Rating: Strong Buy
Reiterated

Basis for Rating

We are reiterating and emphasizing our Strong Buy rating for HPSC, Inc. This specialty financing company deserves consideration by both value oriented and capital growth minded investors. HPSC is well financed. In the third quarter the Company announced additional financing that insures them the capacity to grow its earnings in the coming quarters. The Company has an excellent record of growth in revenues and earnings, and the momentum of growth has continued during the first nine months of 2002. The results for both the third quarter and nine months period ending September 30, 2002, were higher than our estimates. Because of these results we are increasing our estimated earnings per share for the year ending December 31, 2002, to $1.00. We 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 current level and trend of interest rates.

The reiteration of our Strong Buy rating is based on the following:

• The stock of HPSC, Inc. is selling at 75% of adjusted book value.
  
  
• HPSC earnings per share increased at an average annual growth rate of approximately 45% in the periods of FY1995 to FY2000 (adjusted). Net income and diluted earnings per share for the nine months that ended September 30, 2002, increased 69%.
  
  
• For the third quarter that ended September 30, 2002, revenues increased 2% to $13.9 million as compared to $13.6 million for the third quarter last year. Gains on sales of leases and notes were up to $4.8 million from $4.3 million last year, while the deduction from sales for Provision for losses increased to ($3.8 million) from ($2.7 million). Net income increased 27% to $1.19 million as compared to $937,000 last year, and diluted EPS increased 23% to $0.27 per share as compared to $0.22 in last years third quarter.
  
  
• For the nine months that ended September 30, 2002, revenues were down slightly to $40.2 million from $40.8 million. The decrease was the result of lower Gains on sales of leases of $10.7 million as compared to $11.1 million last year. The deduction from sales for Provision for losses increased to $8.4 million from $6.8 million. Net income increased 72% to $3.1 million as compared to $1.8 million last year and diluted EPS increased 23% to $0.27 per share as compared to $0.22 in last years third quarter. At the end of the nine month period, the gross portfolio of owned and managed lease contracts and notes receivable increased 11% to $896 million as compared to $807 million and unearned income increased 10% to $115 million as compared to $105 million at year-end 2001.
  
  
• HPSC has excellent rapport with over 1,000 vendors that allows them to provide quality service to its borrowers.
  
  
• HPSC's gross owned and managed lease contracts and notes receivable continue to grow, increasing 12% to $725.2 million for the period that ended September 30, 2002, over the year-end figure of $648.4 million.
  
  
• The Company has experienced growth in its portfolio of financing contracts. For the nine months that ended September 30, 2002, financing contract originations increased 13% to $220 million from $194 million for the same period in the prior year.
  
  
• HPSC continues to secure financing to increase its business. After completing a major $527 million, equipment receivables backed securitization in late December 2000, the company completed an increase in its financing with a provider for $65.0 million and signed a Receivables Interest Purchase Agreement (RIPA) with ING Capital LLC (ING) for $20.0 million.
  
  
• Based on our estimated earnings per share for 2002 of $1.00, and our initial projection of $1.30 for the year ending December 30, 2003, HPSC, Inc. is selling at an attractive price/earnings ratio of 10.3 for the year ending 2002 and a price earnings ratio of 9.4 for the year 2002. Furthermore, when comparing HPSC fundamentals to those of its two peer companies, HPSC, Inc. 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 tends to limit its losses. The provision for losses for the third quarter of 2002 was $3,844,000 compared to $2,752,000 for the same period in 2001, a 40% increase. The provision for losses for the nine months that ended September 30, 2002, was $8,430,000 compared to $6,812,000 for the nine months that ended September 30, 2001, an increase of 24%. The increase for the three and nine month periods resulted in part from higher levels of new financings in 2002. The net charge offs in the twelve months that ended 12/31/01 was $8.2 million or 3.9% of owned and managed loans. This was partially offset by a charge-off in 2001 in the Company's core financing segment from the bankruptcy of an equipment vendor and resulting customer disputes over the products which the Company had financed. During the second quarter of 2001, the Company agreed to settle the related lawsuit and subsequently wrote-off approximately $1,800,000 remaining due on the disputed customer accounts.

Terms and Conditions of Equipment Financing

HPSC finances the healthcare physicians acquisition 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 non-cancelable. The contracts are full payout contracts and provide for scheduled payments sufficient, in the aggregate, to cover HPSC's costs, and to provide HPSC with an appropriate profit margin. HPSC provides its leasing customers with an option to purchase the equipment at the end of the lease, generally for 10% of its original cost. Historically, the vast majority of all lessees have exercised this option.

All of the Company's equipment financing contracts require the customer to: (1) maintain, service, and operate the equipment in accordance with the manufacturers and government-mandated procedures, and (2) make all scheduled contract payments regardless of the performance of the equipment. Substantially all of the Company's financing contracts provide for principal and interest payments due monthly for the term of the contract. In the event of default by a customer, the financing contract provides that HPSC has the rights afforded creditors under law, including the right to repossess the equipment and, in the case of legal proceeding arising from a default, to recover damages and attorneys fees. The Company's equipment financing contracts provide for late fees and service charges to be applied on payments that are overdue.

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 is approximately $225,000 in 2001, with a typical repayment term of 72 to 84 months.

Since 1994, through the end of 2001, the Company originated a total of approximately 1,160 practice finance loans aggregating approximately $182 million in financings. The term of a practice finance loan generally ranges from 72 to 84 months, with an average original balance of approximately $150,000. In both 2001 and 2000, approximately 17% of HPSC's total healthcare originations consisted of practice finance loans. In the nine month period of FY2002 that ended September 30, 2002, approximately 20% of HPSC's total healthcare originations consisted of practice finance loans. 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.

HPSC solicits business for its practice finance services primarily by advertising in trade magazines, attending healthcare conventions, and directly approaching potential purchasers of healthcare practices. Most of the healthcare practices financed by HPSC to date have been dental practices. HPSC has also financed the purchase of practices by chiropractors, ophthalmologists, general medical practitioners, and veterinarians. HPSC's customers are located throughout the United States, but primarily in heavily populated states such as California, Florida, Texas, Illinois, and New York.

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 borrowers assets and monitors collection of its receivables. Advances on a revolving loan generally do not exceed 80% of the borrowers eligible accounts receivable. ACFC also makes revolving and "term like" inventory loans, generally not exceeding 50% of the value of the customers 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.

HPSC, Inc., announced on June 17, 2002, 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 at that time, because of this fraudulent act, the financial statements for the affected years will, in all probability, be restated and the Company did in fact restate the affected years. Management indicated that a portion of the loss could be recovered through insurance and the possible recovery of assets.

Risk, Risk Management and Competition

We believe that HPSC faces 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.

1. 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.
   
   
2. Managing credit risks: The strategy of financing medical providers has proven to be successful for HPSC. Medical providers generally 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 agency, 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 borrowers 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 borrowers assets and monitors collection of its receivables. Advances on a revolving loan generally do not exceed 80% of the borrowers eligible accounts receivable. ACFC also makes revolving and "term like" inventory loans generally not exceeding 50% of the value of the customers 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.
   
   
3. Managing risk within a changing economic environment: HPSC's strategy of lending to medical providers has insulated the company to some extent from economic downturns. The individual medical providers equipment needs have proven to be a constant during periods of slow economic growth. The fact that the doctor's decision to purchase new or to replace a piece of equipment is usually based on the practices immediate need rather than the level of the economy. Since HSPC services a vast number of medical providers (over 20,000 at year that ended 12/31/00), the risk during downturns is lessened. For ACFC, the lending activity actually increases during slow economic times and the Company's individual credit checks help to insure that the loans made during these times are still viable and profitable.
   
   
4. 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 service 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.

Financial Highlights

For the third quarter that ended 9/30/02, net income, net EPS, and contract originations were all at record levels. Revenues increased 2% to $13.9 million as compared to $13.6 million for the third quarter last year. Gains on sales of leases and notes were up to $4.8 million from $4.3 million last year, while the deduction from sales for Provision for losses increased to ($3.8 million) from ($2.7 million). Net income increased 27% to $1.19 million as compared to $937,000 last year and diluted EPS increased 23% to $0.27 per share as compared to $0.22 in last years third quarter.

For the nine months that ended 9/30/02, revenues were down slightly to $40.2 million from $40.8 million. The decrease was the result of lower Gains on sales of leases of $10.7 million as compared to $11.1 million last year. The deduction from sales for Provision for losses increased to ($8.4 million) from ($6.8 million). Net income increased 72% to $3.1 million as compared to $1.8 million last year and diluted EPS increased 23% to $0.27 per share as compared to $0.22 in last years third quarter. At the end of the nine month period, the gross portfolio of owned and managed lease contracts and notes receivable increased 11% to $896 million as compared to $807 million and unearned income increased 10% to $115 million as compared to $105 million at year-end 2001.

HPSC Inc.
Condensed Consolidated Statements Of Income
For The Three And Nine Months Ended September 30, 2001 And 2000
(In Thousands, Except Per Share And Share Amounts)
(Unaudited)

Projections

Based on the results through nine months that ended September 30, 2002, and the recent financing, we are increasing our earnings estimate for FY2002. We are projecting earned income to increase to $50.7 million, while gains from sales of leases and notes are projected at $15.6 million and provision for losses is projected at $11.9 million, resulting in net revenues of approximately $54.4 million. SG&A is projected at $21.4 million, an amount equal to 40% of the projected earned income. The resulting income before taxes is $7.2 million. Based on an assumed overall tax rate of 40%, the net income for 2002 is projected at $4.3 million, with Basic EPS of $1.06 (basic shares outstanding of 4,100,000) and Diluted EPS of $1.00 (Diluted shares of 4,325,000).

HPSC, Inc.
Income Model As Of 11/14/02

Valuation vs. Financial Federal Corp.

Financial Federal Corp. (NYSE: FIF) is a comparable stock to HPSC. Financial Federal, Corp. is a nationwide independent financial services company that provides collateralized lending, financing, and leasing services nationwide to primarily middle-market commercial enterprises representing diverse industries such as general construction, road and infrastructure construction and repair, manufacturing, trucking and waste disposal.

November 18, 2002
HDR - VS. Financial Federal

Compared to Financial Federal, HPSC sells at a relatively low valuation, including its price earnings ratio. Based on trailing twelve months EPS, the P/E for HPSC is 8.8; 10.3P/E based on actual 2001 EPS of $0.78; and 8.1P/E based on our estimated 2002 EPS of $1.00. For Financial Federal, based on trailing twelve months EPS of $1.99, the P/E is 13.3x, 13.1P/E based on actual EPS of $2.23 forFY7/31/02, and 11.9P/E based on Wall Streets estimated EPS of $2.48 for 7/31/03. On a price to book value (Pr/BV) ratio, HPSC sells at 74.6% of book while FIF sells at 185.2% of book value. HPSC's EPS growth rate from 1995 to 2001 was 47% while FIF's EPS growth rate from 1995 to 2001 was 25%. Most recently, HPSC's EPS growth rate from FY1999 to FY2000 was 22% while FIF's growth rate from FY1999 to FY2000 was 18.

Caveats Concerning HSPC, Inc.

HSPC is listed on the American Stock Exchange. The trading activity with its low average daily volume and the apparent lack of liquidity in the stock has prompted potential investors to defer purchasing the stock. However, we believe that positions carefully established would be most beneficial to growth minded investors.

We are aware that the defalcation that was discovered in June 2002, cast a measure of doubt on managements ability to control credit risk. However this negative event was not the result of bad credit controls, rather it was the result of the well planned and executed fraudulent activity of a perpetrator that was in a position of responsibility and trust. The fraud was allegedly planned and executed by one individual and only one account was involved. Considering the fact that during the period of defalcation HPSC originated over $2.0 billion in new business, this $5.0 million event is a small percentage of HPSC's overall business. The common stock of HPSC registered a new high at $10.15 the day before the announcement and we believe that the common stock has unduly suffered from this event.

Summary

HPSC is a specialty finance company that has found and developed a profitable niche market for its activities. The Company's management has done an excellent job of securing adequate financing at attractive rates and has a proven record of credit risk management. While the Company has recorded varying amounts of "Gain on Sale of Notes and Leases" as revenues in the recent years, management has indicated "...that for the good of the Company its goal is to decrease this in the coming years." At the current price levels, on both a specific stock basis and on a peer comparison basis, the common stock of HPSC, Inc. offers value and growth investors an excellent opportunity for capital appreciation with limited downside risk. Based on our estimated fully diluted earnings per share of $1.00 for FY2001, the common stock of HPSC is selling at an 8.0 P/E ratio. Based on our 2003 projected earnings per share of $1.30, the P/E ratio is 6.2. The price to book value ratio is 75% with net revenues to market cap ratio of 64%.

We are establishing a price target range over the next twelve to eighteen months of $14.00 to $17.55 a share for HPSC, with a mid-price of $15.75. This is based on:

• Price earnings ratio--Assuming HPSC makes the Estimated EPS of $1.00 for FY2002 and $1.30 for FY2003 we believe that near term HPSC could sell at a 13.5 P/E ratio or a per share price of $14.00. Based on our estimate for FY2003 a 13.5 P/E ratio would result in a per share price of $17.55.
• Price to book value--Based on the historical growth in originations and assets a level of 150% of book value would yield a per share price of $16.08.
  
• The historical growth rates in EPS over 45% for HPSC justify a higher price earnings than its current 8.0 ratio.
  
• The continued strong growth in finance contract originations
  
• The absolute current low level and the prospects of relatively low levels interest rates in the coming eighteen months.
  
• Our assessment of managements ability in raising capital and controlling credit risks.
  
  

Therefore we are reiterating our Strong Buy rating for the stock of HPSC, Inc.

Analyst:
Richard W. West, CFA
Mr. West has a range of experience extending over 40 years in securities analysis and investment management. Following three years as a broker with Stein Bros. & Boyce, he moved into investment management and research in the early 1970s with Delaware Management and, from 1974 to 1983, with Brittingham, Inc., where his responsibilities included management of the U.S. portfolio of the Nobel Foundation, one of the premier growth portfolios of its time. Mr. West formed an investment management and research firm in the mid-1980s specializing in small-cap growth stock analysis and investment publishing, following which he served as research director with Gaines Berland, an investment firm specializing primarily in growth stocks and special situations. He has been independently engaged since 1998 in corporate finance and private research activities. Mr. West is a graduate of the Wharton School, University of Pennsylvania (1960), served four years (1954-58) as a Navy pilot, and remains active as a pilot and Master Swimmer. He also maintains an office in New York City.

Contact:
HPSC, Inc. 60 State Street, 35th Floor, Boston, MA 02109. Mr. John Everets, CEO. Tel: (800) 225-2488 Web site: www.hpsc.com

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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