UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2004

Commission file number 000-50448

MARLIN BUSINESS SERVICES CORP.

(Exact name of registrant as specified in its charter)

124 Gaither Drive, Suite 170, Mount Laurel, NJ 08054
(Address of principal executive offices)
(Zip code)

(888) 479-9111
(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(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [  ] No [X]

At October 29, 2004, 11,504,594 shares of Registrant’s common stock, $.01 par value, were outstanding.

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MARLIN BUSINESS SERVICES CORP. AND SUBSIDIARIES

Quarterly Report on Form 10-Q
for the quarter ended September 30, 2004

TABLE OF CONTENTS

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PART I

Item 1. Financial Statements

MARLIN BUSINESS SERVICES CORP.
AND SUBSIDIARIES

The accompanying notes are an integral part of the consolidated financial statements.

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MARLIN BUSINESS SERVICES CORP.
AND SUBSIDIARIES

The accompanying notes are an integral part of the consolidated financial statements.

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MARLIN BUSINESS SERVICES CORP.
AND SUBSIDIARIES

The accompanying notes are an integral part of the consolidated financial statements.

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MARLIN BUSINESS SERVICES CORP.
AND SUBSIDIARIES

The accompanying notes are an integral part of the consolidated financial statements.

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MARLIN BUSINESS SERVICES CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - Organization

Description

Marlin Leasing Corporation provides equipment leasing solutions primarily to small businesses nationwide in a segment of the equipment leasing market commonly referred to as the “small-ticket” segment. The Company finances over 60 categories of commercial equipment important to its end user customers including copiers, telephone systems, computers and certain commercial and industrial equipment. Marlin Leasing Corporation is managed as a single business segment.

In November 2003, Marlin Leasing Corporation merged into a wholly owned subsidiary of Marlin Business Services Corp., a Pennsylvania business corporation, as part of a corporate reorganization described below. Marlin Leasing Corporation is the principal operating subsidiary of Marlin Business Services Corp.

References to the “Company”, “we”, “us”, and “our” herein refer to Marlin Business Services Corp. and its wholly-owned subsidiaries after giving effect to the reorganization described below, unless the context otherwise requires.

Initial Public Offering

Marlin Business Services Corp. completed its initial public offering of common stock and became a publicly traded company on November 12, 2003. Of the 5,060,000 shares sold in the offering, 3,581,255 shares represented primary shares sold by the Company, which increased shares outstanding. The remaining shares were sold by selling shareholders. This offering resulted in net proceeds to the Company of $44.7 million of which $10.1 million was used to retire outstanding 11% subordinated debt and accrued interest thereon and $6.0 million was used to pay accrued preferred dividends payable. The remaining proceeds were used for general corporate purposes and to fund newly originated leases for our portfolio. Our common stock trades on the NASDAQ National Market under the ticker symbol “MRLN”.

Reorganization

Since our founding, we have conducted all of our operations through Marlin Leasing Corporation which was incorporated in the state of Delaware on June 16, 1997. On November 11, 2003, we reorganized our operations into a holding company structure by merging Marlin Leasing Corporation with a wholly owned subsidiary of Marlin Business Services Corp., a Pennsylvania corporation. As a result, all former shareholders of Marlin Leasing Corporation became shareholders of Marlin Business Services Corp. After the reorganization, Marlin Leasing Corporation remains in existence as our primary operating subsidiary.

In anticipation of the public offering, on October 12, 2003, Marlin Leasing Corporation’s Board of Directors approved a stock split of its Class A Common Stock at a ratio of 1.4 shares for every one share of Class A Common Stock in order to increase the number of shares of Class A Common Stock authorized and issued. All per share amounts and outstanding shares, including all common stock equivalents, such as stock options, warrants and convertible preferred stock, have been retroactively restated in the accompanying consolidated financial statements and notes to consolidated financial statements for all periods presented to reflect the stock split.

The following steps to reorganize our operations into a holding company structure were taken prior to the completion of our initial public offering of common stock in November 2003:

•

all classes of Marlin Leasing Corporation’s redeemable convertible preferred stock converted into Class A common stock of Marlin Leasing Corporation;

•

all warrants to purchase Class A common stock of Marlin Leasing Corporation were exercised on a net issuance, or cashless, basis for Class A common stock, and a selling shareholder exercised options to purchase 60,655 shares of Class A common stock. The exercise of warrants resulted in the issuance of 700,046 common shares on a net issuance basis, based on the initial public offering price of $14.00 per share;

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•

all warrants to purchase Class B common stock of Marlin Leasing Corporation were exercised on a net issuance basis for Class B common stock, and all Class B common stock was converted by its terms into Class A common stock;

•

a direct, wholly owned subsidiary of Marlin Business Services Corp. merged with and into Marlin Leasing Corporation, and each share of Marlin Leasing Corporation’s Class A common stock was exchanged for one share of Marlin Business Services Corp. common stock under the terms of an agreement and plan of merger dated August 27, 2003; and

•

The Marlin Leasing Corporation 1997 Equity Compensation Plan was assumed by, and merged into, the Marlin Business Services Corp. 2003 Equity Compensation Plan. All outstanding options to purchase Marlin Leasing Corporation’s Class A common stock under the 1997 Plan were converted into options to purchase shares of common stock of Marlin Business Services Corp.

NOTE 2 - Basis of Financial Statement Presentation and Critical Accounting Policies

In the opinion of the management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring items) necessary to present fairly the Company’s financial position at September 30, 2004 and the results of operations for the three and nine-month periods ended September 30, 2004 and 2003, and cash flows for the nine-month periods ended September 30, 2004 and 2003. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and note disclosures included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 29, 2004. The consolidated results of operations for the three and nine-month periods ended September 30, 2004 and 2003 are not necessarily indicative of the results for the respective full years. All intercompany accounts and transactions have been eliminated in consolidation.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used when accounting for income recognition, the residual values of leased equipment, the allowance for credit losses, deferred initial direct costs and fees, late fee receivables, valuations of warrants and income taxes. Actual results could differ from estimates.

NOTE 3 - Net Investment in Direct Financing Leases

Net investment in direct financing leases consists of the following:

Substantially all of the Company’s leases are assigned as collateral for borrowings.

Initial direct costs and fees deferred were $16.1 million and $14.7 million as of September 30, 2004 and December 31, 2003, respectively, and are netted in unearned income and will be amortized to income using the level yield method. At September 30, 2004 and December 31, 2003, $24.4 million and $20.4 million, respectively, of residual assets retained on our balance sheet were related to copiers.

Minimum lease payments receivable under lease contracts and the amortization of unearned lease income, net of initial direct costs and fees deferred, is as follows as of September 30, 2004:

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NOTE 4 - Derivative Financial Instruments

We use derivative financial instruments to manage exposure to the effects of changes in market interest rates and to fulfill certain covenants in our borrowing arrangements. All derivatives are recorded on the balance sheet at their fair value as either assets or liabilities. Accounting for the changes in fair value of derivatives depends on whether the derivative has been designated and qualifies for hedge accounting treatment pursuant to SFAS 133, as amended, Accounting for Derivative Instruments and Hedging Activities.

We issued a term note securitization on July 22, 2004 where certain classes of notes were issued at variable rates to investors. We simultaneously entered into interest rate swap contracts to convert these borrowings to a fixed interest cost to the Company for the term of the borrowing. As of September 30, 2004, we had interest rate swap agreements related to these transactions with underlying notional amounts of $196.0 million. These interest rate swap agreements are recorded in other liabilities on the consolidated balance sheet at their fair values of $807,000. These interest rate swap agreements were designated as cash flow hedges with unrealized losses recorded in equity section of the balance sheet of approximately $488,000, net of tax, as of September 30, 2004. The ineffectiveness related to these interest rate swap agreements designated as cash flow hedges was not material for the three and nine-month periods ended September 30, 2004. The Company does not expect any of the unrealized losses will be reclassified into earnings within the next twelve months. There were no outstanding interest rate swap agreements at December 31, 2003 or in the three and nine-month periods ended September 30, 2003.

During the three and nine-month period ended September 30, 2004, the Company recognized a net loss of $75,000 in other financing related costs related to the fair values of the interest rate swaps that were terminated or did not qualify for hedge accounting. As of September 30, 2004, the Company had interest rate swap agreements related to non-hedge accounting transactions with underlying notional amounts of $1.4 million. These interest rate swap agreements are recorded in other assets on the consolidated balance sheet at a fair value of $20,000. This derivative is also related to the 2004 term securitization and is intended to offset certain prepayment risks in the lease portfolio pledged in the 2004 term securitization. There were no similar swap arrangements in 2003 and, accordingly, no related gain or loss recognized in the three and nine-month periods ended September 30, 2003.

The Company also uses interest-rate cap agreements that are not designated for hedge accounting treatment to fulfill certain covenants in our warehouse borrowing arrangements. Accordingly, these cap agreements are recorded at fair value in other assets at $137,000 and $144,000 as of September 30, 2004 and December 31, 2003, respectively. Changes in their fair values of the caps are recorded in financing related costs in the accompanying statements of operations. The notional amount of interest rate caps owned as of September 30, 2004 and December 31, 2003 was $144.7 million and $120.7 million, respectively.

Note 5 - Comprehensive Income

Comprehensive income for the three and nine-months ended September 30, 2004 and 2003 was as follows (dollars in thousands):

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NOTE 6 – Earnings Per Common Share

Earnings per common share (“EPS”) was calculated as follows (in thousands, except per share amounts):

Anti-dilutive common stock options amounting to 160,500 and 145,197 were excluded from the weighted average shares outstanding from dilutive per share calculations for the three and nine-month periods ended September 30, 2004, respectively. There were no anti-dilutive common stock options for the three and nine-month periods ended September 30, 2003.

The effect of convertible preferred stock for the nine-month period ended September 30, 2003 was deemed anti-dilutive and, therefore, excluded from the calculation and disclosure of diluted earnings per share for that period.

NOTE 7 - Stock-Based Compensation

On March 9, 2004 the Company issued restricted common shares under its 2003 Equity Compensation Plan of which 127,372 were outstanding and unvested at September 30, 2004. Certain officers of the Company irrevocably elected to receive the restricted shares in lieu of cash based on a percentage of their targeted annual bonus expected to be paid over the next three years. Restrictions on the shares lapse at the end of 10 years but may lapse (vest) in as little as three years if designated performance goals are achieved. The Company recorded deferred compensation of approximately $2.0 million at the time of issuance based on the then stock price of $15.88. As vesting occurs, or is deemed likely to occur, compensation expense is recognized and deferred compensation reduced on the balance sheet. The Company recognized $169,000 and $506,000 of compensation expense related to this program for the three and nine months ended September 30, 2004.

The Company follows the intrinsic value method of accounting for stock-based employee compensation in accordance with Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations. The Company records deferred compensation for option grants to employees for the amount, if any, by which the fair value per share exceeds the exercise price per share at the measurement date, which is generally the grant date. This deferred compensation is recognized over the vesting period. During the three months ended September 30, 2004, the Company issued 15,000 options with an exercise price equal to the fair market value of the Company’s stock on the date of grant. During the nine months ended September 30, 2004, the Company issued 207,000 options with an exercise price equal to the fair market value of the Company’s stock on the date of grant. Therefore, no compensation expense was recognized for 2004 grants.

Under SFAS No. 123, Accounting for Stock-Based Compensation, compensation expense related to stock options granted to employees and directors is computed based on the fair value of the stock option at the date of grant using the minimum value method and the Black-Scholes option pricing model. Pursuant to the disclosure requirements of SFAS No. 123, had compensation expense for stock

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option grants been determined based upon the fair value at the date of grant, the Company’s net income attributable to common stockholders would have decreased as follows (in thousands, except per share amounts):

Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto in our Form 10-K filed with the Securities and Exchange Commission. This discussion contains certain statements of a forward-looking nature that involve risks and uncertainties.

FORWARD-LOOKING STATEMENTS

Certain statements in this document may include the words or phrases “can be,” “expects,” “plans,” “may,” “may affect,” “may depend,” “believe,” “estimate,” “intend,” “could,” “should,” “would,” “if” and similar words and phrases that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are subject to various known and unknown risks and uncertainties and the Company cautions that any forward-looking information provided by or on its behalf is not a guarantee of future performance. Statements regarding the following subjects are forward-looking by their nature: (a) our business strategy; (b) our projected operating results; (c) our ability to obtain external financing; (d) our understanding of our competition; and (e) industry and market trends. The Company’s actual results could differ materially from those anticipated by such forward-looking statements due to a number of factors, some beyond the Company’s control, including, without limitation:

-		availability, terms and deployment of capital;
-		general volatility of the securitization and capital markets;
-		changes in our industry, interest rates or the general economy;
-		changes in our business strategy;
-		the degree and nature of our competition;
-		availability of qualified personnel; and
-		the factors set forth in the section captioned “Risk Factors” in our Form 10-K filed with the Securities and Exchange Commission.

Forward-looking statements apply only as of the date made and the Company is not required to update forward-looking statements for subsequent or unanticipated events or circumstances.

Overview

We are a nationwide provider of equipment financing solutions primarily to small businesses. We finance over 60 categories of commercial equipment important to businesses including copiers, telephone systems, computers, and certain commercial and industrial equipment. We access our end user customers through origination sources comprised of our existing network of independent equipment dealers and, to a lesser extent, through relationships with lease brokers and through direct solicitation of our end user customers. Our leases are fixed rate transactions with terms generally ranging from 36 to 72 months. At September 30, 2004, our lease

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portfolio consisted of approximately 93,000 accounts with an average original term of 46 months and average original transaction size of approximately $8,000.

Since our founding in 1997, we have grown to $576.8 million in total assets at September 30, 2004. Our assets are substantially comprised of our net investment in leases which totaled $480.1 million at September 30, 2004. Our lease portfolio grew approximately 21% in the past twelve months. Personnel costs represent our most significant overhead expense and we have added to our staffing levels to both support and grow our lease portfolio. Since inception, we have also added three regional sales offices to help us penetrate certain targeted markets, with our most recent office opening in Chicago, Illinois in the first quarter of 2004. Growing the lease portfolio, while maintaining asset quality, remains the primary focus of management. We expect our on-going investment in our sales teams and regional offices to drive continued growth in our lease portfolio.

We generally reach our lessees through a network of independent equipment dealers and lease brokers. The number of dealers and brokers we conduct business with depends primarily on the number of sales account executives we have. Accordingly, key growth indicators management evaluates regularly are sales account executive staffing levels and the activity of our origination sources, which are shown below.

(1)

Monthly average of origination sources generating lease volume.

Our revenue consists of interest and fees from our leases and, to a lesser extent, income from our property insurance program and other fee income. Our expenses consist of interest expense, taxes and operating expenses, which include salaries and benefits and other general and administrative expenses. As a credit lender, our earnings are also significantly impacted by credit losses. For the quarter ended September 30, 2004, our annualized net credit losses were 1.90% of our average net investment in leases. We establish reserves for credit losses which requires us to estimate expected losses in our portfolio.

Our leases are classified under accounting principles generally accepted in the United States of America (GAAP) as direct financing leases, and we recognize interest income over the term of the lease. Direct financing leases transfer substantially all of the benefits and risks of ownership to the equipment lessee. Our investment in leases is reflected in our consolidated financial statements as “net investment in direct financing leases.” Net investment in direct financing leases consists of the sum of total minimum lease payments receivable and the estimated residual value of leased equipment, less unearned lease income. Unearned lease income consists of the excess of the total future minimum lease payments receivable plus the estimated residual value expected to be realized at the end of the lease term plus deferred net initial direct costs and fees less the cost of the related equipment. Approximately 68% of our lease portfolio amortizes over the term to a $1 residual value. For the remainder of the portfolio, we must estimate end of term residual values for the leased assets. Failure to correctly estimate residual values could result in losses being realized on the disposition of the equipment at the end of the lease term.

Since our founding, we have funded our business through a combination of variable rate borrowings and fixed rate asset securitization transactions, as well as through the issuance from time to time of subordinated debt and equity. Our variable rate financing sources consist of a revolving bank facility and two CP conduit warehouse facilities. We issue fixed rate term debt through the asset-backed securitization market. Typically, leases are funded through variable rate borrowings until they are refinanced through the term note securitization at fixed rates. All of our term note securitizations have been accounted for as on-balance sheet transactions and, therefore, we have not recognized gains or losses from these transactions. As of September 30, 2004, 100% of our borrowings were in fixed rate term note securitizations following the completion of our sixth term securitization on July 22, 2004.

Since we initially finance our fixed-rate leases with variable rate financing, our earnings are exposed to interest rate risk should interest rates rise before we complete our fixed rate term note securitizations. We generally benefit in times of falling and low interest rates. We are also dependent upon obtaining future financing to refinance our warehouse lines of credit in order to grow our lease portfolio. Failure to obtain such financing, or other alternate financing, would significantly restrict our growth and future financial performance.

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Reorganization

Marlin Leasing Corporation was incorporated in the state of Delaware on June 16, 1997. On August 5, 2003, we incorporated Marlin Business Services Corp. in Pennsylvania. On November 11, 2003, we reorganized our operations into a holding company structure by merging Marlin Leasing Corporation with a wholly owned subsidiary of Marlin Business Services Corp. As a result, all former shareholders of Marlin Leasing Corporation became shareholders of Marlin Business Services Corp. After the reorganization, Marlin Leasing Corporation remains in existence as our primary operating subsidiary.

In anticipation of our public offering, on October 12, 2003, Marlin Leasing Corporation’s Board of Directors approved a stock split of its Class A common stock at a ratio of 1.4 shares for every one share of Class A common stock in order to increase the number of shares of Class A common stock authorized and issued. All per share amounts and outstanding shares, including all common stock equivalents, such as stock options, warrants and convertible preferred stock, have been retroactively restated in the accompanying consolidated financial statements and notes to consolidated financial statements for all periods presented to reflect the stock split.

The following steps to reorganize our operations into a holding company structure were taken prior to the completion of our initial public offering of common stock in November 2003:

•

all classes of Marlin Leasing Corporation’s redeemable convertible preferred stock converted by their terms into Class A common stock of Marlin Leasing Corporation;

•

all warrants to purchase Class A common stock of Marlin Leasing Corporation were exercised on a net issuance, or cashless, basis for Class A common stock, and a selling shareholder exercised options to purchase 60,655 shares of Class A common stock. The exercise of warrants resulted in the issuance of 700,046 common shares on a net issuance basis, based on the initial public offering price of $14.00 per share;

•

all warrants to purchase Class B common stock of Marlin Leasing Corporation were exercised on a net issuance basis for Class B common stock, and all Class B common stock was converted by its terms into Class A common stock;

•

a direct, wholly owned subsidiary of Marlin Business Services Corp. merged with and into Marlin Leasing Corporation, and each share of Marlin Leasing Corporation’s Class A common stock was exchanged for one share of Marlin Business Services Corp. common stock under the terms of an agreement and plan of merger dated August 27, 2003; and

•

the Marlin Leasing Corporation 1997 Equity Compensation Plan was assumed by, and merged into, the Marlin Business Services Corp. 2003 Equity Compensation Plan. All outstanding options to purchase Marlin Leasing Corporation’s Class A common stock under the 1997 Plan were converted into options to purchase shares of common stock of Marlin Business Services Corp.

Initial Public Offering

In November 2003, 5,060,000 shares of our common stock were issued in connection with our IPO. Of these shares, a total of 3,581,255 shares were sold by the Company and 1,478,745 shares were sold by selling shareholders. The initial public offering price was $14.00 per share resulting in net proceeds to us, after payment of underwriting discounts and commissions and other offering costs, of approximately $44.7 million. We did not receive any proceeds from the shares sold by the selling shareholders. We used the net proceeds from the IPO as follows: (i) approximately $10.1 million was used to repay all of our outstanding 11% subordinated debt and all accrued interest thereon; (ii) approximately $6.0 million was used to pay accrued dividends on preferred stock which converted to common stock at the time of the IPO. The remaining proceeds were used to fund newly originated leases in our portfolio and for general business purposes.

Earnings Per Share

As described above, in conjunction with our November 2003 reorganization and IPO, warrants were exercised and convertible preferred stock converted, and our capital structure simplified into one class of common stock outstanding. The number of common shares issued as a result of these conversions was 5.86 million, or approximately 52% of total common shares outstanding following the IPO. Because of the significant impact on share count and the related impact on operations from warrant valuations and preferred

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dividends, we believe a 2003 pro forma analysis of diluted EPS provides a more meaningful basis to evaluate performance of the Company on a comparative basis. The table below reconciles EPS calculations on a GAAP basis to pro forma EPS for the identified periods of 2003 and assumes the exercise of the warrants and the conversion of the convertible preferred stock as of the beginning of such periods reported and adds back warrant expenses and preferred dividends (in thousands, except per share amounts):

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Preparation of these financial statements requires us to make estimates and judgments that affect reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. On an ongoing basis, we evaluate our estimates, including credit losses, residuals, initial direct costs and fees, other fees and realizability of deferred tax assets. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties. Our consolidated financial statements are based on the selection and application of critical accounting policies, the most significant of which are described below.

Income recognition. Interest income is recognized under the effective interest method. The effective interest method of income recognition applies a constant rate of interest equal to the internal rate of return on the lease. When a lease is 90 days or more delinquent, the lease is classified as being on non-accrual and we do not recognize interest income on that lease until the lease is less than 90 days delinquent.

Fee income consists of fees for delinquent lease payments, equipment rental fees for interim periods between the installation of equipment and the commencement of a lease and cash collected on early termination of leases. Fee income also includes net residual

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income which includes income from lease renewals and gains and losses on the realization of residual values of equipment disposed of at the end of term.

Fee income from delinquent lease payments and interim rent are recognized on the accrual basis. Fee income from delinquent lease payments is accrued based on anticipated collection rates. Other fees are recognized when received. Net residual income includes charges for the reduction in estimated residual values on equipment for leases in renewal and is recognized during the renewal period. Residual balances at lease termination which remain uncollected more than 120 days are charged against income.

Insurance income is recognized on an accrual basis as earned over the term of the lease. Payments that are 120 days or more past due are charged against income. Ceding commissions, losses and loss adjustment expenses are recorded in the period incurred and netted against insurance income.

Initial direct costs and fees. We defer initial direct costs incurred and fees received to originate our leases in accordance with SFAS No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases. The initial direct costs and fees we defer are part of the net investment in direct financing leases and are amortized to interest income using the effective interest method. We defer third party commission costs as well as certain internal costs directly related to the origination activity. The costs include evaluating the prospective lessee’s financial condition, evaluating and recording guarantees and other security arrangements, negotiating lease terms, preparing and processing lease documents and closing the transaction. The fees we defer are documentation fees collected at lease inception. The realization of the deferred initial direct costs, net of fees deferred, is predicated on the net future cash flows generated by our lease portfolio.

Lease residual values. A direct financing lease is recorded at the aggregate future minimum lease payments plus the estimated residual values less unearned income. Residual values reflect the estimated amounts to be received at lease termination from lease extensions, sales or other dispositions of leased equipment. These estimates are based on industry data and on our experience. Management performs periodic reviews of the estimated residual values and any impairment, if other than temporary, is recognized in the current period.

Allowance for credit losses. We maintain an allowance for credit losses at an amount sufficient to absorb losses inherent in our existing lease portfolio as of the reporting dates based on our projection of probable net credit losses. To project probable net credit losses, we perform a migration analysis of delinquent and current accounts. A migration analysis is a technique used to estimate the likelihood that an account will progress through the various delinquency stages and ultimately charge off. In addition to the migration analysis, we also consider other factors including recent trends in delinquencies and charge-offs; accounts filing for bankruptcy; recovered amounts; forecasting uncertainties; the composition of our lease portfolio; economic conditions; and seasonality. We then establish an allowance for credit losses for the projected probable net credit losses based on this analysis. A provision is charged against earnings to maintain the allowance for credit losses at the appropriate level. Our policy is to charge-off against the allowance the estimated unrecoverable portion of accounts once they reach 121 days delinquent.

Our projections of probable net credit losses are inherently uncertain, and as a result we cannot predict with certainty the amount of such losses. Changes in economic conditions, the risk characteristics and composition of the portfolio, bankruptcy laws, and other factors could impact our actual and projected net credit losses and the related allowance for credit losses. To the degree we add new leases to our portfolio, or to the degree credit quality is worse than expected, we will record expense to increase the allowance for credit losses for the estimated net losses expected in our lease portfolio.

Derivatives. SFAS 133, as amended, Accounting for Derivative Instruments and Hedging Activities, requires recognition of all derivatives at their fair value as either assets or liabilities in the consolidated balance sheet. The accounting for subsequent changes in the fair value of these derivatives depends on whether it has been designated and qualifies for hedge accounting treatment pursuant to the accounting standard. For derivatives not designated or qualifying for hedge accounting, the related gain or loss is recognized in earnings each period and included in other income or financing related costs in the consolidated statement of operations. For derivatives designated for hedge accounting, initial assessments are made as to whether the hedging relationship is expected to be highly effective and on-going periodic assessments may be required to determine the on-going effectiveness of the hedge. The gain or loss on derivatives qualifying for hedge accounting is recorded in other comprehensive income on the balance sheet net of tax effects (unrealized gain or loss on cash flow hedges) or in current period earnings depending on the effectiveness of the hedging relationship.

Income taxes. Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any necessary valuation allowance recorded against net deferred tax assets. The process involves summarizing temporary differences resulting from the different treatment of items, for example, leases for tax and accounting purposes. These

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differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. Our management must then assess the likelihood that deferred tax assets will be recovered from future taxable income or tax carry-back availability and, to the extent our management believes recovery is not more likely than not, a valuation allowance must be established. To the extent that we establish a valuation allowance in a period, an expense must be recorded within the tax provision in the statement of operations. We currently are in a net operating loss carryforwards (“NOLs”) position for state and federal income tax purposes. No valuation allowance has been established against net deferred tax assets related to our NOLs, as our management believes these NOLs will be realizable through reversal of existing deferred tax liabilities, and future taxable income. If actual results differ from these estimates or these estimates are adjusted in future periods, we may need to establish a valuation allowance, which could materially impact its financial position and results of operations.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended September 30, 2004 and 2003

Net income. Net income was $3.5 million for the three-month period ended September 30, 2004. This represented a $2.6 million increase from the same period of 2003. Excluding the impact of the change in fair value of warrants of $1.4 million for the three-month period ended September 30, 2003, net income would have increased $1.2 million, or 52.6% for the three-month period ended September 30, 2004. Net income was $858,000 for the three-month period ended September 30, 2003 including the impact of changes in fair value of warrants outstanding. All warrants were exercised in November 2003 and are no longer outstanding and therefore had no impact on 2004 results. Our increased earnings are primarily the result of growth and improved net interest and fee margins in our core leasing business. We continue to benefit from lower borrowing costs in the current interest rate environment.

During the three-months ended September 30, 2004, we generated 7,974 new leases with a cost of $68.8 million compared to 7,925 leases with a cost of $65.4 million generated for the three-months period ended September 30, 2003. The weighted average implicit interest rate on new leases originated was 13.75% for the three-months period ended September 30, 2004 compared to 13.80% for same period in 2003. Overall, our average net investment in direct financing leases (“DFL”) grew 23.2%, to $462.1 million at September 30, 2004 from $375.2 million at September 30, 2003.

(1)

Excludes allowance for credit losses and initial direct costs and fees deferred.

Net interest and fee income and margin. Net interest and fee income increased $4.1 million, or 41.7%, to $13.9 million for the three-months ended September 30, 2004 from $9.8 million for the three-months ended September 30, 2003. The increase in the annualized net interest and fee margin represents an increase of 158 basis points to 12.04% in the three-month period ended September 30, 2004 from 10.46% for the same period in 2003. For the three-month period ended September 30, 2004 compared to the same period in 2003, our weighted average cost of borrowing as a percentage of average net investment in DFL declined 115 basis points while our interest income yield declined less significantly, by 10 basis points. During this same period, fee income also increased by 53 basis points contributing to the net margin expansion.

Interest income, net of amortized initial direct costs and fees, increased $2.6 million, or 22.1%, to $14.4 million for the three-month

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period ended September 30, 2004 from $11.8 million for the three-month period ended September 30, 2003. The increase in interest income was due principally to a 23.2% growth in the average net investment in DFL outstanding which increased $86.9 million to $462.1 million at September 30, 2004 from $375.2 million at September 30, 2003.

Fee income increased $1.3 million, or 44.7%, to $4.1 million for the three-month period ended September 30, 2004 from $2.9 million for the same period in 2003. All major components of fee income contributed to the increase in the 2004 period consistent with the continued growth in our lease portfolio. The largest increases came from higher net residual income that grew $722,000 to $1.3 million and additional late fees that grew $383,000 to $1.9 million. Growth in residual income is reflective of the seasoning of our lease portfolio with more lease contracts reaching end of term and moving into renewal status. Fee income, as a percentage of the average net investment in DFL, increased 53 basis points to 3.58% annualized for the three-month period ended September 30, 2004 from 3.05% annualized for the same period in 2003.

Interest expense decreased $211,000 to $4.6 million for the three-month period ended September 30, 2004 from $4.8 million for the same period in 2003. Interest expense, as a percentage of the average net investment in DFL, decreased 115 basis points to 3.97% annualized for the three-month period ended September 30, 2004 from 5.12% annualized for the same period in 2003.

Interest expense as a percentage of weighted average borrowings was 3.81% for the third quarter ended September 30, 2004 compared to 4.90% for the same period in 2003. The average balance for our warehouse facilities was $39.4 million for the three months ended September 30, 2004 compared to $12.4 million for the same period ended September 30, 2003. The average borrowing costs for our warehouse facilities was 2.15% for the three months ended September 30, 2004 compared to 3.36% for the three months ended September 30, 2003.

In addition to lower warehouse funding rates in 2004, scheduled repayments and payoffs of higher coupon term borrowings over the past 12 months also blended borrowing costs lower. In August 2004 we exercised our call option and paid off our 2001 term securitization when the remaining note balances outstanding were $16.3 million at a coupon of approximately 6.00%. In April 2004 we exercised our call option and paid off our 2000 term securitization when the remaining note balances outstanding were $9.4 million at a coupon of 7.96%. In November 2003 we repaid $10 million of subordinated debt with a coupon of 11%. For the quarter ended September 30, 2004 average warehouse funding was $39.4 million or 8.5% of average investment in DFL compared with $12.4 million and 33.0% of average investment in DFL for the same period in 2003.

Insurance and other income. Insurance and other income increased $292,000, or 34.0%, to $1.2 million for the three-month period ended September 30, 2004 from $860,000 for the same period in 2003. The increase is primarily related to higher insurance income of $269,000 from a 28.4% increase in the average number of insured accounts in the 2004 period compared to the same period in the prior year.

Salaries and benefits expense. Salaries and benefits expense increased $907,000, or 34.5%, to $3.5 million for the three-months ended September 30, 2004 from $2.6 million for the same period in 2003. Total personnel increased to 265 at September 30, 2004 from 227 at September 30, 2003. For the three-months ended September 30, 2004 compared to the same period in 2003, sales and credit compensation increased $387,000 related to additional hiring of sales account executives and credit analysts and higher commissions earned for the period net of initial costs deferred per SFAS 91. Compensation in management and support areas increased $519,000 of which $157,000 was related to management incentive bonus accruals.

General and administrative expense. General and administrative expenses increased $708,000, or 39.7%, to $2.5 million for the three-months ended September 30, 2004 from $1.8 million for the same period in 2003. The increase in general and administrative expenses was due primarily to our continued growth and costs associated with being a public company. Increases included: insurance costs of $162,000 related to higher Directors and Officers Insurance costs, investor relations expenses of $52,000, and audit fees of $93,000. Audit services increased due to more external and internal audit services performed by outside firms mostly attributed to Sarbanes-Oxley compliance. Other increases totaling $274,000 were noted in expenses related to occupancy, data processing, collections, postage, bank fees, equipment and depreciation are attributable to overall continued growth of the Company and our lease portfolio.

Financing related costs. Financing related costs include commitment fees paid to our financing sources and costs pertaining to our derivative contracts used to limit our exposure to possible increases in interest rates. Financing related costs increased $193,000 to $635,000 for the three-month period ended September 30, 2004 from $442,000 for the same period in 2003. Expenses and mark-to-market adjustments of $209,000 were recorded on derivatives for the three-month period ended September 30, 2004 compared with income of $39,000 for the three months ended September 30, 2003. Commitment fees were $426,000 for the three months ended September 30, 2004 compared with $481,000 for the three months ended September 30, 2003.

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Change in fair value of warrants. As part of our reorganization undertaken in November 2003, all outstanding warrants were exercised on a net issuance basis for common stock. Accordingly, this non-cash expense did not continue beyond fiscal year 2003. The fair value of warrants issued in connection with subordinated debt increased $1.4 million in the three-month period ended September 30, 2003.

Provision for credit losses. The provision for credit losses increased $600,000, or 29.1%, to $2.7 million for the three-months ended September 30, 2004 from $2.1 million for the same period in 2003. The increase in our provision for credit losses resulted principally from growth of our lease portfolio and corresponding charge-offs and our estimates of losses inherent in the existing portfolio. The provision in the current quarter included $250,000 estimated for certain specifically identified accounts now viewed as probable charge-offs in the fourth quarter. Net charge-offs were $2.2 million for the three-month period ended September 30, 2004 and $1.8 million for the same period in 2003.

Provision for income taxes. The provision for income taxes increased 52.6% to $2.3 million for the three-month period ended September 30, 2004 from $1.5 million for the same period in 2003. The increase is directly attributable to the increase in pretax income. Our effective tax rate was 39.5% for the three-month period ended September 30, 2004 and 63.4% for the same period in 2003. The effective tax rate in 2003 was unusual due to expense in 2003 relating to the change in fair value of warrants, which is a non-cash expense and not tax deductible. We expect the effective tax rate in 2004 to approximate the same level as recognized in the third quarter of 2004.

Comparison of Nine Months Ended September 30, 2004 and 2003

Net income. Net income was $10.2 million for the nine-month period ended September 30, 2004. This represented a $8.6 million increase from the same period of 2003. Excluding the impact of the change in fair value of warrants of $5.0 million for the nine-month period ended September 30, 2003, net income would have increased $3.6 million, or 54.2% for the nine-month period ended September 30, 2004. Net income was $1.6 million for the nine-month period ended September 30, 2003 including the impact of changes in fair value of warrants outstanding. All warrants were exercised in November 2003 and are no longer outstanding and therefore had no impact on 2004 results. Our increased earnings are primarily the result of growth and improved net interest and fee margins in our core leasing business. We continue to benefit from lower borrowing costs in the current interest rate environment.

During the nine-months ended September 30, 2004, we generated 24,300 new leases with a cost of $205.5 million compared to 22,314 leases with a cost of $175.7 million generated for the nine-month period ended September 30, 2003. The weighted average implicit interest rate on new leases originated was 13.86% for the nine-month period ended September 30, 2004 compared to 14.13% for same period in 2003. Overall, our average net investment in direct financing leases (“DFL”) grew 24.7%, to $441.7 million for the nine months ended September 30, 2004 from $354.3 million for the nine months ended September 30, 2003.

(1)

Excludes allowance for credit losses and initial direct costs and fees deferred.

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Net interest and fee margin. Net interest and fee income increased $12.1 million, or 43.1%, to $40.3 million for the nine-months ended September 30, 2004 from $28.2 million for the nine-months ended September 30, 2003. The increase in the annualized net interest and fee margin represents an increase of 157 basis points to 12.17% in the nine-month period ended September 30, 2004 from 10.60% for the same period in 2003. For the nine-month period ended September 30, 2004 compared to the same period in 2003, our weighted average cost of borrowing as a percentage of average net investment in DFL declined 132 basis points while our interest income yield declined less significantly, by 28 basis points. During this same period, fee income also increased by 53 basis points contributing to the net margin expansion.

Interest income, net of amortized initial direct costs and fees, increased $7.4 million, or 21.9%, to $40.9 million for the nine-month period ended September 30, 2004 from $33.5 million for the nine-month period ended September 30, 2003. The increase in interest income was principally due to a 24.7% growth in the average net investment in DFL outstanding which increased $87.4 million to $441.7 million at September 30, 2004 from $354.3 million at September 30, 2003.

Fee income increased $3.7 million, or 46.5%, to $11.6 million for the nine-month period ended September 30, 2004 from $7.9 million for the same period in 2003. All major components of fee income contributed to the increase in the 2004 period consistent with the continued growth in our lease portfolio. The increase in fee income resulted primarily from higher net residual income of $1.9 million on lease terminations and late fees earned of $1.0 million. In addition, early prepayment gains and interim rent accounted for $731,000 of increases in the 2004 period. Fee income, as a percentage of the average net investment in DFL, increased 53 basis points to 3.50% annualized for the nine-month period ended September 30, 2004 from 2.97% annualized for the same period in 2003.

Interest expense decreased $1.2 million to $12.1 million for the nine-month period ended September 30, 2004 from $13.3 million for the same period in 2003. Interest expense, as a percentage of the average net investment in DFL, decreased 132 basis points to 3.67% annualized for the nine-month period ended September 30, 2004 from 4.99% annualized for the same period in 2003. Interest expense as a percentage of weighted average borrowings was 4.08% for the nine months ended September 30, 2004 compared to 4.86% for the same period in 2003. The interest rate environment has generally been lower and resulted in lower blended average borrowing costs as recent term debt issues have been for larger amounts at lower coupons than older issues. Older, higher coupon, term deals continue to amortize and comprise a smaller percentage of fixed rate term borrowings outstanding. Also, the average coupon cost for our warehouse facilities was 2.12% for the nine months ended September 30, 2004 compared to 2.49% for the nine months ended September 30, 2003. The average balance for our warehouse facilities was $92.5 million for the nine months ended September 30, 2004 compared to $80.1 million for the same period ended September 30, 2003.

In addition to lower warehouse funding rates in 2004, scheduled repayments and payoffs of higher coupon term borrowings over the past 12 months also blended borrowing costs lower. In August 2004 we exercised our call option and paid off our 2001 term securitization when the remaining note balances outstanding were $16.3 million at a coupon of approximately 6.00%. In April 2004 we exercised our call option and paid off our 2000 term securitization when the remaining note balances outstanding were $9.4 million at a coupon of 7.96%. In November 2003 we repaid $10 million of subordinated debt with a coupon of 11%. For the nine months ended September 30, 2004 average warehouse funding was $92.5 million or 20.9% of average investment in DFL compared with $80.1 million and 22.6% of average investment in DFL for the same period in 2003.

Insurance and other income. Insurance and other income increased $750,000, or 30.3%, to $3.2 million for the nine-month period ended September 30, 2004 from $2.5 million for the same period in 2003. The increase is primarily related to higher insurance income of $684,000 from a 27.5% increase in the number of insured accounts.

Salaries and benefits expense. Salaries and benefits expense increased $2.7 million, or 36.3%, to $10.2 million for the nine-months ended September 30, 2004 from $7.5 million for the same period in 2003. Total personnel increased to 265 at September 30, 2004 from 227 at September 30, 2003. For the nine-months ended September 30, 2004 compared to the same period in 2003, sales and credit compensation increased $1.4 million related to additional hiring of sales account executives and credit analysts and higher commissions earned for the period net of initial costs deferred per SFAS 91. In addition, collection salaries increased $422,000 due to increased staffing levels and higher collection commissions earned. Compensation in management and other support areas increased $922,000, of which $320,000 was related to management incentive bonus accruals.

General and administrative expense. General and administrative expenses increased $2.2 million, or 42.4%, to $7.5 million for the nine-months ended September 30, 2004 from $5.3 million for the same period in 2003. The increase in general and administrative expenses was due primarily to an increase in insurance costs of $480,000 relating to higher Directors and Officers Insurance costs and of $267,000 in franchise taxes. Other increases included: occupancy expense of $165,000 due to the incremental costs of the new Chicago office and expanded Denver and Atlanta offices, investor relations expense of $147,000, and audit fees of $178,000 for the

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incremental costs associated with being a Public Company and Sarbanes-Oxley compliance.

Financing related costs. Financing related costs include commitment fees paid to our financing sources and costs pertaining to our derivative contracts used to limit our exposure to possible increases in interest rates. Financing related costs increased $416,000 to $1.5 million for the nine-month period ended September 30, 2004 from $1.1 million for the same period in 2003 principally due to write downs in the fair market values of derivatives and increased commitment fees resulting from an increase of $25 million in overall warehouse commitment levels. Mark to market charges taken on our interest rate caps were $450,000 for the nine-month period ended September 30, 2004 compared with $192,000 for the nine-months ended September 30, 2003. Commitment fees were $1.1 million for the nine-month period ended September 30, 2004 compared with $960,000 for the nine-month period ended September 30, 2003.

Change in fair value of warrants. As part of our reorganization undertaken in November 2003, all outstanding warrants were exercised on a net issuance basis for common stock. Accordingly, this non-cash expense did not continue beyond fiscal year 2003. The fair value of warrants issued in connection with subordinated debt increased $5.0 million in the nine-month period ended September 30, 2003.

Provision for credit losses. The provision for credit losses increased $1.6 million, or 27.4%, to $7.4 million for the nine-months ended September 30, 2004 from $5.8 million for the same period in 2003. The increase in our provision for credit losses resulted principally from growth of our lease portfolio and corresponding charge-offs and our estimates of losses inherent in the existing portfolio. Net charge-offs were $6.4 million for the nine-month period ended September 30, 2004 and $5.1 million for the same period in 2003.

Provision for income taxes. The provision for income taxes increased 54.3% to $6.7 million for the nine-month period ended September 30, 2004 from $4.3 million for the same period in 2003. The increase is directly attributable to the increase in pretax income. Our effective tax rate was 39.5% for nine-month period ended September 30, 2004 and 73.2% for the same period in 2003. The effective tax rate in 2003 was unusual due to expense in 2003 relating to the change in fair value of warrants, which is a non-cash expense and not tax deductible. We expect the effective tax rate in 2004 to approximate the same level as that recognized in the third quarter of 2004.

LEASE RECEIVABLES AND ASSET QUALITY

Our net investment in direct financing leases (“DFL”) grew $58.4 million or 13.9% to $480.1 million at September 30, 2004 from $421.7 million at December 31, 2003. Over the past nine months, the Company has increased its sales representatives and the number of independent dealers and other origination sources that generate and develop lease customers. The Company’s leases are assigned as collateral for borrowings as described below in Liquidity and Capital Sources.

The activity of the allowance for credit losses and delinquent accounts follows (dollars in thousands):

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Net investments in direct financing leases are charged-off when they are contractually past due 121 days based on the historical net loss rates realized by the Company. Income is not recognized on leases when a default on monthly payment exists for a period of 90 days or more. Income recognition resumes when a lease becomes less than 90 days delinquent.

Delinquent accounts 60 days or more past due as a percentage of average net investment in DFL declined to 0.73% at September 30, 2004 from 0.74% at December 31, 2003. We generally experience higher delinquency rates in December of each year, as we believe our lessees adjust their payment patterns around the year-end. The September 30, 2004 60 days or more delinquency level was higher than the 0.64% level at September 30, 2003 and 0.66% level as of June 30, 2004. We attribute approximately $250,000, or 0.05% in additional accounts 60 days or more delinquent to approximately four borrowers viewed as probable charge-offs in the fourth quarter of 2004. Accordingly, we increased our provision for credit losses by $250,000 in the third quarter 2004 to reserve for possible exposure from these accounts.

Annualized net charge-offs as a percentage of average net investment in DFL were 1.90% and 1.94% for the three and nine month periods ending September 30, 2004, respectively, compared with 1.93% and 1.92% for the three and nine month periods ending September 30, 2003, respectively. In the current economic environment, we expect net charge-offs to approximate 2.0% of our average net investment in leases and consider our net charge-off levels in the periods reported to be consistent with our expectations.

Residual Performance

Our leases offer our end user customers the option to own the purchased equipment at lease expiration. As of September 30, 2004, approximately 68% of our leases were one dollar purchase option leases, 20% were fair market value leases and 12% were fixed purchase option leases, the latter of which typically are 10% of the original equipment cost. As of September 30, 2004, there were $40.0 million of residual assets retained on our balance sheet of which $24.4 million were related to copiers.

Our leases generally include renewal clauses and some leases continue beyond their initial contractual term. We consider renewal income a component of residual performance. For the three and nine months ended September 30, 2004 and 2003, renewal income, net of depreciation amounted to $1.2 million, $745,000, $3.1 million, and $1.7 million, respectively and net gains (losses) on residual values amounted to $101,000, ($198,000), $71,000, and ($382,000), respectively.

LIQUIDITY AND CAPITAL RESOURCES

Our business requires a substantial amount of cash to operate and grow. Our primary liquidity need is for new lease originations. In addition, we need liquidity to pay interest and principal on our borrowings, to pay fees and expenses incurred in connection with our securitization transactions, to fund infrastructure and technology investment and to pay administrative and other operating expenses. We are dependent upon the availability of financing from a variety of funding sources to satisfy these liquidity needs. Historically, we have relied upon four principal types of third party financing to fund our operations:

•

borrowings under a revolving bank facility;

•

financing of leases in CP conduit warehouse facilities;

•

financing of leases through term note securitizations; and

•

equity and debt securities with third party investors.

We used net cash in investing activities of $65.6 million for the nine months ended September 30, 2004, and $64.6 million for the nine months ended September 30, 2003. Investing activities primarily relate to lease originations.

Net cash provided by financing activities was $77.8 million for the nine months ended September 30, 2004 and $53.6 million for the nine months ended September 30, 2003. Net cash provided by financing activities in 2004 includes $304.6 million of proceeds from our last term securitization completed July 22, 2004. Financing activities in 2004 also include $347.7 million of net repayments of other borrowings including approximately $25.7 million to retire two term note securitizations.

Additional liquidity is provided by our cash flow from operations. We generated cash flow from operations of $25.2 million for the nine months ended September 30, 2004, and $20.5 million for the nine months ended September 30, 2003.

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We expect cash from operations, additional borrowings on existing and future credit facilities, and the completion of additional on-balance-sheet term note securitizations to be adequate to support our operations and projected growth.

Cash and Cash Equivalents. Our objective is to generally maintain a low cash balance, investing any free cash in leases. Total cash and cash equivalents as of September 30, 2004, was $66.8 million compared to $29.4 million at December 31, 2003. The cash position at September 30, 2004 was higher than normal due in part to an $80 million prefunding feature included in our 2004 term securitization. The balance of the prefunding proceeds were released to the company by September 30, 2004, increasing cash and cash equivalents.

As of September 30, 2004, we also had $19.5 million of cash that was classified as restricted cash, compared to $15.7 million at December 31, 2003. Restricted cash consists primarily of the cash reserve and advance payment accounts related to our term note securitizations.

Borrowings. Our borrowing relationships each require the pledging of eligible lease receivables to secure amounts advanced. We initially fund our new lease production with cash from operations, equity and then advances from our warehouse facilities. We refinance our warehouse facilities periodically by completing term note securitizations. Term note securitizations have been done annually since 1999 and provide fixed-rate financing to support our fixed rate lease assets over the remaining term of the lease contracts. On July 22, 2004 we completed our most recent term note securitization for $304.6 million and repaid all amounts borrowed through our warehouse facilities.

Borrowings outstanding under the Company’s revolving credit facilities and long-term debt consist of the following:

(1)

Subject to lease eligibility and borrowing base formula.

(2)

Our term note securitizations are one-time fundings that pay down over time without any ability for us to draw down additional amounts.

Revolving Bank Facility

As of September 30, 2004 and December 31, 2003, the Company has a committed revolving line of credit with several participating banks to provide up to $40.0 million in borrowings at LIBOR plus 2.125%. The credit facility expires on August 31, 2005. There was zero outstanding under this facility at September 30, 2004 and $4.5 million outstanding at December 31, 2003. For the nine-months ended September 30, 2004 and the year ended December 31, 2003, the weighted average interest rates were 3.46% and 3.94%, respectively. For the nine-months ended September 30, 2004 and year ended December 31, 2003, the Company incurred commitment fees on the unused portion of the credit facility of $174,000 and $156,000, respectively.

CP Conduit Warehouse Facilities

We have two Commercial Paper (“CP”) conduit warehouse facilities that allow us to borrow, repay and re-borrow based on a borrowing base formula. In these transactions, we transfer pools of leases and interests in the related equipment to special purpose, wholly-owned, bankruptcy remote, special purpose subsidiaries of the Company, which issue variable rate notes to investors. These facilities require that the Company limit its exposure to adverse interest rate movements on the variable rate notes through entering into interest rate cap agreements.

00-A Warehouse Facility — This facility totals $125 million and was extended in October 2004 and now expires in October 2006. The 00-A Warehouse Facility is credit enhanced through a third party financial guarantee insurance policy. For the nine-months ended September 30, 2004 and the year ended December 31, 2003, the weighted average interest rates were 1.71% and 1.84%, respectively. There was zero outstanding under this facility at September 30, 2004 and $28.1 million outstanding at December 31, 2003.

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02-A Warehouse Facility — This facility was increased from $75 million to $100 million in March 2004 and extended to now expire in April 2006. The 02-A Warehouse Facility is credit enhanced through a third party financial guarantee insurance policy. For the nine-months ended September 30, 2004 and year ended December 31, 2003, the weighted average interest rate was 2.28% and 2.43%, respectively. There was zero outstanding under this facility at September 30, 2004 and $38.1 million at December 31, 2003.

Term Note Securitizations

Since our founding, we have completed six on-balance-sheet term note securitizations. In connection with each securitization transaction, we have transferred leases to our wholly owned, special-purpose bankruptcy remote subsidiaries and issued term debt collateralized by such commercial leases to institutional investors in private securities offerings. Our term note securitizations differ from our CP conduit warehouse facilities primarily in that our term note securitizations have fixed terms, fixed interest costs and fixed principal amounts. Our securitizations do not qualify for sales accounting treatment due to certain call provisions that we maintain and that the special purpose entities also hold residual assets. Accordingly, assets and the related debt of the special purpose entities are included in our consolidated balance sheets. Our leases and restricted cash are assigned as collateral for these borrowings and there is no further recourse to the general credit of the Company. By entering into term note securitizations, we reduce outstanding borrowings under our CP conduit warehouse facilities and revolving bank facility, which increases the amounts available to us under these facilities to fund additional lease originations. Failure to periodically pay down the outstanding borrowings under our warehouse facilities, or increase such facilities, would significantly limit our ability to grow our lease portfolio. At September 30, 2004 and at December 31, 2003, outstanding term securitizations amounted to $459.7 million and $308.1 million, respectively.

On July 22, 2004 we closed on the issuance of our sixth term note securitization transaction in the amount of $304.6 million which included a pre-funding feature whereby approximately $80 million of cash proceeds was deposited into an account to fund qualifying new leases originated up to October 15, 2004. By September 30, 2004, the Company had received the total proceeds from the pre-funding account by delivering additional lease collateral. Partial proceeds from the 2004 transaction were used to reduce borrowings in our warehouse facilities to zero at September 30, 2004. In addition the Company had $66.8 million in cash balances at September 30, 2004 to fund continuing operations and new lease production. The 2004 term securitization included 6 classes of notes issued with three of the classes issued to investors at variable rates but swapped to fixed interest cost to the Company through use of derivative interest rate swap contracts. The weighted average interest coupon will approximate 3.81% over the term of the financing.

On August 16, 2004 we elected to exercise our call option and pay off our 2001-1 term securitization when the remaining note balances outstanding were $16.3 million at a coupon of approximately 6.0%. Our Series 2000-1 transaction was repaid in full on April 15, 2004 when the remaining note balances outstanding were $9.4 million at a coupon of approximately 8.0%. Our Series 1999-2 transaction was repaid in full on January 15, 2003. At September 30, 2004 the Company had three remaining term securitization transactions outstanding.

Our borrowings, including our term note securitizations, are collateralized by the Company’s direct financing leases. The Company is restricted from selling, transferring, or assigning these leases or placing liens or pledges on these leases.

Under the revolving bank facility, warehouse facilities and term securitization agreements, the Company is subject to numerous covenants, restrictions and default provisions relating to, among other things, maximum lease delinquency and default levels, a minimum net worth requirement of $60.1 million and a maximum debt to equity ratio of 10 to 1. A change in the Chief Executive Officer or President is an event of default under the revolving bank facility and warehouse facilities unless a replacement acceptable to the Company’s lenders is hired within 90 days. Such an event is also an immediate event of servicer termination under the term securitizations. A merger or consolidation with another company in which the Company is not the surviving entity is an event of default under the financing facilities. In addition, the revolving bank facility and warehouse facilities contain cross default provisions whereby certain defaults under one facility would also be an event of default on the other facilities. An event of default under the revolving bank facility or warehouse facilities could result in termination of further funds being available under such facility. An event of default under any of the facilities could result in an acceleration of amounts outstanding under the facilities, foreclosure on all or a portion of the leases financed by the facilities and/or the removal of the Company as servicer of the leases financed by the facility. As of September 30, 2004 the Company was in compliance with terms of its warehouse facilities and term securitization agreements.

MARKET INTEREST RATE RISK AND SENSITIVITY

Market risk is the risk of losses arising from changes in values of financial instruments. We engage in transactions in the normal course of business that expose us to market risks. We attempt to mitigate such risks through prudent management practices and

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strategies such as attempting to match the expected cash flows of our assets and liabilities.

We are exposed to market risks associated with changes in interest rates and our earnings may fluctuate with changes in interest rates. The lease assets we originate are almost entirely fixed rate. Accordingly, we generally seek to finance these assets with fixed interest cost term note securitization borrowings that we issue periodically. Between term note securitization issues, we finance our new lease originations through a combination of variable rate warehouse facilities and working capital. Our mix of fixed and variable rate borrowings and our exposure to interest rate risk changes over time. Over the past twelve months, the mix of variable rate borrowings has ranged from zero to 43% of total borrowings and averaged 20%. Our highest exposure to variable rate borrowings generally occurs just prior to the issuance of a term note securitization.

We also use derivative financial instruments to attempt to further reduce our exposure to changing cash flows caused by possible changes in interest rates. On July 22, 2004 we issued a term note securitization where certain classes of notes were issued at variable rates to investors. We simultaneously entered into interest rate swap contracts to convert these borrowings to fixed interest costs to the Company for the term of the borrowing.

We may also use interest rate swaps to reduce our exposure to changing market interest rates prior to issuing a term note securitization. In this scenario we usually enter into a forward starting swap to coincide with the forecasted pricing date of our next term note securitization. The intention of this derivative is to reduce possible variations in future cash flows caused by changes in interest rates prior to our forecasted securitization. We may choose to hedge all or a portion of a forecasted transaction. In October 2004 we entered two forward starting swap agreements with a total notional amount of $100 million to partially hedge our forecasted 2005 term securitization. At September 30, 2004 we did not have any such swap agreements outstanding.

To provide additional protection against potential interest rate increases associated with our variable rate warehouse borrowing facilities, we are required by our CP conduit warehouse facilities to enter into derivative financial transactions. We are using interest rate caps to fulfill these requirements. As of September 30, 2004, we held interest rate caps with a notional amount of $144.7 million with several counterparties at various terms and the fair value of these contracts was $137,000.

The following table presents the expected principal repayment schedule of our debt and the related weighted average interest rates as of September 30, 2004 and for each year ended through December 31, 2008 and for periods thereafter.

Our warehouse facilities charge variable rates of interest based on LIBOR, prime rate or commercial paper interest rates. Because our assets are predominately fixed rate, increases in these market interest rates would negatively impact earnings and decreases in the rates would positively impact earnings because the rate charged on our borrowings would change faster than our assets could reprice. We would have to offset increases in borrowing costs by adjusting the pricing under our new leases or our net interest margin would be reduced. There can be no assurance that we will be able to offset higher borrowing costs with increased pricing of our assets.

For example, the impact of a hypothetical 100 basis point, or 1.0%, increase in the market rates for which our borrowings are indexed for the twelve month period ended September 30, 2004 would be to reduce net interest and fee income by approximately $801,000 based on our average variable rate borrowings of approximately $80.1 million for the year then ended, excluding the effects of any changes in the value of interest rate caps and possible increases in the yields from our lease portfolio due to the origination of new leases at higher interest rates.

We manage and monitor our exposure to interest rate risk using balance sheet simulation models. Such models incorporate many of our assumptions about our business including new asset production and pricing, interest rate forecasts, use of derivatives, overhead expense forecasts and assumed credit losses. Actual results may differ from our simulation models due to various factors including time and magnitude of interest rate changes, changes in customer behavior, effects of competition and other factors.

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RECENTLY ISSUED ACCOUNTING STANDARDS

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, or FIN 46. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003 and to existing entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. In December 2003, the FASB issued Interpretation No. 46 (Revised), Consolidation of Variable Interest Entities, or FIN No. 46R, which provides further guidance on the accounting for variable interest entities. As permitted by FIN No. 46R, and described above, the Company applied the provisions of FIN No. 46 as of December 31, 2003. The adoption of this accounting pronouncement has not had a material effect on the Company’s consolidated financial statements. The Company adopted the provisions of FIN No. 46R in the first quarter of 2004. The adoption of FIN No. 46R did not have a material effect on the Company’s consolidated financial statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 Derivative Instruments and Hedging Activities. This statement amends and clarifies financial accounting and reporting for derivative instruments embedded in other contracts, and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. In particular, this statement: 1) clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative; 2) clarifies when a derivative contains a financing component; 3) amends the definition of an underlying to conform it to language used in FIN 45; and 4) amends certain other existing pronouncements. This Statement is effective for hedging relationships designated after June 30, 2003 and for contracts entered into or modified after June 30, 2003, except for provisions of this statement relating to Statement 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003 which should continue to be applied in accordance with their respective dates. The adoption of this accounting pronouncement did not have a material effect on the Company’s consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments and characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability, or an asset in some circumstances. Many of those instruments were previously classified as equity. This Statement does not apply to features that are embedded in a financial instrument that is not a derivative in its entirety, for example, it does not change the accounting treatment for conversion features, or conditional redemption features. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for public companies at the beginning of the first interim period beginning after June 15, 2003. The adoption of this accounting pronouncement did not have a material effect on the Company’s consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The information required herein is set forth in Item 2 under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Interest Rate Risk and Sensitivity”, above.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We believe that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

(b) Changes in Internal Control over Financial Reporting

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There have been no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

We are party to various legal proceedings, which include claims, litigation and class action suits arising in the ordinary course of business. Some of these cases challenge certain of our lease contract provisions and business practices. None of the current purported class actions have been certified. Although the amount of any liability with respect to any such litigation cannot be determined, in the opinion of management, such liability is not expected to have a material adverse effect on our business, financial condition or results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters To A Vote Of Security Holders

None

Item 5. Other Information

None

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits.

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(1)		Previously filed with the Securities and Exchange Commission as an exhibit to the Registrant’s Registration Statement on Form S-1 (File No. 333-108530), filed on September 5, 2003, and incorporated by reference herein.
(2)		Previously filed with the Securities and Exchange Commission as an exhibit to the Registrant’s Amendment No. 1 to Registration Statement on Form S-1 (File No. 333-108530), filed on October 14, 2003, and incorporated by reference herein.
(3)		Previously filed with the Securities and Exchange Commission as an exhibit to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1 filed on October 28, 2003 (File No. 333-108530), and incorporated by reference herein.
(4)		Previously filed with the Securities and Exchange Commission as an exhibit to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 filed on March 29, 2004, and incorporated by reference herein.
(5)		Previously filed with the Securities and Exchange Commission as an exhibit to the Registrant’s Form 8-K dated October 7,

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(b)		Reports on Form 8-K.
		Current Report on Form 8-K dated July 22, 2004, reporting that the Registrant had issued a press release announcing the completion of a $304.6 million term asset backed securitization, a copy of which was furnished as Exhibit 99.1 to that Form 8-K.
		Current Report on Form 8-K dated July 27, 2004, reporting that the Registrant had issued a press release announcing its results of operations for the second quarter ended June 30, 2004, a copy of which was furnished as Exhibit 99.1 to that Form 8-K.

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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.

November 8, 2004
(Date)

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