreement") contains numerous financial
and operating covenants. There can be no assurance that the Company will be
able to maintain compliance with these covenants, and failure to meet such
covenants would result in a default under the Revolver Agreement. Moreover,
the Company's financing arrangements with Bravo and the savings banks
described above incorporate the covenants and default provisions of the
Revolver Agreement. Thus, any default under the Revolver Agreement will also
trigger defaults under these other financing arrangements. In addition, the
Indenture contains certain covenants that could restrict the Company's access
to funding.
Securitization Recourse; Payment Restriction and Default Risk. As part of
its overall funding strategy, the Company utilizes asset securitization
transactions with wholly-owned, bankruptcy-remote subsidiaries to seek fixed
rate, matched-term financing. The Company sells financing contracts to these
subsidiaries which, in turn, either pledge or sell the contracts to third
parties. The third parties' recourse with regard to the pledge or sale is
limited to the contracts sold to the subsidiary. If the contract portfolio of
these subsidiaries does not perform within certain guidelines, the
subsidiaries must retain or "trap" any monthly cash distribution to which the
Company might otherwise be entitled. This restriction on cash distributions
could continue until the portfolio performance returns to acceptable levels
(as defined in the relevant agreements), which restriction could have a
negative impact on the cash flow available to the Company. There can be no
assurance that the portfolio performance would return to acceptable levels or
that the payment restrictions would be removed. In July and August of 1996,
the level of delinquencies of the contracts held in Funding I rose above
specified levels and triggered such a payment restriction event, "trapping"
any cash distributions to the Company. The event was considered a default
under the Revolver Agreement, which default was waived by the lending banks.
In September 1996, delinquency levels improved and the payment restrictions
were removed. A payment restriction event may occur again before Funding I is
fully paid out. The default provisions of the Revolver Agreement were amended
in December 1996 to conform to the default provisions of the Funding I
agreements. As a result, a payment restriction event under Funding I will not
constitute a default under the Revolver Agreement unless such event continues
for at least six months. There can be no assurance that any future defaults
will be waived by the lending banks.
Customer Credit Risks. The Company maintains an allowance for doubtful
accounts in connection with payments due under financing contracts originated
by the Company (whether or not such contracts have been securitized, held as
collateral for loans to the Company or, when sold, a separate recourse
reserve is maintained) at a level which the Company deems sufficient to meet
future estimated uncollectible receivables, based on an analysis of the
delinquencies, problem accounts, and overall risks and probable losses
associated with such contracts, together with a review of the Company's
historical credit loss experience. There can be no assurance that this
allowance or recourse reserve will prove to be adequate. Failure of the
Company's customers to make scheduled payments under their financing
contracts could require the Company to (i) make payments in connection with
its recourse loan and asset sale transactions, (ii) lose its residual
interest in any underlying equipment and (iii) forfeit collateral pledged as
security for the Company's limited recourse asset securitizations. In
addition, although the provision for losses on the contracts originated by
the Company have been 1.1% of the Company's net investment in leases and
notes for 1996, any increase in such losses or in the rate of payment
defaults under the financing contracts originated by the Company could
adversely affect the Company's ability to obtain additional financing,
including its ability to complete additional asset securitizations and
secured asset sales or loans. There can be no assurance that the Company will
be able to maintain or reduce its current level of credit losses.
Competition. The Company's financing activities are highly competitive.
The Company competes for customers with a number of national, regional and
local finance companies, including those which, like the Company, specialize
in financing for healthcare providers. In addition, the Company's competitors
include those equipment manufacturers which finance the sale or lease of
their products themselves, conventional leasing companies and other types of
financial services companies such as commercial banks and savings and loan
associations. Many of the Company's competitors and potential competitors
possess substantially greater financial, marketing and operational resources
than the Company. Moreover, the Company's future profitability will be
directly related to its ability to obtain capital funding at favorable
funding rates as compared to the capital costs of its competitors. The
Company's competitors and potential competitors include many larger, more
established companies that have a lower cost of funds than the Company and
access to capital markets and to other funding sources that may be
unavailable to the Company. There can be no assurance that the Company will
be able to continue to compete successfully in its targeted markets.
Equipment Market Risk. The demand for the Company's equipment financing
services depends upon various factors not within its control. These factors
include general economic conditions, including the effects of recession or
inflation, and fluctuations in supply and demand related to, among other
things, (i) technological advances in and economic obsolescence of the
equipment and (ii) government regulation of equipment and payment for
healthcare services. The acquisition, use, maintenance and ownership of most
types of medical and dental equipment, including the types of equipment
financed by the Company, are affected by rapid technological changes in the
healthcare field and evolving federal, state and local regulation of
healthcare equipment, including regulation of the ownership and resale of
such equipment. Changes in the reimbursement policies of the Medicare and
Medicaid programs and other third-party payors, such as insurance companies,
as well as changes in the reimbursement policies of managed care
organizations, such as health maintenance organizations, may also affect
demand for medical and dental equipment and, accordingly, may have a material
adverse effect on the Company's business, operating results and financial
condition.
Changes in Healthcare Payment Policies. The increasing cost of medical
care has brought about federal and state regulatory changes designed to limit
governmental reimbursement of certain healthcare providers. These changes
include the enactment of fixed-price reimbursement systems in which the rates
of payment to hospitals, outpatient clinics and private individual and group
practices for specific categories of care are determined in advance of
treatment. Rising healthcare costs may also cause non-governmental medical
insurers, such as Blue Cross and Blue Shield associations and the growing
number of self-insured employers, to revise their reimbursement systems and
policies governing the purchasing and leasing of medical and dental
equipment. Alternative healthcare delivery systems, such as health
maintenance organizations, preferred provider organizations and managed care
programs, have adopted similar cost containment measures. Other proposals to
reform the United States healthcare system are considered from time to time.
These proposals could lead to increased government involvement in healthcare
and otherwise change the operating environment for the Company's customers.
Healthcare providers may react to these proposals and the uncertainty
surrounding such proposals by curtailing or deferring investment in medical
and dental equipment. Future changes in the healthcare industry, including
governmental regulation thereof, and the effect of such changes on the
Company's business cannot be predicted. Changes in payment or reimbursement
programs could adversely affect the ability of the Company's customers to
satisfy their payment obligations to the Company and, accordingly, may have a
material adverse effect on the Company's business, operating results and
financial condition.
Interest Rate Risk. Except for $18.7 million of the Company's financing
contracts, which are at variable interest rates with no scheduled payments,
the Company's financing contracts require the Company's customers to make
payments at fixed interest rates for specified terms. However, approximately
$40.0 million of the Company's borrowings currently are subject to a variable
interest rate. Consequently, an increase in interest rates, before the
Company is able to secure fixed-rate, long-term financing for such contracts
or to generate higher-rate financing contracts to compensate for the
increased borrowing cost, could adversely affect the Company's business,
operating results and financial condition. The Company's ability to secure
additional long-term financing and to generate higher-rate financing
contracts is limited by many factors, including competition, market and
general economic conditions and the Company's financial condition.
Residual Value Risk. At the inception of its equipment leasing
transactions, the Company estimates what it believes will be the fair market
value of the financed equipment at the end of the initial lease term and
records that value (typically 10% of the initial purchase price) on its
balance sheet. The Company's results of operations depend, to some degree,
upon its ability to realize these residual values (as of December 31, 1996,
the estimated residual value of equipment at the end of the lease term was
approximately $9.3 million, representing approximately 5.7% of the Company's
total assets). Realization of residual values depends on many factors,
several of which are not within the Company's control, including, but not
limited to, general market conditions at the time of the lease expiration;
any unusual wear and tear on the equipment; the cost of comparable new
equipment; the extent, if any, to which the equipment has become
technologically or economically obsolete during the contract term; and the
effects of any new government regulations. If, upon the expiration of a lease
contract, the Company sells or refinances the underlying equipment and the
amount realized is less than the original recorded residual value for such
equipment, a loss reflecting the difference will be recorded on the Company's
books. Failure to realize aggregate recorded residual values could thus have
an adverse effect on the Company's business, operating results and financial
condition.
Sales of Receivables. As part of the Company's portfolio management
strategy and as a source of funding of its operations, the Company has sold
selected pools of its lease contracts and notes receivable due in
installments to a variety of savings banks. Each of these transactions is
subject to certain covenants that require the Company to (i) repurchase
financing contracts from the bank and/or make payments under certain
circumstances, including the delinquency of the underlying debtor, and (ii)
service the underlying financing contracts. The Company carries a recourse
reserve for each transaction in its allowance for losses and recognizes a
gain that is included for accounting purposes in earned income for leases and
notes for the year in which the transaction is completed. Each of these
transactions incorporates the covenants under the Revolver as such covenants
were in effect at the time the asset sale or loan agreement was entered into.
Any default under the Revolver may trigger a default under the loan or asset
sale agreements. The Company may enter into additional asset sale agreements
in the future in order to manage its liquidity. The level of recourse
reserves established by the Company in relation to these sales may not prove
to be adequate. Failure of the Company to honor its repurchase and/or payment
commitments under these agreements could create an event of default under the
loan or asset sale agreements and under the Revolver. There can be no
assurance that a continuing market can be found to sell these types of assets
or that the purchase prices in the future would generate comparable gain
recognition.
Dependence on Sales Representatives. The Company is, and its growth and
future revenues are, dependent in large part upon (i) the ability of the
Company's sales representatives to establish new relationships, and maintain
existing relationships, with equipment vendors, distributors and
manufacturers and with healthcare providers and other customers and (ii) the
extent to which such relationships lead equipment vendors, distributors and
manufacturers to promote the Company's financing services to potential
purchasers of their equipment. As of December 31, 1996, the Company had 14
field sales representatives and eight in-house sales personnel. Although the
Company is not materially dependent upon any one sales representative, the
loss of a group of sales representatives could, until appropriate
replacements were obtained, have a material adverse effect on the Company's
business, operating results and financial condition.
Dependence on Current Management. The operations and future success of
the Company are dependent upon the continued efforts of the Company's
executive officers, two of whom are also directors of the Company. The loss
of the services of any of these key executives could have a material adverse
effect on the Company's business, operating results and financial condition.
Fluctuations in Quarterly Operating Results. Historically, the Company
has generally experienced fluctuating quarterly revenues and earnings caused
by varying portfolio performance and operating and interest costs. Given the
possibility of such fluctuations, the Company believes that quarterly
comparisons of the results of its operations during any fiscal year are not
necessarily meaningful and that results for any one fiscal quarter should not
be relied upon as an indication of future performance.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
HPSC, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands,
except share amounts)
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
ASSETS
Cash and Cash Equivalents........................................ $ 2,176 $ 861
Restricted Cash.................................................. 6,769 5,610
Investment in Leases and Notes:
Lease contracts and notes receivable due in installments...... 160,049 128,687
Notes receivable.............................................. 18,688 12,002
Estimated residual value of equipment at end of lease term.... 9,259 9,206
Less unearned income.......................................... (34,482) (25,875)
Less allowance for losses..................................... (4,082) (4,482)
Less security deposits........................................ (4,522) (3,427)
Deferred origination costs.................................... 4,312 3,805
------------ ------------
Net investment in leases and notes......................... 149,222 119,916
------------ ------------
Other Assets:
Other assets.................................................. 3,847 3,096
Refundable income taxes....................................... 1,203 1,088
------------ ------------
Total Assets............................................... $ 163,217 $ 130,571
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Revolving Credit Borrowings...................................... $ 40,000 39,000
Senior Notes..................................................... 76,737 49,523
Accounts Payable and Accrued Liabilities......................... 5,916 3,537
Accrued Interest................................................. 450 339
Estimated Recourse Liabilities................................... 480 30
Income Taxes:
Currently payable............................................. 300 368
Deferred...................................................... 5,002 4,613
------------ ------------
Total Liabilities.......................................... $ 128,885 $ 97,410
------------ ------------
Stockholders' Equity:
Preferred Stock, $1.00 par value; authorized 5,000,000 shares. - -
Issued None......................................................
Common Stock, $.01 par value; 15,000,000 shares authorized; and
issued 4,786,530 shares in 1996 and 1995..................... 48 48
Treasury Stock (at cost) 128,600 shares in 1996 and 100,000
shares in 1995............................................... (587) (410)
Additional paid-in capital....................................... 12,305 11,311
Retained earnings................................................ 25,351 24,476
------------ ------------
37,117 35,425
Less: Deferred compensation...................................... (2,590) (2,066)
Notes receivable from officers and employees............... (195) (198)
------------ ------------
Total Stockholders' Equity................................. 34,332 33,161
------------ ------------
Total Liabilities and Stockholder's Equity................. $ 163,217 $ 130,571
------------ ------------
The accompanying notes are an integral part of the consolidated financial
statements.
HPSC, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share and
share amounts)
YEAR ENDED DECEMBER 31,
-------------------------
1996 1995 1994
---- ---- ----
Revenues
Earned income on leases and notes............................ $ 17,515 $ 12,871 $ 11,630
Gain on sales of leases and notes............................ 1,572 53 -
Provision for losses......................................... (1,564) (1,296) (754)
-----------------------------------
Net Revenues............................................... 17,523 11,628 10,876
Operating and Other (Income) Expenses
Selling, general and administrative.......................... 8,059 5,984 6,970
Interest expense............................................. 8,146 5,339 3,514
Interest income on cash balances............................. (261) (375) (358)
Loss on write-off of foreign currency translation adjustment. - 601 -
-----------------------------------
Income before Income Taxes....................................... 1,579 79 750
Provision for Income Taxes....................................... 704 204 300
-----------------------------------
Net Income (Loss)................................................ $875 $ (125) $450
-----------------------------------
Net Income (Loss) per Share...................................... $.22 $ (.03) $.09
-----------------------------------
Shares Used to Compute Net Income (Loss) per share............... 4,067,236 3,881,361 4,989,391
The accompanying notes are an integral part of the consolidated financial
statements.
HPSC, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands except share amounts)
CUMULATIVE
NOTES FOREIGN
COMMON STOCK ADDITIONAL RECEIVABLE CURRENCY
------------ PAID-IN RETAINED TREASURY DEFERRED FROM OFFICERS TRANSLATION
SHARES AMOUNT CAPITAL EARNINGS STOCK COMPENSATION AND EMPLOYEES ADJUSTMENT TOTAL
----------- ---------- ----------- --------------- --------- ------------- ----------- ------------ -------
Balance 4,923,571 $49 $13,645 $24,151 $ - $ - $ - $(224) $37,621
at
December
25, 1993..
Issuance 824 - 3 - - - - - 3
of
Common
Stock..
Net Income - - 450 - - - - 450
Purchase - - - (5,023) - - - (5,023)
of
Treasury
Stock..
Issuance 650,000 7 2,268 - - (2,275) - - -
of
Common
Stock to
ESOP &
SESOP..
ESOP - - - - - 99 - - 99
Compensation
Foreign - - - - - - - (328) (328)
currency
translation
adjustments..
-------- --------- ---------- ---------- --------- --------- ----------- --------- -------
Balance 5,574,395 56 15,916 24,601 (5,023) (2,176) - (552) 32,822
at
December
31, 1994
Issuance 317 - - - - - - - -
of
Common
Stock..
Net
Loss... - - - (125) - - - - (125)
Retirement of (1,125,182) (12) (4,601) - 4,613 - - - -
Treasury
Stock
Restricted 337,000 4 (4) - - - - - -
Stock
Awards..
ESOP - - - - - 110 - - 110
Compensation
Foreign - - - - - - - (49) (49)
currency
translation
adjustments
Recognized in - - - - - - - 601 601
current
period upon
liquidation
of foreign
subsidiary
Increase in - - - - - - (198) - (198)
Notes
Receivable
from
Officers and
Employees -------- -------- --------- --------- ------- -------- -------- --------- -------
Balance at 4,786,530 48 11,311 24,476 (410) (2,066) (198) - 33,861
December
31, 1995
Net Income - - - 875 - - - - 875
Restricted - - 994 - - (994) - - -
Stock
Awards
Purchase of - - - - (177) - - - (177)
Treasury
Stock
Restricted - - 365 - - 365
Stock
Compensation
ESOP - - - - - 105 - - 105
Compensation
Decrease in - - - - - - 3 - 3
Notes
Receivable
from
Officers and
Employee --------- --------- -------- ---------- -------- --------- --------- ---------- -----
Balance at 4,786,530 $48 $12,305 $25,351 $(587) $(2,590) $(195) $ - $34,332
December
31, 1996 --------- --------- -------- ---------- -------- --------- --------- -------- -------
The accompanying notes are an integral part of the consolidated financial
statements.
HPSC, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
--------- --------------- ---------
Cash Flows from Operating Activities
Net income (loss)............................................................ $ 875 $ (125) $ 450
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Foreign currency translation adjustments.................................... -- 601 --
Depreciation and amortization............................................... 2,862 2,340 1,872
Deferred income taxes....................................................... 389 (926) (1,093)
Restricted stock compensation............................................... 365 -- --
Gain on sale of receivables................................................. (1,572) (53) --
Provision for losses on lease contracts and notes receivable................ 1,564 1,296 754
Increase (decrease) in accrued interest..................................... 111 46 (3,141)
Increase (decrease) in accounts payable and accrued liabilities............. 2,379 1,087 (2,898)
(Decrease) increase in accrued income taxes................................. (68) 348 (290)
Decrease (increase) in refundable income taxes.............................. (115) 358 827
(Increase) decrease in other assets......................................... (110) (458) 921
--------- ------------ ---------
Cash provided by (used in) operating activities.............................. 6,680 4,514 (2,598)
--------- ------------ ---------
Cash Flows from Investing Activities
Origination of lease contracts and notes receivable due in installments...... (90,729) (63,945) (29,710)
Portfolio receipts, net of amounts included in income........................ 38,445 37,654 43,727
Proceeds from sales of lease contracts and notes receivable due in
installments................................................................ 24,344 1,500 6,958
Net increase in notes receivable............................................. (6,730) (7,570) (4,370)
Net increase (decrease) in security deposits................................. 1,095 788 (221)
Net increase in other assets................................................. (834) (844) (700)
Loans to employees........................................................... 3 (198) (9)
--------- ------------ ---------
Cash (used in) provided by investing activities.............................. (34,406) (32,615) 15,675
--------- ------------ ---------
Cash Flows from Financing Activities
Repayment of senior notes and subordinated debt.............................. (26,019) (23,385) (98,976)
Proceeds from issuance of senior notes, net of debt issue costs.............. 52,973 28,422 69,033
Repayment of notes payable-treasury stock purchase........................... -- (4,500) --
Net proceeds from demand and revolving notes payable to banks................ 1,000 25,570 9,370
Purchase of treasury stock................................................... (177) -- (523)
Increase (decrease) in restricted cash....................................... 1,159 2,326 (7,936)
Proceeds from issuance of common stock....................................... -- -- 3
Repayment of employee stock ownership plan promissory note................... 105 110 99
Other........................................................................ -- -- (328)
--------- ------------ ---------
Cash provided by (used in) financing activities.............................. 29,041 28,543 (29,258)
--------- ------------ ---------
Net increase (decrease) in cash and cash equivalents.......................... 1,315 442 (16,181)
Cash and cash equivalents at beginning of year................................ 861 419 16,600
--------- ------------ ---------
Cash and cash equivalents at end of year...................................... $ 2,176 $ 861 $ 419
--------- ------------ ---------
Supplemental disclosures of cash flow information:
Interest paid................................................................ $ 7,719 $ 4,510 $ 6,630
Income taxes paid............................................................ 765 1,423 2,018
The accompanying notes are an integral part of the consolidated financial
statements.
HPSC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business--HPSC, Inc. ("HPSC") and its consolidated subsidiaries (the
"Company") provide credit primarily to healthcare professionals throughout
the United States.
The Company leases dental, ophthalmic, chiropractic, veterinary, podiatry
and other medical equipment utilized in the healthcare professions. The Company
does not carry any inventory. The Company acquires the financed equipment from
vendors at their customary selling price to other customers. All leases are
classified as direct financing leases.
The Company also finances the acquisition of healthcare practices by
healthcare professionals and provides financing on leasehold improvements,
office furniture and equipment and certain other costs involved in opening or
maintaining a healthcare provider's office. In connection with sales of leases
and notes receivable, the Company may retain the rights to service the assets
sold and receive a service fee in connection with such activities. In addition,
through its wholly-owned subsidiary, ACFC, the Company provides asset-based
financing to commercial enterprises.
Consolidation--The accompanying consolidated financial statements include
HPSC, Inc. and the following wholly-owned subsidiaries: HPSC Funding Corp. I
("Funding I"), a special purpose corporation formed in connection with a
securitization transaction in 1993; Credident, Inc. ("Credident") the
Company's Canadian subsidiary; American Commercial Finance Corporation
("ACFC"), an asset-based lender focused primarily on accounts receivable and
inventory financing at variable rates; and HPSC Bravo Funding Corp.
("Bravo"), a special purpose corporation formed in connection with
securitizations in 1995 and 1996. All intercompany transactions have been
eliminated.
Use of Estimates--The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. A significant area requiring the use of
management estimates is the allowance for losses on lease and notes
receivable, including the recourse provisions related to lease and note
receivables sold. Actual results could differ from those estimates.
Revenue Recognition--The Company finances equipment only after a
customer's credit has been approved and a financing agreement for the
transaction has been executed. The Company performs ongoing credit
evaluations of its customers and maintains allowances for potential credit
losses. When a transaction is initially activated, the Company records the
minimum payments and the estimated residual value, if any, associated with
the transaction. An amount equal to the sum of the payments due plus residual
less the cost of the transaction is recorded as unearned income. The unearned
income is recognized as revenue over the life of the transaction using the
interest method in essentially all cases. Recognition of revenue on these
assets is suspended no later than when a transaction becomes 145 days
delinquent. Also included in earned income are fee income from service
charges on portfolio accounts, gains and losses on residual transactions plus
miscellaneous income items net of initial direct cost amortization.
Sales of Leases and Notes Receivable--The Company sells leases and notes
receivable to third parties. Gains on sales of leases and notes are
recognized at the time of the sale in an amount equal to the present value of
the anticipated future cash flows, net of initial direct costs, expenses and
estimated credit losses under certain recourse provisions of the related sale
agreements. Generally, the Company retains the servicing of lease receivables
sold. Servicing fees specified in the sale agreements, which approximate
market-rate servicing fees, are deferred and recognized as revenue in
proportion to the estimated periodic servicing costs.
Deferred Origination Costs--The Company capitalizes initial direct costs
that relate to the origination of leases and notes receivable. These initial
direct costs are comprised of certain specific activities related to
processing requests for financing. Deferred origination costs are amortized
over the life of the receivable as an adjustment of yield.
Allowance for Losses--The Company records an allowance for losses in its
portfolio. The extent of the allowance is based on a specific analysis of
potential loss accounts, delinquencies and historical loss experiences. An
account is specifically reserved for or written off when deemed uncollectible.
The Company occasionally repossesses equipment from lessees who have
defaulted on their obligations to the Company. There was no such equipment held
for sale at December 31, 1996 or December 31, 1995.
Effective January 1, 1995, the Company adopted prospectively, SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosure." These standards, which do not apply to the Company's lease
contracts, apply to the Company's practice acquisition and asset-based loans,
the two major risk classifications
used to aggregate loans for purposes of SFAS No. 114. The standards require that
a loan be classified and accounted for as an impaired loan when it is probable
that the Company will be unable to collect all principal and interest due on the
loan in accordance with the loan's original contractual terms.
Impaired practice acquisition and asset-based loans are valued based on the
present value of expected future cash flows, using the interest rate in effect
at the time the loan was placed on nonaccrual status. A loan's observable market
value or collateral value may be used as an alternative valuation technique.
Impairment exists when the recorded investment in a loan exceeds the value of
the loan measured using the above-mentioned valuation techniques. Such
impairment is recognized as a valuation reserve, which is included as a part of
the Company's allowance for losses. The Company had no impaired loans at
December 31, 1996 or 1995.
Accounting for Stock-Based Compensation--In October 1995, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 123, "Accounting for
Stock-Based Compensation." This standard was effective January 1, 1996. The
standard encourages, but does not require, adoption of a fair value-based
accounting method for stock-based compensation arrangements and would
supersede the provisions of Accounting Principles Board Opinion No. 25 (APB
No. 25), "Accounting for Stock Issued to Employees." An entity may continue
to apply APB No. 25 provided the entity discloses its pro forma net income
and earnings per share as if the fair value-based method had been applied in
measuring compensation cost. The Company continues to apply APB No. 25 and
has disclosed the pro forma information required by SFAS No. 123.
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities--Statement of Financial Accounting Standards
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" (SFAS No. 125), effective for the Company in
January 1997, provides new methods of accounting and reporting for transfers
and servicing of financial assets and extinguishments of liabilities. SFAS
No. 127 has delayed the effective date of certain sections of SFAS No. 125
until January 1, 1998. The Company's adoption of the appropriate sections of
SFAS No. 125 is not expected to have a material effect on the Company's
financial position or results of operations.
Income Taxes--The Company accounts for income taxes in accordance with
SFAS No. 109, "Accounting for Income Taxes." Current tax liabilities or
assets are recognized, through charges or credits to the current tax
provision, for the estimated taxes payable or refundable for the current
year. Net deferred tax liabilities or assets are recognized, through charges
or credits to the deferred tax provision, for the estimated future tax
effects, based on enacted tax rates, attributable to temporary differences.
Deferred tax liabilities are recognized for temporary differences that will
result in amounts taxable in the future, and deferred tax assets are
recognized for temporary differences and tax benefit carryforwards that will
result in amounts deductible or creditable in the future. The effect of
enacted changes in tax law, including changes in tax rates, on these deferred
tax assets and liabilities is recognized in income in the period that
includes the enactment date. A deferred tax valuation reserve is established
if it is more likely than not that all or a portion of the Company's deferred
tax assets will not be realized. Changes in the deferred tax valuation
reserve are recognized through charges or credits to the deferred tax
provision.
Foreign Currency Translation--The Company accounts for translation of
foreign currency in accordance with Statement of Financial Accounting
Standards No. 52, "Foreign Currency Translation" (SFAS No. 52). Over a number
of years, the accounts of the Company's Canadian subsidiary, Credident, when
translated into U.S. dollars, lost value as a result of the decline in the
Canadian dollar in relation to the U.S. dollar. In accordance with SFAS No.
52, the cumulative amount of such translation losses had been presented as a
reduction of stockholders' equity. The Company discontinued its Canadian
operations in 1994, and during 1995, the Company substantially liquidated its
investment in Credident. In accordance with SFAS No. 52, upon substantial
liquidation in 1995, the cumulative exchange losses were reflected in the
statement of operations and eliminated as a separate component of
stockholders' equity. During 1996, such translation adjustments, which were
not significant, were reflected in current operations.
Net Income (Loss) per Share--Earnings per share computations are based
on the weighted average number of common and common share equivalents
outstanding. The weighted average number of common and common share equivalents
outstanding do not include unallocated shares under the Company's ESOP and SESOP
plans, unvested restricted stock awards and treasury stock. Fully diluted and
primary income per share are the same for each of the periods presented.
Cash and Cash Equivalents--The Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
Interest Rate Contracts--The Company utilizes interest rate contracts to
reduce the interest rate risk associated with the Company's variable rate
borrowings. The Company has established a control environment which includes
policies and procedures for risk assessment and the approval, reporting and
monitoring of derivative financial instrument activities. The Company does
not hold or issue derivative financial instruments for trading purposes. The
differentials to be received or paid under contracts designated as hedges are
recognized in income as they accrue over the life of the contracts as
adjustments to interest expense.
Property and Equipment--Office furniture, equipment and capital leases
are recorded at cost and depreciated using the straight-line method over a
period of three to five years. Leasehold improvements are amortized over the
shorter of the life of the lease or the asset. Upon retirement or other
disposition, the cost
and related accumulated depreciation of the assets are removed from the
accounts and the resulting gain or loss is reflected in income. Net property,
plant and equipment is included in other assets and was not material at
December 31, 1996 and 1995.
Deferred Compensation--Deferred compensation includes notes receivable
from the Company's Employee Stock Ownership Plan ("ESOP") and Supplemental
Employee Stock Ownership Plan ("SESOP"), and deferred compensation related to
restricted stock awards. Deferred compensation consists of the following:
(IN THOUSANDS) 1996 1995 1994
- -------------- --------- --------- ---------
ESOP...................... $ 736 $ 841 $ 951
SESOP..................... 1,225 1,225 1,225
Restricted Stock.......... 629 -- --
------- --------- ---------
Total................... $ 2,590 $ 2,066 $ 2,176
------- --------- ---------
Non-Cash Operating, Investing and Financing Activities--On November
1, 1994, the Company executed an agreement with certain secured creditors of
Healthco International, Inc. ("Healthco") under which it settled all existing
and potential claims between the Company and Healthco and purchased 1,225,182
shares of stock. In 1994, the Company made a cash payment of $1,785,000 and
issued a note payable of $4,500,000 to the secured creditors of Healthco to
(i) settle net liabilities of $1,262,000 due to Healthco and (ii) to purchase
the 1,225,182 shares of stock.
In 1996, the Company recognized $365,000 in compensation expense relating
to restricted stock awards under its 1995 Stock Incentive Plan (Note G).
Fiscal Year--For 1994 and prior years, the Company's fiscal year was
the 52 or 53 week period ending on the last Saturday of the calendar year.
The 1994 fiscal year covers the 53-week period from December 26, 1993 to
December 31, 1994. In fiscal year 1995, the Company changed its fiscal
year-end to December 31.
Reclassifications--Certain amounts in the 1995 and 1994 consolidated
financial statements have been reclassified to conform to the current year
presentation.
NOTE B. LEASES AND NOTES RECEIVABLE
The Company considers its finance portfolio assets to consist of two
general categories of assets based on such assets' relative risk.
The first category of assets consists of the Company's lease contracts
and notes receivable due in installments, which comprise approximately 87.7%
of the Company's net investment in leases and notes at December 31, 1996
(90.1% at December 31, 1995). Substantially all of such contracts and notes
are due from licensed medical professionals, principally dentists, who
practice in individual or small group practices. Such contracts and notes are
at fixed interest rates and have terms ranging from 12 to 84 months. The
Company believes that leases and notes entered into with medical
professionals are generally "small-ticket," homogeneous transactions with
similar risk characteristics. Except for the amounts described in the
following paragraph related to asset-based lending, all of the Company's
historical provision for losses, charge offs, recoveries and allowance for
losses have related to its lease contracts and notes due in installments.
The second category of assets consists of the Company's notes receivable,
which comprise approximately 12.3% of the Company's net investment in leases
and notes at December 31, 1996 (9.9% at December 31, 1995). Such notes
receivable consist of commercial, asset-based, revolving lines of credit to
small and medium size manufacturers and distributors, at variable interest
rates, and typically have terms of two years. The Company began commercial
lending activities in mid-1994. Through December 31, 1996, the Company has
not had any charge offs of commercial notes receivable. The provision for
losses related to the commercial notes receivable was $146,000, $95,000 and
$43,000 in 1996, 1995 and 1994, respectively. The amount of the allowance for
losses related to the commercial notes receivable was $284,000 and $138,000
at December 31, 1996 and 1995, respectively.
A summary of activity in the Company's allowance for losses which relates
to the Company's investment in leases and notes for each of the years in the
three-year period ended December 31, 1996 is as follows:
(IN THOUSANDS) 1996 1995 1994
- -------------- --------- --------- ---------
Beginning balance........ $ (4,482) $ (4,595) $ (6,897)
Provision for losses..... (1,114) (1,266) (754)
Charge offs.............. 1,609 1,504 3,350
Recoveries............... (95) (125) (294)
--------- --------- ---------
Balance, end of year..... $ (4,082) $ (4,482) $ (4,595)
--------- --------- ---------
The Company's receivables are exposed to credit risk. To reduce the risk
to the Company, stringent underwriting policies in approving leases and notes
are closely monitored by management.
The total contractual balances of delinquent lease contracts and notes
receivable due in installments over 90 days past due amounted to $5,763,000
at December 31, 1996 compared to $4,964,000 at December 31, 1995. An account
is initially considered delinquent when not paid within thirty days of the
billing due date.
The Company's agreements with its customers, except for notes receivable
related to ACFC (approximately $18,688,000 in 1996 and $12,002,000 in 1995),
are non-cancelable and provide for a full payout at a fixed financing rate
with a fixed payment schedule over a term of three to seven years. Scheduled
future receipts on lease contracts and notes receivable due in installments,
including interest and excluding the residual value of the equipment and ACFC
receivables, as of December 31 are as follows:
(IN THOUSANDS):
- --------------
1997...................... $ 50,156
1998...................... $ 37,740
1999...................... $ 31,221
2000...................... $ 22,941
2001 and thereafter....... $ 17,991
At December 31, 1996 and 1995, the Company had outstanding unfunded
asset-based lending commitments of approximately $14,853,000 and $7,100,000.
These amounts represent the aggregate difference between committed lines of
credit and advances on such lines. The rates on such commitments fluctuate
based on the prime rate. As a result, the Company is not exposed to interest
rate risk on such commitments. In addition, at December 31, 1996 and 1995,
the Company had approved fixed rate lease and practice finance applications
outstanding but not yet activated of approximately $47,500,000 and
$39,900,000, respectively. These approved applications are subject to
reevaluation if not accepted within 60 days. While the Company is not legally
bound to honor such approvals prior to activation, it has historically
honored such approvals. The Company may be exposed to unfavorable movements
in interest rates between the approval date and the activation date.
NOTE C. SALES OF LEASE AND NOTES RECEIVABLE
In November 1995, the Company received a total of approximately
$1,500,000 in connection with a sale of notes receivable due in installments.
In 1996, the Company sold additional leases and notes receivable due in
installments, received a total of $24,344,000 in initial proceeds and is
scheduled to receive $4,074,000 in future payments from such sales. The
related sales agreements are subject to certain covenants that, among other
matters, may require the Company to repurchase the assets sold and/or make
payments under certain circumstances, primarily on the failure of the
underlying debtors to pay when due (the "recourse provisions"). At the time
of sale, the Company recognizes its estimated liability under the recourse
provisions. In connection with the sale of leases and notes during 1996 and
1995, the Company recognized estimated recourse liability of $450,000 and
$30,000 respectively. The Company has contingent obligations to repurchase
leases and notes due in installments, which had an outstanding balance of
$16,696,000 at December 31, 1996 and $1,466,000 at December 31, 1995. In
addition, under the sales agreements the Company is obligated to continue to
service the assets sold. The Company recorded a servicing liability of
approximately $395,000 and $20,000 related to sale transactions in 1996 and
1995, respectively, which will be recognized as revenue in proportion to the
estimated future periodic servicing costs. The Company recognized
approximately $15,000 of such revenue in 1996. Gains of approximately
$1,572,000 and $53,000 were recognized by the Company in 1996 and 1995,
respectively, related to sales of notes and leases.
NOTE D. REVOLVING CREDIT BORROWINGS AND OTHER DEBT
Debt of the Company as of December 31, 1996 and December 31, 1995 is
summarized below:
(IN THOUSANDS) 1996 1995
- -------------- --------- ---------
Revolving credit arrangement Due Dec. 31, 1997...... $ 40,000 $ 39,000
---------- ---------
Senior Notes:
Senior Notes (Funding I)
Due Dec., 1999...................................... 6,861 20,150
Senior Notes (Bravo)
Due Nov., 2000 through Aug., 2001................... 67,524 26,303
Senior Notes (SIS) Due Mar., 2001................... 2,352 3,070
---------- ---------
Total Senior Notes.................................. 76,737 49,523
---------- ---------
Total............................................... $ 116,737 $ 88,523
---------- ---------
Revolving Credit Arrangement--In May 1995, the Company executed an
Amended and Restated Revolving Loan agreement with the First National Bank of
Boston as Managing Agent (the "Revolving Loan Agreement"), increasing
availability under this arrangement to $50,000,000. The Revolving Loan
Agreement was amended in December 1995 to increase availability to
$60,000,000 and to extend the term to December 31, 1996. In December, 1996,
the Revolving Loan Agreement was further amended to increase availability to
$95,000,000 and extend the term to December 30, 1997. Under the Revolving
Loan Agreement, the Company may borrow at variable rates of prime or in
Eurodollar loans at LIBOR plus 1.25% to 1.75%, dependent upon certain
performance covenants. Such rates on the outstanding borrowings were 7.5% and
8.0% at December 31, 1996 and 1995, respectively. In connection with the
arrangement, all HPSC and ACFC assets, including ACFC stock but excluding
assets collateralized under the senior notes, have been pledged as
collateral. The Revolving Loan Agreement has not been historically hedged,
and is not hedged at December 31, 1996, and is, therefore, exposed to upward
movements in interest rates. Management believes that the Company's liquidity
is adequate to meet current obligations and future projected levels of
financings, and to carry on normal operations. The Company will continue to
seek to raise additional capital from bank and non-bank sources, and from
selective use of asset-sale transactions in the future. The Company expects
that it will be able to obtain additional capital at competitive rates, but
there can be no assurance that it will be able to do so.
In July and August of 1996, the level of delinquencies of the contracts
held in Funding I rose above certain levels, as defined in the operative
documents, and triggered a payment restriction event. This restriction had
the effect of "trapping" any cash distribution that the Company otherwise
would have been eligible to receive. The event was considered a technical
default under the Revolving Loan Agreement, which default was waived by the
lending banks. In September 1996, delinquency levels improved and the payment
restrictions were removed. A payment restriction is not unusual during the
later stages of a static pool securitization and may occur again before
Funding I is fully paid out. The default provisions of the Revolving Credit
Agreement were amended on December 12, 1996 to conform to the default
provisions of the Funding I agreements. As a result, a payment restriction
event under Funding I will not constitute a default under the Revolving Loan
Agreement unless such event continues for at least six months.
Senior Notes (Funding I)--The Company borrowed $70,000,000 in a
receivable-backed securitization transaction ("Securitization") on December
27, 1993. Under the terms of the Securitization, the Company formed a
wholly-owned, special-purpose subsidiary, Funding I, to which the Company
sold or contributed certain of its equipment lease contracts, conditional
sales agreements, leasehold improvement loans, equipment residual rights and
rights to underlying equipment ("Collateral"). Funding I subsequently issued
$70,000,000 of secured notes ("Notes"), bearing interest at a fixed rate of
5.01%, secured by the Collateral. The Notes are rated "AAA" by Standard &
Poor's. Monthly payments of interest and principal on the Notes are made
through the application of regularly scheduled monthly receivable payments on
the Collateral. The Company is the servicer of the Collateral portfolio,
subject to its meeting certain covenants. The required monthly payments of
interest and principal to holders of the Notes are unconditionally guaranteed
by Municipal Bond Investor Assurance Corporation pursuant to the terms of a
Note guarantee insurance policy.
As of December 31, 1996 and 1995, Funding I had gross receivables of
approximately $9,758,000 and $26,984,000, respectively, which were pledged as
Collateral. The Agreement also provides for restrictions on cash balances
under certain conditions relating to default and delinquency ratios
applicable to the Collateral. At December 31, 1996 and 1995, restricted cash
amounted to approximately $4,014,000 and approximately $4,693,000,
respectively.
Note payments to investors, based on projected cash flows from the
Collateral, for the years 1997 through 1999 are expected to be as follows:
$5,328,000, $1,307,000, and $226,000, respectively. However, the agreement
also contains a provision that requires early termination and payment to
investors when the restricted cash contains an amount equal to investor
balances. This event may occur during 1997.
Senior Notes (Bravo)--As of January 31, 1995, the Company, along with
its wholly-owned, special-purpose subsidiary, HPSC Bravo Funding Corp.
("Bravo") had available borrowings of $50,000,000 under a revolving credit
facility structured and guaranteed by Capital Markets Assurance Corporation
("CapMAC"). Under the terms of the facility, Bravo, to which the Company
sells and may continue to sell or contribute certain of its portfolio assets,
pledges its interests in these assets to a commercial-paper conduit entity.
Bravo incurs interest at variable rates in the commercial paper market and
enters into interest rate swap agreements to assure fixed rate funding. In
November 1996, the facility was amended to increase available borrowing to
$100,000,000 and to allow up to $30,000,000 of the facility to be used for
sales of financing contracts.
Monthly settlements of principal and interest payments are made from the
collection of payments on Bravo's transactions. The terms of the facility
restrict the use of certain collected cash. Such restricted cash
amounted to approximately $2,755,000 and $917,000 at December 31, 1996 and
1995, respectively. Additional sales to Bravo from HPSC may be made subject
to certain covenants regarding Bravo's portfolio performance and borrowing
base calculations.
The Company is the servicer of the Bravo portfolio, subject to its
meeting certain covenants. The required monthly payments of principal and
interest to purchasers of the commercial paper are guaranteed by CapMAC
pursuant to the terms of the agreement.
In the normal course of its business, the Company enters into interest
rate swap contracts to hedge its interest rate risk related to its variable
rate notes payable. Under such interest rate swap contracts, the Company pays
a fixed rate of interest and receives a variable rate from the counterparty.
Credit risk is the possibility that a loss may occur if a counterparty to a
transaction fails to perform according to the terms of the contract. The
notional amount of interest rate contracts is the amount upon which interest
and other payments under the contract are based.
At December 31, 1996, the Company had approximately $67,524,000
outstanding under the loan portion of this facility and, in connection with
these borrowings, had 14 separate interest rate swap agreements with the Bank
of Boston with a total notional value of approximately $65,231,000. The
Company had utilized approximately $6,991,000 of the sale pool and in
connection with such sale, had one interest rate swap agreement with a total
notional value of approximately $6,713,000.
At December 31, 1995, the Company had approximately $26,303,000
outstanding under the loan facility. In connection with these borrowings, the
Company had six interest rate swap agreements with a notional value of
approximately $27,500,000.
The amounts of borrowings outstanding under the loan portion of the Bravo
facility, the notional amount of swaps outstanding related to such loans and
the effective interest rate under the swaps, assuming payments are made as
scheduled will be as follows:
(IN THOUSANDS EXCEPT FOR %) BORROWINGS SWAPS RATE
- --------------------------- ----------- --------- ---------
December 31, 1996............................. $ 67,524 $ 65,231 6.29%
December 31, 1997............................. $ 46,493 $ 46,576 6.28%
December 31, 1998............................. $ 28,255 $ 29,152 6.24%
December 31, 1999............................. $ 13,593 $ 14,338 6.19%
December 31, 2000............................. $ 4,155 $ 4,553 6.16%
December 31, 2001............................. $ 675 $ 854 6.14%
Senior Notes (SIS)--In April 1995, the Company entered into a
secured, fixed rate, fixed term loan agreement with Springfield Institution
for Savings under which the Company borrowed $3,500,000 at 9.5% subject to
certain recourse and performance covenants.
Certain debt/securitization agreements contain restrictive covenants
which, among other things, include minimum net worth, interest coverage
ratios, capital expenditures, and portfolio performance guidelines. At
December 31, 1996, the Company was in compliance with the provisions of its
debt covenants.
The scheduled maturities of the Company's revolving credit borrowings and
other debt at December 31, 1996 are as follows (in thousands):
1997.............................. $ 67,004
1988.............................. $ 20,248
1999.............................. $ 15,534
2000.............................. $ 9,770
2001.............................. $ 3,508
Thereafter........................ $ 673
NOTE E. LEASE COMMITMENTS
The Company leases various office locations under noncancelable lease
arrangements that have terms of from three to five years and that generally
provide renewal options from one to five years. Rent expense under all
operating leases was $391,000, $318,000, and $198,000 for 1996, 1995 and
1994, respectively.
Future minimum lease payments for commitments exceeding twelve months
under non-cancelable operating leases as of December 31, 1996, are as follows
(in thousands):
1997.............................. $ 324
1998.............................. $ 324
1999.............................. $ 146
2000.............................. -0-
2001 & thereafter................. -0-
NOTE F. INCOME TAXES
Deferred income taxes reflect the impact of "temporary differences"
between the amount of assets and liabilities for financial reporting purposes
and such amounts as measured by tax laws and regulations.
The components of income (loss) before income taxes are as follows (in
thousands):
YEAR ENDED DECEMBER 31,
--------------------------------
(IN THOUSANDS) 1996 1995 1994
- -------------- ---------- --------- ---------
Domestic............................... $1,699 $154 $891
Foreign................................ (120) (75) (141)
---------- --------- ---------
Income (loss) before income taxes...... $1,579 $79 $750
---------- --------- ---------
Income taxes consist of the following:
YEAR ENDED DECEMBER 31,
----------------------------
(IN THOUSANDS) 1996 1995 1994
- -------------- --------- --------- ---------
Federal:
Current.................................. $ 251 $ 832 $ 808
Deferred................................. 310 (569) (530)
State:
Current.................................. 64 426 635
Deferred................................. 79 (357) (563)
Foreign:
Current.................................. -- (128) (50)
Deferred................................. -- -- --
--------- --------- ---------
Provision (credit) for income taxes......... $ 704 $ 204 $ 300
--------- --------- ---------
Deferred income taxes arise from the following:
YEAR ENDED DECEMBER 31,
-------------------------------
(IN THOUSANDS) 1996 1995 1994
- -------------- --------- --------- ---------
Operating method......................... 142 $ (2,501) $ (3,498)
Alternative minimum tax credit........... -- 609 2,147
Other.................................... 247 966 258
--------- --------- ---------
$ 389 $ (926) $ (1,093)
--------- --------- ---------
A reconciliation of the statutory federal income tax rate and the
effective tax rate as a percentage of pre-tax income for each year is as
follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
Statutory rate........................................................ 34.0% 34.0% 34.0%
State taxes net of US federal income tax benefit...................... 6.0 55.7 5.2
Effect of prior year foreign tax recovery............................. -- (162.0) --
Foreign loss not benefited............................................ 2.6 22.7 --
Non-deductible write-off of foreign currency translation adjustment... -- 258.5 --
Other................................................................. 2.0 49.3 .8
--- --------- ---
44.6% 258.2% 40.0%
--- --------- ---
The items which comprise a significant portion of deferred tax liabilities
as of December 31, 1996 and December 31, 1995 are as follows:
(IN THOUSANDS) 1996 1995
- ------------------ --------- ---------
Operating method............ $ 5,146 $ 5,004
Other....................... (144) (391)
--------- ---------
Deferred income taxes....... $ 5,002 $ 4,613
--------- ---------
At December 31, 1996 consolidated retained earnings included $260,000 of
unremitted earnings from the Company's foreign subsidiary. In the event of
repatriation, the Company does not anticipate any significant additional
income taxes.
NOTE G. STOCK OPTION AND STOCK INCENTIVE PLANS
Stock Option Plans--The Company had three stock option plans in place
which provided for the granting of options to purchase up to 801,875 shares
of common stock: the Employee Stock Option Plan dated March 23, 1983, as
amended (the "1983 Plan"), the Stock Option Plan dated March 5, 1986 (the
"1986 Plan") and the 1994 Stock Plan dated March 23, 1994 (the "1994 Plan").
These three plans were terminated in May 1995 upon the approval of the 1995
Stock Incentive Plan discussed below.
Options granted under the 1983 Plan are either incentive stock options or
non-qualified options and were granted at no less than 85% of the fair market
value of the Common Stock on the date of grant. Officers and directors of the
Company and its subsidiaries were eligible to participate under the 1986 Plan
and only non-qualified stock options were granted under the 1986 Plan.
Options under the Plan were granted at an exercise price equal to the market
price on the date of grant. Key employees, directors of and consultants to
the Company were eligible to participate in the 1994 Plan. Only non-qualified
options were granted under the 1994 Plan. The Plan required that the option
exercise price in each case be at least 50% of the fair market value of the
Common Stock on the date of grant. All options granted under the Plan had an
exercise price equal to the fair market value of the Common Stock on the
grant date. Options vest over five years of service.
1995 Stock Incentive Plan--The Company has outstanding stock options and
awards of restricted stock under its 1995 Stock Incentive Plan dated March 8,
1995, as amended March 14, 1996, (the "1995 Stock Plan") pursuant to which
550,000 shares of Common Stock are reserved. A total of 138,000 shares of the
Company's Common Stock remained available for grants of options or awards of
restricted stock under the 1995 Stock Plan at December 31, 1996.
1995 Stock Plan--Restricted Stock--The 1995 Stock Plan provides that
restricted shares of Common Stock awarded under the plan will remain unvested
until certain performance and service conditions are both met.
The performance condition is met with respect to 50% of the restricted
shares if and when during the five-year period after the date of grant ("the
Performance Period") the closing price of the Company's Common Stock, as
reported on the Nasdaq National Market System for a consecutive ten-day
period, equals at least 134.175% of the closing price on the grant date (the
"Partial Performance Condition"). The performance condition is met with
respect to the remaining 50% of the restricted shares if and when during the
Performance Period the closing price of the Company's Common Stock, as
reported on the Nasdaq National Market System for a consecutive ten-day
period, equals at least 168.35% of the closing price on the grant date (the
"Full Performance Condition").
The service condition is met with respect to all restricted shares
(provided that the applicable performance condition has also been met) by the
holder's continuous service for the Company throughout the Performance Period
provided that such holder shall also have completed five (5) years of
continued service with the Company from the date of grant. Upon a change of
control of the Company (as defined in the 1995 Stock Plan), all restricted
stock awards granted prior to such change of control become fully vested.
Upon the termination of a holder's employment by the Company without
cause or by reason of death or disability during the Performance Period, any
restricted stock awards for which the applicable performance condition is
satisfied no later than four months after the date of such termination of
employment shall become fully vested.
Awards of 337,000 restricted shares of the Company's Common Stock were
made in May 1995. The Partial Performance Condition of these shares is $5.90
per share with respect to 332,000 shares and $6.04 with respect to 5,000
shares, and the Full Performance Condition is $7.37 per share with respect to
332,000 shares and $7.58 with respect to 5,000 shares. Additional paid in
capital and deferred compensation of $994,000 was recorded when the
performance criteria was achieved with respect to 50% of the restricted
shares in June 1996. Compensation expense of $365,000 was recognized in 1996
and the remaining deferred compensation will be recognized over the remaining
term of the service condition.
1995 Stock Plan--Stock Options--The 1995 Stock Plan provides that
with respect to options made to key employees (except non-employee
directors), the option term and the terms and conditions upon which the
options may be exercised will be determined by the Compensation Committee of
the Company's Board of Directors for each such option at the time it is
granted (except so delegated to the chief executive officer for non-executive
officer grants). Options granted to key employees of the Company may be
either incentive stock options (within the meaning of Section 422 of the
Internal Revenue Code of 1986 and subject to the restrictions of that section
on certain terms of such options) or non-qualified options, as designated by
the Compensation Committee.
With respect to automatic options to non-employee directors of the
Company (which must be non-qualified options), the 1995 Stock Plan specifies
the option term and the terms and conditions upon which the options may be
exercised. Each non-employee director who is such at the conclusion of any
regular annual meeting of the Company's stockholders while the 1995 Stock
Plan is in effect and who will continue to serve on the Board of Directors is
granted such automatic options to purchase 1,000 shares of the Company's
Common Stock at a price equal to the closing price of the Common Stock, as
reported on the Nasdaq National Market System, on the date of grant of the
option. Each automatic option is exercisable immediately in full or for any
portion thereof and remains exercisable for ten years after the date of
grant, unless terminated earlier (as provided in the Plan) upon or following
termination of the holder's service as a director.
Other Option Grants--At December 31, 1996, there were options
exercisable for an aggregate of 2,000 shares of Common Stock outstanding to a
consultant and options exercisable for an aggregate of 4,000 shares of Common
Stock outstanding to a non-employee director of the Company.
The following table summarizes stock option and restricted stock activity:
OPTIONS
-------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE RESTRICTED
OPTIONS PRICE STOCK
----------- --------- -----------
Outstanding at January 1, 1994..... 471,875 $ 2.96 --
Granted............................ 190,000 $ 3.70 --
Exercised.......................... -- -- --
Expired............................ -- -- --
Forfeited.......................... (25,000) $ 3.25 --
----------- --------- -----------
Outstanding at December 31, 1994.. 636,875 $ 3.17 --
Granted............................ 25,000 $ 4.33 337,000
Exercised.......................... -- -- --
Expired............................ -- -- --
Forfeited.......................... (50,000) $ 3.56 --
----------- --------- -----------
Outstanding at December 31, 1995... 611,875 $ 3.19 337,000
Granted............................ 60,000 $ 5.15 --
Exercised.......................... -- -- --
Expired............................ -- -- --
Forfeited.......................... (30,000) $ 3.31 --
----------- --------- -----------
Outstanding at December 31, 1996... 641,875 $ 3.36 337,000
----------- --------- -----------
The following table sets forth information regarding options outstanding
at December 31, 1996:
WEIGHTED WEIGHTED
NUMBER OF AVERAGE AVERAGE WEIGHTED
RANGE OF OPTIONS OPTIONS OPTIONS AVERAGE
EXERCISE NUMBER OF CURRENTLY GRANTED EXERCISABLE REMAINING
PRICES OPTIONS EXERCISABLE EXERCISABLE PRICE PRICE LIFE (YEARS)
- -------- -------- ----------- ----------------- ------------- -------------
2.63-3.25 391,875 356,500 $2.87 $2.86 6.10
3.38-4.00 175,000 89,667 $3.75 $3.76 7.42
4.50-4.88 59,000 18,000 $4.70 $4.72 8.78
6.13-6.63 16,000 7,000 $6.40 $6.19 9.16
------ ---------- --------------- ------------- ------------
2.63-6.63 641,875 471,167 $3.36 $3.15 6.29
------ ---------- --------------- ------------- ------------
The weighted average grant date fair values of options granted for the
years ending December 31, 1996 and 1995 were $3.07 and $4.24, respectively.
Stock Purchase Plan--Under the Stock Purchase Plan, eligible employees
were granted options to acquire, through authorized payroll deductions,
shares of common stock. The Stock Purchase Plan provided for options to be
granted twice each year, on the first day of a six-month payment period, with
exercise of the option to take place on the last business day of each such
payment period at a purchase price of the lesser of 85% of the fair market
value of the shares on the option grant date or on the option exercise date.
The Stock Purchase Plan was terminated upon the approval of the Stock
Incentive Plan in May, 1995. During 1995 and 1994, 317 and 824 shares,
respectively, were issued under the Stock Purchase Plan.
Notes Receivable from Officers and Employees (Stock Loan Program)--On
January 5, 1995, the Compensation Committee approved a Stock Loan Program
whereby executive officers and other senior personnel of the Company earning
more than $80,000 per year may borrow from the Company an amount equal to the
cost of purchasing two shares of Common Stock, solely for the purpose of
acquiring such stock, for each share of Common Stock purchased by the
employee from sources other than Company funds. Such borrowings may not
exceed $200,000 in any fiscal quarter of the Company, $200,000 per employee
or $400,000 during the term of the loan program for all employees. The loans
are recourse, bear interest at a variable rate which is one-half of one
percent above the Company's cost of funds, payable monthly in arrears, and
are payable as to principal no later than five years after the date of the
loan. All shares purchased with such loans are pledged to the Company as
collateral for repayment of the loans.
Pro Forma Disclosure--As described in Note A, the Company uses the
intrinsic value method to measure compensation expense associated with the
grants of stock options or awards to employees. Had the Company used the fair
value method to measure compensation, reported net income and earnings per
share would have been as follows (in thousands, except per share amounts):
1996 1995
--------- ---------
Income (loss) before income taxes..................... $ 1,598 $ (64)
Provision for income taxes............................ 735 204
--------- ---------
Net income (loss)..................................... $ 863 $ (140)
--------- ---------
Net income (loss) per share........................... $ 0.21 $ (0.04)
--------- ---------
For purposes of determining the above disclosure required by Statement of
Financial Accounting Standards No. 123, the fair value of options on their
grant date was measured using the Black/Scholes option pricing model. Key
assumptions used to apply this pricing model were as follows:
1996 1995
--------- ---------
Risk-free interest rate.............................. 6.0% 6.7%
Expected life of option grants....................... 10 years 10 years
Expected volatility of underlying stock.............. 36.4% 46.6%
The pro forma presentation only includes the effects of grants made
subsequent to January 1, 1995.
NOTE H. EMPLOYEE BENEFIT PLANS
Employee Stock Ownership Plan--In December 1993, the Company
established a stock bonus type of Employee Stock Ownership Plan ("ESOP") for
the benefit of all eligible employees. The ESOP is expected to be primarily
invested in common stock of the Company on behalf of the employees. ESOP
contributions are at the discretion of the Company's Board of Directors and
are determined annually. However, it is the Company's present intention to
make contributions sufficient to repay the ESOP's Promissory Note on a level
funding basis over a 10-year period. The Company measures the expense related
to such contributions based on the original cost of the stock which was
originally issued to the ESOP. Shares of stock which were issued to the ESOP
are allocated to the participants based on a calculation of the ratio of the
annual contribution amount to the original principal of the Promissory Note.
The Company made contributions of $105,000 in 1996, $110,000 in 1995, and
$99,000 in 1994.
Employees with five or more years of service with the Company from and
after December 1993 at the time of termination of employment will be fully
vested in their benefits under the ESOP. For a participant with fewer than
five years of service from December 1993 through his or her termination date,
his or her account balance will vest at the rate of 20% for each year of
employment. Upon the retirement or other termination of an ESOP participant,
the shares of common stock in which he or she is vested, at the option of the
participant, may be converted to cash or may be distributed. The unvested
shares are allocated to the remaining participants. The Company has issued
300,000 shares of Common Stock to this plan in consideration of a Promissory
Note in the principal amount of $1,050,000. As of December 31, 1996, 89,654
shares of Common Stock have been allocated to participant accounts under the
ESOP and 210,346 shares remain unallocated. The market value of unallocated
share was $1,262,076.
Supplemental Employee Stock Ownership Plan--In July, 1994, the
Company adopted a Supplemental Employee Stock Ownership Plan ("SESOP") for
the benefit of all eligible employees. Eligibility requirements are similar
to the ESOP discussed above except that any amounts allocated under the SESOP
would first be
allocated to the accounts of certain highly compensated employees to make up
for certain limitations on Company contributions under the ESOP required by
the 1993 Tax Act and next to all eligible employees on a non-discriminatory
basis. The Company has issued 350,000 shares of Common Stock to this plan in
consideration for a Promissory Note in the principal amount of $1,225,000.
SESOP contributions are at the discretion of the Company's Board of Directors
and are determined annually. No contributions have been made nor have any
allocations yet been made to participant accounts.
Savings Plan--The Company has established a Savings Plan covering
substantially all full-time employees, which allows participants to make
contributions by salary deductions pursuant to Section 401(k) of the Internal
Revenue Code. The Company matches employee contributions up to a maximum of
2% of the employee's salary. Both employee and employer contributions are
vested immediately. The Company's contributions to the Savings Plan were
$62,841 in 1996, $49,419 in 1995 and $37,975 in 1994.
NOTE I. PREFERRED STOCK PURCHASE RIGHTS PLAN
Pursuant to a rights agreement between the Company and the First National
Bank of Boston, as rights agent, dated August 3, 1993, the Board of Directors
declared a dividend on August 3, 1993 of one preferred stock purchase right
("Right") for each share of the Company's common stock (the "Shares")
outstanding on or after August 13, 1993. The Right entitles the holder to
purchase one one-hundredth of a share of Series A Preferred Stock, which
fractional share is substantially equivalent to one share of Common Stock, at
an exercise price of $20. The Rights will not be exercisable or transferable
apart from the Common Stock until the earlier to occur of (i) 10 days
following a public announcement that a person or affiliated group has
acquired 15 percent or more of the outstanding Common Stock (such person or
group, an "Acquiring Person"), or (ii) 10 business days after an announcement
or commencement of a tender offer which would result in a person or group's
becoming an Acquiring Person, subject to certain exceptions. The Rights
beneficially owned by the Acquiring Person and its affiliates become null and
void upon the Rights becoming exercisable.
If a person becomes an Acquiring Person or certain other events occur,
each Right entitles the holder, other than the Acquiring Person, to purchase
common stock (or one one-hundredth of a share of Preferred Stock, at the
discretion of the Board of Directors) having a market value of two times the
exercise price of the Right. If the Company is acquired in a merger or other
business combination, each exercisable Right entitles the holder, other than
the Acquiring Person, to purchase Common Stock of the acquiring company
having a market value of two times the exercise price of the Right.
At any time after a person becomes an Acquiring Person and prior to the
acquisition by such person of 50% or more of the outstanding Common Stock,
the Board of Directors may direct the Company to exchange the Rights held by
any person other than an Acquiring Person at an exchange ratio of one share
of Common Stock per Right. The Rights may be redeemed by the Company, subject
to approval of the Board of Directors, for one cent per Right in accordance
with the provisions of the Rights Plan. The Rights have no voting or dividend
privileges.
NOTE J. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
FASB Statement No. 107, "Disclosures about Fair Value of Financial
Instruments" ("SFAS No. 107"), requires the Company to disclose the estimated
fair values for certain of its financial instruments. Financial instruments
include items such as loans, interest rate contracts, notes payable, and other
items as defined in SFAS No. 107.
Fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing
parties, other than in a forced or liquidation sale.
Quoted market prices are used when available; otherwise, management
estimates fair value based on prices of financial instruments with similar
characteristics or using valuation techniques such as discounted cash flow
models. Valuation techniques involve uncertainties and require assumptions
and judgments regarding prepayments, credit risk and discount rates. Changes
in these assumptions will result in different valuation estimates. The fair
values presented would not necessarily be realized in an immediate sale; nor
are there plans to settle liabilities prior to contractual maturity.
Additionally, SFAS No. 107 allows companies to use a wide range of valuation
techniques; therefore, it may be difficult to compare the Company's fair
value information to other companies' fair value information.
The following table presents a comparison of the carrying value and
estimated fair value of the Company's financial instruments at December 31,
1996:
IN THOUSANDS VALUE FAIR VALUE
- ------------ ---------- ----------
Financial liabilities:
Notes payable.......................................... $116,737 $116,130
Interest rate contracts................................ $-0- $(336)
The following table presents a comparison of the carrying value and
estimated fair value of the Company's financial instruments at December 31,
1995:
CARRYING ESTIMATED
IN THOUSANDS VALUE FAIR VALUE
- ------------ ---------- ----------
Financial assets:
Cash and cash equivalents.............................. $861 $861
Restricted cash........................................ $5,610 $5,610
Net investment in leases and notes..................... $119,916 $119,916
Financial liabilities:
Notes payable.......................................... $88,523 $88,523
The following methods and assumptions were used to estimate the fair
value of each class of financial instrument:
Cash, cash equivalents and restricted cash: For these short-term
instruments, the carrying amount is a reasonable estimate of fair value.
Net investment in leases and notes: The estimated fair value of net
investment in leases and notes approximates carrying value. Loans at rates
similar to those in the current portfolio could be made to borrowers with
similar credit ratings and for similar remaining maturities. For nonaccrual
practice acquisition and asset-based loans, fair value is estimated by
discounting management's estimate of future cash flows with a discount rate
commensurate with the risk associated with such assets.
Notes payable: The fair market value of the Company's senior notes is
estimated based on the quoted market prices for the same or similar issues
or on the current rates offered to the Company for debt of the same
maturity. At December 31, 1995, the Company's senior notes, as shown on the
accompanying balance sheet, reflect their approximate fair market value.
Interest rate contracts: The fair value of interest rate contracts is
estimated based on the estimated amount necessary to terminate the
agreements. At December 31, 1995, this amount was not material to the
financial statements.
NOTE K. SUBSEQUENT EVENT
On March 26, 1997, the Company completed the issuance of $20 million of
unsecured senior subordinated notes due in 2007, which bear interest at a
fixed rate of 11%. The Company received approximately $18.5 million in net
proceeds, which it used to repay a portion of the amount outstanding under
the Revolving Credit Arrangement (Note D).
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of HPSC, Inc.:
We have audited the accompanying consolidated balance sheet of HPSC, Inc.
and subsidiaries as of December 31, 1996, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for the
year then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the consolidated financial position of HPSC, Inc. and
subsidiaries as of December 31, 1996, and the consolidated results of their
operations and their cash flows for the year then ended, in conformity with
generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Boston, Massachusetts
February 28, 1997
(March 26, 1997 as to Note K)
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of HPSC, Inc.:
We have audited the accompanying consolidated balance sheet of HPSC, Inc. as
of December 31, 1995, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for each of the two years in the
period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of HPSC, Inc. as
of December 31, 1995, and the consolidated results of its operations and its
cash flows for each of the two years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles.
As discussed in Note A to the financial statements, the Company adopted
Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
for Impairment of a Loan," as amended by Statement of Financial Accounting
Standards No. 118, "Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosure," effective January 1, 1995.
Coopers & Lybrand L.L.P.
BOSTON, MASSACHUSETTS
March 25, 1996
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The information required by this item has been filed on Form 8-K,
dated June 19, 1996.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference from the
sections captioned "PROPOSAL ONE--ELECTION OF DIRECTORS --Nominees for Class II
Directors," "--Members of the Board of Directors Continuing in Office" and " -
Other Executive Officers" and "VOTING SECURITIES--Section 16(a) Beneficial
Ownership Reporting Compliance" in the 1997 Proxy Statement to be filed not
later than 120 days after the end of the fiscal year covered by this annual
report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
sections captioned "EXECUTIVE COMPENSATION--Summary Compensation Table," "
- -Stock Loan Program," "--Supplemental Executive Retirement Plan," "--Option
Grants in Last Fiscal Year," "--Aggregated Option Exercises and Year-End
Values,"--Employment Agreements" and "--Compensation of Directors" in the 1997
Proxy Statement to be filed not later than 120 days after the end of the fiscal
year covered by this annual report on Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
section captioned "VOTING SECURITIES--Share Ownership of Certain Beneficial
Owners and Management" in the 1997 Proxy Statement to be filed not later than
120 days after the end of the fiscal year covered by this annual report on Form
10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not Applicable
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) 1. FINANCIAL STATEMENTS
--------------------
The consolidated financial statements filed as part of this Report are
listed in Item 8.
(A) 2. FINANCIAL STATEMENT SCHEDULES
-----------------------------
Schedules have been omitted because they are not applicable, or not
required, or because the required information is included in the
consolidated financial statements or notes thereto.
LOCATION OF DOCUMENTS PERTAINING TO EXECUTIVE COMPENSATION PLANS AND
ARRANGEMENTS
ITEM IN
NAME OF DOCUMENT THIS REPORT CROSS REFERENCE
---------------- ----------- ---------------
1. HPSC, Inc. Stock Option 10.2 Incorporated by reference to Exhibit
Plan dated March 5,1986 10.6 to HPSC's Annual Report on Form
10-K for the fiscal year ended
December 30, 1989
2. Employment Agreement 10.3 Incorporated by reference to Exhibit
between the Company and 10.3 to HPSC's Amendment No. 1 to
John W. Everets, dated as of Registration Statement on Form S-1 filed on
July 19, 1996 March 10, 1997
3. Employment Agreement 10.4 Incorporated by reference to Exhibit
between the Company and 10.4 to HPSC's Amendment No. 1 to
Raymond R. Doherty dated as Registration Statement on Form S-1 filed on
of August 2, 1996 March 10, 1997
4. HPSC, Inc. Employee Stock 10.6 Incorporated by reference to Exhibit
Ownership Plan Agreement 10.9 to HPSC's Annual Report on
dated December 22, 1993 Form 10-K for the fiscal year ended
between HPSC, Inc. and John December 25, 1993
Everets and Raymond
Doherty, as trustees
5. First Amendment effective 10.7 Incorporated by reference to Exhibit
January 1, 1993 to HPSC, Inc. 10.2 to HPSC's Quarterly Report on
Employee Stock Ownership Form 10-Q for the quarter ended
Plan June 25, 1994
6. Second Amendment effective 10.8 Incorporated by reference to Exhibit
January 1, 1994 to HPSC, 10.11 to HPSC's Annual Report on
Inc., Employee Stock Form 10-K for the fiscal year ended
Ownership Plan December 31, 1994
7. Third Amendment effective 10.9 Incorporated by reference to Exhibit
January 1, 1993 to HPSC, Inc. 10.12 to HPSC's Annual Report on
Employee Stock Ownership Form 10-K for the fiscal year ended
Plan December 31, 1994
8. HPSC, Inc. 401 (k) Plan dated 10.13 Incorporated by reference to Exhibit
February, 1993 between 10.15 to HPSC's Annual Report on
HPSC, Inc. and Metropolitan Form 10-K for the fiscal year ended
Life Insurance Company December 25, 1993
9. HPSC, Inc. Supplemental 10.10 Incorporated by reference to Exhibit
Employee Stock Ownership 10.3 to HPSC's Quarterly Report on
Plan and Trust dated July 25, Form 10-Q for the quarter ended June
1994 25, 1994
10. HPSC, Inc. 1994 Stock Plan 10.11 Incorporated by reference to Exhibit
dated as of March 23, 1994 10.4 to HPSC's Quarterly Report on
and related forms of Form 10-Q for the quarter ended June
Nonqualified Option Grant 25, 1994
and Option Exercise Form
11. Employment Agreement 10.5 Incorporated by reference to Exhibit
between HPSC, Inc. and Rene 10.5 to HPSC's Quarterly Report on
Lefebvre dated April 6, 1994 Form 10-Q for the quarter ended June
25, 1994
12. Amended and Restated HPSC, 10.29 Incorporated by reference to Exhibit 10.27 to
Inc. 1995 Stock Incentive Plan HPSC's Annual Report on Form 10-K for the
fiscal year ended December
31, 1995.
13. Stock Option grant to Lowell 10.30 Incorporated by reference to Exhibit 10.28 to
P. Weicker effective HPSC's Annual Report on Form 10-K for the
December 7, 1995 fiscal year ended December 31, 1995.
14. HPSC, Inc. Supplemental 10.12 Incorporated by reference to Exhibit 10.12 to
Executive Retirement Plan HPSC's Amendment No. 1 to Registration
dated as of January 1, 1997 Statement on Form S-1 filed March 10, 1997.
(a) 3 EXHIBITS
Exhibits
- --------------
NO. TITLE METHOD OF FILING
--- ----- ----------------
3.1 Restated Certificate of Incorporation of Incorporated by reference to Exhibit 3.1 to HPSC's Annual
HPSC, Inc. Report on Form 10-K for the fiscal year ended December 31,
1995.
3.2 Certificate of Amendment to Incorporated by reference to Exhibit 3.2 to HPSC's Annual
Restated Certificate of Report filed on Form 10-K for the fiscal year ended
Incorporation of HPSC, Inc. December 31, 1995.
in Delaware on September 14,
1987
3.3 Certificate of Amendment to Incorporated by reference to Exhibit 3.3 to HPSC's Annual
Restated Certificate of Report filed on Form 10-K for the fiscal year ended
Incorporation of HPSC, Inc. December 31, 1995.
in Delaware on May 22, 1995
3.4 Amended and Restated By-Laws Incorporated by reference to Exhibit 3.4 to HPSC's Amendment
No. 1 to Registration Statement on Form S-1 filed March 10,
1997
4.1 Rights Agreement dated as of Incorporated by reference to
August 3, 1993 between the Exhibit 4 to HPSC's Amendment
Company and The First National No. 1 to its Current Report on
Bank of Boston, N.A., including Form 8-K filed August 11, 1993
as Exhibit B thereto the form of
Rights Certificate
10.1 Lease dated as of March 8, Incorporated by reference to
1994 between the Trustees of Exhibit 10.1 to HPSC's Annual
60 State Street Trust and Report on Form 10-K for the
HPSC, Inc., dated September fiscal year ended December 31,
10, 1970 and relating to the 1994
principal executive offices of
HPSC, Inc. at 60 State Street,
Boston, Massachusetts
10.2 HPSC, Inc. Stock Option Plan, Incorporated by reference to
dated March 5, 1986 Exhibit 10.6 to HPSC's Annual
Report on Form 10-K for the
fiscal year ended December 30,
1989
10.3 Employment Agreement Incorporated by reference to
between the Company and Exhibit 10.3 to HPSC's Amendment No. 1
John W. Everets, dated as of to Registration Statement on Form S-1
July 19, 1996 filed March 10, 1997
10.4 Employment Agreement Incorporated by reference to
between the Company and Exhibit 10.4 to HPSC's Amendment No. 1
Raymond R. Doherty dated to Registration Statement on Form S-1
as of August 2, 1996 filed March 10, 1997
10.5 Employment Agreement Incorporated by reference to
between HPSC, Inc. and Rene Exhibit 10.5 to HPSC's Quarterly
Lefebvre dated April 6, 1994 Report on Form 10-Q for the
quarter ended June 25, 1994
10.6 HPSC, Inc. Employee Stock Incorporated by reference to
Ownership Plan Agreement Exhibit 10.9 to HPSC's Annual
dated December 22, 1993 Report on Form 10-K for the
between HPSC, Inc. and John fiscal year ended December 25,
W. Everets and Raymond R. 1993
Doherty, as trustees
10.7 First Amendment effective Incorporated by reference to
January 1, 1993 to HPSC, Inc. Exhibit 10.2 to HPSC's Quarterly
Employee Stock Ownership Plan Report on Form 10-Q for the
quarter ended June 25, 1994
10.8 Second Amendment effective Incorporated by reference to
January 1, 1994 to HPSC, Inc. Exhibit 10.11 to HPSC's Annual
Employee Stock Ownership Plan Report on Form 10-K for the fiscal
year ended December 31, 1994
10.9 Third Amendment effective Incorporated by reference to
January 1, 1993 to HPSC, Inc. Exhibit 10.12 to HPSC's Annual
Employee Stock Ownership Plan Report on Form 10-K for the
fiscal year ended December 31, 1994
10.10 HPSC, Inc. Supplemental Incorporated by reference to
Employee Stock Ownership Plan Exhibit 10.3 to HPSC's Quarterly
and Trust dated July 25, 1994 Report on Form 10-Q for the
dated July 25, 1994 quarter ended June 25, 1994
10.11 HPSC, Inc. 1994 Stock Plan Incorporated by reference to
dated as of March 23, 1994 and Exhibit 10.4 to HPSC's Quarterly
related forms of Nonqualified Report on Form 10-Q for the
Option Grant and Option quarter ended June 25, 1994
Exercise Form
10.12 HPSC, Inc. Supplemental Executive Incorporated by reference to Exhibit 10.12
Retirement Plan dated as of to HPSC's Amendment No. 1 to
January 1, 1997 Registration Statement on Form S-1
filed March 10, 1997
10.13 HPSC, Inc. 401(k) Plan dated Incorporated by reference to
February, 1993 between HPSC, Exhibit 10.15 to HPSC's Annual
Inc. and Metropolitan Life Report on Form 10-K for the
Insurance Company fiscal year ended December 25,
1993
10.14 Indenture and Service Incorporated by reference to
Agreement dated as of Exhibit 10.10 to HPSC's Annual
December 23, 1993 by and Report on Form 10-K for the
among HPSC Funding corp. I, fiscal year ended December 25,
HPSC, Inc. and State Street 1993
Bank and Trust company of
Connecticut, N.A.
10.15 Sale and Contribution Incorporated by reference to
Agreement dated as of Exhibit 10.11 to HPSC's Annual
December 23, 1993 between Report on Form 10-K for the
HPSC Funding Corp I and fiscal year ended December 25,
HPSC, Inc. 1993
10.16 Note Purchase Agreement Incorporated by reference to
dated as of December 23, 1993 Exhibit 10.12 to HPSC's Annual
among HPSC Funding Corp. I, Report on Form 10-K for the
HPSC, Inc. and the Prudential fiscal year ended December 25,
Life Insurance Company of 1993
America
10.17 Insurance Agreement dated as Incorporated by reference to
of December 23, 1993 among Exhibit 10.13 to HPSC's Annual
Municipal Bond Investors Report on Form 10-K for the
Assurance Corporation, HPSC fiscal year ended December 25,
Funding Corp. I, HPSC, Inc. and 1993
State Street Bank and Trust
Company of Connecticut, N.A.
10.18 Undertaking with respect to Incorporated by reference to
Exhibits to certain Agreements Exhibit 10.14 to HPSC's Annual
Report on Form 10-K for the
fiscal year ended December 25,
1993
10.19 Second Amended and Restated Incorporated by reference to
Revolving Loan Agreement Exhibit 10.19 to HPSC's
dated as of December 12, 1996, Registration Statement on Form S-1
among HPSC, Inc., The First National filed January 30, 1997
Bank of Boston, individually
and as Managing Agent, Nation Bank,
individually and as Agent, and the
the banks named therein
10.20 First Amendment to Second Amended Filed herewith
and Restated Revolving Loan
Agreement dated as of March 26,
1997 among HPSC, Inc., The First
National Bank of Boston,
individually and as Managing Agent,
National Bank, individually and as
Agent, and the bank named therein
10.21 Loan Agreement dated April 13, 1995 Incorporated by reference to Exhibit 10.1 to HPSC's
between HPSC, Inc. and Springfield Quarterly Report on Form 10-Q for the quarter ended
Institution for Savings March 31, 1995
10.22 Sale Agreement dated November 16, Incorporated by reference to Exhibit 10.24 to HPSC's
1995 between HPSC, Inc. and Annual Report on Form 10-K for the fiscal year ended
Springfield Institution for Savings December 31, 1995
10.23 Stock Purchase Agreement, dated as Incorporated by reference to Exhibit 10.3 to HPSC's
of November 1, 1994, by and among Quarterly Report on Form 10-Q for the quarter ended
HPSC, Inc. and each of Chemical September 24, 1994
Bank; The CIT Group/Business
Credit, Inc.; Van Kampen Merritt
Prime Rate Income Trust; the Nippon
Credit Bank, Ltd.; Union Bank of
Finland, Grand Cayman Branch; HPSC,
Inc.; The Bank of Tokyo Trust
Company; and Morgens, Waterfall,
Vintiadis & Co. Inc., and related
Schedules
10.24 Purchase and Contribution Agreement Incorporated by reference to Exhibit 10.31 to HPSC's
dated as of January 31, 1995 Annual Report on Form 10-K for the fiscal year ended
between HPSC, Inc. and HPSC Bravo December 31, 1994
Funding Corp.
10.25 Credit Agreement dated as of Incorporated by reference to Exhibit 10.32 to HPSC's
January 31, 1995 among HPSC Bravo Annual Report on Form 10-K for the fiscal year ended
Funding Corp., Triple-A One Funding December 31, 1994
Corporation, as lender, and CapMAC,
as Administrative Agent and as
Collateral Agent
10.26 Agreement to furnish copies of Incorporated by reference to Exhibit 10.33 to HPSC's
Omitted Exhibits to Certain Annual Report on Form 10-K for the fiscal year ended
Agreements with HPSC Bravo Funding December 31, 1994
Corp.
10.27 Amendment documents, effective Incorporated by reference to Exhibit 10.26 to HPSC's
November 5, 1996 to Credit Registration Statement on Form S-1 filed January 30, 1997
Agreement dated as of January 31,
1995 among HPSC Bravo Funding
Corp., Triple-A Funding
Corporation, as Lender, and CapMAC,
as Administrative Agent and as
Collateral Agent
10.28 Indenture dated as of March 20, Filed herewith
1997 between HPSC, Inc. and State
Street Bank and Trust Company, as
Trustee
10.29 Amended and Restated HPSC, Inc. Incorporated by reference to Exhibit 10.27 to HPSC's Annual
1995 Stock Incentive Plan Report on Form 10-K for the fiscal year ended December 31, 1995
10.30 Stock Option grant to Lowell P. Incorporated by reference to Exhibit 10.28 to HPSC's Annual
Weicker effective December 7, 1995. Report on Form 10-K for the fiscal year ended December 31, 1995
21.1 Subsidiaries of HPSC, Inc. Filed herewith
23.1 Consent of Deloitte & Touche LLP Filed herewith
23.2 Consent of Coopers & Lybrand Filed herewith
L.L.P.
27.1 HPSC, Inc. Financial Data Schedule Filed herewith
Copies of Exhibits may be obtained for a nominal charge by writing to:
INVESTOR RELATIONS
HPSC, INC.
60 STATE STREET
BOSTON, MASSACHUSETTS 02019
(b) Reports on Form 8-K
NONE
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, HPSC, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HPSC, INC.
BY: John W. Everets
---------------------------
DATED: MARCH 31, 1997 JOHN W. EVERETS
CHAIRMAN, CHIEF EXECUTIVE
OFFICER AND DIRECTOR
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of HPSC, Inc.
and in the capacities and on the dates indicated.
Name Title Date
- ------------------------------ --------------------------- -------------------
By: /S/ JOHN W. EVERETS Chairman, Chief Executive
- ------------------------------ Officer and Director March 31, 1997
John W. Everets (Principal Executive
Officer)
Vice President, Chief
BY: /S/ RENE LEFEBVRE Financial Officer and
- ------------------------------ Treasurer (Principal March 31, 1997
Rene Lefebvre Financial Officer)
BY: /S/ RAYMOND R. DOHERTY President and Director
- ------------------------------ March 24, 1997
Raymond R. Doherty
BY: /S/ DENNIS J. McMAHON Vice President, Administration
- ------------------------------ (Principal Accounting Officer) March 31, 1997
Dennis J. Mcmahon
BY: /S/ DOLLIE A. COLE Director
- ------------------------------ March 26, 1997
Dollie A. Cole
BY: /S/ THOMAS M. McDOUGAL Director
- ------------------------------ March 31, 1997
Thomas M. McDougal
BY: /S/ SAMUEL P. COOLEY Director
- ------------------------------ March 24, 1997
Samuel P. Cooley
BY: /S/ JOSEPH A. BIERNAT Director
- ------------------------------ March 31, 1997
Joseph A. Biernat
BY: /S/ J. KERMIT BIRCHFIELD Director
- ------------------------------ March 31, 1997
J. Kermit Birchfield
BY: /S/ LOWELL P. WEICKER, JR. Director
- ------------------------------ March 31, 1997
Lowell P. Weicker, Jr.
II-6
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, HPSC, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HPSC, INC.
BY: John W. Everets
--------------------------
DATED: MARCH 31, 1997 JOHN W. EVERETS
CHAIRMAN, CHIEF EXECUTIVE
OFFICER AND DIRECTOR
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of HPSC, Inc.
and in the capacities and on the dates indicated.
Name Title Date
- ------------------------------ --------------------------- -------------------
Chairman, Chief Executive
BY: JOHN W. EVERETS Officer and Director
- ------------------------------ (Principal Executive March 31, 1997
John W. Everets Officer)
Vice President, Chief
BY: RENE LEFEBVRE Financial Officer and
- ------------------------------ Treasurer (Principal March 31, 1997
Rene Lefebvre Financial Officer)
BY: RAYMOND R. DOHERTY President and Director
- ------------------------------ March 24, 1997
Raymond R. Doherty
BY: DENNIS J. MCMAHON Vice President,
- ------------------------------ Administration (Principal March 31, 1997
Dennis J. Mcmahon Accounting Officer)
BY: DOLLIE A. COLE Director
- ------------------------------ March 26, 1997
Dollie A. Cole
BY: THOMAS M. MCDOUGAL Director
- ------------------------------ March 31, 1997
Thomas M. McDougal
BY: SAMUEL P. COOLEY Director
- ------------------------------ March 24, 1997
Samuel P. Cooley
BY: JOSEPH A. BIERNAT Director
- ------------------------------ March 31, 1997
Joseph A. Biernat
BY: J. KERMIT BIRCHFIELD Director
- ------------------------------ March 31, 1997
J. Kermit Birchfield
BY: /S/ LOWELL P. WEICKER, JR. Director
- ------------------------------ March 31, 1997
Lowell P. Weicker, Jr.