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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, 1997
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)
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
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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
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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
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The aggregate market value of the voting stock held by non-affiliates of the
registrant was $18,119,012 at February 27, 1998, representing 3,535,417 shares.
The number of shares of common stock, par value $.01 per share, outstanding as
of February 27, 1998 was 4,638,130.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders to be
held April 23, 1998 (the "1998 Proxy Statement") are incorporated by reference
into Part III of this annual report on Form 10-K.
Portions of the 1997 Annual Report to Stockholders (the "1997 Annual
Report") are incorporated by reference into Part I of this annual report on Form
10-K.
The 1998 Proxy Statement and the 1997 Annual Report, 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.
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PART I
Item 1. BUSINESS
GENERAL
The Company is a specialty finance company engaged primarily in
financing healthcare providers throughout the United States. 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. The Company
has over 20 years of experience as a provider of financing to healthcare
professionals in the United States. Through its subsidiary, ACFC, the Company
also provides asset-based lending to a variety of businesses, principally 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% of the Company's
business arises from equipment financing, approximately 30% 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, generally, $250,000 or less, sometimes referred
to as the "small-ticket" market. The average size of the Company's financing
transactions in 1997 has been approximately $27,000. In connection with its
equipment financings, the Company enters into noncancellable finance agreements
and lease contracts, 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 16
offices in nine states and through cooperative arrangements with equipment
vendors.
At December 31, 1997, HPSC's outstanding leases and notes receivable
owned and managed were approximately $283 million, consisting of approximately
13,000 active contracts. HPSC's financing contract originations in 1997 were
approximately $129 million compared to approximately $87 million in 1996, an
increase of 48%, which compared to financing contract originations of
approximately $61 million in 1995.
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. ACFC's
financing originations in 1997 were approximately $14 million compared to
approximately $10 million in 1996, an increase of 40%, which compared to
financing contract originations of approximately $8 million in 1995.
The continuing increase in the Company's originations of financing
contracts and ACFC lines of credit resulted in a 41% increase in the Company's
net revenues for fiscal year 1997, as compared with fiscal year 1996, and a 51%
increase in the Company's net revenues for fiscal year 1996 compared with
fiscal year 1995. 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.
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.
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 generally does not
compete, is financing of equipment priced at over $250,000, which is typically
sold to larger group practices, hospitals and other institutional purchasers.
Because of the size of
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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, finance 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 continues to expand 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. HPSC may finance up to 100% of the cost of the practice being
purchased. 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.
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 Company provides its leasing
customers with an option to purchase the equipment at the end of the lease for
10% of its original cost. Historically, approximately 99% of lessees have
exercised this option. 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.
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 the legal
proceeding 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.
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 84 months.
Customers
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The primary customers for the Company's financing contracts are
healthcare providers, including dentists, ophthalmologists, other physicians,
chiropractors and veterinarians.
As of December 31, 1997, 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
Historically, 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, 1997 are attributable to leases
which will expire by the end of 2002. 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, 1997, the Company has originated a total of approximately
400 practice finance loans aggregating approximately $40 million. In 1997,
practice finance generated approximately 12% 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 offices, 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.
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.
ASSET-BASED LENDING
ACFC makes asset-based loans of $5 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 healthcare related). ACFC takes
a security interest in all of the borrowers' assets and monitors collection of
their 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
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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 generally two years. 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 tracks the
changes to its borrowers' accounts receivable on a daily basis. ACFC requires
that all collections be deposited to an ACFC account. Availability under
borrowers' 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 1994 through December 31, 1997, ACFC has provided 38 lines of
credit totaling approximately $57 million and currently has approximately $33
million of loans outstanding to 32 borrowers. The annual dollar volume of
originations of lines of credit by ACFC has grown from $5 million in 1994 to
$12 million in 1995 to $17.6 million in 1996 to $22 million in 1997.
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. 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.
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
its clients' debtors. ACFC may also require its customers to obtain credit
insurance on certain or all of its debtors. 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 monthly.
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 85% of
the Company's net investment in leases and notes at December 31, 1997 (87% at
December 31, 1996). 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 15% of the Company's net investment in
leases and notes at December 31, 1997 (13% at December 31, 1996). These notes
receivable are 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, 1997, the Company has not had any
charge-offs of commercial notes receivable.
ALLOWANCE FOR LOSSES AND 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
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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, 1997, this allowance for losses was 2.5% 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 were 0.7% of
the Company's average net investment in leases and notes (before allowance) for
the year ended December 31, 1997, 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.
The Company's receivables are subject to credit risk. To reduce this
risk, the Company has stringent underwriting policies in approving leases and
notes that are closely monitored by management. Additionally, certain of the
Company's leases and notes receivable, which have been sold under certain sales
agreements, are subject to recourse and estimated losses are provided for by the
Company.
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 December 31,
(in thousands) 1997 1996 1995
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Beginning balance....................... $(4,562) $(4,512) $(4,595)
Provision for losses.................... (2,194) (1,564) (1,296)
Charge-offs............................. 1,304 1,609 1,504
Recoveries.............................. (89) (95) (125)
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Balance, end of year.................... $(5,541) $(4,562) $(4,512)
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The total contractual balances of delinquent lease contracts and notes
receivable due in installments, both owned by the Company and owned by others
and managed by the Company, over 90 days past due amounted to $6,806,000 at
December 31, 1997 compared to $5,763,000 at December 31, 1996.
The above table includes a provision for losses related to the
commercial notes receivable of $236,000, $146,000 and $95,000 in 1997, 1996 and
1995, respectively. The amount of the allowance for losses related to the
commercial notes receivable was $520,000 and $284,000 at December 31, 1997 and
1996, respectively.
FUNDING SOURCES
The Company's principal sources of funding for its financing
transactions are: (i) a revolving loan arrangement with BankBoston as managing
agent providing borrowing availability of up to $100 million (the "Revolver"),
(ii) securitized limited recourse revolving credit facilities with wholly
owned, special-purpose subsidiaries of the Company, HPSC Bravo Funding Corp.
("Bravo") and HPSC Capital Funding, Inc. ("Capital"), currently in the amounts
of $100 million each, (iii) defined recourse fixed-term loans from, and sales
of financing contracts to, savings banks and other purchasers and (iv) the
Company's internally generated revenues. 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 agreement under which the Company may
borrow up to $100 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 Note C of the "Notes to
Consolidated Financial Statements" in the 1997 Annual Report.
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
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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 borrowings 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 in income for accounting
purposes 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.
See Note C of the "Notes to Consolidated Financial Statements" in the
1997 Annual Report incorporated by reference in Item 8 of this annual report on
Form 10-K and "Management's Discussion and Analysis of Financial
Condition-Liquidity and Capital Resources" in this report on Form 10-K for a
more complete description of the funding sources referred to above.
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 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 the many advanced features of
its system provide 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
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 sources to purchasers of
their equipment. The Company's sales representatives support the equipment
manufacturer or vendor or their representatives in their sales efforts by
providing (i) timely, convenient and competitive financing for their equipment
sales and (ii) 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; training the vendors' 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 complete the equipment financing transaction.
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HPSC currently has 30 field sales and marketing personnel located in 16
offices throughout the United States, including 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
management is located in West Hartford, Connecticut. It business is presently
conducted primarily in the northeastern United States with all sales and
marketing efforts managed from its West Hartford office.
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 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. In addition, the Company may face greater
competition with its expansion into the practice finance and asset-based lending
markets.
EMPLOYEES
At December 31, 1997, the Company had 82 full-time employees, 11 of
whom work for ACFC, and none of whom was represented by a labor union.
Approximately 12 of the Company's employees are engaged in credit, collections
and lease documentation, approximately 35 are in sales, marketing and customer
service, and 35 are engaged in general administration, tax and accounting.
Management believes that the Company's employee relations are good.
Item 2. PROPERTIES
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
1997 under all operating leases was $448,000. 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
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No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1997.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of HPSC is traded on the NASDAQ National Market
System. The high and low prices for the Common Stock as reported by NASDAQ for
each quarter in the last two fiscal years, as well as the approximate number of
record holders and information with respect to dividend restrictions, are
incorporated by reference from the section captioned "Market Information" on
page 23 of the 1997 Annual Report.
RECENT SALES OF UNREGISTERED STOCK
Not applicable.
Item 6. SELECTED FINANCIAL DATA
Selected financial data for the five years ended December 31, 1997 is
incorporated by reference from the section captioned "Selected Financial Data"
on page 24 of the 1997 Annual Report.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 below
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and under the section captioned "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 under the caption "Certain Factors" and
the matters set forth in this annual report generally.
Results of Operations
Fiscal Years Ended December 31, 1997 and December 31, 1996:
Earned income from leases and notes for 1997 was $23,691,000 (including
$4,036,000 from ACFC) as compared to $17,515,000 (including $2,643,000 for ACFC)
for 1996. This increase of approximately 35.3% was due primarily to the increase
in the net investment in leases and notes from 1996 to 1997. The increase in net
investment in leases and notes resulted from an increase of approximately 47.4%
in the Company's financing contract originations for fiscal 1997 to
approximately $143,000,000 (including approximately $14,000,000 in ACFC
originations, and excluding approximately $4,500,000 of initial direct costs)
from approximately $97,000,000 (including approximately $10,000,000 in ACFC
originations, and excluding approximately $3,800,000 of initial direct costs)
for 1996. Gains on sales of leases and notes increased to $3,123,000 in 1997
compared to $1,572,000 in 1996. This increase was caused by higher levels of
sales activity in 1997. 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 1997 was
$10,288,000 (43.4% of earned income) compared to $7,885,000 (45.0% of earned
income) for 1996, an increase in amount of 30.5%. The increase in net interest
expense was due primarily to a 56.7% increase in debt levels from 1996 to 1997,
which resulted primarily from increased borrowings to finance the company's
financing contract originations. The decrease as a percentage of earned income
was due to lower interest rates on debt in 1997 as compared to 1996.
Net financing margin (earned income less net interest expense) for fiscal 1997
was $13,403,000 (56.6% of earned income) as compared to $9,630,000 (55.0% of
earned income) for 1996. The increase in amount was due to higher earnings on a
higher balance of earning assets. The increase in percentage of earned income
was due to higher debt during 1997 at lower rates as compared to 1996.
The provision for losses for fiscal 1997 was $2,194,000 (9.3% of earned income)
compared to $1,564,000 (8.9% of earned income) for 1996. This increase in amount
resulted from higher levels of new financings
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in 1997 and the Company's continuing evaluation of its allowance for losses. The
allowance for losses at December 31, 1997 was $5,541,000 (2.6% of net investment
in leases and notes) as compared to $4,562,000 (3.1% of net investment in leases
and notes) at December 31, 1996. Net charge-offs were approximately $1,200,000
in 1997 compared to $1,500,000 in 1996.
Selling, general and administrative expenses for fiscal 1997 were $12,330,000
(52.0% of earned income) as compared to $8,059,000 (46.0% of earned income) for
1996. This increase resulted from increased staffing and systems and support
costs required by higher volumes of financing activity in 1997 and to permit
anticipated near-term growth in financing activity.
The Company's income before income taxes for fiscal 1997 was $2,002,000 compared
to $1,579,000 for 1996. The provision for income taxes was $881,000 (44.0% of
income before tax) in 1997 compared to $704,000 (44.6%) in 1996.
The Company's net income for fiscal 1997 was $1,121,000 or $0.30 per basic share
and $0.26 per diluted share, compared to $875,000 or $0.23 per basic share and
$0.20 per diluted share for 1996. The increase in 1997 over 1996 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, and higher average debt levels in 1997.
At December 31, 1997, the Company had approximately $59,000,000 of customer
applications which had been approved but had not yet resulted in a completed
transaction, compared to approximately $47,500,000 of such customer applications
at December 31, 1996. Not all approved applications will result in completed
financing transactions with the Company.
The Company has reviewed all significant areas within its operations, including
the application, underwriting and accounting management systems, for date
sensitive issues after December 31, 1999 ("Year 2000 Issues"). The Company is
also monitoring the progress of its major service providers. Based on this
review, the Company does not anticipate any material adverse impact from Year
2000 Issues.
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 (including $1,316,000 for 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 approximately $3,800,000 of initial direct costs)
from approximately $68,600,000 (including approximately $7,600,000 in ACFC
originations, and excluding approximately $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 $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 $4,562,000 (3.1% of net investment in leases and notes) as
compared to $4,512,000 (3.8% of net investment in leases and notes) at December
31, 1995. Net charge-offs were approximately $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.
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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 a $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 $0.23 per basic share
and $0.20 per diluted share, compared to $(125,000) or $(0.03) per basic and
diluted 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, approximately $47,500,000 of customer applications which
had been approved but had not yet resulted in a completed transaction were
outstanding, 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.
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 Capital, and
loans secured by financing contracts. The Company obtains cash from sales of its
financing contracts under its securitization facilities and from lease and note
payments received. 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 retained
interest, if any, that 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, 1997, the Company had $9,137,000 in cash, cash equivalents and
restricted cash as compared to $8,945,000 at the end of 1996. As described in
Note C to the Company's Consolidated Financial Statements in the 1997 Annual
Report, $7,000,000 of such cash was restricted pursuant to financing agreements
as of December 31, 1997, compared to $6,769,000 at December 31, 1996.
Cash provided by operating activities was $5,278,000 for the year ended
December 31, 1997 compared to $6,680,000 in 1996 and $4,514,000 in 1995. The
significant components of cash provided by operating activities for 1997 as
compared to 1996 were an increase in net income in 1997 to $1,121,000 from
$875,000 in 1996; an increase in the gain on sales of leases and notes to
$3,123,000 in 1997 from $1,572,000 in 1996, which was caused by a higher level
of sales activity in 1997; and an increase in accounts payable and accrued
expenses, including accrued interest, of $1,025,000 as compared to 1996, which
was caused primarily by the issuance of subordinated debt and higher senior
note balances in 1997.
Cash used in investing activities was $69,298,000 for the year ended December
31, 1997, compared to $34,406,000 in 1996 and $32,615,000 in 1995. The primary
components of cash used in investing activities for 1997 as compared to 1996
were an increase in originations of lease contracts and notes receivable to
$135,625,000 in 1997 from $90,729,000 in 1996, offset by an increase in
proceeds from sales of lease contracts and notes receivable to $33,039,000 in
1997 from $24,344,000 in 1996.
Cash provided by financing activities was $63,981,000 for the year ended
December 31, 1997 compared to cash provided by financing activities of
$29,041,000 for December 31, 1996 and $28,543,000 in 1995. The significant
components of cash provided by financing activities in 1997 as compared to 1996
were proceeds from the issuance of subordinated debt of $18,306,000 in 1997 and
an increase in the proceeds from senior notes in 1997 to $100,087,000 from
$52,973,000 in 1996, offset by repayments of senior notes in 1997 of $53,125,000
compared to $26,019,000 in 1996.
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 were 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 and were
fully paid in June of 1997.
The Revolving Loan Agreement was extended on December 10, 1997 until March 31,
1998 with availability of $60,000,000. The Revolver was amended and restated on
March 16,1998 to increase the availability to $100,000,000 and to extend its
term to March 1999. Under the Revolver, 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, 1997, the Company had $39,000,000 outstanding under
this facility and $21,000,000 available for borrowing, subject to borrowing base
limitations. The Revolver Agreement is not currently 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 facility. The Company had $57,295,000 outstanding under the
Bravo facility at December 31, 1997, and in connection
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with this facility, had 16 separate interest rate swap agreements with
BankBoston with a total notional value of $60,432,000. Effective November 5,
1996, the Bravo facility was increased to $100,000,000 and amended to provide up
to $30,000,000 of such facility to be used as sales of receivables from Bravo
for accounting purposes.
The Company had $29,162,000 outstanding from sales of receivables under this
portion of the facility, and in connection with this portion of the facility,
had six separate interest rate swap agreements with BankBoston with a total
notional value of $30,129,000 at December 31, 1997.
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 approximately $3,500,000 at 9.5% subject to certain recourse and
performance covenants. In July 1997, the Company entered into another fixed
rate, fixed term loan agreement with SIS under which the Company borrowed an
additional $3,984,000 at 8% subject to the same conditions as the first loan.
The Company had $4,913,000 outstanding under these agreements at December 31,
1997.
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 of unsecured senior subordinated
notes due 2007 ("Senior Subordinated Note") bearing interest at a fixed rate of
11% (the "Note Offering"). The Company received approximately $18,300,000 in net
proceeds from the Note Offering and used such proceeds to repay amounts
outstanding under the Revolver Agreement.
In June 1997, the Company, along with its wholly-owned, special purpose
subsidiary, HPSC Capital Funding, Inc. ("Capital"), established a $100,000,000
Lease Receivable Purchase Agreement with EagleFunding Capital Corporation
("Eagle"). Under the terms of the facility (the "Capital Facility"), Capital, to
which the Company may sell certain of its portfolio assets from time to time,
pledges or sells its interests in these assets to Eagle, a commercial paper
conduit entity. Capital may borrow at variable rates in the commercial paper
market and may enter into interest rate swap agreements to assure fixed rate
funding. Monthly settlements of the borrowing base and any applicable principal
and interest payments will be made from collections of Capital's portfolio. The
Company will be the servicer of the Capital portfolio subject to certain
covenants. The agreement originally expired in September 2000. Effective January
1, 1998 the agreement was amended to extend the expiration date to September
2002. The Company had $61,744,000 of indebtedness outstanding under this
facility at December 31, 1997, and in connection with this facility had six
separate swap agreements with a total national value of $59,373,000.
In 1997, the Company repurchased an aggregate of 108,300 shares of its Common
Stock for approximately $623,000. The Company may repurchase its Common Stock
from time to time at prices favorable to the Company, although it has no
specific repurchase plan in place at this time.
Management believes that the Company's liquidity, resulting from the
availability of credit under the Revolver Agreement, the Bravo facility, the
Capital facility and loans from savings banks, along with cash obtained from the
sales of its financing contracts and from internally generated revenues 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 1998 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 CONSIDERATIONS
The following important factors, among others, could cause actual
results to differ materially from those described in the forward-looking
statements made in this annual report on Form 10-K and presented elsewhere by
management from time to time. HPSC cautions the reader 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.
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. The Company's principal sources of funding for its financing
transactions are (i) the Revolver, providing up to $100 million of borrowing
availability, (ii) $200.0 million in limited resource resolving credit
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facilities with Bravo and Capital, (iii) fixed-rate, full recourse term loans
from a savings bank, (iv) specific recourse sales of financing contracts to
savings banks and other purchasers, and (v) the Company's internally generated
revenues. There can be no assurance that the Company will be able to renew or
extend the Revolver at its expiration in March 1999, 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 if the portfolio
failed to perform within the specified guidelines, its performance would return
to acceptable levels or that the payment restrictions would be removed.
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 Company has stringent underwriting
policies in approving financing contracts and the net charge-offs on the
contracts originated by the Company have been approximately 0.7% of the
Company's average net investment in leases and notes for 1997, any increase in
such net charge-offs 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. Healthcare provider financing and asset-based lending 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.
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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 approximately $33 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 $39 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 its financing
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, 1997, the estimated residual value of equipment at
the end of the lease term was approximately $11 million, representing
approximately 4.9% 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
number 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 in income for
accounting purposes 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, 1997, the Company had 14 field sales representatives and eight
in-house sales personnel. Although the Company is not materially
15
16
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
The information required by this item together with Independent
Auditors Report is incorporated by reference from pages 2 through 22 of the
1997 Annual Report. (See also the Report of Coopers & Lybrand L.L.P. filed
under Item 14 of this Form 10-K.)
16
17
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
III 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 1998 Proxy Statement.
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 Option
Values," - Employment Agreements" and " - Compensation of Directors" in the 1998
Proxy Statement.
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 1998 Proxy Statement .
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 following financial statements of HPSC, Inc. and report of independent
accountants included in the 1997 Annual Report are incorporated herein by
reference as a part of this Form 10-K
Page Number In
1997 Annual Report
------------------
Consolidated Balance Sheets at December 31,
1997 and December 31, 1996 2
Consolidated Statements of Operations for each
of the three years in the period ended
December 31, 1997 3
Consolidated Statements of Changes in Stock-
holders' Equity for each of the three years in
the period ended December 31, 1997 4
Consolidated Statements of Cash Flows for
each of the three years in the period ended
December 31, 1997 5
Notes to Consolidated Financial Statements 6-21
Report of Deloitte & Touche LLP 22
17
18
Page Number in
Form 10-K
---------
(a) 2. Financial Statement Schedules
-----------------------------
Report of Coopers & Lybrand LLP F-1
All other Financial Statement Schedules are omitted because the information
required is inapplicable or is included in the Financial Statements or the
Notes thereto.
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INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
and Stockholders of HPSC, Inc.:
We have audited the accompanying consolidated statements of operations, changes
in stockholders' equity and cash flows of HPSC, Inc. for the year 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 included 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 results of operations and cash flows of
HPSC, Inc. for the year ended December 31, 1995, in connformity 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.
/s/ Coopers & Lybrand L.L.P.
---------------------------------
Coopers & Lybrand L.L.P.
Boston, Massachusetts
March 25, 1998
F-1
20
(a) 3 Exhibits
Management contracts or compensatory plans or arrangements required to be filed
as exhibits are identified by an asterisk.
No. Title Method of Filing
--- ----- ----------------
3.1 Restated Certificate of Incorporated by reference to Exhibit 3.1
Incorporation of HPSC, Inc. to HPSC's Annual 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
Restated Certificate of to HPSC's Annual Report on Form 10-K for
Incorporation of HPSC, Inc. filed the fiscal year ended December 31, 1995.
in Delaware on September 14,
1987
3.3 Certificate of Amendment to Restated Incorporated by reference to Exhibit 3.3
Certificate of December 31, 1995. to HPSC's Annual Report on Form 10-K for
Incorporation of HPSC, Inc. filed the fiscal year ended 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 Exhibit 4 to
August 3, 1993 between the HPSC's Amendment No. 1 to its Current Report
Company and The First National on Form 8-K filed August 11, 1993.
Bank of Boston, N.A., including
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
quarter ended June 25, 1994
19
21
*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 Filed herewith
Executive Retirement Plan
dated as of January 1, 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 Third Amended and Restated Credit Filed herewith
Agreement dated as of March 16, 1998,
among HPSC, Inc., BankBoston, NA,
individually and as Agent and the
Banks named therein
10.15 Purchase and Contribution Incorporated by reference to
Agreement dated as of Exhibit 10.31 to HPSC's Annual
January 31, 1995 between Report on Form 10-K for the fiscal
HPSC, Inc. and HPSC Bravo year ended December 31, 1994
Funding Corp.
10.16 Credit Agreement dated as of Incorporated by reference to
January 31, 1995 among Exhibit 10.32 to HPSC's Annual
HPSC Bravo Funding Corp., Report on Form 10-K for the fiscal
Triple-A One Funding year ended December 31, 1994
Corporation, as lender, and
CapMAC, as Administrative
Agent and as Collateral Agent
10.17 Agreement to furnish copies of Incorporated by reference to
Omitted Exhibits to Certain Exhibit 10.33 to HPSC's Annual
Agreements with HPSC Bravo Report on Form 10-K for the
Funding Corp. fiscal year ended December 31,
1994
10.18 Amendment documents, effective Incorporated by reference to
November 5, 1996 to Credit Exhibit 10.26 to HPSC's Registration
Agreement dated as of January 31, Statement on Form S-1 filed
1995 among HPSC Bravo Funding January 30, 1997
Corp., Triple-A Funding Corporation,
as Lender, and CapMAC, as
Administrative Agent and as
Collateral Agent
10.19 Lease Receivables Purchase Incorporated by reference to Exhibit 10.1
Agreement dated as of June 27, to HPSC's Quarterly Report on Form 10-Q for
1997 among HPSC Capital the quarter ended September 30, 1997.
Funding, Inc., as Seller, HPSC,
Inc. as Servicer and Custodian,
EagleFunding Capital
Corporation as Purchaser and
BankBoston Securities, Inc. as
Deal Agent.
10.20 Appendix A to EagleFunding Incorporated by reference to Exhibit 10.2
Purchase Agreement (Definitions to HPSC's Quarterly Report on Form 10-Q for
List Attached). the quarter ended September 30, 1997
10.21 Purchase and Contribution Incorporated by reference to Exhibit 10.3
Agreement dated as of June 27, to HPSC's Quarterly Report on Form 10-Q for
1997 Between HPSC Capital the quarter ended September 30, 1997
Funding, Inc. as the Buyer, and
HPSC, Inc. as the Originator and
the Servicer.
10.22 Undertaking to Furnish Certain Incorporated by reference to Exhibit 10.4
Copies of Omitted Exhibits to to HPSC's Quarterly Report on Form 10-Q for
Exhibit 10.19 and 10.21 hereof. the quarter ended September 30, 1997
10.23 Indenture dated as of March 20, Incorporated by reference to Exhibit 10.28
1997 between HPSC, Inc. and to HPSC's Annual Report on Form 10-K for the
State Street Bank and Trust fiscal year ended December 31, 1997
Company, as Trustee
*10.24 Amended and Restated HPSC, Incorporated by reference to Exhibit 10.27
Inc. 1995 Stock Incentive Plan to HPSC's Annual Report on Form 10-K for
the fiscal year ended December 31, 1995
*10.25 Stock Option grant to Lowell P. Incorporated by reference to Exhibit 10.28
Weicker effective December 7, to HPSC's Annual Report on Form 10-K for
1995. the fiscal year ended
20
22
December 31, 1995
*10.26 Amended and Restated Stock Filed herewith
Loan Program
13.1 1997 Annual Report to Filed herewith
Stockholders
21.1 Subsidiaries of HPSC, Inc. Filed herewith
23.1 Consent of Deloitte & Touche Filed herewith
LLP
23.2 Consent of Coopers & Lybrand Filed herewith
L.L.P.
27.1 HPSC, Inc. Financial Data Filed herewith
Schedule
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
No reports on Form 8-K were filed during the fourth quarter of the fiscal year
covered by this report.
21
23
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: /s/ John W. Everets
-------------------------------
Dated: March 27, 1998 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 Dated
- ---- ----- -----
By: /s/ John W. Everets Chairman, Chief Executive March 27, 1998
--------------------------------- Officer and Director (Principal
John W. Everets Executive Officer)
By: /s/ Rene Lefebvre Vice President, Chief March 27, 1998
--------------------------------- Financial Officer and
Rene Lefebvre Treasurer (Principal Financial
Officer)
By: /s/ Raymond R. Doherty President and Director March 27, 1998
---------------------------------
Raymond R. Doherty
By: /s/ Dennis J. McMahon Vice President, Administration March 27, 1998
--------------------------------- (Principal Accounting Officer)
Dennis J. McMahon
By: /s/ Dollie A. Cole Director March 27, 1998
---------------------------------
Dollie A. Cole
By: /s/ Thomas M. McDougal Director March 24, 1998
---------------------------------
Thomas M. McDougal
By: /s/ Samuel P. Cooley Director March 23, 1998
---------------------------------
Samuel P. Cooley
By: /s/ Joseph A. Biernat Director March 27, 1998
---------------------------------
Joseph A. Biernat
By: /s/ J. Kermit Birchfield Director March 27, 1998
---------------------------------
J. Kermit Birchfield
By: /s/ Lowell P. Weicker, Jr. Director March 27, 1998
---------------------------------
Lowell P. Weicker, Jr.
22