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, 2002
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
Incorporation or Organization) Identification No.)
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 3, 2002, 12,821,946 shares of the registrant's common stock were
outstanding.
MICROFINANCIAL INCORPORATED
TABLE OF CONTENTS
Page
Part I FINANCIAL INFORMATION
Item 1 Financial Statements (unaudited):
Condensed Consolidated Balance Sheets
December 31, 2001 and March 31, 2002 3
Condensed Consolidated Statements of Operations
Three months ended March 31, 2001 and 2002 4
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 2001 and 2002 5
Notes to Condensed Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 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 17
Signatures 20
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
December 31, March 31,
2001 2002
--------- ---------
ASSETS
Net investment in leases and loans:
Receivables due in installments $ 399,361 $ 389,843
Estimated residual value 37,114 36,202
Initial direct costs 7,090 6,755
Loans receivable 2,248 2,152
Less:
Advance lease payments and deposits (287) (269)
Unearned income (104,538) (96,481)
Allowance for credit losses (45,026) (44,745)
--------- ---------
Net investment in leases and loans $ 295,962 $ 293,457
Investment in service contracts 14,126 15,006
Cash and cash equivalents 20,645 22,047
Property and equipment, net 16,034 15,034
Other assets 14,961 15,606
--------- ---------
Total assets $ 361,728 $ 361,150
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable $ 203,053 $ 198,050
Subordinated notes payable 3,262 3,262
Capitalized lease obligations 833 732
Accounts payable 2,517 2,501
Dividends payable 642 641
Other liabilities 6,182 6,984
Income taxes payable 4,211 3,223
Deferred income taxes payable 30,472 32,617
--------- ---------
Total liabilities
251,172 248,010
--------- ---------
Commitments and contingencies -- --
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized;
no shares issued at 12/31/02 and 3/31/02 -- --
Common stock, $.01 par value; 25,000,000 shares authorized;
13,410,646 shares issued at 12/31/01 and 3/31/02 134 134
Additional paid-in capital 47,723 47,723
Retained earnings 69,110 71,684
Treasury stock (588,700 shares of common stock at 12/31/01,
588,700 shares of common stock at 3/31/02), at cost (6,343) (6,343)
Notes receivable from officers and employees (68) (58)
--------- ---------
Total stockholders' equity 110,556 113,140
--------- ---------
Total liabilities and stockholders' equity $ 361,728 $ 361,150
========= =========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
For the three months ended
March 31,
2001 2002
---------- ----------
Revenues:
Income on financing leases and loans $ 18,731 $ 15,235
Income on service contracts 2,135 2,395
Rental income 9,135 9,863
Loss and damage waiver fees 1,580 1,526
Service fees and other 7,761 6,266
---------- ----------
Total revenues 39,342 35,285
---------- ----------
Expenses:
Selling general and administrative 11,903 12,574
Provision for credit losses 10,266 10,964
Depreciation and amortization 3,442 3,639
Interest 4,370 2,747
---------- ----------
Total expenses 29,981 29,924
---------- ----------
Income before provision for income taxes 9,361 5,361
Provision for income taxes 3,942 2,145
---------- ----------
Net income $ 5,419 $ 3,216
=========== ===========
Net income per common share - basic $ 0.43 $ 0.25
=========== ===========
Net income per common share - diluted $ 0.42 $ 0.25
=========== ===========
Weighted-average shares used to compute:
Basic net income per share 12,740,946 12,821,946
---------- ----------
Fully diluted net income per share 12,940,094 12,853,061
---------- ----------
The accompanying notes are an integral part of the condensed consolidated
financial statements
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
For the three months ended
March 31,
2001 2002
--------- ---------
Cash flows from operating activities:
Cash received from customers $ 47,627 $ 46,729
Cash paid to suppliers and employees (9,286) (11,642)
Cash paid for income taxes (136) (988)
Interest paid (4,435) (2,310)
Interest received 404 154
--------- ---------
Net cash provided by operating activities 34,174 31,943
--------- ---------
Cash flows from investing activities:
Investment in lease contracts (23,838) (20,027)
Investment in inventory (750) (1,018)
Investment in direct costs (1,484) (1,296)
Investment in service contracts (1,328) (2,326)
Investment in Resource Leasing Corporation (6,900) 0
Investment in fixed assets (425) (138)
Repayment of notes from officers 0 10
Investment in notes receivable (23) 0
Repayment of notes receivable 4 0
--------- ---------
Net cash used in investing activities (34,744) (24,795)
--------- ---------
Cash flows from financing activities:
Proceeds from secured debt 35,379 9,300
Repayment of secured debt (31,124) (14,218)
Proceeds from refinancing of secured debt 104,500 120,000
Prepayment of secured debt (104,500) (120,000)
Proceeds from short term demand notes payable 0 (85)
Proceeds from issuance of subordinated debt 1,800 0
Repayment of subordinated debt (3,000) 0
Repayment of capital leases (140) (101)
Payment of dividends (573) (642)
--------- ---------
Net cash provided by financing activities 2,342 (5,746)
--------- ---------
Net increase in cash and cash equivalents: 1,772 1,402
Cash and cash equivalents, beginning of period 17,957 20,645
--------- ---------
Cash and cash equivalents, end of period $ 19,729 $ 22,047
========= =========
(continued on following page)
The accompanying notes are an integral part of the consolidated
financial statements.
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Continued)
(Unaudited)
For the three months ended
March 31,
--------------------------
2001 2002
-------- --------
Reconciliation of net income to net cash
provided by operating activities:
Net income $ 5,419 $ 3,216
Adjustments to reconcile net income to cash
provided by operating activities
Depreciation and amortization 3,442 3,639
Provision for credit losses 10,266 10,964
Recovery of equipment cost and residual value,
net of revenue recognized 10,017 12,203
Decrease in current taxes (121) (988)
Increase in deferred income taxes 3,939 2,145
Change in assets and liabilities:
Decrease in other assets 101 416
Increase (decrease) in accounts payable 165 (16)
Increase in accrued liabilities 946 364
-------- --------
Net cash provided by operating activities $ 34,174 $ 31,943
======== ========
Supplemental disclosure of noncash activities:
Property acquired under capital leases $ 341 $ 0
Accrual of common stock dividends $ 573 $ 641
(Concluded)
The accompanying notes are an integral part of the consolidated
financial statements.
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 $1,100 and
an average lease term of 43 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 accounting principles generally accepted in the
United States of America 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, 2001.
The results for the three-month period ended March 31, 2002 are not necessarily
indicative of the results that may be expected for the full year ended December
31, 2002.
The balance sheet at December 31, 2001 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, 2001.
Allowance for Credit Losses:
The Company maintains an allowance for estimated credit losses on its
investment in leases, loans, rental contracts 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, rental contracts and service contracts.
The following table sets forth the Company's allowance for credit losses as
of December 31, 2001 and March 31, 2002 and the related provision, charge-offs
and recoveries for the year ended December 31, 2001 and the three months ended
March 31, 2002.
MICROFINANCIAL INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tables in thousands, except share and per share data)
(Unaudited)
Balance of allowance for credit losses at December 31, 2001 $45,026
=======
Balance of other asset reserve at December 31, 2001 $ 401
=======
Provision for credit losses 10,964
Provision for other asset credit losses 0
-------
Total provisions for credit losses 10,964
Charge-offs (including $31 in other asset charge-offs) 14,686
Recoveries 3,410
-------
Charge-offs, net of recoveries 11,276
-------
Balance of allowance for credit losses at March 31, 2002 $44,745
=======
Balance of other asset reserve at March 31, 2002 $370
=======
At December 31, 2001 and March 31, 2002, other assets included prepayments
and deposits of $4,809,000 and $4,393,000, respectively, and receivables
totaling $10,553,000 and $11,583,000, respectively. The other asset reserve
reflects management's judgement of loss potential considering current economic
conditions and the nature of the underlying assets.
Earnings 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. 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 520,609 and 1,936,000 shares of
common stock were not included in the computation of diluted earnings per share
for the three months ended March 31, 2001 and the three months ended March 31,
2002, respectively, because their effects were antidilutive.
For three months ended
March 31,
---------------------------
2001 2002
----------- -----------
Net income $ 5,419 $ 3,216
Shares used in computation:
Weighted-average common shares
outstanding used in computation
of net income per common share 12,740,946 12,821,946
Dilutive effect of common stock
options 199,148 31,115
Shares used in computation of net
income per common share -
assuming dilution 12,940,094 12,853,061
----------- -----------
Net income per common share $ 0.43 $ 0.25
Net income per common share
assuming dilution $ 0.42 $ 0.25
MICROFINANCIAL INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tables in thousands, except share and per share data)
(Unaudited)
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 seven-day maturity and upon their maturity they automatically
convert into prime rate loans. In addition, the Company's aggregate outstanding
principal amount of Swing Line advances shall not exceed $10 million. The prime
rate at December 31, 2001, and March 31, 2002 was 4.75%. The 90-day LIBOR rates
December 31, 2001, and March 31, 2002 were 1.9380% and 2.0375%, respectively.
The 7-day Money Market rates December 31, 2001, and March 31, 2002 were 1.88%
and 1.80%, respectively.
The Company had borrowings outstanding under these agreements with the following
terms:
December 31, 2001 March 31, 2002
----------------------- -----------------------
Type Rate Amount Rate Amount
---- ---- ------ ---- ------
(in thousands) (in thousands)
Prime 4.5000% $4,640 4.5000% $13,940
LIBOR 3.8750% 100,000 3.6250% 30,000
LIBOR 3.6875% 20,000
LIBOR 3.7500% 50,000
-------- --------
Total Outstanding $104,640 $113,940
======== ========
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.
MFI I has three series of notes outstanding, the 2000-1 Notes, the 2000-2
Notes, and the 2001-3 Notes. In March 2000, MFI I issued the 2000-1 Notes in
aggregate principal amount of $50,056,686. In December 2000, MFI I issued the
2000-2 Notes in aggregate principal amount of $50,561,633. In September 2001,
MFI I issued the 2001-3 Notes in aggregate principal amount of $39,397,354.
Outstanding borrowings are collateralized by a specific pool of lease
receivables. In September 2001, MFI II, LLC was formed and issued one series of
notes, the 2001-1 Notes in aggregate principal amount of $10,000,000.
Outstanding borrowings are collateralized by a specific pool of lease
receivables as well as the excess cash flow from the MFI I collateral. These
notes are subordinate to the three series of notes issued by MFI I.
MICROFINANCIAL INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tables in thousands, except share and per share data)
(Unaudited)
At December 31, 2001 and March 31, 2002, MFI I and MFI II had borrowings
outstanding under the series of notes with the following terms:
December 31, 2001 March 31, 2002
-------------------------- --------------------------
Series Rate Amount Rate Amount
- ------ ---- ------- ---- ------
(in thousands) (in thousands)
MFI I
2000-1 Notes 7.3750% 19,855 7.3750% 15,879
2000-2 Notes 6.9390% 34,518 6.9390% 30,391
2001-3 Notes 5.5800% 34,160 5.5800% 29,320
MFI II LLC
2001-1 Notes 8.0000% 8,725 8.0000% 7,450
------- -------
Total Outstanding $97,258 $83,040
======= =======
At December 31, 2001 and March 31, 2002, the Company also had other notes
payable which totaled $1,155,000 and $1,070,000 respectively. Of these notes, at
December 2001 and March 31, 2002, $339,000 and $254,000, respectively, are notes
that are due on demand and bear interest at a rate of prime less 1.00%. At
December 31, 2001 and March 31, 2002, the Company also had $816,000 of notes
which were borrowed 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 4,120,380 shares of the Company's
common stock for issuance pursuant to the 1998 Plan. The Company granted a total
of 520,000 options and a total of 100,000 options were surrendered during the
three months ended March 31, 2002. A total of 2,456,000 options were outstanding
at March 31, 2002 of which 756,000 were vested.
Dividends:
On March 18, 2002 the Company's Board of Directors approved a dividend of
$.050 per common share for all outstanding common shares as of March 29, 2002
which was paid on April 15, 2002.
New Accounting Pronouncements:
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 142, "Goodwill and Other Intangible Assets". This Statement supersedes
APB Opinion No. 17, "Intangible Assets" 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
determined that the adoption of this Statement does not have a material impact
on its results of operations or consolidated financial position.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 provides new accounting standards for
recording of liabilities related to legal obligations to retire tangible
long-lived assets. The Statement requires an entity to recognize at fair value a
liability associated with an asset retirement obligation in the period in which
the liability is both incurred and in which the fair value is determinable. The
MICROFINANCIAL INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tables in thousands, except share and per share data)
(Unaudited)
provisions of this Statement are effective for the Company's fiscal year ended
December 31, 2003, although earlier application is permitted. The Company has
not completed its evaluation of SFAS No. 143 and has not yet determined the
effect on its consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of a long-lived asset or
group of assets. This pronouncement, which supersedes and amends several earlier
interpretations, establishes a single comprehensive statement to provide
impairment accounting guidance for tangible long-lived assets to be either held
and continued to be used by the entity or disposed of by sale or by some other
means. This Statement will be effective for the first quarter of the Company's
fiscal year ending December 31, 2002, although earlier application is permitted.
The Company has determined that the adoption of this Statement does not have a
material impact on its results of operations or consolidated financial position.
On January 1, 2002, the Company adopted the provisions of Statement of
Position ("SOP") 01-6, Accounting by Certain Entities (Including Entities With
Trade Receivables) That Lend to or Finance the Activities of Others. The SOP was
effective for financial statements issued for the fiscal year beginning after
December 15, 2001. The Company has determined that the adoption of this SOP does
not have a material impact on its results of operations or consolidated
financial position.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64 and Technical Corrections." This Statement which
rescinds and amends several statements, improves financial reporting for
extinguishment of debt, modifies the accounting for certain leasing
transactions, and makes various technical corrections to existing
pronouncements. The Statement requires the gains and losses from the
extingushment of debt to be classified as extraordinary items only if they meet
the criteria in APB Opinion No. 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions."
Also, the Statement requires that the accounting treatment of certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-leaseback transactions. The
provisions for this Statement are required to be applied for fiscal years
beginning after May 15, 2002, with earlier application encouraged. The Company
has not completed its evaluation of SFAS No. 145 and has not yet determined the
effect on its 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.
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Three months ended March 31, 2002 as compared to the three months ended March
31, 2001.
Net income for the three months ended March 31, 2002 was approximately
$3.2 million, a decrease of $2.2 million or 41% from the three months ended
March 31, 2001. This represents diluted earnings per share for the three months
ended March 31, 2002 of $0.25 per share on weighted-average outstanding shares
of 12,853,061 as compared to $0.42 per share on weighted-average outstanding
shares of 12,940,094 for the three months ended March 31, 2001.
Total revenues for the three months ended March 31, 2002 were $35.3
million, a decrease of $4.1 million, or 10%, from the three months ended March
31, 2001. The decrease was primarily due to a decrease of $3.5 million, or 19%,
in financing leases and loans, and $1.5 million or 17% in fee and other income
offset by an increase of $988,000 or 9% in rental and service contract income.
The decrease in income on financing leases and loans was due to the decreased
number of leases originated primarily resulting from the Company's change in its
credit approval process. The decrease in fee income and other income is the
result of decreased fees from the lessees related to the collection and legal
process employed by the Company. The increase in rental and service contract
income is a result of the increased number of lessees that have continued to
rent their equipment beyond their original lease term, an increase in the rental
business originated through our Resource Leasing division, and an increase in
originations in rental and service contracts.
Selling, general and administrative expenses increased by $671,000, or 6%,
for the three months ended March 31, 2002, as compared to the three months ended
March 31, 2001. Legal expenses increased $193,000 or 74%, marketing programs
increased $175,000 or 51% and professional service fees increased $196,000 or
37%.
Depreciation and amortization increased by $197,000, or 6%, 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 $700,000, or 7%,
for the three months ended March 31, 2002 as compared to the three months ended
March 31, 2001. 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.
Interest expense decreased by $1.6 million, or 37%, for the three months
ended March 31, 2002 as compared to the three months ended March 31, 2001. This
decrease resulted primarily from the Company's declining cost of funds, and an
overall decrease in the level of borrowings.
Dealer fundings were $22.6 million for the three months ended March 31,
2002, down $11.3 million, or 33% as compared to the three months ended March
31, 2001. 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, described below. 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 decreased by $898,000 or 2% to a total of
$46.7 million. This decrease is primarily the result of an decrease in the size
of the overall portfolio. Investment in lease and loan receivables due in
installments, estimated residuals, rental and service contracts were down from
$470.6 million in December of 2001 to $461.4 million in March of 2002.
Critical Accounting Policies
In response to the SEC's release No. 33-8040, "Cautionary Advice Regarding
Disclosure About Critical Accounting Policies," Management identified the most
critical accounting principles upon which the Company's financial status
depends. The Company determined the critical principles by considering
accounting policies that involve the most complex or subjective decisions or
assessments. We identified our most critical accounting policies to be those
related to revenue recognition and maintaining the allowance for credit losses.
These accounting policies are discussed below as well as within the notes to the
consolidated financial statements.
The Company's lease contracts are accounted for as financing leases. At
origination, the Company records the gross lease receivable, the estimated
residual value of the leased equipment, initial direct costs incurred and the
unearned lease income. Unearned lease income is the amount by which the gross
lease receivable plus the estimated residual value exceeds the cost of the
equipment. Unearned lease income and initial direct costs incurred are amortized
over the related lease term using the interest method. Amortization of unearned
lease income and initial direct costs is suspended if, in the opinion of
management, full payment of the contractual amount due under the lease agreement
is doubtful. In conjunction with the origination of leases, the Company may
retain a residual interest in the underlying equipment upon termination of the
lease. The value of such interests is estimated at inception of the lease and
evaluated periodically for impairment. Other revenues such as loss and damage
waiver fees, service fees relating to the leases, contracts and loans, and
rental revenues are recognized as they are earned.
The Company's investments in cancelable service contracts are recorded at
cost and amortized over the expected life of the service period. Income on
service contracts from monthly billings is recognized as the related services
are provided. The Company periodically evaluates whether events or circumstances
have occurred that may affect the estimated useful life or recoverability of the
investment in service contracts. Rental equipment is either recorded at
estimated residual value and depreciated using the straight-line method over a
period of 12 months or at the acquisition cost and depreciated using the
straight line method over a period of 36 months. Loans are reported at their
outstanding principal balance. Interest income on loans is recognized as it is
earned.
The Company maintains an allowance for credit losses on its investment in
leases, service contracts, rental contracts and loans at an amount that it
believes is sufficient to provide adequate protection against losses in its
portfolio. The allowance is determined principally on the basis of the
historical loss experience of the Company and the level of recourse provided by
such lease, service contract, rental contract or loan, if any, and reflects
management's judgment of additional loss potential considering current economic
conditions and the nature and characteristics of the underlying lease portfolio.
The Company determines the necessary periodic provision for credit losses taking
into account actual and expected losses in the portfolio as a whole and the
relationship of the allowance to the net investment in leases, service
contracts, rental contracts and loans. Such provisions generally represent a
percentage of funded amounts of leases, contracts and loans. The resulting
charge is included in the provision for credit losses.
Leases, service contracts, rental contracts and loans are charged against
the allowance for credit losses and are put on non-accrual when they are deemed
to be uncollectable. Generally, the Company deems leases, service contracts,
rental contracts and loans to be uncollectable when one of the following occurs:
(i) the obligor files for bankruptcy; (ii) the obligor dies, and the equipment
is returned; or (iii) when an account has become 360 days delinquent. The
typical monthly payment under the Company's leases is between $30 and $50 per
month. As a result of these small monthly payments, the Company's experience is
that lessees will pay past due amounts later in the process because of the small
amount necessary to bring an account current (at 360 days past due, a lessee
will only owe lease payments of between $360 and $600).
The Company has developed and regularly updates proprietary credit scoring
systems designed to improve its risk-based pricing. The Company uses credit
scoring in most, but not all, of its extensions of credit. In addition, the
Company aggressively employs collection procedures and a legal process to
resolve any credit problems.
Exposure to Credit Losses
The following table sets forth certain information as of December 31, 2000
and 2001 and March 31, 2002 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 March 31
----------------------- --------
2000 2001 2002
-------- -------- --------
Cumulative amounts billed (in thousands) $462,011 $602,649 $612,466
31-60 days past due 1.9% 1.8% 3.1%
61-90 days past due 1.6% 1.7% 2.1%
Over 90 days past due 10.0% 13.4% 12.2%
------- ------- -------
Total past due 13.5% 16.9% 17.4%
======= ======= =======
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 March 31, 2002, the Company had an
aggregate maximum of $192 million available for borrowing under its credit
facility, of which approximately $113.9 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.
Contractual Obligations and Commercial Commitments
The Company has entered into various agreements, such as the long-term
debt agreements, capital lease agreements and operating lease agreements that
require future payments be made. Long-term debt agreements include all debt
outstanding under the revolving credit line, securitizations, subordinated
notes, demand notes and other notes payable.
At March 31, 2002 the repayment schedules for outstanding long-term debt,
minimum lease payments under noncancelable operating leases and future minimum
lease payments under capital leases were as follows:
For the year ended Long Term Operating Capital
December 31, Debt Leases Leases Total
- ------------------ --------- -------- ----- ---------
2002 $ 41,280 $ 1,358 $ 330 $ 42,968
2003 37,550 1,754 267 39,571
2004 5,126 835 154 6,115
2005 - 214 44 258
2006 2,600 - - 2,600
Thereafter 816 - - 816
--------- -------- ----- ---------
87,372 4,161 795 92,328
Outstanding balance of revolving
credit facility 113,940 - - 113,940
--------- -------- ----- ---------
Total $ 201,312 $ 4,161 $ 795 $ 206,268
========= ======== ===== =========
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 March 31, 2002, the
Company's outstanding fixed rate indebtedness, including indebtedness
outstanding under the Company's securitizations, represented 43.3% of the
Company's outstanding indebtedness.
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 subject to
substantial legal defenses, and the Company is vigorously defending each of the
allegations. The Company also is subject to claims and suits arising in the
ordinary course of business. At this time, it is not possible to estimate the
ultimate loss or gain, if any, related to these lawsuits, nor if any such loss
will have a material adverse effect on the Company's results of operations or
financial position.
A. The Company filed an action in the United States District Court for the
District of Massachusetts against Sentinel Insurance Company, Ltd.,
("Sentinel"), Premier Holidays International, Inc., ("Premier") and Daniel
DelPiano ("DelPiano") arising from Premier's October, 1999, default on its
repayment obligations to the Company under a Twelve Million Dollar ($12,000,000)
loan. Judgment has been entered in this case against Sentinel, which had issued
a business performance insurance policy guaranteeing repayment of the loan, in
the amount of Fourteen Million Dollars ($14,000,000). This judgment has not been
satisfied. Sentinel is currently undergoing liquidation proceedings, and a claim
in this amount has been filed with the bankruptcy court. As part of the
Massachusetts litigation, Premier has asserted a counterclaim against the
Company for Seven Hundred Sixty Nine Million Three Hundred Fifty Thousand
dollars ($769,350,000) in actual and consequential damages, and for Five Hundred
Million Dollars ($500,000,000) in punitive damages, plus interest, cost and
attorney's fees. The counterclaim is based upon an alleged representation by the
Company that it would lend Premier an additional Forty-Five Million Dollars
($45,000,000), when all documents evidencing the Premier loan refer only to the
Twelve Million ($12,000,000) amount actually loaned and not repaid. The Company
denies any liability on the counterclaim, which the Company is vigorously
contesting. Because of the uncertainties inherent in litigation, the Company
cannot predict whether the outcome will have a material adverse effect on the
Company's results of operations or consolidated financial position.
B. On January 29, 2002, Leasecomm was served with an Amended Complaint
("Complaint") in an action entitled People v. Roma Computer Solutions, Inc., et
al., Ventura County (California) Superior Court Case No. CIV207490. The
Complaint asserts two claims, one for violation of the California Business
Professions Code Section 17500 (false advertising), and the other for violation
of the California Business and Professions Code Section 17200 (unfair or
unlawful acts or practices). The claims arise from the marketing and selling
activities of other defendants, including Roma Computer Solutions, Inc., and/or
Maro Securities, Inc. The Complaint seeks to have Leasecomm held liable for the
acts of other defendants, alleging that Leasecomm directly participated in those
acts and received proceeds and the assignment of lease contracts as a result of
those acts. The Complaint requests injunctive relief, rescission, restitution,
and a civil penalty. No answer or motion has been filed. Because of the
uncertainties inherent in litigation, the Company cannot predict whether the
outcome will have a material adverse effect on the Company's results of
operations or consolidated financial position.
C. On May 8, 2000, Plaintiff Efraim Bason brought an action in the Supreme
Court of the State of New York, County of Nassau, seeking compensatory damages
in the amount of $450,000 and punitive damages under various legal theories for
Leasecomm's refusal to promptly release him from an equipment lease to which he
claims his name was forged (the "Bason Complaint"). The Bason Complaint alleges
that Leasecomm's failure to promptly release him from the lease, and subsequent
negative reports to credit agencies, ruined his credit and prevented him from
securing certain financing that he allegedly needed to purchase merchandise
which he claims he could have then re-sold at a $450,000 profit. The Company has
filed a motion for summary judgment, which Bason has opposed. The Court has not
yet ruled on the motion. Because of the uncertainties inherent in litigation,
the Company cannot predict whether the outcome will have a material adverse
effect on the Company's results of operations or consolidated financial
position.
D. On January 29, 2002, Leasecomm was served with an Amended Complaint
("Complaint") in an action entitled Rae Lynn Copitka v. Leasecomm Corp., et al.,
Travis County (Texas) District Court Case No. GN-102292. The Complaint asserts
that the original action, filed mid-2001 by a single plaintiff should proceed as
a class action. In the original action, Ms. Copitka sought to rescind her
finance lease with Leasecomm and to recover economic damages arising from prior
payments under the lease. Ms. Copitka alleges that her proposed class includes
all persons in Texas who have executed Leasecomm finance leases for "virtual
terminal" type credit card software
during the years 1998, 1999, 2000, and 2001. Leasecomm intends to vigorously
contest both the class certification and the substantive merits of the lawsuit.
No answer or motion has been filed. Because of the uncertainties inherent in
litigation, the Company cannot predict whether the outcome will have a material
adverse effect on the Company's results of operations or consolidated financial
position.
E. 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
complaint seeks certification of a subclass of those class members who entered
into any lease agreement contracts with Leasecomm for the purposes of financing
the goods or services allegedly purchased from other defendant entities. The
class action complaint alleges multiple causes of action, including: fraud and
deceit; negligent misrepresentation; unfair competition; false advertising;
unjust enrichment; fraud in the inducement and the inception of contract; lack
of consideration for contact; and breach of the contractual covenant of good
faith and fair dealing.
On February 1, 2002, the parties entered into stipulation of settlement to
the class action litigation. The stipulation of settlement will be effective
only if and when it 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.
F. On October 29, 2001, a purported class action suit was filed in
Superior Court of the State of California, County of Orange against Leasecomm
and MicroFinancial and another entity known as Prospecting Services of America,
Inc. ("PSOA"). The plaintiffs purport to represent a class of customers who were
allegedly solicited by PSOA to enter into leases with Leasecomm for the lease of
a "virtual link point gateway" and "I-phone." Plaintiffs alleged that PSOA made
numerous misrepresentations and omissions during the course of solicitation for
which Leasecomm and MicroFinancial Incorporated should be responsible. On
January 25, 2002, the trial court granted the motion of Leasecomm and
MicroFinancial to stay the claims against them, on the grounds that the forum
selection clause contained in the lease agreements required plaintiffs to
litigate any claims against those entities in Massachusetts. In the event that
this matter cannot be resolved, Leasecomm and MicroFinancial intend to
vigorously defend the action. Because of the uncertainties inherent in
litigation, the Company cannot predict whether the outcome will have a material
adverse effect on the Company's results of operations or consolidated financial
position.
G. On January 25, 2002, a purported class action suit was filed in
Superior Court of the State of California, County of Los Angeles against
Leasecomm. The complaint alleges that, two individuals were acting as agents of
Leasecomm, and that they solicited the plaintiff to enter into a lease agreement
with Leasecomm. The complaint seeks declaratory and injunctive relief against
all defendants based upon alleged violations of California law. The plaintiff
purports to represent two subclasses comprised of: business entities who entered
into commercial lease agreements with Leasecomm, and all California residents
who entered into lease agreements with Leasecomm for consumer goods. Leasecomm
intends to vigorously defend the action. Because of the uncertainties inherent
in litigation, the Company cannot predict whether the outcome will have a
material adverse effect on the Company's results of operations or consolidated
financial position.
Leasecomm has been served with Civil Investigative Demands by the Offices
of the Attorney General for the states of Kansas, Illinois, and Florida, and for
the Commonwealth of Massachusetts. Those Offices of the Attorney General, in
conjunction with the Northwest Region Office of the Federal Trade Commission and
the Offices of the Attorney General for Texas and North Dakota, have informed
Leasecomm that they are coordinating their investigations jointly. The
investigations raise a number of issues concerning Leasecomm's vendors and
Leasecomm's leases, covering without limitation, enforceability,
noncancellability, unconscionability, forum selection, rights of rescission,
lease termination provisions, electronic funds transfer, software license
leases, leases of satellites and computers, billing and collection practices,
and business opportunity seminars.
Since the investigations are at an early stage, and no legal action has
been commenced against Leasecomm, there can be no assurance as to the eventual
outcome.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
(b) None.
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
----------------------------
Chairman of the Board and
Chief Executive Officer
By: /s/ Richard F. Latour
----------------------------
President, and Chief
Operating Officer
Date: May 15, 2002