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 June 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 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 August 10, 2001, 12,819,946 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, 2000 and June 30, 2001 3 Condensed Consolidated Statements of Operations Three and six months ended June 30, 2000 and 2001 4 Condensed Consolidated Statements of Cash Flows Three and six months ended June 30, 2000 and 2001 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 16 Item 6 Exhibits and Reports on Form 8-K 20 Signatures 21 2 3 MICROFINANCIAL INCORPORATED CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share data) (Unaudited) December 31, June 30, ------------ --------- 2000 2001 ---- ---- ASSETS Net investment in leases and loans: Receivables due in installments $ 405,437 $ 401,977 Estimated residual value 35,368 37,859 Initial direct costs 9,321 8,561 Loans receivable 12,080 4,474 Less: Advance lease payments and deposits (400) (406) Unearned income (132,687) (121,485) Allowance for credit losses (40,924) (34,454) --------- --------- Net investment in leases and loans $ 288,195 $ 296,526 Investment in service contracts 12,553 13,103 Cash and cash equivalents 17,957 19,333 Property and equipment, net 11,505 20,313 Other assets 12,392 12,533 --------- --------- Total assets $ 342,602 $ 361,808 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Notes payable $ 201,991 $ 206,968 Subordinated notes payable 4,785 4,662 Capitalized lease obligations 859 944 Accounts payable 1,605 2,128 Dividends payable 573 640 Other liabilities 5,433 6,137 Income taxes payable 2,333 566 Deferred income taxes payable 29,000 33,776 --------- --------- Total liabilities 246,579 255,821 --------- --------- Commitments and contingencies -- -- Stockholders' equity: Preferred stock, $.01 par value; 5,000,000 shares authorized; 0 shares issued at 12/31/00; 0 shares issued at 6/30/01 -- -- Common stock, $.01 par value; 25,000,000 shares authorized; 13,410,646 shares issued at 12/31/00; 13,410,646 shares issued at 6/30/01 134 134 Additional paid-in capital 47,900 47,769 Retained earnings 55,291 64,676 Treasury stock (669,700 shares of common stock at 12/31/00, 603,938 shares of common stock at 6/30/01), at cost (7,234) (6,524) Notes receivable from officers and employees (68) (68) --------- --------- Total stockholders' equity 96,023 105,987 --------- --------- Total liabilities and stockholders' equity $ 342,602 $ 361,808 ========= ========= 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 three months ended For the six months ended June 30, June 30, -------------------------------- -------------------------------- 2000 2001 2000 2001 ---- ---- ---- ---- Revenues: Income on financing leases and loans $ 16,946 $ 18,060 $ 32,490 $ 36,791 Income on service contracts 2,183 2,099 4,373 4,234 Rental income 6,861 9,252 12,671 18,387 Loss and damage waiver fees and other 1,485 2,683 2,955 5,526 Service fees 3,467 3,682 7,094 7,633 -------------------------------- -------------------------------- Total revenues 30,942 35,776 59,583 72,571 -------------------------------- -------------------------------- Expenses: Selling general and administrative 6,839 8,105 13,168 17,709 Provision for credit losses 9,040 11,819 17,569 22,085 Depreciation and amortization 2,554 3,640 4,587 7,082 Interest 3,650 3,271 6,725 7,393 -------------------------------- -------------------------------- Total expenses 22,083 26,835 42,049 54,269 -------------------------------- -------------------------------- Income before provision for income taxes 8,859 8,941 17,534 18,302 Provision for income taxes 3,728 3,762 7,433 7,704 -------------------------------- -------------------------------- Net income $ 5,131 $ 5,179 $ 10,101 $ 10,598 ================================ ================================ Net income per common share - basic $ 0.40 $ 0.41 $ 0.79 $ 0.83 ================================ ================================ Net income per common share - diluted $ 0.40 $ 0.40 $ 0.78 $ 0.82 ================================ ================================ Weighted-average shares used to compute: Basic net income per share 12,707,898 12,759,548 12,748,238 12,750,299 -------------------------------- -------------------------------- Fully diluted net income per share 12,780,334 12,981,450 12,941,357 12,933,339 -------------------------------- -------------------------------- 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 three months ended For the six months ended June 30, June 30, ----------------------------- ----------------------------- 2000 2001 2000 2001 ---- ---- ---- ---- Cash flows from operating activities: Cash received from customers $ 43,941 $ 47,500 $ 85,828 $ 95,127 Cash paid to suppliers and employees (7,191) (13,423) (18,257) (23,459) Cash paid for income taxes (3,792) (4,572) (7,637) (4,708) Interest paid (3,862) (3,605) (6,959) (8,040) Interest received 406 365 771 769 ----------------------------- ----------------------------- Net cash provided by operating activities 29,502 26,265 53,746 59,689 ----------------------------- ----------------------------- Cash flows from investing activities: Investment in lease contracts (46,716) (24,813) (81,942) (48,651) Investment in direct costs (2,162) (1,399) (4,682) (2,883) Investment in service contracts (1,054) (1,631) (2,368) (2,959) Investment in Resource Leasing Corporation 0 0 0 (6,900) Investment in fixed assets (722) (432) (1,121) (857) Repayment of notes from officers 1 0 3 0 Investment in notes receivable (39) (24) (70) (47) Repayment of notes receivable 23 2 262 6 ----------------------------- ----------------------------- Net cash used in investing activities (50,669) (28,297) (89,918) (62,291) ----------------------------- ----------------------------- Cash flows from financing activities: Proceeds from secured debt 51,764 22,473 115,382 57,852 Repayment of secured debt (26,410) (22,565) (51,309) (53,689) Proceeds from refinancing of secured debt 92,000 104,500 233,557 209,000 Prepayment of secured debt (92,000) (104,500) (248,557) (209,000) Proceeds from short term demand notes payable 0 889 144 889 Repayment of short term demand notes payable (47) (75) (446) (75) Proceeds from issuance of subordinated debt 0 1,075 0 2,875 Repayment of subordinated debt (1,000) 0 (2,000) (3,000) Proceeds from exercise of common stock options 0 529 49 529 Repayment of capital leases (118) (116) (257) (256) Purchase of treasury stock (50) 0 (1,595) 0 Payment of dividends (508) (574) (1,022) (1,147) ----------------------------- ----------------------------- Net cash provided by financing activities 23,631 1,636 43,946 3,978 ----------------------------- ----------------------------- Net increase in cash and cash equivalents: 2,464 (396) 7,774 1,376 Cash and cash equivalents, beginning of period: 16,372 19,729 11,062 17,957 ----------------------------- ----------------------------- Cash and cash equivalents, end of period: $ 18,836 $ 19,333 $ 18,836 $ 19,333 ============================= ============================= (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 three months ended For the six months ended June 30, June 30, --------------------------- --------------------------- 2000 2001 2000 2001 ---- ---- ---- ---- Reconciliation of net income to net cash provided by operating activities: Net Income $ 5,131 $ 5,179 $ 10,101 $ 10,598 Adjustments to reconcile net income to cash provided by operating activities Depreciation and amortization 2,554 3,640 4,587 7,082 Provision for credit losses 9,040 11,819 17,569 22,085 Recovery of equipment cost and residual value, net of revenue recognized 12,031 7,039 22,824 16,306 Decrease in current taxes (40) (1,647) (159) (1,767) Increase in deferred income taxes 78 837 232 4,776 Change in assets and liabilities: Decrease (increase) in other assets 379 (9) (1,594) 92 (Decrease) increase in accounts payable 362 (683) 230 (518) Increase (decrease) in accrued liabilities (33) 90 (44) 1,035 --------------------------- --------------------------- Net cash provided by operating activities $ 29,502 $ 26,265 $ 53,746 $ 59,689 =========================== =========================== Supplemental disclosure of noncash activities: Property acquired under capital leases $ 71 $ 0 $ 71 $ 341 Accrual of common stock dividends $ 572 $ 640 $ 572 $ 640 (Concluded) 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 commercial finance company that primarily leases and rents "microticket" equipment and provides other financing services in amounts generally ranging from $400 to $3,000 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 condensed 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, 2000. The results for the six-month period ended June 30, 2001 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2001. The balance sheet at December 31, 2000 has been derived from the audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. 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 current economic conditions and the nature and characteristics 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, 1999, 2000 and June 30, 2001 and the related provision, charge-offs and recoveries for the year ended December 31, 2000 and the six months ended June 30, 2001. 7 8 MICROFINANCIAL INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except share and per share data) (Unaudited) Balance at December 31, 1999 $41,719 Provision for credit losses 36,029 Provision for other asset credit losses 2,883 ------- Total provisions for credit losses 38,912 Charge-offs (including $1,064 in other asset charge-offs) 57,145 Recoveries 19,257 ------- Charge-offs, net of recoveries 37,888 ------- 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 credit losses 22,085 Provision for other asset credit losses 0 ------- Total provisions for credit losses 22,085 Charge-offs (including $27 in other asset charge-offs) 38,921 Recoveries 10,339 ------- Charge-offs, net of recoveries 28,582 ------- Balance of allowance for credit losses at June 30, 2001 $34,454 ======= Balance of other asset reserve at June 30, 2001 $ 1,792 ======= At December 31, 2000 and June 30, 2001, other assets included prepayments and deposits of $6,394,000 and $3,519,000 respectively, and receivables totaling $7,817,000 and $10,806,000, respectively. The other asset reserve reflects management's judgement of loss potential considering current economic conditions and the nature of the underlying receivables. 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 830,000 and 40,609 shares of common stock were not included in the computation of diluted earnings per share for the three months ended June 30, 2000 and 2001 respectively because their effects were antidilutive. Options to purchase 832,637 and 393,384 shares of common stock were not included in the computation of diluted earnings per share for the six months ended June 30, 2000 and 2001 respectively because their effects were antidilutive. 8 9 MICROFINANCIAL INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except share and per share data) (Unaudited) For three months ended For six months ended June 30, June 30, -------------------------------- -------------------------------- 2000 2001 2000 2001 ---- ---- ---- ---- Net Income $ 5,131 $ 5,179 $ 10,101 $ 10,598 Shares used in computation: Weighted average common shares outstanding used in computation of net income per common share 12,707,898 12,759,548 12,748,238 12,750,299 Dilutive effect of common stock options 72,437 221,902 193,119 183,040 Shares used in computation of net income per common share - assuming dilution 12,780,335 12,981,450 12,941,357 12,933,339 -------------------------------- -------------------------------- Net income per common share $ 0.40 $ 0.41 $ 0.79 $ 0.83 Net income per common share assuming dilution $ 0.40 $ 0.40 $ 0.78 $ 0.82 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, loans, rentals and service contracts. On August 22, 2000, the revolving line of credit and term loan facility was amended and restated where by the Company may now borrow a maximum of $192,000,000 based upon qualified lease receivables, loans, rentals and service contracts. Outstanding borrowings with respect to the revolving line of credit bear interest based at Prime minus 0.25% for Prime Rate Loans, 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. 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 $10 million. The prime rates at December 31, 2000, and June 30, 2001 were 9.50% and 6.75% respectively. The 90-day LIBOR rates December 31, 2000, and June 30, 2001 were 6.403% and 3.71%, respectively. The 7-day Money Market rates December 31, 2000, and June 30, 2001 were 6.63% and 4.13%, respectively. The Company had borrowings outstanding under these agreements with the following terms: December 31, 2000 June 30, 2001 -------------------- ------------------- Type Rate Amount Rate Amount - ---- ---- ------- ---- ------ (in thousands) (in thousands) Prime 9.2500% $ 17,260 6.5000% $ 25,137 Swing Line 8.8100% 5,076 LIBOR 8.2500% 12,000 5.5625% 87,000 LIBOR 8.5625% 17,500 6.5625% 17,500 LIBOR 8.2500% 50,000 -------- -------- Total Outstanding $101,836 $129,637 ======== ======== 9 10 MICROFINANCIAL INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except share and per share data) (Unaudited) Outstanding borrowings are collateralized by leases, loans, rentals 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, 2002 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, rentals 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 one series of notes outstanding, the 1998-A Notes. In November 1998, BLT III issued the 1998-A Notes in aggregate principal amount of $40,769,000. MFI I has two series of notes outstanding, the 2000-1 Notes and the 2000-2 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. Outstanding borrowings are collateralized by a specific pool of lease receivables. At December 31, 2000 and June 30, 2001, BLT III and MFI I had borrowings outstanding under the series of notes with the following terms: December 31, 2000 June 30, 2001 -------------------- ------------------- Series Rate Amount Rate Amount - ------ ---- ------- ---- ------ (in thousands) (in thousands) BLT III 1998-A Notes 6.0300% $12,252 6.0300% $ 5,239 MFI I 2000-1 Notes 7.3750% 36,995 7.3750% 28,278 2000-2 Notes 6.9390% 50,562 6.9390% 42,654 ------- ------- Total Outstanding $99,809 $76,171 ======= ======= The Company also had other notes payable which totaled $346,000 and $271,000 at December 31, 2000 and June 30, 2001, respectively. The notes are due on demand and bear interest at a rate of prime minus 1.00%. The Company also borrowed $889,000 against the cash surrender value of the life insurance policies held on key officers. The interest rates on these loans range from 5.05% to 8.00%. 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 400,000 options during the six months ended June 30, 2001. A total of 1,816,238 options were outstanding at June 30, 2001 of which 444,238 were vested. Dividends: On June 18, 2001 the Company's Board of Directors approved a dividend of $.050 per common share for all outstanding common shares as of June 29, 2001 which was paid on July 13, 2001. Acquisition of Resource Leasing Corporation: On January 3, 2001, the Company acquired the rental and lease portfolio, along with certain other assets and assumed certain liabilities of Resource Leasing Corporation ("Resource"), for $10,700,000 subject to a $1,000,000 holdback on deliverables in connection with certain software included in the acquired assets. In December 2000, the 10 11 MICROFINANCIAL INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except share and per share data) (Unaudited) Company made a prepayment on that purchase of $2,800,000 which was reflected in other assets at December 31, 2000. The remaining $6,900,000 was paid on January 3, 2001. This transaction was accounted for under the purchase method of accounting, and accordingly, the results of operations of Resource, for the period from the acquisition date, are included in the consolidated financial statements. The purchase price was allocated to the assets purchased and liabilities assumed based on fair values at the date of acquisition and did not result in the recording of excess costs over the fair value of assets acquired. Since the acquisition did not have a material impact on the Company's consolidated financial statements, and Resource does not meet the quantitative thresholds for disclosure as a separate operating segment, segment reporting as required under Statement of Financial Accounting Standards No. 131, is not applicable. New Accounting Pronouncements: In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations"("SFAS No. 141"). SFAS No. 141 addresses financial accounting and reporting for business combinations and amends or supercedes a number of interpretations concerning business combinations. SFAS No. 141 requires companies to use the purchase method of accounting for all business combinations, whereas previous interpretations provided for the use of another method (pooling of interests method) if certain criteria were met. This statement also amends the recognition policies of intangible assets and goodwill and provides for additional disclosure requirements for business combinations. The provisions for this statement apply to all business combinations initiated after June 30, 2001. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"("SFAS No. 142"). This statement supercedes APB Opinion No. 17, "Intangible Assets"("APB No. 17") and addresses financial accounting and reporting for intangible assets, but not those acquired in a business combination at acquisition. SFAS No. 142 addresses financial accounting and reporting of goodwill and other intangible assets subsequent to their acquisition, assigning a definite or indefinite useful life to these assets. Goodwill and other intangible assets having an indefinite useful life will not be amortized, but rather tested at least annually for impairment. It also provides guidance on how to define, measure and record impairment losses on goodwill and other intangible assets and provides for additional disclosures regarding these assets in years subsequent to their acquisition. The provisions for this statement are required to be applied for fiscal years beginning after December 15, 2001, although earlier adoption is permitted. The Company has not completed its evaluation of SFAS No. 141 and SFAS No. 142 and has not yet determined their effect on it's consolidated financial statements. Reclassification of Prior Year Balances: Certain reclassifications have been made to prior years' consolidated financial statements to conform to the current presentation. Commitments and Contingencies: Please refer to Part II Other Information, Item 1 Legal Proceedings for information about pending litigation of the Company. 11 12 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Three months ended June 30, 2001 as compared to the three months ended June 30, 2000. Net income for the three months ended June 30, 2001 was approximately $5.2 million, an increase of $48,000 or 1% from the three months ended June 30, 2000. This represents diluted earnings per share for the three months ended June 30, 2001 of $0.40 per share on weighted average outstanding shares of 12,981,450 as compared to $0.40 per share on weighted average outstanding shares of 12,780,334 for the three months ended June 30, 2000. Total revenues for the three months ended June 30, 2001 were $35.8 million, an increase of $4.8 million, or 16%, from the three months ended June 30, 2000. The increase was primarily due to an increase of $1.1 million, or 7%, in income on financing leases, $2.3 million, or 26%, in rental and service contract income, and $1.4 million, or 29% in fee and other income. The increase in income on financing leases and loans was due to the increased number of leases originated. 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 an increase in the rental business originated through our Resource Leasing division. The increase in fee income and other income is the result of increased fees from the lessees related to the collection and legal process employed by the Company, and the addition of a new line of business of selling new and refurbished equipment. Selling, general and administrative expenses increased by $1.3 or 19%, for the three months ended June 30, 2001, as compared to the three months ended June 30, 2000. Compensation and personnel related expenses increased by $900,000 or 24%, due to an increase in overall compensation levels and an increase in the number of employees needed to maintain the Company's portfolio, including the addition of the personnel employed by Resource Leasing Corporation. Also, cost of goods sold increased by $900,000, or 100%, due to the Company's acquisition of Resource Leasing Corporation, and the addition of a new line of business of selling new and refurbished equipment. Depreciation and amortization increased by $1.1 million, or 43%, due to the increased number of rental contracts, including the addition of the Resource Leasing portfolio of rental contracts, and amortization of the Company's investment in service contracts. The Company's provision for credit losses increased by $2.8 million or 31%, for the three months ended June 30, 2001 as compared to the three months ended June 30, 2000. 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 reflects management's judgement of loss potential considering current economic conditions and the nature of the underlying receivables. Total revenues increased by $4.8 million, or 16% for the three months ended June 30, 2001 as compared to the three months ended June 30, 2000. Net interest expense decreased by $380,000, or 10%, for the three months ended June 30, 2001 as compared to the three months ended June 30, 2000. This decrease resulted primarily from the Company's declining cost of funds, offset by an increased level of borrowings on its revolving line of credit. Dealer fundings were $27.4 million for the three months ended June 30, 2001, down $19.9 million, or 42% as compared to the three months ended June 30, 2000. This decrease is a result of the Company's decision during the second quarter of 2000 to increase pricing and tighten its credit approval standards. The new credit policies were put into place in August of 2000. This is an ongoing effort, and is expected to continue going forward. Total cash from customers increased by $3.6 million or 8% to a total of $47.5 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 down from $465.4 million in December of 2000 to $457.4 million in June of 2001, representing a 2% decrease. 12 13 Six months ended June 30, 2001 as compared to the six months ended June 30, 2000. Net income for the six months ended June 30, 2001 was approximately $10.6 million, an increase of $500,000 or 5% from the six months ended June 30, 2000. This represents diluted earnings per share for the six months ended June 30, 2001 of $0.82 per share on weighted average outstanding shares of 12,933,339 as compared to $0.78 per share on weighted average outstanding shares of 12,941,357 for the six months ended June 30, 2000. Total revenues for the six months ended June 30, 2001 were $72.6 million, an increase of $13.0 million, or 22%, from the six months ended June 30, 2000. The increase was primarily due to an increase of $4.3 million, or 13%, in income on financing leases and loans, $5.6 million, or 33%, in rental and service contract income, and $3.1 million, 31% in fee and other income. The increase in income on financing leases and loans was due to the increased number of leases originated. 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 acquisition of the rental portfolio of Resource Leasing Corporation. The increase in fee income and other income is the result of increased fees from the lessees related to the collection and legal process employed by the Company, and the addition of a new line of business of selling new and refurbished equipment out of existing inventory. Selling, general and administrative expenses increased by $4.5 or 34%, for the six months ended June 30, 2001, as compared to the six months ended June 30, 2000. Compensation and personnel related expenses increased by $2.7 million or 36%, due to an increase in overall compensation levels and an increase in the number of employees needed to maintain the Company's portfolio, including the addition of the personnel employed by Resource Leasing Corporation. Also, cost of goods sold increased by $1.8 million, or 100%, due to the Company's acquisition of the assets of Resource Leasing Corporation, and the addition of a new line of business of selling new and refurbished equipment. Depreciation and amortization increased by $2.5 million, or 54%, due to the increased number of rental contracts, including the addition of the Resource Leasing portfolio of rental contracts, and amortization of the Company's investment in service contracts. The Company's provision for credit losses increased by $4.5 million or 26%, for the six months ended June 30, 2001 as compared to the six months ended June 30, 2000. 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 reflects management's judgement of loss potential considering current economic conditions and the nature of the underlying receivables. Net interest expense increased by $670,000, or 10%, for the six months ended June 30, 2001 as compared to the six months ended June 30, 2000. This increase resulted primarily from the Company's increased level of borrowings on its revolving line of credit, offset by a lower cost of funds. Dealer fundings were $61.3 million for the six months ended June 30, 2001, down $23.3 million, or 28% as compared to the six months ended June 30, 2000. This decrease is a result of the Company's decision during the second quarter of 2000 to increase pricing and tighten its credit approval standards. The new credit policies were put into place in August of 2000. This is an ongoing effort, and is expected to continue going forward. Total cash from customers increased by $9.3 million or 11% to a total of $95.1 million. This increase is primarily the result of an increase in the size of the overall portfolio. 13 14 EXPOSURE TO CREDIT LOSSES The following table sets forth certain information as of December 31, 1999 and 2000 and June 30, 2001 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 As of December 31 June 30 ----------- ------- 1999 2000 2001 ---- ---- ---- Cumulative amounts billed (in thousands) $ 380,380 $ 462,011 $ 506,760 31-60 days past due 1.7% 1.9% 2.1% 61-90 days past due 1.3% 1.6% 1.7% over 90 days past due 7.4% 10.0% 13.1% ---------- ---------- ---------- Total past due 10.4% 13.5% 16.9% ========== ========== ========== 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, rentals 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, rentals 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, rentals and service contracts that satisfy the eligibility requirements established pursuant to each facility. All balances under the revolving line of credit will be automatically converted to a term loan on September 30, 2002 provided the line of credit is not renewed and no event of default exists at that date. At June 30, 2001, the Company had an aggregate maximum of $192 million available for borrowing under its credit facility, of which approximately $129.6 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. 14 15 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. 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. 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 The implicit yield to the Company on all of its leases, loans, rentals and service contracts is on a fixed interest rate basis due to the leases, loans, rentals and service contracts having scheduled payments that are fixed at the time of origination of the lease, loan, rentals 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, rentals and service contracts, the Company's goal is to maintain a blend of fixed and variable interest rate obligations. As of June 30, 2001, the Company's outstanding fixed rate indebtedness, including indebtedness outstanding under the Company's securitizations, represented 37.0% of the Company's outstanding indebtedness. 15 16 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company has filed answers denying the allegations included in each of the lawsuits described below. The first two (2) actions described below have been filed by the same attorney, on behalf of various plaintiffs. The Company is vigorously defending each of the allegations, but is unable to predict with certainty the ultimate outcome of the proceedings. 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") (as amended, the "Clark Complaint"). The purported class would be limited to 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"), and that, among other things, have been sued in a Massachusetts court for breach of the Lease Agreements. 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's because of Leasecomm's greater bargaining power, and purported class members allegedly have valid defenses to the claims asserted against them by Leasecomm. On August 16, 2000, the Court granted the Company's motion to dismiss, resulting in the dismissal of all claims against the Company. The Court also granted Leasecomm's motion to dismiss as to all of the plaintiffs' individual claims, and as to all but one of the plaintiffs' purported class claims. As a result, the only claim that remains is a purported class claim against Leasecomm by plaintiffs against whom Leasecomm has a pending Massachusetts action, for alleged violations of Chapter 93A of the Massachusetts General Laws arising out of the inclusion of a forum selection clause in Leasecomm leases. As to this claim, the plaintiffs are seeking no monetary relief beyond attorneys' fees. The plaintiffs filed a revised motion for class certification in light of the Court's prior rulings. The Company has filed an opposition to the revised motion for class certification, which was heard by the Court on May 16, 2001. The Company is awaiting the decision of the Court. 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 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. 16 17 By Memorandum and Order dated July 11, 2001, the Court denied plaintiffs motion for class certification in all respects, effectively limiting the pending action to the claims of the individual named plaintiffs. III.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 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 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. Leasecomm filed a motion to dismiss the Premier Complaint, or, alternatively, to transfer this case to federal court in Massachusetts. Leasecomm's motion was granted on July 27, 2000, and the case was transferred to the District of Massachusetts, where it has been consolidated with the Massachusetts action. The parties have reached a settlement whereby the defendant Sentinel was to pay the Company a sum of money on or before May 25, 2001, or, alternatively, judgment for the full amount of $14,000,000 is to be entered against Sentinel, and the Company may also pursue its claims against other defendants. Pursuant thereto judgment has been entered against Sentinel in the amount of $14,000,000. In addition, the Provisional Liquidator of Sentinel, appointed pursuant to an order of the Supreme Court of Bermuda, has agreed to allow MicroFinancial's claim against Sentinel in that amount. The amount, if any, which may be paid to the Company pursuant to this allowed claim is dependent entirely upon the value of the Sentinel assets recovered by the Provisional Liquidator. MicroFinancial is continuing to pursue its claims against the other defendants, and has expanded these claims to include fraud claims. IV. On or about April 30, 2001, 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 June 22, 2001 (as amended, the "Grant Complaint"). The purported class consists of all persons who are not residents of Massachusetts who entered into a lease agreement with Leasecomm after April 30, 1997, and who were sued by Leasecomm in Massachusetts courts for defaults under the Lease Agreements. The Grant Complaint was filed by the same attorney who previously filed the McKenzie-Pollock complaint (reported in the Company's earlier filings), and closely tracks the amended complaint in that case. On February 7, 2001, the McKenzie-Pollock case was dismissed with prejudice by agreement of the parties, with no money having been paid by the Company. The Grant Complaint alleges: that Leasecomm causes individuals to enter into non-cancelable, long-term leases when there is no reasonable expectation that most of the individuals would need or use the equipment for the 17 18 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 disclaims warranties that it allegedly cannot disclaim; 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; 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; unspecified statutory penalties; a declaration that the Lease Agreements are void, and return of all moneys paid to Leasecomm; an accounting and reimbursement of alleged excessive interest charges; and restitutionary damages for unjust enrichment. On July 16, 2001, Leasecomm filed a motion to dismiss all counts of the Grant Complaint. Plaintiffs' Opposition is due on or about July 26, 2001. Since this matter is in an early stage, there can be no assurance as to its eventual outcome. V. On or about September 19, 2000, Leasecomm was served with a Subpoena Duces Tecum from the Office of the Attorney General of the State of Florida. The nature of the proceeding, if any, against Leasecomm is unclear at this time, but appears to relate to alleged complaints against Leasecomm by lessees in Florida and involves the question of whether any of the leases entered into by Leasecomm with Florida residents is a consumer lease. Leasecomm believes that the commercial leases it has entered into are in fact commercial leases, and is attempting to cooperate with the Attorney General's Office on this matter. Leasecomm has responded to the subpoena and provided documents. Since this matter is at an early stage, and the nature of the proceedings against Leasecomm, if any, are not known, there can be no assurance as to its eventual outcome. VI. On or about May 28, 2001, Leasecomm and the Company were served with Civil Investigative Demands from the Office of the Attorney General of the Commonwealth of Massachusetts which requested the production of documents. The Civil Investigative Demands were issued by the Office of the Attorney General, Consumer Protection and Anti-Trust Division, pursuant to M.G.L. c. 93A, ss. 6, in connection with an investigation of potentially unfair or deceptive acts or practices relating to the sale, solicitation and marketing of lease agreements and the billing and collection procedures to secure payment pursuant to said lease agreements. Leasecomm and the Company have provided responsive documents and are cooperating in the investigation. Because the investigation is ongoing and has not come to a conclusion, no specific allegations have been asserted as to which a response may be made. Since this matter is at an early stage, and the nature of the proceedings against Leasecomm or the Company, if any, are not known, there can be no assurance as to its eventual outcome. VII. 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 18 19 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 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. On May 31, 2000, Leasecomm filed a motion for an order staying all litigation in California against Leasecomm Corporation and MicroFinancial Incorporated on the grounds that the lease contracts at issue contained a forum selection clause providing that any litigation concerning the leases would be brought in Massachusetts where Leasecomm Corporation is headquartered. By order dated August 22, 2000, the Court granted that motion and stayed further litigation in the California proceedings against Leasecomm Corporation and MicroFinancial Incorporated. On September 27, 2000, plaintiffs filed an appeal seeking to overturn that ruling. Plaintiffs filed their appeal brief on December 29, 2000, and Leasecomm filed a response on January 29, 2001. On July 16, 2001, the parties entered into a letter of intent to settle the class action litigation. The letter of intent must be reduced to a stipulation of settlement and will be effective only if and when the stipulation of settlement is approved by the San Mateo Superior Court as fair and reasonable to the members of the plaintiff class and as a good faith settlement pursuant to Section 877.6 of the California Code of Civil Procedure. It is unclear at this point how long this process will take. The hearing on the appeal filed by the plaintiffs has been continued until December 18, 2001, while the parties pursue approval of the proposed settlement. 19 20 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit Index None (b) Not Applicable 20 21 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: August 14, 2001 21