1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File No. 1-14771
MICROFINANCIAL INCORPORATED
(Exact name of Registrant as specified in its Charter)
Massachusetts 04-2962824
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
950 Winter Street, Waltham, MA 02451
(Address of Principal Executive Offices)
(781) 890-0177
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(b) of the Securities and Exchange act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
As of May 11, 2000, 12,710,046 shares of the registrant's common stock were
outstanding.
2
MICROFINANCIAL INCORPORATED
Table of Contents
Page
Part I FINANCIAL INFORMATION
Item 1 Financial Statements (unaudited):
Condensed Consolidated Balance Sheets
December 31, 1999 and March 31, 2000 3
Condensed Consolidated Statements of Operations
Three months ended March 31, 1999 and 2000 4
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 1999 and 2000 5
Notes to Condensed Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operation 12
Item 3 Quantitative and Qualitative Disclosures about Market Risk 15
Part II OTHER INFORMATION
Item 1 Legal Proceedings 17
Item 6 Exhibits and Reports on Form 8-K 22
Signatures 23
2
3
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(Unaudited)
December 31, March 31,
1999 2000
----------- ---------
ASSETS
Net investment in leases and loans:
Receivables due in installments $ 321,578 $ 348,703
Estimated residual value 21,070 25,433
Initial direct costs 8,164 9,271
Loans receivable 20,073 19,604
Less:
Advance lease payments and deposits (2,164) (651)
Unearned income (100,815) (114,056)
Allowance for credit losses (41,719) (43,455)
--------- ---------
Net investment in leases and loans: $ 226,187 $ 244,849
Investment in service contracts 14,250 14,516
Cash and cash equivalents 11,062 16,372
Property and equipment, net 7,713 7,918
Other assets 6,644 7,489
--------- ---------
Total assets $ 265,856 $ 291,144
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable $ 144,871 $ 168,335
Subordinated notes payable 9,238 8,250
Capitalized lease obligations 1,244 1,105
Accounts payable 339 207
Dividends payable 514 508
Other liabilities 4,748 4,833
Income taxes payable 3,544 3,425
Deferred income taxes payable 22,520 22,674
--------- ---------
Total liabilities 187,018 209,337
--------- ---------
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value; 25,000,000 authorized; 13,347,726
shares issued at 12/31/99; 13,374,646 issued at 3/31/00 133 134
Additional paid-in capital 47,920 47,968
Retained earnings 36,656 41,119
Treasury stock (667,790 shares of common stock at 12/31/99,
826,790 shares of common stock at 3/31/00), at cost (5,777) (7,322)
Notes receivable from officers and employees (94) (92)
--------- ---------
Total stockholders' equity 78,838 81,807
--------- ---------
Total liabilities and stockholders' equity $ 265,856 $ 291,144
========= =========
The accompanying notes are an integral part of the consolidated
financial statements
3
4
MICROFINANCIAL INCORPORATED CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(Unaudited)
For the quarters ended
March 31,
--------------------------------
1999 2000
---- ----
Revenues:
Income on financing leases and loans $ 12,377 $ 15,544
Income on service contracts 1,184 2,190
Rental income 5,681 5,810
Loss and damage waiver fees 1,396 1,470
Service fees 1,817 3,627
----------- -----------
Total revenues 22,455 28,641
----------- -----------
Expenses:
Selling general and administrative 6,004 6,329
Provision for credit losses 5,399 8,529
Depreciation and amortization 1,687 2,033
Interest 2,620 3,075
----------- -----------
Total expenses 15,710 19,966
----------- -----------
Income before provision for income taxes 6,745 8,675
Provision for income taxes 2,776 3,705
----------- -----------
Net Income $ 3,969 $ 4,970
=========== ===========
Net Income per common share - basic $ 0.33 $ 0.39
=========== ===========
Net Income per common share - diluted $ 0.33 $ 0.39
=========== ===========
Dividends per common share $ 0.035 $ 0.040
=========== ===========
Weighted average shares used to compute:
Basic Net Income per share 12,002,922 12,788,578
----------- -----------
Fully diluted Net Income per share 12,109,050 12,893,559
----------- -----------
The accompanying notes are an integral part of the consolidated
financial statements
4
5
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
For the quarter ended
March 31,
----------------------------
1999 2000
---- ----
Cash flows from operating activities:
Cash received from customers $ 38,281 $ 41,887
Cash paid to suppliers and employees (5,886) (11,066)
Cash paid for income taxes (530) (3,845)
Interest paid (2,895) (3,097)
Interest received 816 365
--------- ---------
Net cash provided by operating activities 29,786 24,244
--------- ---------
Cash flows from investing activities:
Investment in lease contracts (21,235) (35,226)
Investment in direct costs (979) (2,520)
Investment in service contracts (1,845) (1,314)
Investment in loans receivable (8,431) 0
Investment in fixed assets (137) (399)
Issuance of notes from officers and employees (1) 0
Repayment of notes from officers 102 2
Investment in notes receivable (298) (31)
Repayment of notes receivable 87 239
--------- ---------
Net cash used in investing activities (32,737) (39,249)
--------- ---------
Cash flows from financing activities:
Proceeds from secured debt 28,959 63,618
Repayment of secured debt (56,944) (24,899)
Proceeds from refinancing of secured debt 93,548 141,557
Prepayment of secured debt (93,548) (156,557)
Proceeds from short term demand notes payable 685 112
Repayment of short term demand notes payable (26) (367)
Proceeds from issuance of subordinated debt 0 0
Repayment of subordinated debt (10,747) (1,000)
Proceeds from sale of common stock 46,116 0
Proceeds from exercise of common stock options 0 49
Repayment of capital leases (189) (139)
Purchase of treasury stock 0 (1,545)
Payment of dividends (347) (514)
--------- ---------
Net cash provided by (used in) financing activities 7,507 20,315
--------- ---------
Net increase (decrease) in cash and cash equivalents: 4,556 5,310
Cash and cash equivalents, beginning of period: 6,817 11,062
--------- ---------
Cash and cash equivalents, end of period: $ 11,373 $ 16,372
========= =========
(continued on following page)
The accompanying notes are an integral part of the consolidated
financial statements.
5
6
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Continued)
(Unaudited)
For the quarter ended
March 31,
----------------------------
1999 2000
---- ----
Reconciliation of net income to net cash provided
by operating activities:
Net Income $ 3,969 $ 4,970
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization 1,688 2,033
Provision for credit losses 5,399 8,529
Recovery of equipment cost and residual value,
net of revenue recognized 15,536 10,793
Increase (decrease) in current taxes (500) (119)
Increase in deferred income taxes 2,775 154
Change in assets and liabilities:
Decrease (increase) in other assets 426 (1,973)
(Decrease) increase in accounts payable (10) (132)
Increase (decrease) in accrued liabilities 503 (11)
-------- --------
Net cash provided by operating activities $ 29,786 $ 24,244
======== ========
Supplemental disclosure of noncash activities:
Property acquired under capital leases $ 213 $ --
Accrual of common stock dividends $ 467 $ 508
The accompanying notes are an integral part of the consolidated
financial statements.
6
7
MICROFINANCIAL INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tables in thousands, except share and per share data)
(Unaudited)
(A) Nature of Business:
MicroFinancial Incorporated (the "Company") which operates primarily
through its wholly owned subsidiary, Leasecomm Corporation, is a specialized
finance company that primarily leases and rents commercial "microticket"
equipment and provides other financing services in amounts generally ranging
from $900 to $2,500 with an average amount financed of approximately $1,500 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 funds its operations primarily through borrowings under
its credit facilities, issuances of subordinated debt and on balance sheet
securitizations.
(B) Summary of Significant Accounting Policies:
Basis of Presentation:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles and the
rules and regulations of the Securities and Exchange Commission for interim
financial statements. Accordingly, the interim statements do not include all of
the information and disclosures required for the annual financial statements. In
the opinion of the Company's management, the consolidated financial statements
contain all adjustments, consisting only of normal recurring adjustments,
considered necessary for a fair presentation of these interim results. These
financial statements should be read in conjunction with the consolidated
financial statements and notes included in the Company's Annual Report and Form
10-K for the year ended December 31, 1999. The results for the three-month
period ended March 31, 2000 are not necessarily indicative of the results that
may be expected for the full year ended December 31, 2000.
The balance sheet at December 31, 1999 has been derived from the audited
financial statements included in the Company's Annual Report and Form 10-K for
the year ended December 31,1999.
Allowance for Credit Losses:
The Company maintains an allowance for credit losses on its investment in
leases, loans and service contracts at an amount that it believes is sufficient
to provide an adequate provision 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 leases, loans and service
contracts, if any. In addition, the allowance reflects management's judgment of
the additional loss potential considering future economic conditions and the
nature and characteristics
7
8
of the underlying lease portfolio. The Company determines the necessary periodic
provision for the 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, loans and service contracts.
The following table sets forth the Company's allowance for credit losses as
of December 31, 1998 and, 1999 and March 31, 2000 and the related provision,
charge-offs and recoveries for the year ended December 31, 1999 and the three
months ended March 31, 2000.
Balance at December 31, 1998 ....... $24,850
Provision for credit losses......... 37,836
Charge-offs......................... 35,957
Recoveries.......................... 14,990
-------
Charge-offs, net of recoveries..... 20,967
-------
Balance at December 31, 1999........ $41,719
=======
Provision for credit losses......... 8,529
Charge-offs......................... 8,708
Recoveries.......................... 3,848
-------
Charge-offs, net of recoveries..... 4,860
Transfer to other asset reserve..... 1,933
-------
Balance at March 31, 2000........... $43,455
=======
For the three months ended March 31, 2000, the Company reserved $1.9
million against other receivables. The allowance reflects management's judgement
of loss potential considering future economic conditions and the nature of the
underlying receivables.
The following table sets forth the Company's other asset reserve as of
December 31, 1999 and March 31, 2000 and the related provision, charge-offs and
recoveries for the three months ended March 31, 2000.
Balance at December 31, 1999............... $ 0
======
Transfer from allowance for credit losses.. 1,933
------
Charge-offs................................ 0
Recoveries................................. 0
------
Charge-offs, net of recoveries............ 0
Balance at March 31, 2000.................. $1,933
======
8
9
Earnings Per Share:
The Company applies the principles set forth in Statement of Financial
Accounting Standard No. 128, "Earnings Per Share." ("SFAS No.128") which
specifies the computation, presentation and disclosure requirements for net
income per share. Basic net income per common share is computed based upon the
weighted average number of common shares outstanding during the period. Dilutive
net income per common share gives effect to all dilutive potential common shares
outstanding during the period. Under SFAS No. 128, the computation of dilutive
earnings per share does not assume the issuance of common shares that have an
antidilutive effect on the net income per share. Options to purchase zero and
830,000 shares of common stock were not included in the computation of diluted
earnings per share for the three months ended March 31, 1999 and 2000
respectively because their effects were antidilutive.
For quarter ended
March 31,
----------------------
1999 2000
---- ----
Net Income $ 3,969 $ 4,970
Shares used in computation:
Weighted average common shares
outstanding used in computation
of net income per common share 12,002,922 12,788,578
Dilutive effect of common stock
options 106,128 104,981
Shares used in computation of net
income per common share -
assuming dilution 12,109,050 12,893,559
----------- -----------
Net income per common share $ 0.33 $ 0.39
Net income per common share
assuming dilution $ 0.33 $ 0.39
Notes Payable:
On December 21, 1999, the Company entered into a revolving line of credit
and term loan facility with a group of financial institutions whereby it may
borrow a maximum of $150,000,000 based upon qualified lease receivables.
Outstanding borrowings with respect to the revolving line of credit bear
interest based at Prime for Prime Rate Loans, the prevailing rate per annum as
offered in the interbank Eurodollar market (Eurodollar) plus 1.75% for
Eurodollar Loans or the seven day Money Market rate plus 1.75% for Swing Line
advances. If the Eurodollar Loans are not renewed upon their maturity they
automatically convert into prime rate loans. Swing Line advances have a 7 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 $5 million. The prime rates at December 31,
1999, and March 31, 2000
9
10
were 8.50% and 9.00% respectively. The 90-day Eurodollar rates December 31,
1999, and March 31, 2000 were 5.9375% and 6.2500%, respectively. The 7-day Money
Market rates December 31, 1999, and March 31, 2000 were 5.6875% and 6.2200%,
respectively.
The Company had borrowings outstanding under these agreements with the following
terms:
December 31, 1999 March 31, 2000
--------------------- --------------------
Type Rate Amount Rate Amount
- ---- ---- ------ ---- ------
(in thousands) (in thousands)
Prime 8.5000% $ 14,330 9.0000% 5,095
Swing Line 8.0600% 1,743
Swing Line 8.0625% 1,888
Eurodollar 7.9375% 17,500 7.7200% 17,500
Eurodollar 7.8125% 12,000 8.0000% 12,000
Eurodollar 8.0000% 65,000 7.9400% 50,000
----------- ----------
Total Outstanding $108,830 $88,226
----------- ----------
Outstanding borrowings are collateralized by leases and service contracts
pledged specifically to the financial institutions. All balances under the
revolving line of credit will be automatically converted to a term loan on
September 30, 2001 provided the line of credit is not renewed and no event of
default exists at that date. All converted term loans are payable over the term
of the underlying leases, loans and service contracts, but in any event not to
exceed 36 monthly installments. The most restrictive covenants of the agreement
have minimum net worth and income requirements.
BLT III has two series of notes outstanding, the 1997-A Notes and the
1998-A Notes. In August 1997, BLT III issued the 1997-A Notes in aggregate
principal amount of $44,763,000 and in November 1998, BLT III issued the 1998-A
Notes in aggregate principal amount of $40,769,000. In March 2000, MFI I issued
the 2000-1 Notes in aggregate principal amount of $50,056,686. Outstanding
borrowings are collateralized by a specific pool of lease receivables.
At December 31, 1999 and March 31,2000, BLT and MFI I had borrowings
outstanding under the series of notes with the following terms:
10
11
December 31, 1999 March 31, 2000
-------------------- --------------------
Series Rate Amount Rate Amount
- ------ ---- ------ ---- ------
(in thousands) (in thousands)
BLT III
1997-A Notes 6.4200% $ 9,498 6.4200% $ 6,017
1998-A Notes 6.0300% $25,473 6.0300% $23,219
MFI I
2000-1 Notes $ -- 7.3750% $50,057
-------- ---------
Total Outstanding $34,971 $79,293
-------- ---------
The Company also had other notes payable which totaled $816,000 and
$1,070,000, at March 31, 2000 and December 31,1999, respectively. The notes are
due on demand and bear interest at a rate of prime less 1.00%.
Stock Options:
Under the 1998 Equity Incentive Plan (the "1998 Plan") which was adopted on
July 9, 1998 the Company had reserved 2,000,000 shares of the Company's common
stock for issuance pursuant to the 1998 Plan. The Company granted a total of
730,000 options during the three months ended March 31, 2000, to various members
of management and board of directors. A total of 1,630,000 options were
outstanding at March 31, 2000 of which 171,000 were vested.
Dividends:
On February 14, 2000 the Company's Board of Directors approved a dividend
of $.04 per common share for all outstanding common shares as of March 31, 2000
which were paid on April 17, 2000.
11
12
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Quarter ended March 31, 2000 as compared to the quarter ended March 31, 1999.
Net income for the three months ended March 31, 2000 was approximately $5.0
million, an increase of $1.0 million or 25% from the three months ended March
31, 1999. This represents diluted earnings per share for the three months ended
March 31, 2000 of $0.39 per share on weighted average outstanding shares of
12,893,559 as compared to $0.33 per share on weighted average outstanding shares
of 12,109,050 for the three months ended March 31, 1999.
Total revenues for the three months ended March 31, 2000 were $28.6
million, an increase of $6.2 million, or 28%, from the three months ended March
31, 1999. The increase was primarily due to an increase of $3.2 million, or 26%,
in income on financing leases and loans, $1.1 million, or 17%, in rental and
service contract income and $1.9 million, or 59%, in fee income. The increase in
income on financing leases and loans was due to the increased number of leases
originated. The majority of 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 and the increased number of service
contracts originated. The increase in fee income is the result of increased fees
from the lessees related to the collection and legal process employed by the
Company.
Selling, general and administrative expenses increased by $325,000, or 5%,
for the three months ended March 31, 2000, as compared to the three months ended
March 31, 1999. Compensation and personnel related expenses increased by
$618,000, or 18%, due to an increase in overall compensation levels, an increase
in the number of employees needed to maintain the Company's portfolio as well as
an increase of $142,000 in contract labor. These increases were offset in part
by the expenses billed back to lessees related to the collection and legal
process employed by the Company.
Depreciation and amortization increased by $346,000, or 21%, due to the
increased number of rental contracts and amortization of the Company's
investment in service contracts.
The Company's provision for credit losses increased by $3.1 million or 58%,
for the three months ended March 31, 2000 as compared to the three months ended
March 31, 1999. This increase is a result of 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 the Company's review of
their overall receivables. Dealer fundings increased by $6.5 million, or 21% and
total revenues increased by $6.2 million, or 28% for the three months ended
March 31, 2000 as compared to the three months ended March 31, 1999. This
provision reflects management's judgement of loss potential considering economic
conditions and the nature of the underlying receivables.
Net interest expense increased by $455,000, or 17%, for the three months
ended March 31, 2000 as compared to the three months ended March 31, 1999. This
increase resulted from the
12
13
Company's increased level of borrowings on its revolving line of credit as well
as rising interest rates.
Dealer fundings were $37.3 million for the three months ended March 31,
2000, up $6.5 million, or 21% as compared to the three months ended March 31,
1999. This increase is a result of a 118% growth in the Company's Point Of Sale
business, as well as, continued growth in the Company's Non-Point Of Sale
business. Total cash from customers increased by $3.6 million or 9.0% to a total
of $41.9 million. This increase is primarily the result of an increase in the
size of the overall portfolio. Investment in lease and loan receivables due in
installments, estimated residuals, and service contracts were up from $377
million in December of 1999 to $408.3 million in March of 2000, representing an
8% increase.
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, loans
and service contracts. Since inception, the Company has funded its operations
primarily through borrowings under its credit facilities, issuances of
subordinated debt and its on-balance sheet securitizations. The Company will
continue to require significant additional capital to maintain and expand its
volume of leases, loans and service contracts, as well as to fund future
acquisitions of leasing companies or portfolios.
The Company's uses of cash include the origination and acquisition of
leases, loans and service contracts, payment of interest expenses, repayment of
borrowings under its credit facilities, subordinated debt and securitizations,
payment of selling, general and administrative expenses, income taxes, capital
expenditures, and the Company's stock repurchase program.
The Company utilizes its credit facility to fund the origination and
acquisition of leases, loans and service contracts that satisfy the eligibility
requirements established pursuant to each facility. At March 31, 2000, the
Company had an aggregate maximum of $150.0 million available for borrowing under
its credit facility, of which approximately $88.2 million was outstanding as of
such date. To date, cash flow from its portfolio and other fees have been
sufficient to repay current amounts due under the credit facilities and
subordinated debt.
The Company believes that the cash flow from its operations and the amounts
available under its credit facilities will be sufficient to fund the Company's
operations for the foreseeable future. Although the Company is not currently
involved in negotiations and has no current commitments or agreements with
respect to any acquisition, to the extent that the Company successfully
consummates acquisitions, it may be necessary to finance such acquisitions
through the issuance of additional debt or equity securities, the incurrence of
indebtedness or a combination of both.
13
14
Note on Forward Looking Information
Statements in this document that are not historical facts are
forward-looking statements made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. In addition, words such as
"believes," "anticipates," "expects," and similar expressions are intended to
identify forward-looking statements. The Company cautions that a number of
important factors could cause actual results to differ materially from those
expressed in any forward-looking statements made by or on behalf of the Company.
Such statements contain a number of risks and uncertainties, including but not
limited to: the Company's dependence on point-of-sale authorization systems and
expansion into new markets; the Company's significant capital requirements;
risks associated with economic downturns; higher interest rates; intense
competition; change in regulatory environment and risks associated with
acquisitions. Readers should not place undue reliance on forward-looking
statements, which reflect the management's view only as of the date hereof. The
Company undertakes no obligation to publicly revise these forward-looking
statements to reflect subsequent events or circumstances. The Company cannot
assure that it will be able to anticipate or respond timely to changes which
could adversely affect its operating results in one or more fiscal quarters.
Results of operations in any past period should not be considered indicative of
results to be expected in future periods. Fluctuations in operating results may
result in fluctuations in the price of the Company's common stock. For a more
complete description of the prominent risks and uncertainties inherent in the
Company's business, see the risks factors described in the Company's Form S-1
Registration Statement and other documents filed from time to time with the
Securities and Exchange Commission.
14
15
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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, or
fair value of the financial instrument and derivative instruments held by the
Company at March 31, 2000, that are sensitive to changes in interest rates. The
Company uses interest-rate swaps to manage the primary market exposures
associated with underlying liabilities and anticipated transactions. The Company
uses 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 country
risk, credit risk and legal risk, and are not represented in the analysis that
follows.
Interest Rate Risk Management
This analysis presents the hypothetical loss in earnings of the financial
instruments and derivative instruments held by the Company at March 31, 2000
that are sensitive to changes in interest rates. The Company enters into
interest rate swaps to reduce exposure to interest-rate risk connected to
existing liabilities. The Company does not hold or issue derivative financial
instruments for trading purposes.
Because the Company's net-earnings exposure under the combined debt and
interest-rate swap was to 90-day Eurodollar Rate, the hypothetical loss was
modeled by calculating the 10 percent adverse change in 90-day Eurodollar Rate
and then multiplying it by the face amount of the debt (which equaled the face
amount of the interest rate swap).
The implicit yield to the Company on all of its leases, loans and service
contracts is on a fixed interest rate basis due to the leases, loans and service
contracts having scheduled payments that are fixed at the time of origination of
the lease, loan or service contract. When the Company originates or acquires
leases, loans and service contracts it bases its pricing in part on the "spread"
it expects to achieve between the implicit yield rate to the Company on each
lease, loan or service contract and the effective interest cost it will pay when
it finances such leases, loans and service contracts through its Credit
Facilities. Increases in the interest rates during the term of each lease, loan
or service contract 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, loan or service
contract.
Given the relatively short average life of the Company's leases, loans and
service contracts, the Company's goal is to maintain a blend of fixed and
variable interest rate obligations. As of
15
16
March 31, 2000, the Company's outstanding fixed rate indebtedness, including
indebtedness outstanding under the Company's securitizations and indebtedness
subject to the swap described below, represented 55% of the Company's
outstanding indebtedness. In July 1997, the Company entered into an interest
rate swap agreement with one of its banks. This agreement, which expires in July
2000, has a notional amount of $17.5 million, which represented 18% of the
Company's fixed rate indebtedness outstanding at March 31, 2000. The interest
rate associated with the swap is capped at 6.6%. During the term of the swap,
the Company has agreed to match the swap amount with 90-day Eurodollar loans. If
at any time the 90-day Eurodollar rate exceeds the swap cap of 6.6%, the bank
would pay the Company the difference. Through March 31, 2000, the Company had
entered into Eurodollar loans with interest rates ranging from 7.72% to 8.00%.
This arrangement effectively changes the Company's floating interest rate
exposure on the $17.5 million notional amount to a fixed rate of 8.35%.
The aggregate hypothetical loss in earnings on an annual basis on the
financial instruments and derivative instruments that would have resulted from a
hypothetical increase of 10% in the 90-day Eurodollar rate, sustained for one
month, is estimated to be $12,175.
16
17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Management believes, after consultation with counsel, that the allegations
against the Company included in the lawsuits described below are without merit,
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.
I. On August 24, 1999, a purported class action lawsuit was filed in
Middlesex Superior Court for The Commonwealth of Massachusetts against the
Company and its wholly-owned subsidiary Leasecomm Corporation ("Leasecomm").
The complaint has been amended four times, most recently by the Fourth
Amended Complaint and Jury Claim filed on or about November 4, 1999 (as amended,
the "Clark Complaint").
The purported class consists of individuals and businesses that have been
sued by Leasecomm in a Massachusetts court for allegedly breaching Leasecomm's
Non Cancellable Equipment Lease Agreement or Non Cancellable Lease Agreement
(the "Lease Agreements") containing a forum selection clause. The forum
selection clause is an agreement between the parties to the Lease Agreements to
submit to the jurisdiction of the courts of The Commonwealth of Massachusetts
for the bringing of any suit or other proceeding. The purported class would be
limited to individuals and businesses that: have no place of business or
residence in New England; have been sued in a Massachusetts court for breach of
the Lease Agreements; had no more than three employees as of the date of the
Lease Agreement; had been in existence for no more than three years as of the
date of the Lease Agreement; and had entered into Lease Agreements with
scheduled monthly lease payments which aggregated to less than $5,000.
The Clark Complaint alleges that enforcement of the forum selection clause
is not fair or reasonable because, among other things, litigation in
Massachusetts is prohibitively costly and time consuming for purported class
members, purported class members have no choice but to enter into the Lease
Agreement because of Leasecomm's greater bargaining power, and purported class
members allegedly have valid defenses to the claims asserted against them by
Leasecomm. The Plaintiffs seek: a declaration that the forum selection clause is
not fair or reasonable as to purported class members and that the Massachusetts
courts lack personal jurisdiction over purported class members; dismissal
without prejudice of all cases pending in Massachusetts against purported class
members; a permanent injunction preventing Leasecomm and its affiliates from
bringing suit in Massachusetts against purported class members; a permanent
injunction preventing Leasecomm or its affiliates from entering into Lease
Agreements containing the forum selection clause; unspecified monetary damages
against Leasecomm and the Company in favor of purported class members equal to
double or treble the moneys collected in connection with lawsuits filed against
purported class members in Massachusetts courts, together with attorneys' fees
and costs.
17
18
The parties have filed various motions with the Court, which will be heard
by the Court within the next several months.
Since this matter is in an early stage, there can be no assurance as to its
eventual outcome. However, the forum selection clause at issue in this
litigation has been enforced in other cases.
II. On June 3, 1999 a purported class action lawsuit was filed in Middlesex
Superior Court in The Commonwealth of Massachusetts against Leasecomm. The
complaint was amended on or about July 26, 1999 (as amended, the
"McKenzie-Pollock Complaint"). On September 3, 1999 Leasecomm removed the action
to the United States District Court for the District of Massachusetts.
The purported class consists of individuals who entered into a Lease
Agreement with Leasecomm between June 4, 1993 and the date of the
McKenzie-Pollock Complaint.
Plaintiffs allege: that Leasecomm causes individuals to enter into
non-cancellable, long-term leases when there is no reasonable expectation that
most of the individuals would need or use the equipment for the duration of the
lease term; that Leasecomm conceals or misrepresents the nature of the terms of
its Lease Agreements; that the Lease Agreements are non-negotiable adhesion
contracts which are oppressive and unfair; that the cost of acquiring the
equipment through Leasecomm is often double or triple the retail cost of the
equipment; that Leasecomm violates state usury laws; that Leasecomm engages in
unfair debt collection practices; that Leasecomm brings lawsuits against
purported class members in Massachusetts even though it has no jurisdiction over
them in Massachusetts courts; that Leasecomm fails to make proper service and
then files pleadings which state that proper service was made, thereby obtaining
default judgments against certain members of the purported class; that Leasecomm
conspired with its salespersons to cause members of the purported class to enter
into unconscionable leases by concealing and misrepresenting their terms; that
Leasecomm failed to comply with the Truth in Lending Act and the Massachusetts
Consumer Credit Cost Disclosure Act; and that Leasecomm has engaged in unfair
trade practices in violation of the Massachusetts consumer protection statute.
Plaintiffs and the members of the purported class seek: unspecified damages
for monetary losses allegedly sustained by them as a result of this conduct by
Leasecomm and reimbursement of costs and attorneys' fees; treble damages and
other punitive damages; rescission of the Lease Agreements, or a declaration
that they are void, and return of all moneys paid to Leasecomm; and damages for
unjust enrichment.
The parties have filed various motions with the Court. In December 1999,
the Court granted Leasecomm's motion to dismiss in part, and ordered that the
federal Truth in Lending and Fair Debt Collection Practices claims be dismissed.
The Court then ordered the remaining claims to be remanded to the Middlesex
Superior Court for further proceedings, including decisions on the balance of
Leasecomm's motion to dismiss, since all federal claims in the case had been
dismissed. Leasecomm subsequently filed a renewed motion to dismiss in the
Superior Court, again asserting
18
19
that the remaining non-federal claims are legally insufficient and should have
been presented in earlier court proceedings, which will be heard by the Court
within the next several months.
Since this matter is in an early stage, there can be no assurance as to its
eventual outcome.
III. On October 25, 1999, a purported class action lawsuit was filed in
Middlesex Superior Court in The Commonwealth of Massachusetts against Leasecomm
(the "Lamar Complaint"). The purported class consists of all individuals and
businesses who, on or after September 28, 1996, signed a Leasecomm agreement
which states that it is "non-cancelable" and/or contains certain standard
provisions relating to delivery and acceptance of the leased equipment and
warranties and servicing for the equipment. The Plaintiffs contend that these
particular lease terms are contrary to Article 2A of the Uniform Commercial Code
as adopted in Massachusetts and that Leasecomm's use of these terms constitutes
an unfair and deceptive trade practice under Chapter 93A of the Massachusetts
General Laws. The Plaintiffs seek a declaration that the lease terms in question
are unfair and deceptive and that Leasecomm's use of those terms is unfair and
deceptive. The Plaintiffs also seek a Court order requiring Leasecomm to notify
all purported class members of the Court's ruling in the case; to stop using the
lease terms or similar lease terms which allegedly misstate lessees' rights
under Massachusetts law; to refrain from enforcing those lease terms against any
of the purported class members; to refrain from providing or communicating
incorrect information regarding lessees' rights under Massachusetts law; and to
include in every lease agreement language which conspicuously describes the
rights of lessees under Massachusetts law. Finally, the Plaintiffs seek
reimbursement of their costs and attorneys' fees.
The parties have filed various motions with the Court, which will be heard
by the Court over the next several months.
Since this matter is in an early stage, there can be no assurance as to its
eventual outcome.
IV. On January 20, 2000, the Company filed suit against Sentinel Insurance
Company Limited ("Sentinel"), in the United States District Court for the
District of Massachusetts (the "Sentinel Complaint"). On August 18, 1999,
Sentinel had issued a Business Performance Insurance Policy (the "Policy") to
the Company as collateral for a Twelve Million Dollar ($12,000,000) loan (the
"Loan") that the Company had made to Premier Holidays International, Inc.
("Premier"). The Loan was personally guaranteed by Premier's President, Daniel
DelPiano ("DelPiano"). Pursuant to the terms of the Policy, Sentinel was
obligated to make payment to the Company for any and all amounts payable under
the terms of the Loan, in the event a default by Premier occurred. After Premier
and DelPiano defaulted on their repayment obligations, the Company made demand
on Sentinel for payment under the Policy. The Company filed the Sentinel
Complaint after Sentinel refused to make payment to the Company under the
Policy. On February 3, 2000, the Company amended its Complaint to assert claims
against Premier and DelPiano arising out of their failure to make payments
required under the Loan and the personal guaranty. On March 1, 2000, the Company
filed a motion for summary judgment on its claims against Sentinel, seeking
judgment in the amount of approximately $13.0 million, plus post-judgment
interest and attorneys' fees.
19
20
Subsequently, on January 26, 2000, Premier and DelPiano filed suit against
the Company, its wholly-owned subsidiary, Leasecomm Corporation, and Sentinel in
the Superior Court of Fulton County, Georgia (the "Premier Complaint"). Premier
and DelPiano allege that, notwithstanding the plain wording of both the Loan and
the Policy, Premier agreed to borrow the full amount of the Loan only upon
alleged representations by the Company that it would loan Premier an additional
Forty-Five Million Dollars ($45,000,000). The documents evidencing the Loan, and
the documents evidencing the Policy, refer only to the amount of the Loan
($12,000,000), and not to any greater amount. Premier alleges that, as a result,
it has suffered actual and consequential damages in the amount of Seven Hundred
Sixty-Nine Million Three Hundred Fifty Thousand Dollars ($769,350,000) plus
interest, costs, and attorneys' fees. Premier also seeks punitive damages in the
amount of Five Hundred Million Dollars ($500,000,000). Premier also seeks
injunctive relief barring the Company and Leasecomm from making demand on or
commencing court action to collect on the Policy.
On February 22, 2000, Leasecomm removed this case to federal court for the
Northern District of Georgia. The parties have filed various motions with the
Court, which will be heard over the next several months. Among the Company's and
Leasecomm's motions, are motions to dismiss the Premier Complaint, or,
alternatively, to transfer this case to federal court in Massachusetts; and, a
motion for preliminary injunction regarding the Sentinel Complaint, seeking an
order requiring Sentinel, Premier and Del Piano to turn over to the Company any
collateral in their possession or to which the Company and Leasecomm may be
entitled as a result of both Premier's and Sentinel's defaults under the Loan
and the Policy, respectively.
Since this matter is in an early stage, there can be no assurance as to its
eventual outcome.
V. On April 3, 2000 a purported class action suit was filed in Superior
Court of the State of California, County of San Mateo against Leasecomm and
MicroFinancial as well as a number of other defendants with whom Leasecomm and
MicroFinancial are alleged to have done business, directly or indirectly.
The action is alleged as a "consumer fraud class action on behalf of
defrauded California small businesses and their owners, who were induced to
purchase services and/or goods from Defendants through false and misleading
representations and material omissions." More specifically, the complaint seeks
certification of a class of California persons and entities who purchased
services or goods from Internet Success Systems, Inc., Fortune Financial
Systems, Inc. (previously known as Fortune 21, Inc.), Fortune Financial Systems
of Nevada, Inc., MarketComm Production; Bizz-e Inc. (also known as Bizz-e.com,
Inc.), Cardservice International Inc. (also known as Cardservice Global
Solutions) or Power Communications, Inc., directly or indirectly, at any time
between February 7, 1997 and the present date. The complaint seeks certification
of a subclass of those class members who entered into any lease agreement
contracts with Leasecomm Corporation for the purposes of financing the goods or
services allegedly purchased from these other entities. The class action
complaint alleges ten causes of action for: (1) fraud and deceit; (2) negligent
misrepresentation; (3) violations of California's Business & Professions Code
ss.ss.17200 et seq. (unfair competition); (4) violations of California's
Business & Professions Code ss.ss.17500
20
21
et seq. (false advertising); (5) violations of California's Civil Code
ss.ss.1750 et seq. (Consumer Legal Remedies Act); (6) unjust enrichment; (7)
fraud in the inducement of contract; (8) fraud in the inception of contract; (9)
lack of consideration for contact; and (10) breach of the contractual covenant
of good faith and fair dealing.
The complaint prays for compensatory general and special damages according
to proof; restitution and disgorgement according to proof; rescission of class
member contracts with Leasecomm Corporation; injunctive relief against
enforcement of class member contracts with Leasecomm Corporation; prejudgment
interest; punitive and exemplary damages, costs, attorneys fees and such other
relief as the court deems just.
Since this matter is in an early stage, there can be no assurance as to its
eventual outcome.
21
22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
EXHIBIT DESCRIPTION OF EXHIBIT
- ------- ----------------------
10.1 Standard Terms and Condition of Indenture dated as of March 21, 2000
governing the MFI Finance Corp. I, 7.375% Lease-Backed Notes, Series
2000-1 (the "2000-1 Notes")
10.2 Supplement to Indenture dated March 21,2000 governing the 2000-1
Notes.
10.3 Specimen 2000-1 Note.
10.4 Standard Terms and Conditions of Servicing governing the 2000-1 Notes.
27 Financial Data Schedule
(b) Not Applicable
22
23
SIGNATURES
Pursuant to the requirements 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/ Peter R. Bleyleben
-----------------------------------------
President and Chief Executive Officer
By: /s/ Richard F. Latour
-----------------------------------------
Executive Vice President, Chief
Operating and Chief Financial Officer
Date: May 22, 2000
23