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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
Commission File No. 1-14771
MICROFINANCIAL INCORPORATED
(Exact name of Registrant as specified in its Charter)
Massachusetts 04-2962824
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
10 M Commerce Way, Woburn, MA 01801
(Address of Principal Executive Offices)
(781) 994-4800
(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
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
As of August 4, 2003, 13,461,018 shares of the registrant's common
stock were outstanding.
MICROFINANCIAL INCORPORATED
TABLE OF CONTENTS
Page
----
Part I FINANCIAL INFORMATION
Item 1 Financial Statements (unaudited):
Condensed Consolidated Balance Sheets
December 31, 2002 and June 30, 2003 3
Condensed Consolidated Statements of Operations
Three months ended June 30, 2002 and 2003 4
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2002 and 2003 5
Notes to Condensed Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3 Quantitative and Qualitative Disclosures about Market Risk 20
Item 4 Controls and Procedures 20
Part II OTHER INFORMATION
Item 1 Legal Proceedings 21
Item 3 Recent Sales of Unregistered Securities 23
Item 5 Other Information 23
Item 6 Exhibits and Reports on Form 8-K 24
Signatures 25
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31, June 30,
------------ ------------
2002 2003
------------ ------------
ASSETS
Net investment in leases and loans:
Receivables due in installments $ 334,623 $ 257,680
Estimated residual value 30,754 25,813
Initial direct costs 4,891 3,247
Loans receivable 1,796 1,771
Less:
Advance lease payments and deposits (96) (52)
Unearned income (67,574) (44,715)
Allowance for credit losses (69,294) (59,180)
------------ ------------
Net investment in leases and loans $ 235,100 $ 184,564
Investment in service contracts 14,463 11,383
Cash and cash equivalents 5,494 8,189
Restricted cash 18,516 12,197
Property and equipment, net 9,026 6,935
Income taxes receivable 8,652 0
Other assets 3,834 6,144
------------ ------------
Total assets $ 295,085 $ 229,412
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable $ 168,927 $ 110,151
Subordinated notes payable 3,262 3,262
Capitalized lease obligations 471 297
Accounts payable 3,840 3,141
Other liabilities 6,776 5,542
Income taxes payable 1,400 3,838
Deferred income taxes payable 23,806 20,812
------------ ------------
Total liabilities 208,482 147,043
------------ ------------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized;
no shares issued at 12/31/02 and 6/30/03 - -
Common stock, $.01 par value; 25,000,000 shares authorized; 13,410,646
and 13,765,116 shares issued at 12/31/02 and 6/30/03, respectively 134 138
Additional paid-in capital 47,723 46,316
Retained earnings 45,089 40,599
Treasury stock (588,700 and 426,366 shares of common stock at 12/31/02
and 6/30/03), at cost (6,343) (4,590)
Unearned compensation 0 (94)
------------ ------------
Total stockholders' equity 86,603 82,369
------------ ------------
Total liabilities and stockholders' equity $ 295,085 $ 229,412
============ ============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
For the three months ended For the six months ended
June 30, June 30,
--------------------------- ---------------------------
2002 2003 2002 2003
------------ ------------ ------------ ------------
Revenues:
Income on financing leases and loans $ 13,790 $ 8,378 $ 29,026 $ 18,199
Income on service contracts 2,458 2,334 4,853 4,586
Rental income 9,220 8,628 19,083 17,175
Loss and damage waiver fees 1,532 1,423 3,057 2,906
Service fees and other 5,961 3,201 12,227 6,669
--------------------------- ---------------------------
Total revenues 32,961 23,964 68,246 49,535
--------------------------- ---------------------------
Expenses:
Selling general and administrative 11,409 8,709 23,983 17,841
Provision for credit losses 10,824 15,249 21,788 26,048
Depreciation and amortization 4,851 4,087 8,490 8,357
Interest 2,618 2,145 5,365 4,774
--------------------------- ---------------------------
Total expenses 29,702 30,190 59,626 57,020
--------------------------- ---------------------------
Income/(loss) before provision for income taxes 3,259 (6,226) 8,620 (7,485)
Provision/(benefit) for income taxes 1,304 (2,490) 3,448 (2,994)
--------------------------- ---------------------------
Net income/(loss) $ 1,955 ($ 3,736) $ 5,172 ($ 4,491)
=========================== ===========================
Net income/(loss) per common share - basic $ 0.15 ($ 0.29) $ 0.40 ($ 0.35)
=========================== ===========================
Net income/(loss) per common share - diluted $ 0.15 ($ 0.29) $ 0.40 ($ 0.35)
=========================== ===========================
Weighted-average shares used to compute:
Basic net income (loss) per share 12,821,946 12,917,752 12,821,946 12,917,752
--------------------------- ---------------------------
Fully diluted net income (loss) per share 12,901,149 12,917,752 12,877,839 12,917,752
--------------------------- ---------------------------
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the three months ended For the six months ended
June 30, June 30,
--------------------------- ---------------------------
2002 2003 2002 2003
------------ ------------ ------------ ------------
Cash flows from operating activities:
Cash received from customers $ 45,004 $ 35,503 $ 91,732 $ 75,156
Cash paid to suppliers and employees (10,149) (12,263) (21,791) (23,059)
Cash (paid) received for income taxes (2,271) 11,098 (3,259) 11,090
Interest paid (2,579) (2,731) (4,889) (5,912)
Interest received 87 31 242 74
--------------------------- ---------------------------
Net cash provided by operating activities 30,092 31,638 62,035 57,349
--------------------------- ---------------------------
Cash flows from investing activities:
Investment in lease contracts (23,358) (276) (43,385) (1,699)
Investment in inventory (1,057) (8) (2,076) (78)
Investment in direct costs (1,417) (12) (2,713) (137)
Investment in service contracts (2,081) 0 (4,407) 0
Investment in fixed assets 19 (92) (118) (142)
Repayment of notes from officers 23 0 33 0
--------------------------- ---------------------------
Net cash used in investing activities (27,871) (388) (52,666) (2,056)
--------------------------- ---------------------------
Cash flows from financing activities:
Proceeds from secured debt 11,929 0 21,229 0
Repayment of secured debt (13,733) (35,010) (27,952) (58,745)
Repayment of short term demand notes payable (200) (30) (285) (30)
Decrease in restricted cash 1,015 2,223 1,113 6,319
Repayment of capital leases (105) (47) (206) (142)
Payment of dividends (642) 0 (1,283) 0
--------------------------- ---------------------------
Net cash used in financing activities (1,736) (32,864) (7,384) (52,598)
--------------------------- ---------------------------
Net increase (decrease) in cash and cash equivalents: 485 (1,614) 1,985 2,695
Cash and cash equivalents, beginning of period 1,646 9,803 146 5,494
--------------------------- ---------------------------
Cash and cash equivalents, end of period $ 2,131 $ 8,189 $ 2,131 $ 8,189
=========================== ===========================
(continued on following page)
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Continued)
For the three months ended For the six months ended
June 30, June 30,
--------------------------- ---------------------------
2002 2003 2002 2003
----------- ----------- ------------ ------------
Reconciliation of net income to net cash provided
by operating activities:
Net income (loss) $ 1,955 ($ 3,736) $ 5,172 ($ 4,491)
Adjustments to reconcile net income (loss) to
cash provided by operating activities
Depreciation and amortization 4,851 4,087 8,490 8,357
Provision for credit losses 10,824 15,249 21,788 26,048
Recovery of equipment cost and residual value,
net of revenue recognized 13,367 27,569 25,571 39,980
Change in assets and liabilities:
Decrease (increase) in current taxes payable (1,523) 2,446 (2,512) 2,274
Increase (decrease) in current taxes receivable 0 (8,652) 0 (8,652)
Decrease (increase) in deferred income taxes 557 (2,491) 2,701 (2,994)
Increase (decrease) in other assets 502 (1,836) 918 (2,399)
Increase (decrease) in accounts payable 39 (804) 23 (699)
Increase in accrued liabilities (480) (194) (116) (75)
--------------------------- ---------------------------
Net cash provided by operating activities $ 30,092 $ 31,638 $ 62,035 $ 57,349
=========================== ===========================
Supplemental disclosure of noncash activities:
Property acquired under capital leases $ 68 $ 0 $ 68 $ 0
Accrual of common stock dividends $ 641 $ 0 $ 641 $ 0
The accompanying notes are an integral part of the condensed consolidated
financial statements.
6
MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(A) Nature of Business:
MicroFinancial Incorporated (the "Company") which operates primarily
through its wholly-owned subsidiary, Leasecomm Corporation, is a specialized
commercial finance company that primarily leases and rents "microticket"
equipment and provides other financing services in amounts generally ranging
from $400 to $15,000 with an average amount financed of approximately $1,700 and
an average lease term of 44 months. The Company does not market its services
directly to lessees but sources leasing transactions through a network of
independent sales organizations and other dealer-based origination networks
nationwide. The Company has funded its operations primarily through borrowings
under its credit facilities, the issuance of subordinated debt and on balance
sheet securitizations.
MicroFinancial incurred net losses of $22.1 million for the year ended
December 31, 2002. The net losses incurred by the Company during the third and
fourth quarters caused the Company to be in default of certain debt covenants in
its credit facility and securitization agreements. In addition, as of September
30, 2002, the Company's credit facility failed to renew and consequently, the
Company was forced to suspend new origination activity as of October 11, 2002.
On April 14, 2003, the Company entered into a long-term agreement with its
lenders. This long-term agreement waives the defaults described above, and in
consideration for this waiver, requires the outstanding balance of the loan to
be repaid over a term of 22 months beginning in April 2003 at an interest rate
of prime plus 2.0%. The Company received a waiver, which was set to expire on
April 15, 2003, for the covenant violations in connection with the
securitization agreement. Subsequently, the Company received a permanent waiver
of the covenant defaults and the securitization agreement was amended so that
going forward, the covenants are the same as those contained in the long-term
agreement entered into on April 14, 2003, for the senior credit facility. The
Company remains in full compliance with the terms and conditions of its
securitizations and senior credit facility. The Company operates within all
delinquency and charge-off covenants and has continued to make or exceed all
scheduled payments on these debt instruments in a timely manner.
In an effort to improve its financial position, MicroFinancial has
taken certain steps including the engagement of a financial and strategic
advisory firm, Triax Capital Advisors, LLC. Management and its advisors are
actively considering various financing, restructuring and strategic
alternatives. In addition, Management has taken steps to reduce overhead,
including a reduction in headcount from 380 at December 31, 2001 to 203 at
December 31, 2002. During the six months ended June 30, 2003, the employee
headcount was further reduced to 159 in a continued effort to maintain an
appropriate cost structure.
Leasecomm Corporation periodically finances its lease and service
contracts, together with unguaranteed residuals, through securitizations using
special purpose vehicles. MFI Finance Corporation I and MFI Finance Corporation
II, LLC are special purpose companies. The assets of such special purpose
vehicles and cash collateral or other accounts created in connection with the
financings in which they participate are not available to pay creditors of
Leasecomm Corporation, MicroFinancial Incorporated, or other affiliates. While
Leasecomm Corporation generally does not sell its interests in leases, service
contracts or loans to third parties after origination, the Company does, from
time to time, contribute certain leases, service contracts, or loans to
special-purpose entities for purposes of obtaining financing in connection with
the related receivables. The contribution of such assets under the terms of such
financings are intended to constitute "true sales" of such assets for bankruptcy
purposes (meaning that such assets are legally isolated from Leasecomm
Corporation). However, the special purpose entities to which such assets are
contributed are not "qualifying special purpose entities" within the meaning
Statement of Financial Accounting Standards ("SFAS") SFAS No. 140, and are
required under generally accepted accounting principles to be consolidated in
the financial statements of the Company. As a result, such assets and the
related liability remain on the balance sheet and do not receive gain on sale
treatment.
7
MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(B) Summary of Significant Accounting Policies:
Basis of Presentation:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America and the rules and regulations of the Securities and
Exchange Commission for interim financial statements. Accordingly, the interim
statements do not include all of the information and disclosures required for
the annual financial statements. In the opinion of the Company's management, the
condensed consolidated financial statements contain all adjustments, consisting
only of normal recurring adjustments, considered necessary for a fair
presentation of these interim results. These financial statements should be read
in conjunction with the consolidated financial statements and notes included in
the Company's Annual Report and Form 10-K for the year ended December 31, 2002.
The results for the six-month period ended June 30, 2003 are not necessarily
indicative of the results that may be expected for the full year ended December
31, 2003.
The balance sheet at December 31, 2002 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, 2002.
Allowance for Credit Losses:
The Company maintains an allowance for credit losses on its investment
in leases, service contracts and loans at an amount that it believes is
sufficient to provide adequate protection against losses in its portfolio. The
allowance is determined principally on the basis of the historical loss
experience of the Company and the level of recourse provided by such lease,
service contract or loan, if any, and reflects management's judgment of
additional loss potential considering current economic conditions and the nature
and characteristics of the underlying lease portfolio. The Company determines
the necessary periodic provision for credit losses, taking into account actual
and expected losses in the portfolio, as a whole, and the relationship of the
allowance to the net investment in leases, service contracts and loans.
The following table sets forth the Company's allowance for credit
losses as of December 31, 2002 and June 30, 2003 and the related provision,
charge-offs and recoveries for the six months ended June 30, 2003.
Balance of allowance for credit losses at December 31, 2002 $ 69,294
============
Provision for credit losses 26,048
Total provisions for credit losses 26,048
Charge-offs (40,362)
Recoveries 4,200
-------
Charge-offs, net of recoveries (36,162)
------------
Balance of allowance for credit losses at June 30, 2003 $ 59,180
============
Earnings (Loss) Per Share:
Basic net income (loss) per common share is computed based on the
weighted-average number of common shares outstanding during the period. Dilutive
net income (loss) per common share gives effect to all dilutive potential common
shares outstanding during the period. The computation of diluted earnings (loss)
per share does not assume the issuance of common shares that have an
antidilutive effect on net income per common share. Options to purchase
1,770,000 shares of common stock were not included in the computation of diluted
earnings per share for the three months and six months ended June 30, 2002
because their effects were antidilutive. All stock options, common stock
warrants, and unvested restricted stock were excluded from the computation of
dilutive
8
MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
earnings (loss) per share for the three and six months ended June 30,
2003, because their inclusion would have had an antidilutive effect on earnings
(loss) per share.
For three months ended For six months ended
June 30, June 30,
--------------------------- ---------------------------
2002 2003 2002 2003
---- ---- ---- ----
Net income (loss) $ 1,955 ($ 3,736) $ 5,172 ($ 4,491)
Shares used in computation:
Weighted average common shares
outstanding used in computation
of net income (loss) per common share 12,821,946 12,917,752 12,821,946 12,917,752
Dilutive effect of common stock
options 79,203 - 55,893 -
--------------------------- ---------------------------
Shares used in computation of net
income (loss) per common share -
assuming dilution 12,901,149 12,917,752 12,877,839 12,917,752
--------------------------- ---------------------------
Net income (loss) per common share $ 0.15 ($ 0.29) $ 0.40 ($ 0.35)
Net income (loss) per common share
assuming dilution $ 0.15 ($ 0.29) $ 0.40 ($ 0.35)
Stock Options
Under the 1998 Equity Incentive Plan (the "1998 Plan") which was
adopted on July 9, 1998 the Company had reserved 4,120,380 shares of the
Company's common stock for issuance pursuant to the 1998 Plan. The Company
granted a total of 200,000 options during the six months ended June 30, 2003. A
total of 195,000 options were surrendered during the six months ended June 30,
2003. A total of 1,675,000 options were outstanding at June 30, 2003 of which
783,000 were vested.
On February 7, 2003, the Company offered non-director employees and
executives who had been granted stock options in the past the opportunity to
cancel any of the original option agreements in exchange for a grant of
restricted stock. All option awards subject to the offer were converted to
restricted stock. In connection with this offer, on February 12, 2003, 1,325,000
options converted to 319,854 shares of restricted common stock. In addition, on
March 17, 2003 one non-employee director was granted 50,000 shares of restricted
stock. The restricted stock vested 20% upon grant, and vests 5% on the first day
of each quarter after the grant date, with accelerated vesting if the price of
the Company's common stock exceeds certain thresholds during the vesting period.
As of June 30, 2003, 15,384 shares had been cancelled, 232,201 shares were fully
vested, and $178,000 had been amortized from unearned compensation to
compensation expense.
Stock-based Employee Compensation
All stock options issued to directors and employees have an exercise
price not less than the fair market value of the Company's common stock on the
date of grant. In accordance with accounting for such options utilizing the
intrinsic-value method, there is no related compensation expense recorded in the
Company's financial statements. The Company follows the disclosure requirements
of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires
that compensation under a fair value method be determined using the
Black-Scholes option-pricing model and disclosed in a pro forma effect on
earnings and earnings per share. The Company accounts for stock-based employee
compensation plans under the recognition and measurement principles of APB
Opinion No.
9
MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
25, Accounting for Stock Issued to Employees, and related Interpretations. The
current period amortization of unearned compensation expense relating to the
restricted stock awards is reflected in net income (loss). No other stock-based
employee compensation cost is reflected in net income (loss), as either all
options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant or options granted
that result in variable compensation costs had an exercise price greater than
the fair market value of the underlying common stock on June 30, 2003. The
following table illustrates the effect on net income (loss) and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
For the six months ended
June 30,
------------------------
2002 2003
---- ----
Net income (loss), as reported $5,172 ($ 4,491)
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (676) (403)
------ ---------
Pro forma net income (loss) $4,496 ($ 4,894)
====== =========
Earnings (loss) per share:
Basic - as reported $ 0.40 ($ 0.35)
====== =========
Basic - pro forma $ 0.35 ($ 0.38)
====== =========
Diluted - as reported $ 0.40 ($ 0.35)
====== =========
Diluted - pro forma $ 0.35 ($ 0.38)
====== =========
The fair value of option grants for options granted during the six
months ended June 30, 2003 was estimated on the date of grant utilizing the
Black-Scholes option-pricing model with the following weighted-average
assumptions.
Risk-free interest rate 3.34%
Expected dividend yield 0.00%
Expected life 7 years
Volatility 76.00%
The weighted-average fair value at the date of grant for options
granted during the six months ended June 30, 2003 approximated $0.62 per option.
The Company granted 200,000 options during the six months ended June 30, 2003.
There were no options granted during the three months ended June 30, 2002.
Notes Payable:
On August 22, 2000, the Company entered into a revolving line of credit
and term loan facility with a group of financial institutions whereby it may
borrow a maximum of $192,000,000 based upon qualified lease receivables, loans,
rentals and service contracts. According to the agreement, outstanding
borrowings with respect to the revolving line of credit bear interest based
either at Prime minus 0.25% for Prime Rate Loans or the prevailing rate per
annum as offered in the London Interbank Offered Rate (LIBOR) plus 1.75% for
LIBOR Loans or the seven-day Money Market rate plus 2.00% for Swing Line
Advances. If the LIBOR loans are not renewed upon their maturity they
automatically convert into prime rate loans. The Swing Line Advances have a
seven-day maturity, and upon their maturity they automatically convert into
prime rate loans. In addition, the Company's aggregate outstanding principal
amount of Swing Line Advances shall not exceed $10 million. The prime rate at
December 31, 2002, and June 30, 2003 was 4.25% and 4.00%. The 90-day LIBOR rate
at December 31, 2002 and June 30, 2003 was 1.40% and 1.12% respectively.
10
MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
As of September 30, 2002 the revolving credit line failed to renew and
the Company began paying down the balance on the basis of a 36-month
amortization plus interest. Based on the terms of the agreement, interest rates
increased from Prime minus 0.25% to Prime plus 0.50% for prime based loans and
from LIBOR plus 1.75% to LIBOR plus 2.50% for existing LIBOR based loans. In
addition, based on the covenant defaults described below, the outstanding
borrowings on all loans bear an additional 2.00% default interest. On January 3,
2003, the Company entered into a Forbearance and Modification Agreement for the
senior credit facility which expired on February 7, 2003. Based on the terms of
the Forbearance and Modification Agreement, interest rates increased again on
the prime based loans to prime plus 1.00%.
At December 31, 2002, the Company was in default of certain of its debt
covenants in its senior credit facility. The covenants that were in default with
respect to the senior credit facility require that the Company maintain a fixed
charge ratio in an amount not less than 130% of consolidated earnings, a
consolidated tangible net worth minimum of $77.5 million plus 50% of net income
quarterly beginning with September 30, 2000 and compliance with the borrowing
base. On April 14, 2003, the Company entered into a long-term agreement with its
lenders. This long-term agreement waives the defaults described above, and in
consideration for this waiver, requires the outstanding balance of the loan to
be repaid over a term of 22 months beginning in April 2003 at an interest rate
of prime plus 2.0%. Based on the amortization schedule in the new agreement, as
subsequently amended on June 30, 2003, the Company is obligated to repay a
minimum of $56.1 million, plus applicable interest, over the next twelve months.
The Company had borrowings outstanding under the senior credit facility
with the following terms:
December 31, 2002 June 30, 2003
------------------- ------------------
Type Rate Amount Rate Amount
- ---- ---- ------ ---- ------
(in thousands) (in thousands)
Prime 4.7500% $ 31,556 6.0000% $88,906
LIBOR 4.1875% 50,000
LIBOR 4.1875% 45,000
-------- -------
Total Outstanding $126,556 $88,906
======== =======
On April 14, 2003, the Company issued warrants to purchase an aggregate
of 268,199 shares of the Company's common stock at an exercise price of $.825
per share. The warrants were issued to the nine lenders in the Company's lending
syndicate in connection with the waiver of defaults and an extension of the
Company's term loan. The warrants will be automatically terminated if all of the
obligations owed by the Company to the lenders pursuant to the loan agreement
have been paid in full prior to June 30, 2004. If all of the Company's
obligations to the Lenders have not been paid in full prior to June 30, 2004,
the warrants will become 50% exercisable as of that date. If all of the
Company's obligations to the Lenders have not been paid in full prior to
September 30, 2004, the warrants will then become 100% exercisable as of that
date. Unless the warrants are automatically terminated or exercised pursuant to
the above criteria, they will expire on September 30, 2014. The fair market
value of the warrants, as determined using the Black-Scholes option-pricing
model, was accounted for as additional paid in capital. The resulting cost of
the warrants was $77,000, which is being amortized to interest expense under the
interest method. As of June 30, 2003, $20,000 had been accreted to interest
expense and the resulting effective interest rate on the senior credit facility
was prime plus 2.09%.
MFI I issued three series of notes, the 2000-1 Notes, the 2000-2 Notes,
and the 2001-3 Notes. In March 2000, MFI I issued the 2000-1 Notes in aggregate
principal amount of $50,056,686. In December 2000, MFI I issued the 2000-2 Notes
in aggregate principal amount of $50,561,633. In September 2001, MFI I issued
the 2001-3 Notes in aggregate principal amount of $39,397,354. Outstanding
borrowings are collateralized by specific pools of lease receivables. In
September 2001, MFI II, LLC was formed and issued one series of notes, the
2001-1 Notes in aggregate principal amount of $10,000,000. Outstanding
borrowings are collateralized by a specific pool of lease
11
MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
receivables as well as the excess cash flow from the MFI I collateral. These
notes are subordinate to the three series of notes issued by MFI I.
At December 31, 2002, the Company was in default on two of its debt
covenants in its securitization agreements. The covenants that were in default
with respect to the securitization agreements require that the Company maintain
a fixed charge ratio in an amount not less than 125% of consolidated earnings
and a consolidated tangible net worth greater than $90 million plus 50% of net
income for each fiscal quarter after June 30, 2001. Additionally per the terms
of the securitization agreement, any default with respect to the senior credit
facility is considered a default under the terms of the agreement. The Company
received a waiver, which was set to expire on April 15, 2003, for the covenant
violations in connection with the securitization agreement. Subsequently, the
Company received a permanent waiver of the covenant defaults and the
securitization agreement was amended so that going forward, the covenants are
the same as those contained in the long-term agreement entered into on April 14,
2003, for the senior credit facility.
At December 31, 2002 and June 30, 2003, MFI I and MFI II had borrowings
outstanding under the series of notes with the following terms:
December 31, 2002 June 30, 2003
------------------ --------------------
Series Rate Amount Rate Amount
- ------ ---- ------ ---- ------
(in thousands) (in thousands)
MFI I
2000-1 Notes 7.3750% 3,464 7.3750% -
2000-2 Notes 6.9390% 17,983 6.9390% 9,444
2001-3 Notes 5.5800% 17,019 5.5800% 10,477
MFI II LLC
2001-1 Notes 8.0000% 3,625 8.0000% 1,075
-------- -------
Total Outstanding $ 42,091 $20,996
======== =======
On February 18, 2003, the Company repaid $2.4 million in principal plus
accrued interest for the MFI Finance I series 2000-1 notes utilizing the clean
up call provision under its securitizations. The re-payment was made using cash
previously classified as restricted.
At December 31, 2002 and June 30, 2003, the Company also had other
notes payable which totaled $280,000 and $250,000 respectively. Of these notes,
at December 31, 2002 and June 30, 2003, $250,000 were term notes that carry an
interest rate of 7.5% and are due on February 1, 2005. As of December 2002,
there was also a demand note in the amount of $30,000, bearing an interest rate
of prime less 1.0%, outstanding. The Company had repaid the $30,000 demand note
as of June 30, 2003.
Dividends:
During the fourth quarter of 2002, the Board of Directors suspended the
future payment of dividends to comply with the Company's banking agreements.
Provisions in certain of the Company's credit facilities and agreements
governing its subordinated debt contain, and the terms of any indebtedness
issued by the Company in the future are likely to contain, certain restrictions
on the payment of dividends on the Common Stock. The decision as to the amount
and timing of future dividends paid by the Company, if any, will be made at the
discretion of the Company's Board of Directors in light of the financial
condition, capital requirements, earnings and prospects of the Company and any
restrictions under the Company's credit facilities or subordinated debt
agreements, as well as other factors the Board of Directors may deem relevant,
and there can be no assurance as to the amount and timing of payment of future
dividends.
12
MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
New Accounting Pronouncements:
The FASB issued SFAS No. 149, "Amendments of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. The Company has determined that the adoption
SFAS No. 149 does not have a material impact on its results of operations or
consolidated financial position.
The FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." The statement
establishes standards for how an issuer classifies and measures certain
financial instruments with 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. Some of the provisions of this Statement
are consistent with the current definition of liabilities in FASB Concepts
Statement No. 6, Elements of Financial Statements. The Company has not completed
its evaluation of SFAS No. 150 and has not yet determined the effect on its
consolidated financial statements.
Reclassification of Prior Year Balances:
Certain reclassifications have been made to prior years' Consolidated
Financial Statements to conform to the current presentation.
Commitments and Contingencies:
Please refer to Part II Other Information, Item 1 Legal Proceedings for
information about pending litigation of the Company.
13
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Three months ended June 30, 2003 as compared to the three months ended June 30,
2002.
Net income for the three months ended June 30, 2003 was a loss of
approximately $3.7 million, a decrease of $5.7 million or 291% from the three
months ended June 30, 2002. This represents diluted earnings per share for the
three months ended June 30, 2003 of ($0.29) per share on weighted-average
outstanding shares of 12,917,752 as compared to $0.15 per share on
weighted-average outstanding shares of 12,821,946 for the three months ended
June 30, 2002.
Total revenues for the three months ended June 30, 2003 were $24.0
million, a decrease of $9.0 million, or 27%, from the three months ended June
30, 2002. The decrease was primarily due to a decrease of $5.4 million, or 39%,
in financing leases and loans, $2.9 million or 38% in fee and other income, and
$592,000 or 6% in rental income. The decrease in income on financing leases and
loans was due to the decreased number of leases originated primarily resulting
from the Company's decision during the third quarter of 2002 to suspend the
funding of new contracts. The decrease in fee income and other income is the
result of decreased fees from the lessees related to the collection and legal
process employed by the Company. The decrease in rental income is the result of
a decrease in the origination of rental contracts.
Selling, general and administrative expenses decreased by $2.7 million,
or 24%, for the three months ended June 30, 2003, as compared to the three
months ended June 30, 2002. Compensation expenses decreased by $1.2 million or
27% primarily due to staff reductions. Cost of goods sold expenses decreased
$1.0 million or 82%. Collections expense decreased by $383,000 or 32%.
Depreciation and amortization decreased by $764,000 or 16%, due to a
decrease in the number of early terminations and new originations of monthly
rental and service contracts.
The Company's provision for credit losses increased by $4.4 million or
41%, for the three months ended June 30, 2003 as compared to the three months
ended June 30, 2002, while net charge-offs increased 39% to $36.2 million. This
provision was based on the Company's historical policy, based on experience, of
providing a provision for credit losses based upon the dealer fundings and
revenue recognized in any period and reflects management's judgement of loss
potential considering current economic conditions and the nature of the
underlying receivables.
Interest expense decreased by $473,000, or 18%, for the three months
ended June 30, 2003 as compared to the three months ended June 30, 2002. This
decrease resulted primarily from an overall decrease in the level of borrowings.
Dealer fundings were $232,000 for the three months ended June 30, 2003,
down $25.4 million, or 99% as compared to the three months ended June 30, 2002.
This decrease is a result of the Company's decision during the third quarter of
2002 to suspend new contract originations until a new line of credit is
obtained. Total cash from customers decreased by $9.5 million or 21% to a total
of $35.5 million. This decrease is primarily the result of a decrease in the
size of the overall portfolio. Investment in lease and loan receivables due in
installments, estimated residuals, rental and service contracts were down from
$396.5 million in December of 2002 to $311.3 million in June of 2003.
14
Six months ended June 30, 2003 as compared to the six months ended June 30,
2002.
Net income for the six months ended June 30, 2003 was a loss of
approximately $4.5 million, a decrease of $9.7 million or 187% from the six
months ended June 30, 2002. This represents diluted earnings per share for the
six months ended June 30, 2003 of ($0.35) per share on weighted-average
outstanding shares of 12,917,752 as compared to $0.40 per share on
weighted-average outstanding shares of 12,821,946 for the six months ended June
30, 2002.
Total revenues for the six months ended June 30, 2003 were $49.5
million, a decrease of $18.7 million, or 27%, from the six months ended June 30,
2002. The decrease was primarily due to a decrease of $10.8 million, or 37%, in
financing leases and loans, $5.7 million or 37% in fee and other income, and
$2.2 million or 9% in rental and service contract income. The decrease in income
on financing leases and loans was due to the decreased number of leases
originated primarily resulting from the Company's change in its credit approval
process. The decrease in fee income and other income is the result of decreased
fees from the lessees related to the collection and legal process employed by
the Company. The decrease in rental and service contract income is a result of
the decreased number of lessees that have continued to rent their equipment
beyond their original lease term and a decrease in originations in rental and
service contracts.
Selling, general and administrative expenses decreased by $6.1 million,
or 26%, for the six months ended June 30, 2003, as compared to the six months
ended June 30, 2002. Compensation expenses decreased by $2.9 million or 31%
primarily due to staff reductions. Headcount decreased to 159 as of June 30,
2003 from 356 as of June 30, 2002. Cost of goods sold expenses decreased $1.6
million or 78%. Collection expense decreased by $1.3 million or 42%.
Depreciation and amortization increased by $133,000, or 2% due to an
increase in the number of early terminations of monthly cancelable contracts.
The Company's provision for credit losses increased by $4.3 million, or
20%, for the six months ended June 30, 2003 as compared to the six months ended
June 30, 2002. This increase is a result of the Company's historical policy,
based on experience, of providing a provision for credit losses based upon the
dealer fundings and revenue recognized in any period and reflects management's
judgement of loss potential considering current economic conditions and the
nature of the underlying receivables.
Interest expense decreased by $591,000, or 11%, for the six months
ended June 30, 2003 as compared to the six months ended June 30, 2002. This
decrease resulted primarily from an overall decrease in the level of borrowings.
Dealer fundings were $1.4 million for the six months ended June 30,
2003, down $46.9 million, or 97% as compared to the six months ended June 30,
2002. This decrease is a result of the Company's decision during the third
quarter of 2002 to suspend new contract originations until a new line of credit
is obtained. Total cash from customers decreased by $16.6 million or 18% to a
total of $75.1 million. This decrease is primarily the result of a decrease in
the size of the overall portfolio. Investment in lease and loan receivables due
in installments, estimated residuals, rental and service contracts were down
from $396.5 million in December of 2002 to $311.3 million in June of 2003.
15
Critical Accounting Policies
In response to the SEC's release No. 33-8040, "Cautionary Advice
regarding Disclosure About Critical Accounting Policies," Management identified
the most critical accounting principles upon which our financial status depends.
The Company determined the critical principles by considering accounting
policies that involve the most complex or subjective decisions or assessments.
We identified our most critical accounting policies to be those related to
revenue recognition and maintaining the allowance for credit losses. These
accounting policies are discussed below as well as within the notes to the
consolidated financial statements.
The Company's investments in cancelable service contracts are recorded
at cost and amortized over the expected life of the service period. Income on
service contracts from monthly billings is recognized as the related services
are provided. The Company periodically evaluates whether events or circumstances
have occurred that may affect the estimated useful life or recoverability of the
investment in service contracts. Rental equipment is either recorded at
estimated residual value and depreciated using the straight-line method over a
period of 12 months or at the acquisition cost and depreciated using the
straight line method over a period of 36 months. Loans are reported at their
outstanding principal balance. Interest income on loans is recognized as it is
earned.
The Company's lease contracts are accounted for as financing leases. At
origination, the Company records the gross lease receivable, the estimated
residual value of the leased equipment, initial direct costs incurred and the
unearned lease income. Unearned lease income is the amount by which the gross
lease receivable plus the estimated residual value exceeds the cost of the
equipment. Unearned lease income and initial direct costs incurred are amortized
over the related lease term using the interest method. Amortization of unearned
lease income and initial direct costs is suspended if, in the opinion of
management, full payment of the contractual amount due under the lease agreement
is doubtful. In conjunction with the origination of leases, the Company may
retain a residual interest in the underlying equipment upon termination of the
lease. The value of such interests is estimated at inception of the lease and
evaluated periodically for impairment. Other revenues such as loss and damage
waiver fees, service fees relating to the leases, contracts and loans, and
rental revenues are recognized as they are earned.
The Company maintains an allowance for credit losses on its investment
in leases, service contracts, rental contracts and loans at an amount that it
believes is sufficient to provide adequate protection against losses in its
portfolio. The allowance is determined principally on the basis of the
historical loss experience of the Company and the level of recourse provided by
such lease, service contract, rental contract or loan, if any, and reflects
management's judgment of additional loss potential considering current economic
conditions and the nature and characteristics of the underlying lease portfolio.
The Company determines the necessary periodic provision for credit losses taking
into account actual and expected losses in the portfolio as a whole and the
relationship of the allowance to the net investment in leases, service
contracts, rental contracts and loans. Such provisions generally represent a
percentage of funded amounts of leases, contracts and loans. The resulting
charge is included in the provision for credit losses.
Leases, service contracts, rental contracts and loans are charged
against the allowance for credit losses and are put on non-accrual when they are
deemed to be uncollectable. Generally, the Company deems leases, service
contracts, rental contracts and loans to be uncollectable when one of the
following occurs: (I) the obligor files for bankruptcy; (ii) the obligor dies,
and the equipment is returned; or (iii) when an account has become 360 days
delinquent without contact with the lessee. The typical monthly payment under
the Company's leases is between $30 and $50 per month. As a result of these
small monthly payments, the Company's experience is that lessees will pay past
due amounts later in the process because of the small amount necessary to bring
an account current (at 360 days past due, a lessee will typically only owe lease
payments of between $360 and $600).
The Company has developed and regularly updates proprietary credit
scoring systems designed to improve its risk-based pricing. The Company uses
credit scoring in most, but not all, of its extensions of credit. In addition,
the Company monitors delinquent accounts using its automated collection process.
The Company's collection efforts include one or more of the following: sending
collection letters, making collection calls, reporting delinquent accounts to
credit reporting agencies, and litigating delinquent accounts when necessary.
The Company also uses a collectability scoring model to determine if the
benefits from further collection efforts will out weigh the costs associated
with those efforts.
16
Exposure to Credit Losses
The following table sets forth certain information as of December 31,
2001 and 2002 and June 30, 2003 with respect to delinquent leases, service
contracts and loans. The percentages in the table below represent the aggregate
on such date of the actual amounts not paid on each invoice by the number of
days past due, rather than the entire balance of a delinquent receivable, over
the cumulative amount billed at such date from the date of origination on all
leases, service contracts, and loans in the Company's portfolio. For example, if
a receivable is 90 days past due, the portion of the receivable that is over 30
days past due will be placed in the 31-60 days past due category, the portion of
the receivable which is over 60 days past due will be placed in the 61-90 days
past due category and the portion of the receivable which is over 90 days past
due will be placed in the over 90 days past due category. The Company
historically used this methodology of calculating its delinquencies because of
its experience that lessees who miss a payment do not necessarily default on the
entire lease. Accordingly, the Company includes only the amount past due rather
than the entire lease receivable in each category.
As of As of
December 31, June 30,
------------ --------
2001 2002 2003
---- ---- ----
Cumulative amounts billed ( in thousands) $ 602,649 $ 600,637 $ 553,900
31-60 days past due 1.8% 1.0% 0.8%
61-90 days past due 1.7% 1.0% 0.8%
Over 90 days past due 13.4% 22.9% 21.4%
---------- ---------- ----------
Total past due 16.9% 24.9% 23.0%
========== ========== ==========
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, contracts and loans. Since inception, the Company has funded its
operations primarily through borrowings under its credit facilities, on-balance
sheet securitizations, subordinated debt and an initial public offering
completed in February of 1999. The Company will continue to require significant
additional capital to maintain and expand its volume of leases, contracts and
loans funded, as well as to fund any future acquisitions of leasing companies or
portfolios.
As of September 30, 2002 the Company's senior credit facility failed to
renew. While cash flows from its portfolio and other fees have been sufficient
to repay amounts borrowed under the senior credit facility, securitizations and
subordinated debt, in October 2002, the Company was forced to suspend new
contract originations until a new source of liquidity is obtained.
The Company's uses of cash include, repayment of borrowings under its
senior credit facility, securitizations, and subordinated debt, payment of
interest expenses, payment of selling, general and administrative expenses,
income taxes, capital expenditures and the origination and acquisition of
leases, contracts and loans.
The Company utilizes its credit facilities to fund the origination and
acquisition of leases that satisfy the eligibility requirements established
pursuant to each facility. On August 22, 2000, the Company entered into a $192
million credit facility with nine banks, expiring on September 30, 2002. As of
September 30, 2002 the credit facility failed to renew and the Company began
paying down the balance on the basis of a 36-month amortization plus interest.
Based on the terms of the agreement, interest rates increased from Prime minus
0.25% to Prime plus 0.50% for prime based loans and from LIBOR plus 1.75% to
LIBOR plus 2.50% for LIBOR based loans. In addition, based on the covenant
defaults described below, the outstanding borrowings on all loans bear an
additional 2.00% default interest. On January 3, 2003, the Company entered into
a Forbearance and Modification Agreement from the senior credit facility, which
expired on February 7, 2003. Based on the terms of the Forbearance and
Modification Agreement, interest rates increased again on the prime based loans
to prime plus 1.00%. At June 30,
17
2003, the Company had approximately $88.9 million outstanding under the
facility. The Company also may use its subordinated debt program as a source of
funding for potential acquisitions of portfolios and leases which otherwise are
not eligible for funding under the credit facilities.
At December 31, 2002, the Company was in default of certain of its debt
covenants in its senior credit facility and securitization agreements. The
covenants that were in default with respect to the senior credit facility,
require that the Company maintain a fixed charge ratio in an amount not less
than 130% of consolidated earnings, a consolidated tangible net worth minimum of
$77.5 million plus 50% of net income quarterly beginning with September 30,
2000, and compliance with the borrowing base. On April 14, 2003, the Company
entered into a long-term agreement with its lenders. This long-term agreement
waives the defaults described above, and in consideration for this waiver,
requires the outstanding balance of the loan to be repaid over a term of 22
months beginning in April 2003 at an interest rate of prime plus 2.0%. Based on
the amortization schedule in the new agreement, as subsequently amended on June
30, 2003, the Company is obligated to repay a minimum of $56.1 million, plus
applicable interest, over the next twelve months. The covenants that were in
default with respect to the securitization agreements, require that the Company
maintain a fixed charge ratio in an amount not less than 125% of consolidated
earnings and a consolidated tangible net worth greater than $90 million plus 50%
of net income for each fiscal quarter after June 30, 2001. The Company received
a waiver, which was set to expire on April 15, 2003, for the covenant violations
in connection with the securitization agreement. Subsequently, the Company
received a permanent waiver of the covenant defaults and the securitization
agreement was amended so that going forward, the covenants are the same as those
contained in the long-term agreement entered into on April 14, 2003, for the
senior credit facility.
The Company believes that cash flows from its portfolio will be
sufficient to fund the Company's operations for the foreseeable future, given
the satisfactory resolution of the Company's discussions with the lenders
involved in the senior credit facility and the securitized notes.
Contractual Obligations and Commercial Commitments
The Company has entered into various agreements, such as long term debt
agreements, capital lease agreements and operating lease agreements that require
future payments be made. Long term debt agreements include all debt outstanding
under the senior credit facility, securitizations, subordinated notes, demand
notes and other notes payable.
At June 30, 2003 the repayment schedules for outstanding long term
debt, minimum lease payments under non-cancelable operating leases and future
minimum lease payments under capital leases were as follows:
For the year ended Long-Term Operating Capital
December 31, Debt Leases Leases Total
- ------------------ ---- ------ ------ -----
2003 $ 44,219 $ 670 $ 74 $ 44,963
2004 60,827 291 169 61,287
2005 5,767 174 54 5,995
2006 2,600 - - 2,600
Thereafter - - - -
-------- ------- -------- --------
Total $113,413 $ 1,135 $ 297 $114,845
======== ======= ======== ========
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
18
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.
19
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market-Rate-Sensitive Instruments and Risk Management
The following discussion about the Company's risk management activities
includes forward-looking statements that involve risk and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements.
In the normal course of operations, the Company also faces risks that
are either nonfinancial or nonquantifiable. Such risks principally include
country risk, credit risk, and legal risk, and are not represented in the
analysis that follows.
Interest Rate Risk Management
The implicit yield to the Company on all of its leases, contracts and
loans is on a fixed interest rate basis due to the leases, contracts and loans
having scheduled payments that are fixed at the time of origination of the
lease. When the Company originates or acquires leases, contracts, and loans it
bases its pricing in part on the spread it expects to achieve between the
implicit yield rate to the Company on each lease and the effective interest cost
it will pay when it finances such leases, contracts and loans through its credit
facility. Increases in interest rates during the term of each lease, contract or
loan 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, contract or loan.
Given the relatively short average life of the Company's leases,
contracts and loans, the Company's goal is to maintain a blend of fixed and
variable interest rate obligations. As of June 30, 2003, the Company's
outstanding fixed-rate indebtedness outstanding under the Company's
securitizations and subordinated debt represented 19.1% of the Company's total
outstanding indebtedness.
ITEM 4 CONTROLS AND PROCEDURES
(a) Disclosure controls and procedures. Within 90 days before filing this
report, we evaluated the effectiveness of the design and operation of our
disclosure controls and procedures. Our disclosure controls and procedures are
the controls and other procedures that we designed to ensure that we record,
process, summarize and report in a timely manner the information we must
disclose in reports that we file with or submit to the SEC. Richard F. Latour,
our President and Chief Executive Officer, and James R. Jackson Jr., our Vice
President and Chief Financial Officer, reviewed and participated in this
evaluation. Based on this evaluation, Messrs. Richard F. Latour and James R.
Jackson Jr. concluded that, as of the date of their evaluation, our disclosure
controls were effective.
(b) Internal controls. Since the date of the evaluation described above,
there have not been any significant changes in our internal accounting controls
or in other factors that could significantly affect those controls.
20
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
Management believes, after consultation with counsel, that the
allegations against the Company included in the lawsuits described below are
subject to substantial legal defenses, and the Company is vigorously defending
each of the allegations. The Company also is subject to claims and suits arising
in the ordinary course of business. At this time, it is not possible to estimate
the ultimate loss or gain, if any, related to these lawsuits, nor if any such
loss will have a material adverse effect on the Company's results of operations
or financial position.
Leasecomm had been served with Civil Investigative Demands and
subpoenas by the Offices of the Attorney General for the states of Kansas,
Illinois, Florida, and Texas, and for the Commonwealth of Massachusetts. Those
Offices of the Attorney General, in conjunction with the Northwest Region Office
of the Federal Trade Commission, the Offices of the Attorney General for North
Carolina and North Dakota, and the Ventura County, California, District
Attorney's Office, had informed Leasecomm that they were seeking to coordinate
their investigations. All of these investigations have been concluded by the
entry of consent judgements in each of the applicable jurisdictions. The consent
judgments resolve all matters alleged by the government agencies in their court
filings without any admission of liability or of wrongful conduct by Leasecomm
or MicroFinancial. Under the terms of the settlement, Leasecomm has agreed to
the following: (1) Not to collect upon certain court judgments where the
financing included virtual terminals or the predominant purpose of the financing
was for business opportunities. (2) Not to finance any product in conjunction
with a business opportunity solicitation, and not to finance the virtual
terminal product for four years. (3) Include in its lease forms, and in its
lease processing and collection activities, certain provisions and practices,
including filing collection actions in the customer's home forum. (Existing
actions pending in Massachusetts may be transferred or dismissed and then
re-filed in the lessee's home forum.) Neither MicroFinancial nor Leasecomm were
required to pay any fines or penalties; however, the Company agreed to pay $1.0
million in twelve equal monthly installments, as recovery in the investigations.
In addition Leasecomm has agreed to take steps to monitor its vendors, and to
file periodic reports concerning its vendors for two years. The financial impact
directly related to the terms of the settlement, have been accounted for in
current and or past periods as appropriate.
A. The Company filed an action in the United States District Court for
the District of Massachusetts against Sentinel Insurance Company, Ltd.,
("Sentinel"), Premier Holidays International, Inc., ("Premier") and Daniel
DelPiano ("DelPiano") arising from Premier's October, 1999, default on its
repayment obligations to the Company under a Twelve Million Dollar ($12,000,000)
loan. Judgment has been entered in this case against Sentinel, which had issued
a business performance insurance policy guaranteeing repayment of the loan, in
the amount of Fourteen Million Dollars ($14,000,000). This judgment has not been
satisfied. Sentinel is currently undergoing liquidation proceedings, and a claim
in this amount has been filed with the bankruptcy court. Premier has asserted a
counterclaim against the Company for Seven Hundred Sixty Nine Million Three
Hundred Fifty Thousand dollars ($769,350,000) in actual and consequential
damages, and for Five Hundred Million Dollars ($500,000,000) in punitive
damages, plus interest, cost and attorney's fees. The counterclaim is based upon
an alleged representation by the Company that it would lend Premier an
additional Forty-Five Million Dollars ($45,000,000), when all documents
evidencing the Premier loan refer only to the Twelve Million ($12,000,000)
amount actually loaned and not repaid. The Company denies any liability on the
counterclaim, which the Company is vigorously contesting. The Company's motion
for summary judgment seeking dismissal of the counterclaim and the award of full
damages on the Company's claims was denied by Court Order, without a written
decision. The Company's motion for the appointment of a special master was also
denied without a written decision. The case is currently scheduled to be tried
in November, 2003. Because of the uncertainties inherent in litigation, we
cannot predict whether the outcome will have a material adverse effect.
B. On January 29, 2002, Leasecomm was served with an Amended Complaint
("Complaint") in an action entitled People v. Roma Computer Solutions, Inc., et
al., Ventura County Superior Court Case No. CIV207490. The Complaint asserts two
claims, one for violation of the California Business Professions Code Section
17500 (false advertising), and the other for violation of the California
Business and Professions Code Section 17200 (unfair or unlawful acts or
practices). The claims arise from the marketing and selling activities of other
defendants, including Roma Computer Solutions, Inc., and/or Maro Securities,
Inc. The Complaint seeks to have Leasecomm held liable for the acts of other
defendants, alleging that Leasecomm directly participated in those acts and
received proceeds
21
and the assignment of lease contracts as a result of those acts. The case has
been concluded through the filing of stipulated consent judgement.
C. In October, 2002, the Company was served with a Complaint in an
action in the United States District Court for the Southern District of New York
filed by approximately 170 present and former lessees asserting individual
claims. The Complaint contains claims for violation of RICO (18 U.S.C. Section
1964), fraud, unfair and deceptive acts and practices, unlawful franchise
offerings, and intentional infliction of mental anguish. The claims purportedly
arise from Leasecomm's dealer relationships with Themeware, E-Commerce Exchange,
Cardservice International, Inc., and Online Exchange for the leasing of websites
and virtual terminals. The Complaint asserts that the Company is responsible for
the conduct of its dealers in trade shows, infomercials and web page
advertisements, seminars, direct mail, telemarketing, all which are alleged to
constitute unfair and deceptive acts and practices. Further, the Complaint
asserts that Leasecomm's lease contracts as well as its collection practices and
late fees are unconscionable. The Complaint seeks restitution, compensatory and
treble damages, and injunctive relief. The Company filed a Motion to Dismiss the
Complaint on January 31, 2003. Briefing has been completed, but the Motion to
Dismiss has not been decided. Because of the uncertainties inherent in
litigation, we cannot predict whether the outcome will have a material adverse
effect.
D. On August 22, 2002 plaintiff Aaron Cobb filed a Complaint against
Leasecomm Corporation and MicroFinancial, Inc. and another Entity known as
Galaxy Mall, Inc. alleging breach of contract; Fraud, Suppression and Deceit;
Unjust Enrichment; Conspiracy; Conversion; Theft by Deception; and violation of
Alabama Usury Laws. The Complaint was filed on behalf of Aaron Cobb
individually, and on behalf of a class of persons and entities similarly
situated in the State of Alabama. More specifically, the Plaintiff purports to
represent a class of persons and small business in the State of Alabama who
allegedly were induced to purchase services and/or goods from any of the
Defendants named in the Complaint. The case is venued in Bullock County,
Alabama. On March 31, 2003 the trial court entered an Order denying the
Company's Motion to Dismiss. An appeal of the Order was filed with the Alabama
Supreme Court on May 12, 2003. The Company continues to deny any wrongdoing and
plans to vigorously defend this claim. Because of the uncertainties inherent in
litigation, the company cannot predict whether the outcome will have a material
adverse affect.
E. In March, 2003, an action was filed by a shareholder against the
Company in United States District Court asserting a single count of common law
fraud and constructive fraud. The complaint alleges that the shareholder was
defrauded by untrue statements made to him by management, upon which he relied
in the purchase of Company stock for himself and for others. The complaint seeks
damages in an unspecified amount. The Company has filed an answer denying the
allegations. Because of the uncertainties inherent in litigation, we cannot
predict whether the outcome will have a material adverse effect.
F. In March, 2003, a purported class action was filed in Superior Court
in Massachusetts against Leasecomm and one of its dealers. The class sought to
be certified is a nationwide class (excluding certain residents of the State of
Texas) who signed identical or substantially similar lease agreements with
Leasecomm covering the same product. The complaint asserts claims for
declaratory relief, rescission, civil conspiracy, usury, breach of fiduciary
duty, and violation of Massachusetts General Laws Chapter 93A, Section 11
("Chapter 93A"). The claims concern the validity, enforceability, and alleged
unconscionability of agreements provided through the dealer, including a
Leasecomm lease, to acquire on line credit card processing services. The
complaint seeks rescission of the lease agreements with Leasecomm, restitution,
multiple damages and attorneys fees under Chapter 93A, and injunctive relief.
The Company has filed a motion to dismiss the complaint, which is scheduled to
be heard by the Court in September, 2003. Because of the uncertainties inherent
in litigation we cannot predict whether the outcome will have a material adverse
effect.
G. On April 28, 2003 plaintiff Wallace Dickey filed a purported class
action against Leasecomm Corporation, Cardservice International, Linkpoint
International and Clear Commerce Corporation alleging that he lease-financed
through Leasecomm the right to use certain computer software manufactured,
distributed and sold by the other defendants. The plaintiff does not allege that
Leasecomm failed to provide the lease financing contemplated by the Leasecomm
Lease, rather the Plaintiff alleges that the software failed to operate as he
believed it would, and he has sued for a declaration that would allow him to
rescind his contract, to recover money paid in the course of the transaction and
to recover damages allegedly caused by unspecified deceptive trade practices.
The plaintiff asserts his claims "on behalf of himself and all others similarly
situated." Leasecomm denies all of the Plaintiff's
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allegations and intends to vigorously defend this suit. It is expected that the
Court will soon hold a hearing on Leasecomm's motion to dismiss. The court has
not yet addressed the Plaintiff's class certification allegations. Because of
the uncertainties inherent in litigation, the company cannot predict whether the
outcome will have a material adverse affect.
H. On April 29, 2003, Leasecomm was served with a Complaint filed in
the Orange County Superior Court for the State of California. In that Complaint,
Maria J. Smith purports to bring a claim against Leasecomm and two other
defendants (Galaxy Mall, Inc. and Electronic Commerce International, Inc.) for
unfair business practices and competition under California Business and
Professions Code section 17200 et seq. The essence of the claim is that Smith
and others who are similarly situated were defrauded in connection with their
acquisition of certain licenses that were financed by Leasecomm. In May 2003,
Leasecomm filed a motion to stay the action in favor of a Massachusetts forum
based on a forum selection clause contained in plaintiff's lease agreement with
Leasecomm. After filing the motion, Leasecomm entered into settlement
negotiations with plaintiff's counsel to explore the possibility of resolving
the matter on a class wide basis without the need for further litigation
(meaning the settlement would, if accepted, apply not only to the named
plaintiff but to others similarly situated). The parties have agreed to postpone
the hearing on Leasecomm's stay motion until August 22, 2003 in order to allow
the parties time to explore possible settlement. Because of the uncertainties
inherent in litigation we cannot predict whether the outcome will have a
material adverse effect.
In February 2003, Leasecomm received a CID from the Office of the
Attorney General, State of Washington, to which it has responded. The CID
concerns an investigation of monitoring agreements between Priority One, Inc.
and various State of Washington consumers, as to which Leasecomm appears to be
the assignee of the right to receive monthly payments. Since the investigation
has not been concluded, and no legal action has been commenced against
Leasecomm, there can be no assurance as to the eventual outcome.
ITEM 3 RECENT SALES OF UNREGISTERED SECURITIES
On April 14, 2003, the Company issued warrants to purchase an aggregate
of 268,199 shares of the Company's common stock at an exercise price of $.825
per share. The warrants were issued to the nine lenders in the Company's lending
syndicate in connection with a waiver of defaults and an extension of the
Company's term loan, and are only exercisable if the debt remains outstanding as
of June 30, 2004. The exemption from registration relied on by the Company was
Section 4(2) of the Securities Act of 1933. All investors were accredited
investors and the offering otherwise met the requirements of Regulation D under
the Securities Act.
ITEM 5 OTHER INFORMATION
The Company's Chief Executive Officer and Chief Financial Officer have
furnished to the SEC the certification with respect to this Form 10-Q that is
required by Section 906 of the Sarbanes-Oxley Act of 2002.
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ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed herewith:
10.1 Third Amendment to Fourth Amended and Restated Revolving
Credit Agreement dated June 30, 2003 among Leasecomm
Corporation, Fleet National Bank, as agent, and the other
Lenders named therein.
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) A form 8-K was filed on April 16, 2003, to announce that the Company
has secured an amendment to its Credit Agreement and received permanent
waivers under its securitization facility. A second report on Form 8-K
was filed on April 16, 2003 to announce fourth quarter results for the
year ended December 31, 2002. A third report on Form 8-K was filed on
May 7, 2003 to announce first quarter 2003 results. A fourth report on
Form 8-K was filed on May 22, 2003 to disclose that the New York Stock
Exchange has accepted the Company's proposed compliance plan for
continued listing on the Exchange. On May 29,2003, a fifth report on
Form 8-K was filed announcing the settlement of several pending
investigations concerning the Company's wholly owned subsidiary,
Leasecomm Corporation.
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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.
MicroFinancial Incorporated
By: /s/ Richard F. Latour
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President and Chief Executive Officer
By: /s/ James R. Jackson Jr.
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Vice President and Chief Financial Officer
Date: August 14, 2003
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