1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997 OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from _____________to______________
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
--------------
NONE
(FORMER NAME, FORMER ADDRESS, AND FORMER FISCAL YEAR IF CHANGED SINCE LAST
REPORT)
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 and 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 / /
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
COMMON STOCK, PAR VALUE $.01 PER SHARE. SHARES OUTSTANDING AT NOVEMBER 1, 1997,
4,549,630
1
2
HPSC, INC.
INDEX
PAGE
----
PART 1 -- FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets as of September 30, 1997 and
December 31,1996 ......................................................... 3
Condensed Consolidated Statements of Income for Each of the
Three and Nine Months Ended September 30, 1997 and September 30, 1996 .... 4
Condensed Consolidated Statements Of Cash Flows for Each Of
The Nine Months Ended September 30, 1997 and September 30,1996 ........... 5
Notes to Condensed Consolidated Financial Statements ....................... 6
Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................................... 7
PART II -- OTHER INFORMATION
Signatures ................................................................ 13
Exhibit Index ............................................................. 14
2
3
ITEM 1. FINANCIAL STATEMENTS.
HPSC, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
(unaudited)
SEPTEMBER 30, DECEMBER 31,
1997 1996
---- ----
ASSETS
------
CASH AND CASH EQUIVALENTS $ 6,645 $ 2,176
RESTRICTED CASH 4,773 6,769
INVESTMENT IN LEASES AND NOTES:
Lease contracts and notes receivable due in installments 206,712 160,049
Notes receivable 24,615 18,688
Estimated residual value of equipment at end of lease term 10,461 9,259
Less unearned income (47,505) (34,482)
Less allowance for losses (4,174) (4,082)
Less security deposits (5,501) (4,522)
Deferred origination costs 4,660 4,312
--------- ---------
Net investment in leases and notes 189,268 149,222
--------- ---------
OTHER ASSETS:
Other assets 4,918 3,847
Refundable income taxes 703 1,203
--------- ---------
TOTAL ASSETS $ 206,307 $ 163,217
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
REVOLVING CREDIT BORROWINGS $ 35,000 $ 40,000
SENIOR NOTES 105,729 76,737
SENIOR SUBORDINATED NOTES 20,000 --
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES 2,486 5,916
ACCRUED INTEREST 1,693 450
ESTIMATED RECOURSE LIABILITIES 895 480
INCOME TAXES:
Currently payable 420 300
Deferred 5330 5,002
--------- ---------
TOTAL LIABILITIES 171,553 128,885
--------- ---------
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 and outstanding
4,786,530 shares in 1997 and 1996 48 48
TREASURY STOCK (at cost) 236,900 shares in
1997 and 128,600 in 1996 (1,210) (587)
Additional paid-in capital 13,062 12,305
Retained earnings 26,115 25,351
--------- ---------
38,015 37,117
Less: Deferred compensation (3,092) (2,590)
Notes receivable from officers
and employees (169) (195)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 34,754 34,332
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 206,307 $ 163,217
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
3
4
HPSC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR EACH OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND
SEPTEMBER 30, 1996
(in thousands, except per share and share amounts)
(unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
------------- ------------- ------------- -------------
REVENUES:
Earned income on leases and notes $ 6,115 $ 4,434 $ 16,531 $ 12,562
Gain on sales of leases and notes 759 610 1,927 885
Provisions for losses (381) (424) (821) (1,224)
----------- ----------- ----------- -----------
Net Revenues 6,493 4,620 17,637 12,223
----------- ----------- ----------- -----------
EXPENSES:
Selling, general and administrative 3,289 1,867 9,072 5,580
Interest expense 2,772 2,403 7,470 5,826
Interest income (79) (58) (264) (177)
----------- ----------- ----------- -----------
Net operating expenses 5,982 4,212 16,278 11,229
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES: 511 408 1,359 994
----------- ----------- ----------- -----------
PROVISION FOR INCOME TAXES:
Federal, Foreign and State:
Current 97 650 268 1,950
Deferred 120 (490) 327 (1,560)
----------- ----------- ----------- -----------
TOTAL INCOME TAXES 217 160 595 390
----------- ----------- ----------- -----------
NET INCOME $ 294 $ 248 $ 764 $ 604
----------- ----------- ----------- -----------
NET INCOME PER SHARE $ .07 $ .06 $ .19 $ .15
----------- ----------- ----------- -----------
SHARES USED TO COMPUTE
INCOME PER SHARE 4,019,148 4,145,270 4,073,752 4,107,313
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
4
5
HPSC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1996
(in thousands)
(unaudited)
SEPT 30, SEPT 30,
1997 1996
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 764 $ 604
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 2,847 2,818
Deferred income taxes 328 (1,560)
Restricted stock compensation 149 --
Gain on sale of receivables (1,927) (885)
Provision for losses on lease contracts and notes
receivable 821 1,224
Increase in accrued interest 1,243 415
Decrease in accounts payable and accrued liabilities (3,430) (2,229)
Increase in accrued income taxes 120 415
Decrease in refundable income taxes 500 1,088
Decrease in other assets 228 142
-------- --------
Cash provided by operating activities 1,643 2,032
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Origination of lease contracts and notes receivable
due in installments (94,965) (62,750)
Portfolio receipts, net of amounts included in income 42,594 30,478
Proceeds from sales of lease contracts and notes
receivable due in installments 20,616 12,629
Net increase in notes receivable (5,883) (6,507)
Net increase in security deposits 979 721
Net (increase) in other assets (38) (593)
Net decrease (increase) in loans to employees 26 (13)
-------- --------
Cash used in investing activities (36,671) (26,035)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of senior notes (29,837) (16,438)
Proceeds from issuance of senior notes, net of debt
issue costs 58,550 24,381
Proceeds from issuance of senior subordinated notes,
net of debt issuance costs 18,306 --
Net repayment of revolving credit borrowings (28,500) (8,000)
Proceeds from revolving credit borrowings, net of debt
issuance costs 23,492 24,950
Purchase of treasury stock (623) --
Net decrease in restricted cash (1,996) (1,141)
Repayment of employee stock ownership plan promissory note 105 105
-------- --------
Cash provided by financing activities 39,497 23,857
-------- --------
Net increase (decrease) in cash and cash equivalents 4,469 (146)
Cash and cash equivalents at beginning of period 2,176 861
-------- --------
Cash and cash equivalents at end of period $ 6,645 $ 715
======== ========
Supplemental disclosures of cash flow information:
Interest paid $ 6,218 $ 5,127
Income taxes paid 111 675
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
5
6
HPSC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The information presented for the interim periods is unaudited, but includes
all adjustments (consisting only of normal recurring adjustments) which, in the
opinion of HPSC, Inc. (the "Company"), are necessary for a fair presentation of
the financial position, results of operations and cash flows for the periods
presented. The results for interim periods are not necessarily indicative of
results to be expected for the full fiscal year. Certain 1996 account balances
have been reclassified to conform with 1997 presentation.
2. The earnings per share computations assume the exercise of stock options
under the modified treasury stock method and include those shares allocated to
participant accounts in the Company's Employee Stock Ownership Plan and those
shares subject to time vesting under the Restricted Stock Award Plan.
3. On September 30, 1997, the Company had $4,773,000 in restricted cash, all of
which was reserved for debt service. On June 20, 1997, the Company terminated
its agreement with HPSC Funding Corp I with respect to the $70,000,000
securitization transaction on December 27, 1993.
4. In connection with the HPSC Bravo Funding Corp. ("Bravo") revolving credit
facility, the Company had $67,919,000 of its Senior Notes subject to interest
rate swap agreements. Under this facility, Bravo incurs interest at various
rates in the commercial paper market and enters into interest rate swap
agreements to assure fixed rate funding. At September 30, 1997, Bravo had
twenty-two separate swap contracts with BankBoston with a total notional value
of $71,838,000. These interest rate swaps are matched swaps, and as such, are
accounted for using settlement accounting. Monthly cash settlements on the swap
agreements are recognized in income as they accrue. 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 through income until new borrowings are incurred which would be
subject to such swap agreements. All interest rate swap agreements entered into
by the Company are for other than trading purposes.
5. In March 1997, the Company completed the issuance of $20,000,000 of unsecured
senior subordinated notes (the "Notes") due in 2007, which bear interest at a
fixed rate of 11%. The Notes pay interest semi-annually on April 1 and October
1, beginning on 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 100% of such principal amount redeemed
plus accrued but unpaid interest to the redemption date.
6. In June 1997, the Company entered into a three-year $100,000,000 Lease
Receivable Purchase Agreement with EagleFunding Capital Corporation ("Eagle")
under which the Company may transfer assets from time to time to HPSC Capital
Funding, Inc. ("Capital"), a wholly-owned, bankruptcy remote, special purpose
corporation. Capital may then pledge or sell assets to Eagle. Under this
Agreement, the Company had Senior Notes outstanding of $32,532,000 at September
30, 1997, and in connection with this agreement had three separate swap
contracts with a national value of $30,456,000.
7. Statement of Financial Accounting Standards No. 128, "Earnings per Share",
effective for the Company for reporting periods ending after December 15, 1997,
provides new standards for computing and presenting earnings per share (EPS). It
replaces primary EPS with basic EPS and requires dual presentation of basic and
diluted EPS. For the three and nine months ended September 30, 1997, the pro
forma basic EPS for the Company would be $0.08 and $0.20 per share,
respectively, while pro forma diluted EPS would be $0.07 and $0.19 per share,
respectively.
8. Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income," establishes standards for reporting and presentation of comprehensive
income and its components. This standard will be effective for the Company for
its reporting periods beginning after December 15, 1997.
9. Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information," establishes standards for
public enterprises in reporting information about its operating segments and in
disclosing information related to their operations. This statement will be
effective for the Company for its reporting periods beginning after December 15,
1997.
6
7
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Earned income from leases and notes for the three months ended September 30,
1997 was $6,115,000 (including approximately $1,007,000 from the Company's
commercial lending subsidiary ("ACFC")) as compared to $4,434,000 (including
approximately $729,000 from ACFC) for the three months ended September 30, 1996.
Earned income for the nine months ended September 30, 1997 was $16,531,000
(including approximately $2,842,000 from ACFC) compared to $12,562,000
(including approximately $1,843,000 from ACFC) for the comparable period of
1996. The increases of 38% for the three months and 32% for the nine months were
due principally to increases in net investment in leases and notes for both
periods in 1997 over 1996. The increases in net investment for both periods
resulted in part from a higher level of originations in the 1997 third quarter
of $36,121,000 compared to $22,389,000 for the third quarter of 1996 and
$97,492,000 for the nine months ended September 30, 1997 compared to $66,026,000
in the comparable 1996 period. Gains on sales of leases and notes were $759,000
in the three months ended September 30, 1997 compared to $610,000 for the 1996
quarter. Gains on sales of leases and notes for the nine months ended September
30, 1997 were $1,927,000 compared to $885,000 in the comparable 1996 period. The
increases were caused by a higher level of asset sales activity in the current
year.
Interest expense (net of interest income) for the third quarter of 1997 was
$2,693,000 (44% of earned income) compared to $2,345,000 (53% of earned income)
in the comparable 1996 period. For the nine months ended September 30,1997, net
interest expense was $7,206,000 (44% of earned income) compared to $5,649,000
(45% of earned income) in the nine months ended September 30,1996. The increase
in net interest expense was due primarily to an increase in debt levels of 24%
from September 30, 1996 to September 30, 1997. These higher debt levels resulted
primarily from borrowings to finance a higher level of financing contract
originations.
Net financing margin (earned income less net interest expense) for the third
quarter of 1997 was $3,422,000 (56% of earned income) compared to $2,089,000
(47% of earned income) for the third quarter of 1996. For the nine months, net
interest margin in 1997 was $9,325,000 (56% of earned income) compared to
$6,913,000 (55% of earned income). The increases in margins in both periods were
due to higher earnings on higher balances of earning assets. The decline in
percentage in third quarter was due to higher debt levels in the 1997 period as
compared to the 1996 period.
The provision for losses for the third quarter of 1997 was $381,000 (6% of
earned income) compared to $424,000 (10% of earned income) in the third quarter
of 1996. For the nine months ended September 30,1997, the provision for losses
was $821,000 (5% of earned income) compared to $1,224,000 (10% of earned income)
for the comparable 1996 period. The decline in both periods is due to the
Company's continuing evaluation of its portfolio quality, loss history and
allowance for losses.
The allowance for losses at September 30, 1997 was $4,174,000 (2.2% of net
investment) compared to $4,082,000 (2.7% of net investment) at September 30,
1996. Net charge offs for the nine months ended September 30, 1997 were $767,000
compared to $ 781,000 in 1996.
Selling, general and administrative expenses for the three months ended
September 30, 1997 were $3,289,000 (54% of earned income) compared to $1,867,000
(42% of earned income) in the comparable 1996 period. For the nine months ended
September 30, 1997, selling, general and administrative expenses were $9,072,000
(55% of earned income) compared to $5,580,000 (44% of earned income) in the same
1996 period. The increases in both periods were caused by increased staffing and
increased personnel and sales and marketing costs required by higher levels of
owned and managed assets and the acceleration of the recognition of unamortized
deferred costs associated with the termination in June 1997 of HPSC Funding Corp
I ($350,000 for the nine months ended September 30, 1997).
The Company's income before income taxes for the quarter ended September 30,
1997 was $511,000 compared to $408,000 in the 1996 period. For the nine months
ended September 30, 1997, income before income taxes was $1,359,000
7
8
compared to $994,000 in the 1996 period. For the quarter ended September 30,
1997 the provision for income taxes was $217,000 (42% of income before income
taxes) compared to $160,000 (39% of income before income taxes) in the third
quarter of 1996. For the nine months ended September 30,1997, the provision for
income taxes was $595,000 (44% of income before income taxes) compared to
$390,000 ( 39% of income before income taxes) in the 1996 period. The increase
in the nine month provision was caused by expenses related to the continuing
wind-down of the Company's Canadian operation in the first quarter that are not
deductible in computing the tax provision.
The Company's net income for the three months ended September 30, 1997 was
$294,000 ($.07 per share) compared to $248,000 ($.06 per share) for the three
months ended September 30, 1996. For the nine months ended September 30, 1997,
the Company's net income was $764,000 ($.19 per share) compared to $604,000
($.15 per share) for the nine months ended September 30, 1996. The increases in
both periods in 1997 as compared to 1996 were due to higher earned income on
leases and notes, higher gains on sales and a lower provision for losses
partially offset by higher selling, general and administrative costs, higher net
interest costs and a higher effective tax rate.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1997, the Company had $11,418,000 in cash, cash
equivalents and restricted cash as compared to $8,945,000 at December 31, 1996.
As described in Note 3 to the Company's condensed consolidated financial
statements included in this report on Form 10-Q, $4,773,000 was restricted
pursuant to financing agreements as of September 30, 1997, compared to
$6,769,000 at December 31, 1996.
Cash provided by operating activities was $1,643,000 for the nine months
ended September 30, 1997 compared to cash provided by operating activities of
$2,032,000 for the nine months ended September 30, 1996. The significant
components of cash used in operating activities for the nine months ended
September 30, 1997, as compared to the same period in 1996, were the decrease in
accounts payable and accrued liabilities of $3,430,000 as compared to $2,229,000
for the same period of 1996, an increase in the gain on sale of receivables
caused by a higher level of sales activity in the first nine months of 1997, and
a net increase in deferred income taxes.
Cash used in investing activities was $36,671,000 for the nine months ended
September 30, 1997 compared to $26,035,000 for the nine months ended September
30, 1996. The significant components of cash used in investing activities for
the first nine months of 1997 compared to the same period in 1996 were an
increase in originations of lease contracts and notes receivable to $94,965,000
from $62,750,000, offset by an increase in proceeds from sales of lease
contracts and notes receivable to $20,616,000 in the 1997 period from
$12,629,000 in the 1996 period and higher portfolio receipts of $42,594,000 in
the 1997 period as compared to $30,478,000 in the 1996 period.
Cash provided by financing activities for the nine months ended September
30, 1997 was $39,497,000 compared to $23,857,000 for the nine months ended
September 30, 1996. The significant components of cash provided by financing
activities for the first nine months of 1997 as compared to 1996 were an
increase in proceeds from issuance of senior notes, net of debt issue costs, to
$58,550,000 from $24,381,000; an increase in proceeds from issuance of senior
subordinated notes in March 1997, net of debt issuance costs, of $18,306,000 in
the 1997 period; an increase in repayment of senior notes to $29,837,000 from
$16,438,000; net repayment of revolving credit borrowings of $28,500,000 in the
1997 period from $8,000,000 in the 1996 period; and lower proceeds from
revolving credit borrowings net of debt issuance costs to $23,492,000 in the
1997 period from $24,950,000.
On December 27, 1993, the Company raised $70,000,000 through an asset
securitization transaction in which its wholly-owned subsidiary, HPSC Funding
Corp I ("Funding I"), issued senior secured notes (the "Funding I Notes") at a
rate of 5.01%. Under the terms of the Funding I securitization, when the
principal balance of the Funding I Notes equals the balance of the restricted
cash in the facility, the Funding I Notes are paid off from the restricted cash
and Funding I terminates. This occurred during the second quarter of 1997, prior
to the scheduled termination of Funding I. Due to this early termination, the
Company incurred a $350,000 non-cash, non-operating charge against earnings
representing the early recognition of certain unamortized deferred transaction
origination costs. The Company recognized approximately $175,000 in each of the
first and second quarters of 1997.
8
9
The Company's Second Amended and Restated Revolving Credit Agreement with
the First National Bank of Boston (now BankBoston) as Agent Bank, dated December
12, 1996 ("the Revolver Agreement") increased the Company's availability under
the Revolver Agreement to $95,000,000. Under the Revolver Agreement, the Company
may borrow at variable rates of prime and at LIBOR plus 1.25% to 1.75%,
dependent on certain performance covenants. At September 30, 1997, the Company
had $35,000,000 outstanding under this facility and $60,000,000 available for
borrowing, subject to borrowing base limitations. The Revolver Agreement
currently is not hedged and is, therefore, exposed to upward movements in
interest rates.
As of January 31, 1995, the Company, along with its wholly-owned,
special-purpose subsidiary HPSC Bravo Corp ("Bravo"), established a $50,000,000
revolvings credit facility structured and guaranteed by Capital Markets
Assurance Corporation ("CapMAC"). Under the terms of this facility (the "Bravo
Facility"), Bravo, to which the Company has sold and may continue to sell or
contribute certain of its portfolio assets, pledges its interests in these
assets to a commercial paper conduit entity. Bravo incurs interest at variable
rates in the commercial paper market and enters into interest rate swap
agreements to assure fixed rate funding. Monthly settlements of principal and
interest payments are made from the collection of payments on Bravo's portfolio.
HPSC may make additional sales to Bravo subject to certain covenants regarding
Bravo's portfolio performance and borrowing base calculations. The Company is
the servicer of the Bravo portfolio, subject to meeting certain covenants. The
required monthly payments of principal and interest to purchasers of the
commercial paper are guaranteed by CapMAC pursuant to the terms of the
agreement. Effective November 5, 1996, the Bravo facility was increased to
$100,000,000 and amended to provide that up to $30,000,000 of such facility may
be used for sale accounting treatment. The Company had $25,964,000 outstanding
at September 30, 1997 from sales of receivables under this portion of the Bravo
facility. The Company had $67,919,000 of indebtedness outstanding under the
Bravo loan facility at September 30, 1997, and in connection with this facility,
had 22 separate interest rate swap agreements with BankBoston with a total
notional value of $71,451,000.
In April, 1995, the Company entered into a fixed rate, fixed term loan
agreement with Springfield Institution for Savings ("SIS") under which the
Company borrowed approximately $3,500,000 at 9.5% subject to certain recourse
and performance covenants. In July 1997, the Company entered into another fixed
rate, fixed term loan agreement with SIS under which the Company borrowed an
additional $3,984,000 at 8% subject to the same conditions as the first loan.
The Company had $5,278,000 outstanding under these agreements at September 30,
1997.
In March 1997, the Company completed a $20,000,000 offering of unsecured
senior subordinated notes due 2007 ("Senior Subordinated Note") bearing interest
at a fixed rate of 11% (the "Note Offering"). The Note Offering was completed on
the terms and conditions described in Amendment No. 2 to the Company's
Registration Statement No. 333-20733 on Form S-1. The Company received
approximately $18,300,000 in net proceeds from the Note Offering and used such
proceeds to repay amounts outstanding under the Revolver Agreement.
In June 1997, the Company, along with its wholly-owned, special purpose
subsidiary, HPSC Capital Funding, Inc. ("Capital"), established a $100,000,000
Lease Receivable Purchase Agreement with EagleFunding Capital Corporation
("Eagle"). Under the terms of the facility (the "Capital Facility"), Capital, to
which the Company may sell certain of its portfolio assets from time to time,
pledges or sells its interests in these assets to Eagle, a commercial paper
conduit entity. Capital may borrow at variable rates in the commercial paper
market and may enter into interest rate swap agreements to assure fixed rate
funding. Monthly settlements of the borrowing base and any applicable principal
and interest payments will be made from collections of Capital's portfolio. The
Company will be the servicer of the Capital portfolio subject to certain
covenants. The agreement expires in September 2000. The Company had $32,532,000
of indebtedness outstanding under this facility at September 30, 1997, and in
connection with this facility had three separate swap agreements with a total
national value of $30,456,000.
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 1997 and use its current credit facilities. The Company expects
that it will be able to obtain additional capital at competitive rates, but
there can be no assurance it will be able to do so.
9
10
Inflation in the form of rising interest rates could have an adverse impact
on the interest rate margins of the Company and its ability to maintain adequate
earning spreads on its portfolio assets.
FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. If used in this
Form 10-Q, 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:
a) 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)
the Revolving Agreement, (ii) the Capital Facility, (iii) the Bravo
Facility, (iv) a fixed-rate, full recourse term loans, from savings banks,
(v) specific recourse sales of financing contracts to savings banks and
other purchasers, (vi) the Senior Subordinated Note, and (vii) the
Company's internally generated revenues. There can be no assurance that
the Company will be able to negotiate a new revolving credit facility at
the end of the current term of the Revolver Agreement in December 1997,
complete additional asset securitizations or obtain other additional
financing, when needed and on acceptable terms. The Company would be
adversely affected if it were unable to continue to secure sufficient and
timely funding on acceptable terms. The 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, Capital and 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.
b) 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 get
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.
c) Customer Credit Risks. The Company maintains an allowance for doubtful
accounts in connection with payments due under financing contracts
originated by the Company (whether or not such contracts have been
securitized, held as collateral for loans to the Company or, when sold, a
separate recourse reserve is maintained) at a level which the Company
deems sufficient to meet future estimated uncollectible receivables, based
on an analysis of the delinquencies, problem accounts, and overall risks
and probable losses associated with such contracts, together with a review
of the Company's historical credit loss experience. There can be no
assurance that this allowance or recourse reserve will prove to be
adequate. Failure of the Company's customers to make scheduled payments
under their financing contracts could require the Company to (i) make
payments in connection with its recourse loan and asset sale transactions,
(ii) lose its residual interest in any underlying equipment and (iii)
forfeit collateral pledged as security for the Company's limited recourse
asset securitizations. In addition, although the allowance for losses on
the contracts originated by the Company have been 2.2% of the Company's
net investment in leases and notes for 1997, any increase in such losses
or in the rate of payment defaults under the financing contracts
originated by the Company will be able to maintain or
10
11
reduce its current level of credit losses.
d) 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 of 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
their 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.
e) 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
payers, 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.
f) 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 change sin 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.
g) Interest Rate Risk. Except for approximately $25 million of the Company's
financing contracts at September 30, 1997, 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 $35 million of the Company's
borrowings currently are subject to a variable interest rate.
Consequently, an increase in interest rates, before the Company is able to
secure fixed-rate, long-term financing for such contracts or to generate
higher-rate financing contracts to compensate for the increased borrowing
cost, could adversely affect the Company's business, operating results and
financial condition. The Company's ability to secure additional long-term
financing and to generate higher-rate financing contracts is limited by
many factors, including competition, market and general economic
conditions and the Company's financial conditions.
h) Residual Value Risk. At the inception of its equipment leasing
transactions, the Company estimates what it believes will
11
12
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 September 30, 1997, the estimated residual value of equipment at
the end of the lease term was approximately $10.5 million, representing
approximately 5.1% 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 realize 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.
i) 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 the Bravo facility. These
transactions are subject to certain covenants that require the Company to
(i) in the savings bank sales, repurchase financing contracts from the
bank and/or make payments under certain circumstances, including the
delinquency of the underlying debtor, (ii) under the Bravo Facility, a
limited recourse reserve is established and (iii) service the underlying
financing contracts. The Company carries a recourse reserve for each
transaction and recognizes a gain that is included for accounting purposes
in revenues for the year in which the transaction is completed. Each of
these transactions incorporates the covenants under the Revolver
Agreement as such covenants were in effect at the time the asset sale or
loan agreement was entered into. Any default under the Revolver Agreement
may trigger a default under the loan or asset sale agreements. The Company
may enter into additional asset sale agreements in the future in order to
manage its liquidity. The level of recourse reserves established by the
Company in relation to these sales may not prove to be adequate. Failure
of the Company to honor its repurchase and/or payment commitments under
these agreements could create an event of default under the loan or asset
sale agreements and under the Revolver Agreement. 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.
j) Dependence on Sales Representatives. The Company is, and its growth and
future revenues are, dependent in large part upon (i) the ability of the
Company's sales representatives to establish new relationships, and
maintain existing relationships, with equipment vendors, distributors and
manufacturers and with healthcare providers and other customers and (ii)
the extent to which such relationships lead equipment vendors,
distributors and manufacturers to promote the Company's financing services
to potential purchasers of their equipment. As of September 30, 1997, the
Company had 15 field sales representatives and eight in-house sales
personnel. Although the Company is not materially dependent upon any one
sales representative, the loss of a group of sales representatives could,
until appropriate replacements were obtained, have a material adverse
effect on the Company's business, operating results and financial
condition.
k) 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.
l) Fluctuations in Quarterly Operating Results. Historically, the Company has
generally experienced fluctuation in 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.
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.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Not applicable.
12
13
HPSC, INC.
PART II. OTHER INFORMATION
ITEMS 1 THROUGH 5 ARE OMITTED BECAUSE THEY ARE INAPPLICABLE.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
10.1 Lease Receivables Purchase Agreement dated as of June 27,
1997 among HPSC Capital Funding, Inc., as Seller, HPSC,
Inc. as Servicer and Custodian, EagleFunding Capital
Corporation as Purchaser and BancBoston Securities, Inc.
as Deal Agent.
10.2 Appendix A to EagleFunding Purchase Agreement (Definitions
List Attached).
10.3 Purchase and Contribution Agreement Dated as of June 27,
1997 Between HPSC Capital Funding, Inc. as the Buyer, and
HPSC, Inc. as the Originator and the Servicer.
10.4 Undertaking to Furnish Certain Copies of Omitted Exhibits
to Exhibit 10.1 and 10.3 hereof.
27 Financial Data Schedule
b) Reports on Form 8-K:
There were no reports on Form 8-K filed during the three months
ended September 30, 1997.
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.
Dated: November 14, 1997 HPSC, INC.
-------------------------
(Registrant)
By: /s/ John W. Everets
-------------------------
John W. Everets
Chief Executive Officer
Chairman of the Board
By: /s/ Rene Lefebvre
-------------------------
Rene Lefebvre
Vice President
Chief Financial Officer
13