1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (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, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from ______ to ______ Commission File No. 1-14771 MICROFINANCIAL INCORPORATED (Exact name of Registrant as specified in its Charter) Massachusetts 04-2962824 (State or other jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 950 Winter Street, Waltham, MA 02451 (Address of Principal Executive Offices) (781) 890-0177 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(b) of the Securities and Exchange act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No As of July 15, 1999, 13,142,164 shares of the registrant's common stock were outstanding. 2 MICROFINANCIAL INCORPORATED Table of Contents PART I FINANCIAL INFORMATION PAGE ---- Item 1 Financial Statements: Consolidated Balance Sheets December 31, 1998 (audited) June 30, 1999 (unaudited) 3 Consolidated Income Statements Three months ended June 30, 1998 and 1999 and six months ended June 30, 1998 and 1999 (unaudited) 4 Consolidated Statements of Cash Flows Three months ended June 30, 1998 and 1999 and six months ended June 30, 1998 and 1999 (unaudited) 5 Notes to Consolidated Financial Statements 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operation 11 Item 3 Quantitative and Qualitative Disclosures about Market Risks 14 PART II OTHER INFORMATION Item 4 Submission Of Matters To A Vote Of Security Holders 18 Item 6 Exhibits and Reports on Form 8-K 19 Signatures 20 3 MICROFINANCIAL INCORPORATED CONSOLIDATED BALANCE SHEETS (in thousands) DECEMBER 31, JUNE 30, 1998 1999 (AUDITED) (UNAUDITED) ------------ ----------- ASSETS Net investment in leases and loans: Receivables due in installments $251,060 $271,442 -------- -------- Estimated residual value 17,562 18,788 Initial direct costs 4,260 5,544 Loans receivable 12,253 20,960 Less: Advance lease payments and deposits (1,081) (2,415) Unearned income (74,520) (82,083) Allowance for credit losses (24,850) (24,471) -------- -------- Net investment in leases and loans: $184,684 $207,765 Investment in service contracts 8,920 11,926 Cash and cash equivalents 6,817 11,688 Property and equipment, net 6,747 7,321 Other assets 3,086 5,912 -------- -------- Total assets $210,254 $244,612 ======== ======== LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY Notes payable $130,421 $117,924 Subordinated notes payable 24,421 12,712 Capitalized lease obligations 774 1,203 Accounts payable 149 285 Dividends payable 346 534 Other liabilities 5,481 6,064 Income taxes payable 625 125 Deferred income taxes payable 18,554 24,344 -------- -------- Total liabilities 180,771 163,191 -------- -------- Commitments and contingencies - - Redeemable convertible preferred stock (liquidation preference $12, at December 31, 1997 and 1998) - - Stockholders' equity: Common stock 99 133 Additional paid-in capital 1,816 47,910 Retained earnings 27,956 35,469 Treasury stock, at cost (138) (1,946) Notes receivable from officers and employees (250) (145) -------- -------- Total stockholders' equity 29,483 81,421 -------- -------- Total liabilities and stockholders' equity $210,254 $244,612 ======== ======== The accompanying notes are an integral part of the consolidated financial statements 3 4 MICROFINANCIAL INCORPORATED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) For the quarters ended For the 6 months ended June 30, June 30, 1998 1999 1998 1999 (unaudited) (unaudited) (unaudited) (unaudited) ---------------------------- ---------------------------- Revenues: Income on financing leases and loans $11,836 $13,661 $23,346 $26,038 Income on service contracts 507 1,369 795 2,553 Rental income 3,696 5,036 7,061 10,717 Loss and damage waiver fees 1,331 1,399 2,726 2,795 Service fees 1,089 2,246 2,620 4,063 ---------------------------- ---------------------------- Total revenues 18,459 23,711 36,548 46,166 ---------------------------- ---------------------------- Expenses: Selling general and administrative 5,063 5,708 9,345 11,712 Provision for credit losses 3,698 6,064 8,273 11,463 Depreciation and amortization 1,274 1,767 2,451 3,455 Interest 3,131 2,366 5,951 4,985 ---------------------------- ---------------------------- Total expenses 13,166 15,905 26,020 31,615 ---------------------------- ---------------------------- Income before provision for income taxes 5,293 7,806 10,528 14,551 Provision for income taxes 2,160 3,263 4,284 6,039 ---------------------------- ---------------------------- Net Income $3,133 $4,543 $6,244 $8,512 ============================ ============================ Net Income per common share - basic $0.32 $0.34 $0.64 $0.67 ============================ ============================ Net Income per common share - diluted $0.31 $0.34 $0.62 $0.67 ============================ ============================ Dividends per common share $0.035 $0.040 $0.065 $0.075 ============================ ============================ The accompanying notes are an integral part of the consolidated financial statements. 4 5 MICROFINANCIAL INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, except per share data) For the quarters ended For the 6 months ended June 30, June 30, 1998 1999 1998 1999 (unaudited) (unaudited) (unaudited) (unaudited) --------------------------- -------------------------- Cash flows from operating activities: Cash received from customers $ 34,462 $ 38,446 $ 65,721 $ 76,727 Cash paid to suppliers and employees (8,765) (12,642) (15,718) (19,058) Interest paid (2,570) (2,089) (5,554) (4,984) Interest received 233 1,040 443 1,856 --------------------------- -------------------------- Net cash provided by operating activities 23,360 24,755 44,892 54,541 --------------------------- -------------------------- Cash flows from investing activities: Investment in leased equipment (20,151) (28,285) (37,378) (49,520) Investment in direct costs (1,214) (2,050) (1,971) (3,029) Investment in service contracts (1,909) (2,343) (3,682) (4,188) Investment in loans receivable (3,111) (2,698) (5,110) (11,129) Investment in fixed assets (159) (435) (279) (572) Issuance of notes from officers and employees 0 (1) (144) (2) Repayment of notes from officers 15 4 23 106 Investment in notes receivable (91) (119) (149) (417) Repayment of notes receivable 114 115 174 202 --------------------------- -------------------------- Net cash used in investing activities (26,506) (35,812) (48,516) (68,549) --------------------------- -------------------------- Cash flows from financing activities: Proceeds from secured debt 30,321 24,312 48,494 53,271 Repayment of secured debt (16,785) (9,631) (36,996) (66,575) Proceeds from refinancing of secured debt 58,500 65,452 108,000 159,000 Prepayment of secured debt (58,500) (65,452) (108,000) (159,000) Proceeds from short term demand notes payable 180 155 180 840 Repayment of short term demand notes payable (217) (3) (217) (29) Proceeds from issuance of subordinated debt 0 0 1,000 0 Repayment of subordinated debt (211) (1,000) (231) (11,747) Proceeds from sale of common stock 0 0 0 46,116 Proceeds from exercise of common stock options 64 13 146 13 Repayment of capital leases (246) (200) (370) (389) Purchase of treasury stock 0 (1,808) 0 (1,808) Payment of dividends (296) (466) (590) (813) --------------------------- -------------------------- Net cash provided by (used in) financing activities 12,810 11,372 11,416 18,879 --------------------------- -------------------------- Net increase (decrease) in cash and cash equivalents: 9,664 315 7,792 4,871 Cash and cash equivalents, beginning of period: 7,380 11,373 9,252 6,817 --------------------------- -------------------------- Cash and cash equivalents, end of period: $ 17,044 $ 11,688 $ 17,044 $ 11,688 =========================== ========================== Reconciliation of net income to net cash provided by operating activities: Net Income $ 3,133 $ 4,543 $ 6,245 $ 8,512 Adjustments to reconcile net income to cash provided by Casoperatingdactivitiesing Activities: Depreciation and amortization 1,274 1,767 2,451 3,455 Provision for credit losses 3,698 6,064 8,273 11,463 Recovery of equipment cost and residual value, net of revenue recognized Net of Interest Income 13,058 9,627 23,857 25,163 Increase (decrease) in current taxes 0 0 0 (500) Increase in deferred income taxes 2,129 3,014 4,237 5,789 Change in assets and liabilities: Decrease (increase) in other assets (728) (357) (664) 69 (Decrease) increase in accounts payable 168 145 24 135 Increase (decrease) in accrued liabilities 628 (48) 469 455 --------------------------- -------------------------- Net cash provided by operating activities $ 23,360 $ 24,755 $ 44,892 $ 54,541 =========================== ========================== Cash paid for income taxes $40 $267 $80 $797 =========================== ========================== Supplemental disclosure of noncash activities: Property acquired under capital leases $ 31 $ 606 $ 214 $ 819 Accrual of common stock dividends $ 296 $ 534 $ 296 $ 534 The accompanying notes are an integral part of the consolidated financial statements. 5 6 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables are in thousands, except per share data) (Unaudited) (A) Nature of Business: MicroFinancial Incorporated (the "Company") which operates primarily through its wholly owned subsidiary, Leasecomm Corporation, is a specialized finance company that primarily leases and rents commercial "microticket" equipment and provides other financing services in amounts generally ranging from $900 to $10,000 with an average amount financed of approximately $1,400 and an average lease term of 45 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 the interim financial statements. Accordingly, the interim statements do not include all of the information and disclosures required for the annual financial statements. In the opinion of the Company's management, the consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation of these interim results. Inter-company accounts and transactions have been eliminated. For further information, refer to the consolidated financial statements and notes included in the Company's Annual Report and Form 10-K for the year ended December 31, 1998. The results for the three-month and six-month periods ended June 30, 1999 are not necessarily indicative of the results that may be expected for the full year ended December 31, 1999. The balance sheet at December 31, 1998 has been derived from the audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31,1998. 6 7 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 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 leases, loans and service contracts, if any. In addition, the allowance reflects management's judgment of the additional loss potential considering future economic conditions and the nature and characteristics 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, 1997 and, 1998 and June 30, 1999 and the related provision, charge-offs and recoveries for the years ended December 31, 1998 and the quarter ended June 30, 1999. Balance at December 31, 1997 $26,319 Provision for credit losses 19,075 Charge-offs 28,750 Recoveries 8,206 ------- Charge-offs net of recoveries 20,544 ------- Balance at December 31, 1998 $24,850 Provision for credit losses 11,463 Charge-offs 19,651 Recoveries 7,809 ------- Charge-offs net of recoveries 11,842 ------- Balance at June 30, 1999 $24,471 7 8 Earnings Per Share: The Company has adopted Statement of Financial Accounting 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. For 3 months ended For 6 months ended June 30, June 30, -------- -------- 1998 1999 1998 1999 ----- ---- ---- ---- Net Income $3,133 $4,543 $6,244 $8,512 Shares used in computation: Weighted average common shares outstanding used in computation of net income per common share 9,873,067 12,002,922 9,836,445 13,295,416 Dilutive effect of redeemable convertible preferred stock 19,600 0 19,600 0 Dilutive effect of common stock options 146,951 150,136 146,951 237,953 Shares used in computation of net income per common share - assuming dilution 10,039,618 12,153,058 10,039,618 13,533,369 ---------- ---------- ---------- ---------- Net income per common share $0.32 $0.33 $0.32 $0.34 Net income per common share assuming dilution $0.31 $0.33 $0.31 $0.34 Notes Payable: On January 27, 1999 the Company amended and restated both of its revolving lines of credit and term loan facilities whereby it may borrow a maximum of $55,000,000 under each facility based upon qualified leases, loans and service contracts. Outstanding borrowings with respect to the revolving line of credit bear interest based either at Prime or London Interbank Offered Rate (LIBOR) plus 1.75%. The prime rates at December 31, 1998 and June 30, 1999 were 7.75%. The 90-day LIBOR rates at December 31, 1998 and June 30, 1999 were 5.28% and 5.3675% respectively. 8 9 The Company had borrowings outstanding under these agreements with the following terms: December 31, 1998 June 30, 1999 ----------------- --------------- Type Rate Amount Rate Amount ----- ------- ------- ------- ------- Prime 7.7500% $ 6,515 7.7500% $42,414 LIBOR 7.4068% 15,000 6.8437% 5,000 LIBOR 7.3939% 20,000 6.7700% 17,500 LIBOR 7.1938% 10,001 LIBOR 7.4103% 7,499 Fixed 7.7500% 3,709 7.7500% 927 ------- ------- Total Outstanding $62,724 $65,841 ------- ------- Outstanding borrowings are collateralized by leases, loans and service contracts pledged specifically to the financial institutions. All balances under the revolving lines of credit will automatically convert to a term loan on July 31, 2000 and September 30, 2000, respectively, provided the lines of credit are not renewed and no event of default exists at that date. All converted term loans are payable over the term of the underlying leases, loans and service contracts, but in any event not to exceed 36 monthly installments. The most restrictive covenants of the agreement have a minimum net worth and income requirement and limit payment of dividends to no more than 50% of the consolidated net income, as defined, for the immediately preceding fiscal year. Initial Public Offering: On February 5, 1999, the Company was admitted to the New York Stock Exchange following its initial public offering of 4 million shares of common stock at $15 per share, 600,000 of which were sold by existing shareholders. The Company's stock trades under the ticker symbol MFI. Total costs of $1,313,891 related to the initial public offering offset the proceeds of $51,000,000. On June 12, 1998 the Company's Board of Directors authorized a two-for-one stock split which was effective with the initial public offering. All share and per share amounts have been restated to reflect this stock split. In conjunction with the initial public offering in February 1999, the Board of Directors of the Company authorized 5,000,000 shares of preferred stock, none of which have been issued. Shares of such preferred stock may be issued from time to time in one or more series and with such designations, voting powers, preferences, and relative participating optional or other special rights, and qualifications, limitations, and restrictions on such rights as the Board of Directors may authorize. 9 10 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. On February 25, 1999 and April 12, 1999 the Company granted a total of 750,000 and 80,000 stock options respectively at prices of $12.313, $13.544 and $13.125, which were the fair market values on the date of grants, to various members of management and board of directors. Dividends: On June 19, 1999 the Company's Board of Directors approved a dividend of $.04 per common share for all outstanding common shares as of June 30,1999 to be paid on July 15, 1999. 10 11 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Three months ended June 30, 1999 as compared to the three months ended June 30, 1998. Net income for the three months ended June 30, 1999 was approximately $4.5 million, an increase of $1.4 million or 45% from the three months ended June 30, 1998. This represents diluted earnings per share for the three months ended June 30, 1999 of $.34 per share on weighted average outstanding shares of 13,533,369 as compared to $.31 per share on weighted average outstanding shares of 10,039,618 for the three months ended June 30, 1998. Total revenues for the three months ended June 30, 1999 were $23.7 million, an increase of $5.2 million, or 28%, from the three months ended June 30, 1998. The increase was primarily due to an increase of $2.2 million, or 52%, in rental and service contract income, $1.8 million, or 15%, in income on financing leases and loans and $1.2 million, or 51%, in fee income. The majority of the increase in rental and service contract income is a result of the increased number of lessees that have continued to rent their equipment beyond their original lease term, as well as the acquisition of a rental portfolio from a major bank and the increased number of service contracts originated during the second quarter. The increase in income on financing leases and loans was due to the increased number of leases and loans originated, while the increase in fee income is the result of increased fees from the lessees related to the collection and legal process employed by the Company. Selling, general and administrative expenses increased by $645,000, or 13%, for the three months ended June 30, 1999, as compared to the three months ended June 30, 1998. Compensation and personnel related expenses increased by $549,000, or 18%, due to an increase in overall compensation levels, as well as an increase in the number of employees needed to maintain the Company's portfolio. Rent expense increased by $146,000, or 54%, which is a result of carrying additional office space during the opening phase of the new facility in Woburn. Depreciation and amortization increased by $493,000, or 39%, 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 $2.4 million or 64%, for the three months ended June 30, 1999 as compared to the three months ended June 30, 1998. This increase is primarily a result of an increase in dealer fundings of $8 million, or 33% and total revenues of $5.3 million, or 28% for the three months ended June 30, 1999 as compared to the three months ended June 30, 1998. Interest expense decreased by $765,000, or 24%, for the three months ended June 30, 1999 as compared to the three months ended June 30, 1998 as a result of the use of the initial public offering proceeds to repay a portion of the Company's outstanding bank debt as well as a portion of the Company's junior subordinated debt. 11 12 Dealer fundings were $33.6 million for the three months ended June 30, 1999, up $8 million, or 33% as compared to the three months ended June 30, 1998. This increase is a result of a 37% growth in the Company's Point OF Sale business, as well as, continued growth in the Company's Non-Point Of Sale business. Cash collections were $38.4 million, up by $4.0 million, or 12%. Leases and loan receivables due in installments and estimated residuals were up from $280.9 million in December of 1998 to $311.2 million in June of 1999, representing a 11% increase. The Company's investment in service contracts increased by $6.6 million from $5.3 million for the period ended June 30, 1998 to $11.7 million for the period ended June 30, 1999. Six months ended June 30, 1999 as compared to the six months ended June 30, 1998. Net income for the six months ended June 30, 1999 was approximately $8.5 million, an increase of $2.3 million or 36% from the six months ended June 30, 1998. This represents diluted earnings per share for the six months ended June 30, 1999 of $.67 per share on weighted average outstanding shares of 12,811,471 as compared to $.62 per share on weighted average outstanding shares of 10,031,082 for the six months ended June 30, 1998. Total revenues for the six months ended June 30, 1999 were $46.2 million, an increase of $9.6 million, or 26%, from the six months ended June 30, 1998. The increase was primarily due to an increase of $5.4 million, or 69%, in rental and service contract income, $2.7 million, or 12%, in income on financing leases and loans and $1.5 million, or 28%, in fee income. The majority of the increase in rental and service contract income is a result of the increased number of lessees that have continued to rent their equipment beyond their original lease term, as well as the acquisition of a rental portfolio from a major bank and the increased number of service contracts originated during the second quarter. The increase in income on financing leases and loans was due to the increased number of leases and loans originated. The increase in fee income is the result of increased fees to the lessees related to the collection and legal process employed by the Company. Selling, general and administrative expenses increased by $2.4 million, or 25%, for the six months ended June 30, 1999, as compared to the six months ended June 30, 1998. Compensation and personnel related expenses increased by $1.5 million, or 27%, due to an increase in overall compensation levels, an increase in the number of employees needed to maintain the Company's portfolio, as well as an increase of $284,000 in contract labor and a $250,000 accrual for management bonuses for the first quarter. Rent expense increased by $307,000, or 56%, which is a result of carrying additional office space during the opening phase of the new facility in Woburn. Depreciation and amortization increased by $1 million, or 41%, due to the increased number of rental contracts and amortization of the Company's investment in service contracts. 12 13 The Company's provision for credit losses increased by $3.2 million or 39%, for the six months ended June 30, 1999 as compared to the six months ended June 30, 1998. This increase is primarily a result of an increase in the dealer fundings of $17.8 million, or 38% and an increase in total revenues of $9.6 million, or 26% for the six months ended June 30, 1999 as compared to the six months ended June 30, 1998. Interest expense decreased by $1 million, or 16%, for the six months ended June 30, 1999 as compared to the six months ended June 30, 1998 as a result of the use of the initial public offering proceeds to repay a portion of the Company's outstanding bank debt as well as a portion of the Company's junior subordinated debt. Dealer fundings were $63.3 million for the six months ended June 30, 1999, up $17.7 million, or 38% as compared to the six months ended June 30, 1998. This increase is a result of a 24% increase in the Company's Point Of Sale business and the continued growth in the Company's Non-Point Of Sale business. Cash collections were $76.7 million, up by $11 million, or 17%. LIQUIDITY AND CAPITAL RESOURCES GENERAL The Company's lease and finance business is capital-intensive and requires access to substantial short-term and long-term credit to fund new leases, loans and service contracts. Since inception, the Company has funded its operations primarily through borrowings under its credit facilities, issuances of subordinated debt and its on-balance sheet securitizations. The Company will continue to require significant additional capital to maintain and expand its volume of leases, loans and service contracts, as well as to fund future acquisitions of leasing companies or portfolios. The Company's uses of cash include the origination and acquisition of leases, loans and service contracts, payment of interest expenses, repayment of borrowings under its credit facilities, subordinated debt and securitizations, payment of selling, general and administrative expenses, income taxes and capital expenditures. The Company utilizes its credit facilities to fund the origination and acquisition of leases, loans and service contracts that satisfy the eligibility requirements established pursuant to each facility. At June 30, 1999, the Company had an aggregate maximum of $110.0 million available for borrowing under its two credit facilities, of which approximately $65.8 million was outstanding as of such date. To date, cash flow from its portfolio and other fees have been sufficient to repay amounts borrowed under the credit facilities and subordinated debt. 13 14 The Company believes that the cash flow from its operations and the amounts available under its credit facilities will be sufficient to fund the Company's operations for the foreseeable future. Although the Company is not currently involved in negotiations and has no current commitments or agreements with respect to any acquisition, to the extent that the Company successfully consummates acquisitions, it may be necessary to finance such acquisitions through the issuance of additional debt or equity securities, the incurrence of indebtedness or a combination of both. YEAR 2000 Many computer programs and microprocessors were designed and developed without consideration of the impact of the transition to the year 2000. As a result, these programs and microprocessors may not be able to differentiate between the year "1900" and "2000"; the year 2000 may be recognized as the two digit number "00". If not corrected, this could cause difficulties in obtaining accurate system data and support. The Company has designed and purchased numerous computer systems since its inception. The Company's owned software and hardware is substantially Year 2000 compliant. The costs associated with such compliance will not be material to the Company's liquidity or results of operations. The Company believes, based on written and verbal advice from its vendors, that its critical third party software is generally Year 2000 compliant, with minor issues, and will be capable of functioning after December 31, 1999. However, the Company does and will continue to interconnect certain portions of its network and systems with other companies' networks and systems, certain of which may not be as Year 2000 compliant as those installed by the Company. While the Company has discussed these matters with, and/or obtained written certification from, such other companies as to their Year 2000 compliance, there can be no assurance that any potential impact associated with incompatible systems after December 31, 1999 would not have a material adverse effect on the Company's business, financial condition or results of operations. 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. 15 16 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market-Rate-Sensitive Instruments and Risk Management The following discussion about the Company's risk management activities includes "forward-looking statements" that involve risk and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. This analysis presents the hypothetical loss in earnings, cash flows, or fair value of the financial instrument and derivative instruments held by the Company at June 30, 1999, that are sensitive to changes in interest rates. The Company uses interest-rate swaps to manage the primary market exposures associated with underlying liabilities and anticipated transactions. The Company uses these instruments to reduce risk by creating offsetting market exposures. The instruments held by the Company are not held for trading purposes. In the normal course of operations, the Company also faces risks that are either nonfinancial or nonquantifiable. Such risks principally include country risk, credit risk and legal risk, and are not represented in the analysis that follows. Interest Rate Risk Management This analysis presents the hypothetical loss in earnings of the financial instruments and derivative instruments held by the Company at June 30, 1999 that are sensitive to changes in interest rates. The Company enters into interest rate swaps to reduce exposure to interest-rate risk connected to existing liabilities. The Company does not hold or issue derivative financial instruments for trading purposes. Because the Company's net-earnings exposure under the combined debt and interest-rate swap was to 90-day LIBOR, the hypothetical loss was modeled by calculating the 10 percent adverse change in 90-day LIBOR and then multiplying it by the face amount of the debt (which equaled the face amount of the interest rate swap). The implicit yield to the Company on all of its leases, loans and service contracts is on a fixed interest rate basis due to the leases, loans and service contracts having scheduled payments that are fixed at the time of origination of the lease, loan or service contract. When the Company originates or acquires leases, loans and service contracts it bases its pricing in part on the "spread" it expects to achieve between the implicit yield rate to the Company on each lease, loan or service contract and the effective interest cost it will pay when it finances such leases, loans and service contracts through its Credit Facilities. Increases in the interest rates during the term of each lease, loan or service contract could narrow or eliminate the spread, or result in a negative spread. The Company has adopted a policy designed to protect itself against interest rate volatility during the term of each lease, loan or service contract. 16 17 Given the relatively short average life of the Company's leases, loans and service contracts, the Company's goal is to maintain a blend of fixed and variable interest rate obligations. As of June 30, 1999, the Company's outstanding fixed rate indebtedness, including indebtedness outstanding under the Company's securitizations and indebtedness subject to the swap described below, represented 63.7% of the Company's outstanding indebtedness. In July 1997, the Company entered into an interest rate swap agreement with one of its banks. This agreement, which expires in July 2000, has a notional amount of $17.5 million, which represented 22.8% of the Company's fixed rate indebtedness outstanding at June 30, 1999. The interest rate associated with the swap is capped at 6.6%. During the term of the swap, the Company has agreed to match the swap amount with 90-day LIBOR loans. If at any time the 90-day LIBOR rate exceeds the swap cap of 6.6%, the bank would pay the Company the difference. Through June 30, 1999, the Company had entered into LIBOR loans with interest rates ranging from 6.75% to 6.77 %. This arrangement effectively changes the Company's floating interest rate exposure on the $17.5 million notional amount to a fixed rate of 8.35%. The aggregate hypothetical loss in earnings on an annual basis on the financial instruments and derivative instruments that would have resulted from a hypothetical increase of 10% in the 90-day LIBOR, sustained for one month, is estimated to be $12,175. 17 18 PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The corporation held a Special Meeting of Stockholders in lieu of an Annual Meeting on June 8, 1999 (the "Special Meeting"). (b) Not applicable. (c) A brief description of each matter voted upon at the meeting and the number of votes cast for, against or withheld, as well as the number of abstentions, as to each matter, follows. There were no broker non-votes for either matter. A separate tabulation with respect to each nominee for office is also included. Two matters were voted on at the Special Meeting of Stockholders. The tabulated proxies representing 10,574,893 votes, or 79.302% of the outstanding votes as follows. 1. Election of Directors The two directors that were nominated for election were elected. NAME OF DIRECTOR FOR AGAINST WITHHELD TERM EXPIRATION - ---------------- --- ------- -------- -------------- Torrence C. Harder 10,572,301 0 2,592 2002 Jeffrey P. Parker 10,572,301 0 2,592 2002 The following directors will continue in office and were not up for re-election. Brian E. Boyle 2000 Alan J. Zakon 2000 Peter R. Bleyleben 2001 2. The Appointment of Independent Auditors The second proposal voted on by the stockholders of the corporation was the appointment of PricewaterhouseCoopers LLP as the independent auditors for the Company. This proposal was approved with 10,562,951 votes cast for, 9,200 votes cast against, and 2,742 abstentions. (d) Not applicable. 18 19 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit Index EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - -------------- ---------------------- Exhibit 27 Financial Data Schedule (b) Not applicable 19 20 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 6, 1999 20