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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NO.
MICROFINANCIAL INCORPORATED
(Exact name of registrant as specified in its Charter)
MASSACHUSETTS 04-2962824
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10M COMMERCE WAY 01801
WOBURN, MA (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(781) 994-4800
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
Common Shares, $0.01 par value per share New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
---------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the registrant's voting and non-voting common
equity held by non-affiliates of the registrant was approximately $15,217,000,
computed by reference to the closing price of such stock as of June 30, 2003,
which is the last business day of the registrant's most recently completed
second fiscal quarter.
As of March 19, 2004, 13,176,416 shares of the registrant's common stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement to be filed pursuant to
Regulation 14A within 120 days after the Registrant's fiscal year end of
December 31, 2003, is incorporated by reference in Part III hereof.
TABLE OF CONTENTS
PAGE
DESCRIPTION NUMBER
----------- ------
PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 7
Item 3. Legal Proceedings........................................... 7
Item 4. Submission of Matters to a Vote of Security Holders......... 9
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 10
Item 6. Selected Financial Data..................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 13
Item 7a. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 21
Item 8. Financial Statements and Supplementary Data, Including
Selected Quarterly Financial Data (Unaudited)............... 22
Item 9. Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 22
Item 9a. Controls and Procedures..................................... 22
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 23
Item 11. Executive Compensation...................................... 23
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 23
Item 13. Certain Relationships and Related Transactions.............. 23
Item 14. Principal Accounting Fees and Services...................... 23
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 23
SIGNATURES............................................................... 28
1
PART I
ITEM 1. BUSINESS
GENERAL
MicroFinancial Incorporated ("MicroFinancial" or the "Company") was formed
as a Massachusetts corporation on January 27, 1987. The Company, which operates
primarily through its wholly-owned subsidiary, Leasecomm Corporation, is a
specialized commercial finance company that leases and rents "microticket"
equipment and provides other financing services in amounts generally ranging
from $400 to $15,000, with an average amount financed of approximately $1,900
and an average lease term of 44 months. Leasecomm Corporation started
originating leases in January 1986. The Company has used proprietary software in
developing a sophisticated, risk-adjusted pricing model and in automating its
credit approval and collection systems, including a fully-automated,
Internet-based application, credit scoring and approval process.
The Company provides financing to lessees which may have few other sources
of credit. The Company primarily leases and rents low-priced commercial
equipment, which is used by these lessees in their daily operations. The Company
does not market its services directly to lessees, but sources leasing
transactions through a nationwide network of independent sales organizations and
other dealer-based origination networks ("Dealers").
The majority of the Company's leases are currently for authorization
systems for point-of-sale, card-based payments by, for example, debit, credit
and charge cards ("POS authorization systems"). POS authorization systems
require the use of a POS terminal capable of reading a cardholder's account
information from the card's magnetic strip and combining this information with
the amount of the sale entered via a POS terminal keypad, or POS software used
on a personal computer to process a sale. The terminal electronically transmits
this information over a communications network to a computer data center and
then displays the returned authorization or verification response on the POS
terminal.
As of September 30, 2002, the Company's credit facility failed to renew.
Renewal of the credit facility required 100% participation from the nine
lenders, and one of the lenders chose not to renew. As a result, in October
2002, the Company was forced to suspend virtually all new contract originations
until a source of funding is obtained or at such time that the senior credit
facility has been paid in full. During 2003, the Company was able to fund a very
limited number of new contracts using its own free cash flow. The amount and
timing of the new originations is restricted by both the amount of available
cash, and the terms of the Company's banking agreements. The Company is
currently working with a capital advisory firm in an effort to obtain a new line
of credit in order to resume funding activity. The Company remains hopeful that
a new funding facility can be in place in a reasonable period of time.
LEASING, SERVICING AND FINANCING PROGRAMS
The Company originates leases for products that typically have limited
distribution channels and high selling costs. The Company facilitates sales of
such products by making them available to Dealers' customers for a small monthly
lease payment rather than a higher initial purchase price. The Company primarily
leases and rents low-priced commercial equipment to small merchants. The
majority of the Company's leases are currently for POS authorization systems;
however, the Company also leases a wide variety of other equipment including
advertising and display equipment, coffee machines, paging systems, water
coolers and restaurant equipment. In addition, the Company also acquires service
contracts and contracts in certain other financing markets. The Company
opportunistically seeks to enter various other financing markets.
The Company's residential financings include acquiring service contracts
from Dealers that primarily provide security monitoring services.
Prior to the suspension of new contract originations in October, 2002, the
Company originated leases, contracts and loans in all 50 states of the United
States and its territories. The Company continues to service leases, contracts
and loans in all 50 states of the United States and its territories. As of
December 31, 2002 and
2
2003, leases in California, Florida, Texas, Massachusetts and New York accounted
for approximately 42% and 40% of the Company's portfolio respectively. Only
California accounted for more than 10% of the total portfolio as of December 31,
2002 and 2003 at approximately 14%. None of the remaining states accounted for
more than 4% of such total.
TERMS OF EQUIPMENT LEASES
Substantially all equipment leases originated or acquired by the Company
are non-cancelable. In a typical lease transaction, the Company originates
leases referred to it by the Dealer and buys the underlying equipment from the
referring Dealer upon the funding of an approved application. Leases are
structured with limited recourse to the Dealer, with risk of loss in the event
of default by the lessee residing with the Company in most cases. The Company
performs all processing, billing and collection functions under its leases.
During the term of a typical lease, the Company is scheduled to receive
payments sufficient, in the aggregate, to cover the Company's borrowing costs
and the costs of the underlying equipment, and to provide the Company with an
appropriate profit. Throughout the term of the lease, the Company charges late
fees, prepayment penalties, loss and damage waiver fees and other service fees,
when applicable. Initial terms of the leases in the Company's portfolio
generally range from 12 to 48 months, with an average initial term of 44 months
as of December 31, 2003.
The terms and conditions of all of the Company's leases are substantially
similar. In most cases, the contracts require lessees to: (i) maintain, service
and operate the equipment in accordance with the manufacturer's and
government-mandated procedures; (ii) insure the equipment against property and
casualty loss; (iii) pay all taxes associated with the equipment; and (iv) make
all scheduled contract payments regardless of the performance of the equipment.
The Company's standard lease forms provide that in the event of a default by the
lessee, the Company can require payment of liquidated damages and can seize and
remove the equipment for subsequent sale, refinancing or other disposal at its
discretion. Any additions, modifications or upgrades to the equipment,
regardless of the source of payment, are automatically incorporated into, and
deemed a part of, the equipment financed.
The Company seeks to protect itself from credit exposure relating to
poor-quality Dealers by entering into limited recourse agreements with its
Dealers, under which the Dealer agrees to reimburse the Company for payment of
defaulted amounts under certain circumstances, primarily defaults within the
first month following origination, and upon evidence of Dealer errors or
misrepresentations in originating a lease or contract.
RESIDUAL INTERESTS IN UNDERLYING EQUIPMENT
The Company typically owns a residual interest in the equipment covered by
a lease. At the end of the lease term, the lease typically converts into a
month-to-month rental contract. If the lease does not convert, the lessee either
buys the equipment at a price quoted by the Company or returns the equipment. If
the equipment is returned, the Company may either sell the equipment, or place
it into its used equipment rental or leasing program.
SERVICE CONTRACTS
In a typical transaction for the acquisition of service contracts, a
homeowner will purchase a security system and simultaneously sign a contract
with the Dealer for the monitoring of that system for a monthly fee. The Dealer
will then sell the right to payment under that contract to the Company for a
multiple of the monthly payments. The Company performs all processing, billing
and collection functions under these contracts.
DEALERS
Prior to the suspension of new contract originations in October 2002, the
Company provided financing to obligors under microticket leases, contracts and
loans through a network of independent Dealers. Historically, the Company has
had over 1,000 different Dealers originating leases, contracts and loans. One
dealer
3
accounted for approximately 7.38%, 10.98% and 56.14% of all originations during
the years ended December 31, 2001, 2002, and 2003, respectively. Another dealer
accounted for approximately 23.38% of all originations during the year ended
December 31, 2003 and a third dealer accounted for 10.79% of all originations
during the year ended December 31, 2003. No other dealer accounted for more than
10% of the Company's origination volume during the years ended December 31,
2001, 2002, or 2003.
The Company does not sign exclusive agreements with its Dealers. Dealers
interact with merchants directly and typically market not only POS authorization
systems, but also financing through the Company and ancillary POS processing
services.
USE OF TECHNOLOGY
The Company's business is operationally intensive, due in part to the small
average amount financed. Accordingly, technology and automated processes are
critical in keeping servicing costs to a minimum while providing quality
customer service.
The Company has developed LeasecommDirect(TM), an Internet-based
application processing, credit approval and Dealer information tool. Using
LeasecommDirect(TM), a Dealer can input an application directly to the Company
via the Internet and obtain almost instantaneous approval automatically over the
Internet through the Company's computer system, all without any contact with any
employee of the Company. The Company also offers Instalease(R), a program that
allows a Dealer to submit applications by telephone, telecopy or e-mail to a
Company representative, receive approval, and complete a sale from a lessee's
location. By assisting the Dealers in providing timely, convenient and
competitive financing for their equipment or service contracts and offering
Dealers a variety of value-added services, the Company simultaneously promotes
equipment and service contract sales and the utilization of the Company as the
finance provider, thus differentiating the Company from its competitors.
The Company has used its proprietary software to develop a multidimensional
credit-scoring model which generates pricing of its leases, contracts and loans
commensurate with the risk assumed. This software does not produce a binary "yes
or no" decision, but rather, determines the price at which the lease, contract
or loan might be profitably underwritten. The Company uses credit scoring in
most, but not all, of its extensions of credit.
UNDERWRITING
The nature of the Company's business requires two levels of review: the
first focused on the ultimate end-user of the equipment or service and the
second focused on the Dealer. The approval process begins with the submission by
telephone, facsimile or electronic transmission of a credit application by the
Dealer. Upon submission, the Company, either manually or through
LeasecommDirect(TM) over the Internet, conducts its own independent credit
investigation of the lessee through its own proprietary database and recognized
commercial credit reporting agencies such as Dun & Bradstreet, Experian, Equifax
and TransUnion. The Company's software evaluates this information on a
two-dimensional scale, examining both credit depth (how much information exists
on an applicant) and credit quality (past payment history). The Company is thus
able to analyze both the quality and amount of credit history available with
respect to both obligors and Dealers and to assess the credit risk. The Company
uses this information to underwrite a broad range of credit risks and provide
financing in situations when its competitors may be unwilling to provide such
financing. The credit-scoring model is complex and automatically adjusts for
different transactions. In situations where the amount financed is over $6,000,
the Company may go beyond its own data base and recognized commercial credit
reporting agencies to obtain information from less readily available sources
such as banks. In certain instances, the Company will require the lessee to
provide verification of employment and salary.
The second aspect of the credit decision involves an assessment of the
originating Dealer. Dealers undergo both an initial screening process and
ongoing evaluation, including an examination of Dealer portfolio credit quality
and performance, lessee complaints, cases of fraud or misrepresentation, aging
studies, number of applications and conversion rates for applications. This
ongoing assessment enables the Company to manage its Dealer relationships,
including ending relationships with poorly performing Dealers.
4
Upon credit approval, the Company requires receipt of signed lease
documentation on the Company's standard, or other pre-approved, lease form
before funding. Once the equipment is shipped and installed, the Dealer invoices
the Company, and thereafter, the Company verifies that the lessee has received
and accepted the equipment. Upon the lessee authorizing payment to the Dealer,
the lease is forwarded to the Company's funding and documentation department for
funding, transaction accounting and billing procedures.
BULK AND PORTFOLIO ACQUISITIONS
In addition to originating leases through its Dealer relationships, the
Company, from time to time, has purchased lease portfolios from Dealers. While
certain of these leases initially do not meet the Company's underwriting
standards, the Company often will purchase the leases once the lessee
demonstrates a payment history. The Company will only acquire these smaller
lease portfolios in situations where the company selling the portfolio will
continue to act as a Dealer following the acquisition. The Company has also
completed the acquisition of six large POS authorization system lease and rental
portfolios: two in 1996, one in 1998, one in 1999, one in 2000 and the
acquisition of the rental and lease portfolio of Resource Leasing in 2001.
SERVICING AND COLLECTIONS
The Company performs all servicing functions on its leases, contracts and
loans, including its securitized leases, through its automated servicing and
collection system. Servicing responsibilities generally include billing,
processing payments, remitting payments to Dealers and investors in the
Company's securitization programs (the "Securitizations"), preparing investor
reports, paying taxes and insurance and performing collection and liquidation
functions.
The Company's automated lease administration system handles application
tracking, invoicing, payment processing, automated collection queuing, portfolio
evaluation and report writing. The system is linked with bank accounts for
payment processing and provides for direct withdrawal of lease, contract and
loan payments. The Company monitors delinquent accounts using its automated
collection process. The Company uses several computerized processes in its
customer service and collection efforts, including the generation of daily
priority call lists and scrolling for daily delinquent account servicing,
generation and mailing of delinquency letters, and routing of incoming customer
service calls to appropriate employees with instant computerized access to
account details. The Company's collection efforts include one or more of the
following: sending collection letters, making collection calls, reporting
delinquent accounts to credit reporting agencies, and litigating delinquent
accounts when necessary and obtaining and enforcing judgments. The Company also
uses a collectability scoring model to determine if the benefits from further
collection efforts will out weigh the costs associated with those efforts.
COMPETITION
The microticket leasing and financing industry is highly competitive. The
Company competes for customers with a number of national, regional and local
banks and finance companies. The Company's competitors also include equipment
manufacturers that lease or finance the sale of their own products. While the
market for microticket financing has traditionally been fragmented, the Company
could also be faced with competition from small- or large-ticket leasing
companies that could use their expertise in those markets to enter and compete
in the microticket financing market. The Company's competitors include larger,
more established companies, some of which may possess substantially greater
financial, marketing and operational resources than the Company, including a
lower cost of funds and access to capital markets and to other funding sources
which may be unavailable to the Company.
5
EMPLOYEES
As of December 31, 2003, the Company had 136 full-time employees, of whom 4
were engaged in credit activities and Dealer service, 93 were engaged in
servicing and collection activities, and 39 were engaged in general
administrative activities. Management believes that its relationship with its
employees is good. No employees of the Company are members of a collective
bargaining unit in connection with their employment by the Company.
EXECUTIVE OFFICERS
NAME AND AGE OF
EXECUTIVE OFFICERS TITLE
------------------ -----
Richard F. Latour, 50.................... Director, President, Chief Executive
Officer, Treasurer, Secretary and Clerk
James R. Jackson, Jr., 42................ Vice President and Chief Financial
Officer
John Plumlee, 52......................... Vice President, MIS
Carol A. Salvo, 37....................... Vice President, Legal
Steven J. LaCreta, 44.................... Vice President, Lessee Relations
Stephen J. Constantino, 38............... Vice President, Human Resources
Backgrounds of Executive Officers
Richard F. Latour has served as President, Chief Executive Officer, Chief
Financial Officer, Treasurer, Clerk and Secretary of the Company since October
2002 and as President, Chief Operating Officer, Chief Financial Officer,
Treasurer, Clerk and Secretary, as well as a director of the Corporation, since
February 2002. From 1995 to January 2002, he served as Executive Vice President,
Chief Operating Officer, Chief Financial Officer, Treasurer, Clerk and
Secretary. From 1986 to 1995 Mr. Latour served as Vice President of Finance and
Chief Financial Officer. Prior to joining the Company, Mr. Latour was Vice
President of Finance for eleven years with Trak Incorporated, an international
manufacturer and distributor of consumer goods, where he was responsible for all
financial and operational functions. Mr. Latour earned a B.S. in accounting from
Bentley College in Waltham, Massachusetts.
James R. Jackson Jr. has served as Vice President and Chief Financial
Officer of the Company since April 2002. Prior to joining the Company, from 1999
to 2001, Mr. Jackson was Vice President of Finance for Deutsche Financial
Services Technology Leasing Group. From 1992 to 1999, Mr. Jackson held positions
as Manager of Pricing and Structured Finance and Manager of Business Planning
with AT&T Capital Corporation.
John Plumlee has served as Vice President, MIS of the Company since 1990.
Prior to joining the Company, Mr. Plumlee was Vice President of M.M.C., Inc., a
firm focusing on the delivery of software services to local governments.
Carol A. Salvo has served as Vice President, Legal of the Company since
1996. From 1995 to 1996, Ms. Salvo served as Director of Legal Collection
Services of the Company. From 1992 to 1995, Ms. Salvo served as Litigation
Supervisor of the Company. Prior to joining the Company, Ms. Salvo was a junior
accountant with InfoPlus Inc.
Steven J. LaCreta has served as Vice President, Lessee Relations since May
2000. From November 1996 to May 2000, Mr. LaCreta served as Director of Lessee
Relations of the Company. Prior to joining the Company, Mr. LaCreta was a
Leasing Collection Manager with Bayer Corporation.
Stephen J. Constantino has served as Vice President, Human Resources since
May 2000. From 1994 to May 2000, Mr. Constantino served as Director of Human
Resources of the Company. From 1992 to 1994, Mr. Constantino served as the
Controller of the Company. From 1991 to 1992, Mr. Constantino served as the
Accounting Manager of the Company. From 1989 to 1991, Mr. Constantino served as
a Senior Accountant of
6
the Company. Prior to joining the Company, Mr. Constantino was a Senior
Accountant with Child World, Inc.
AVAILABILITY OF INFORMATION
The Company maintains an Internet website at http://www.microfinancial.com.
The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to such reports filed or furnished
pursuant to Section 13 (a) or 15(d) of the Securities Exchange Act of 1934, as
well as Section 16 reports on Form 3, 4, or 5, are available free of charge on
this site as soon as is reasonably practicable after the Company files or
furnishes these reports with the Securities and Exchange Commission (SEC). The
Company's Guidelines on Corporate Governance, Code of Business Conduct and
Ethics and charters for its Board Committees are also available on its internet
site. The Guidelines, Code of Ethics and charters are also available in print to
any shareholder upon request. Requests for such documents should be directed to
Richard F. Latour, Chief Executive Officer, at 10M Commerce Way, Woburn,
Massachusetts 01801. The Company's Internet site and the information contained
therein or connected thereto are not incorporated by reference into this Form
10-K.
ITEM 2. PROPERTIES
At December 31, 2003, the Company's corporate headquarters and operations
center occupied 44,659 square feet of office space at 10M Commerce Way, Woburn,
Massachusetts 01801. The lease for this space expires on December 31, 2005.
During 2003, the Company also leased 5,133 square feet of office space for
its West Coast office in Newark, California, under a lease expiring on May 1,
2005, and 21,656 square feet of office space in Waltham, Massachusetts, under a
lease expiring on July 31, 2004 and occupied 15,399 square feet of office space
in Herndon, Virginia. As of December 31, 2003, the Company had negotiated early
terminations of the leases related to the facilities in Newark, California,
Herndon, Virginia and Waltham, Massachusetts.
ITEM 3. LEGAL PROCEEDINGS
Management believes, after consultation with counsel, that the allegations
against the Company included in the lawsuits described below are subject to
substantial legal defenses, and the Company is vigorously defending each of the
allegations. The Company also is subject to claims and suits arising in the
ordinary course of business. At this time, it is not possible to estimate the
ultimate loss or gain, if any, related to these lawsuits, nor if any such loss
will have a material adverse effect on the Company's results of operations or
financial position.
A. The Company filed an action in the United States District Court for the
District of Massachusetts against Sentinel Insurance Company, Ltd.,
("Sentinel"), Premier Holidays International, Inc., ("Premier") and Daniel
DelPiano ("DelPiano") arising from Premier's October, 1999, default on its
repayment obligations to the Company under a Twelve Million Dollar ($12,000,000)
loan. Judgment has been entered in this case against Sentinel, which had issued
a business performance insurance policy guaranteeing repayment of the loan, in
the amount of Fourteen Million Dollars ($14,000,000). This judgment has not been
satisfied. Sentinel is currently undergoing liquidation proceedings, and a claim
in this amount has been filed with the bankruptcy court. The Company's case
against Premier and DelPiano was tried in November, 2003 and was decided by the
Court in March, 2004. The Court entered a judgment for the Company against
Premier and DelPiano, jointly and severally, on all of the Company's counts,
including fraud and violation of Massachusetts General Laws, Chapter 9A, and
dismissing with prejudice all of Premier and DelPiano's claims and
counterclaims. The Court awarded the Company Twenty Three Million Dollars
($23,000,000) in damages. Collection of this award is not assumed and therefore
it is not reflected in the financial statements as of December 31, 2003.
B. In October, 2002, the Company was served with a Complaint in an action
in the United States District Court for the Southern District of New York filed
by approximately 170 present and former lessees asserting individual claims. The
Complaint contains claims for violation of RICO (18 U.S.C. sec. 1964), fraud,
unfair and deceptive acts and practices, unlawful franchise offerings, and
intentional infliction of mental
7
anguish. The claims purportedly arise from Leasecomm's dealer relationships with
Themeware, E-Commerce Exchange, Cardservice International, Inc., and Online
Exchange for the leasing of websites and virtual terminals. The Complaint
asserts that the Company is responsible for the conduct of its dealers in trade
shows, infomercials and web page advertisements, seminars, direct mail,
telemarketing, all which are alleged to constitute unfair and deceptive acts and
practices. Further, the Complaint asserts that Leasecomm's lease contracts as
well as its collection practices and late fees are unconscionable. The Complaint
seeks restitution, compensatory and treble damages, and injunctive relief. The
Company filed a Motion to Dismiss the Complaint on January 31, 2003. By decision
dated September 30, 2003, the court dismissed the complaint with leave to file
an amended complaint. An Amended Complaint was filed in November, 2003. The
Company filed a Motion to Dismiss the Amended Complaint, which is awaiting
decision by the Court. Because of the uncertainties inherent in litigation, we
cannot predict whether the outcome will have a material adverse effect.
C. On August 22, 2002 plaintiff Aaron Cobb filed a Complaint against
Leasecomm Corporation and MicroFinancial, Inc. and another Entity known as
Galaxy Mall, Inc. alleging breach of contract; Fraud, Suppression and Deceit;
Unjust Enrichment; Conspiracy; Conversion; Theft by Deception; and violation of
Alabama Usury Laws. The Complaint was filed on behalf of Aaron Cobb
individually, and on behalf of a class of persons and entities similarly
situated in the State of Alabama. More specifically, the Plaintiff purports to
represent a class of persons and small business in the State of Alabama who
allegedly were induced to purchase services and/or goods from any of the
Defendants named in the Complaint. The case is venued in Bullock County,
Alabama. On March 31, 2003 the trial court entered an Order denying the
Company's Motion to Dismiss. An appeal of the Order was filed with the Alabama
Supreme Court on May 12, 2003. The Company continues to deny any wrongdoing and
plans to vigorously defend this claim. Because of the uncertainties inherent in
litigation, the company cannot predict whether the outcome will have a material
adverse affect.
D. In March, 2003, an action was filed by a shareholder against the Company
in United States District Court asserting a single count of common law fraud and
constructive fraud. The complaint alleges that the shareholder was defrauded by
untrue statements made to him by management, upon which he relied in the
purchase of Company stock for himself and for others. The complaint seeks
damages in an unspecified amount. The Company filed an answer denying the
allegations. In December, 2003, upon motion filed by the plaintiff shareholder,
the Court dismissed the action without prejudice.
E. In March, 2003, a purported class action was filed in Superior Court in
Massachusetts against Leasecomm and one of its dealers. The class sought to be
certified is a nationwide class (excluding certain residents of the State of
Texas) who signed identical or substantially similar lease agreements with
Leasecomm covering the same product. After the Company had filed a motion to
dismiss, but before the motion to dismiss was heard by the Court, plaintiffs
filed an Amended Complaint. The Amended Complaint asserts claims against the
Company for declaratory relief, absence of consideration, unconscionability, and
violation of Massachusetts General Laws Chapter 93A, Section 11. The Company
filed a motion to dismiss the Amended Complaint. The Court allowed the Company's
motion to dismiss the Amended Complaint in March, 2004.
F. On April 28, 2003 plaintiff Wallace Dickey filed a purported class
action against Leasecomm Corporation, Cardservice International, Linkpoint
International and Clear Commerce Corporation alleging that he lease-financed
through Leasecomm the right to use certain computer software manufactured,
distributed and sold by the other defendants. The plaintiff does not allege that
Leasecomm failed to provide the lease financing contemplated by the Leasecomm
lease. Instead, the Plaintiff alleges that the software failed to operate as he
believed it would, and he has sued for a declaration that would allow him to
rescind his contract, to recover money paid in the course of the transaction and
to recover damages allegedly caused by unspecified deceptive trade practices.
The plaintiff asserts his claims "on behalf of himself and all others similarly
situated." Leasecomm denies all of the Plaintiff's allegations. The parties have
reached an agreement on settlement terms and are currently drafting the
settlement documents. The settlement, if finalized and signed by the parties,
will require court approval to become effective. Because of the uncertainties
inherent in litigation, the company cannot predict whether the outcome will have
a material adverse affect.
8
G. On April 29, 2003, Leasecomm was served with a Complaint filed in the
Orange County Superior Court for the State of California. In that Complaint,
Maria J. Smith purports to bring a claim against Leasecomm and two other
defendants (Galaxy Mall, Inc. and Electronic Commerce International, Inc.) for
unfair business practices and competition under California Business and
Professions Code section 17200 et seq. The essence of the claim is that Smith
and others who are similarly situated were defrauded in connection with their
acquisition of certain licenses that were financed by Leasecomm. In May 2003,
Leasecomm filed a motion to stay the action in favor of a Massachusetts forum
based on a forum selection clause contained in plaintiff's lease agreement with
Leasecomm. After filing the motion, Leasecomm entered into settlement
negotiations with plaintiff's counsel to explore the possibility of resolving
the matter on a class wide basis without the need for further litigation
(meaning the settlement would, if accepted, apply not only to the named
plaintiff but to others similarly situated). The parties have reached agreement
on settlement terms and are currently drafting the settlement documents. The
settlement, if finalized and signed by the parties, will require Court approval
to become effective. Because of the uncertainties inherent in litigation, the
company cannot predict whether the outcome will have a material adverse affect.
H. In October, 2003, the Company was served with a purported class action
complaint which was filed in United States District Court for the District of
Massachusetts alleging violations of federal securities law. The purported class
would consist of all persons who purchased Company securities between February
5, 1999 and October 30, 2002. The Complaint asserts that during this period the
Company made a series of materially false or misleading statements about the
Company's business, prospects and operations, including with respect to certain
lease provisions, the Company's course of dealings with its vendor/dealers, and
the Company's reserves for credit losses. No motion or answer has been filed in
response to the Complaint. Because of the uncertainties inherent in litigation,
we cannot predict whether the outcome will have a material adverse effect.
I. In February, 2004, a purported class action was filed in Superior Court
in Massachusetts against Leasecomm, a dealer, and a party purportedly related to
the dealer. The class sought to be certified is a nationwide class who signed
lease agreements identical to, or substantially similar to, the plaintiff's
lease agreement with Leasecomm, and covering the same product. The Complaint
asserts claims for declaratory judgment, absence of consideration,
unconscionability, and violation of Massachusetts General Laws Chapter 93A,
Section 11. The claims concern the validity, enforceability, and alleged
unconscionability of this Leasecomm lease of a product which enabled a merchant
to process credit card payments. The Complaint seeks rescission of lease
agreements with Leasecomm, restitution, multiple damages and attorneys fees
under Chapter 93A, and injunctive relief. Because of the uncertainties inherent
in litigation we cannot predict whether the outcome will have a material adverse
effect. As of the date of this filing, the Company has not been served with this
complaint.
J. In February, 2003, Leasecomm received a Civil Investigative Demand
("CID") from the Office of the Attorney General, State of Washington, to which
it has responded. The CID concerns an investigation of monitoring agreements
between Priority One, Inc. and various State of Washington consumers, as to
which Leasecomm appears to be the assignee of the right to receive monthly
payments. Since the investigation has not been concluded, and no legal action
has been commenced against Leasecomm, there can be no assurance as to the
eventual outcome.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders of the Company
during the fourth quarter of its fiscal year ended December 31, 2003.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information
The Company's common stock, par value $0.01 per share (the "Common Stock"),
is listed on the New York Stock Exchange under the symbol "MFI."
2002 2003
------------------------------------- -------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- ------- ------- ------- ------- ------- -------
Stock Price
High................. 10.50 10.93 9.30 4.44 1.49 1.84 3.49 3.44
Low.................. 6.40 7.24 4.01 .99 .56 .37 1.75 2.64
(b) Holders
At March 14, 2004, there were approximately 120 stockholders of record of
the common stock. However, many holders' shares are listed under their brokerage
firms' names. We estimate that our number of beneficial shareholders to be
approximately 850.
(c) Dividends
The Company paid the following quarterly cash dividends on the Common
Stock.
YEAR ENDED YEAR ENDED
DECEMBER 31, 2002 DECEMBER 31, 2003
----------------- -----------------
First Quarter....................................... $0.050 --
Second Quarter...................................... $0.050 --
Third Quarter....................................... $0.050 --
Fourth Quarter...................................... -- --
During the fourth quarter of 2002, the Board of Directors suspended the
future payment of dividends to comply with the Company's banking agreements.
Currently, the terms of the Company's senior credit facility prohibit the
payment of dividends, so long as there is a balance outstanding on the debt. The
Provisions in certain of the Company's credit facilities and agreements
governing its subordinated debt contain, and the terms of any indebtedness
issued by the Company in the future are likely to contain, certain restrictions
on the payment of dividends on the Common Stock. The decision as to the amount
and timing of future dividends paid by the Company, if any, will be made at the
discretion of the Company's Board of Directors in light of the financial
condition, capital requirements, earnings and prospects of the Company and any
restrictions under the Company's credit facilities or subordinated debt
agreements, as well as other factors the Board of Directors may deem relevant,
and there can be no assurance as to the amount and timing of payment of future
dividends.
(d) Recent Sales of Unregistered Securities
None
(e) Use of Proceeds from Registered Securities
Not applicable
10
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial and
operating data for the Company and its subsidiaries for the periods and at the
dates indicated. The selected financial data were derived from the financial
statements and accounting records of the Company. The data presented below
should be read in conjunction with the consolidated financial statements,
related notes and other financial information included herein.
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1999 2000 2001 2002 2003
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Income Statement Data:
Revenues
Income on financing leases and
loans...................... $ 55,545 $ 69,847 $ 70,932 $ 53,012 $ 30,904
Income on service contracts... 6,349 8,687 8,665 9,734 8,593
Rental income................. 21,582 27,638 37,664 37,154 34,302
Other income(1)............... 24,802 33,305 36,830 26,922 17,775
-------- -------- -------- -------- --------
Total revenues................ 108,278 139,477 154,091 126,822 91,574
-------- -------- -------- -------- --------
Expenses:
Selling, general and
administrative............. 33,827 38,371 44,899 45,535 33,856
Provision for credit losses... 37,836(2) 38,912 54,092 88,948(3) 59,758
Depreciation and
amortization............... 7,597 10,227 14,378 18,385 16,592
Interest...................... 10,781 15,858 14,301 10,787 7,515
-------- -------- -------- -------- --------
Total expenses................ 90,041 103,368 127,670 163,655 117,721
-------- -------- -------- -------- --------
Income (loss) before provision
(benefit) for income taxes.... $ 18,237 $ 36,109 $ 26,421 $(36,833) $(26,147)
======== ======== ======== ======== ========
Net income (loss)............... $ 10,728 $ 20,860 $ 16,317 $(22,098) $(15,687)
======== ======== ======== ======== ========
Net income (loss) per common
share
Basic(4)...................... $ 0.84 $ 1.64 $ 1.28 $ (1.72) $ (1.20)
Diluted(5).................... 0.83 1.63 1.26 (1.72) (1.20)
Dividends per common share...... 0.16 0.18 0.20 0.15 0.00
DECEMBER 31,
-------------------------------------------------------
1999 2000 2001 2002 2003
--------- --------- --------- -------- --------
(DOLLARS IN THOUSANDS)
Balance Sheet Data:
Gross investment in leases
and loans(6)............... $ 362,721 $ 452,885 $ 438,723 $367,173 $194,898
Unearned income.............. (100,815) (132,687) (104,538) (67,574) (23,729)
Allowance for credit
losses..................... (41,719) (40,924) (45,026) (69,294) (43,011)
Investment in service
contracts.................. 14,250 12,553 14,126 14,463 8,844
Total assets............... 265,856 342,602 361,728 295,085 156,414
Notes payable................ 144,871 201,991 203,053 168,927 58,843
Subordinated notes payable... 9,238 4,785 3,262 3,262 3,262
Total liabilities.......... 187,018 246,579 251,172 208,482 85,148
Total stockholders'
equity.................. 78,838 96,023 110,556 86,603 71,266
11
DECEMBER 31,
----------------------------------------------------------
1999 2000 2001 2002 2003
--------- --------- --------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT STATISTICAL DATA)
Other Data:
Operating Data:
Total leases and loans
originated(7)................ $ 223,446 $ 236,763 $ 155,308 $111,829 $ 3,429
Total service contracts
acquired(8).................. 9,105 4,138 6,658 6,773 --
Total rental contracts
originated................... 220 5,686 12,379 677 157
Dealer fundings(9).............. 137,300 145,400 111,100 74,000 1,600
Average yield on leases and
loans(10).................... 36.8% 38.0% 38.1% 36.9% 32.5%
Cash Flows From (used in):
Operating activities............ $ 114,723 $ 116,360 $ 122,280 $120,628 $ 98,052
Investing activities............ (147,587) (157,947) (116,860) (80,141) (2,839)
Financing activities............ 33,123 43,081 (10,104) (35,139) (94,174)
--------- --------- --------- -------- --------
Total........................... 259 1,494 (4,684) 5,348 1,039
Selected Ratios:
Return on average assets........ 4.51% 6.86% 4.63% (6.73)% (6.95)%
Return on average stockholders'
equity....................... 19.81 23.86 15.80 (22.42) (19.87)
Operating margin(11)............ 51.79 53.79 52.25 41.09 36.70
Credit Quality Statistics:
Net charge-offs................. $ 20,967 $ 37,888(2) $ 51,408(2) $ 65,081(3) $ 86,041
Net charge-offs as a percentage
of average gross
investment(12)............... 6.29% 9.00% 11.20% 15.60% 29.40%
Provision for credit losses as a
percentage of average gross
investment(13)............... 11.35 9.24 11.78 21.32 20.42
Allowance for credit losses as a
percentage of gross
investment(14)............... 11.07 8.79 9.94 18.16 21.11
---------------
(1) Includes loss and damage waiver fees, service fees, interest income, and
equipment sales revenue.
(2) The provision for 1999 includes a special provision of $12.7 million for a
loan made to one company, collateralized by approximately 3,500 microticket
consumer contracts, and guaranteed by, among other security, an insurance
performance bond. MicroFinancial has obtained judgements against the
Company and the Insurance Company in the amounts of $23.0 million and $14.0
million, respectively. Charge-offs against the special reserve were $6.4
and $7.1 million for the years ended December 31, 2000 and 2001,
respectively.
(3) The provision for 2002 includes an additional provision of $35.0 million to
reserve against certain dealer receivables as well as delinquent portfolio
assets. In the past, dealer receivables had been offset, in some instances,
against the funding of new contracts. Since the Company has suspended the
funding of new deals, Management feels that the collection of these
receivables will be more difficult. Although the Company will continue to
pursue collections on these accounts, management believes that the cost
associated with the legal enforcement would outweigh the benefits realized.
(4) Net income per common share (basic) is calculated based on weighted-average
common shares outstanding of 12,795,809, 12,728,441, 12,789,605, 12,821,946
and 13,043,744 for the years ended December 31, 1999, 2000, 2001, 2002, and
2003 respectively.
12
(5) Net income per common share (diluted) is calculated based on
weighted-average common shares outstanding on a diluted basis of
12,904,231, 12,807,814, 12,945,243, 12,821,946 and 13,043,744 for the years
ended December 31, 1999, 2000, 2001, 2002 and 2003 respectively.
(6) Consists of receivables due in installments, estimated residual value, and
loans receivable.
(7) Represents the amount paid to Dealers upon funding of leases and loans,
plus the associated unearned income.
(8) Represents the amount paid to Dealers upon the acquisition of service
contracts, including both non-cancelable service contracts and
month-to-month service contracts.
(9) Represents the amount paid to Dealers upon funding of leases, contracts and
loans.
(10) Represents the aggregate of the implied interest rate on each lease and
loan originated during the period weighted by the amount funded at
origination for each such lease and loan.
(11) Represents income before provision for income taxes and provision for
credit losses as a percentage of total revenues.
(12) Represents net charge-offs as a percentage of average gross investment in
leases and loans and investment in service contracts.
(13) Represents provision for credit losses as a percentage of average gross
investment in leases and loans and investment in service contracts.
(14) Represents allowance for credit losses as a percentage of gross investment
in leases and loans and investment in service contracts.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion includes forward-looking statements (as such term
is defined in the Private Securities Litigation Reform Act of 1995). When used
in this discussion, the words "believes," "anticipates," "expects" and similar
expressions are intended to identify forward-looking statements. Such
forward-looking statements involve known and unknown risks, uncertainties and
other important factors that could cause the actual results, performance or
achievements of the Company, or industry results, to differ materially from any
future results, performance or achievements expressed or implied by such
forward-looking statements. Such risks, uncertainties and other important
factors include, among others: the Company's inability to obtain financing in
order to continue originating new contracts; the Company's dependence on POS
authorization systems and expansion into new markets; the Company's significant
capital requirements; the risks of defaults on the Company's leases; adverse
consequences associated with the Company's collection policy; risks associated
with economic downturns; the effect on the Company's portfolio of higher
interest rates; intense competition; increased governmental regulation of the
rates and methods used by the Company in financing and collecting its leases and
loans; risks associated with acquiring other portfolios and companies;
dependence on key personnel; and other factors, many of which are beyond the
Company's control. The Company expressly disclaims any obligation or undertaking
to disseminate any updates or revisions to any forward-looking statement
contained herein to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any such
statement is based. In light of these risks and uncertainties, there can be no
assurance that the forward-looking information contained herein will in fact
transpire.
OVERVIEW
The Company is a specialized commercial finance company that provides
"microticket" equipment leasing and other financing services in amounts
generally ranging from $400 to $15,000, with an average amount financed of
approximately $1,900. The Company primarily leases POS authorization systems and
other small business equipment to small commercial enterprises.
The Company derives the majority of its revenues from leases originated and
held by the Company, payments on service contracts, rental payments, and fee
income. Historically, the Company funded the majority of leases, contracts and
loans through its revolving-credit and term loan facilities (the "Credit
13
Facilities") and on-balance sheet securitizations, and to a lesser extent, its
subordinated debt program ("Subordinated Debt") and internally generated funds.
As of September 30, 2002, the credit facility failed to renew and the Company
began paying down the balance of the debt. At December 31, 2002, the Company was
in default of certain of its debt covenants in its credit facility and
securitization agreements. The covenants that were in default with respect to
the credit facility, require that the Company maintain a fixed charge ratio in
an amount not less than 130% of consolidated earnings, a consolidated tangible
net worth minimum of $77.5 million plus 50% of net income quarterly beginning
with September 30, 2000 and compliance with the borrowing base. The covenants
that were in default with respect to the securitization agreements, require that
the Company maintain a fixed charge ratio in an amount not less than 125% of
consolidated earnings and a consolidated tangible net worth greater than $90
million plus 50% of net income for each fiscal quarter after June 30, 2001. On
April 14, 2003, the Company entered into a long-term agreement with its lenders.
This long-term agreement waived the defaults described above, and in
consideration for the waiver, required the outstanding balance of the loan to be
repaid over a term of 22 months beginning in April 2003 at an interest rate of
prime plus 2.0%. The Company received a waiver, which was set to expire on April
15, 2003, for the covenant violations in connection with the securitization
agreement. Subsequently, the Company received a permanent waiver of the covenant
defaults and the securitization agreement was amended so that going forward, the
covenants are the same as those contained in the long-term agreement entered
into on April 14, 2003, for the senior credit facility. In October 2002, the
Company was forced to suspend virtually all new contract originations until a
new source of financing is obtained or until such time as the credit facility
has been paid in full. The Company is currently in the process of pursuing
alternative financing sources.
In February 2003, the Company was advised by the New York Stock Exchange
(NYSE) that it was not in compliance with the NYSE's continued listing
standards. Specifically, the Company did not meet the following requirements
based on a consecutive thirty (30) day trading period: average market
capitalization of not less than $15 million and a share price of not less than
$1.00. In accordance with the continued listing criteria set forth by the NYSE,
on April 1, 2003, the Company presented a plan which management believed had the
potential to bring the Company back into compliance with the listing standards
within the required timeframes. Subsequently, the Company was able to achieve
and maintain compliance with the continued listing criteria. The Company
continues to work closely with the NYSE in the execution of its plan objectives.
In a typical lease transaction, the Company originates leases through its
network of independent Dealers. Upon approval of a lease application by the
Company and verification that the lessee has both received the equipment and
signed the lease, the Company pays the Dealer the cost of the equipment, plus
the Dealer's profit margin. In a typical transaction for the acquisition of
service contracts, a homeowner purchases a security system and simultaneously
signs a contract with the Dealer for the monitoring of that system for a monthly
fee. Upon credit approval of the monitoring application and verification with
the homeowner that the system is installed, the Company purchases from the
Dealer the right to the payment stream under that monitoring contract at a
negotiated multiple of the monthly payments.
Substantially all leases originated or acquired by the Company are
non-cancelable. During the term of the lease, the Company is scheduled to
receive payments sufficient, in the aggregate, to cover the Company's borrowing
costs and the costs of the underlying equipment, and to provide the Company with
an appropriate profit. The Company enhances the profitability of its leases,
contracts and loans by charging late fees, prepayment penalties, loss and damage
waiver fees and other service fees, when applicable. Collection fees are imposed
based on the Company's estimate of the costs of collection. The Company may only
impose late fees on the first four months of late payments and is prohibited
from imposing compound late fees or from assessing late fees as a percentage of
the total outstanding late payments including outstanding late fees. The loss
and damage waiver fees are charged if a customer fails to provide proof of
insurance and are reasonably related to the cost of replacing the lost or
damaged equipment or product. The initial non-cancelable term of the lease is
equal to or less than the equipment's estimated economic life and often provides
the Company with additional revenues based on the residual value of the
equipment financed at the end of the initial term of the lease. Initial terms of
the leases in the Company's portfolio generally range from 12 to 48 months, with
an average initial term of 44 months as of December 31, 2003. Substantially all
service and rental contracts are
14
month-to-month contracts with expected terms of 7 years for service contracts,
15 months for lessees that continue to rent their equipment beyond the original
term, and 22 months for other types of rental contracts.
CRITICAL ACCOUNTING POLICIES
In response to the SEC's release No. 33-8040, "Cautionary Advice regarding
Disclosure About Critical Accounting Policies," Management identified the most
critical accounting principles upon which our financial status depends. The
Company determined the critical principles by considering accounting policies
that involve the most complex or subjective decisions or assessments. We
identified our most critical accounting policies to be those related to revenue
recognition and maintaining the allowance for credit losses. These accounting
policies are discussed below as well as within the notes to the consolidated
financial statements.
Revenue Recognition
The Company's lease contracts are accounted for as financing leases. At
origination, the Company records the gross lease receivable, the estimated
residual value of the leased equipment, initial direct costs incurred and the
unearned lease income. Unearned lease income is the amount by which the gross
lease receivable plus the estimated residual value exceeds the cost of the
equipment. Unearned lease income and initial direct costs incurred are amortized
over the related lease term using the interest method. Amortization of unearned
lease income and initial direct costs is suspended if, in the opinion of
management, full payment of the contractual amount due under the lease agreement
is doubtful. In conjunction with the origination of leases, the Company may
retain a residual interest in the underlying equipment upon termination of the
lease. The value of such interests is estimated at inception of the lease and
evaluated periodically for impairment. Other revenues such as loss and damage
waiver fees, service fees relating to the leases, contracts and loans, and
rental revenues are recognized as they are earned.
The Company's investments in cancelable service contracts are recorded at
cost and amortized over the expected life of the service period. Income on
service contracts from monthly billings is recognized as the related services
are provided. The Company periodically evaluates whether events or circumstances
have occurred that may affect the estimated useful life or recoverability of the
investment in service contracts. Rental equipment is either recorded at
estimated residual value and depreciated using the straight-line method over a
period of 12 months or at the acquisition cost and depreciated using the
straight line method over a period of 36 months. Loans are reported at their
outstanding principal balance. Interest income on loans is recognized as it is
earned.
Allowance for Credit Losses
The Company maintains an allowance for credit losses on its investment in
leases, service contracts, rental contracts and loans at an amount that it
believes is sufficient to provide adequate protection against losses in its
portfolio. The allowance is determined principally on the basis of the
historical loss experience of the Company and the level of recourse provided by
such lease, service contract, rental contract or loan, if any, and reflects
management's judgment of additional loss potential considering current economic
conditions and the nature and characteristics of the underlying lease portfolio.
The Company determines the necessary periodic provision for credit losses taking
into account actual and expected losses in the portfolio as a whole and the
relationship of the allowance to the net investment in leases, service
contracts, rental contracts and loans. Such provisions generally represent a
percentage of funded amounts of leases, contracts and loans. The resulting
charge is included in the provision for credit losses.
Leases, service contracts, rental contracts and loans are charged against
the allowance for credit losses and are put on non-accrual when they are deemed
to be uncollectable. Generally, the Company deems leases, service contracts,
rental contracts and loans to be uncollectable when one of the following occurs:
(i) the obligor files for bankruptcy; (ii) the obligor dies, and the equipment
is returned; or (iii) when an account has become 360 days delinquent without
contact with the lessee. The typical monthly payment under the Company's leases
is between $30 and $50 per month. As a result of these small monthly payments,
the Company's experience is that lessees will pay past due amounts later in the
process because of the small
15
amount necessary to bring an account current (at 360 days past due, a lessee may
only owe lease payments of between $360 and $600).
The Company has developed and regularly updates proprietary credit scoring
systems designed to improve its risk-based pricing. The Company uses credit
scoring in most, but not all, of its extensions of credit. In addition, the
Company aggressively employs collection procedures and a legal process to
resolve any credit problems.
RESULTS OF OPERATIONS
Revenue
2001 CHANGE 2002 CHANGE 2003
-------- ------ -------- ------ -------
(IN THOUSANDS)
Income on financing leases and
loans............................... $ 70,932 (25.3)% $ 53,012 (41.7)% $30,904
Income on service contracts........... 8,665 12.3% 9,734 (11.7)% 8,593
Rental income......................... 37,664 (1.4)% 37,154 (7.7)% 34,302
Service fees and other................ 36,830 (26.9)% 26,922 (34.0)% 17,775
-------- ----- -------- ----- -------
Total revenues........................ 154,091 (17.7)% 126,822 (27.8)% 91,574
-------- -------- -------
The Company's lease contracts are accounted for as financing leases. At
origination, the Company records the gross lease receivable, the estimated
residual value of the leased equipment, initial direct costs incurred and the
unearned lease income. Unearned lease income is the amount by which the gross
lease receivable plus the estimated residual value exceeds the cost of the
equipment. Unearned lease income and initial direct costs incurred are amortized
over the related lease term using the interest method. Other revenues such as
loss and damage waiver fees, service fees relating to the leases, contracts and
loans, and rental revenues are recognized as they are earned.
Total revenues for the year ended December 31, 2003 were $91.6 million, a
decrease of $35.2 million, or 27.8%, from the year ended December 31, 2002. The
decline in revenue was due to decreases of $22.1 million, or 41.7%, in income on
financing leases and loans and $9.1 million, or 34.0%, in service fee and other
income. In addition, rental revenue decreased $2.9 million or 7.7% and income on
service contracts decreased $1.1 million, or 11.7%, as compared to such amounts
in the previous year's period. The overall decrease in revenue can be attributed
to the decrease in the overall size of the Company's portfolio of leases,
rentals and service contracts. The shrinking portfolio is a direct result of the
Company's decision during the third quarter of 2002 to cease funding new
originations as a result of its Lenders not renewing the revolving credit
facility on September 30, 2002. Revenues are expected to continue to decline so
long as the Company is not originating new contracts.
Total revenues for the year ended December 31, 2002, were $126.8 million, a
decrease of $27.3 million, or 17.7%, from the year ended December 31, 2001, due
primarily to decreases of $17.9 million, or 25.3%, in income on financing leases
and loans and $9.8 million, or 32.2%, in service fee and other income; offset by
an increase of $559,000, or 1.2% in rental and service contract income over such
amounts in the previous year's period. The decrease in income on financing
leases and loans was due to the decreased number of leases originated primarily
resulting from the Company's decision during the third quarter of 2002 to
suspend the funding of new contracts. The decrease in fee income and other
income is the result of decreased fees from the lessees related to the
collection and legal process employed by the Company. The increase in rental and
service contract income is a result of the increased number of lessees that have
continued to rent their equipment beyond their original lease term, the
acquisition of the rental portfolio of Resource Leasing Corporation, and
increased originations in rental and service contracts in 2002.
16
Selling, General and Administrative
2001 CHANGE 2002 CHANGE 2003
------ ------ ------ ------ ------
(IN THOUSANDS)
Selling, general and administrative........ 44,899 1.4% 45,535 (25.6)% 33,856
As a percent of revenue.................... 29.1% 35.9% 37.0%
Our selling, general and administrative (SG&A) expenses include costs of
maintaining corporate functions including accounting, finance, collections,
legal, human resources, information systems and communications. SG&A expenses
also include commissions, service fees and other marketing costs associated with
the Company's portfolio of leases and rental contracts. SG&A expenses decreased
by $11.7 million, or 25.6%, for the year ended December 31, 2003, as compared to
the year ended December 31, 2002. The decrease was primarily driven by a
reduction in personnel related expenses of approximately $5.8 million, as
management reduced headcount from 203 to 136, $2.0 million decrease in
collection related expenses, $1.8 million in cost of goods sold, and $700,000
reduction in rent expense. The expense reductions were achieved as management
continued to align the Company's infrastructure with the current business
conditions.
SG&A expenses increased by $636,000 or 1.4%, for the year ended December
31, 2002, as compared to the year ended December 31, 2001. Marketing programs
increased by $1.4 million, or 117.2%, due to increased dealer service fees paid
on a portfolio of leases acquired in 2002. Legal services increased by $2.2
million, or 198.2%, primarily due to costs incurred for the different class
actions and investigations and in conjunction with the workout on the Company's
credit facility and securitization covenant defaults. Compensation expenses
decreased by $2.1 million, or 11.3%, primarily due to staff reductions.
Provision for Credit Losses
2001 CHANGE 2002 CHANGE 2003
------ ------ ------ ------ ------
(IN THOUSANDS)
Provision for credit losses................ 54,092 64.4% 88,948 (32.8)% 59,758
As a percent of revenue.................... 35.1% 70.1% 65.3%
The Company maintains an allowance for credit losses on its investment in
leases, service contracts, rental contracts and loans at an amount that it
believes is sufficient to provide adequate protection against losses in its
portfolio. The Company's provision for credit losses decreased by $29.2 million,
or 32.8%, for the year ended December 31, 2003, as compared to the year ended
December 31, 2002, while net charge-offs increased 32.0% to $86.0 million. The
provision was based on the Company's historical policy of providing a provision
for credit losses based upon the dealer fundings and revenue recognized in any
period, as well as taking into account actual and expected losses in the
portfolio as a whole and the relationship of the allowance to the net investment
in leases, service contracts, rental contracts and loans.
The Company's provision for credit losses increased by $34.9 million, or
64.4%, for the year ended December 31, 2002, as compared to the year ended
December 31, 2001, while net charge-offs increased 26.6% to $65.1 million. This
provision was based on the Company's historical policy, based on experience, of
providing a provision for credit losses based upon the dealer fundings and
revenue recognized in any period and reflects management's judgement of loss
potential considering current economic conditions and the nature of the
underlying receivables. The Company took an additional provision of $35 million
during the third quarter of 2002 to reserve against certain dealer receivables
as well as delinquent portfolio assets. In the past, dealer receivables had been
offset, in some instances, against the funding of new contracts. Since the
Company has suspended the funding of new deals, the Company feels that the
collection of these receivables will be more difficult. Although the Company
will continue to pursue collections on these accounts, management believes that
the cost associated with the legal enforcement would outweigh the benefits
realized.
17
Depreciation and Amortization
2001 CHANGE 2002 CHANGE 2003
------ ------ ------ ------ ------
(IN THOUSANDS)
Depreciation and amortization.............. 14,378 27.9% 18,385 (9.8)% 16,592
As a percent of revenue.................... 9.3% 14.5% 18.1%
Depreciation and amortization expenses consist primarily of the
depreciation taken against fixed assets and rental equipment, and the
amortization of the Company's investment in service contracts. The Company's
investment in fixed assets is recorded at cost and amortized over the expected
life of the service period of the asset. Rental equipment is either recorded at
estimated residual value and depreciated using the straight-line method over a
period of 12 months or at the acquisition cost and depreciated using the
straight line method over a period of 36 months. Service contracts are recorded
at cost and amortized over 84 months. The Company periodically evaluates whether
events or circumstances have occurred that may affect the estimated useful life
or recoverability of the asset and any resulting charge is made to depreciation
and amortization expense. Depreciation and amortization decreased by $1.8
million, or 9.8%, for the year ended December 31, 2003, as compared to the year
ended December 31, 2002, primarily due to the decrease in the overall portfolio
of service and rental contracts.
For the year ended December 31, 2002 as compared to the year ended December
31, 2001, depreciation and amortization increased by $4.0 million, or 27.9%, due
to the increased number of rental contracts and amortization of the Company's
investment in service contracts.
Interest Expense
2001 CHANGE 2002 CHANGE 2003
------ ------ ------ ------ -----
(IN THOUSANDS)
Interest.................................... 14,301 (24.6)% 10,787 (30.3)% 7,515
As a percent of revenue..................... 9.3% 8.5% 8.2%
The Company pays interest on borrowings under the senior credit facility,
subordinated debt and the on balance sheet securitizations. Interest expense
decreased by $3.3 million, or 30.3%, for the year ended December 31, 2003, as
compared to the year ended December 31, 2002. This decrease resulted primarily
from the Company's decreased level of borrowings. At December 31, 2003, the
Company had notes payable of $58,843, compared to $168,927 at December 31, 2002.
Interest expense decreased by $3.5 million, or 24.6%, for the year ended
December 31, 2002, as compared to the year ended December 31, 2001. This
decrease resulted primarily from the Company's declining cost of funds as well
as a decreased level of borrowings.
Other Operating Data
Dealer Fundings were $1.6 million during the year ended December 31, 2003,
a decrease of $72.4 million, or 97.8%, compared to the year ended December 31,
2002. . This decrease is a result of the failure of the credit facility to
renew, which, in turn, forced the Company to suspend virtually all new contract
originations in the third quarter of 2002. Receivables due in installments,
estimated residual values, loans receivable, investment in service contracts,
and investment in rental equipment also decreased from $396.5 million for the
year ended December 31, 2002 to $218.3 million for the year ended December 31,
2003, representing a decrease of $178.2 million, or 44.9%. Unearned income
decreased by $43.9 million, or 64.9%, from $67.6 million at December 31, 2002 to
$23.7 million at December 31, 2003. This decrease was primarily due to continued
amortization and a lack of new lease originations in 2003. Net cash provided by
operating activities decreased by $22.5 million, or 18.7%, to $98.1 million
during the year ended December 31, 2003, from the year ended December 31, 2002,
because of the decrease in the size of the Company's overall portfolio.
Dealer Fundings were $74.0 million during the year ended December 31, 2002,
a decrease of $37.1 million, or 33.4%, compared to the year ended December 31,
2001. This decrease is a result of the failure of the credit facility to renew,
which in turn, forced the Company to suspend virtually all new contract
18
originations in the third quarter of 2002. Receivables due in installments,
estimated residual values, loans receivable, investment in service contracts,
and investment in rental equipment also decreased from $470.6 million for the
year ended December 31, 2001, to $396.5 million for the year ended December 31,
2002, representing a decrease of $74.1 million, or 15.7%. Unearned income
decreased by $37.0 million, or 35.4%, from $104.5 million at December 31, 2001
to $67.6 million at December 31, 2002. This decrease was primarily due to the
33.4% decrease in dealer fundings during 2002. Net cash provided by operating
activities decreased by $1.7 million to $120.6 million during the year ended
December 31, 2002, or 1.4%, from the year ended December 31, 2001 because of the
decrease in the size of the Company's overall portfolio.
EXPOSURE TO CREDIT LOSSES
The following table sets forth certain information as of December 31, 2001,
2002 and 2003, with respect to delinquent leases, service contracts and loans.
The percentages in the table below represent the aggregate on such date of the
actual amounts not paid on each invoice by the number of days past due, rather
than the entire balance of a delinquent receivable, over the cumulative amount
billed at such date from the date of origination on all leases, service
contracts, and loans in the Company's portfolio. For example, if a receivable is
90 days past due, the portion of the receivable that is over 30 days past due
will be placed in the 31-60 days past due category, the portion of the
receivable which is over 60 days past due will be placed in the 61-90 days past
due category and the portion of the receivable which is over 90 days past due
will be placed in the over 90 days past due category. The Company historically
used this methodology of calculating its delinquencies because of its experience
that lessees who miss a payment do not necessarily default on the entire lease.
Accordingly, the Company includes only the amount past due rather than the
entire lease receivable in each category.
AS OF DECEMBER 31,
------------------------------
2001 2002 2003
-------- -------- --------
Cumulative amounts billed (in thousands)............. $602,649 $600,637 $478,791
31-60 days past due.................................. 1.8% 1.0% 1.1%
61-90 days past due.................................. 1.7% 1.0% 0.8%
Over 90 days past due................................ 13.4% 22.9% 17.9%
-------- -------- --------
Total past due..................................... 16.9% 24.9% 19.8%
======== ======== ========
LIQUIDITY AND CAPITAL RESOURCES
General
The Company's lease and finance business is capital-intensive and requires
access to substantial short-term and long-term credit to fund new leases,
contracts and loans. Since inception, the Company has funded its operations
primarily through borrowings under its credit facilities, its on-balance sheet
securitizations, the issuance of subordinated debt and an initial public
offering completed in February of 1999. The Company will continue to require
significant additional capital to maintain and expand its volume of leases,
contracts and loans funded, as well as to fund any future acquisitions of
leasing companies or portfolios.
The Company's uses of cash include the origination and acquisition of
leases, contracts and loans, payment of interest expenses, repayment of
borrowings under its credit facilities, subordinated debt and securitizations,
payment of selling, general and administrative expenses, income taxes and
capital expenditures.
The Company utilizes its credit facilities to fund the origination and
acquisition of leases that satisfy the eligibility requirements established
pursuant to each facility. On August 22, 2000, the Company entered into a new
$192 million credit facility with nine banks, expiring on September 30, 2002. As
of September 30, 2002, the credit facility failed to renew and the Company began
paying down the outstanding balance. As a result of the failure to renew, the
Company was forced to suspend essentially all new contract originations until a
new source of financing is obtained or at such time that the senior credit
facility has been paid in full. At
19
December 31, 2002, the Company was in default of certain of its debt covenants
in its credit facility. The covenants that were in default with respect to the
credit facility, require that the Company maintain a fixed charge ratio in an
amount not less than 130% of consolidated earnings, a consolidated tangible net
worth minimum of $77.5 million plus 50% of net income quarterly beginning with
September 30, 2000, and compliance with the borrowing base. On April 14, 2003,
the Company entered into a long-term agreement with its lenders. This long-term
agreement waives the defaults described above, and in consideration for this
waiver, requires the outstanding balance of the loan to be repaid over a term of
22 months beginning in April 2003 at an interest rate of prime plus 2.0%. Based
on the amortization schedule in the new agreement, as subsequently amended in
June and November 2003, as of December 31, 2003, the Company is obligated to
repay a minimum of $54.8 million, plus applicable interest, over the next twelve
months. At December 31, 2003, the Company had approximately $55.4 million
outstanding under the facility.
The Company, through its wholly owned subsidiary, Leasecomm Corporation,
periodically finances its lease and service contracts, together with
unguaranteed residuals, through securitizations using special purpose entities.
The assets of such special purpose entities and cash collateral or other
accounts created in connection with the financings in which they participate are
not available to pay creditors of Leasecomm Corporation, MicroFinancial
Incorporated, or other affiliates. However, the special purpose entities to
which such assets are contributed are required under generally accepted
accounting principles to be consolidated in the financial statements of the
Company. As a result, such assets and the related liability remain on the
balance sheet and do not receive gain on sale treatment. At December 31, 2002,
the Company was in default of certain of its debt covenants in its
securitization agreements. The covenants that were in default with respect to
the securitization agreements, required that the Company maintain a fixed charge
ratio in an amount not less than 125% of consolidated earnings and a
consolidated tangible net worth greater than $90 million plus 50% of net income
for each fiscal quarter after June 30, 2001. The Company received a permanent
waiver of the covenant defaults and the securitization agreement was amended so
that going forward, the covenants are the same as those contained in the
long-term agreement entered into on April 14, 2003, for the senior credit
facility. To date, cash flows from its portfolio and other fees have been
sufficient to repay amounts borrowed under the securitization agreements. At
December 31, 2003, the Company had approximately $3.2 million outstanding under
its securitizations.
MicroFinancial has taken certain steps in an effort to improve its
financial position. Management continues to actively consider various financing,
restructuring and strategic alternatives as well as continuing to work closely
with the Company's lenders to ensure continued compliance with the terms of the
long term agreement. In addition, management has taken steps to reduce overhead
and align its infrastructure with current business conditions, including a
reduction in headcount from 380 at December 31, 2001 to 136 at December 31,
2003. The failure or inability of MicroFinancial to successfully carry out these
plans could ultimately have a material adverse effect on the Company's financial
position and its ability to meet its obligations when due. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Provided that the Company continues to comply with the terms of the long
term bank agreement, including the suspension of new contract originations, the
Company believes that cash flows from its existing portfolio will be sufficient
to fund the Company's operations for the foreseeable future.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The Company has entered into various agreements, such as the long-term debt
agreements, capital lease agreements and operating lease agreements that require
future payments be made. Long-term debt agreements include all debt outstanding
under the credit facility, securitizations, subordinated notes, demand notes and
other notes payable.
20
At December 31, 2003 the repayment schedules for outstanding long-term
debt, minimum lease payments under non-cancelable operating leases and future
minimum lease payments under capital leases were as follows:
LONG-TERM OPERATING CAPITAL
FOR THE YEAR ENDED DECEMBER 31, DEBT LEASES LEASES TOTAL
------------------------------- --------- --------- ------- -------
2004........................................... $58,078 $ 585 $164 $58,827
2005........................................... 1,427 585 56 2,068
2006........................................... 2,600 -- -- 2,600
2007........................................... -- -- -- --
2008........................................... -- -- -- --
2009........................................... -- -- -- --
Thereafter..................................... -- -- -- --
------- ------ ---- -------
Total.......................................... $62,105 $1,170 $220 $63,495
======= ====== ==== =======
Recently Issued Accounting Pronouncements
See Note B of the notes to the consolidated financial statements included
herein for a discussion of the impact of recently issued accounting
pronouncements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
General Risks
MicroFinancial incurred net losses of $22.1 million and $15.7 million for
the years ended December 31, 2002 and 2003, respectively. The net losses
incurred by the Company during the third and fourth quarters of 2002 caused the
Company to be in default of certain debt covenants in its credit facility and
securitization agreements. In addition, as of September 30, 2002, the Company's
credit facility failed to renew and consequently, the Company was forced to
suspend new origination activity as of October 11, 2002. On April 14, 2003, the
Company entered into a long-term agreement with its lenders. This long-term
agreement waives the covenant defaults as of December 31, 2002, and in
consideration for this waiver, requires the outstanding balance of the loan to
be repaid over a term of 22 months beginning in April 2003 at an interest rate
of prime plus 2.0%. The Company received a waiver, which was set to expire on
April 15, 2003, for the covenant violations in connection with the
securitization agreement. Subsequently, the Company received a permanent waiver
of the covenant defaults and the securitization agreement was amended so that
going forward, the covenants are the same as those contained in the long-term
agreement entered into on April 14, 2003, for the senior credit facility. To
date, the Company has fulfilled all of its debt obligations, as agreed to by the
bank group, in a timely manner.
MicroFinancial has taken certain steps in an effort to improve its
financial position. Management continues to actively consider various financing,
restructuring and strategic alternatives as well as continuing to work closely
with the Company's lenders to ensure continued compliance with the terms of the
long term agreement. In addition, Management has taken steps to reduce overhead
and align its infrastructure with current business conditions, including a
reduction in headcount from 380 at December 31, 2001 to 136 at December 31,
2003. The failure or inability of MicroFinancial to successfully carry out these
plans could ultimately have a material adverse effect on the Company's financial
position and its ability to meet its obligations when due. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
21
Market-Rate-Sensitive Instruments and Risk Management
The following discussion about the Company's risk management activities
includes forward-looking statements that involve risk and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements.
This analysis presents the hypothetical loss in earnings, cash flows, and
fair value of the financial instruments held by the Company at December 31,
2003, that are sensitive to changes in interest rates. The Company has used
interest-rate swaps to manage the primary market exposures associated with
underlying liabilities and anticipated transactions. The Company used these
instruments to reduce risk by creating offsetting market exposures. The
instruments held by the Company are not held for trading purposes.
In the normal course of operations, the Company also faces risks that are
either nonfinancial or nonquantifiable. Such risks principally include credit
risk, and legal risk, and are not represented in the analysis that follows.
Interest Rate Risk Management
The implicit yield to the Company on all of its leases, contracts and loans
is on a fixed interest rate basis due to the leases, contracts and loans having
scheduled payments that are fixed at the time of origination of the lease. When
the Company originates or acquires leases, contracts, and loans it bases its
pricing in part on the spread it expects to achieve between the implicit yield
rate to the Company on each lease and the effective interest cost it will pay
when it finances such leases, contracts and loans through its credit facility.
Increases in interest rates during the term of each lease, contract or loan
could narrow or eliminate the spread, or result in a negative spread. The
Company has adopted a policy designed to protect itself against interest rate
volatility during the term of each lease, contract or loan.
Given the relatively short average life of the Company's leases, contracts
and loans, the Company's goal is to maintain a blend of fixed and variable
interest rate obligations. Currently, given the fixed repayment schedules of the
Company's outstanding debt, the Company is limited in its ability to manage the
blend of fixed and variable rate interest obligations. As of December 31, 2003,
the Company's outstanding fixed-rate indebtedness outstanding under the
Company's securitizations and subordinated debt represented 10.9% of the
Company's total outstanding indebtedness.
The Company's credit facility bears interest at rates, which fluctuate with
changes in the prime rate or the 90-day LIBOR. The Company's interest expense on
its credit facility and the fair value of its fixed rate debt is sensitive to
changes in market interest rates. The effect of a 10% adverse change in market
interest rates, sustained for one year, on the Company's interest expense and
the fair value of its fixed rate debt would be $332,000 and $275,000,
respectively.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, INCLUDING SELECTED
QUARTERLY FINANCIAL DATA (UNAUDITED)
MicroFinancial Incorporated's Financial Statements, together with the
related Independent Auditors' Report, appear at pages F-1 through F-27 of this
Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure controls and procedures
We evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as of December 31, 2003. Our disclosure
controls and procedures are the controls and other procedures that we designed
to ensure that we record, process, summarize and report in a timely manner the
information we must disclose in reports that we file with or submit to the SEC.
Richard F. Latour, our President and Chief
22
Executive Officer, and James R. Jackson, our Vice President and Chief Financial
Officer, reviewed and are responsible for conducting this evaluation. Based on
this evaluation, Messrs. Richard F. Latour and James R. Jackson concluded that,
as of the date of their evaluation, our disclosure controls were effective.
Internal controls
Since the date of the evaluation described above, there have not been any
significant changes in the Company's internal controls or in other factors that
could significantly affect those controls.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The sections, "Section 16(a) Beneficial Ownership Reporting Compliance,"
"Governance of the Corporation" and "Proposal 1 -- Election of Directors,"
included in the Company's proxy statement for its 2004 Special Meeting in Lieu
of Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission on or before April 29, 2004, are hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The sections, "Compensation of Executive Officers," "Governance of the
Corporation," "Compensation Committee Report," and "Performance Graph" included
in the Company's proxy statement for its 2004 Special Meeting in Lieu of Annual
Meeting of Stockholders to be filed with the Securities and Exchange Commission
on or before April 29, 2004, are hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The section "Security Ownership of Certain Beneficial Owners and
Management," included in the Company's proxy statement for its 2004 Special
Meeting in Lieu of Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission on or before April 29, 2004, is hereby
incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section "Governance of the Corporation," included in the Company's
proxy statement for its 2004 Special Meeting in Lieu of Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission on or
before April 29, 2004, is hereby incorporated by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The section "Proposal 2 -- Ratification of the Selection of
MicroFinancial's Independent Auditors," included in the Company's proxy
statement for its 2004 Special Meeting in Lieu of Annual Meeting of Stockholders
to be filed with the Securities and Exchange Commission on or before April 29,
2004, is hereby incorporated by reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements MicroFinancial Incorporated's Financial Statements,
together with the related Independent Auditors' Report, appear at pages
F-1 through F-27 of this Form 10-K
(2) None
23
(3) Exhibits Index
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Restated Articles of Organization, as amended. Incorporated
by reference to the Exhibit with the same exhibit number in
the Registrant's Registration Statement on Form S-1
(Registration Statement No. 333-56639) filed with the
Securities and Exchange Commission on June 9, 1998.
3.2 Bylaws. Incorporated by reference to the Exhibit with the
same exhibit number in the Registrant's Registration
Statement on Form S-1 (Registration Statement No. 333-56639)
filed with the Securities and Exchange Commission on June 9,
1998.
10.1 Fourth Amended and Restated Revolving Credit Agreement,
dated August 22, 2000, among Leasecomm Corporation, the
lenders parties thereto, and Fleet National Bank as agent.
Incorporated by reference to Exhibit 10.6 in the
Registrant's Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on November 14, 2000.
10.2 Forbearance Agreement dated January 3, 2003 among Leasecomm
Corporation, Fleet National Bank, as agent, and the other
Lenders named therein. Incorporated by reference to Exhibit
10.11 in the Registrant's Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on May 15,
2003.
10.3 Forbearance Agreement dated January 24, 2003 among Leasecomm
Corporation, Fleet National Bank, as agent, and the other
Lenders named therein. Incorporated by reference to Exhibit
10.12 in the Registrant's Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on May 15,
2003.
10.4 First Amendment to Fourth Amended and Restated Revolving
Credit Agreement dated September 21, 2001 among Leasecomm
Corporation, Fleet National Bank, as agent, and the other
Lenders named therein. Incorporated by reference to Exhibit
10.10 in the Registrant's Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on May 15,
2003.
10.5 Second Amendment to Fourth Amended and Restated Revolving
Credit Agreement dated April 14, 2003 among Leasecomm
Corporation, Fleet National Bank, as agent, and the other
Lenders named therein. Incorporated by reference to Exhibit
10.1 in the Registrant's Quarterly Report on Form 10-Q filed
with the Securities and Exchange Commission on May 15, 2003.
10.6 Third Amendment to Fourth Amended and Restated Revolving
Credit Agreement dated June 30, 2003 among Leasecomm
Corporation, Fleet National Bank, as agent, and the other
Lenders named therein. Incorporated by reference to Exhibit
10.1 in the Registrant's Quarterly Report on Form 10-Q filed
with the Securities and Exchange Commission on August 14,
2003.
10.7+ Fourth Amendment to Fourth Amended and Restated Revolving
Credit Agreement dated November 7, 2003 among Leasecomm
Corporation, Fleet National Bank, as agent, and the other
Lenders named therein.
10.8 Warrant Purchase Agreement dated April 14, 2003 among the
Company, Fleet National Bank, as agent, and the other
Lenders named therein. Incorporated by reference to Exhibit
10.2 in the Registrant's Quarterly Report on Form 10-Q filed
with the Securities and Exchange Commission on May 15, 2003.
10.9 Form of Warrants to purchase Common Stock of the Company
issued April 14, 2003, together with schedule of warrant
holders. Incorporated by reference to Exhibit 10.3 in the
Registrant's Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on May 15, 2003.
10.10 Co-Sale Agreement dated April 14, 2003 among the Company,
Peter R. Bleyleben, Torrence C. Harder, Brian E. Boyle,
Richard F. Latour, Alan J. Zakon, and James R. Jackson, Jr.,
and the Lenders named therein. Incorporated by reference to
Exhibit 10.4 in the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on
May 15, 2003.
10.11 Registration Rights Agreement dated April 14, 2003 among the
Company and the Lenders named therein. Incorporated by
reference to Exhibit 10.5 in the Registrant's Quarterly
Report on Form 10-Q filed with the Securities and Exchange
Commission on May 15, 2003.
24
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.12 Letter Agreement dated April 14, 2003 among Fleet National
Bank, as Agent, the Company, and the holders of the
Company's 7.5% Term Notes. Incorporated by reference to
Exhibit 10.14 in the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on
May 15, 2003.
10.13 Letter Agreement dated April 14, 2003 among Fleet National
Bank, as Agent, the Company, and the holders of the
Company's Subordinated Capital Notes. Incorporated by
reference to Exhibit 10.15 in the Registrant's Quarterly
Report on Form 10-Q filed with the Securities and Exchange
Commission on May 15, 2003.
10.14 Commercial Lease, dated November 3, 1998, between Cummings
Properties Management, Inc. and MicroFinancial Incorporated.
Incorporated by reference to Exhibit 10.25 in the
Registrant's Amendment No. 2 to Registration Statement on
Form S-1 (Registration Statement No. 333-56639) filed with
the Securities and Exchange Commission on January 11, 1999.
10.15 Amendment to Lease #1, dated November 3, 1998, between
Cummings Properties Management, Inc. and MicroFinancial
Incorporated. Incorporated by reference to Exhibit 10.26 in
the Registrant's Amendment No. 2 to Registration Statement
on Form S-1 (Registration Statement No. 333-56639) filed
with the Securities and Exchange Commission on January 11,
1999.
10.16 Lease Extension for the facility at 10-M Commerce Way,
Woburn, MA dated September 16, 2003 among MicroFinancial
Incorporated and Cummings Properties, LLC. Incorporated by
reference to Exhibit 10.1 in the Registrant's Quarterly
Report on Form 10-Q filed with the Securities and Exchange
Commission on November 14, 2003.
10.17* 1987 Stock Option Plan. Incorporated by reference to the
Exhibit with the same exhibit number in the Registrant's
Registration Statement on Form S-1 (Registration Statement
No. 333-56639) filed with the Securities and Exchange
Commission on June 9, 1998.
10.18* Forms of Grant under 1987 Stock Option Plan Incorporated by
reference to the Exhibit with the same exhibit number in the
Registrant's Registration Statement on Form S-1
(Registration Statement No. 333-56639) filed with the
Securities and Exchange Commission on June 9, 1998.
10.19* 1998 Equity Incentive Plan Incorporated by reference to the
Exhibit with the same exhibit number in the Registrant's
Amendment No. 2 to Registration Statement on Form S-1
(Registration Statement No. 333-56639) filed with the
Securities and Exchange Commission on January 11, 1999.
10.20* Employment Agreement between the Company and Peter R.
Bleyleben. Incorporated by reference to Exhibit 10.13 in the
Registrant's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 15, 2003.
10.21* Employment Agreement between the Company and Richard F.
Latour. Incorporated by reference to Exhibit 10.14 in the
Registrant's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 15, 2003.
10.22* Employment Agreement between the Company and John Plumlee.
Incorporated by reference to Exhibit 10.40 in the
Registrant's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 15, 2003.
10.23* Employment Agreement between the Company and Carol Salvo.
Incorporated by reference to Exhibit 10.41 in the
Registrant's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 15, 2003.
10.24* Employment Agreement between the Company and James R.
Jackson, Jr.. Incorporated by reference to Exhibit 10.42 in
the Registrant's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 15, 2003.
10.25* Employment Agreement between the Company and Stephen
Constantino. Incorporated by reference to Exhibit 10.43 in
the Registrant's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 15, 2003.
10.26* Employment Agreement between the Company and Steven LaCreta.
Incorporated by reference to Exhibit 10.44 in the
Registrant's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 15, 2003.
25
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.27*+ Forms of Restricted Stock Agreement grant under 1987 Stock
Option Plan.
10.28 Amended and Restated Standard Terms and Condition of
Indenture dated as of September 2001 governing the MFI
Finance Corp. I, 5.5800% Lease-Backed Notes, Series 2000-3
(the "2001-3 Notes"). Incorporated by reference to Exhibit
10.15 in the Registrant's Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on
November 14, 2001.
10.29 Supplement to Indenture dated September 2001 governing the
2001-3 Notes. Incorporated by reference to Exhibit 10.16 in
the Registrant's Quarterly Report on Form 10-Q filed with
the Securities and Exchange Commission on November 14, 2001.
10.30 Specimen 2001-3 Note. Incorporated by reference to Exhibit
10.17 in the Registrant's Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on
November 14, 2001.
10.31 Standard Terms and Conditions of Servicing governing the
2001-3 Notes. Incorporated by reference to Exhibit 10.18 in
the Registrant's Quarterly Report on Form 10-Q filed with
the Securities and Exchange Commission on November 14, 2001.
10.32 Direction and Permanent Waiver of Trigger Events and
Servicer Events of Default dated April 15, 2003 among Ambac
Assurance Corporation, Wells Fargo Bank Minnesota, National
Association ("Wells Fargo"), as indenture trustee, MFI
Finance Corp. I and Leasecomm Corporation waiving certain
covenants under the Amended and Restated Indenture dated as
of September 1, 2001 and related documents thereto, all with
respect to MFI Finance Corp. I. Incorporated by reference to
Exhibit 10.6 in the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on
May 15, 2003.
10.33 First Amendment to Amended and Restated Indenture dated
April 15, 2003 among the Company, MFI Finance Corp I, Wells
Fargo, as back-up servicer and Wells Fargo, as indenture
trustee. Incorporated by reference to Exhibit 10.8 in the
Registrant's Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on May 15, 2003.
10.34 Second Amendment to Servicing Agreement dated October 14,
2002 among the Company, MFI Finance Corp I, Wells Fargo, as
back-up servicer and Wells Fargo, as indenture trustee.
Incorporated by reference to Exhibit 10.13 in the
Registrant's Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on May 15, 2003.
10.35 Third Amendment to Servicing Agreement dated April 15, 2003
among the Company, MFI Finance Corp I, Wells Fargo, as
back-up servicer and Wells Fargo, as indenture trustee.
Incorporated by reference to Exhibit 10.9 in the
Registrant's Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on May 15, 2003.
10.36 Standard Terms and Condition of Indenture dated as of
September 2001 governing the MFI Finance Corp. II, LLC ,
8.0000% Lease-Backed Notes, Series 2001-1 (the "2001-1
Notes"). Incorporated by reference to Exhibit 10.19 in the
Registrant's Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on November 14, 2001.
10.37 Supplement to Indenture dated September 2001 governing the
2001-1 Notes. Incorporated by reference to Exhibit 10.20 in
the Registrant's Quarterly Report on Form 10-Q filed with
the Securities and Exchange Commission on November 14, 2001.
10.38 Specimen 2001-1 Note. Incorporated by reference to the
Exhibit 10.21 in the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on
November 14, 2001.
10.39 Standard Terms and Conditions of Servicing governing the
2001-1 Notes. Incorporated by reference to Exhibit 10.22 in
the Registrant's Quarterly Report on Form 10-Q filed with
the Securities and Exchange Commission on November 14, 2001.
10.40 MFI Finance II, LLC 8.00% Asset-Backed Notes, Series 2001-1:
MFI II Permanent Waiver dated April 15, 2003 between N M
Rothschild & Sons Limited and the Company waiving certain
covenants under the Amended and Restated Indenture dated as
of September 1, 2001 and related documents thereto, all with
respect to MFI Finance Corp. II. Incorporated by reference
to Exhibit 10.7 in the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on
May 15, 2003.
21.1 Subsidiaries of Registrant
26
EXHIBIT
NUMBER DESCRIPTION
------- -----------
23.1+ Consent of Deloitte & Touche LLP
31.1+ Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2+ Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1+ Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2+ Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
---------------
+ Filed herewith.
* Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to Item 14(c) of this Report.
(b) Reports on Form 8-K
The Company filed a current report on Form 8-K, dated October 24, 2003,
announcing financial results for the quarter ended September 30, 2003. The
Company filed a second current report on Form 8-K, dated March 10, 2004,
announcing financial results for the year ended December 31, 2003.
(c) See (a)(3) above.
(d) None.
27
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
MICROFINANCIAL INCORPORATED
By: /s/ RICHARD F. LATOUR
------------------------------------
Richard F. Latour
President and Chief Executive
Officer
By: /s/ JAMES R. JACKSON JR.
------------------------------------
James R. Jackson Jr.
Vice President and Chief Financial
Officer
Date: March 30, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ PETER R. BLEYLEBEN Chairman of the Board of Directors March 30, 2004
------------------------------------------------
Peter R. Bleyleben
/s/ RICHARD F. LATOUR President, Chief Executive March 30, 2004
------------------------------------------------ Officer, Treasurer, Clerk,
Richard F. Latour Secretary
and Director
/s/ JAMES R. JACKSON JR. Vice President and March 30, 2004
------------------------------------------------ Chief Financial Officer
James R. Jackson Jr.
/s/ BRIAN E. BOYLE Director March 30, 2004
------------------------------------------------
Brian E. Boyle
/s/ TORRENCE C. HARDER Director March 30, 2004
------------------------------------------------
Torrence C. Harder
/s/ FRITZ VON MERING Director March 30, 2004
------------------------------------------------
Fritz Von Mering
/s/ ALAN J. ZAKON Director March 30, 2004
------------------------------------------------
Alan J. Zakon
28
MICROFINANCIAL INCORPORATED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report................................ F-2
Financial Statements:
Consolidated Balance Sheets as of December 31, 2002 and
2003...................................................... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 2001, 2002, and 2003......................... F-4
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 2001, 2002, and 2003............. F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2002, and 2003......................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of MicroFinancial Incorporated:
We have audited the accompanying consolidated balance sheets of MicroFinancial
Incorporated and subsidiaries (the "Company") as of December 31, 2002 and 2003,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2003.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of MicroFinancial Incorporated and
subsidiaries as of December 31, 2002 and 2003, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America.
DELOITTE & TOUCHE LLP
Boston, Massachusetts
March 30, 2004
F-2
MICROFINANCIAL INCORPORATED
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------
2002 2003
--------- ---------
(IN THOUSANDS, EXCEPT
SHARE DATA)
ASSETS
Net investment in leases and loans:
Receivables due in installments........................... $334,623 $175,788
Estimated residual value.................................. 30,754 19,110
Initial direct costs...................................... 4,891 1,804
Loans receivable.......................................... 1,796 --
Less:
Advance lease payments and deposits.................... (96) (37)
Unearned income........................................ (67,574) (23,729)
Allowance for credit losses............................ (69,294) (43,011)
-------- --------
Net investment in leases and loans.......................... $235,100 $129,925
Investment in service contracts............................. 14,463 8,844
Cash and cash equivalents................................... 5,494 6,533
Restricted cash............................................. 18,516 2,376
Property and equipment, net................................. 9,026 5,844
Income taxes receivable..................................... 8,652 --
Other assets................................................ 3,834 2,892
-------- --------
Total assets......................................... $295,085 $156,414
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable............................................... $168,927 $ 58,843
Subordinated notes payable.................................. 3,262 3,262
Capitalized lease obligations............................... 471 209
Accounts payable............................................ 3,840 3,186
Other liabilities........................................... 6,776 4,104
Income taxes payable........................................ 1,400 7,789
Deferred income taxes payable............................... 23,806 7,755
-------- --------
Total liabilities.................................... 208,482 85,148
-------- --------
Commitments and contingencies (Note I)...................... -- --
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized; none issued at 12/31/02 and 12/31/03....... -- --
Common stock, $.01 par value; 25,000,000 shares
authorized; 13,410,646 shares issued at 12/31/02 and
12/31/03............................................... 134 134
Additional paid-in capital................................ 47,723 44,245
Retained earnings......................................... 45,089 29,402
Treasury stock, at cost (588,700 shares at 12/31/02 and
234,230 shares at 12/31/03)............................ (6,343) (2,515)
-------- --------
Total stockholders' equity........................... 86,603 71,266
-------- --------
Total liabilities and stockholders' equity........... $295,085 $156,414
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
MICROFINANCIAL INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
2001 2002 2003
----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER-SHARE DATA)
Revenues:
Income on financing leases and loans...................... $ 70,932 $ 53,012 $ 30,904
Income on service contracts............................... 8,665 9,734 8,593
Rental income............................................. 37,664 37,154 34,302
Loss and damage waiver fees............................... 6,344 6,257 5,525
Service fees and other.................................... 30,486 20,665 12,250
-------- -------- --------
Total revenues......................................... 154,091 126,822 91,574
-------- -------- --------
Expenses:
Selling, general and administrative....................... 44,899 45,535 33,856
Provision for credit losses............................... 54,092 88,948 59,758
Depreciation and amortization............................. 14,378 18,385 16,592
Interest.................................................. 14,301 10,787 7,515
-------- -------- --------
Total expenses......................................... 127,670 163,655 117,721
-------- -------- --------
Income (loss) before provision for income taxes............. 26,421 (36,833) (26,147)
Provision (benefit) for income taxes........................ 10,104 (14,735) (10,460)
-------- -------- --------
Net income (loss)........................................... $ 16,317 $(22,098) $(15,687)
======== ======== ========
Net income (loss) per common share -- basic................. $ 1.28 $ (1.72) $ (1.20)
======== ======== ========
Net income (loss) per common share -- diluted............... $ 1.26 $ (1.72) $ (1.20)
======== ======== ========
Dividends per common share.................................. $ 0.195 $ 0.150 $ 0.000
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
MICROFINANCIAL INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
COMMON STOCK ADDITIONAL TREASURY STOCK
------------------- PAID-IN RETAINED ------------------
SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT
---------- ------ ---------- -------- -------- -------
(IN THOUSANDS, EXCEPT SHARE DATA)
Balance at December 31,
2000........................ 13,410,646 $134 $47,900 $ 55,291 669,700 $(7,234)
Exercise of stock options, net
of tax benefit.............. (177) (96,000) 1,037
Common stock dividends........ (2,498)
Treasury stock repurchased.... 15,000 (146)
Net income.................... 16,317
---------- ---- ------- -------- -------- -------
Balance at December 31,
2001........................ 13,410,646 $134 $47,723 $ 69,110 588,700 $(6,343)
Common stock dividends........ (1,923)
Notes receivable from officers
and employees...............
Net loss...................... (22,098)
---------- ---- ------- -------- -------- -------
Balance at December 31,
2002........................ 13,410,646 $134 $47,723 $ 45,089 588,700 $(6,343)
Restricted stock granted...... 284
Restricted stock forfeited.... (11)
Amortization of unearned
compensation................
Treasury stock issued......... (3,828) (354,470) 3,828
Warrants issued............... 77
Net loss...................... (15,687)
---------- ---- ------- -------- -------- -------
Balance at December 31,
2003........................ 13,410,646 $134 $44,245 $ 29,402 234,230 $(2,515)
========== ==== ======= ======== ======== =======
NOTES
RECEIVABLE TOTAL
FROM UNEARNED STOCKHOLDERS'
OFFICERS COMPENSATION EQUITY
---------- ------------ -------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Balance at December 31,
2000........................ $(68) $ 0 $ 96,023
Exercise of stock options, net
of tax benefit.............. 860
Common stock dividends........ (2,498)
Treasury stock repurchased.... (146)
Net income.................... 16,317
---- ----- --------
Balance at December 31,
2001........................ $(68) $ 0 $110,556
Common stock dividends........ (1,923)
Notes receivable from officers
and employees............... 68 68
Net loss...................... (22,098)
---- ----- --------
Balance at December 31,
2002........................ $ 0 $ 0 $ 86,603
Restricted stock granted...... (284) --
Restricted stock forfeited.... 11 --
Amortization of unearned
compensation................ 273 273
Treasury stock issued......... --
Warrants issued............... 77
Net loss...................... (15,687)
---- ----- --------
Balance at December 31,
2003........................ $ 0 $ 0 $ 71,266
==== ===== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
MICROFINANCIAL INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
2001 2002 2003
--------- --------- ---------
(IN THOUSANDS)
Cash flows from operating activities:
Cash received from customers.............................. $ 185,939 $ 175,859 $ 136,834
Cash paid to suppliers and employees...................... (44,060) (41,573) (39,359)
Cash (paid) received for income taxes..................... (6,767) (3,829) 9,451
Interest paid............................................. (14,186) (10,222) (8,987)
Interest received......................................... 1,354 393 113
--------- --------- ---------
Net cash provided by operating activities............... 122,280 120,628 98,052
--------- --------- ---------
Cash flows from investing activities:
Investment in lease contracts............................. (92,118) (66,042) (2,260)
Investment in inventory................................... (4,198) (2,989) (225)
Investment in direct costs................................ (5,200) (4,150) (137)
Investment in service contracts........................... (6,658) (6,773) --
Investment in Resource Leasing Corporation................ (6,900) -- --
Investment in fixed assets................................ (1,722) (255) (221)
Repayment of notes from officers.......................... -- 68 --
Investment in notes receivable............................ (70) -- --
Repayment of notes receivable............................. 6 -- 4
--------- --------- ---------
Net cash used in investing activities................... (116,860) (80,141) (2,839)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from secured debt................................ 84,750 33,521 --
Repayment of secured debt................................. (90,839) (66,672) (110,054)
Proceeds from refinancing of secured debt................. 515,897 490,000 --
Prepayment of secured debt................................ (509,555) (490,100) --
Proceeds from short-term demand notes payable............. 902 305 --
Repayment of short-term demand notes payable.............. (93) (1,181) (30)
Proceeds from issuance of subordinated debt............... 2,975 -- --
Repayment of subordinated debt............................ (4,500) -- --
(Increase) decrease in restricted cash.................... (7,372) 1,983 16,140
Proceeds from exercise of common stock options............ 810 -- --
Repayment of capital leases............................... (505) (430) (230)
Purchase of treasury stock................................ (146) -- --
Payment of dividends...................................... (2,428) (2,565) --
--------- --------- ---------
Net cash provided by (used in) financing activities..... (10,104) (35,139) (94,174)
--------- --------- ---------
Net increase in cash and cash equivalents................... (4,684) 5,348 1,039
Cash and cash equivalents, beginning of period.............. 4,830 146 5,494
--------- --------- ---------
Cash and cash equivalents, end of period.................... $ 146 $ 5,494 $ 6,533
========= ========= =========
Reconciliation of net income to net cash provided by
operating activities:
Net income (loss)......................................... $ 16,317 $ (22,098) $ (15,687)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization........................... 14,378 18,385 16,592
Provision for credit losses............................. 54,092 88,948 59,758
Recovery of equipment cost and residual value, net of
revenue recognized..................................... 34,685 49,046 41,571
Increase (decrease) in income taxes payable............. 1,878 (2,811) 6,389
Increase in income taxes receivable..................... -- (8,652) 8,652
Increase (decrease) in deferred income taxes............ 1,472 (6,666) (16,050)
Changes in assets and liabilities:
Decrease (increase) in other assets................... (1,200) 3,124 (1,207)
Increase (decrease) in accounts payable............... (129) 1,323 (653)
Increase in accrued liabilities....................... 787 29 (1,313)
--------- --------- ---------
Net cash provided by operating activities............... $ 122,280 $ 120,628 $ 98,052
========= ========= =========
Supplemental disclosure of noncash activities:
Property acquired under capital leases.................... $ 479 $ 68 $ --
========= ========= =========
Accrual of common stock dividends......................... $ 642 $ -- $ --
========= ========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER-SHARE DATA)
A. NATURE OF BUSINESS
MicroFinancial Incorporated (the "Company") which operates primarily
through its wholly-owned subsidiary, Leasecomm Corporation, is a specialized
commercial finance company that primarily leases and rents "microticket"
equipment and provides other financing services in amounts generally ranging
from $400 to $15,000 with an average amount financed of approximately $1,900 and
an average lease term of 44 months. The Company does not market its services
directly to lessees but sources leasing transactions through a network of
independent sales organizations and other dealer-based origination networks
nationwide. The Company has funded its operations primarily through borrowings
under its credit facilities, issuances of subordinated debt and on balance sheet
securitizations.
MicroFinancial incurred net losses of $22.1 million and $15.7 million for
the years ended December 31, 2002 and 2003, respectively. The net losses
incurred by the Company during the third and fourth quarters of 2002 caused the
Company to be in default of certain debt covenants in its credit facility and
securitization agreements. In addition, as of September 30, 2002, the Company's
credit facility failed to renew and consequently, the Company was forced to
suspend substantially all new origination activity as of October 11, 2002. On
April 14, 2003, the Company entered into a long-term agreement with its lenders.
This long-term agreement waives the defaults described above, and in
consideration for this waiver, requires the outstanding balance of the loan to
be repaid over a term of 22 months beginning in April 2003 at an interest rate
of prime plus 2.0%. The Company received a waiver, which was set to expire on
April 15, 2003, for the covenant violations in connection with the
securitization agreement. Subsequently, the Company received a permanent waiver
of the covenant defaults and the securitization agreement was amended so that,
going forward, the covenants are the same as those contained in the long-term
agreement entered into on April 14, 2003, for the senior credit facility. To
date, the Company has fulfilled all of its debt obligations, as agreed to by the
bank group, in a timely manner.
MicroFinancial has taken certain steps in an effort to improve its
financial position. Management is actively considering various financing,
restructuring and strategic alternatives as well as continuing to work closely
with the Company's lenders to ensure continued compliance with the terms of the
long term agreement. In addition, Management has taken steps to reduce overhead,
including a reduction in headcount from 380 at December 31, 2001, to 203 at
December 31, 2002. During the twelve months ended December 31, 2003, the
employee headcount was further reduced to 136 in a continued effort to maintain
an infrastructure that is aligned with current business conditions.
Leasecomm Corporation periodically finances its lease and service
contracts, together with unguaranteed residuals, through securitizations using
special purpose vehicles. MFI Finance Corporation I and MFI Finance Corporation
II, LLC are special purpose companies. The assets of such special purpose
vehicles and cash collateral or other accounts created in connection with the
financings in which they participate are not available to pay creditors of
Leasecomm Corporation, MicroFinancial Incorporated, or other affiliates. While
Leasecomm Corporation generally does not sell its interests in leases, service
contracts or loans to third parties after origination, the Company does, from
time to time, contribute certain leases, service contracts, or loans to
special-purpose entities for purposes of obtaining financing in connection with
the related receivables. The contribution of such assets under the terms of such
financings are intended to constitute "true sales" of such assets for bankruptcy
purposes (meaning that such assets are legally isolated from Leasecomm
Corporation). However, the special purpose entities to which such assets are
contributed are required under generally accepted accounting principles to be
consolidated in the financial statements of the Company. As a result, such
assets and the related liability remain on the balance sheet and do not receive
gain on sale treatment.
F-7
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. Intercompany accounts and transactions have
been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reported period. A significant area requiring the use of
management estimates is the allowance for credit losses. Actual results could
differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid instruments purchased with
remaining maturities of less than three months to be cash equivalents. Cash
equivalents consist principally of overnight investments.
Restricted Cash
As part of its servicing obligation under the securitization agreements,
the Company collects cash receipts for financing contracts that have been
pledged to special purpose entities, specifically MFI Finance Corporation I and
MFI Finance Corporation II, LLC. These collections are segregated into separate
accounts for the benefit of the entities to which the related contracts were
pledged or sold and are remitted to such entities on a weekly basis.
Leases and Loans
The Company's lease contracts are accounted for as financing leases. At
origination, the Company records the gross lease receivable, the estimated
residual value of the leased equipment, initial direct costs incurred, and the
unearned lease income. Unearned lease income is the amount by which the gross
lease receivable plus the estimated residual value exceeds the cost of the
equipment. Unearned lease income and initial direct costs incurred are amortized
over the related lease term using the interest method, which results in a level
rate of return on the net investment in leases. Unamortized unearned lease
income and initial direct costs are written off if, in the opinion of
management, the lease agreement is determined to be impaired. It is management's
opinion, given the nature of its business and the large number of small balance
lease receivables, that a lease is impaired when one of the following occurs:
(i) the obligor files for bankruptcy; (ii) the obligor dies, and the equipment
is returned; or (iii) an account has become 360 days past due without contact
with the lessee for 12 months. It is also management's policy to maintain an
allowance for credit losses that will be sufficient to provide adequate
protection against losses in its portfolio. Management regularly reviews the
collectability of its lease receivables based upon all of its communications
with the individual lessees through its extensive collection efforts and through
further review of the creditworthiness of the lessee.
In conjunction with the origination of leases, the Company may retain a
residual interest in the underlying equipment upon termination of the lease. The
value of such interest is estimated at inception of the lease and evaluated
periodically for impairment. An impairment is recognized when expected cash
flows to be realized subsequent to the end of the lease are expected to be less
than the residual value recorded. Other revenues, such as loss and damage waiver
and service fees relating to the leases, contracts, and loans and rental
revenues are recognized as they are earned.
F-8
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Loans are reported at their outstanding principal balances. Interest income
on loans is recognized as it is earned.
Allowance for Credit Losses
The Company maintains an allowance for credit losses on its investment in
leases, service contracts and loans at an amount that it believes is sufficient
to provide adequate protection against losses in its portfolio. The allowance is
determined principally on the basis of the historical loss experience of the
Company and the level of recourse provided by such lease, service contract or
loan, if any, and reflects management's judgment of additional loss potential
considering current economic conditions and the nature and characteristics of
the underlying lease portfolio. The Company determines the necessary periodic
provision for credit losses, taking into account actual and expected losses in
the portfolio, as a whole, and the relationship of the allowance to the net
investment in leases, service contracts and loans.
Investment in Service Contracts
The Company's investments in cancelable service contracts are recorded at
cost and amortized over the expected life of the service period, which is seven
years. Income on service contracts is recognized monthly as the related services
are provided. The Company periodically evaluates whether events or circumstances
have occurred that may affect the estimated useful life or recoverability of the
investment in service contracts.
Property and Equipment
At the end of the lease term, the lease typically converts into a
month-to-month rental contract. Rental equipment is recorded at estimated
residual value and depreciated using the straight-line method over a period of
twelve months.
Office furniture, equipment and capital leases are recorded at cost and
depreciated using the straight-line method over a period of three to five years.
Leasehold improvements are amortized over the shorter of the life of the lease
or the asset. Upon retirement or other disposition, the cost and related
accumulated depreciation of the assets are removed from the accounts and the
resulting gain or loss is reflected in income.
Fair Value of Financial Instruments
For financial instruments including cash and cash equivalents, restricted
cash, net investment in leases and loans, accounts payable, and other
liabilities, it is assumed that the carrying amount approximates fair value.
Derivative Financial Instruments
On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" as amended by SFAS No. 138. SFAS
No. 133, as amended, requires that all derivative instruments be measured at
fair value and recognized in the consolidated balance sheet as either assets or
liabilities. The Company has assessed the effects of SFAS No. 133 and has
determined that the adoption of SFAS No. 133 does not have a material impact on
its results of operations or consolidated financial position. The Company did
not hold any derivative instruments at either December 31, 2002 or 2003.
Debt Issue Costs
Debt issuance costs incurred in securing credit facility financing are
capitalized and subsequently amortized over the term of the credit facility.
F-9
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Income Taxes
Deferred income taxes are determined under the liability method.
Differences between the financial statement and tax bases of assets and
liabilities are measured using the currently enacted tax rates expected to be in
effect when these differences reverse. Deferred tax expense is the result of
changes in the liability for deferred taxes. The principal differences between
assets and liabilities for financial statement and tax return purposes are the
treatment of leased assets, accumulated depreciation and provisions for doubtful
accounts. The deferred tax liability is reduced by loss carry-forwards and
alternative minimum tax credits available to reduce future income taxes.
New Accounting Pronouncements
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" ("SFAS 149"). SFAS 149 was issued to amend and clarify financial
accounting and reporting for derivative instruments and hedging activities under
SFAS 133, "Accounting for Derivative Instruments and Hedging Activities."
Specifically, SFAS 149 clarifies under what circumstances a contract with an
initial net investment meets the characteristic of a derivative and when a
derivative contains a financing component. Additionally, SFAS 149 amends the
definition of an "underlying" to conform to the definition used in FIN 45 and
amends certain other existing pronouncements. SFAS 149 is effective for
contracts entered into or modified subsequent to June 30, 2003, and hedging
relationships designated subsequent to June 30, 2003. The Company has determined
that the adoption of this Statement does not have a material impact on its
results of operations or consolidated financial position.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150, "Accounting for Certain Financial Instruments with Characteristics of
Both Liabilities and Equity" ("SFAS 150"). SFAS 150 requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances). Many of those instruments were previously
classified as equity. Some of the provisions of this Statement are consistent
with the current definition of liabilities in FASB Concepts Statement No. 6,
Elements of Financial Statements. The remaining provisions of this Statement are
consistent with the Board's proposal to revise that definition to encompass
certain obligations that a reporting entity can or must settle by issuing its
own equity shares, depending on the nature of the relationship established
between the holder and the issuer. The Company has determined that the adoption
of this Statement does not have a material impact on its results of operations
or consolidated financial position.
Net Income (Loss) Per Common Share
Basic net income (loss) per common share is computed based on the
weighted-average number of common shares outstanding during the period. Dilutive
net income (loss) per common share gives effect to all dilutive potential common
shares outstanding during the period. The computation of diluted net income
(loss) per share does not assume the issuance of common shares that have an
antidilutive effect on net income (loss) per common share. Options to purchase
440,609, 2,995,000 and 1,675,000 shares of common stock were not included in the
computation of diluted earnings per share for the years ended December 31, 2001,
2002 and 2003 because their effects were antidilutive.
F-10
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
2001 2002 2003
----------- ----------- -----------
Net income (loss)............................. $ 16,317 $ (22,098) $ (15,687)
----------- ----------- -----------
Shares used in computation:
Weighted-average common shares outstanding
used in computation of net income per
common share............................. 12,789,605 12,821,946 13,043,744
Dilutive effect of common stock options..... 155,638 -- --
----------- ----------- -----------
Shares used in computation of net income per
common share -- assuming dilution........... 12,945,243 12,821,946 13,043,744
=========== =========== ===========
Net income (loss) per common share -- basic... $ 1.28 $ (1.72) $ (1.20)
=========== =========== ===========
Net income (loss) per common
share -- diluted............................ $ 1.26 $ (1.72) $ (1.20)
=========== =========== ===========
STOCK-BASED EMPLOYEE COMPENSATION
All stock options issued to directors and employees have an exercise price
not less than the fair market value of the Company's common stock on the date of
grant. In accordance with accounting for such options utilizing the
intrinsic-value method, there is no related compensation expense recorded in the
Company's financial statements. The Company follows the disclosure requirements
of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires
that compensation under a fair value method be determined using the
Black-Scholes option-pricing model and disclosed in a pro forma effect on
earnings and earnings per share. The Company accounts for stock-based employee
compensation plans under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. The current period amortization of unearned compensation
expense relating to the restricted stock awards is reflected in net income
(loss). No other stock-based employee compensation cost is reflected in net
income (loss), as either all options granted under those plans had an exercise
price equal to the market value of the underlying common stock on the date of
grant or options granted that result in variable compensation costs had an
exercise price greater than the fair market value of the underlying common stock
on December 31, 2002 and December 31, 2003. The following table illustrates the
effect on net income (loss) and earnings per share if the Company had applied
the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, to stock-based employee compensation.
YEAR ENDED DECEMBER 31
-----------------------------
2001 2002 2003
------- -------- --------
Net income (loss), as reported........................ $16,317 $(22,098) $(15,687)
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects.............. (1,305) (1,475) (792)
------- -------- --------
Pro forma net income (loss)........................... $15,012 $(23,573) $(16,479)
======= ======== ========
Earnings (loss) per share:
Basic -- as reported.................................. $ 1.28 $ (1.72) $ (1.20)
======= ======== ========
Basic -- pro forma.................................... $ 1.17 $ (1.84) $ (1.26)
======= ======== ========
Diluted -- as reported................................ $ 1.26 $ (1.72) $ (1.20)
======= ======== ========
Diluted -- pro forma.................................. $ 1.16 $ (1.84) $ (1.26)
======= ======== ========
F-11
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of option grants is estimated on the date of grant utilizing
the Black-Scholes option-pricing model with the following weighted-average
assumptions.
2001 2002 2003
------- ------- -------
Risk-free interest rate................................... 5.03% 3.63% 3.34%
Expected dividend yield................................... 2.50% 0.80% 0.00%
Expected life............................................. 7 years 7 years 7 years
Volatility................................................ 51.00% 68.00% 76.00%
The weighted-average fair value at the date of grant for options granted
during 2001, 2002, and 2003 approximated $5.34, $2.03 and $0.62 per option,
respectively.
C. NET INVESTMENT IN LEASES AND LOANS
At December 31, 2003, future minimum payments on the Company's lease
receivables are as follows:
FOR THE YEAR ENDED
DECEMBER 31,
------------------
2004........................................................ $141,987
2005........................................................ 26,867
2006........................................................ 6,467
2007........................................................ 466
2008........................................................ 1
--------
Total....................................................... $175,788
========
At December 31, 2003, the weighted-average remaining life of leases in the
Company's lease portfolio is approximately 20 months and the implicit rate of
interest is approximately 32.5%.
The Company's business is characterized by a high incidence of
delinquencies that in turn may lead to significant levels of defaults. The
Company evaluates the collectability of leases originated and loans based on the
level of recourse provided, if any, delinquency statistics, historical loss
experience, current economic conditions and other relevant factors. The Company
provides an allowance for credit losses for leases which are considered
impaired.
The Company takes charge-offs against its receivables when such receivables
are 360 days past due and no contact has been made with the lessee for 12
months. Cumulative net charge-offs after recoveries from the Company's inception
to December 31, 2003 have totaled 16.45% of total cumulative receivables plus
total billed fees over such period.
F-12
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth the Company's allowance for credit losses as
of December 31, 2001, 2002, and 2003 and the related provisions, charge-offs and
recoveries for the years ended December 31, 2001, 2002, and 2003.
Balance of allowance for credit losses at December 31,
2000...................................................... $40,924
-------
Balance of other asset reserve at December 31, 2000......... $ 1,819
-------
Provision for leases and loans credit losses................ 54,092
Total provisions for credit losses........................ 54,092
Charge-offs (including $1,418 in other asset charge-offs)... 68,882
Recoveries.................................................. 17,474
------
Charge-offs, net of recoveries............................ 51,408
-------
Balance of allowance for credit losses at December 31,
2001...................................................... $45,026
-------
Balance of other asset reserve at December 31, 2001......... $ 401
-------
Provision for leases and loans credit losses................ 88,948
Total provisions for credit losses........................ 88,948
Charge-offs (including $401 in other asset charge-offs)..... 76,844
Recoveries.................................................. 11,763
------
Charge-offs, net of recoveries............................ 65,081
-------
Balance of allowance for credit losses at December 31,
2002...................................................... $69,294
-------
Balance of other asset reserve at December 31, 2002......... $ 0
-------
Provision for leases and loans credit losses................ 59,758
Total provisions for credit losses........................ 59,758
Charge-offs................................................. 93,153
Recoveries.................................................. 7,112
------
Charge-offs, net of recoveries............................ 86,041
-------
Balance of allowance for credit losses at December 31,
2003...................................................... $43,011
=======
In conjunction with the origination of leases, the Company may retain a
residual interest in the underlying equipment upon termination of the lease. The
value of such interests is estimated at inception of the lease and evaluated
periodically for impairment. The following table sets forth the Company's
estimated residual value as of December 31, 2001, 2002, and 2003 and changes in
the Company's estimated residual value as a result of new originations, and
lease terminations for the years ended December 31, 2001, 2002, and 2003.
Balance of Estimated Residual Value at December 31, 2001.... $ 37,114
New Originations............................................ 10,254
Lease Terminations.......................................... (16,614)
--------
Balance of Estimated Residual Value at December 31, 2002.... $ 30,754
New Originations............................................ 186
Lease Terminations.......................................... (11,830)
--------
Balance of Estimated Residual Value at December 31, 2003.... $ 19,110
========
F-13
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
New originations represent the residual value added to the Company's
estimated residual value upon origination of new leases. Lease terminations
represent the residual value deducted from the company's estimated residual
value upon the termination of a lease (i) that is bought out during or at the
end of the lease term; (ii) upon expiration of the original lease term when the
lease converts to an extended rental contract or (iii) that has been charged off
by the Company.
D. PROPERTY AND EQUIPMENT
At December 31, 2002 and 2003, property and equipment consisted of the
following:
DECEMBER 31,
-----------------
2002 2003
------- -------
Rental Equipment and Inventory.............................. $15,751 $15,482
Computer Equipment.......................................... 7,072 6,124
Office Equipment............................................ 1,278 1,155
Leasehold improvements...................................... 154 112
------- -------
24,255 22,873
Less accumulated depreciation and amortization.............. 15,229 17,029
------- -------
Total....................................................... $ 9,026 $ 5,844
======= =======
Depreciation and amortization expense totaled $14,378,000, $18,385,000, and
$16,592,000 for the years ended December 31, 2001, 2002 and 2003, respectively.
At December 31, 2002 and 2003, computer equipment includes $1,650,000 under
capital leases. Accumulated amortization related to capital leases amounted to
$1,186,000 and $1,437,000 in 2002 and 2003, respectively.
E. NOTES PAYABLE AND SUBORDINATED DEBT
Notes Payable
On August 22, 2000, the Company entered into a revolving line of credit and
term loan facility with a group of financial institutions whereby it could
borrow a maximum of $192,000,000 based upon qualified lease receivables, loans,
rentals and service contracts. As of September 30, 2002, this credit facility
failed to renew. While cash flows from its portfolio and other fees have been
sufficient to repay amounts borrowed under the senior credit facility,
securitizations and subordinated debt, in October 2002, the Company was forced
to suspend virtually all new contract originations until a new source of
liquidity is obtained.
According to the original agreement, outstanding borrowings with respect to
the revolving line of credit bear interest based either at Prime minus 0.25% for
Prime Rate Loans or the prevailing rate per annum as offered in the London
Interbank Offered Rate (LIBOR) plus 1.75% for LIBOR Loans or the seven-day Money
Market rate plus 2.00% for Swing Line Advances. If the LIBOR loans are not
renewed upon their maturity they automatically convert into prime rate loans.
The Swing Line Advances have a seven-day maturity, and upon their maturity they
automatically convert into prime rate loans. In addition, the Company's
aggregate outstanding principal amount of Swing Line Advances shall not exceed
$10 million. The prime rate at December 31, 2001, 2002, and 2003 was 4.75%,
4.25% and 4.00% respectively. The 90-day LIBOR rates at December 31, 2001, 2002
and 2003 were 1.938%, 1.400% and 1.152% respectively. The 7-day Money Market
Rates at December 31, 2001 was 1.88%.
As of September 30, 2002, the revolving credit line failed to renew and the
Company began paying down the balance on the basis of a 36-month amortization
plus interest. Based on the terms of the agreement,
F-14
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
interest rates increased from Prime minus 0.25% to Prime plus 0.50% for prime
based loans and from LIBOR plus 1.75% to LIBOR plus 2.50% for existing LIBOR
based loans. In addition, based on the covenant defaults described below, the
outstanding borrowings on all loans bear an additional 2.00% default interest.
On January 3, 2003, the Company entered into a Forbearance and Modification
Agreement for the senior credit facility, which expired on February 7, 2003.
Based on the terms of the Forbearance and Modification Agreement, interest rates
increased again on the prime based loans to prime plus 1.00%.
At December 31, 2002, the Company was in default of certain of its debt
covenants in its senior credit facility. The covenants that were in default with
respect to the senior credit facility require that the Company maintain a fixed
charge ratio in an amount not less than 130% of consolidated earnings, a
consolidated tangible net worth minimum of $77.5 million plus 50% of net income
quarterly beginning with September 30, 2000, and compliance with the borrowing
base. On April 14, 2003, the Company entered into a long-term agreement with its
lenders. This long-term agreement waived the defaults described above, and in
consideration for this waiver, required the outstanding balance of the loan to
be repaid over a term of 22 months beginning in April 2003 at an interest rate
of prime plus 2.0%. Based on the amortization schedule in the new agreement, as
subsequently amended on June 30, 2003, and November 7, 2003, the Company is
obligated to repay a minimum of $54.8 million, plus applicable interest, over
the next twelve months.
At December 31, 2002 and 2003, the Company had borrowings outstanding under
this agreement with the following terms:
2002 2003
----------------- ----------------
TYPE RATE AMOUNT RATE AMOUNT
---- ------ -------- ------ -------
Prime........................................... 4.7500% $ 31,556 6.0000% $55,346
LIBOR........................................... 4.1875% 50,000
LIBOR........................................... 4.1875% 45,000
-------- -------
Total Outstanding............................. $126,556 $55,346
======== =======
Outstanding borrowings are collateralized by leases, loans, rentals, and
service contracts pledged specifically to the financial institutions. In
addition, on April 14, 2003, the Company granted its lenders a security interest
in all assets of the Company to further collateralize the outstanding
borrowings.
On April 14, 2003, the Company issued warrants to purchase an aggregate of
268,199 shares of the Company's common stock at an exercise price of $.825 per
share. The warrants were issued to the nine lenders in the Company's lending
syndicate in connection with the waiver of defaults and an extension of the
Company's term loan. The warrants will be automatically terminated if all of the
obligations owed by the Company to the lenders pursuant to the loan agreement
have been paid in full prior to June 30, 2004. If all of the Company's
obligations to the Lenders have not been paid in full prior to June 30, 2004,
the warrants will become 50% exercisable as of that date. If all of the
Company's obligations to the Lenders have not been paid in full prior to
September 30, 2004, the warrants will then become 100% exercisable as of that
date. Unless the warrants are automatically terminated or exercised pursuant to
the above criteria, they will expire on September 30, 2014. The fair market
value of the warrants, as determined using the Black-Scholes option-pricing
model, was accounted for as additional paid in capital. The resulting cost of
the warrants was $77,000, which is being amortized to interest expense under the
interest method. As of December 31, 2003, $52,000 had been accreted to interest
expense and the resulting effective interest rate on the senior credit facility
was prime plus 2.09%.
BLT III had three series of notes, the 1996-A Notes, the 1997-A Notes and
the 1998-A Notes. In May 1996, BLT III issued the 1996-A Notes in aggregate
principal amount of $23,406,563. In August 1997, BLT III issued the 1997-A Notes
in aggregate principal amount of $44,763,000 and in November 1998,
F-15
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
BLT III issued the 1998-A Notes in aggregate principal amount of $40,769,000.
All outstanding amounts under the 1996-A Notes were repaid in October 1999. All
outstanding amounts under the 1997-A Notes were repaid in September 2000. All
outstanding amounts under the 1998-A notes were repaid in September 2001. MFI I
had three series of notes, the 2000-1 Notes, the 2000-2 Notes, and the 2001-3
Notes. In March 2000, MFI I issued the 2000-1 Notes in aggregate principal
amount of $50,056,686. In December 2000, MFI I issued the 2000-2 Notes in
aggregate principal amount of $50,561,633. In September 2001, MFI I issued the
2001-3 Notes in aggregate principal amount of $39,397,354. On February 18, 2003,
the Company repaid $2.4 million in principal plus accrued interest for the MFI I
series 2000-1 Notes utilizing the clean up call provision under its
securitizations. On October 16, 2003, the Company repaid $5.2 million in
principal plus accrued interest for the MFI I series 2000-2 Notes utilizing the
clean up call provision under its securitizations. Both of the re-payments were
made using cash previously classified as restricted. Outstanding borrowings are
collateralized by a specific pool of lease receivables. In September 2001, MFI
II, LLC was formed and issued one series of notes, the 2001-1 Notes in aggregate
principal amount of $10,000,000. All outstanding amounts under the 2001-1 Notes
were repaid in September 2003. Outstanding borrowings were collateralized by a
specific pool of lease receivables as well as the excess cash flow from the MFI
I collateral. These notes were subordinated to the three series of notes issued
by MFI I.
At December 31, 2002, the Company was in default on two of its debt
covenants in its securitization agreements. The covenants that were in default
with respect to the securitization agreements require that the Company maintain
a fixed charge ratio in an amount not less than 125% of consolidated earnings
and a consolidated tangible net worth greater than $90 million plus 50% of net
income for each fiscal quarter after June 30, 2001. Additionally per the terms
of the securitization agreement, any default with respect to the senior credit
facility is considered a default under the terms of the agreement. The Company
received a waiver, which was set to expire on April 15, 2003, for the covenant
violations in connection with the securitization agreement. Subsequently, the
Company received a permanent waiver of the covenant defaults and the
securitization agreement was amended so that going forward, the covenants are
the same as those contained in the long-term agreement entered into on April 14,
2003, for the senior credit facility.
At December 31, 2002 and 2003, MFI I and MFI II, LLC had borrowings
outstanding under the series of notes with the following terms:
2002 2003
NOTE SERIES EXPIRATION RATE AMOUNT AMOUNT
----------- ---------- ---- ------- ------
MFI I
2000-1 Notes.................................... 9/16/2005 7.38% 3,464 --
2000-2 Notes.................................... 6/16/2006 6.94% 17,983 --
2001-3 Notes.................................... 2/18/2008 5.58% 17,019 3,247
MFI II LLC
2001-1 Notes.................................... 2/18/2008 8.00% 3,625 --
------- ------
Total Outstanding............................. $42,091 $3,247
======= ======
At December 31, 2002 and 2003, the Company also had other notes payable
which totaled $280,000 and $250,000 respectively. Of these notes, at December
2002, $30,000 were notes that are due on demand and bore interest at a rate of
prime less 1.00%. As of December 31, 2002 and 2003, $250,000 are two-year term
notes that bear interest at a rate of 7.5%. Other notes payable included
$250,000 due to stockholders and directors of the Company at December 31, 2002
and 2003. Interest paid to stockholders under such notes was not material for
the years ended December 31, 2002 and 2003.
F-16
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Subordinated Notes Payable
At December 31, 2002 and 2003, the Company also had subordinated debt
outstanding amounting to $3,262,000. This debt is subordinated in the rights to
the Company's assets to notes payable to the primary lenders as described above.
Outstanding borrowings bear interest ranging from 8% to 12.5% for fixed rate
financing and prime plus 3% to 4% for variable rate financing. These notes have
maturity dates ranging from February 2005 to November 2007.
At December 31, 2002 and 2003, subordinated notes payable included $727,000
due to stockholders, officers and directors. Interest paid to stockholders,
officers and directors under such notes, at rates ranging between 8% and 12%,
amounted to $53,700, $84,000, and $83,000 for the years ended December 31, 2001,
2002, and 2003, respectively.
REPAYMENT SCHEDULE
At December 31, 2003, the repayment schedule for outstanding notes and
subordinated notes is as follows:
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2004........................................................ $58,078
2005........................................................ 1,427
2006........................................................ 2,600
2007........................................................ --
Thereafter.................................................. --
-------
Total....................................................... $62,105
=======
It is estimated that the carrying amounts of the Company's borrowings under
its variable rate revolving credit agreements approximate their fair value. The
fair value of the Company's short-term and long-term fixed rate borrowings is
estimated using discounted cash flow analysis, based on the Company's current
incremental borrowing rates for similar types of borrowing arrangements. At
December 31, 2002 and 2003, the aggregate carrying value of the Company's fixed
rate borrowings was approximately $45,603,000 and $6,759,000 respectively, with
an estimated fair value of approximately $45,562,000 and $6,553,000
respectively.
F. REDEEMABLE PREFERRED STOCK:
At December 2002 and 2003, the Company had authorized 5,000,000 shares of
preferred stock ("preferred stock") with a par value of $0.01 of which zero
shares were issued and outstanding.
G. STOCKHOLDERS' EQUITY:
COMMON STOCK
The Company had 25,000,000 authorized shares of common stock with a par
value of $.01 per share of which 13,410,646 shares were issued and outstanding
at December 31, 2002 and 2003.
TREASURY STOCK
The Company had 588,700 and 234,230 shares of common stock in treasury at
December 31, 2002 and 2003.
F-17
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STOCK OPTIONS
In 1987, the Company adopted its 1987 Stock Option Plan (the "Plan") which
provided for the issuance of qualified or nonqualified options to purchase
shares of the Company's common stock. In 1997, the Company's Board of Directors
approved an amendment to the Plan, as a result of the June 16, 1997 stock split.
Pursuant to this amendment, the aggregate number of shares issued could not
exceed 1,220,000 and the exercise price of any outstanding options issued
pursuant to the Plan would be reduced by a factor of ten and the number of
outstanding options issued pursuant to the Plan would be increased by a factor
of ten. The Company adopted the 1998 Equity Incentive Plan (the "1998 Plan") on
July 9, 1998. The 1998 Plan permits the Compensation Committee of the Company's
Board of Directors to make various long-term incentive awards, generally
equity-based, to eligible persons. The Company reserved 4,120,380 shares of its
common stock for issuance pursuant to the 1998 Plan. Qualified stock options,
which are intended to qualify as "incentive stock options" under the Internal
Revenue Code, may be issued to employees at an exercise price per share not less
than the fair value of the common stock at the date granted as determined by the
Board of Directors. Nonqualified stock options may be issued to officers,
employees and directors of the Company as well as consultants and agents of the
Company at an exercise price per share not less than fifty percent of the fair
value of the common stock at the date of grant as determined by the Board. The
vesting periods and expiration dates of the grants are determined by the Board
of Directors. The option period may not exceed ten years.
On February 7, 2003, the Company offered non-director employees and
executives who had been granted stock options in the past the opportunity to
cancel any of the original option agreements in exchange for a grant of
restricted stock. All option awards subject to the offer were converted to
restricted stock. In connection with this offer, on February 12, 2003, 1,325,000
options converted to 319,854 shares of restricted common stock. In addition, on
March 17, 2003, one non-employee director was granted 50,000 shares of
restricted stock. The restricted stock vested 20% upon grant, and 5% on the
first day of each quarter after the grant date, with accelerated vesting if the
price of the Company's common stock exceeds certain thresholds during the
vesting period. As of December 31, 2003, 15,384 shares had been cancelled,
354,470 shares were fully vested, and $273,000 had been amortized from unearned
compensation to compensation expense.
The following summarizes the stock option activity:
AVERAGE
SHARES PRICE PER SHARE EXERCISE PRICE
---------- ------------------- --------------
Outstanding at December 31, 2000........ 1,594,000 $1.95 to $13.544 $11.003
Exercised............................... (96,000) $1.95 to $13.125 $ 8.439
Canceled................................ (112,000) $9.78125 to $13.125 $11.214
Granted................................. 650,000 $9.48 to $13.10 $11.708
----------
Outstanding at December 31, 2001........ 2,036,000 $9.48 to $13.544 $11.337
----------
Canceled................................ (391,000) $6.70 to $13.544 $11.184
Granted................................. 1,350,000 $1.585 to $6.70 $ 3.555
----------
Outstanding at December 31, 2002........ 2,995,000 $1.585 to $13.544 $ 7.849
----------
Converted to Restricted Stock........... (1,325,000) $1.585 to $13.10 $ 7.727
Canceled................................ (195,000) $1.585 to $12.313 $ 7.618
Granted................................. 200,000 $0.86 $ 0.860
----------
Outstanding at December 31, 2003........ 1,675,000 $0.86 to $13.544 $ 7.139
==========
F-18
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The options vest over five years and are exercisable only after they become
vested. At December 31, 2001, 2002 and 2003, 414,000, 876,000, and 843,000
respectively, of the outstanding options were fully vested.
At December 31, 2002 and 2003, 2,995,000 and 1,675,000 shares,
respectively, of common stock were reserved for common stock option exercises.
Information relating to stock options at December 31, 2003, summarized by
exercise price, is as follows:
OUTSTANDING EXERCISABLE
------------------------ ------------------------
WEIGHTED- WEIGHTED-
AVERAGE LIFE AVERAGE
EXERCISE PRICE SHARES (YEARS) EXERCISE PRICE SHARES
-------------- --------- ------------ -------------- -------
$12.3125................................ 359,391 5.16 $12.3125 287,513
$13.5440................................ 40,609 5.16 $13.5440 32,487
$9.7813................................. 350,000 6.16 $ 9.7813 210,000
$13.1000................................ 90,000 7.15 $13.1000 36,000
$6.7000................................. 235,000 8.17 $ 6.7000 47,000
$1.5850................................. 400,000 8.91 $ 1.5850 160,000
$0.8600................................. 200,000 9.08 $ 0.8600 70,000
--------- -------
$0.86 to $13.544........................ 1,675,000 7.26 $ 8.4631 843,000
========= =======
H. INCOME TAXES:
The provision (benefit) for income taxes consists of the following:
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2001 2002 2003
-------- --------- ---------
Current:
Federal............................................. $ 7,633 $ (7,198) $ 4,683
State............................................... 1,000 (872) 907
------- -------- --------
8,633 (8,070) 5,590
------- -------- --------
Deferred:
Federal............................................. 1,256 (4,685) (13,510)
State............................................... 215 (1,980) (2,540)
------- -------- --------
1,471 (6,665) (16,050)
------- -------- --------
Total............................................ $10,104 $(14,735) $(10,460)
======= ======== ========
F-19
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 2002 and 2003, the components of the net deferred tax
liability were as follows:
2002 2003
--------- --------
Deferred tax assets:
Allowance for credit losses................................. $ 17,353 $ 9,367
Lease receivable and unearned income........................ 59,582 --
Depreciation and amortization............................... -- 10,723
State NOL and other state attributes........................ 1,249 1,922
--------- --------
Total deferred tax asset.................................. $ 78,184 $ 22,012
========= ========
Residual value.............................................. $ (8,428) $ (7,644)
Initial direct cost......................................... (4,013) (722)
State refunds............................................... (432) --
Lease receivable and unearned income........................ -- (21,401)
Depreciation and amortization............................... (89,117) --
--------- --------
Total deferred tax liability.............................. $(101,990) $(29,767)
========= ========
Net deferred tax liability................................ $ (23,806) $ (7,755)
========= ========
A valuation allowance against the deferred tax assets is not considered
necessary, because it is more likely than not that the deferred tax assets will
be fully realized.
At December 31, 2003, the Company had state loss carry-forwards of
$22,000,000, which may be used to offset future income. These loss
carry-forwards are available for use against future state income until they
expire between the years 2007 and 2023.
The following is a reconciliation between the effective income tax rate and
the applicable statutory federal income tax rate:
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2001 2002 2003
-------- --------- ---------
Federal statutory rate................................ 35.00% -35.00% -35.00%
State income taxes, net of federal benefit............ 4.60% -5.38% -4.91%
Nondeductible expenses and other...................... -1.40% 0.38% -0.09%
------ ------- -------
Effective income tax rate............................. 38.20% -40.00% -40.00%
====== ======= =======
I. COMMITMENTS AND CONTINGENCIES:
OPERATING AND CAPITAL LEASES
The Company's lease for its facility in Woburn, Massachusetts expires in
2005. In 2003, the Company vacated the facilities in Waltham, Massachusetts,
Newark, California and Herndon, Virginia and negotiated early terminations of
the outstanding leases.
F-20
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company also has entered into various operating lease agreements
ranging from three to four years for additional office equipment. At December
31, 2003, the future minimum lease payments under non-cancelable operating
leases with remaining terms in excess of one year are as follows:
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2004........................................................ $ 585
2005........................................................ 585
2006........................................................ --
2007........................................................ --
------
Total....................................................... $1,170
======
Rental expense under operating leases totaled $1,998,000, $2,321,000 and
$1,620,000 for the years ended December 31, 2001, 2002, and 2003, respectively.
Rental expense for the year ended 2002 includes $316,000 for the net present
value for the remaining lease payments on office space that was not being
utilized.
The Company has entered into various capital lease agreements ranging from
three to four years for office equipment, computer equipment and
telecommunication systems. At December 31, 2003, future minimum lease payments
under capital leases were as follows:
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2004........................................................ $164
2005........................................................ 56
2006........................................................ --
2007........................................................ --
----
Total minimum lease payments................................ 220
Less amounts representing interest.......................... (11)
----
Total....................................................... $209
====
LEGAL MATTERS
Management believes, after consultation with counsel, that the allegations
against the Company included in the lawsuits described below are subject to
substantial legal defenses, and the Company is vigorously defending each of the
allegations. The Company also is subject to claims and suits arising in the
ordinary course of business. At this time, it is not possible to estimate the
ultimate loss or gain, if any, related to these lawsuits, nor if any such loss
will have a material adverse effect on the Company's results of operations or
financial position.
A. The Company filed an action in the United States District Court for the
District of Massachusetts against Sentinel Insurance Company, Ltd.,
("Sentinel"), Premier Holidays International, Inc., ("Premier") and Daniel
DelPiano ("DelPiano") arising from Premier's October, 1999, default on its
repayment obligations to the Company under a Twelve Million Dollar ($12,000,000)
loan. Judgment has been entered in this case against Sentinel, which had issued
a business performance insurance policy guaranteeing repayment of the loan, in
the amount of Fourteen Million Dollars ($14,000,000). This judgment has not been
satisfied. Sentinel is currently undergoing liquidation proceedings, and a claim
in this amount has been filed with the bankruptcy court. The Company's case
against Premier and DelPiano was tried in November 2003, and was decided by the
Court in March 2004. The Court entered a judgment for the Company against
Premier and DelPiano, jointly and severally, on all of the Company's counts,
including fraud and violation of Massachusetts General Laws, Chapter 9A, and
dismissing with prejudice all of Premier and DelPiano's claims and
counterclaims. The
F-21
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Court awarded the Company Twenty Three Million Dollars ($23,000,000) in damages.
Collection of this award is not assumed and therefore it is not reflected in the
December 31, 2003 financial statements.
B. In October, 2002, the Company was served with a Complaint in an action
in the United States District Court for the Southern District of New York filed
by approximately 170 present and former lessees asserting individual claims. The
Complaint contains claims for violation of RICO (18 U.S.C. sec. 1964), fraud,
unfair and deceptive acts and practices, unlawful franchise offerings, and
intentional infliction of mental anguish. The claims purportedly arise from
Leasecomm's dealer relationships with Themeware, E-Commerce Exchange,
Cardservice International, Inc., and Online Exchange for the leasing of websites
and virtual terminals. The Complaint asserts that the Company is responsible for
the conduct of its dealers in trade shows, infomercials and web page
advertisements, seminars, direct mail, telemarketing, all which are alleged to
constitute unfair and deceptive acts and practices. Further, the Complaint
asserts that Leasecomm's lease contracts as well as its collection practices and
late fees are unconscionable. The Complaint seeks restitution, compensatory and
treble damages, and injunctive relief. The Company filed a Motion to Dismiss the
Complaint on January 31, 2003. By decision dated September 30, 2003, the court
dismissed the complaint with leave to file an amended complaint. An Amended
Complaint was filed in November, 2003. The Company filed a Motion to Dismiss the
Amended Complaint, which is awaiting decision by the Court. Because of the
uncertainties inherent in litigation, we cannot predict whether the outcome will
have a material adverse effect.
C. On August 22, 2002 plaintiff Aaron Cobb filed a Complaint against
Leasecomm Corporation and MicroFinancial, Inc. and another Entity known as
Galaxy Mall, Inc. alleging breach of contract; Fraud, Suppression and Deceit;
Unjust Enrichment; Conspiracy; Conversion; Theft by Deception; and violation of
Alabama Usury Laws. The Complaint was filed on behalf of Aaron Cobb
individually, and on behalf of a class of persons and entities similarly
situated in the State of Alabama. More specifically, the Plaintiff purports to
represent a class of persons and small business in the State of Alabama who
allegedly were induced to purchase services and/or goods from any of the
Defendants named in the Complaint. The case is venued in Bullock County,
Alabama. On March 31, 2003 the trial court entered an Order denying the
Company's Motion to Dismiss. An appeal of the Order was filed with the Alabama
Supreme Court on May 12, 2003. The Company continues to deny any wrongdoing and
plans to vigorously defend this claim. Because of the uncertainties inherent in
litigation, the company cannot predict whether the outcome will have a material
adverse affect.
D. In March 2003, an action was filed by a shareholder against the Company
in United States District Court asserting a single count of common law fraud and
constructive fraud. The complaint alleges that the shareholder was defrauded by
untrue statements made to him by management, upon which he relied in the
purchase of Company stock for himself and for others. The complaint seeks
damages in an unspecified amount. The Company filed an answer denying the
allegations. In December 2003, upon motion filed by the plaintiff shareholder,
the Court dismissed the action without prejudice.
E. In March 2003, a purported class action was filed in Superior Court in
Massachusetts against Leasecomm and one of its dealers. The class sought to be
certified is a nationwide class (excluding certain residents of the State of
Texas) who signed identical or substantially similar lease agreements with
Leasecomm covering the same product. After the Company had filed a motion to
dismiss, but before the motion to dismiss was heard by the Court, plaintiffs
filed an Amended Complaint. The Amended Complaint asserts claims against the
Company for declaratory relief, absence of consideration, unconscionability, and
violation of Massachusetts General Laws Chapter 93A, Section 11. The Company
filed a motion to dismiss the Amended Complaint. The Court allowed the Company's
motion to dismiss the Amended Complaint in March 2004.
F. On April 28, 2003 plaintiff Wallace Dickey filed a purported class
action against Leasecomm Corporation, Cardservice International, Linkpoint
International and Clear Commerce Corporation alleging
F-22
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
that he lease-financed through Leasecomm the right to use certain computer
software manufactured, distributed and sold by the other defendants. The
plaintiff does not allege that Leasecomm failed to provide the lease financing
contemplated by the Leasecomm lease. Instead, the Plaintiff alleges that the
software failed to operate as he believed it would, and he has sued for a
declaration that would allow him to rescind his contract, to recover money paid
in the course of the transaction and to recover damages allegedly caused by
unspecified deceptive trade practices. The plaintiff asserts his claims "on
behalf of himself and all others similarly situated." Leasecomm denies all of
the Plaintiff's allegations. The parties have reached an agreement on settlement
terms and are currently drafting settlement documents. The settlement, if
finalized, and signed by the parties, will require court approval to become
effective. Because of the uncertainties inherent in litigation, the company
cannot predict whether the outcome will have a material adverse affect.
G. On April 29, 2003, Leasecomm was served with a Complaint filed in the
Orange County Superior Court for the State of California. In that Complaint,
Maria J. Smith purports to bring a claim against Leasecomm and two other
defendants (Galaxy Mall, Inc. and Electronic Commerce International, Inc.) for
unfair business practices and competition under California Business and
Professions Code section 17200 et seq. The essence of the claim is that Smith
and others who are similarly situated were defrauded in connection with their
acquisition of certain licenses that were financed by Leasecomm. In May 2003,
Leasecomm filed a motion to stay the action in favor of a Massachusetts forum
based on a forum selection clause contained in plaintiff's lease agreement with
Leasecomm. After filing the motion, Leasecomm entered into settlement
negotiations with plaintiff's counsel to explore the possibility of resolving
the matter on a class wide basis without the need for further litigation
(meaning the settlement would, if accepted, apply not only to the named
plaintiff but to others similarly situated). The parties have reached agreement
on settlement terms and are currently drafting the settlement documents. The
settlement, if finalized and signed by the parties, will require Court approval
to become effective. Because of the uncertainties inherent in litigation, the
company cannot predict whether the outcome will have a material adverse affect.
H. In October 2003, the Company was served with a purported class action
complaint which was filed in United States District Court for the District of
Massachusetts alleging violations of federal securities law. The purported class
would consist of all persons who purchased Company securities between February
5, 1999 and October 30, 2002. The Complaint asserts that during this period the
Company made a series of materially false or misleading statements about the
Company's business, prospects and operations, including with respect to certain
lease provisions, the Company's course of dealings with its vendor/dealers, and
the Company's reserves for credit losses. No motion or answer has been filed in
response to the Complaint. Because of the uncertainties inherent in litigation,
we cannot predict whether the outcome will have a material adverse effect.
I. In February 2004, a purported class action was filed in Superior Court
in Massachusetts against Leasecomm, a dealer, and a party purportedly related to
the dealer. The class sought to be certified is a nationwide class who signed
lease agreements identical to, or substantially similar to, the plaintiff's
lease agreement with Leasecomm, and covering the same product. The Complaint
asserts claims for declaratory judgment, absence of consideration,
unconscionability, and violation of Massachusetts General Laws Chapter 93A,
Section 11. The claims concern the validity, enforceability, and alleged
unconscionability of this Leasecomm lease of a product which enabled a merchant
to process credit card payments. The Complaint seeks rescission of lease
agreements with Leasecomm, restitution, multiple damages and attorneys fees
under Chapter 93A, and injunctive relief. Because of the uncertainties inherent
in litigation we cannot predict whether the outcome will have a material adverse
effect. As of the date of this filing, the Company has not been served with this
complaint.
J. In February 2003, Leasecomm received a Civil Investigative Demand
("CID") from the Office of the Attorney General, State of Washington, to which
it has responded. The CID concerns an investigation of monitoring agreements
between Priority One, Inc. and various State of Washington consumers, as to
which Leasecomm appears to be the assignee of the right to receive monthly
payments. Since the investigation has
F-23
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
not been concluded, and no legal action has been commenced against Leasecomm,
there can be no assurance as to the eventual outcome.
INDEMNITIES
In the normal course of its business, the Company has entered into
agreements that include indemnities in favor of third parties, such as
engagement letters with advisors and consultants, outsourcing agreements,
underwriting and agency agreements, information technology agreements,
distribution agreements and service agreements. The foregoing agreements
generally do not contain any limits on the Company's liability and therefore, it
is not possible to estimate the Company's potential liability under these
indemnities.
The Company has entered into agreements relating to the acquisition of
assets, each of which contains indemnities in favor of third parties that are
customary to such commercial transactions. It is not possible to estimate the
Company's potential liability for these indemnities due to the nature of these
indemnities.
In certain cases, the Company has recourse against third parties with
respect to the foresaid indemnities and the Company also maintains insurance
policies that may provide coverage against certain of these claims.
J. EMPLOYEE BENEFIT PLAN:
The Company has a defined contribution plan under Section 401 (k) of the
Internal Revenue Code to provide retirement and profit sharing benefits covering
substantially all full-time employees. Employees are eligible to contribute up
to 15% of their gross salary. The Company will contribute $0.50 for every $1.00
contributed by an employee up to 3% of the employee's salary. Vesting in the
Company contributions is over a five-year period based upon 20% per year. The
Company's contributions to the defined contribution plan were $89,100, $216,900
and $110,500 for the years ended December 31, 2001, 2002, and 2003,
respectively.
K. CONCENTRATION OF CREDIT RISK:
The Company's financial instruments that are exposed to concentrations of
credit risk consist primarily of lease and loan receivables and cash and cash
equivalent balances. To reduce the risk to the Company, credit policies are in
place for approving leases and loans, and lease pools are monitored by
management. In addition, the cash and cash equivalents are maintained with
several high-quality financial institutions.
One dealer accounted for approximately 7.38%, 10.98% and 56.14% of all
originations during the years ended December 31, 2001, 2002, and 2003,
respectively. Another dealer accounted for approximately 23.38% of all
originations during the year ended December 31, 2003 and a third dealer
accounted for 10.79% of all originations during the year ended December 31,
2003. No other dealer accounted for more than 10% of the Company's origination
volume during the years ended December 31, 2001, 2002, or 2003.
Prior to the suspension of new contract originations in October 2002, the
Company originated leases, contracts and loans in all 50 states of the United
States and its territories. The Company continues to service leases, contracts
and loans in all 50 states of the United States and its territories. As of
December 31, 2002 and 2003, leases in California, Florida, Texas, and New York
accounted for approximately 38% of the Company's portfolio. Only California
accounted for more than 10% of the total portfolio as of December 31, 2002 and
2003 at approximately 14%. None of the remaining states accounted for more than
4% of such total.
L. RELATED-PARTY TRANSACTIONS:
The Company had notes receivable from officers and employees of $68,000 at
December 31, 2001. During 1997 and 1998, the Company issued notes to certain
officers and employees in connection with the exercise of common stock options
amounting to $150,000 and $144,000 respectively, in exchange for recourse loans
with fixed maturity dates prior to the expiration date of the original grant.
These notes are non-interest
F-24
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
bearing unless the principal amount thereof is not paid in full when due, at
which time interest will accrue at a rate per annum equal to the prime rate plus
4.0%. All principal amounts outstanding under these notes is due in full on the
earlier of the end of employment or the expiration date. As of December 31,
2002, the notes were paid in full. No new notes were issued during 2002 or 2003.
Other notes payable includes $250,000 due to stockholders of the Company at
December 31, 2002 and 2003. Interest paid to stockholders under such notes was
not material for the years ended December 31, 2002 and 2003.
At December 31, 2002 and 2003, subordinated notes payable included $727,000
due to stockholders, officers and directors. Interest paid to stockholders,
officers and directors under such notes, at rates ranging between 8% and 12%,
amounted to $53,700, $84,000 and $83,000 for the years ended December 31, 2001,
2002 and 2003, respectively.
M. SELECTED QUARTERLY DATA (UNAUDITED):
The following is a summary of the unaudited quarterly results of operations
of the Company for 2002 and 2003.
2002 2003
--------------------------------------- --------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- -------- -------- ------- ------- ------- --------
Revenues:
Income on leases and loans... $15,235 $13,791 $ 12,819 $ 11,167 $ 9,821 $ 8,378 $ 7,173 $ 5,532
Income on service contracts
rental and fees............ 20,050 19,170 17,730 16,860 15,750 15,586 14,884 14,450
------- ------- -------- -------- ------- ------- ------- --------
Total revenues............. 35,285 32,961 30,549 28,027 25,571 23,964 22,057 19,982
------- ------- -------- -------- ------- ------- ------- --------
Expenses:
Selling general and
administrative............. 12,574 11,409 10,306 11,246 9,131 8,709 7,837 8,178
Provision for credit
losses..................... 10,964 10,824 44,672 22,488 10,799 15,249 13,852 19,858
Depreciation and
amortization............... 3,639 4,851 5,713 4,182 4,270 4,087 4,106 4,129
Interest..................... 2,747 2,618 2,458 2,964 2,629 2,145 1,589 1,152
------- ------- -------- -------- ------- ------- ------- --------
Total expenses............. 29,924 29,702 63,149 40,880 26,829 30,190 27,384 33,317
------- ------- -------- -------- ------- ------- ------- --------
Income (loss) before provision
for income taxes............. 5,361 3,259 (32,600) (12,853) (1,258) (6,226) (5,327) (13,335)
------- ------- -------- -------- ------- ------- ------- --------
Net Income (loss).............. $ 3,216 $ 1,955 $(19,558) $ (7,711) $ (755) $(3,736) $(3,196) $ (8,000)
======= ======= ======== ======== ======= ======= ======= ========
Net Income (loss) per common
share -- basic............... 0.25 0.15 (1.53) (0.60) (0.06) (0.29) (0.24) (0.61)
Net Income (loss) per common
share -- diluted............. 0.25 0.15 (1.53) (0.60) (0.06) (0.29) (0.24) (0.61)
Dividends per common share..... 0.050 0.050 0.050 -- -- -- -- --
F-25
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
N. CONSOLIDATING BALANCE SHEET (UNAUDITED):
The following outlines the leases and other assets that have been
transferred to special purpose entities, MFI Finance Corp I and MFI Finance Corp
II, LLC.
ELIMINATING CONSOLIDATED ELIMINATING MICROFINANCIAL
LEASECOMM MFI FC I MFI FCII ENTRIES LEASECOMM MFI ENTRIES CONSOLIDATED
--------- -------- -------- ----------- ------------ ------- ----------- --------------
ASSETS:
Net investment in leases
and loans:
Receivables due in
installments.......... $170,632 $ 5,156 $175,788 $175,788
Estimated residual
value................. 19,110 19,110 19,110
Initial direct costs.... 1,707 97 1,804 1,804
Loans receivable........ -- -- $ 733 $ (733) --
Less:
Advance lease payments
and deposits........ (28) (9) (37) (37)
Unearned income:...... (22,453) (1,276) (23,729) (23,729)
Allowance for credit
losses.............. (36,545) (6,466) (43,011) (43,011)
-------- -------- ------- -------- -------- ------- -------- --------
Net investment in leases
and loans:.............. 132,423 (2,498) $ -- $ -- 129,925 733 (733) 129,925
-------- -------- ------- -------- -------- ------- -------- --------
Investment in service
contracts, net.......... 8,844 8,844 8,844
Cash and cash
equivalents............. 6,234 6,234 299 6,533
Restricted cash........... 2,376 2,376 2,376
Property and equipment,
net..................... 2,775 1,924 4,699 1,145 5,844
Investment in
subsidiary.............. 52,249 (52,249) -- 48,317 (48,317) --
Other assets.............. 1,889 190 2,079 44,582 (43,769) 2,892
Income taxes receivable... -- -- -- --
-------- -------- ------- -------- -------- ------- -------- --------
Total assets:............. $204,414 $ 1,992 $ -- $(52,249) $154,157 $95,076 $(92,819) $156,414
======== ======== ======= ======== ======== ======= ======== ========
LIABILITIES:
Notes payable........... $ 55,411 $ 3,247 $ 58,658 $ 250 $ (65) $ 58,843
Subordinated notes
payable............... -- 3,262 3,262
Notes payable to
parent................ 733 733 (733) --
Capitalized lease
obligations........... -- 209 209
Accounts Payable........ 99,580 (49,528) $(3,956) 46,096 859 (43,769) 3,186
Other liabilities....... 3,937 (21) 3,916 188 4,104
Income taxes payable.... (2,724) (2,724) 10,513 7,789
Deferred tax
liability............. -- 7,755 7,755
-------- -------- ------- -------- -------- ------- -------- --------
Total Liabilities:........ 156,937 (46,302) (3,956) $ -- 106,679 23,036 (44,567) 85,148
-------- -------- ------- -------- -------- ------- -------- --------
Stockholders' Equity:
Common Stock............ 1 1 134 (1) 134
Additional
Paid-In-Capital....... 207 207 44,245 (207) 44,245
Retained Earnings....... 47,269 48,294 3,956 (52,249) 47,270 30,176 (48,044) 29,402
Treasury Stock.......... -- (2,515) (2,515)
-------- -------- ------- -------- -------- ------- -------- --------
Total Stockholders'
Equity:................. 47,477 48,294 3,956 (52,249) 47,478 72,040 (48,252) 71,266
-------- -------- ------- -------- -------- ------- -------- --------
Total Equity and
Liabilities:............ $204,414 $ 1,992 $ -- $(52,249) $154,157 $95,076 $(92,819) $156,414
======== ======== ======= ======== ======== ======= ======== ========
F-26
MICROFINANCIAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Leasecomm Corporation periodically finances its lease and service
contracts, together with unguaranteed residuals, through securitizations using
special purpose vehicles. MFI Finance Corporation I and MFI Finance Corporation
II, LLC are special purpose companies. The assets of such special purpose
vehicles and cash collateral or other accounts created in connection with the
financings in which they participate are not available to pay creditors of
Leasecomm Corporation, MicroFinancial Incorporated, or other affiliates. While
Leasecomm Corporation generally does not sell its interests in leases, service
contracts or loans to third parties after origination, the Company does, from
time to time, contribute certain leases, service contracts, or loans to
special-purpose entities for purposes of obtaining financing in connection with
the related receivables. The contribution of such assets under the terms of such
financings are intended to constitute "true sales" of such assets for bankruptcy
purposes (meaning that such assets are legally isolated from Leasecomm
Corporation). However, the special purpose entities to which such assets are
contributed are required under generally accepted accounting principles to be
consolidated in the financial statements of the Company. As a result, such
assets and the related liability remain on the balance sheet and do not receive
gain on sale treatment.
F-27