<PAGE> 1
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, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-11618
HPSC, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 04-2560004
------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
60 STATE STREET, BOSTON, MASSACHUSETTS 02109
- ---------------------------------------- ----------
(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
-------------------------------------
(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 _X_ NO ___
The aggregate market value of the voting stock held by non-affiliates of the
registrant was $25,701,269 at February 26, 1999, representing 3,091,882 shares.
The number of shares of common stock, par value $.01 per share, outstanding as
of February 26, 1999 was 4,185,529.
- 1 -
<PAGE> 2
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held April 26, 1999 (the "1999 Proxy Statement") are incorporated by
reference into Part III of this annual report on Form 10-K.
The 1999 Proxy Statement, except for the parts therein which have been
specifically incorporated by reference, shall not be deemed "filed" as part of
this annual report on Form 10-K.
Portions of the Company's 1998 Annual Report to Shareholders (the "1998
Annual Report") are incorporated by reference into Parts I and II of this annual
report on Form 10-K.
- 2 -
<PAGE> 3
PART I
Item 1. BUSINESS
GENERAL
HPSC, Inc. ("HPSC" or the "Company") is a specialty finance company
engaged primarily in financing licensed healthcare providers throughout the
United States. The largest part of the Company's revenues comes from its
financing of healthcare equipment and financing of 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, American Commercial Finance Corporation ("ACFC"), the Company also
provides asset-based lending to commercial and industrial businesses,
principally in the eastern United States.
HPSC provides financing for equipment and other practice-related
expenses to the dental, ophthalmic, general medical, chiropractic and veterinary
professions. At December 31, 1998, on a consolidated basis, approximately 92% of
the Company's portfolio was comprised of financing to licensed professionals,
including equipment financing and other non-equipment financing including
practice finance, leasehold improvements, office furniture, working capital and
supplies. Approximately 8% of the portfolio was asset-based lending to
commercial and industrial businesses. 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 1998 was approximately
$31,000. In connection with its equipment financing, the Company enters into
noncancellable finance agreements and/or 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 14 states and through
cooperative arrangements with equipment vendors.
At December 31, 1998, HPSC's gross outstanding owned and managed leases
and notes receivable to licensed professionals, excluding asset-based lending,
were approximately $387 million, consisting of approximately 15,000 active
contracts. HPSC's financing contract originations in 1998 were approximately
$159 million compared to approximately $129 million in 1997, an increase of 23%,
which compared to financing contract originations of approximately $87 million
in 1996.
ACFC, the Company's wholly-owned subsidiary, provides asset-based
financing, principally in the eastern United States, for commercial and
industrial companies which generally 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 financing
business to licensed professional. ACFC's financing originations of new lines of
credit in 1998 were approximately $23 million compared to approximately $25
million in 1997, a decrease of 8%, which compared to financing contract
originations of approximately $18 million in 1996
The continuing increase in the Company's originations of financing
contracts and lines of credit helped contribute to a 37% increase in the
Company's net revenues for fiscal year 1998 as compared with fiscal year 1997,
and a 41% increase in the Company's net revenues for fiscal year 1997 compared
with fiscal year 1996. This percentage change in revenues is different from the
percentage change 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
inception.
BUSINESS STRATEGY
The Company's strategy is to expand its business and enhance its
profitability by (i) maintaining its share of the dental equipment market and
increasing its share of the other medical equipment financing markets; (ii)
diversifying the Company's revenue stream through its 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.
- 3 -
<PAGE> 4
INDUSTRY OVERVIEW
The equipment financing industry in the United States includes a wide
variety of sources for financing the purchase or lease 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 currently does not
compete, is financing of equipment generally 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 does compete, 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 $18,000 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.
The length of the Company's lease agreements and notes due in
installments ranges from 12 to 84 months, with a median term of 60 months and an
average initial term of 55 months.
Although the Company has focused its business in the past on equipment
financing to licensed professionals, 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.
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. The average original size of a practice finance transaction was
approximately $124,000 in 1998, with a typical contract term of 72 to 84 months.
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 of healthcare providers of various types of equipment as well as
leasehold improvements, working capital and supplies. The contracts are either
finance agreements (notes) or lease agreements, and are noncancellable. The
contracts 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 financing, 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 finance agreements range from 12 to
84 months, with a weighted average original term of 55 months for the year ended
December 31, 1998.
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, and (ii) make all scheduled
- 4 -
<PAGE> 5
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 a financing agreement (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.
Since 1994, the Company has originated a total of approximately 600
practice finance loans aggregating approximately $66 million in financings. The
term of such loans generally range from 72 to 84 months. In 1998, practice
finance generated approximately 10% of HPSC's total 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,
practice brokers, 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.
Customers
The primary customers for the Company's financing contracts are
healthcare providers, including dentists, ophthalmologists, other physicians,
chiropractors and veterinarians. As of December 31, 1998, 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 generally 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, 1998 are
attributable to leases which will expire by the end of 2003. 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
generally 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.
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
- 5 -
<PAGE> 6
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 to commercial and
industrial companies, primarily secured by accounts receivable, inventory and
equipment. ACFC typically makes accounts receivable loans to borrowers in a
variety of industries that cannot obtain traditional bank financing. ACFC takes
a security interest in all of the borrower's assets and monitors collection of
its receivable. 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. No single
borrower accounts for more than 8.5% of ACFC's aggregate portfolio, and no more
than 10% 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 senior management of HPSC, must approve all ACFC loans in advance.
From its inception through December 31, 1998, ACFC has provided 57
lines of credit totaling approximately $70 million and currently has
approximately $30 million of loans outstanding to 30 borrowers. The annual
dollar volume of originations of new lines of credit by ACFC has grown from $5.0
million in 1994, to $12.1 million in 1995, $17.6 million in 1996, $24.8 million
in 1997 and $23.1 million in 1998.
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 procedures
require 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 accounting
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 generally makes payments to vendors for
financing transactions within one day of authorization to pay from the customer.
- 6 -
<PAGE> 7
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 lending standards and for monitoring 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 originated and an evaluation of
the condition of the portfolio of loans outstanding. An account will be placed
in non-accrual status when management determines that 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 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% of
the Company's net investment in leases and notes at December 31, 1998 (85% at
December 31, 1997). Substantially all of such contracts and notes are due from
licensed medical professionals 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, substantially 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 13% of the Company's net investment in
leases and notes at December 31, 1998 (15% at December 31, 1997). These notes
receivable are primarily asset-based, revolving lines of credit to small and
medium size commercial and industrial companies, at variable interest rates, and
typically have terms of two to three years. The Company began commercial lending
activities in mid-1994. Through December 31, 1998, the Company has had
charge-offs of commercial notes receivable of $75,000. The provision for losses
related to the commercial notes receivable was $147,000, $236,000 and $146,000
in 1998, 1997 and 1996, respectively. The amount of the allowance for losses
related to the commercial notes receivable was $592,000 and $520,000 at December
31, 1998 and 1997, respectively.
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 to meet future estimated
uncollectible receivables, based on an analysis of delinquencies, problem
accounts, overall risks and probable losses associated with such contracts, and
a review of the Company's historical loss experience. At December 31, 1998, this
allowance for losses was 2.6% 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
portfolio of the Company were less than 1% of the Company's average net
investment in leases and notes (before allowance) for the year ended December
31, 1998, 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.
- 7 -
<PAGE> 8
The Company's receivables are subject to credit risk. To reduce this
risk, the Company has adopted 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.
A summary of activity in the Company's allowance for losses for each of
the years in the three-year period ended December 31, 1998 is as follows:
<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Beginning balance $(5,541) $(4,562) $(4,512)
Provision for losses (4,201) (2,194) (1,564)
Charge-offs 2,498 1,304 1,609
Recoveries (106) (89) (95)
------- ------- -------
Balance, end of year $(7,350) $(5,541) $(4,562)
======= ======= =======
</TABLE>
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 $9,967,000 at
December 31, 1998 compared to $6,806,000 at December 31, 1997. An account is
considered delinquent when not paid within thirty days of the billing due date.
FUNDING SOURCES
General
The Company's principal sources of funding for its financing
transactions have been: (i) a revolving loan agreement 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
aggregate amount of $375 million, (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.
Information about the Revolver, the securitization transactions and
other funding sources referred to in the previous paragraph is incorporated by
reference from Note C and D of the "Notes to Consolidated Financial Statements"
at pages 11 through 13 of the 1998 Annual Report and "Management's Discussion
and Analysis of Financial Condition" at pages 11 through 17 of this Annual
Report on Form 10-K.
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
- 8 -
<PAGE> 9
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 analysis, 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.
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. In the future, the
Company may 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, 1998, the Company had 99 full-time employees, 15 of
whom work for ACFC, and none of whom was represented by a labor union.
Management believes that the Company's employee relations are good.
Item 2. PROPERTIES
The Company leases approximately 13,887 square feet of office space at
60 State Street, Boston, Massachusetts for approximately $34,000 per month. This
lease expires on June 30, 2004 with a five-year extension option. ACFC leases
approximately 4,101 square feet at 433 South Main Street, West Hartford,
Connecticut for approximately $6,047 per month. This lease expires on August 31,
2001 with a three-year extension option. The Company's total rent expense for
1998 under all operating leases was $628,000. The Company also rents space as
required for its sales locations on a shorter-term basis. The Company believes
that its facilities are adequate for its current operations and for the
foreseeable future.
- 9 -
<PAGE> 10
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, 1998.
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 page 24 of the 1998 Annual Report.
The Company sold no equity securities during the period covered by this
annual report on Form 10-K other than sales registered under the Securities Act
of 1933, as amended.
Item 6. SELECTED FINANCIAL DATA
Selected financial data for each of the periods in the five year period
ended December 31, 1998 is incorporated by reference from page 25 of the 1998
Annual Report.
- 10 -
<PAGE> 11
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
FISCAL YEARS ENDED DECEMBER 31, 1998
AND DECEMBER 31, 1997
Earned income from leases and notes for 1998 was $32,961,000 (including
$4,916,000 from ACFC) as compared to $23,691,000 (including $4,036,000 for ACFC)
for 1997. This increase of approximately 39.1% was due primarily to the increase
in the net investment in leases and notes from 1997 to 1998. The increase in net
investment in leases and notes resulted primarily from an increase of
approximately 19.0% in the Company's financing contract originations for fiscal
1998 to approximately $182,000,000 (including approximately $23,000,000 in ACFC
line of credit originations, and excluding approximately $6,000,000 of initial
direct costs) from approximately $153,000,000 (including approximately
$24,000,000 in ACFC line of credit originations, and excluding approximately
$4,500,000 of initial direct costs) for 1997. Pre-tax net gains on sales of
leases and notes increased to $4,906,000 in 1998 compared to $3,123,000 in 1997.
This increase was caused by improved margins associated with current year asset
sales activity. 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 using the interest method over the life of
the net investment in leases and notes.
Interest expense net of interest income on cash balances for 1998 was
$15,126,000 (45.9% of earned income) compared to $11,019,000 (46.5% of earned
income) for 1997, an increase of 37.3%. The increase in net interest expense was
due primarily to a 33.1% increase in debt levels from 1997 to 1998, 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 1998 as compared to 1997.
Net financing margin (earned income less net interest expense) for fiscal 1998
was $17,835,000 (54.1% of earned income) as compared to $12,672,000 (53.5% of
earned income) for 1997. 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 a higher percentage of the portfolio being matched to lower interest
rate debt during 1998 as compared to 1997.
The provision for losses for fiscal 1998 was $4,201,000 (12.8% of earned income)
compared to $2,194,000 (9.3% of earned income) for 1997. The increase in amount
resulted from higher levels of new financings in 1998 and the Company's
continuing evaluation of its portfolio quality, loss history and allowance for
losses. The allowance for losses at December 31, 1998 was $7,350,000 (2.6% of
net investment in leases and notes) as compared to $5,541,000 (2.6% of net
investment in leases and notes) at December 31, 1997. Net charge-offs were
approximately $2,400,000 in 1998 compared to $1,200,000 in 1997.
Selling, general and administrative expenses for fiscal 1998 were $15,021,000
(45.6% of earned income) as compared to $11,599,000 (49.0% of earned income) for
1997. The increase in amount resulted from increased staffing and systems and
support costs required by higher volumes of financing activity in 1998 and costs
incurred to permit anticipated near-term growth in financing activity. The
increase in amount was also caused by increased compensation and related costs
associated with the Company's 1995 Stock Incentive Plan as certain performance
benchmarks in such plans related to the price of HPSC common stock were met and
by the extension of certain five-year options which were scheduled to expire.
The decrease as a percentage of earned income was the result of improved per
unit costs on higher levels of originations and higher levels of owned portfolio
assets.
The Company's income before income taxes for fiscal 1998 was $3,519,000 compared
to $2,002,000 for 1997. The provision for income taxes was $1,543,000 (43.9% of
income before tax) in 1998 compared to $881,000 (44.0%) in 1997.
The Company's net income for fiscal 1998 was $1,976,000 or $0.53 per basic share
and $0.47 per diluted share, compared to $1,121,000 or $0.30 per basic share and
$0.26 per diluted share for 1997. The increase in 1998 over 1997 was due to
higher earned income from leases and notes, higher gains on sales of assets, and
lower cost of funds, offset by increases in the provision for losses, higher
selling, general and administrative expenses, and higher average debt levels.
Net profit contribution, representing income before interest and taxes (see
Note L to Notes to Consolidated Financial Statements) from the licensed
professional financing segment was $15,504,000 for the year ended December 31,
1998 compared to $10,607,000 for the comparable period in 1997, a 46% increase.
The increase was due to an increase in earned income on leases and notes to
$28,045,000 in 1998 compared to $19,712,000 in 1997, higher gain on sales of
leases and notes of $4,906,000 in 1998 from $3,123,000 in 1997, offset by an
increase in the provision for losses in 1998 to $4,054,000 from $1,958,000 in
the prior year, as well as an increase in selling, general and administrative
expenses to $13,393,000 in 1998 compared to $10,270,000 in 1997.
Net profit contribution (income before interest and taxes) from the commercial
and industrial financing segment was $3,141,000 for the year ended December 31,
1998 compared to $2,414,000 for the comparable period in 1997, a 30% increase.
The increase was due to an increase in earned interest and fee income on notes
to $4,916,000 in 1998 compared to $3,979,000 in 1997; as well as a decrease in
the provision for losses in 1998 to $147,000 from $236,000 in the prior year,
offset by an increase in selling, general and administrative expenses to
$1,628,000 in 1998 compared to $1,329,000 in 1997.
- 11 -
<PAGE> 12
At December 31, 1998, the Company had approximately $81,000,000 of customer
applications which had been approved but had not yet resulted in a completed
transaction, compared to approximately $59,000,000 of such customer applications
at December 31, 1997. Not all approved applications will result in completed
financing transactions with the Company.
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 45.7%
in the Company's financing contract originations for fiscal 1997 to
approximately $153,000,000 (including approximately $24,000,000 in ACFC line of
credit originations, and excluding approximately $4,500,000 of initial direct
costs) from approximately $105,000,000 (including approximately $18,000,000 in
ACFC line of credit 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 using the
interest method over the life of the net investment in leases and notes.
Interest expense net of interest income on cash balances for 1997 was
$11,019,000 (46.5% of earned income) compared to $7,885,000 (45.0% of earned
income) for 1996, an increase in amount of 39.7%. 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.
Net financing margin (earned income less net interest expense) for fiscal 1997
was $12,672,000 (53.5% 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 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 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 (3.0% 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 $11,599,000
(49.0% 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.
Net profit contribution, representing income before interest and taxes (see Note
L to Notes to Consolidated Financial Statements) from the licensed professional
financing segment was $10,607,000 for the year ended December 31, 1997 compared
to $7,943,000 for the comparable period in 1996, a 34% increase. The increase
was due to an increase in earned income on leases and notes to $19,712,000 in
1998 compared to $14,899,000 in 1997, higher gain on sales of leases and notes
of $3,123,000 in 1997 from $1,572,000 in 1996, offset by an increase in the
provision for losses in 1998 to $1,958,000 from $1,381,000 in the prior year, as
well as an increase in selling, general and administrative expenses to
$10,270,000 in 1997 compared to $7,147,000 in 1996.
Net profit contribution (income before interest and taxes) from the commercial
and industrial financing segment was $2,414,000 for the year ended December 31,
1997 compared to $1,521,000 for the comparable period in 1996, a 59% increase.
The increase was due to an increase in earned interest and fee income on notes
to $3,979,000 in 1997 compared to $2,616,000 in 1996, offset by an increase in
the provision for losses in 1997 to $236,000 from $183,000 in the prior year, as
well as an increase in selling, general and administrative expenses to
$1,329,000 in 1997 compared to $912,000 in 1996.
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.
- 12 -
<PAGE> 13
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 residual
interest, if any, that it has in the securitized financing contracts should a
default occur. The Company's borrowings under the Revolver (as defined below)
are full recourse obligations of HPSC. The Company's borrowings under the
Revolver are used to provide asset based lending within ACFC as well as to
temporarily fund new financing contracts entered into by the Company. These
borrowings 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, 1998, the Company had $14,171,000 in cash, cash equivalents and
restricted cash as compared to $9,137,000 at the end of 1997. As described in
Note C to the Company's Consolidated Financial Statements, $9,588,000 of such
cash was restricted pursuant to financing agreements as of December 31, 1998,
compared to $7,000,000 at December 31, 1997.
Cash provided by operating activities was $8,811,000 for the year ended December
31, 1998 compared to $5,278,000 in 1997 and $6,680,000 in 1996. The significant
components of cash provided by operating activities in 1998 as compared to 1997
were an increase in net income in 1998 to $1,976,000 from $1,121,000 in 1997, an
increase in the gain on sales of leases and notes to $4,906,000 in 1998 from
$3,123,000 in 1997, which resulted from improved margins associated with current
year asset sales activity, and a decrease in refundable income taxes of
$1,996,000 in 1998 compared to an increase of $1,567,000 in 1997, offset by a
decrease in accounts payable and accrued liabilities of $920,000 in 1998
compared to an increase of $346,000 for the same period in 1997.
Cash used in investing activities was $68,909,000 for the year ended December
31, 1998 compared to $69,298,000 in 1997 and $34,406,000 in 1996. The primary
component of cash used in investing activity for 1998 as compared to 1997 was an
increase in originations of lease contracts and notes receivable to $166,672,000
in 1998 from $135,625,000 in 1997. This use of cash was offset by an increase in
portfolio receipts of $59,365,000 in 1998 from $48,889,000 in 1997, an increase
in notes receivable of $289,000 in 1998 as compared to $16,729,000 in 1997, and
an increase in proceeds from sales of lease contracts and notes receivable to
$38,696,000 in 1998 from $33,039,000 in 1997.
Cash provided by financing activities was $62,544,000 for the year ended
December 31, 1998 compared to $63,981,000 in 1997 and $29,041,000 in 1996. The
significant components of cash provided by financing activities in 1998 as
compared to 1997 were an increase in the net proceeds from senior notes in 1998
to $111,474,000 from $100,087,000 in 1997, net proceeds from revolving notes
payable of $10,000,000 in 1998 compared to net repayments of $1,000,000 in 1997,
and an increase in restricted cash of $2,588,000 in the current year compared to
$231,000 in 1997, offset by repayments of senior notes of $61,030,000 in 1998
compared to $53,125,000 in 1997 as well as no senior subordinated note
borrowings in 1998.
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. Under the terms
of the Funding I Notes, when the principal balance equals the balance of the
restricted cash in the facility, the Funding I Notes are paid off from the
restricted cash and Funding I terminates. This occurred in June of 1997. Due to
this early termination, the Company incurred a $175,000 non-cash, non-operating
charge against earnings in both the first and second quarters of 1997
representing the partial early recognition of certain unamortized deferred
transaction origination costs.
- 13 -
<PAGE> 14
In December 1996, the Company executed a Second Amended and Restated Revolving
Loan Agreement with BankBoston as Managing Agent (the "Revolving Loan Agreement"
or "Revolver"), providing availability up to $95,000,000. In December 1997, this
agreement was extended on the same terms and conditions until March 1998,
providing availability of $60,000,000. In March 1998, the Company executed a
Third Amended and Restated Revolving Loan Agreement with BankBoston as Managing
Agent, providing availability up to $100,000,000 through March 16, 1999. In
March 1999, this agreement was extended under the same terms and conditions
through May 14, 1999, providing availability up to $86,000,000. It is
anticipated the Company will execute a Fourth Amended and Restated Revolving
Loan Agreement in May 1999 which will provide the Company availability up to
$100,000,000 through May 2000. Under the Revolver, the Company may borrow at
variable rates of prime and at LIBOR plus 1.35% to 1.50%, depending on certain
performance covenants. At December 31, 1998, the Company had $49,000,000
outstanding under this facility and $51,000,000 available for borrowing, subject
to borrowing base limitations. The Revolver is not currently hedged and is,
therefore, exposed to upward movements in interest rates.
As of January 31, 1995, the Company, along with its wholly-owned,
special-purpose subsidiary Bravo Funding Corp. ("Bravo"), established a
$50,000,000 revolving credit facility (the "Bravo Facility") structured and
guaranteed by Capital Markets Assurance Corporation ("CapMAC", subsequently
acquired by MBIA in February 1998). 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 MBIA pursuant to the terms of the Bravo Facility. In November, 1996, the
Bravo Facility was increased to $100,000,000 and amended to provide that up to
$30,000,000 of the Bravo Facility may be used as sales of receivables from Bravo
for accounting purposes. In June 1998, the Bravo Facility was further amended by
increasing availability to $225,000,000 with $67,500,000 available to be used
for sale accounting treatment. The Company had $61,506,000 outstanding under the
loan portion of the Bravo Facility at December 31, 1998, and in connection with
these borrowings, had 19 separate interest rate swap agreements with BankBoston
with a total notional value of $57,120,000. The Company had $44,549,000
outstanding from sales of receivables under the sale portion of the Bravo
Facility and in connection with this portion of the facility, had 9 separate
interest rate swap agreements with BankBoston with a total notional value of
$45,860,000 at December 31, 1998.
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. 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 approximately $2,781,000 outstanding under these agreements at December 31,
1998.
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 is the servicer of the Capital portfolio subject to certain covenants.
The required monthly payments
- 14 -
<PAGE> 15
of principal and interest to purchasers of the commercial paper are guaranteed
by BankBoston pursuant to the terms of the facility. In April 1998, the Capital
Facility was amended to increase availability to $150,000,000 under the same
terms and conditions through April 2001. The Company had $110,254,000 of
indebtedness outstanding under the loan portion of the Capital Facility at
December 31, 1998, and in connection with these borrowings had 14 separate
interest rate swap agreements with BankBoston with a total notional value of
$105,241,000. The Company had $16,073,000 outstanding from sales of receivables
under the sale portion of the Capital Facility and in connection with this
portion of the facility, had 3 separate interest rate swap agreements with
BankBoston with a total notional value of $14,657,000 at December 31, 1998.
In September 1998, the Company initiated a stock repurchase program under which
up to 175,000 shares of the Company's common stock may be repurchased from a
pool of up to $1,700,000, subject to market conditions, in open market or
negotiated transactions on the NASDAQ National Market. Based on year end market
prices, the shares subject to repurchase represent approximately 3.7% of the
outstanding common stock. No minimum number or value of shares to be repurchased
has been fixed, nor has a time limit been established for the duration of the
repurchase program. The Company expects to use the repurchased stock to meet the
current and future requirements of its employee stock plans. In 1998, the
Company repurchased an aggregate of 131,100 shares of its common stock for
approximately $1,020,000.
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 1999 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.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of its business, the Company is subject to a variety of
risks, including market risk associated with interest rate movements. The
Company is exposed to such interest rate risk from the time elapsed between the
approval of a transaction with a customer and when permanent fixed rate
financing is secured. The Company does not hold or issue financial instruments
for trading purposes.
The Company temporarily funds its new fixed rate financing contracts through
variable rate revolving credit borrowings until permanent fixed rate financing
is secured through its securitization facilities. The Company's exposure to
interest rate risk relates to changes in interest rates between the time a new
financing contract is approved and the time the permanent, fixed-rate financing
is completed. The Company believes that it mitigates this exposure by obtaining
such permanent financing generally within 60 days of the activation date of the
new financing contract and believes it will be able to continue this operating
strategy.
The Company manages its exposure to interest rate risk by entering into interest
rate swap agreements under its securitization transactions. These swap
agreements have the effect of converting the Company's debt from securitizations
from a variable rate to a fixed rate. Changes in interest rates would result in
unrealized gains or losses in the market value of the fixed rate debt to the
extent of differences between current market rates and the actual stated rates
for these debt instruments. Assuming all swap agreements were to be terminated,
the cost to the Company would have been approximately $2,958,000 at December 31,
1998. Assuming a hypothetical 10% change in interest rates from current weighted
average swap rates, the cost to the Company for terminating such swap agreements
would have been approximately $4,895,000 at December 31, 1998.
The carrying value of the Company's fixed rate debt at December 31, 1998 was
$194,541,000. The estimated fair value of this debt was $197,082,000, which was
determined by applying the fixed rate that the Company received on its
securitization transaction in December 1998 against the entire outstanding fixed
rate debt balance at December 31, 1998. The Company's variable rate debt at
December 31, 1998 was $49,000,000, which approximated fair value. Assuming a
hypothetical 10% change in interest rates from current weighted average debt
rates, market risk for the fixed rate debt is estimated as the potential change
in the fair value of the debt, which would have approximated $3,373,000 at
December 31, 1998. The effect of a 10% hypothetical change in interest rates on
the Company's variable rate debt would have changed the Company's consolidated
interest expense by $348,000 for the year ended December 31, 1998.
- 15 -
<PAGE> 16
The Company's portfolio of financing contracts originated in its licensed
professional financing segment are fixed rate, non-cancelable, full payout lease
contracts and notes receivable due in installments. At December 31, 1998, the
carrying value of these assets, including the retained interest of sold assets,
was approximately $246,984,000, which approximated fair value. Assuming implicit
rates changed by a hypothetical 10% from current weighted average implicit
rates, the effect on the fair value of the Company's fixed rate financing
contracts would have approximated $2,725,000 at December 31, 1998.
The Company's variable rate assets are generally comprised of financing
contracts originated by its commercial asset-based lending subsidiary, ACFC.
These financing agreements are structured as variable rate lines of credit
extended to various commercial and industrial entities, collateralized by
accounts receivable, inventory, or fixed assets, generally for periods of two to
three years. At December 31, 1998, the carrying value of these assets was
approximately $30,991,000 which approximated fair value. The effect of a
hypothetical 10% change in interest rates on the Company's variable rate
financing contracts would have changed the Company's consolidated interest
income by $412,000 for the year ended December 31, 1998.
For additional information about the Company's financial instruments, see Note K
in Notes to Consolidated Financial Statements.
YEAR 2000 ISSUES
The year 2000 issue relates to the inability of computer applications to
distinguish between years with the same last two digits in different centuries
such as 1900 and 2000. In 1996, the Company, along with its subsidiary, ACFC,
began a review to assess the year 2000 readiness of all of its information
technology ("IT") systems. In 1998, the Company expanded this review to include
non-IT systems, including embedded software such as the Company's telephone
system, as well as the systems of third parties who are important business
partners with the Company.
The Company is heavily reliant on integrated IT systems for providing much of
its day-to-day operations, including application processing, underwriting,
billing and collections, as well as much of the financial and operational
reporting to management. The Company has performed a complete review of all
relevant computer systems. Based on its internal review, the Company believes
that substantially all of its internal IT systems are year 2000 compliant. The
Company has also obtained written assurances from all providers of its IT
software and systems as to the year 2000 compliance of each of these systems.
The Company believes that the loss of any ancillary systems as to which the
Company is not currently assured of year 2000 compliance would not cause major
business disruption.
The Company is currently monitoring the year 2000 progress of its major service
providers of non-IT systems, including embedded systems and software, as well as
of its third party business partners such as banking institutions and customers.
The Company has recently begun a review of the systems of major customers of its
subsidiary, ACFC. The Company continues to work to obtain written assurances
from all such identified third parties. In situations where any of these third
parties are not yet compliant, the Company will closely monitor such party's
plans to implement the changes necessary to become compliant.
The Company's target is to complete its year 2000 compliance review by the
second quarter of 1999. Expenses incurred to date associated with implementing
the year 2000 review process have not been material. The Company does not
separately track the internal costs associated with the year 2000 project. All
such costs, which primarily consist of payroll and IT related consulting costs,
have been expensed as incurred. The Company does not anticipate that any
remaining costs will have a material impact on the future financial position or
results of operations of the Company.
The estimates and conclusions stated above contain forward-looking statements
and are based on management's best estimates of future events. These statements
should be read in conjunction with the Company's disclosures under the heading
"Forward-Looking Statements".
- 16 -
<PAGE> 17
Item 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Discussion regarding Quantitative and Qualitative Disclosures About
Market Risk is included in Management's Discussion and Analysis of Financial
Condition and Results of Operations at pages 15 and 16 of this annual report on
Form 10-K.
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" sections of this Form 10-K, as well as within the
annual report generally. When used in this annual report, the words "believes,"
- 17 -
<PAGE> 18
"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 heading "Certain
Considerations" 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
BankBoston, as Agent, for borrowing up to $100 million (the "Revolver"), (ii)
$375 million in limited recourse revolving credit facilities with Bravo and
Capital, (iii) fixed-rate, full recourse term loans from several savings banks,
(iv) specific recourse sales of financing contracts to savings banks and other
purchasers, (v) the issuance of Subordinated Debt in 1997 and (vi) the Company's
internally generated revenues. The Company extended its revolving credit
facility on March 14, 1999 to May 14, 1999 and plans to renew the facility until
May 2000 at that time, but there can be no assurance that it will be able to
renew or extend this agreement at its expiration or 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 Capital 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, dated March 20, 1997, between the Company and State Street Bank and
Trust Company, as Trustee 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.
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 sold) 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
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 charge-offs on the portfolio of the
Company were less than 1% of the Company's average net investment in leases and
notes for 1998, 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
- 18 -
<PAGE> 19
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 approximately $30 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 $49 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 at favorable rates 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.
- 19 -
<PAGE> 20
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, 1998, the estimated residual value of equipment at
the end of the lease term was approximately $15 million, representing
approximately 5% 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 and as part of both the Bravo and Capital securitization
facilities. 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 reserve for each transaction in its allowance for losses and
recognizes a gain that is included for accounting purposes in net revenues 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 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 a 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, 1998, the Company had 21 field sales representatives and 15
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.
- 20 -
<PAGE> 21
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item together with the Independent
Auditors' Report is incorporated by reference from pages 4 through 23
of the 1998 Annual Report. (See also the "Financial Statement
Schedule" filed under Item 14 of this Form 10-K.)
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
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
I 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 1999 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, Termination of Employment and Change of
Control Arrangements" and " - Compensation of Directors" in the 1999 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 1999 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
- 21 -
<PAGE> 22
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
PAGE NUMBER IN
(a) 1. FINANCIAL STATEMENTS 1998 ANNUAL REPORT
-------------------- ------------------
Incorporated by reference from the Company's
Annual Report to Stockholders for the fiscal
year ended December 31, 1998
Consolidated Balance Sheets at December 31,
1998 and December 31, 1997 4
Consolidated Statements of Operations for each
of the three years in the period ended
December 31, 1998 5
Consolidated Statements of Changes in Stock-
holders' Equity for each of the three years in
the period ended December 31, 1998 6
Consolidated Statements of Cash Flows for
each of the three years in the period ended
December 31, 1998 7
Independent Auditors' Report 23
(a) 2. FINANCIAL STATEMENT SCHEDULES
Financial Statement Schedules have been omitted because of the absence of
conditions under which they are required or because the required information is
given in the consolidated financial statements or notes thereto.
(a) 3 EXHIBITS
Exhibits
- --------
Management contracts or compensatory plans or arrangements required to be filed
as exhibits are identified by an asterisk.
<TABLE>
<CAPTION>
NO. TITLE METHOD OF FILING
<S> <C> <C>
3.1 Restated Certificate of Incorporated by reference to
Incorporation of HPSC, Inc. Exhibit 3.1 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
Restated Certificate of Exhibit 3.2 to HPSC's Annual
Incorporation of HPSC, Inc. filed Report on Form 10-K for the fiscal
in Delaware on September 14, 1987 year ended December 31, 1995.
3.3 Certificate of Amendment to Incorporated by reference to
Restated Certificate of Exhibit 3.3 to HPSC's Annual
Incorporation of HPSC, Inc. filed Report on Form 10-K for the fiscal
in Delaware on May 22, 1995 year ended December 31, 1995.
</TABLE>
- 22 -
<PAGE> 23
<TABLE>
<S> <C> <C>
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 between HPSC, Incorporated by reference to
Inc. and Rene Lefebvre dated April Exhibit 10.2 to HPSC's Quarterly
23, 1998 Report on Form 10-Q for the
quarter ended June 30, 1998
*10.6 HPSC, Inc. Employee Stock Incorporated by reference to
Ownership Plan Agreement dated Exhibit 10.9 to HPSC's Annual
December 22, 1993 between HPSC, Report on Form 10-K for the
Inc. and John W. Everets and fiscal year ended December 25,
Raymond R Doherty, as trustees 1993
*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 January Incorporated by reference to
1, 1993 to HPSC, Inc. Employee Exhibit 10.12 to HPSC's Annual
Stock Ownership Plan Report on Form 10-K for the
fiscal year ended December 31,
1994
*10.10 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
</TABLE>
- 23 -
<PAGE> 24
<TABLE>
<S> <C> <C>
*10.11 HPSC, Inc. Supplemental Executive Incorporated by reference to
Retirement Plan dated as of Exhibit 10.12 to HPSC's Annual
January 1, 1997 Report on Form 10-K for the
fiscal year-ended December 31,
1997
*10.12 First Amendment dated March 15, Filed herewith
1999 to HPSC, Inc. Supplemental
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 Credit Agreement Incorporated by reference to
dated as of March 16, 1998 among Exhibit 10.14 to HPSC's Annual
HPSC, Inc., BankBoston Report on Form 10-K for the
individually and as Agent and the fiscal year ended December 31,
Banks named therein 1997
10.15 First Amendment dated June 29, Filed herewith
1998 to Third Amended and Restated
Credit Agreement dated as of March
16, 1998 among HPSC, Inc.,
BankBoston, individually and as
Agent and the Banks named therein.
10.16 Second Amendment dated March 14, Filed herewith
1999 to Third Amended and Restated
Credit Agreement dated as of
March 16, 1998 among HPSC, Inc.,
Bank Boston, individually and as
Agent, and the banks named therein
10.17 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.
10.18 Amendment No. 4 dated June 29, Incorporated by reference to
1998 to Purchase and Contribution Exhibit 10.7 to HPSC, Inc.'s
Agreement, dated January 31, 1995 Quarterly Report on Form 10-Q for
by and among HPSC, Inc. and Bravo the quarter ended June 30, 1998
Funding Corp.
10.19 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
10.20 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
10.21 Amendment documents, effective Incorporated by reference to
November 5, 1996 to Credit Exhibit 10.26 to HPSC's
Agreement dated as of January 31, Registration Statement on Form S-1
1995 among HPSC Bravo Funding filed January 30, 1997
Corp., Triple-A Funding
Corporation, as Lender, and
CapMAC, as Administrative Agent
and as Collateral Agent
</TABLE>
- 24 -
<PAGE> 25
<TABLE>
<S> <C> <C>
10.22 Amendment No. 3 dated June 29, Incorporated by reference to
1998 to Credit Agreement dated Exhibit 10.6 to HPSC's Quarterly
January 31, 1995 by and among Report on Form 10-Q for the
HPSC Bravo Funding Corp., quarter ended March 30, 1998
Triple-A One Funding Corporation
and CapMac, as Administrative
Agent and Collateral Agent
10.23 Lease Receivables Purchase Incorporated by reference to
Agreement dated as of June 27, Exhibit 10.1 to HPSC's Quarterly
1997 among HPSC Capital Funding, Report on Form 10-Q for the
Inc., as Seller, HPSC, Inc. as quarter ended September 30, 1997.
Service and Custodian,
EagleFunding Capital Corporation
as Purchaser and BankBoston
Securities, Inc. as Deal Agent
10.24 Appendix A to EagleFunding Incorporated by reference to
Purchase Agreement (Definitions Exhibit 10.2 to HPSC's Quarterly
List Attached). Report on Form 10-Q for the
quarter ended September 30, 1997
10.25 Purchase and Contribution Incorporated by reference to
Agreement dated as of June 27, Exhibit 10.3 to HPSC's Quarterly
1997 Between HPSC Capital Report on Form 10-Q for the
Funding, Inc. as the Buyer, and quarter ended September 30, 1997
HPSC, Inc. as the Originator and
the Servicer.
10.26 Undertaking to Furnish Certain Incorporated by reference to
Copies of Omitted Exhibits to Exhibit 10.4 to HPSC's Quarterly
Exhibit 10.19 and 10.21 hereof. Report on Form 10-Q for the
quarter ended September 30, 1997.
10.27 Amendment No. 2, dated April 30, Incorporated by reference to
1998 to Lease Receivable Purchase Exhibit 10.4 to HPSC's Quarterly
Agreement dated June 27, 1997, by Report on Form 10-Q for the
and among HPSC Capital Funding, quarter ended June 30, 1998
Inc. (Seller), EagleFunding
Capital Corporation (Purchaser),
HPSC, Inc. (Servicer and
Custodian), and BankBoston
Securities, Inc. (Deal Agent)
10.28 Indenture dated as of March 20, Incorporated by reference to
1997 between HPSC, Inc. and State HPSC's Exhibit 10.28 to HPSC's
Street Bank and Trust Company, Annual Report on Form 10K for the
as Trustee fiscal year ended December 31, 1997
*10.29 Amended and Restated HPSC, Inc. Incorporated by reference to
1995 Stock Incentive Plan Exhibit 10.27 to HPSC's Annual
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
Weicker effective December 7,
1995 Exhibit 10.28 to
HPSC's Annual Report on
Form 10-K for the fiscal
year ended December 31,
1995
*10.31 HPSC 1998 Stock Incentive Plan Incorporated by reference to
Exhibit 10.1 to HPSC's Quarterly
Report on Form 10-Q for the
quarter ended March 30, 1998
*10.32 HPSC, Inc. 1998 Executive Bonus Filed herewith
Plan
*10.33 HPSC, Inc. Outside Directors Incorporated by reference to
Stock Bonus Plan Exhibit 10.1 to HPSC's Quarterly
Report on Form 10-Q for the
quarter ended June 30, 1998
</TABLE>
- 25 -
<PAGE> 26
<TABLE>
<S> <C> <C>
*10.34 Amended and Restated Stock Loan Incorporated by reference to
Program Exhibit 10.26 to HPSC's Annual
Report on Form 10-K for the fiscal
year ended December 31, 1997
13.1 1998 Annual Report to Stockholders Filed herewith
21.1 Subsidiaries of HPSC, Inc. Filed herewith
23.1 Consent of Deloitte & Touche LLP Filed herewith
27.1 HPSC, Inc. Financial Data Filed herewith
Schedule
</TABLE>
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
- 26 -
<PAGE> 27
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.
Dated: March 29, 1999 By: /s/ John W. Everets
---------------------------------
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.
<TABLE>
<CAPTION>
NAME TITLE DATED
<S> <C> <C>
By: /s/ John W. Everets Chairman, Chief Executive March 29, 1999
---------------------------- Officer and Director (Principal
John W. Everets Executive Officer)
By: /s/ Rene Lefebvre Vice President, March 29, 1999
---------------------------- Chief Financial Officer and
Rene Lefebvre Treasurer (Principal Financial
Officer)
By: /s/ Dennis J. McMahon Vice President, Administration March 29, 1999
----------------------------
Dennis J. McMahon (Principal Accounting Officer)
By: /s/ Raymond R. Doherty President and Director March 29, 1999
----------------------------
Raymond R. Doherty
By: /s/ Dollie A. Cole Director March 29, 1999
----------------------------
Dollie A. Cole
By: /s/ Thomas M. McDougal Director March 29, 1999
----------------------------
Thomas M. McDougal
</TABLE>
- 27 -
<PAGE> 28
<TABLE>
<S> <C> <C>
By: /s/ Samuel P. Cooley Director March 29, 1999
----------------------------
Samuel P. Cooley
By: /s/ Joseph A. Biernat Director March 29, 1999
----------------------------
Joseph A. Biernat
By: /s/ J. Kermit Birchfield Director March 29, 1999
----------------------------
J. Kermit Birchfield
By: /s/ Lowell P. Weicker, Jr. Director March 29, 1999
----------------------------
Lowell P. Weicker, Jr.
</TABLE>
- 28 -
<PAGE> 1
EXHIBIT 10.12
HPSC, INC.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
FIRST AMENDMENT
WHEREAS, HPSC, Inc. (the "Company") maintains the HPSC, Inc. Supplemental
Executive Retirement Plan (the "Plan") for the benefit of certain eligible
executive employees;
WHEREAS, the Company desires to amend the Plan to reduce benefit levels as has
been agreed to between the Company and Participants;
NOW THEREFORE, the Plan is amended effective January 1, 1997, as follows:
Section 2.4 is amended to read as follows:
"2.4 AVERAGE FINAL COMPENSATION. The average of a Participant's Compensation for
the three calendar years in which the Participant's greatest Compensation was
received during his or her final five calendar years of Service."
Section 2.11 is amended in its entirety to read as follows:
"2.11 COMPENSATION. The base salary earned by a Participant for personal
services rendered to an Employing Company for any Plan Year, regardless of when
such remuneration is actually paid (or would be paid if not deferred pursuant to
any deferred compensation plan). Compensation shall include (a) any amount of
base salary deferred under any deferred compensation plan and (b) any amount of
base salary contributed under any plan maintained by an Employing Company
pursuant to Code Sections 125, 132, 401(k), or any other Code provision which
provides tax benefits to an employee on account of a voluntary reduction in base
salary. The Participant's Compensation during his or her final calendar year of
Service shall be deemed to equal the Participant's annual base salary at the
time of his or her Separation from Service."
The first paragraph of Section 2.24 is amended in its entirety to read as
follows:
"2.24 OTHER RETIREMENT BENEFITS. Other Retirement Benefits means the lump sum
benefits available to or on behalf of the Participant as of the first day of the
month immediately preceding his benefit commencement date (i) under each of the
benefit plans
<PAGE> 2
specified below, (ii) attributable to Employing Company contributions, and (iii)
calculated as specified for each such benefit plan: "
Section 2.24 is amended so that the second bulleted paragraph now reads as
follows:
"HPSC, INC. EMPLOYEE STOCK OWNERSHIP PLAN (and any successor thereto ("ESOP") -
the benefit determined by MULTIPLYING all shares of Company stock allocated or
otherwise issued or transferred to the Participant's ESOP account through the
date of the determination of his or her Other Retirement Benefits without
regards to any benefit distribution taken by the Participant under the ESOP
TIMES the average closing price of the stock during the most recent five trading
days immediately preceding such date of determination of his or her Other
Retirement Benefits."
Section 2.31 of the Plan is amended in its entirety to read as follows:
"2.31 TARGET RETIREMENT BENEFIT. The Actuarial Equivalent of a retirement
benefit payable on a Participant's Normal Retirement Date and continuing for the
Participant's life in an amount equal to [((a) minus (b)) times (c)] minus (d).
For purposes of the preceding sentence (a) equals fifty-five percent of the
Participant's Average Final Compensation, (b) equals fifty percent of the
Participant's Primary Insurance Amount ("PIA"), (c) equals a fraction not
greater than 1.0, the numerator of which equals the Participant' s total years
of Benefit Service as of the date of determination and the denominator equals
fifteen (15) and (d) equals his or her Other Retirement Benefits."
For purposes of this Section 2.31, PIA means the Participant's old age or
disability insurance benefit determined under Section 202 of the Social Security
Act available to the participant at his retirement, or projected to be available
to the participant at his Normal Retirement Date if his Separation from Service
occurred prior to early retirement. If the Social Security benefit is not
immediately payable, it shall be based on the assumption that the Participant's
then current compensation will remain level until the Participant's Normal
Retirement Date.
Section 5.4 is amended so that the first sentence reads as follows:
"No amendment made to the Plan shall reduce a Participant's Vested
Benefit under the Plan unless such Participant agrees to such a
reduction in writing."
Section 6.1 is amended in its entirety to read as follows:
"6.1 DETERMINATION OF ACCRUED BENEFIT. A Participant's Accrued Benefit as of any
date shall be such Participant's Target Retirement Benefit determined under
Section 2.29 except that such Participant is deemed to have fifteen (15) total
Years of Benefit Service if such date is on or after the date on which a Change
in Control occurs, unless such Change in Control was approved by a resolution
adopted by at least two-thirds of the members of the Incumbent Board (as defined
in Section 2.8)."
<PAGE> 3
Article XII is amended so that Section 12.2 is deleted in its entirety without
replacement and Section 12.1 is amended so that the third sentence reads as
follows:
"No amendment shall diminish or deprive a Participant of a benefit already
accrued unless the Participant agrees to such a reduction or elimination in
writing."
IN WITNESS WHEREOF, the Company has caused this Amendment to be executed by its
duly authorized officer this 15th day of March, 1999.
HPSC, INC.
By: JOHN W. EVERETS
Title: Chief Executive Officer
The following Participants do hereby consent to the terms and effect of this
amendment.
/s/ John W. Everets March 15, 1999
------------------- --------------
John W. Everets Date
/s/ Raymond Doherty March 15, 1999
------------------- --------------
Raymond Doherty Date
/s/ Rene Lefebvre March 15, 1999
----------------- --------------
Rene Lefebvre Date
<PAGE> 1
Exhibit 10.15
-------------
- --------------------------------------------------------------------------------
FIRST AMENDMENT
TO
THIRD AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT
- --------------------------------------------------------------------------------
First Amendment dated as of June 29, 1998 to the Third Amended and
Restated Revolving Credit Agreement (the "First Amendment"), by and among HPSC,
INC., a Delaware corporation (the "Borrower"), AMERICAN COMMERCIAL FINANCE
COMPANY, a Delaware corporation (the "Guarantor" or "ACFC"), BANKBOSTON, N.A.
and the other lending institutions listed on SCHEDULE 1 to the Credit Agreement
(as hereinafter defined) (the "Banks"), and BankBoston, N.A. as agent for the
Banks (in such capacity, the "Agent"), amending certain provisions of the Third
Amended and Restated Revolving Credit Agreement dated as of March 16, 1998 (as
amended and in effect from time to time, the "Credit Agreement") by and among
the Borrower, the Guarantor, the Banks and the Agent. Terms not otherwise
defined herein which are defined in the Credit Agreement shall have the same
respective meanings herein as therein.
WHEREAS, the Borrower and the Banks have agreed to modify certain terms
and conditions of the Credit Agreement as specifically set forth in this First
Amendment;
NOW, THEREFORE, in consideration of the premises and the mutual
agreements contained herein and for other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, the parties hereto
hereby agree as follows:
Section 1. AMENDMENT TO SECTION 1 OF THE CREDIT AGREEMENT.
(a) Section 1.1 of the Credit Agreement is hereby amended by deleting
the following definitions in their entirety and restating such definitions as
follows:
BRAVO CREDIT AGREEMENT. The lease receivables-backed credit
agreement dated as of January 31, 1995 by and among Bravo, Triple-A One
Funding Corporation, a Delaware corporation and Capital Markets
Assurance Corporation, a New York stock insurance company, as amended
by Amendment No. 1 dated as of December 19, 1995, Amendment No. 2 dated
as of October 18, 1996 and Amendment No. 3 dated as of June 29, 1998.
BRAVO PURCHASE AGREEMENT. The Purchase and Contribution
Agreement dated as of January 31, 1995 by and between Bravo and the
Borrower, as amended by Amendment No. 1 dated as of December 19, 1995,
Amendment No. 2 dated as of October 18, 1996, Amendment No. 3 dated as
of May 29, 1997 and Amendment No. 4 dated as of June 29, 1998.
CAPITAL LEASE-RECEIVABLES PURCHASE AGREEMENT. The lease
receivables purchase agreement dated as of June 27, 1997 by and among
Capital, Borrower, EagleFunding Capital Corporation, a Delaware
corporation and BancBoston Securities Inc., a Massachusetts
corporation, as
<PAGE> 2
-2-
amended by Amendment No. 1 dated as of January 30, 1998 and Amendment
No. 2 dated as of April 30, 1998.
(b) The definition of "Bravo Facility Documents" is hereby amended by
adding the phrase ", the Bravo Lease Receivables Purchase Agreement" immediately
following the phrase "Bravo Credit Agreement" on line 2 thereof.
(c) The definition of "Bravo Wind-Down Event" is hereby amended by
adding the phrase, "or Section 7.01 of the Bravo Lease Receivables Purchase
Agreement" at the end of the sentence.
(d) The following new definition is hereby added to Section 1.1 in the
appropriate alphabetical order thereto:
BRAVO LEASE RECEIVABLES PURCHASE AGREEMENT. The Lease
Receivables Purchase Agreement dated as of October 18, 1996 among
Bravo, the Borrower, Triple-A One Funding Corporation and Capital
Markets Assurance Corporation, as amended by Amendment No. 1 dated as
of June 29, 1998.
Section 2. AMENDMENT TO SECTION 10 OF THE CREDIT AGREEMENT.
Section 10 of the Credit Agreement is hereby amended as follows in the
sub-sections indicated:
(a) At the end of Section 10.1(l) before the semi-colon, the words
"Credit Agreement" are hereby deleted and replaced thereto with the
words "Facility Documents".
(b) Section 10.3(f) is hereby deleted in its entirety and replaced
with the following language thereto: "(f) Investments consisting of the
Guaranty, Investments by the Borrower in Subsidiaries of the Borrower
existing on the Closing Date, Investments made pursuant to the Bravo
Facility Documents or Investments in connection with the Capital
Lease-Receivables Purchase Agreement;"
(c) Section 10.5.2 is hereby amended by adding the word "Bravo"
immediately preceding the words "Purchase Agreement" in line 10
thereto.
(d) Section 10.5.2 is hereby amended by adding the words ", the
Bravo Lease Receivables Purchase Agreement" immediately following the
words "Capital Lease-Receivables Purchase Agreement" in line 11
thereto.
Section 3. AMENDMENT TO SECTION 14 OF THE CREDIT AGREEMENT.
Section 14 of the Credit Agreement is hereby amended by adding the following
language in the sub-sections indicated:
(a) In line 8 of Section 14.1(j) immediately following the words
"Purchase Agreement", the words "or Sections 2.04(d) or 2.04(e) of the
Bravo Lease Receivables Purchase Agreement".
<PAGE> 3
-3-
(b) In line 3 of Section 14.1(r) immediately prior to the words
"Purchase Agreement", the word "Bravo".
Section 4. CONDITIONS TO EFFECTIVENESS. This First Amendment shall
not become effective until the Agent receives a counterpart of this First
Amendment, executed by the Borrower, the Guarantor and the Majority Banks.
Section 5. REPRESENTATIONS AND WARRANTIES. The Borrower hereby
repeats, on and as of the date hereof, each of the representations and
warranties made by it in ss.8 of the Credit Agreement, and such representations
and warranties remain true as of the date hereof (except to the extent of
changes resulting from transactions contemplated or permitted by the Credit
Agreement and the other Loan Documents and changes occurring in the ordinary
course of business that singly or in the aggregate are not materially adverse,
and to the extent that such representations and warranties relate expressly to
an earlier date), PROVIDED, that all references therein to the Credit Agreement
shall refer to such Credit Agreement as amended hereby. In addition, the
Borrower hereby represents and warrants that the execution and delivery by the
Borrower of this First Amendment and the performance by the Borrower of all of
its agreements and obligations under the Credit Agreement as amended hereby are
within the corporate authority of the Borrower and has been duly authorized by
all necessary corporate action on the part of the Borrower.
Section 6. RATIFICATION, ETC. Except as expressly amended hereby,
the Credit Agreement, the Security Documents and all documents, instruments and
agreements related thereto are hereby ratified and confirmed in all respects and
shall continue in full force and effect. The Credit Agreement and this First
Amendment shall be read and construed as a single agreement. All references in
the Credit Agreement or any related agreement or instrument to the Credit
Agreement shall hereafter refer to the Credit Agreement as amended hereby.
Section 7. NO WAIVER. Nothing contained herein shall constitute a
waiver of, impair or otherwise affect any Obligations, any other obligation of
the Borrower or any rights of the Agent or the Banks.
Section 8. COUNTERPARTS. This First Amendment may be executed in one
or more counterparts, each of which shall be deemed an original but which
together shall constitute one and the same instrument.
Section 9. GOVERNING LAW. THIS FIRST AMENDMENT SHALL BE GOVERNED BY,
AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE COMMONWEALTH OF MASSACHUSETTS
(WITHOUT REFERENCE TO CONFLICT OF LAWS).
<PAGE> 4
-4-
IN WITNESS WHEREOF, the undersigned have duly executed this First
Amendment as a sealed instrument as of the date first set forth above.
HPSC, INC.
By: /s/ Rene Lefebvre
----------------------------------------
Name: Rene Lefebvre
Title: Chief Financial Officer
BANKBOSTON, N.A., individually and as Agent
By: /s/ Harvey J. Thayer, Jr.
----------------------------------------
Name: Harvey H. Thayer, Jr.
Title: Director
THE SUMITOMO BANK, LIMITED
By:
----------------------------------------
Name:
Title:
By:
----------------------------------------
Name:
Title:
FIRST UNION NATIONAL BANK, FORMERLY
CORESTATES BANK, N.A.
By: /s/ Theresa M. Smith
----------------------------------------
Name: Theresa M. Smith
Title: Vice President
<PAGE> 5
-5-
MELLON BANK, N.A.
By: /s/ Gregory R. Schultz
----------------------------------------
Name: Gregory R. Schultz
Title: Vice President
NATIONAL BANK OF CANADA
By: /s/ Leonard J. Pellecchia
----------------------------------------
Name: Leonard J. Pellecchia
Title: Vice President
By: /s/ A. Keith Broyles
----------------------------------------
Name: A. Keith Broyles
Title: Vice President
UNION BANK OF CALIFORNIA, N.A.
By: /s/ Robert J. Vernagallo
----------------------------------------
Name: Robert J. Vernagallo
Title: Vice President
KEYBANK NATIONAL ASSOCIATION
By: /s/ Eric S. Christensen
----------------------------------------
Name: Eric S. Christensen
Title: Vice President
<PAGE> 6
-6-
RATIFICATION BY GUARANTOR
The undersigned Guarantor hereby acknowledges and consents to the
foregoing First Amendment as of June 29, 1998 and agrees that the Guaranty dated
as of June 23, 1994 from the undersigned in favor of the Agent and each of the
Banks, as amended by Omnibus Amendment No. 3 to Security Documents, dated March
16, 1998, remains in full force and effect, and the Guarantor confirms and
ratifies all of its obligations thereunder.
AMERICAN COMMERCIAL
FINANCE CORPORATION
By: /s/ John W. Everets
----------------------------------------
Name: John W. Everets
Title: Chief Financial Officer
<PAGE> 1
EXHIBIT 10.16
- --------------------------------------------------------------------------------
SECOND AMENDMENT
TO
THIRD AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT
- --------------------------------------------------------------------------------
Second Amendment dated as of March 15, 1999 to the Third Amended and
Restated Revolving Credit Agreement (the "Second Amendment"), by and among HPSC,
INC., a Delaware corporation (the "Borrower"), AMERICAN COMMERCIAL FINANCE
COMPANY, a Delaware corporation (the "Guarantor" or "ACFC"), BANKBOSTON, N.A.
and the other lending institutions listed on SCHEDULE 1 to the Credit Agreement
(as hereinafter defined) (the "Banks"), and BankBoston, N.A. as agent for the
Banks (in such capacity, the "Agent"), amending certain provisions of the Third
Amended and Restated Revolving Credit Agreement dated as of March 16, 1998 (as
amended and in effect from time to time, the "Credit Agreement") by and among
the Borrower, the Guarantor, the Banks and the Agent. Terms not otherwise
defined herein which are defined in the Credit Agreement shall have the same
respective meanings herein as therein.
WHEREAS, the Borrower and the Banks have agreed to modify certain terms and
conditions of the Credit Agreement as specifically set forth in this Second
Amendment;
NOW, THEREFORE, in consideration of the premises and the mutual agreements
contained herein and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties hereto hereby agree as
follows:
Section 1. AMENDMENT TO SECTION 1 OF THE CREDIT AGREEMENT.
(a) Section 1.1 of the Credit Agreement is hereby amended by deleting the
following definitions in their entirety and restating such definitions as
follows:
REVOLVING CREDIT LOAN MATURITY DATE. May 14, 1999.
Section 2. AMENDMENT TO SCHEDULE TO CREDIT AGREEMENT. Schedule 1 to the
Credit Agreement is hereby amended by replacing the existing SCHEDULE 1 with the
new SCHEDULE 1 attached hereto.
Section 3. AMENDMENT TO CERTAIN EXHIBITS TO CREDIT AGREEMENT. EXHIBIT
B-1 to the Credit Agreement is hereby amended by replacing the date "March 16,
1998" on the first line thereof with the date "March 15, 1999". EXHIBIT B-2 to
the Credit Agreement is hereby amended by replacing the date "March 15, 1999" on
the first line thereof with the date "May 14, 1999".
Section 4. CONDITIONS TO EFFECTIVENESS. This Second Amendment shall not
become effective until the Agent receives (a) a counterpart of this Second
Amendment, executed by
<PAGE> 2
-2-
the Borrower, the Guarantor and each of the Banks, (b) revolving credit notes
of the Borrower dated as of March 15, 1999 and otherwise in substantially the
form of EXHIBIT B-1 to the Credit Agreement and completed with appropriate
insertions (the "Revolving Credit Notes"), (c) certificates executed by the
respective secretaries of the Borrower and the Guarantor (i) confirming that
the charter and by-laws of each of the Borrower and the Guarantor have not been
amended since the Closing Date, (ii) as to evidence that all necessary
corporate action for the valid execution and delivery of this Second Amendment
shall have been duly and effectively taken by the Borrower and the Guarantor,
(iii) as to the incumbency and signature of the officers signing this Second
Amendment on behalf of the Borrower and the Guarantor and (iv) certifying as to
the continuing accuracy of the Perfection Certificates, (d) a favorable legal
opinion, dated as of the date hereof, in form and substance satisfactory to the
Agent from Hill & Barlow, counsel to the Borrower and the Guarantor and (e)
such UCC-3 continuation statements and UCC-1 financing statements as the Agent
shall request.
Section 5. REPRESENTATIONS AND WARRANTIES. The Borrower hereby repeats,
on and as of the date hereof, each of the representations and warranties made by
it in ss.8 of the Credit Agreement, and such representations and warranties
remain true as of the date hereof (except to the extent of changes resulting
from transactions contemplated or permitted by the Credit Agreement and the
other Loan Documents, and to the extent that such representations and warranties
relate expressly to an earlier date), PROVIDED, that all references therein to
the Credit Agreement shall refer to such Credit Agreement as amended hereby. In
addition, the Borrower hereby represents and warrants that the execution and
delivery by the Borrower of this Second Amendment and the performance by the
Borrower of all of its agreements and obligations under the Credit Agreement as
amended hereby are within the corporate authority of the Borrower and has been
duly authorized by all necessary corporate action on the part of the Borrower.
Section 6. RATIFICATION, ETC. Except as expressly amended hereby, the
Credit Agreement, the Security Documents and all documents, instruments and
agreements related thereto are hereby ratified and confirmed in all respects and
shall continue in full force and effect. The Credit Agreement and this Second
Amendment shall be read and construed as a single agreement. All references in
the Credit Agreement or any related agreement or instrument (a) to the Credit
Agreement shall hereafter refer to the Credit Agreement as amended hereby and
(b) to Revolving Credit Notes shall hereafter refer to the Revolving Credit
Notes issued pursuant to ss.4 of this Second Amendment.
Section 7. NO WAIVER. Nothing contained herein shall constitute a
waiver of, impair or otherwise affect any Obligations, any other obligation of
the Borrower or any rights of the Agent or the Banks.
Section 8. COUNTERPARTS. This Second Amendment may be executed in one
or more counterparts, each of which shall be deemed an original but which
together shall constitute one and the same instrument.
<PAGE> 3
-3-
Section 9. GOVERNING LAW. THIS SECOND AMENDMENT SHALL BE GOVERNED BY,
AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE COMMONWEALTH OF MASSACHUSETTS
(WITHOUT REFERENCE TO CONFLICT OF LAWS).
<PAGE> 4
-4-
IN WITNESS WHEREOF, the undersigned have duly executed this Second
Amendment as a sealed instrument as of the date first set forth above.
HPSC, INC.
By: /s/ Rene Lefebvre
-----------------------------------
Name: Rene Lefebvre
Title: Vice President and Chief
Financial Officer
BANKBOSTON, N.A., individually and as
Agent
By: /s/ Roberta F. Keeler
-----------------------------------
Name: Roberta F. Keeler
Title: Vice President
<PAGE> 5
-5-
MELLON BANK, N.A.
By: /s/ Michael Shuster
-----------------------------------
Name: Michael Shuster
Title: Vice President
NATIONAL BANK OF CANADA
By: /s/ A. Keith Broyles
-----------------------------------
Name: A. Keith Broyles
Title: Vice President and Manager
By: /s/ Leonard J. Pellecchia
-----------------------------------
Name: Leonard J. Pellecchia
Title: Vice President
UNION BANK OF CALIFORNIA, N.A.
By: /s/ Alison A. Mason
-----------------------------------
Name: Alison A. Mason
Title: Vice President
KEYBANK NATIONAL ASSOCIATION
By: /s/ Noel Graydon
-----------------------------------
Name: Noel Graydon
Title: Vice President
<PAGE> 6
-6-
FLEET BANK, N.A.
By: /s/ Maureen Brody
-----------------------------------
Name: Maureen Brody
Title: Vice President
<PAGE> 7
-7-
RATIFICATION BY GUARANTOR
The undersigned Guarantor hereby acknowledges and consents to the foregoing
Second Amendment as of March 15, 1999 and agrees that the Guaranty dated as of
June 23, 1994 from the undersigned in favor of the Agent and each of the Banks,
as amended by Omnibus Amendment No. 3 to Security Documents, dated March 16,
1998, and each of the other Security Documents to which it is a party remain in
full force and effect, and the Guarantor confirms and ratifies all of its
obligations thereunder.
AMERICAN COMMERCIAL
FINANCE CORPORATION
By: /s/ John W. Everets
-----------------------------------
Name: John W. Everets
Title: Chief Executive Officer
<PAGE> 1
EXHIBIT 10.32
HPSC, INC.
1998 EXECUTIVE BONUS PLAN
1. PURPOSE. The purpose of this Plan is to advance the interests of HPSC,
Inc. (the "Company") and its shareholders by strengthening the ability of the
Company to retain and motivate its executive officers, and to compensate such
executive officers for the forfeiture of previously awarded shares of restricted
stock, by paying such executive officers a cash bonus upon the attainment of
certain performance goals to be used by such executive officers solely for the
purpose of paying the exercise price for certain stock options granted on the
date of adoption of this Plan.
2. EFFECTIVE DATE. This Plan is effective as of April 23, 1998.
3. ADMINISTRATION. This Plan shall be administered by the Compensation
Committee (the "Committee") of the Board of Directors of the Company. Subject to
the provisions of this Plan, the Committee shall have full power to construe and
interpret the Plan and to establish, amend and rescind rules and regulations for
its administration.
4. PARTICIPANTS. John W. Everets, Raymond R. Doherty and Rene Lefebvre,
all of whom are executive officers of the Company on the date of the adoption of
the Plan are eligible to participate in the Plan. Each such executive officer
shall be deemed a "Participant" for purposes of this Plan.
5. AWARD OF BONUSES. Pursuant to the terms of the Plan, the Company shall
pay a cash bonus to each Participant up to the amount set forth below next to
each Participant's name.
PARTICIPANT MAXIMUM BONUS
John Everets $474,062.50
Raymond Doherty $230,625.00
Rene Lefebvre $ 64,062.50
Each Participant shall have the opportunity to earn his bonus in eight
equal quarterly increments, provided that the Company meets the Benchmarks set
forth in Section 6 below as of the relevant dates.
6. VESTING. The Company's obligation to pay bonuses under the Plan shall
be subject to the Company's attainment of the Benchmarks and the Participant's
satisfaction of the Service Requirement, as further described below.
Each Participant shall earn one-eighth (1/8th) of the bonus payable to the
Participant under the Plan on the last day of each of the eight fiscal quarters
following the effective date of the Plan, commencing with the quarter ending
June 30, 1998 (each such date, a "Determination Date"),
<PAGE> 2
provided that (i) the Company's volume of financial contract originations for
the twelve-month period ending on such Determination Date ("Originations")
equals or exceeds $140,000,000 (the "Benchmark"), and (ii) the Participant meets
the Service Requirement on the Determination Date. If Originations as of a
Determination Date are lower than the Benchmark, each Participant may earn his
incremental bonus for such Determination Date on any subsequent Determination
Date if Originations with respect to such later Determination Date exceed the
Benchmark by at least the amount of the Originations shortfall with respect to
the earlier Determination Date; provided that if a shortfall in Originations
occurs with respect to more than one Determination Date, a Participant must earn
the bonus with respect to the earlier Determination Date before excess
Originations can be applied to make up for a shortfall with respect to later
Determination Dates.
The Service Requirement is met if the Participant has provided continuous
Service (as defined below) from the effective date of the Plan through the
relevant Determination Date. "Service" means the performance of work as an
employee of the Company.
Notwithstanding the provisions of this Section 6, in the event of (i) the
termination of a Participant's Service without cause, or by reason of death or
disability, or (ii) a Change in Control of the Company (as defined in the
Company's 1998 Stock Incentive Plan) during a Participant's Service, the
Participant shall be deemed to have earned the entire bonus payable to such
Participant under the Plan, without respect to the attainment of the Benchmark
as of any Determination Date. The Board of Directors' good faith determination
of whether the termination of a Participant's Service was without cause or for
cause shall be binding for purposes of the Plan.
7. PAYMENT OF BONUSES. The Company shall make bonus payments to a
Participant only to the extent that the bonus (or any increment thereof) has
been earned by the Participant pursuant to Section 6 above, at such time or
times as a Participant exercises all or a portion of the stock option granted to
such Participant under the terms of the Company's 1995 Stock Incentive Plan on
the date of adoption of this Plan (each such option, an "Option"). The Company
shall pay the Participant only that portion of the bonus earned as is required
to pay the exercise price for the portion of the Option being exercised at the
time. After the Participant's Option has expired or terminated, the remaining
portion of the bonus which has been earned by the Participant and not previously
utilized for option exercises shall be paid to the Participant.
8. DURATION OF THE PLAN. This Plan shall terminate ten (10) years from
the effective date hereof, or at such time as all of the Options have been fully
exercised, or have been cancelled, terminated or expired. The Company's
obligations under the Plan shall be binding on its successors and assigns.
9. GOVERNING LAW. This Plan shall be governed by, construed and enforced
in accordance with the laws of the Commonwealth of Massachusetts, without regard
to conflict of law principles.
2
<PAGE> 1
EXHIBIT 13.1
TO OUR STOCKHOLDERS
1998 was another year of significant progress for HPSC. Net income increased 81%
to $0.47 per diluted share. Unearned income increased to $73,019,000, a 36%
increase over $53,868,000 at the end of the prior year. Owned and managed leases
and notes receivable increased to $423,331,000 at December 31, 1998, a 34%
increase over $315,170,000 at December 31, 1997. Originations increased to
$182,000,000 from $153,000,000 in 1997, a 19% increase. These results reflect
five years of continual growth.
Five years ago, our 1993 Annual Report listed seven strategic goals for the
Company. Those goals are restated below with an update on our progress.
1. Achieve a highly competitive return on stockholder equity.
o Net income (loss) per share has increased from a net loss of $1.48 per
diluted share in 1993 to net income of $0.47 per diluted share in
1998. Unearned income has increased from $21,800,000 to $73,000,000, a
235% increase.
2. Create a high quality diversified portfolio of leases and notes secured by
equipment and merchandise, with primary emphasis on the healthcare
professions, including but not limited to the dental profession.
o Our portfolio now includes receivables from more than twelve medical
specialties located in fifty states.
3. Increase significantly the size of the HPSC portfolio through new bookings
and portfolio acquisitions.
o Volume of new leases and loans exceeded $182,000,000 in 1998, an
increase of $168,000,000 over 1993 or 1,200% in five years. The
portfolio of owned and managed receivables at year end 1998 was
$423,331,000.
4. Build investor confidence so that HPSC stock is priced at an appropriate
premium to book value.
o At year end 1998, our stock price was $9.75, an increase of 188% from
the $3.38 closing price at year end 1993.
2
<PAGE> 2
5. Offer HPSC customers and vendors excellent service.
o HPSC has developed an enviable nationwide reputation for its service
to customers and vendors.
6. Increase significantly the number of vendors we now serve.
o From a one-vendor relationship in 1993, HPSC has grown to service over
1,000 vendors in 1998.
7. Maintain strong controls on overhead expenses, while managing operations
through state-of-the-art data processing.
o Our data processing systems now serve a rapidly growing enterprise
with reliability while enabling our Company to monitor and control
information vital to our growth and profitability.
While our progress over the last five years has been significant, our goals for
the future are equally high...We are encouraged by the continued support of our
stockholders, lenders and our employee shareholders. Future gains and increased
profitability remain our focus.
/s/ John W. Everets
- -------------------------
John W. Everets
Chairman of the Board and
Chief Executive Officer
3
<PAGE> 3
CONSOLIDATED BALANCE SHEETS
HPSC, Inc. and Subsidiaries
<TABLE>
<CAPTION>
December 31
----------------------
(in thousands, except per share and share amounts) 1998 1997
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and Cash Equivalents $ 4,583 $ 2,137
Restricted Cash 9,588 7,000
Investment in Leases and Notes:
Lease contracts and notes receivable due in installments 293,211 216,852
Notes receivable 35,863 35,540
Retained interest in leases and notes sold 14,500 11,190
Estimated residual value of equipment at end of lease term 14,830 11,342
Less unearned income (73,019) (53,868)
Less allowance for losses (7,350) (5,541)
Less security deposits (6,756) (5,801)
Deferred origination costs 6,696 5,300
--------- ---------
Net investment in leases and notes 277,975 215,014
--------- ---------
Other Assets:
Other assets 5,682 5,705
Refundable income taxes 774 2,770
--------- ---------
Total Assets $ 298,602 $ 232,626
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Revolving Credit Borrowings $ 49,000 $ 39,000
Senior Notes 174,541 123,952
Subordinated Debt 20,000 20,000
Accounts Payable and Accrued Liabilities 7,030 5,752
Accrued Interest 1,285 1,129
Income Taxes:
Currently payable 84 66
Deferred 9,096 7,553
--------- ---------
Total Liabilities 261,036 197,452
--------- ---------
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;
issued, 4,618,530 shares in 1998 and 4,912,530 shares in 1997 46 49
Additional paid-in capital 12,941 12,304
Retained earnings 28,448 26,472
Less: Treasury stock, at cost (368,000 shares in 1998 and 236,900 shares in 1997) (2,230) (1,210)
Deferred compensation (1,141) (2,286)
Notes receivable from officers and employees (498) (155)
--------- ---------
Total Stockholders' Equity 37,566 35,174
--------- ---------
Total Liabilities and Stockholders' Equity $ 298,602 $ 232,626
========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
4
<PAGE> 4
---------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
---------------------------------------------
HPSC, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------------------
(in thousands, except per share and share amounts) 1998 1997 1996
- -------------------------------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
REVENUES:
Earned income on leases and notes $ 32,961 $ 23,691 $ 17,515
Gain on sales of leases and notes 4,906 3,123 1,572
Provision for losses (4,201) (2,194) (1,564)
----------- ----------- -----------
Net Revenues 33,666 24,620 17,523
----------- ----------- -----------
OPERATING AND OTHER (INCOME) EXPENSES:
Selling, general and administrative 15,021 11,599 8,059
Interest expense 15,463 11,380 8,146
Interest income on cash balances (337) (361) (261)
----------- ----------- -----------
Income before Income Taxes 3,519 2,002 1,579
Provision for Income Taxes 1,543 881 704
----------- ----------- -----------
Net Income $ 1,976 $ 1,121 $ 875
=========== =========== ===========
Basic Net Income per Share $ 0.53 $ 0.30 $ 0.23
----------- ----------- -----------
Shares Used to Compute Basic Net Income per Share 3,719,026 3,732,576 3,786,799
----------- ----------- -----------
Diluted Net Income per Share $ 0.47 $ 0.26 $ 0.20
----------- ----------- -----------
Shares Used to Compute Diluted Net Income per Share 4,194,556 4,315,370 4,326,604
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
<PAGE> 5
-----------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
-----------------------------------------------------------------
HPSC, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Notes
Receivable
Common Stock Additional from
----------------- Paid-in Retained Treasury Deferred Officers and
(in thousands, except share amounts) Shares Amount Capital Earnings Stock Compensation Employees Total
- ------------------------------------ --------- ------ ---------- -------- ------- ------------ ------------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996 4,786,530 $ 48 $ 11,311 $ 24,476 $ (410) $(2,066) $ (198) $ 33,161
Net Income -- -- -- 875 -- -- -- 875
Restricted Stock Awards -- -- 994 -- -- (994) -- --
Purchase of Treasury Stock -- -- -- -- (177) -- -- (177)
Restricted Stock Compensation -- -- -- -- -- 365 -- 365
ESOP Compensation -- -- -- -- -- 105 -- 105
Notes Receivable from
Officers and Employees -- -- -- -- -- -- 3 3
- ------------------------------------ --------- ------ ---------- -------- ------- ------------ ------------ --------
BALANCE AT DECEMBER 31, 1996 4,786,530 48 12,305 25,351 (587) (2,590) (195) 34,332
Net Income -- -- -- 1,121 -- -- -- 1,121
Restricted Stock Awards 126,000 1 (1) -- -- -- -- --
Purchase of Treasury Stock -- -- -- -- (623) -- -- (623)
Restricted Stock Compensation -- -- -- -- -- 199 -- 199
ESOP Compensation -- -- -- -- -- 105 -- 105
Notes Receivable from
Officers and Employees -- -- -- -- -- -- 40 40
- ------------------------------------ --------- ------ ---------- -------- ------- ------------ ------------ --------
BALANCE AT DECEMBER 31, 1997 4,912,530 49 12,304 26,472 (1,210) (2,286) (155) 35,174
Net Income -- -- -- 1,976 -- -- -- 1,976
Restricted Stock Awards -- -- 643 -- -- (643) -- --
Purchase of Treasury Stock -- -- -- -- (1,020) -- -- (1,020)
Restricted Stock Compensation -- -- -- -- -- 458 -- 458
ESOP Compensation -- -- -- -- -- 105 -- 105
Notes Receivable from
Officers and Employees -- -- -- -- -- -- (343) (343)
Cancellation of SESOP (350,000) (4) (1,221) -- -- 1,225 -- --
Stock Bonus Awards 6,000 -- 31 -- -- -- -- 31
Exercise of Stock Options 200,000 2 883 -- -- -- -- 885
Conversion of Restricted
Stock to Stock Options (150,000) (1) 1 -- -- -- -- --
Extension of Stock Options
Scheduled to Expire -- -- 300 -- -- -- -- 300
- ------------------------------------ --------- ------ ---------- -------- ------- ------------ ------------ --------
BALANCE AT DECEMBER 31, 1998 4,618,530 $ 46 $ 12,941 $ 28,448 $(2,230) $(1,141) $ (498) $ 37,566
====================================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
6
<PAGE> 6
CONSOLIDATED STATEMENTS OF CASH FLOWS
HPSC, Inc and Subsidiaries
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------------
(in thousands) 1998 1997 1996
- ----------------------------------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,976 $ 1,121 $ 875
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization 4,275 3,558 2,862
Increase in deferred income taxes 1,543 2,551 389
Restricted stock compensation 458 199 365
Gain on sale of lease contracts and notes receivable (4,906) (3,123) (1,572)
Provision for losses on lease contracts and notes receivable 4,201 2,194 1,564
Increase in accrued interest 156 679 111
Increase (decrease) in accounts payable and accrued liabilities (920) 346 2,379
Increase (decrease) in accrued income taxes 18 (234) (68)
(Increase) decrease in refundable income taxes 1,996 (1,567) (115)
(Increase) decrease in other assets 14 (446) (110)
--------- --------- ---------
Cash provided by operating activities 8,811 5,278 6,680
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Origination of lease contracts and notes receivable due in installments (166,672) (135,625) (90,729)
Portfolio receipts, net of amounts included in income 59,365 48,889 38,445
Proceeds from sales of lease contracts and notes
receivable due in installments 38,696 33,039 24,344
Net increase in notes receivable (289) (16,729) (6,730)
Net increase in security deposits 955 1,279 1,095
Net increase in other assets (621) (191) (834)
Net (increase) decrease in loans to employees (343) 40 3
--------- --------- ---------
Cash used in investing activities (68,909) (69,298) (34,406)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior subordinated notes,
net of debt issue costs -- 18,306 --
Repayment of senior notes (61,030) (53,125) (26,019)
Proceeds from issuance of senior notes, net of debt issue costs 111,474 100,087 52,973
Net proceeds (repayments) from demand and
revolving notes payable to banks 10,000 (1,000) 1,000
Purchase of treasury stock (1,020) (623) (177)
Increase in restricted cash 2,588 231 1,159
Exercise of employee stock options 427 -- --
Repayment of employee stock ownership plan promissory note 105 105 105
--------- --------- ---------
Cash provided by financing activities 62,544 63,981 29,041
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 2,446 (39) 1,315
Cash and cash equivalents at beginning of year 2,137 2,176 861
--------- --------- ---------
Cash and cash equivalents at end of year $ 4,583 $ 2,137 $ 2,176
========= ========= =========
Supplemental disclosures of cash flow information:
Interest paid $ 14,775 $ 9,835 $ 7,719
Income taxes paid 52 616 765
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
7
<PAGE> 7
------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------------
HPSC, Inc. and Subsidiaries
NOTE A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
HPSC, Inc. ("HPSC") and its consolidated subsidiaries (the "Company") provide
financing to licensed professionals, principally healthcare providers, through
leases and notes due in installments. The Company also provides asset-based
financing to small and medium-sized manufacturing and distribution companies
throughout the United States.
The Company finances dental, ophthalmic, chiropractic, veterinary 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 prices 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.
Through its wholly-owned subsidiary, American Commercial Finance Corporation
("ACFC"), the Company also provides asset-based financing to manufacturing and
distribution companies whose borrowing requirements are generally less than
$5,000,000.
CONSOLIDATION
The accompanying consolidated financial statements include HPSC, Inc. and the
following wholly-owned subsidiaries: ACFC, an asset-based lender focused
primarily on providing accounts receivable and inventory financing at variable
rates; HPSC Funding Corp. I ("Funding I"), HPSC Bravo Funding Corp. ("Bravo")
and HPSC Capital Funding Inc. ("Capital"), special-purpose corporations formed
in connection with securitizations; and Credident, Inc. ("Credident") the
Company's inactive Canadian subsidiary. All intercompany transactions have been
eliminated in consolidation.
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 leases and notes receivable. Actual results could differ from those
estimates.
REVENUE RECOGNITION
The Company finances equipment only after a customer's credit has been approved
and a lease or 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 value 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. Recognition of revenue on
these assets is suspended no later than when a transaction enters the legal
collection phase. Also included in earned income are fee income from service
charges on portfolio accounts, gains and losses on residual transactions, and
miscellaneous income items, net of initial direct cost amortization.
SALES OF LEASES AND NOTES RECEIVABLE
The Company sells a portion of its 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. Generally, the
Company retains the servicing of financing contracts 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. Effective January 1, 1997, the Company adopted the provisions
of Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
for recording the net gains and retained interests from such sales. The adoption
of SFAS No. 125, which superseded SFAS No. 77, "Reporting by Transferors for
Transfers of Financial Assets and Extinguishments of Liabilities," did not have
a material effect on the Company's consolidated financial position or results of
operations.
DEFERRED ORIGINATION COSTS
The Company capitalizes initial direct costs that relate to the origination of
leases and notes receivable in accordance with SFAS No. 91, "Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases". These initial direct costs comprise certain
specific activities related to processing requests for financing. Deferred
origination costs are amortized on the interest method 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 historical loss experiences, delinquencies, and a specific
analysis of potential loss accounts. 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 resale
at December 31, 1998 or 1997.
The Company accounts for impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118,
8
<PAGE> 8
Notes to Consolidated Financial Statements
HPSC, Inc. and Subsidiaries
"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 Company's 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, 1998 or 1997.
ACCOUNTING FOR STOCK-BASED COMPENSATION
Effective January 1, 1996, the Company elected to continue to account for
stock-based compensation in accordance with Accounting Principles Board Opinion
No. 25 ("APB No. 25"), "Accounting for Stock Issued to Employees." The Company
continues to apply the intrinsic value method under APB No. 25, and has
disclosed the pro forma information required by SFAS No. 123, "Accounting for
Stock-Based Compensation".
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.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when acquired to be cash equivalents.
RESTRICTED CASH
As part of its servicing obligation under its securitization and sales
agreements (Notes C and D), the Company collects certain cash receipts on
financing contracts pledged or sold. These collections are segregated in
separate accounts for the benefit of the third parties to whom the related lease
contracts and notes receivable were pledged or sold and are remitted to the
third parties on a monthly basis.
INTEREST RATE SWAP CONTRACTS
Pursuant to the terms of its securitization agreements (Notes C and D), the
Company is required to enter into interest rate swap contracts. These interest
rate swaps are matched swaps and, as such, are accounted for using settlement
accounting. In the case where the notional value of the interest rate swap
agreements significantly exceeds the outstanding underlying debt, the excess
swap agreements would be marked-to-market. All interest rate swap agreements
entered into by the Company are for other than trading purposes. 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.
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, 1998 or 1997.
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. In
April 1998, the Company canceled its SESOP. The Company had originally issued
350,000 shares of common stock to this plan in July 1994 in consideration of a
promissory note. The shares issued to the SESOP were retired and the promissory
note in the principal amount of $1,225,000 was canceled. Deferred compensation
consists of the following:
<TABLE>
<CAPTION>
------ ------ ------
(in thousands) 1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
ESOP $ 526 $ 631 $ 736
SESOP -- 1,225 1,225
Restricted stock 615 430 629
------ ------ ------
Total $1,141 $2,286 $2,590
====== ====== ======
</TABLE>
9
<PAGE> 9
Notes to Consolidated Financial Statements
HPSC, Inc. and Subsidiaries
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". This statement established standards for reporting and
presenting comprehensive income and its components. Comprehensive income equals
net income for the years ended December 31, 1998, 1997, and 1996.
Effective January 1, 1998, the Company adopted the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," and SFAS
No. 132, "Employers' Disclosure about Pensions and Other Post Retirement
Benefits". The Company has provided the required disclosures of these
pronouncements in Notes L and I, respectively.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" was issued. This statement establishes new accounting and reporting
standards for derivative instruments and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
This statement will be effective for the first quarter of the Company's year
ended December 31, 2000. The Company is evaluating the impact of the adoption of
this statement on its consolidated financial statements.
RECLASSIFICATIONS
Certain amounts in the 1997 and 1996 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% of the
Company's net investment in leases and notes at December 31, 1998 (85% at
December 31, 1997). 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 receivable
due in installments.
The second category of assets consists of the Company's notes receivable, which
comprise approximately 13% of the Company's net investment in leases and notes
at December 31, 1998 (15% at December 31, 1997). These notes primarily relate to
commercial, asset-based, revolving lines of credit to small and medium sized
manufacturers and distributors, at variable interest rates, and typically have
terms of two years. The provision for losses related to the commercial notes
receivable were $147,000, $236,000, and $146,000 in 1998, 1997, and 1996,
respectively. Charge-offs of commercial notes receivable were $75,000, $0, and
$0 in 1998, 1997, and 1996, respectively. The amount of the allowance for losses
related to the commercial notes receivable were $592,000 and $520,000 at
December 31, 1998 and 1997, respectively.
A summary of activity in the Company's allowance for losses for each of the
years in the three-year period ended December 31, 1998 is as follows:
<TABLE>
<CAPTION>
------- ------- -------
(in thousands) 1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Balance, beginning of year $(5,541) $(4,562) $(4,512)
Provision for losses (4,201) (2,194) (1,564)
Charge-offs 2,498 1,304 1,609
Recoveries (106) (89) (95)
------- ------- -------
Balance, end of year $(7,350) $(5,541) $(4,562)
======= ======= =======
</TABLE>
The Company's receivables are subject to credit risk. To reduce this risk, the
Company has adopted 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 (Note
D), are subject to recourse and estimated losses are provided for by the
Company.
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, which were over 90 days past due amounted to
$9,967,000 at December 31, 1998 compared to $6,806,000 at December 31, 1997. An
account is considered delinquent when not paid within thirty days of the billing
due date.
The Company's agreements with its customers, except for commercial notes
receivable of approximately $35,863,000 in 1998 and $35,540,000 in 1997, are
non-cancelable and provide for a full payout at a fixed financing rate with a
fixed payment schedule over a term of one to seven years. Scheduled future
receipts on lease contracts and notes receivable due in installments, plus
retained interest on leases and notes sold, including interest and excluding the
residual value of the equipment and ACFC receivables, at December 31, 1998 are
as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------
(in thousands):
- -----------------------------------------------------
<S> <C>
1999 $85,210
2000 75,445
2001 61,335
2002 45,771
2003 26,457
2004 and thereafter 13,493
</TABLE>
10
<PAGE> 10
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
NOTE C. REVOLVING CREDIT BORROWINGS AND OTHER DEBT
Debt of the Company as of December 31, 1998 and 1997 is summarized below.
- -------------------------------------------------------------------------
(in thousands) 1998 1997
- -------------------------------------------------------------------------
Revolving credit arrangement,
due March 16, 1999 $ 49,000 $ 39,000
- -------------------------------------------------------------------------
Senior Notes:
Senior Notes (Bravo), due June 2003 61,506 57,295
Senior Notes (Capital), due April 2001 110,254 61,744
Senior Notes (SIS), due June 2004 2,781 4,913
- -------------------------------------------------------------------------
Total Senior Notes 174,541 123,952
- -------------------------------------------------------------------------
Unsecured Senior Subordinated Notes,
due March 2007 20,000 20,000
- -------------------------------------------------------------------------
Total $243,541 $182,952
=========================================================================
REVOLVING CREDIT ARRANGEMENT
In December, 1996, the Company executed a Second Amended and Restated Revolving
Loan Agreement with BankBoston as Managing Agent (the "Revolving Loan Agreement"
or "Revolver"), providing availability of up to $95,000,000. In December 1997,
this agreement was extended on the same terms and conditions until March 1998,
providing availability of $60,000,000. In March 1998, the Company executed a
Third Amended and Restated Revolving Loan Agreement with BankBoston as Managing
Agent, providing availability of up to $100,000,000 through March 16, 1999. In
March 1999, this agreement was extended on the same terms and conditions through
May 14, 1999, providing availability up to $86,000,000. It is anticipated the
Company will execute a Fourth Amended and Restated Revolving Loan Agreement by
May 1999 which will provide the Company with availability up to $100,000,000
through May 2000. Under the Revolving Loan Agreement, the Company may borrow at
variable interest rates of prime and at LIBOR plus 1.35% to 1.50%, depending
upon certain performance covenants. The weighted average interest rates on the
outstanding borrowings were 7.1% and 7.4% at December 31, 1998 and 1997,
respectively. In connection with the arrangement, all HPSC and ACFC assets,
including ACFC stock, but excluding assets collateralizing the senior notes,
have been pledged as collateral. The Revolver has not been hedged and was not
hedged at December 31, 1998 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.
SENIOR NOTES (BRAVO)
In January 1995, the Company, along with its wholly-owned, special-purpose
subsidiary, HPSC Bravo Funding Corp. ("Bravo") established a $50,000,000
revolving credit facility (the "Bravo Facility") structured and guaranteed by
Capital Markets Assurance Corporation ("CapMAC", subsequently acquired by MBIA
in February, 1998). Under the terms of the facility, Bravo, to which the Company
sells and may continue to sell or contribute certain of its portfolio assets,
subject to certain covenants regarding Bravo's portfolio performance and
borrowing base calculations, pledges its interests in these assets to a
commercial-paper conduit entity. Bravo incurs interest at variable rates based
on rates in the commercial paper market and enters into interest rate swap
agreements to assure fixed rate funding. In November 1996, the Bravo Facility
was amended to increase available borrowings to $100,000,000 and to allow up to
$30,000,000 of the Bravo Facility to be used to finance sales of financing
contracts. In June 1998, the Bravo Facility was further amended by increasing
the available borrowings to $225,000,000 with $67,500,000 of the Bravo Facility
available to be used for sales of financing contracts.
Monthly settlements of principal and interest payments are made from payments on
portfolio assets held by Bravo. The terms of the Bravo Facility restrict the use
of certain collected cash. This restricted cash amounted to approximately
$5,114,000 and $5,359,000 at December 31, 1998 and 1997, respectively. The
required monthly payments of principal and interest to purchasers of commercial
paper issued pursuant to the Bravo Facility are guaranteed by MBIA.
Bravo enters into interest rate swap contracts to hedge its interest rate risk
related to its variable rate obligation to the commercial paper conduit. Under
such interest rate swap contracts, Bravo pays a fixed rate of interest and
receives a variable rate from the counterparty. At the time of entering into the
interest rate swap contract, Bravo may assign its right, title, and interest in
such contracts to the assignee or purchaser of the assets. There is credit risk
to the extent 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, 1998, the Company had approximately $61,506,000 outstanding
under the loan portion of the Bravo Facility and, in connection with these
borrowings, had interest rate swap contracts with BankBoston with a total
notional value of approximately $57,120,000 at an effective interest rate of
6.10%. At December 31, 1997, the Company had approximately $57,295,000
outstanding under the loan portion of
11
<PAGE> 11
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
the Bravo Facility and, in connection with these borrowings, had interest rate
swap contracts with BankBoston with a total notional value of approximately
$60,432,000 at an effective interest rate of 6.24%.
SENIOR NOTES (CAPITAL)
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"). In April 1998, the Lease Receivable Purchase Agreement was amended to
increase availability to $150,000,000. 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, subject to certain covenants regarding
Capital's portfolio performance and borrowing base calculations, pledges or
sells its interests in these assets to a commercial paper conduit entity.
Capital incurs interest at variable rates based on rates in the commercial paper
market and enters into interest rate swap agreements to assure fixed rate
funding.
Monthly settlements of the borrowing base and any applicable principal and
interest payments are made from collections of Capital's portfolio. The terms of
the Capital Facility restrict the use of certain collected cash. This restricted
cash equaled approximately $4,474,000 and $1,641,000 at December 31, 1998 and
1997, respectively. The required monthly payments of principal and interest to
the purchasers of the commercial paper are guaranteed by BankBoston pursuant to
the terms of the Capital Facility.
In the normal course of securitization transactions, Capital enters into
interest rate swap contracts to hedge its interest rate risk related to its
variable rate obligation to the commercial paper conduit. Under such interest
rate swap contracts, Capital pays a fixed rate of interest and receives a
variable rate from the counterparty. At the time of entering into the interest
rate swap contract, Capital may assign its right, title, and interest in such
contracts to the assignee or purchaser of the assets. There is credit risk to
the extent 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, 1998, the Company had approximately $110,254,000 of indebtedness
outstanding under the Capital Facility, and in connection with these borrowings,
had swap contracts with BankBoston with a total notional value of $105,241,000
at an effective interest rate of 5.76%. At December 31, 1997, the Company had
approximately $61,744,000 outstanding under the loan portion of the Capital
Facility and, in connection with these borrowings, had interest rate swap
contracts with BankBoston with a total notional value of approximately
$59,373,000 at an effective interest rate of 6.12%.
The total amount of loans outstanding under both the Bravo and Capital
Facilities, 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, 1999 $122,083 $113,318 5.83%
December 31, 2000 79,753 70,674 5.77%
December 31, 2001 45,374 39,294 5.71%
December 31, 2002 18,856 15,821 5.60%
December 31, 2003 5,432 4,457 5.52%
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%. In July 1997, the Company entered into an
additional secured, fixed term loan agreement borrowing $4,000,000 at a fixed
rate of 8.0%. Both loans are subject to certain recourse and performance
covenants. At December 31, 1998 and 1997, the Company had outstanding
approximately $2,781,000 and $4,913,000, respectively, under these loan
agreements.
SENIOR SUBORDINATED NOTES
In March 1997, the Company issued $20,000,000 of unsecured senior subordinated
notes (the "Notes") due in 2007. The Notes bear interest at a fixed rate of 11%,
payable semi-annually on April 1 and October 1, beginning October 1, 1997. The
Notes are redeemable at the option of the Company, in whole or in part, other
than through the operation of a sinking fund, after April 1, 2002 at established
redemption prices, plus accrued but unpaid interest to the date of repurchase.
Beginning July 1, 2002, the Company is required to redeem through sinking fund
payments, on January 1, April 1, July 1, and October 1 of each year, a portion
of the aggregate principal amount of the Notes at a redemption price equal to
$1,000,000 plus accrued but unpaid interest to the redemption date.
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, 1998, the
Company was in compliance with the provisions of its debt covenants.
The scheduled maturities of the Company's revolving credit borrowings and all
other debt at December 31, 1998 are as follows:
- ---------------------------------------------------
(in thousands)
- ---------------------------------------------------
1999 $99,559
2000 42,993
2001 34,897
2002 28,921
2003 17,674
Thereafter 19,497
12
<PAGE> 12
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
NOTE D. SALES OF LEASES AND NOTES RECEIVABLE
The Company sells lease contracts and notes receivable due in installments under
certain sales and securitization agreements. In 1998, 1997 and 1996, the Company
received cash proceeds of approximately $38,696,000, $33,039,000, and
$24,344,000, respectively, and recognized pre-tax net gains of approximately
$4,906,000, $3,123,000, and $1,572,000, respectively, in connection with these
sales.
In conjunction with the Company's two securitization facilities, the Company may
sell certain of its portfolio assets to one of its two wholly-owned, special
purpose, bankruptcy-remote subsidiaries, Bravo and Capital (Note C). Under the
terms of the agreements for these facilities, the special purpose entities in
turn sell the assets to a commercial paper conduit. Sales by the Company to
either of its subsidiaries are subject to certain asset performance and asset
base calculations. Proceeds from sales consist of cash, representing a portion
of the net present value of the future scheduled payments for the assets sold,
and a non-certificated, undivided interest in the assets sold. In recording the
net gain on the sale of the assets and the fair value of the net receivables
due, the Company assumes a loss rate on its retained interest approximating its
historical loss rates, and present values its receivable stream at the implicit
rate of the underlying sold assets. At December 31, 1998 and 1997, the Company
had approximately $60,623,000 and $33,610,000 outstanding, respectively, under
the Bravo and Capital agreements. As a hedge against fluctuations in interest
rates associated with commercial paper markets, both Bravo and Capital enter
into interest rate swap agreements. At December 31, 1998 and 1997, interest rate
swap agreements, with a total notional value of approximately $60,517,000 and
$33,129,000, respectively, were in place in connection with such sales.
Certain sales agreements from 1996 and 1995 are subject to 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 make payments when due. The total outstanding balances of lease
contracts and notes due in installments which are subject to repurchase
obligations by the Company were approximately $8,093,000 at December 31, 1998
and $13,105,000 at December 31, 1997.
Under the sales and securitization agreements, the Company may continue to
service the assets sold, subject to the maintenance of certain covenants. The
Company believes that its servicing fee approximates its estimated servicing
costs, but does not have a market to assess the fair value of its servicing
asset. Accordingly, the Company has valued its servicing asset and liability as
zero. The Company will recognize servicing fee revenue as earned over the
servicing period. The Company recognized approximately $208,000, $171,000 and
$15,000 of such revenue in 1998, 1997 and 1996, respectively.
NOTE E. LEASE COMMITMENTS
The Company leases various office locations under noncancelable lease
arrangements that have initial terms of from three to six years and that
generally provide renewal options from one to five years. Rent expense under all
operating leases was $628,000, $448,000, and $391,000 for 1998, 1997, and 1996,
respectively.
Future minimum lease payments for commitments exceeding twelve months under
non-cancelable operating leases as of December 31, 1998 are as follows:
- -------------------------------------------------
(in thousands)
- -------------------------------------------------
1999 $514
2000 494
2001 451
2002 402
2003 and thereafter 604
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:
Year Ended December 31,
- -----------------------------------------------------------------------------
(in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------
Domestic $3,729 $2,072 $1,699
Foreign (210) (70) (120)
- -----------------------------------------------------------------------------
Income before income taxes $3,519 $2,002 $1,579
=============================================================================
Income taxes consist of the following:
Year Ended December 31,
- -----------------------------------------------------------------------------
(in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------
Federal:
Current $ (511) $(1,347) $251
Deferred 1,525 2,050 310
Additional paid in capital
from exercise of
non-qualified stock
options 215 -- --
State:
Current 240 (346) 64
Deferred 19 524 79
Additional paid in capital
from exercise of
non-qualified stock
options 55 -- --
- -----------------------------------------------------------------------------
Provision for income taxes $1,543 $ 881 $704
=============================================================================
13
<PAGE> 13
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
Deferred income taxes arise from the following:
Year Ended December 31,
- -----------------------------------------------------------------------
(in thousands) 1998 1997 1996
- -----------------------------------------------------------------------
Operating method $ 3,509 $2,785 $142
Alternative minimum
tax credit (1,425) -- --
Other (540) (211) 247
- -----------------------------------------------------------------------
$ 1,544 $2,574 $389
=======================================================================
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,
- -----------------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------------
Statutory rate 34.0% 34.0% 34.0%
State taxes net of U.S.
federal income tax benefit 5.9 5.9 6.0
Foreign loss not benefited 2.1 1.2 2.6
Non-deductible write-off
of foreign currency
translation adjustment 0.2 -- --
Other 1.6 2.9 2.0
- -----------------------------------------------------------------------
43.8% 44.0% 44.6%
=======================================================================
The items which comprise a significant portion of deferred tax liabilities are
as follows at December 31:
- -----------------------------------------------------------------------
(in thousands) 1998 1997
- -----------------------------------------------------------------------
Operating method $11,416 $7,906
Alternative minimum tax credit (1,425) --
Other (895) (353)
- -----------------------------------------------------------------------
Deferred income taxes $ 9,096 $7,553
=======================================================================
The Company has approximately $6,100,000 of state net operating loss
carryforwards scheduled to expire beginning in 2000.
NOTE G. STOCKHOLDERS' EQUITY AND EARNINGS PER SHARE
COMMON STOCK
The Company has 15,000,000 shares authorized and 4,618,530 shares outstanding at
December 31, 1998. Of the outstanding shares, 300,000 shares have been issued to
the Company's ESOP (Note I), 313,000 shares have been issued to certain
employees under the 1995 Stock Incentive Plan (Note H), and 368,000 shares are
held in treasury.
PREFERRED STOCK
The Company has 5,000,000 shares of $1.00 par value preferred stock authorized
with no shares outstanding at December 31, 1998. (Note J., Preferred Stock
Purchase Rights Plan.)
TREASURY STOCK
In September 1998, the Company initiated a stock repurchase program pursuant to
which up to 175,000 shares of the Company's common stock may be repurchased from
a pool of up to $1,700,000, subject to market conditions, in open market or
negotiated transactions on the NASDAQ National Market. Based on year end market
prices, the shares subject to repurchase represent approximately 3.7% of the
outstanding common stock. No minimum number or value of shares to be repurchased
has been fixed, nor has a time limit been established for the duration of the
repurchase program. The Company expects to use the repurchased stock to meet the
current and future requirements of its employee stock plans.
EARNINGS PER SHARE
SFAS No. 128, "Earnings per Share" became effective for the Company for the year
ended December 31, 1997. SFAS No. 128 superseded APB Opinion No. 15, "Earnings
per Share," by establishing new requirements for calculating and reporting
earnings per share. Net income per share data for 1996 has been restated to
conform to the provisions of SFAS No. 128. The Company's basic net income per
share calculation is based on the weighted average number of common shares
outstanding, which does not include unallocated shares under the Company's ESOP
and SESOP (Note I), restricted shares issued under the Stock Plan (Note H),
treasury stock, or any shares issuable upon the exercise of outstanding stock
options. Diluted net income per share includes the weighted average number of
common shares related to stock options and contingently issuable common shares
under the Restricted Stock Plan outstanding as calculated under the treasury
stock method but not unallocated shares under the Company's ESOP and SESOP.
14
<PAGE> 14
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
The following is a reconciliation of the numerators and denominators of the
basic and diluted net income per share:
<TABLE>
<CAPTION>
Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------
(in thousands, except per share and share amounts) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Basic Net Income per Share:
Net income $ 1,976 $ 1,121 $ 875
Weighted average common shares outstanding 3,719,026 3,732,576 3,786,799
---------------------------------------------
Basic net income per share $ 0.53 $ 0.30 $ 0.23
=============================================
Diluted Net Income per Share:
Net income $ 1,976 $ 1,121 $ 875
Denominator:
Weighted average common shares outstanding 3,719,026 3,732,576 3,786,799
Stock options and restricted shares 475,530 582,794 539,805
---------------------------------------------
Total diluted shares 4,194,556 4,315,370 4,326,604
---------------------------------------------
Diluted net income per share $ 0.47 $ 0.26 $ 0.20
=============================================
</TABLE>
NOTE H. STOCK OPTION AND STOCK INCENTIVE PLANS
STOCK OPTION PLANS
The Company had three initial stock option plans in place which provided for the
granting of options to purchase up to 355,375 shares of common stock of the
Company: 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
(the "1995 Plan"). The 1995 Plan was subsequently terminated in February 1998
upon the approval of the 1998 Stock Incentive Plan (the "1998 Plan").
Options granted under the 1983 Plan are non-qualified options granted at an
exercise price not less than 85% of the fair market value of the common stock on
the date of grant. Options granted under the 1986 Plan are non-qualified stock
options granted at an exercise price equal to the market price on the date of
grant. Options granted under the 1994 Plan are non-qualified options granted at
an exercise price equal to the fair market value of the common stock on the date
of grant.
In April 1998, 120,000 five year options issued under the 1986 Plan which were
scheduled to expire in 1998 were extended for 5 years. Upon the extension of the
options, the Company recorded compensation expense of $300,000, representing the
difference between the original option exercise price on the date of grant and
the market price of the Company's stock (the intrinsic value) on the date the
extension was granted.
1995 PLAN
The Company has outstanding stock options and awards of restricted stock under
its 1995 Plan. The options are incentive stock options and non-qualified options
and were granted at an exercise price equal to the market price on the date of
the grant. Restricted shares of common stock awarded under the 1995 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 to 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 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
15
<PAGE> 15
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
respect to 5,000 shares. Additional paid in capital and deferred compensation of
$994,000 was recorded when the partial performance criteria was achieved with
respect to 50% of the restricted shares in June 1996. In April 1998, 150,000 of
the outstanding restricted shares were forfeited in exchange for stock options
granted pursuant to the 1995 Plan. Additional paid in capital and deferred
compensation of $136,345 was recorded when the Full Performance Condition was
met with respect to the remaining restricted shares outstanding.
In May 1997, an additional 126,000 restricted shares were awarded under the 1995
Plan. The Partial Performance Condition of these shares is $8.05 per share and
the Full Performance Condition is $10.10 per share. Additional paid in capital
and deferred compensation of $507,150 was recorded in May 1998 when the Partial
Performance Condition was met with respect to 50% of the restricted shares.
In 1998, 1997, and 1996, the Company recognized approximately $458,000,
$199,000, and $365,000, respectively, in compensation expense related to
restricted stock awards under its 1995 Plan. The compensation expense is
recognized by the Company on a straight line basis over the 5 year service
period which begins on the date of grant. A cumulative adjustment is recorded by
the Company on the date the performance conditions are met to retroactively
recognize compensation expense from the date of grant to the date the
performance condition was met.
1998 PLAN
In February 1998, the Company's Board of Directors approved the 1998 Plan
pursuant to which 550,000 shares of common stock are reserved. In addition, any
shares subject to options or stock awards under the 1995 Plan that expire or are
terminated unexercised will be available for issuance pursuant to stock options
or restricted stock awards under the 1998 Plan.
1998 PLAN - STOCK OPTIONS
The 1998 Plan provided that with respect to options granted to key employees
(except non-employee directors), the option term and the terms and conditions
upon which the options may be exercised shall be determined by the Compensation
Committee of the Company's Board of Directors for each such option at the time
it is granted. Options granted to key employees of the Company are 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. In the case of incentive stock options, the exercise
price may not be less than the average of the closing prices of the common stock
on each of the days on which the stock was traded during the thirty calendar day
period ending on the day before the date of the option grant. The exercise price
for non-qualified options may not be less than 85% of the market price on the
date of the grant.
With respect to automatic options to non-employee directors of the Company
(which must be non-qualified options), the 1998 Plan specifies the option term
and the terms and conditions upon which the options may be exercised. Each
non-employee director who was such at the conclusion of any regular annual
meeting of the Company's stockholders while the 1998 Plan is in effect and who
continues to serve on the Board of Directors is granted such automatic options
to purchase 1,000 shares of the Company's common stock at an exercise price not
less than the average of the closing prices of the common stock on each of the
days on which the stock was traded during the thirty calendar day period ending
on the day before the date of the option grant. 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 1998 Plan) upon or following termination of the holder's service
as a director.
1998 PLAN - RESTRICTED STOCK
The 1998 Plan provides that restricted shares of common stock awarded under the
1998 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
137.1% of the average of the closing prices on the thirty calendar day period
ending immediately prior to 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 174.2% of the average
of the closing prices on the thirty calendar day period ending immediately prior
to 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 to 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 1998 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. As of December 31, 1998, no restricted shares had been
awarded under the 1998 Plan.
16
<PAGE> 16
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
1998 OUTSIDE DIRECTORS STOCK BONUS PLAN
The Company's Board of Directors approved the 1998 Outside Directors Stock Bonus
Plan in April 1998, pursuant to which 25,000 shares of the Company's common
stock were reserved for issuance. Under the terms of the agreement, 1,000 bonus
shares of common stock will be awarded to each non-employee director who is such
at the beginning of any regular annual meeting of the Company's stockholders
while the 1998 Outside Directors Stock Bonus Plan is in effect and who will
continue to serve on the Board of Directors. Bonus shares are issued in
consideration of services previously rendered to the Company. The Outside
Directors Stock Bonus Plan will terminate 5 years from the effective date,
unless terminated earlier (as provided in the plan). In 1998, 6,000 shares of
common stock were issued pursuant to the 1998 Outside Directors Stock Bonus
Plan.
The following table summarizes stock option and restricted stock activity:
<TABLE>
<CAPTION>
Options
---------------------------------
Number of Weighted Average Restricted
Options Exercise Price Stock
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding at January 1, 1996 611,875 $3.19 337,000
Granted 60,000 5.15 --
Forfeited (30,000) 3.31 --
---------------------------------------------
Outstanding at December 31, 1996 641,875 3.36 337,000
Granted 16,000 6.08 126,000
Forfeited (5,000) 4.75 --
---------------------------------------------
Outstanding at December 31, 1997 652,875 3.43 463,000
Granted 419,000 5.37 --
Exercised (200,000) 3.08 --
Forfeited (28,000) 5.51 --
Restricted stock converted to stock options 150,000 5.13 (150,000)
---------------------------------------------
Outstanding at December 31, 1998 993,875 $4.52 313,000
=============================================
</TABLE>
The following table sets forth information regarding options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------- ------------------------------
Weighted Average Weighted Average Weighted Average
Range of Number of Remaining Contractual Exercise Number Exercise
Exercise Prices Options Life (Years) Price of Options Price
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$2.63-3.25 268,875 3.98 $2.97 268,875 $2.97
$3.37-4.00 90,000 0.96 3.75 86,500 3.76
$4.50-4.88 49,000 6.82 4.70 35,500 4.71
$5.12-5.37 564,000 9.25 5.30 141,758 5.27
$6.00-6.75 22,000 7.89 6.35 16,000 6.21
- ----------------------------------------------------------------------------------------------------------
$2.63-6.75 993,875 6.92 $4.52 548,633 $3.90
==========================================================================================================
</TABLE>
The weighted average grant date fair values of options granted for the years
ended December 31, 1998, 1997, and 1996 were $3.50, $3.29, and $3.07,
respectively.
NOTES RECEIVABLE FROM OFFICERS AND EMPLOYEES ("STOCK LOAN PROGRAM")
The Company maintains a Stock Loan Program (as most recently amended on July 28,
1997) whereby executive officers and other senior personnel of the Company may
borrow from the Company for the purpose of acquiring common stock of the
Company. Such borrowings may not exceed $200,000 in any fiscal quarter or
$500,000 in the aggregate at any time during the term of the Stock 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, are 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, with periodic principal
prepayments equal to between 20% and 30% of the participant's after-tax bonus.
17
<PAGE> 17
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
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 basic and diluted earnings per share would have been as
follows:
- ----------------------------------------------------------------------
(in thousands, except
per share amounts) 1998 1997 1996
- ----------------------------------------------------------------------
Income before income taxes $3,315 $1,985 $1,591
Provision for income taxes 1,594 898 731
- ----------------------------------------------------------------------
Net income $1,721 $1,087 $ 860
- ----------------------------------------------------------------------
Basic net income per share $ 0.46 $ 0.29 $ 0.23
- ----------------------------------------------------------------------
Diluted net income per share $ 0.41 $ 0.25 $ 0.20
======================================================================
For purposes of determining the above disclosure required by SFAS 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:
- ----------------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------------
Risk-free interest rate 6.0% 5.7% 6.0%
Expected life of
option grants 5-10 years 5-10 years 5-10 years
Expected volatility
of underlying stock 45.9% 29.7% 36.4%
The pro forma presentation only includes the effects of grants made subsequent
to January 1, 1995. The pro forma amounts may not be indicative of the future
benefit, if any, to be received by the option holder.
NOTE I. 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 1998, 1997, and 1996.
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, 1998, 149,654 shares of common stock have been
allocated to participant accounts under the ESOP and 150,346 shares remain
unallocated. The market value of unallocated shares at December 31, 1998 was
$1,465,873.
SUPPLEMENTAL EMPLOYEE STOCK OWNERSHIP PLAN
In April 1998, the Company canceled its Supplemental Employee Stock Ownership
Plan ("SESOP"). The Company had originally issued 350,000 shares of common stock
to this plan in July 1994 in consideration of a promissory note in the principal
amount of $1,225,000. No contributions or allocations had been made to any
participant accounts. The shares issued to the SESOP were retired and the
promissory note was canceled.
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 $90,410 in 1998, $71,772 in 1997, and
$62,841 in 1996.
SUPPLEMENTAL EMPLOYEE RETIREMENT PLAN
In 1997, the Company adopted an unfunded
Supplemental Executive Retirement Plan ("SERP") effective January 1, 1997. The
SERP provides certain executives retirement income benefits in addition to
certain other retirement programs received by the executives. Benefits under the
plan, based on an actuarial equivalent of a life annuity, are based on age,
length of service and average earnings and vest over 15 years, assuming five
years of service. Benefits are payable upon separation of service.
18
<PAGE> 18
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
Details of the SERP for the years ended December 31, 1998 and 1997 are as
follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
(in thousands) December 31, 1998 December 31, 1997
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation, beginning of year $ 630 $ --
Benefit obligation, at plan inception -- 401
Service cost 137 118
Interest cost 44 28
Actuarial loss (gain) (82) 83
-------------------------
Benefit obligation, end of year 729 630
-------------------------
FUNDED STATUS AND STATEMENT OF FINANCIAL POSITION:
Fair value of assets, end of year -- --
Benefit obligation, end of year 729 630
Funded status (729) (630)
Unrecognized actuarial loss 20 110
Unrecognized prior service cost 345 373
-------------------------
Net accrued benefit cost (364) (147)
-------------------------
Amount recognized in the statement of financial position consist of:
Accrued benefit liability included in accrued liabilities (453) (350)
Intangible assets included in other assets 89 203
-------------------------
Net accrued benefit cost (364) (147)
-------------------------
COMPONENTS OF NET PERIODIC BENEFIT COSTS:
Service cost 137 118
Interest cost 44 28
Amortization of prior service cost 28 28
Recognized actuarial loss (gain) 8 (27)
-------------------------
Net periodic benefit cost $ 217 $ 147
-------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
December 31, 1998 December 31, 1997
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
WEIGHTED AVERAGE ASSUMPTIONS
For pension cost and year end benefit obligation
Discount rate 7.00% 7.00%
Compensation increase 4.00% 4.00%
Assumed retirement age 65 years 65 years
</TABLE>
19
<PAGE> 19
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
NOTE J. PREFERRED STOCK PURCHASE RIGHTS PLAN
Pursuant to a rights agreement between the Company and BankBoston, 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 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 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 K. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", 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.
The 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.
20
<PAGE> 20
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
The following table presents a comparison of the carrying value and estimated
fair value of the Company's financial instruments at December 31, 1998:
Carrying Estimated
(in thousands) Value Fair Value
- --------------------------------------------------------------------------------
Financial assets:
Cash and cash equivalents $ 4,583 $ 4,583
Restricted cash 9,588 9,588
Net investment in leases and notes 277,975 277,975
Financial liabilities:
Notes payable and
subordinated debt 243,541 246,082
Interest rate swap contracts -- 2,958
The following table presents a comparison of the carrying value and estimated
fair value of the Company's financial instruments at December 31, 1997:
Carrying Estimated
(in thousands) Value Fair Value
- --------------------------------------------------------------------------------
Financial assets:
Cash and cash equivalents $ 2,137 $ 2,137
Restricted cash 7,000 7,000
Net investment in leases and notes 215,014 215,014
Financial liabilities:
Notes payable and
subordinated debt 182,952 183,013
Interest rate swap contracts -- 1,060
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. If the Company had nonaccrual practice
acquisition loans, or impaired asset based loans, the fair value would be
estimated by discounting management's estimate of future cash flows with a
discount rate commensurate with the risk associated with such assets.
Notes payable and subordinated debt: The fair market value of the Company's
senior and subordinated notes is estimated based on the quoted market prices for
similar issues or on the current rates offered to the Company for debt of the
same maturity.
Interest rate swap contracts: The fair value of interest rate swap contracts is
estimated based on the estimated amount necessary to terminate the agreements.
NOTE L. OPERATING SEGMENTS
GENERAL
The Company has two reportable segments: (i) financing to licensed
professionals, and (ii) asset-based financing to commercial and industrial
companies. The Company's financing to licensed professionals is structured as
non-cancelable, full-payout lease contracts or notes receivable due in
installments. Asset-based financing includes revolving lines of credit to
commercial and industrial companies in the form of notes receivable
collateralized by accounts receivable, inventory and/or fixed assets. These two
segments employ separate sales forces and market their products to different
types of customers. The licensed professional financing segment derives its
revenues primarily from earnings generated by the fixed-rate lease and loan
contracts, whereas the revenues from the commercial and industrial financing
segment are derived primarily from the variable interest rates on the usage of
the lines of credit plus miscellaneous commitment and performance-based fees.
FINANCIAL STATEMENT INFORMATION
In the monthly internal management reports, the Company allocates resources and
assesses performance of the operating segments by monitoring the profit
contribution of each segment before interest expense, interest income on cash
balances, and income tax provision. The Company does not allocate corporate
overhead to its asset-based financing segment since the majority of all such
overhead is related to the licensed professional financing segment.
21
<PAGE> 21
Notes to Consolidated Financial Statements
HPSC. Inc. and Subsidiaries
A summary of information about the Company's operations by segment for the years
ended December 31, 1998, 1997, and 1996 is as follows:
<TABLE>
<CAPTION>
Licensed Commercial and
Professional Industrial
(in thousands) Financing Financing Total
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1998
Earned income on leases and notes $ 28,045 $ 4,916 $ 32,961
Gain on sales of leases and notes 4,906 -- 4,906
Provision for losses (4,054) (147) (4,201)
Selling, general and administrative expenses (13,393) (1,628) (15,021)
-------------------------------------------------
Net profit contribution 15,504 3,141 18,645
Total assets 264,419 34,183 298,602
1997
Earned income on leases and notes 19,712 3,979 23,691
Gain on sales of leases and notes 3,123 -- 3,123
Provision for losses (1,958) (236) (2,194)
Selling, general and administrative expenses (10,270) (1,329) (11,599)
-------------------------------------------------
Net profit contribution 10,607 2,414 13,021
Total assets 198,200 34,426 232,626
1996
Earned income on leases and notes 14,899 2,616 17,515
Gain on sales of leases and notes 1,572 -- 1,572
Provision for losses (1,381) (183) (1,564)
Selling, general and administrative expenses (7,147) (912) (8,059)
-------------------------------------------------
Net profit contribution 7,943 1,521 9,464
Total assets 141,889 20,494 162,383
</TABLE>
The following reconciles net segment profit contribution as reported above to
total consolidated income before income taxes:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
(in thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net segment profit contribution $ 18,645 $ 13,021 $ 9,464
Interest expense (15,463) (11,380) (8,146)
Interest income on cash balances 337 361 261
-------------------------------------------------
Income before income taxes $ 3,519 $ 2,002 $ 1,579
</TABLE>
OTHER SEGMENT INFORMATION
The Company derives substantially all of its revenues from domestic customers.
As of December 31, 1998, no single customer within the licensed professional
financing segment accounted for greater than 1% of the total owned and serviced
portfolio of that segment. Within the commercial and industrial financing
segment, no single customer accounted for greater than 8.5% of the total
portfolio of that segment. The licensed professional financing segment does rely
on certain vendors to provide referrals to the Company, but for the year ended
December 31, 1998, no one vendor accounted for greater than 14% of the Company's
lease originations.
22
<PAGE> 22
--------------------------------------------
Independent Auditors Report
--------------------------------------------
To the Board of Directors and Stockholders of HPSC, Inc.:
We have audited the accompanying consolidated balance sheets of HPSC, Inc. and
subsidiaries (the "Company") as of December 31, 1998 and 1997, and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. 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, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of HPSC, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
/s/ Deloitte & Touche LLP
Boston, Massachusetts
February 26, 1999
23
<PAGE> 23
--------------------------------------------
Market Information
--------------------------------------------
The table below sets forth the representative high and low closing prices for
shares of the common stock of the Company in the over-the-counter market as
reported by the NASDAQ National Market System (Symbol: "HPSC") for the fiscal
years 1998 and 1997:
1998 Fiscal Year High Low 1997 Fiscal Year High Low
- ----------------------------------------------------------------------------
First Quarter $ 5 5/8 $5 First Quarter $6 3/8 $5 3/4
Second Quarter 8 3/4 5 1/8 Second Quarter 6 1/8 5 1/8
Third Quarter 12 7 5/8 Third Quarter 6 7/8 5 1/4
Fourth Quarter 9 15/16 7 7/8 Fourth Quarter 7 5 1/4
The foregoing quotations represent prices between dealers, and do not include
retail markups, markdowns, or commissions.
HOLDERS
Approximate Number of Record
Title of Class Holders (as of February 26, 1999)
- --------------------------------------------------------------------------------
Common Stock, par value $.01 per share 96(1)
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.
(1) This number does not reflect beneficial ownership of shares held in
"nominee" or "street name".
24
<PAGE> 24
--------------------------------------------
Selected Financial Data
--------------------------------------------
<TABLE>
<CAPTION>
Year Ended
----------------------------------------------------------------------
(in thousands, except Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 25,
share and per share data) 1998 1997 1996 1995(2) 1994(1)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Revenues:
Earned income on leases and notes $ 32,961 $ 23,691 $ 17,515 $ 12,871 $ 11,630
Gain on sales of leases and notes 4,906 3,123 1,572 53 --
Provision for losses (4,201) (2,194) (1,564) (1,296) (754)
- ---------------------------------------------------------------------------------------------------------------------
Net Revenues $ 33,666 $ 24,620 $ 17,523 $ 11,628 $ 10,876
- ---------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 1,976 $ 1,121 $ 875 $ (125) $ 450
- ---------------------------------------------------------------------------------------------------------------------
Net Income (Loss) per Share: Basic(3) $ 0.53 $ 0.30 $ 0.23 $ (0.03) $ 0.09
Diluted(3) $ 0.47 $ 0.26 $ 0.20 $ (0.03) $ 0.09
- ---------------------------------------------------------------------------------------------------------------------
Shares Used to Compute Basic(3) 3,719,026 3,732,576 3,786,799 4,575,970 4,952,532
Net Income (Loss) per Share Diluted(3) 4,194,556 4,315,370 4,326,604 4,575,970 5,044,754
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Dec. 31, Dec. 31, Dec.31, Dec. 31, Dec. 25,
(in thousands) 1998 1997 1996 1995 1994(1)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Cash and Cash Equivalents $ 4,583 $ 2,137 $ 2,176 $ 861 $ 419
Restricted Cash 9,588 7,000 6,769 5,610 7,936
Lease Contracts Receivable and Notes
Receivable(4) 343,574 263,582 178,383 140,689 103,531
Unearned Income 73,019 53,868 34,482 25,875 16,924
Total Assets 298,602 232,626 162,383 130,571 103,148
Revolving Credit Borrowings 49,000 39,000 40,000 39,000 16,500
Senior Notes 174,541 123,952 76,737 46,523 41,024
Subordinated Debt 20,000 20,000 -- -- --
Stockholders' Equity 37,566 35,174 34,332 33,161 32,822
</TABLE>
(1) 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.
(2) Net loss reflects a one-time, non-cash loss on write-off of cumulative
foreign currency translation adjustment of $601,000 related to the Company's
discontinued Canadian operations.
(3) Net income (loss) per share for all periods presented conform to the
provisions of Statement of Financial Accounting Standards No. 128, "Earnings
per Share".
(4) Lease contracts receivable and notes receivable include the Company's
retained interest in leases and notes receivable sold under certain sales
and securitization agreements.
25
<PAGE> 25
------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition
------------------------------------------------------------------
RESULTS OF OPERATIONS
FISCAL YEARS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997
Earned income from leases and notes for 1998 was $32,961,000 (including
$4,916,000 from ACFC) as compared to $23,691,000 (including $4,036,000 for ACFC)
for 1997. This increase of approximately 39.1% was due primarily to the increase
in the net investment in leases and notes from 1997 to 1998. The increase in net
investment in leases and notes resulted primarily from an increase of
approximately 19.0% in the Company's financing contract originations for fiscal
1998 to approximately $182,000,000 (including approximately $23,000,000 in ACFC
line of credit originations, and excluding approximately $6,000,000 of initial
direct costs) from approximately $153,000,000 (including approximately
$24,000,000 in ACFC line of credit originations, and excluding approximately
$4,500,000 of initial direct costs) for 1997. Pre-tax net gains on sales of
leases and notes increased to $4,906,000 in 1998 compared to $3,123,000 in 1997.
This increase was caused by improved margins associated with current year asset
sales activity. 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 using the interest method over the life of
the net investment in leases and notes.
Interest expense net of interest income on cash balances for 1998 was
$15,126,000 (45.9% of earned income) compared to $11,019,000 (46.5% of earned
income) for 1997, an increase of 37.3%. The increase in net interest expense was
due primarily to a 33.1% increase in debt levels from 1997 to 1998, 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 1998 as compared to 1997.
Net financing margin (earned income less net interest expense) for fiscal 1998
was $17,835,000 (54.1% of earned income) as compared to $12,672,000 (53.5% of
earned income) for 1997. 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 a higher percentage of the portfolio being matched to lower interest
rate debt during 1998 as compared to 1997.
The provision for losses for fiscal 1998 was $4,201,000 (12.8% of earned income)
compared to $2,194,000 (9.3% of earned income) for 1997. The increase in amount
resulted from higher levels of new financings in 1998 and the Company's
continuing evaluation of its portfolio quality, loss history and allowance for
losses. The allowance for losses at December 31, 1998 was $7,350,000 (2.6% of
net investment in leases and notes) as compared to $5,541,000 (2.6% of net
investment in leases and notes) at December 31, 1997. Net charge-offs were
approximately $2,400,000 in 1998 compared to $1,200,000 in 1997.
Selling, general and administrative expenses for fiscal 1998 were $15,021,000
(45.6% of earned income) as compared to $11,599,000 (49.0% of earned income) for
1997. The increase in amount resulted from increased staffing and systems and
support costs required by higher volumes of financing activity in 1998 and costs
incurred to permit anticipated near-term growth in financing activity. The
increase in amount was also caused by increased compensation and related costs
associated with the Company's 1995 Stock Incentive Plan as certain performance
benchmarks in such plans related to the price of HPSC common stock were met and
by the extension of certain five-year options which were scheduled to expire.
The decrease as a percentage of earned income was the result of improved per
unit costs on higher levels of originations and higher levels of owned portfolio
assets.
The Company's income before income taxes for fiscal 1998 was $3,519,000 compared
to $2,002,000 for 1997. The provision for income taxes was $1,543,000 (43.9% of
income before tax) in 1998 compared to $881,000 (44.0%) in 1997.
The Company's net income for fiscal 1998 was $1,976,000 or $0.53 per basic share
and $0.47 per diluted share, compared to $1,121,000 or $0.30 per basic share and
$0.26 per diluted share for 1997. The increase in 1998 over 1997 was due to
higher earned income from leases and notes, higher gains on sales of assets, and
lower cost of funds, offset by increases in the provision for losses, higher
selling, general and administrative expenses, and higher average debt levels.
Net profit contribution, representing income before interest and taxes (see Note
L to Notes to Consolidated Financial Statements) from the licensed professional
financing segment was $15,504,000 for the year ended December 31, 1998 compared
to $10,607,000 for the comparable period in 1997, a 46% increase. The increase
was due to an increase in earned income on leases and notes to $28,045,000 in
1998 compared to $19,712,000 in 1997, higher gain on sales of leases and notes
of $4,906,000 in 1998 from $3,123,000 in 1997, offset by an increase in the
provision for losses in 1998 to $4,054,000 from $1,958,000 in the prior year, as
well as an increase in selling, general and administrative expenses to
$13,393,000 in 1998 compared to $10,270,000 in 1997.
Net profit contribution (income before interest and taxes) from the commercial
and industrial financing segment was $3,141,000 for the year ended December 31,
1998 compared to $2,414,000 for the comparable period in 1997, a 30% increase.
The increase was due to an increase in earned interest and fee income on notes
to $4,916,000 in 1998 compared to $3,979,000 in 1997; as well as a decrease in
the provision for losses in 1998 to $147,000 from $236,000 in the prior year,
offset by an increase in selling, general and administrative expenses to
$1,628,000 in 1998 compared to $1,329,000 in 1997.
28
<PAGE> 26
Management's Discussion and Analysis of Financial Condition
At December 31, 1998, the Company had approximately $81,000,000 of customer
applications which had been approved but had not yet resulted in a completed
transaction, compared to approximately $59,000,000 of such customer applications
at December 31, 1997. Not all approved applications will result in completed
financing transactions with the Company.
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 45.7%
in the Company's financing contract originations for fiscal 1997 to
approximately $153,000,000 (including approximately $24,000,000 in ACFC line of
credit originations, and excluding approximately $4,500,000 of initial direct
costs) from approximately $105,000,000 (including approximately $18,000,000 in
ACFC line of credit 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 using the
interest method over the life of the net investment in leases and notes.
Interest expense net of interest income on cash balances for 1997 was
$11,019,000 (46.5% of earned income) compared to $7,885,000 (45.0% of earned
income) for 1996, an increase in amount of 39.7%. 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.
Net financing margin (earned income less net interest expense) for fiscal 1997
was $12,672,000 (53.5% 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 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 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 (3.0% 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 $11,599,000
(49.0% 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.
Net profit contribution, representing income before interest and taxes (see Note
L to Notes to Consolidated Financial Statements) from the licensed professional
financing segment was $10,607,000 for the year ended December 31, 1997 compared
to $7,943,000 for the comparable period in 1996, a 34% increase. The increase
was due to an increase in earned income on leases and notes to $19,712,000 in
1998 compared to $14,899,000 in 1997, higher gain on sales of leases and notes
of $3,123,000 in 1997 from $1,572,000 in 1996, offset by an increase in the
provision for losses in 1998 to $1,958,000 from $1,381,000 in the prior year, as
well as an increase in selling, general and administrative expenses to
$10,270,000 in 1997 compared to $7,147,000 in 1996.
Net profit contribution (income before interest and taxes) from the commercial
and industrial financing segment was $2,414,000 for the year ended December 31,
1997 compared to $1,521,000 for the comparable period in 1996, a 59% increase.
The increase was due to an increase in earned interest and fee income on notes
to $3,979,000 in 1997 compared to $2,616,000 in 1996, offset by an increase in
the provision for losses in 1997 to $236,000 from $183,000 in the prior year, as
well as an increase in selling, general and administrative expenses to
$1,329,000 in 1997 compared to $912,000 in 1996.
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.
27
<PAGE> 27
Management's Discussion and Analysis of Financial Condition
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 residual
interest, if any, that it has in the securitized financing contracts should a
default occur. The Company's borrowings under the Revolver (as defined below)
are full recourse obligations of HPSC. The Company's borrowings under the
Revolver are used to provide asset based lending within ACFC as well as to
temporarily fund new financing contracts entered into by the Company. These
borrowings 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, 1998, the Company had $14,171,000 in cash, cash equivalents and
restricted cash as compared to $9,137,000 at the end of 1997. As described in
Note C to the Company's Consolidated Financial Statements, $9,588,000 of such
cash was restricted pursuant to financing agreements as of December 31, 1998,
compared to $7,000,000 at December 31, 1997.
Cash provided by operating activities was $8,811,000 for the year ended December
31, 1998 compared to $5,278,000 in 1997 and $6,680,000 in 1996. The significant
components of cash provided by operating activities in 1998 as compared to 1997
were an increase in net income in 1998 to $1,976,000 from $1,121,000 in 1997, an
increase in the gain on sales of leases and notes to $4,906,000 in 1998 from
$3,123,000 in 1997, which resulted from improved margins associated with current
year asset sales activity, and a decrease in refundable income taxes of
$1,996,000 in 1998 compared to an increase of $1,567,000 in 1997, offset by a
decrease in accounts payable and accrued liabilities of $920,000 in 1998
compared to an increase of $346,000 for the same period in 1997.
Cash used in investing activities was $68,909,000 for the year ended December
31, 1998 compared to $69,298,000 in 1997 and $34,406,000 in 1996. The primary
component of cash used in investing activity for 1998 as compared to 1997 was an
increase in originations of lease contracts and notes receivable to $166,672,000
in 1998 from $135,625,000 in 1997. This use of cash was offset by an increase in
portfolio receipts of $59,365,000 in 1998 from $48,889,000 in 1997, an increase
in notes receivable of $289,000 in 1998 as compared to $16,729,000 in 1997, and
an increase in proceeds from sales of lease contracts and notes receivable to
$38,696,000 in 1998 from $33,039,000 in 1997.
Cash provided by financing activities was $62,544,000 for the year ended
December 31, 1998 compared to $63,981,000 in 1997 and $29,041,000 in 1996. The
significant components of cash provided by financing activities in 1998 as
compared to 1997 were an increase in the net proceeds from senior notes in 1998
to $111,474,000 from $100,087,000 in 1997, net proceeds from revolving notes
payable of $10,000,000 in 1998 compared to net repayments of $1,000,000 in 1997,
and an increase in restricted cash of $2,588,000 in the current year compared to
$231,000 in 1997, offset by repayments of senior notes of $61,030,000 in 1998
compared to $53,125,000 in 1997 as well as no senior subordinated note
borrowings in 1998.
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. Under the terms
of the Funding I Notes, when the principal balance equals the balance of the
restricted cash in the facility, the Funding I Notes are paid off from the
restricted cash and Funding I terminates. This occurred in June of 1997. Due to
this early termination, the Company incurred a $175,000 non-cash, non-operating
charge against earnings in both the first and second quarters of 1997
representing the partial early recognition of certain unamortized deferred
transaction origination costs.
28
<PAGE> 28
Management's Discussion and Analysis of Financial Condition
In December 1996, the Company executed a Second Amended and Restated Revolving
Loan Agreement with BankBoston as Managing Agent (the "Revolving Loan Agreement"
or "Revolver"), providing availability up to $95,000,000. In December 1997, this
agreement was extended on the same terms and conditions until March 1998,
providing availability of $60,000,000. In March 1998, the Company executed a
Third Amended and Restated Revolving Loan Agreement with BankBoston as Managing
Agent, providing availability up to $100,000,000 through March 16, 1999. In
March 1999, this agreement was extended under the same terms and conditions
through May 14, 1999, providing availability up to $86,000,000. It is
anticipated the Company will execute a Fourth Amended and Restated Revolving
Loan Agreement in May 1999 which will provide the Company availability up to
$100,000,000 through May 2000. Under the Revolver, the Company may borrow at
variable rates of prime and at LIBOR plus 1.35% to 1.50%, depending on certain
performance covenants. At December 31, 1998, the Company had $49,000,000
outstanding under this facility and $51,000,000 available for borrowing, subject
to borrowing base limitations. The Revolver is not currently hedged and is,
therefore, exposed to upward movements in interest rates.
As of January 31, 1995, the Company, along with its wholly-owned,
special-purpose subsidiary Bravo Funding Corp. ("Bravo"), established a
$50,000,000 revolving credit facility (the "Bravo Facility") structured and
guaranteed by Capital Markets Assurance Corporation ("CapMAC", subsequently
acquired by MBIA in February 1998). 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 MBIA pursuant to the terms of the Bravo Facility. In November, 1996, the
Bravo Facility was increased to $100,000,000 and amended to provide that up to
$30,000,000 of the Bravo Facility may be used as sales of receivables from Bravo
for accounting purposes. In June 1998, the Bravo Facility was further amended by
increasing availability to $225,000,000 with $67,500,000 available to be used
for sale accounting treatment. The Company had $61,506,000 outstanding under the
loan portion of the Bravo Facility at December 31, 1998, and in connection with
these borrowings, had 19 separate interest rate swap agreements with BankBoston
with a total notional value of $57,120,000. The Company had $44,549,000
outstanding from sales of receivables under the sale portion of the Bravo
Facility and in connection with this portion of the facility, had 9 separate
interest rate swap agreements with BankBoston with a total notional value of
$45,860,000 at December 31, 1998.
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. 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 approximately $2,781,000 outstanding under these agreements at December 31,
1998.
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 is the servicer of the Capital portfolio subject to certain covenants.
The required monthly payments
29
<PAGE> 29
of principal and interest to purchasers of the commercial paper are guaranteed
by BankBoston pursuant to the terms of the facility. In April 1998, the Capital
Facility was amended to increase availability to $150,000,000 under the same
terms and conditions through April 2001. The Company had $110,254,000 of
indebtedness outstanding under the loan portion of the Capital Facility at
December 31, 1998, and in connection with these borrowings had 14 separate
interest rate swap agreements with BankBoston with a total notional value of
$105,241,000. The Company had $16,073,000 outstanding from sales of receivables
under the sale portion of the Capital Facility and in connection with this
portion of the facility, had 3 separate interest rate swap agreements with
BankBoston with a total notional value of $14,657,000 at December 31, 1998.
In September 1998, the Company initiated a stock repurchase program under which
up to 175,000 shares of the Company's common stock may be repurchased from a
pool of up to $1,700,000, subject to market conditions, in open market or
negotiated transactions on the NASDAQ National Market. Based on year end market
prices, the shares subject to repurchase represent approximately 3.7% of the
outstanding common stock. No minimum number or value of shares to be repurchased
has been fixed, nor has a time limit been established for the duration of the
repurchase program. The Company expects to use the repurchased stock to meet the
current and future requirements of its employee stock plans. In 1998, the
Company repurchased an aggregate of 131,100 shares of its common stock for
approximately $1,020,000.
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 1999 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.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of its business, the Company is subject to a variety of
risks, including market risk associated with interest rate movements. The
Company is exposed to such interest rate risk from the time elapsed between the
approval of a transaction with a customer and when permanent fixed rate
financing is secured. The Company does not hold or issue financial instruments
for trading purposes.
The Company temporarily funds its new fixed rate financing contracts through
variable rate revolving credit borrowings until permanent fixed rate financing
is secured through its securitization facilities. The Company's exposure to
interest rate risk relates to changes in interest rates between the time a new
financing contract is approved and the time the permanent, fixed-rate financing
is completed. The Company believes that it mitigates this exposure by obtaining
such permanent financing generally within 60 days of the activation date of the
new financing contract and believes it will be able to continue this operating
strategy.
The Company manages its exposure to interest rate risk by entering into interest
rate swap agreements under its securitization transactions. These swap
agreements have the effect of converting the Company's debt from securitizations
from a variable rate to a fixed rate. Changes in interest rates would result in
unrealized gains or losses in the market value of the fixed rate debt to the
extent of differences between current market rates and the actual stated rates
for these debt instruments. Assuming all swap agreements were to be terminated,
the cost to the Company would have been approximately $2,958,000 at December 31,
1998. Assuming a hypothetical 10% change in interest rates from current weighted
average swap rates, the cost to the Company for terminating such swap agreements
would have been approximately $4,895,000 at December 31, 1998.
The carrying value of the Company's fixed rate debt at December 31, 1998 was
$194,541,000. The estimated fair value of this debt was $197,082,000, which was
determined by applying the fixed rate that the Company received on its
securitization transaction in December 1998 against the entire outstanding fixed
rate debt balance at December 31, 1998. The Company's variable rate debt at
December 31, 1998 was $49,000,000, which approximated fair value. Assuming a
hypothetical 10% change in interest rates from current weighted average debt
rates, market risk for the fixed rate debt is estimated as the potential change
in the fair value of the debt, which would have approximated $3,373,000 at
December 31, 1998. The effect of a 10% hypothetical change in interest rates on
the Company's variable rate debt would have changed the Company's consolidated
interest expense by $348,000 for the year ended December 31, 1998.
30
<PAGE> 30
Management's Discussion and Analysis of Financial Condition
The Company's portfolio of financing contracts originated in its licensed
professional financing segment are fixed rate, non-cancelable, full payout lease
contracts and notes receivable due in installments. At December 31, 1998, the
carrying value of these assets, including the retained interest of sold assets,
was approximately $246,984,000, which approximated fair value. Assuming implicit
rates changed by a hypothetical 10% from current weighted average implicit
rates, the effect on the fair value of the Company's fixed rate financing
contracts would have approximated $2,725,000 at December 31, 1998.
The Company's variable rate assets are generally comprised of financing
contracts originated by its commercial asset-based lending subsidiary, ACFC.
These financing agreements are structured as variable rate lines of credit
extended to various commercial and industrial entities, collateralized by
accounts receivable, inventory, or fixed assets, generally for periods of two to
three years. At December 31, 1998, the carrying value of these assets was
approximately $30,991,000 which approximated fair value. The effect of a
hypothetical 10% change in interest rates on the Company's variable rate
financing contracts would have changed the Company's consolidated interest
income by $412,000 for the year ended December 31, 1998.
For additional information about the Company's financial instruments, see Note K
in Notes to Consolidated Financial Statements.
YEAR 2000 ISSUES
The year 2000 issue relates to the inability of computer applications to
distinguish between years with the same last two digits in different centuries
such as 1900 and 2000. In 1996, the Company, along with its subsidiary, ACFC,
began a review to assess the year 2000 readiness of all of its information
technology ("IT") systems. In 1998, the Company expanded this review to include
non-IT systems, including embedded software such as the Company's telephone
system, as well as the systems of third parties who are important business
partners with the Company.
The Company is heavily reliant on integrated IT systems for providing much of
its day-to-day operations, including application processing, underwriting,
billing and collections, as well as much of the financial and operational
reporting to management. The Company has performed a complete review of all
relevant computer systems. Based on its internal review, the Company believes
that substantially all of its internal IT systems are year 2000 compliant. The
Company has also obtained written assurances from all providers of its IT
software and systems as to the year 2000 compliance of each of these systems.
The Company believes that the loss of any ancillary systems as to which the
Company is not currently assured of year 2000 compliance would not cause major
business disruption.
The Company is currently monitoring the year 2000 progress of its major service
providers of non-IT systems, including embedded systems and software, as well as
of its third party business partners such as banking institutions and customers.
The Company has recently begun a review of the systems of major customers of its
subsidiary, ACFC. The Company continues to work to obtain written assurances
from all such identified third parties. In situations where any of these third
parties are not yet compliant, the Company will closely monitor such party's
plans to implement the changes necessary to become compliant.
The Company's target is to complete its year 2000 compliance review by the
second quarter of 1999. Expenses incurred to date associated with implementing
the year 2000 review process have not been material. The Company does not
separately track the internal costs associated with the year 2000 project. All
such costs, which primarily consist of payroll and IT related consulting costs,
have been expensed as incurred. The Company does not anticipate that any
remaining costs will have a material impact on the future financial position or
results of operations of the Company.
The estimates and conclusions stated above contain forward-looking statements
and are based on management's best estimates of future events. These statements
should be read in conjunction with the Company's disclosures under the heading
"Forward-Looking Statements".
31
<PAGE> 31
Management's Discussion and Analysis of Financial Condition
FORWARD-LOOKING STATEMENTS
This Annual Report 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," as well as
within the Annual Report generally. When used in this Annual Report, the words
"believes," "anticipates," "expects," "plans," "intends," "estimates,"
"continue," "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, including but not limited to
the following: the Company's dependence on funding sources; restrictive
covenants in funding documents; payment restrictions and default risks in asset
securitization transactions to which the Company is a party; customer credit
risks; competition for customers and for capital funding at favorable rates
relative to the capital cost of the Company's competitors; changes in
healthcare payment policies; interest rate risk; the risk that the Company may
not be able to realize the residual value on financed equipment at the end of
its lease term; risks associated with the sale of certain receivable pools by
the Company; dependence on sales representatives and the current management
team; the risk that the Company's or its customers' computer systems will not
be fully year 2000 compliant; and fluctuations in quarterly operating results.
The Company's filings with the Securities and Exchange Commission, including
its Annual Report on Form 10-K for the year ended December 31, 1998, to be
filed on or before March 31, 1999, contain additional information concerning
such risk factors. Actual results in the future could differ materially from
those described in the forward-looking statements as a result of the risk
factors set forth above, the risk factors described in Annual Report on Form
10-K for the year ended December 31, 1998, and the matters set forth in this
Annual Report generally. HPSC cautions the reader, however, that such list of
risk factors 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.
32
<PAGE> 1
EXHIBIT 21.1
------------
SUBSIDIARIES OF HPSC, INC.
Name of Subsidiary Jurisdiction of Incorporation
------------------ -----------------------------
Credident, Inc. Canada
American Commercial Finance Corporation Delaware
HPSC Funding Corp. I Delaware
HPSC Bravo Funding Corp. Delaware
HPSC Capital Funding, Inc. Delaware
<PAGE> 1
Exhibit 23.1
------------
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
333-56927, 333-28983, 33-60077, 33-60073, 33-10796 and 33-6075 of HPSC, Inc. on
Form S-8 of our Report dated February 26, 1999 incorporated by reference in this
Annual Report on Form 10-K of HPSC, Inc. for the fiscal year ended December 31,
1998.
/s/ Deloitte & Touche LLP
Boston, Massachusetts
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 14,171
<SECURITIES> 0
<RECEIVABLES> 343,574
<ALLOWANCES> 7,350
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 3,228
<DEPRECIATION> 1,684
<TOTAL-ASSETS> 298,602
<CURRENT-LIABILITIES> 0
<BONDS> 243,541
0
0
<COMMON> 46
<OTHER-SE> 37,520
<TOTAL-LIABILITY-AND-EQUITY> 298,602
<SALES> 0
<TOTAL-REVENUES> 37,867
<CGS> 0
<TOTAL-COSTS> 15,021
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4,201
<INTEREST-EXPENSE> 15,463
<INCOME-PRETAX> 3,519
<INCOME-TAX> 1,543
<INCOME-CONTINUING> 1,976
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,976
<EPS-PRIMARY> .53
<EPS-DILUTED> .47
</TABLE>
