Recommendation: Strong Buy

Recommendation and Summary:

We are reiterating our Strong Buy recommendation for the common stock of HPSC, Inc., which is a specialty financing company that deserves consideration by both value oriented and capital growth minded investors. HPSC has an excellent record of growth in revenues and earnings and this record has been reaffirmed as evidenced by the strong year-end/fourth quarter results that were released since our initial report dated December 17, 2001, and the strong first quarter results. However, the stock price of HPSC has failed to adequately respond to these positive earnings results. We believe that the lack of interest in taking a position in HPSC is the result of the general market malaise and the perception that higher interest rates could affect their earnings going forward. While we cannot speak to the overall skittishness of the stock market, we can point to the fact that because of the recent financing undertaken by HPSC and the spreads they are now receiving on their loans, near term higher interest rates should not commensurately affect HPSC's bottom line. We continue to believe that the current market valuation of HPSC, Inc. does not reflect its excellent financial history, the value of its assets nor the potential growth in the coming years from continued increases in loan portfolios and the increase in net income from increased originations and margins. The Strong Buy rating is being reiterated based on the following:

· For the first quarter ended March 31, 2002, fully diluted basic earnings per share increased 15% to $0.23 from $0.20 last year. Operating expenses decreased 8% to $10.8 million from $11.7 million in the same period last year, which contributed to an 18% increase in net income to $1,001,000 from $843,000 for the same period last year. Lower asset sales activity and lower weighted-average implicit rates resulted in a decrease of 5% in revenues to $12.5 million from $13.5 million.

· The Company's owned net investment in leases and notes continues to grow, increasing by 7% to $424,752,000 at March 31, 2002, from $397,865,000 at December 31, 2001. The total managed portfolio of financing contracts, which includes both leases and notes owned by the Company as well as those sold to others and serviced by the Company, increased 3.0% to $668,969,000 at March 31, 2002 from $649,275,000 at December 31, 2001.

· HPSC's cost of borrowing is lower not only because of the securitization, but also because of the trend in interest rates this past 18 months. The Federal Reserve Board has reduced rates by 4.75 basis points during this time frame to its present level and we believe that investors should soon look favorably upon financing companies in this current market environment.

· The Company continues to effectively use interest rate swaps to offset changes in the hedged portion of the cash flows of the Company's variable-rate debt obligations. The total pretax cost to terminate the swap contracts for the three months ended March 31, 2002, and the three months ended March 31, 2001, was $174,000 and $280,000, respectively, and is reflected as a component of selling, general and administrative expenses.

· Net financing margin (earned income less net interest expense) for the three months ended March 31, 2002 was $6,345,000 (51.9% of earned income) as compared to $5,476,000 (45.5% of earned income) for the first quarter of 2001, a 16% increase. The increase in amount and percentage was largely due to net interest charges incurred in the first quarter of 2001 associated with the $95,000,000 provided to the Company from the ER 2000-1 prefunding arrangement as well as a lower weighted-average cost of funds.

· The provision for losses for the three months ended March 31, 2002 increased 18% to $1,780,000 as compared to $1,507,000 for the same period in 2001. A portion of the increase was due to the higher levels of new financings in 2002. As a result, the Company's experience, higher charge-offs in its portfolio of financing contracts, and taking into account the potential impact general economic conditions, the Company increased the amount of its provision for losses. At March 31, 2002, the Company's allowance for losses was $15,387,000 (3.6% of owned net investment in leases and notes) compared to $15,359,000 (3.9% of owned net investment in leases and notes) at December 31, 2001. Total consolidated net charge-offs for the three months ended March 31, 2002, were $1,752,000 compared to $1,600,000 for the three months ended March 31, 2001.

· HPSC indicated in its SEC 10Q filing for March 31, 2002, that in May 2002, the Company signed a Fourth Amendment to the Fourth Amended and Restated Credit Agreement, providing the Company with availability of up to $75,000,000 through August, 2002. The Company is currently in discussion with a replacement agent bank to structure and syndicate a new revolving loan facility to replace the existing Revolver and expects to have the transaction finalized by August 5, 2002.

· Based on our estimated earnings per share of $0.98 for the year ended December 30, 2002, HPSC, Inc. is selling at an attractive price/earnings ratio of 9.3x for the year ended 2002. On a price to book value basis, HPSC is currently selling at 84% of book value. Therefore, we believe HPSC, Inc. currently offers investors exceptional prospects for capital gains over the next twelve to eighteen months.

The Company

HPSC, Inc., headquartered in Boston, Massachusetts, is a unique specialty/niche finance company whose core business is providing financing to licensed healthcare practitioners in the United States. The second and smaller portion of its business, conducted through its subsidiary, American Commercial Finance Corporation ("ACFC"), provides the asset-based financing to commercial and industrial companies that generally could not readily obtain traditional bank financing.

Healthcare Financing Market

HPSC's financing agreements with licensed healthcare professionals include equipment financing as well as non-equipment financing, such as practice finance, leasehold improvements, office furniture, working capital and supplies. The size of the leased medical equipment market is over $5.0 billion and is expected to grow at a rate of 10% through the year 2003. This healthcare market served by HPSC consists of more than ten different medical professionals including; internists, radiologists, OB/GYN doctors, ophthalmologists, dermatologists, dentists, chiropractors, cosmetic surgeons, veterinarians, orthopedists, and community health practitioners. This market is a "small ticket" market, in which the size of the transaction is usually $250,000 or less. HPSC's average financial transaction for its 20,000 healthcare accounts was approximately $40,000 in the past fiscal year. In connection with its equipment financing, HPSC enters into non-cancelable 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. HPSC 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 22 offices in 13 states and through cooperative arrangements with equipment vendors. It serves more than 1,000 medical equipment vendors.

HPSC's strategy of concentrating on financing prime credits within the healthcare professional market has served it well. Its history of net charge offs has been $8.25 million or 1.0% of gross owned and managed receivables in the year ended 2001 of $807 million and $4.27 million in 2000 or 0.6% of gross owned and managed receivables of $696 million and $2.8 million. These figures are relatively low when viewed against losses recorded by lenders in the general financing of small businesses. The decision to focus on the small-ticket healthcare market was based on the premise that HPSC is able to respond in a prompt and flexible manner to the needs of individual healthcare professionals. Further, history has proven that the medical provider's need for medical equipment, either new or replacement is not usually affected by the state of the economy, but is based on the needs of the individual practice. Management believes that its quick response time, its value-added sales support, and overall ease of conducting business that it offers the healthcare professional, make its service far superior to banks with their traditionally long approval time and rigid committee oriented standards of financing.

Practice Finance

In 1993, HPSC began to expand into practice finance. Practice finance is a specialized segment of the medical finance industry, in which HPSC's primary competitors are banks. Since practice financing was a relatively new business, which had developed as the sale of healthcare professional practices had increased, HPSC has a competitive edge by being in on the ground floor. A practice finance transaction typically takes the form of a loan to a healthcare provider purchasing a practice, providing up to 100% of the cost of the practice being purchased. The loan is secured by the assets of the practice being purchased and may be secured by one or more personal guarantees and by the personal assets of the practitioner. The average original size of a practice finance transaction was approximately $225,000 in 2001, with a typical repayment term of 72 to 84 months.

Since 1994, HPSC has originated approximately 1,200 practice loans aggregating approximately $180 million in financing. The terms of such loans generally range from 72 to 84 months. In 2000, practice financing generated approximately 17 % of HPSC's total healthcare originations. Management believes that its practice finance business contributes to the diversification of HPSC's revenue sources and earns HPSC substantial goodwill among healthcare providers.

Asset Based Financing to Commercial and Industrial Companies

Through its subsidiary, American Commercial Finance Corporation ("ACFC"), HSPC provides asset-based lending to commercial and industrial businesses, principally in the eastern United States. ACFC makes asset-based loans of up to $5 million to commercial and industrial companies; the loans are 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 receivables. Advances on a revolving loan generally do not exceed 80% of the borrower's eligible accounts receivable. ACFC also makes revolving and "term like" inventory loans, generally not exceeding 50% of the value of the customer's active inventory, valued at the lower of cost or market value. In addition, ACFC provides term financing for equipment, which is secured by the machinery and equipment of the borrower. The average ACFC loan is for a term of two to three years. No single borrower accounts for more than 10% 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. Available credit under lines is usually calculated daily. ACFC's credit committee, which includes members of senior management of HPSC, must approve all ACFC loans in advance. Each of ACFC's officers has over 20 years of experience providing these types of financing.

Risk, Risk Management, and Competition

We believe that HPSC has faced and met several risks in its financing business: (1) maintaining and sourcing adequate capital to continue its growth; (2); managing credit risks; (3) managing within a changing economic environment; and (4) competition.

Maintaining and sourcing adequate capital to continue its growth: Historically HPSC has utilized a variety of funding sources. In late December 2000, it completed a major securitization and asset sale with Credit Suisse First Boston. The total amount financed by the Company through the securitization was $527 million. This transaction not only reduced the cost of borrowing approximately 60 basis points but it also provided approximately $95.2 million of new funding which shows on the year-end balance sheet as Restricted Cash-Prefunding. Through the nine months September 30, 2001, the Company utilized approximately $91.3 million to fund the Company's financing activity. The balance of approximately $3.4 million was used to pay principal on the notes. The December 2000 transaction was accomplished after several months of intense due diligence by the lending institution, Credit Suisse First Boston, and completion of the transaction places HPSC, Inc. in a premium category for a company this size. S&P, Moody and Fitch rated the Senior Tranche AAA. The due diligence process and high ratings should make additional securitization transactions easier to accomplish should the company choose to pursue further transactions. HPSC is currently negotiating a new revolving loan facility and expects to finalize the terms of this transaction before August 5, 2002.

Managing credit risks: The strategy of financing medical providers has proven to be successful for HPSC. Medical providers normally enjoy a higher credit rating than the general population. In addition, the Company utilizes comprehensive credit review procedures when making loans by checking the credit background of the potential client with one or more commercial credit reporting agencies, including TRW Inc., Equifax Inc., Trans Union Corporation, and Dun & Bradstreet Corporation. The Company also considers the type of equipment being loaned against and the vendor. HPSC also has a proven on-line credit evaluation procedure to screen applicants. In some cases, HPSC may require a personal guarantee by the medical provider. Proof of HPSC's ability to manage credit risk is validated by the fact of the relatively low net charge-offs of $4.2 million or 0.8% of portfolio in 2000, $2.7 million or 0.6% of portfolio in 1999 and $2.4 million or 0.7% of portfolio in 1998.

The same procedures for credit checks are utilized for the commercial lending prospects of ACFC. 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 on its loans. ACFC typically makes accounts receivable loans to borrowers in a variety of industries that cannot obtain traditional bank financing. Consequently, 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 generally not exceeding 50% of the value of the customer's active inventory, valued at the lower of cost or market value. In addition, ACFC provides term financing for equipment, which is secured by the machinery and equipment of the borrower. The average ACFC loan is for a term of two to three years.

On June 17, 2002, HPSC, Inc., announced the discovery of an act of fraud that was perpetrated by an employee of the Company's asset-backed lending subsidiary, American Commercial Finance Corporation (ACFC). An employee diverted approximately $5.0 million by fraudulent transactions with a single factoring customer over a period of the last four to five years. The Company indicated that because of this fraudulent act, the financial statements for the affected years will, in all probability be restated. We expect that the restatement reflecting this event will mainly affect the balance sheet and cash flow statements on the restated financials, covering the total amount of funds embezzled, however considering the net margins on factoring business, we expect that the affect on net income to be negligible in the individual years. Management indicated that a portion of the loss could be recovered through insurance and the possible recovery of assets.

Competition: HPSC faces competition on several fronts, including companies similar to HPSC that specialize in financing for healthcare providers. In addition, HPSC faces competitors that include equipment manufacturers that 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 companies. HPSC believes that its quick reaction time of twenty-four hours or less and its proven record in the medical equipment lending business combine to make its practices most competitive. In addition, the size of the medical leasing business (over $5 billion) provides room for continued growth and expansion.

HPSC, Inc., announced on June 21, 2001, that the June issue of "The Monitor 100 List"; ranked HPSC as the 65th largest equipment/asset leasing company in the country, based on an 18.4% increase in net assets. This is an improvement from last years ranking at the 77th position. The Monitor 100 is a list published by the Monitor Daily, an independent publication, and reflects HPSC's growth in assets. Growth in net assets and growth in origination volume are two of the base line measurements used in ranking similar companies in the industry.

Financial Highlights

HPSC, Inc., reported preliminary results for the first quarter ended March 31, 2002. Revenues decreased 5% to $12.5 million from $13.5 million reflecting lower asset sales activity and lower weighted-average implicit rates. The Company reported that for the quarter, operating expenses decreased 8% to $10.8 million from $11.7 million in the same period last year, which contributed to an 18% increase in net income to $1,001,000 from $843,000 for the same period last year. On a fully diluted basis, earnings per share increased 15% to $0.23 from $0.20 last year.

On a sequential quarter basis, revenues were relatively flat and the net income of $1,001,000 showed an increase of 11.6% as compared to the net income in the fourth quarter ended December 31, 2001, of $895,000. The first quarter results came in at the high end of our estimates, and as John Everets, chairman and chief executive officer noted in the release, these results were accomplished "....in the face of a challenging market", and he further stated that their "....core business of financing medical equipment continues to grow." It is our opinion that these results give credence to our theory that HPSC can continue to growth net income, even during this period of recession and in the face possible future increases in interest rates. From these preliminary results, it appears that HPSC, Inc. is on track to achieve our estimate of fully diluted EPS of $0.98 for this year. The fact that the Company is evidencing positive results from its efforts to control operating expenses bodes well to offset any increase in interest rates that may take place later this year.

J.M.Dutton & Associates, LLC. John M. Dutton, President and Supervisory Analyst, 1129 Manning Drive, Suite 310, El Dorado Hills, CA 95762 Phone (916) 941-4985, Fax (978) 418-6422 Email: [email protected] Web site: www.JMDutton.com

Information, opinions or recommendations contained in this research report or research note are submitted solely for advisory and information purposes. The information used and statements of fact made have been obtained from sources considered reliable but we neither guarantee nor represent the completeness or accuracy. Such information and the opinions expressed are subject to change without notice. This research report or note is not intended as an offering or a solicitation of an offer to buy or sell the securities mentioned or discussed. Neither the Firm, its principals, nor the assigned analysts own or trade shares of any company covered. The Firm does not accept any equity compensation. Anyone may enroll a company for research coverage, which currently costs US $25,000 prepaid for one-year. Dutton & Associates received $19,700 from the Company for coverage for the year. Reports are performed on behalf of the public, and are not a service to any company. The analysts are responsible only to the public, and are paid in advance to eliminate pecuniary interests and insure independence. Please read full disclosure and other reports and notes on the Company at www.JMDutton.com..

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