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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2005

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 April 15, 2005, 13,395,145 shares of the registrant's common stock,
$0.01 par value, were outstanding.



MICROFINANCIAL INCORPORATED
TABLE OF CONTENTS



Page
----

Part I FINANCIAL INFORMATION

Item 1 Financial Statements (unaudited):
Condensed Consolidated Balance Sheets
December 31, 2004 and March 31, 2005 3
Condensed Consolidated Statements of Operations
Three months ended March 31, 2004 and 2005 4
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 2004 and 2005 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 22

Item 4 Controls and Procedures 22

Part II OTHER INFORMATION

Item 1 Legal Proceedings 23

Item 6 Exhibits 25

Signatures 26




MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)



December 31, March 31,
2004 2005
------------ ---------

ASSETS
Cash and cash equivalents $ 9,709 $ 18,006
Net investment in leases:
Receivables due in installments 59,679 42,928
Estimated residual value 9,502 7,737
Initial direct costs 453 300
Less:
Advance lease payments and deposits (25) (29)
Unearned income (6,313) (4,552)
Allowance for credit losses (14,963) (10,639)
------------ ---------
Net investment in leases $ 48,333 $ 35,565
Investment in service contracts, net 4,777 3,840
Investment in rental contracts, net 1,785 2,448
Property and equipment, net 754 759
Other assets 2,412 2,161
Deferred income taxes 3,500 4,822
------------ ---------
Total assets $ 71,270 $ 67,781
============ =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable $ 34 $ 79
Subordinated notes payable 4,589 4,628
Capitalized lease obligations 41 9
Accounts payable 2,474 1,703
Dividends payable -- 659
Other liabilities 2,039 2,585
Income taxes payable -- 14
------------ ---------
Total liabilities 9,177 9,677
------------ ---------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized; no shares
issued at December 31, 2004 and March 31, 2005 -- --
Common stock, $.01 par value; 25,000,000 shares authorized;
13,410,646 shares issued at December 31, 2004 and March 31, 2005 134 134
Additional paid-in capital 45,244 42,980
Retained earnings 19,186 15,203
Treasury stock, at cost (225,480 and 16,751 shares at December 31, 2004
and March 31, 2005, respectively) (2,420) (166)
Unearned compensation (51) (47)
------------ ---------
Total stockholders' equity 62,093 58,104
------------ ---------
Total liabilities and stockholders' equity $ 71,270 $ 67,781
============ =========


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)
(Unaudited)



For the three months ended
March 31,
---------------------------
2004 2005
------------ ------------

Revenues:
Income on financing leases and loans $ 4,167 $ 1,508
Rental income 8,465 6,429
Income on service contracts 1,731 1,088
Loss and damage waiver fees 1,131 819
Service fees and other 2,514 1,017
------------ ------------
Total revenues 18,008 10,861
------------ ------------
Expenses:
Selling general and administrative 7,280 6,348
Provision for credit losses 13,408 5,810
Depreciation and amortization 4,294 2,484
Interest 846 205
------------ ------------
Total expenses 25,828 14,847
------------ ------------
Loss before benefit for income taxes (7,820) (3,986)
Benefit for income taxes (3,128) (1,322)
------------ ------------
Net loss ($ 4,692) ($ 2,664)
============ ============
Net loss per common share - basic and diluted ($ 0.36) ($ 0.20)
============ ============
Weighted-average shares used to compute:
Net loss per share - basic and diluted 13,179,548 13,254,838
------------ ------------
Dividends declared per common share $ 0.00 $ 0.10
============ ============


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

4



MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)



For the three months ended
March 31,
--------------------------
2004 2005
-------- ---------

Cash flows from operating activities:
Cash received from customers $ 25,218 $ 16,074
Cash paid to suppliers and employees (7,206) (5,961)
Cash received for income taxes 37 14
Interest paid (928) (123)
Interest received 3 32
-------- ---------
Net cash provided by operating activities 17,124 10,036
-------- ---------
Cash flows from investing activities:
Investment in lease and rental contracts (73) (1,040)
Investment in inventory (54) (2)
Investment in direct costs -- (7)
Investment in fixed assets (45) (44)
-------- ---------
Net cash used in investing activities (172) (1,093)
-------- ---------
Cash flows from financing activities:
Proceeds from secured debt -- 45
Repayment of secured debt (17,389) --
Decrease in restricted cash 144 --
Repayment of capital leases (44) (32)
Payment of dividends -- (659)
-------- ---------
Net cash used in financing activities (17,289) (646)
-------- ---------
Net increase (decrease) in cash and cash equivalents: (337) 8,297
Cash and cash equivalents, beginning of period 6,533 9,709
-------- ---------
Cash and cash equivalents, end of period $ 6,196 $ 18,006
======== =========


(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)
(Unaudited)



For the three months ended
March 31,
--------------------------
2004 2005
-------- ----------

Reconciliation of net loss to net cash provided
by operating activities:

Net loss ($ 4,692) ($ 2,664)
Adjustments to reconcile net loss to
cash provided by operating activities:
Amortization of unearned income, net of initial direct costs (4,167) (1,508)
Depreciation and amortization 4,294 2,484
Provision for credit losses 13,408 5,810
Recovery of equipment cost and residual value 11,687 6,407
Share based compensation expense -- 748
Amortization of unearned compensation 16 4
Non-cash interest expense -- 49
Change in assets and liabilities:
Decrease (increase) in current taxes payable 37 14
Decrease (increase) in deferred income taxes (3,128) (1,322)
Increase (decrease) in other assets 768 240
Increase (decrease) in accounts payable (402) (771)
Decrease in other liabilities (697) 545
-------- ----------
Net cash provided by operating activities $17,124 $ 10,036
======== ==========
Supplemental disclosure of non-cash activities:
Treasury stock issued for option exercises $ -- $ 2,018
Treasury stock issued for warrants exercised $ -- $ 222
Fair market value of restricted stock issued $ 79 $ --


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 subsidiaries, Leasecomm Corporation and TimePayment
Corp, LLC, is a specialized commercial finance company that primarily leases and
rents equipment and provides other financing services in amounts generally
ranging from $500 to $15,000 with an average amount financed of approximately
$1,900 and an average lease term of 44 months. The Company primarily sources its
originations through a network of independent sales organizations and other
dealer-based origination networks nationwide. The Company funds its operations
through cash provided by operating activities, borrowings under its credit
facilities, the issuance of subordinated debt and on balance sheet
securitizations.

MicroFinancial incurred net losses of $22.1 million, $15.7 million, and
$10.2 million for the years ended December 31, 2002, 2003 and 2004,
respectively. The net losses incurred by the Company during the third and fourth
quarters of 2002 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 substantially all new
origination activity as of October 11, 2002. MicroFinancial has taken certain
steps in an effort to improve its financial position. In June 2004,
MicroFinancial secured a $10.0 million credit facility, comprised of a one-year
$8.0 million line of credit and a $2.0 million three-year subordinated note,
which enabled the Company to resume contract originations. In conjunction with
raising new capital, the Company also inaugurated a new wholly owned operating
subsidiary, TimePayment Corp. LLC. On September 29, 2004, MicroFinancial secured
a three-year, $30.0 million, senior secured revolving line of credit from CIT
Commercial Services, a unit of CIT Group. This line of credit replaced the
previous one year, $8 million line of credit obtained in June 2004 under more
favorable terms and conditions including, but not limited to, pricing at prime
plus 1.5% or LIBOR plus 4%. In addition, it retired the existing outstanding
debt with the former bank group.

The Company has also continued to follow the cost reduction initiatives
that have been ongoing for the past several quarters, including a reduction in
headcount from 136 at December 31, 2003 to 103 at December 31, 2004. During the
three months ended March 31, 2005, the employee headcount was further reduced to
98 in a continued effort to maintain an infrastructure that is aligned with
current business conditions. In addition, during the three months ended March
31, 2005, the Company has begun to actively increase its industry presence with
a more focused and targeted sales and marketing effort. The Company continues to
invest capital to build an infrastructure to support a new sales and marketing
effort, and has brought in new sales and marketing management to spearhead the
effort.

MicroFinancial, through its wholly owned subsidiaries, may periodically
finance its lease and service contracts, together with unguaranteed residuals,
through securitizations using special purpose entities. MFI Finance Corporation
I (or "MFI I") and MFI Finance Corporation II, LLC (or "MFI II") are special
purpose entities that the Company had set up in the past to facilitate these
securitizations. The assets of such special purpose entities 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,
TimePayment Corp. LLC, 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). However, the special
purpose entities to which such assets are contributed 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. While the
Company does not currently have any securitizations outstanding it is expected
that the Company will use securitizations as on means of re-financing
outstanding debt when the need arises in the future.

7



MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(B) Summary of Significant Accounting Policies:

Basis of Presentation:

The accompanying unaudited condensed 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 on Form 10-K for
the year ended December 31, 2004. The results for the quarter ended March 31,
2005 are not necessarily indicative of the results that may be expected for the
full year ended December 31, 2005. The Company adopted the provisions of SFAS
123(R) on January 1, 2005, as discussed more fully below.

The balance sheet at December 31, 2004 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, 2004.

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, 2004 and March 31, 2005 and the related provision,
charge-offs and recoveries for the three months ended March 31, 2005.



Balance of allowance for credit losses at December 31, 2004 $ 14,963
----------
Provision for credit losses 5,810
Charge-offs (11,724)
Recoveries 1,590
----------
Charge-offs, net of recoveries (10,134)
----------
Balance of allowance for credit losses at March 31, 2005 $ 10,639
==========


Net Income (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. Diluted
net income (loss) per common share gives effect to all potentially dilutive
common shares outstanding during the period. The computation of diluted net
income (loss) per share does not assume the issuance of common shares that have
an antidilutive effect on net income per common share. All stock options, common
stock warrants, and unvested restricted stock were excluded from the computation
of diluted net income (loss) per share for the three month periods ended March
31, 2004 and March 31, 2005, because their inclusion would have had an
antidilutive effect on net income (loss) per share. At March 31, 2004, 1,675,000

8



MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

options, 268,199 warrants and 20,000 shares of restricted stock, were excluded
from the computation of diluted net income (loss) per share. At March 31, 2005,
1,242,500 options, 638,299 warrants, and 15,000 shares of restricted stock were
excluded from the computation of diluted net income (loss) per share.



For three months ended
March 31
---------------------------
2004 2005
------------ ------------

Net loss ($ 4,692) ($ 2,664)
Shares used in computation:
Weighted average common shares
outstanding used in computation
of net loss per common share 13,179,548 13,254,838

Dilutive effect of common stock
Options -- --
------------ ------------
Shares used in computation of net
income loss per common share -
assuming dilution 13,179,548 13,254,838
------------ ------------
Net income (loss) per common share -
basic and diluted ($ 0.36) ($ 0.20)
============ ============


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. No options were granted
during the three months ended March 31, 2005. A total of 1,242,500 options were
outstanding at March 31, 2005, of which 1,060,500 were vested.

On February 4, 2004, one non-employee director was granted 25,000 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. As vesting occurs,
compensation expense is recognized and unearned compensation on the balance
sheet is reduced. As of March 31, 2005, 10,000 shares were fully vested, and
$32,000 had been amortized from unearned compensation to compensation expense.

Stock-based Employee Compensation

Prior to 2005, the Company accounted for stock-based employee compensation
plans under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. The
current period amortization of unearned compensation expense relating to the
restricted stock awards was reflected in net income (loss). In 2004, no other
stock-based employee compensation cost was 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.

Effective January 1, 2005, the Company adopted the fair value recognition
provisions for FASB Statement No. 123(R), Accounting for Stock-Based
Compensation ("SFAS 123(R)"). Under the modified prospective method of adoption
selected by the Company under the provisions of SFAS 123(R), compensation cost
was recognized during the quarter ended March 31, 2005 for unvested stock
options. Results for prior years have not been restated. The following table
illustrates the effect on net income (loss) and earnings per share if the
Company had applied the fair value based method had been applied to all
outstanding and unvested awards in each period.

9



MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



For the three months ended
March 31,
--------------------------
2004 2005
------- --------

Net loss, as reported ($4,692) ($ 2,664)
Add: Stock-based employee compensation
expense included in reported net loss 16 752
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards (177) (752)
------- --------
Pro forma net loss ($4,853) ($ 2,664)
======= ========
Earnings (loss) per share:
As reported - basic and diluted ($ 0.36) ($ 0.20)
======= ========
Proforma - basic and diluted ($ 0.37) ($ 0.20)
======= ========


The following summarizes the stock option activity for the three months
ended March 31, 2005:



Weighted-
Average
Shares Price Per Share Exercise Price
--------- ----------------- --------------

Outstanding at December 31, 2004 1,675,000 $ 0.86 to $13.544 $7.139
Exercised (432,500) $ 0.86 to $ 1.585 $1.250
---------
Outstanding at March 31, 2005 1,242,500 $1.585 to $13.544 $9.189
=========


Information relating to stock options at March 31, 2005, summarized by exercise
price, is as follows:



Outstanding Exercisable
- --------------------------------------------------------------- -------------------------------------------
Weighted- Weighted-
Average Aggregate Average Aggregate
Exercise Price Shares Life (Years) Intrinsic Value Exercise Price Shares Intrinsic Value
- ------------------ --------- ------------ --------------- -------------- --------- ---------------

$ 12.3125 359,391 3.91 $ 2,321,176 $ 12.3125 359,391 $ 2,321,176
$ 13.5440 40,609 3.91 $ 288,479 $ 13.5440 40,609 $ 288,479
$ 9.7813 350,000 4.91 $ 1,907,883 $ 9.7813 350,000 $ 1,907,883
$ 13.1000 90,000 5.91 $ 538,208 $ 13.1000 72,000 $ 439,536
$ 6.7000 235,000 6.92 $ 875,455 $ 6.7000 141,000 $ 539,864
$ 1.5850 167,500 7.66 $ 179,929 $ 1.5850 97,500 $ 143,221
--------- --------------- --------- ---------------
$ 1.585 to $13.544 1,242,500 5.41 $ 6,111,130 $ 9.8453 1,060,500 $ 5,640,159
========= =============== ========= ===============


10



MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In March 2005, the Company's Board of Directors elected to allow for the
immediate vesting of all of the President and CEO's in the money options. This
resulted in the acceleration of vesting for 70,000 options with an exercise
price of $1.585 and 80,000 options with an exercise price of $0.86. As a result
of that acceleration, which was permitted under the terms of the 1998 Plan, the
Company recognized additional compensation expense of $566,000 for the three
months ended March 31, 2005. In addition, the Company's Board of Directors
elected to allow the cashless exercise of all options exercised during the three
months ended March 31, 2005. As a result of the circumstances of the exercises,
all awards made under the 1998 Plan have been classified as share-based
liability awards.

In accordance with SFAS 123(R), for share-based liability awards, the
Company must recognize compensation cost equal to the greater of (a) the grant
date fair value or (b) the fair value of the modified liability when it is
settled. As of March 31, 2005, a minimum of $506,000 of total unrecognized
compensation costs related to non-vested awards is expected to be recognized
over a weighted average period of 2 years. In addition, the Company will also
recognize any additional incremental compensation cost as it is incurred. For
the three months ended March 31, 2005, the Company recognized an additional
$20,000 in compensation expense due to the change in the fair value of the
share-based liability awards outstanding.

The Company estimates the fair value of stock options using a
Black-Scholes valuation model, consistent with the provisions of SFAS 123(R),
Securities and Exchange Commission (SEC) Staff Accounting Bulletin No. 107 and
the company's prior period pro forma disclosures of net earnings, including
stock-based compensation (determined under a fair value method as prescribed by
SFAS 123). Key input assumptions used to estimate the fair value of stock
options include the grant price of the award, the expected option term,
volatility of the company's stock, the risk-free rate and the Company's dividend
yield.

There were no options granted during the three months ended March 31, 2004
and 2005, respectively. The fair values as of March 31, 2005, of the remaining
unvested options classified as liability instruments per SFAS 123(R) were
estimated using the following key input assumptions at March 31, 2005:



Original grant date 11/25/2002 2/28/2002 2/20/01 2/24/2000 2/25/1999 2/25/1999
Exercise price $ 1.585 $ 6.700 $13.100 $ 9.781 $ 13.544 $ 12.313
Expected life (in years) 4.0 4.0 3.5 3.0 2.5 2.5
Annualized volatility 82.09% 82.09% 82.09% 82.09% 82.09% 82.09%
Dividend yield 4.30% 4.30% 4.30% 4.30% 4.30% 4.30%
Risk free rate 4.050% 4.050% 3.910% 3.910% 3.820% 3.820%


The expected life represents the average period of time that the options
are expected to be outstanding given consideration to vesting schedules;
annualized volatility is based on historical volatilities of the Company's
common stock; dividend yield represents the current dividend yield expressed as
a constant percentage of the stock price and the risk free rate is based on the
U.S. Treasury yield curve in effect on the measurement date for periods
corresponding to the expected life of the option. At each subsequent reporting
date, the Company is required to remeasure the fair value of its share-based
liability awards.

Notes Payable:

The Company had borrowings outstanding under its respective credit
facilities, securitization, and long-term debt agreements with the following
terms:



Amounts outstanding as of
-------------------------
Interest December 31, March 31,
(dollars in thousands) Rate 2004 2005
----------- ------------ ---------

Revolving credit facility prime + 1.5% $ 34 $ 79
Subordinated notes 7.75%-13.0% 5,152 5,152
------------ ---------
$ 5,186 $ 5,231
============ =========


11



MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On September 29, 2004, the Company entered into a three-year senior
secured revolving line of credit with CIT Commercial Services, a unit of CIT
Group ("CIT"), whereby it may borrow a maximum of $30.0 million based upon
qualified lease receivables. Outstanding borrowings with respect to the
revolving line of credit bear interest based at Prime plus 1.5% for Prime Rate
Loans, or the prevailing rate per annum as offered in the London Interbank
Offered Rate (LIBOR) plus 4.0% for LIBOR Loans. If the LIBOR Loans are not
renewed upon their maturity they automatically convert into prime rate loans.
The prime rates at December 31, 2004, and March 31, 2005 were 5.25% and 5.75%
respectively. The 90-day LIBOR rate at December 31, 2004 and March 31, 2005 were
2.56% and 3.12% respectively.

Dividends:

During the fourth quarter of 2002, the Board of Directors suspended the
future payment of dividends to comply with the Company's then-existing banking
agreements. The Company paid no dividends for the years ended December 31, 2003
and December 31, 2004, respectively.

The Company's Board of Directors announced a resumption of dividend
payments with a cash dividend of $0.05 per share payable to shareholders of
record on February 9, 2005. Additionally, the Company's Board of Directors
declared a second dividend of $0.05 per share on March 16, 2005, payable on May
13, 2005 to holders of record of MFI common stock at the close of business on
April 29, 2005. Future dividend payments are subject to ongoing quarterly review
and evaluation by the Board of Directors. 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.

New Accounting Pronouncements:

On December 16, 2004, the FASB issued FASB Statement No. 153, Exchanges of
Nonmonetary Assets - An Amendment of APB Opinion No. 29 (SFAS 153). APB Opinion
No. 29, Accounting for Nonmonetary Transactions (APB 29) required that
nonmonetary exchanges be accounted for at fair value, subject to certain
exceptions. SFAS 153 has removed the exception for nonmonetary exchanges of
similar productive assets, and replaced it with an exception for exchanges that
lack commercial substance. The provisions of SFAS 153 are effective
prospectively for all nonmonetary asset exchanges in fiscal periods beginning
after June 15, 2004. The Company has determined that the adoption of this
Statement will not have a material impact on its results of operations of
consolidated financial position.

Reclassification of Prior Year Balances:

Certain reclassifications have been made to prior years' condensed
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.

The Company accepts lease applications on a daily basis and as a result
has a pipeline of applications that have been approved, where a lease has not
been originated. The Company's commitment to lend, however, does not become
binding until all of the steps in the lease origination process have been
completed, including but not limited to, the receipt of a complete and accurate
lease document and all required supporting information and successful

12



MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

verification with the lessee. Since the Company funds on the same day a lease is
successfully verified, at any given time, the Company has no firm outstanding
commitments to lend.

13



ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Three months ended March 31, 2005 as compared to the three months ended March
31, 2004.

RESULTS OF OPERATIONS



For the three months ended
March 31,
2004 Change 2005
------- ------ -------
(dollars in thousands)

Income on financing leases and loans.... $ 4,167 (63.8)% $ 1,508
Rental income........................... 8,465 (24.1)% 7,548
Income on service contracts ............ 1,731 (37.1)% 1,376
Service fees, waiver fees and other..... 3,646 (49.6)% 1,836
------- ----- -------
Total revenues.......................... 18,009 (39.7)% 10,861
------- ----- -------


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. Rental income from
monthly billings is recognized on a monthly basis as the customer continues to
rent the equipment. Income on service contracts from monthly billings is
recognized as the related services are provided. Other revenues such as loss and
damage waiver fees, and service fees relating to the leases, contracts and
loans, and rental revenues are recognized as they are earned.

Total revenues for the three months ended March 31, 2005 were $10.9
million, a decrease of $7.1 million, or 39.7%, from the three months ended March
31, 2004. The decrease was primarily due to a decrease of $2.7 million, or
63.8%, in income on financing leases and loans; $2.0 million or 24.1% in rental
income; $1.8 million, or 49.6% in service fees, loss and damage waiver fees and
other income; and $643,000, or 37.1% in service contract income. The overall
decrease in revenue can be attributed to the decrease in the overall size of the
Company's portfolio of leases, rentals and service contracts outstanding during
the period. The shrinking portfolio is a direct result of the Company's decision
during the third quarter of 2002 to cease funding new originations as a result
of its Lenders not renewing the revolving credit facility on September 30, 2002.
Revenue is expected to continue to decline until such time as new originations
begin to outpace the rate of attrition of contracts in the existing portfolio.

Selling, General and Administrative



For the three months ended
March 31,
2004 Change 2005
----- ------ -----
(dollars in thousands)

Selling, general and administrative..... 7,280 (12.8)% 6,348
As a percent of revenue................. 40.4% 58.4%


The Company's selling, general and administrative (SG&A) expenses include
costs of maintaining corporate functions including accounting, finance,
collections, legal, human resources, information systems and communications.
SG&A expenses also include commissions, service fees and other marketing costs
associated with the Company's portfolio of leases and rental contracts. SG&A
expenses decreased by $932,000, or 12.8%, for the three months ended March 31,
2005, as compared to the three months ended March 31, 2004. The decrease was
primarily driven by a reduction in debt closing expenses and bank charges of
approximately $393,000, $392,000 reduction in sales program expenses and
inventory services related to the existing portfolio, and $138,000 reduction in
insurance expense. Despite a reduction in headcount to 98 as of March 31, 2005,
personnel-related expenses remained relatively flat at $2.6 million. The
decrease in headcount was offset by the recognition of $748,000 of additional
compensation expense recognized as a result of the acceleration of vesting of
150,000 options as well as a cashless exercise of the vested shares and the
adoption of SFAS 123(R) as of January 1, 2005. The acceleration was approved by
the Board and permitted under the 1998 Plan.

14



Provision for Credit Losses



For the three months ended
March 31,
2004 Change 2005
------ ------ -----
(dollars in thousands)

Provision for credit losses............. 13,408 (56.7)% 5,810
As a percent of revenue................. 74.5% 53.5%


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 Company's provision for credit losses decreased by $7.6 million,
or 56.7%, for the three months ended March 31, 2005, as compared to the three
months ended March 31, 2004, while net charge-offs decreased 48.3% to $10.1
million. The provision was based on the Company's historical policy of providing
for credit losses based upon the dealer fundings and revenue recognized in any
period, as well as 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.

Depreciation and Amortization



For the three months ended
March 31,
2004 Change 2005
------ ------ ------
(dollars in thousands)

Depreciation - fixed assets.................. $ 251 (53.0)% $ 118
Depreciation and amortization - rentals...... 2,887 (50.5)% 1,429
Depreciation and amortization - contracts.... 1,157 (19.0)% 937
-----
Total depreciation and amortization.......... 4,295 (42.2)% 2,484
====== ===== ======
As a percent of revenue...................... 23.8% 22.9%


Depreciation and amortization expenses consist primarily of the
depreciation taken against fixed assets and rental equipment, and the
amortization of the Company's investment in service contracts. The Company's
investment in fixed assets is recorded at cost and amortized over the expected
life of the service period of the asset. 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. Service contracts are recorded
at cost and amortized over their estimated life of 84 months. The Company
periodically evaluates whether events or circumstances have occurred that may
affect the estimated useful life or recoverability of the asset and any
resulting charge is made to depreciation and amortization expense. Depreciation
and amortization related to rental contracts decreased by $1.5 million, or 50.5%
and depreciation and amortization related to service contracts decreased by
$220,000, or 19.0%, for the three months ended March 31, 2005, as compared to
the year ended March 31, 2004. The decrease in depreciation and amortization can
be attributed to the decrease in the overall size of the Company's portfolio of
leases, rentals and service contracts. Depreciation related to the Company's
property and equipment decreased by $133,000, or 53.0%, for the three months
ended March 31, 2005, as compared to the three months ended March 31, 2004.

Interest Expense



For the three months ended
March 31,
2004 Change 2005
---- ------ ----
(dollars in thousands)

Interest................................ 846 (75.8)% 205
As a percent of revenue................. 4.7% 1.9%


The Company pays interest on borrowings under the senior credit facility
and subordinated debt. Interest expense decreased by $641,000, or 75.8%, for the
quarter ended March 31, 2005, as compared to the quarter ended March 31, 2004.
This decrease resulted primarily from the Company's decreased level of
borrowings. At March 31, 2005, the Company had notes payable of $79,000 and
subordinated notes payable of $4.6 million ($5.1 million

15



net of a discount of $500,000), compared to notes payable of $41.2 million and
subordinated notes payable of $3.3 million at March 31, 2004.

Benefit for Income Taxes



For the three months ended
March 31,
2004 Change 2005
------ ------ ------
(dollars in thousands)

Benefit for income tax.................. (3,128) (63.6)% (1,322)
As a percent of revenue................. 17.4% 12.2%


The process for determining the provision for income taxes, deferred tax
assets and liabilities and any necessary valuation allowance recorded against
net deferred tax assets, involves summarizing temporary differences resulting
from the different treatment of items, for example, leases, for tax and
accounting purposes. These differences result in deferred tax assets and
liabilities, which are recorded on the balance sheet. 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 management
believes recovery is more likely than not, whether a valuation allowance is
deemed necessary. Benefit for income taxes decreased by $2.0 million, or 63.6%,
for the three months ended March 31, 2005, as compared to the three months ended
March 31, 2004. This decrease resulted primarily from a $3.9 million reduction
in the Company's loss before benefit for income taxes as well as a reduction in
the Company's estimated effective tax rate from (40.0%) for the three months
ended March 31, 2004 to (33.2%) for the three months ended March 31, 2005. The
change in the effective tax rate is primarily due to the fact that no state tax
benefit was recorded for the three months ended March 31, 2005. The Company has
recorded a valuation allowance against the State deferred tax assets as it is
unlikely that these deferred tax assets will be fully realized. In addition,
during the quarter ended March 31, 2005, the Company recognized a corporate tax
deduction associated with the exercise of employee stock options. Under the
Internal Revenue Service Code, deductions for remuneration in excess of $1.0
million which is not performance based is disallowed for publicly traded
companies. The Company estimates that this deduction limitation will increase
the effective tax rate by approximately 1.8%.

Other Operating Data

Dealer fundings were $1.09 million for the three months ended March 31,
2005, an increase of $1.05 million, or 96.3%, compared to the three months ended
March 31, 2004. The Company was forced to suspend virtually all originations
from October 2002 until June 2004 when the Company was able to secure a limited
amount of new financing. During the third quarter of 2004, the Company focused
its efforts on securing a larger, lower priced line of credit and restarting its
origination business with a few select vendors. Receivables due in installments,
estimated residual values, loans receivable, investment in service contracts,
and investment in rental equipment decreased from $85.0 million for the year
ended December 31, 2004 to $66.0 million in March 31, 2005. Net cash provided by
operating activities decreased by $2.3 million, or 39.1%, to $3.6 million during
the quarter ended March 31, 2005.

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. The
Company identified its most critical accounting policies to be those related to
revenue recognition, maintaining the allowance for credit losses, determining
provisions for income taxes and accounting for stock options. These accounting
policies are discussed below as well as within the notes to the consolidated
financial statements.

Revenue Recognition

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

16



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. At the end of the lease term,
contractually, the lessee has the option to either buy the equipment at a price
quoted by the Company, return the equipment or continue to rent the equipment on
a month-to month basis. If the lessee continues to rent the equipment, the
Company records an investment in rental contracts at estimated residual value
and recognizes revenue and depreciation based on the methodology described
below. Other revenues such as loss and damage waiver fees, and service fees
relating to the leases, contracts and loans are recognized as they are earned.

The Company's investments in cancelable service contracts are recorded at
cost and amortized over the expected life of the service period. Income on
service contracts from monthly billings is recognized as the related services
are provided. The Company periodically evaluates whether events or circumstances
have occurred that may affect the estimated useful life or recoverability of the
investment in service contracts. The Company's investment in rental contracts 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. Rental
income from monthly billings is recognized on a monthly basis as the customer
continues to rent the equipment. The Company periodically evaluates whether
events or circumstances have occurred that may affect the estimated useful life
or recoverability of the investment in rental contracts. Loans are reported at
their outstanding principal balance. Interest income on loans is recognized as
it is earned.

Allowance for Credit Losses

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. Historically, the typical monthly payment under the
Company's leases has been 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 may 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 employs collection procedures and a legal process to resolve any credit
problems.

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. In
addition, the calculation of the Company's tax liabilities involves dealing with
estimates in

17



the application of complex tax regulations in a multitude of jurisdictions.
Differences between the basis of assets and liabilities result in deferred tax
assets and liabilities, which are recorded on the balance sheet. 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
management believes recovery is more likely than not, whether a valuation
allowance is deemed necessary.

Stock Option Accounting

As of January 1, 2005, the Company adopted SFAS 123(R), which requires the
measurement of compensation cost for all outstanding unvested share-based awards
at fair value and recognition of compensation over the service period for awards
expected to vest. The estimation of stock awards that will ultimately vest
requires judgment, and to the extent actual results differ from our estimates,
such amounts will be recorded as a cumulative adjustment in the period estimates
are revised. Actual results may differ substantially from these estimates. The
Company estimates the fair value of stock options using a Black-Scholes
valuation model, consistent with the provisions of SFAS 123(R), Securities and
Exchange Commission (SEC) Staff Accounting Bulletin No. 107 and the Company's
prior period pro forma disclosures of net earnings, including stock-based
compensation (determined under a fair value method as prescribed by SFAS 123).
Key input assumptions used to estimate the fair value of stock options include
the grant price of the award, the expected option term, volatility of the
Company's stock, the risk-free rate and the Company's dividend yield. Estimates
of fair value are not intended to predict actual future events or the value
ultimately realized by employees who receive equity awards, and subsequent
events are not indicative of the reasonableness of the original estimates of
fair value made by the Company under SFAS 123(R).

Exposure to Credit Losses

The following table sets forth certain information as of December 31,
2002, 2003 and 2004 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 has
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 December 31, As of March 31,
(dollars in thousands) 2004 2005
------------------ ---------------

Cumulative amounts billed $303,695 $274,500

31-60 days past due $ 1,858 0.6% $ 1,392 0.5%
61-90 days past due 1,818 0.6% 1,351 0.5%
Over 90 days past due 29,673 9.8% 20,907 7.6%
-------- ---- -------- ---
Total past due $ 33,349 11.0% $ 23,650 8.6%
======== ==== ======== ===


Alternatively, the amounts in the table below represent the balance of
delinquent receivables on an exposure basis for all leases, rental contracts,
and service contracts in the Company's portfolio as of December 31, 2004 and
March 31, 2005. An exposure basis aging classifies the entire receivable based
on the invoice that is the most delinquent. For example, in the case of a rental
or service contract, if a receivable is 90 days past due, all amounts billed and
unpaid are placed in the over 90 days past due category. In the case of lease
receivables, where the minimum contractual obligation of the lessee is booked as
a receivable at the inception of the lease, if a receivable is 90 days past due,
the entire receivable, including all amounts billed and unpaid as well as the
minimum contractual obligation yet to be billed, will be placed in the over 90
days past due category.

18





(dollars in thousands) December 31, 2004 March 31, 2005
----------------- --------------

Current $ 19,945 33.40% 14,529 33.85%
31-60 days past due 1,079 1.80% 718 1.67%
61-90 days past due 987 1.70% 713 1.66%
Over 90 days past due 37,668 63.10% 26,968 62.82%
-------- ------ ------- ------
Gross receivables due in installments $ 59,679 100.00% $42,928 100.00%
======== ====== ======= ======


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 lease
originations. Since inception, the Company has funded its operations primarily
through borrowings under its credit facilities, its on-balance sheet
securitizations, the issuance of 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, and
contracts funded, as well as to fund any future acquisitions of leasing
companies or portfolios. Additionally, the Company's uses of cash include the
payment of interest expenses, repayment of borrowings under its credit
facilities and securitizations, payment of selling, general and administrative
expenses, income taxes and capital expenditures.

For the three months ended March 31, 2004 and March 31, 2005,
respectively, the Company's primary source of liquidity was cash provided by
operating activities. The Company generated cash flow from operations of $10.0
million for the three months ended March 31, 2005 and $17.1 million for the
three months ended March 31, 2004.

The Company used net cash in investing activities of $1.1 million for the
three months ended March 31, 2005 and $172,000 for the three months ended March
31, 2004. Investing activities primarily relate to the origination of new leases
and contracts as well as capital expenditures.

Net cash used in financing activities was $646,000 for the three months
ended March 31, 2005 and $17.3 million for the three months ended March 31,
2004. Financing activities include net borrowings and repayments on our various
financing sources as well as dividends paid.

The Company believes that cash flows from its existing portfolio and
available borrowings on the existing credit facility will be sufficient to
support the Company's operations and lease origination activity for the
foreseeable future.

Borrowings

The Company utilizes its credit facilities to fund the origination and
acquisition of leases that satisfy the eligibility requirements established
pursuant to each facility.

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



As of As of
December 31, 2004 March 31, 2005
-------------------------- -------------------------------------------------
Maximum
Amounts Interest Amounts Interest Unused Facility
(dollars in thousands) Outstanding Rate Outstanding Rate Capacity Amount
----------- ----------- ----------- ----------- -------- --------

Revolving credit facility (1) $ 34 Prime + 1.5% $ 79 Prime + 1.5% $ 29,921 $ 30,000

Subordinated notes (2) 5,152 7.75%-13.0% 5,152 7.75%-13.0% -- --
----------- ----------- -------- --------
$ 5,186 $ 5,231 $29,921 $ 30,000
=========== =========== ======== ========


19



- ----------------
(1) The unused capacity is subject to lease eligibility and the borrowing base
formula

(2) Subordinated notes are generally one-time fundings, without any ability
for the Company to draw down additional amounts.

On September 29, 2004, the Company entered into a three-year senior
secured revolving line of credit with CIT Commercial Services, a unit of CIT
Group (CIT), whereby it may borrow a maximum of $30.0 million based upon
qualified lease receivables. Outstanding borrowings with respect to the
revolving line of credit bear interest based at Prime plus 1.5% for Prime Rate
Loans, or the prevailing rate per annum as offered in the London Interbank
Offered Rate (LIBOR) plus 4.0% for LIBOR Loans. If the LIBOR Loans are not
renewed upon their maturity they automatically convert into Prime Rate Loans.
The prime rates at December 31, 2004, and March 31, 2005 were 5.25% and 5.75%
respectively. The 90-day LIBOR rates at December 31, 2004 and March 31, 2005
were 2.56% and 3.12% respectively. As of March 31, 2005, based on lease
eligibility and the borrowing base formula, the Company had $12.3 million in
borrowing capacity available on the CIT line of credit.

Financial Covenants

The Company's secured revolving line of credit with CIT has financial
covenants that it must comply with in order to obtain funding through the
facility and to avoid an event of default. Some of the critical financial
covenants under the CIT line of credit as of March 31, 2005 include:

- Consolidated tangible capital funds not less than $42.5 million

- Allowance for credit losses of at least 9.0% of gross lease
installments

- Maximum leverage ratio of not more than 3:1

As of March 31, 2005, management believes that the Company was in
compliance with all covenants in its borrowing relationships.

Contractual Obligations and Commercial Commitments

Contractual Obligations

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 securitization, subordinated notes, demand notes and other notes
payable.

At March 31, 2005, the repayment schedules for outstanding borrowings on
the revolving credit facility, long-term debt, minimum lease payments under
non-cancelable operating leases and future minimum lease payments under capital
leases were as follows:



Revolving
For the period ended Credit Long-Term Operating Capital
December 31, Facility(1) Debt Leases Leases Total
- -------------------- ----------- --------- --------- ------- -------

2005 $ 79 $ 2,550 $ 439 $ 9 $ 3,077
2006 -- 2,600 -- -- 2,600
2007 -- -- -- -- --
2008 -- -- -- -- --
2009 -- -- -- -- --
2010 -- -- -- -- --
Thereafter -- -- -- -- --
----------- --------- --------- ------- -------
$ 79 $ 5,152 $ 439 $ 9 $ 5,677
=========== ========= ========= ======= =======


(1) The Company's obligation to repay the revolving credit facility in the
current year is subject to lease collateral availability and the borrowing
base formula. The credit facility expires on September 29, 2007.

20



Commitments

The Company accepts lease applications on daily basis and as a result has
a pipeline of applications that have been approved, where a lease has not been
originated. The Company's commitment to lend, however, does not become binding
until all of the steps in the lease origination process have been completed,
including but not limited to, the receipt of a complete and accurate lease
document and all required supporting information and successful verification
with the lessee. Since the Company funds on the same day a lease is successfully
verified, at any given time, the Company has no firm outstanding commitments to
lend.

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 need for additional financing in order to originate
new leases and contracts; the Company's dependence on point-of-sale
authorization systems and expansion into new markets; the Company's significant
capital requirements; risks associated with economic downturns; higher interest
rates; intense competition; change in regulatory environment; the availability
of qualified personnel 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. Statements relating to past dividend
payments or the Company's current dividend policy should not be construed as a
guarantee that any future dividends will be paid. For a more complete
description of the prominent risks and uncertainties inherent in the Company's
business, see the risk factors described in the Company's Annual Report on Form
10-K and other documents filed from time to time with the Securities and
Exchange Commission.

21



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 non-financial or nonquantifiable. Such risks principally include 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. Currently, given the restrictions imposed by the
Company's senior lender on the Company's ability to prepay its fixed rate debt,
the Company is limited in its ability to manage the blend of fixed and variable
rate interest obligations. As of March 31, 2005, the Company's outstanding
fixed-rate indebtedness outstanding under the Company's subordinated debt
represented 98.5% of the Company's total outstanding indebtedness of $5.2
million.

ITEM 4 CONTROLS AND PROCEDURES

Disclosure controls and procedures: As of the end of the period covered by
this report, the Company carried out an evaluation, under the supervision and
with the participation of the Company's management, including the Company's
Chief Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to the Exchange Act Rule 13a-15. Based upon the evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective. Disclosure controls
and procedures are controls and procedures that are designed to ensure that
information required to be disclosed in Company reports filed or submitted under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.

Internal Controls: During the fiscal quarter ended March 31, 2005, no
changes were made to the Company's internal control over financial reporting
that materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.

22



PART II. OTHER INFORMATION

ITEM 1 LEGAL PROCEEDINGS

Management believes, after consultation with counsel, that the allegations
against the Company included in the lawsuits described below are subject to
substantial legal defenses, and the Company is vigorously defending each of the
allegations. The Company also is subject to claims and suits arising in the
ordinary course of business. At this time, it is not possible to estimate the
ultimate loss or gain, if any, related to these lawsuits, nor if any such loss
will have a material adverse effect on the Company's results of operations or
financial position.

A. 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. By decision dated September 30, 2003, the court
dismissed the complaint with leave to file an amended complaint. An Amended
Complaint was filed in November 2003. The Company filed a Motion to Dismiss the
Amended Complaint, which was denied by the United States District Court in
September 2004. The Company has filed an answer to the Amended Complaint denying
the Plaintiffs' allegations and asserting counterclaims. Because of the
uncertainties inherent in litigation, the Company cannot predict whether the
outcome will have a material adverse effect.

B. 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. On February 20, 2004, the Alabama Supreme Court
overruled the Company's application for rehearing. On February 24, 2004,
Plaintiff filed a First Amended Class Action Complaint in which Plaintiff added
Electronic Commerce International ("ECI") as an additional party defendant. No
new allegations were asserted against the Company in the Amended Complaint. On
March 31, 2004 the Company filed an answer to the Amended Complaint denying the
Plaintiff's allegations. The Company continues to deny any wrongdoing and plans
to vigorously defend this claim. The Company also filed an additional motion to
enforce a forum selection clause, which, if successful, would have caused the
case to be dismissed with leave to re-file in Massachusetts. Galaxy Mall filed a
similar motion. The motions were scheduled to be heard in September 2004,
however, the parties have reached an agreement on settlement terms. On April 12,
2005, the Parties sought and the Court indicated that it would sign the
preliminary approval order to the settlement class during the week of April 12,
2005. The Court has set the final approval hearing for June 20, 2005. If the
settlement is approved in its current form, the outcome will not have a material
adverse effect on the Company.

C. 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. After the Company had filed a motion to
dismiss, but before the motion to dismiss was heard by the Court, plaintiffs
filed an Amended Complaint. The Amended Complaint asserted claims against the
Company for declaratory relief, absence of consideration, unconscionability, and
violation of Massachusetts General Laws Chapter 93A, Section 11. The Company
filed a motion to dismiss the Amended Complaint. The Court allowed the Company's
motion to dismiss the Amended Complaint in March 2004. In May 2004, a purported
class action on

23



behalf of the same named plaintiffs and asserting the same claims was filed in
Cambridge District Court. The Company has filed a Motion to Dismiss the
Complaint, which was heard in August 2004, and denied by the District Court. On
September 16, 2004, the Company filed an Answer and Counterclaims to the Amended
Complaint denying the plaintiffs' allegations. On March 2, 2005, the plaintiffs
filed a motion for leave to file an amended complaint. The Court has not ruled
yet on plaintiffs' motion for leave to file an amended complaint. In plaintiffs'
proposed amended complaint plaintiffs seek to add a claim for usury against the
Company. Because of the uncertainties inherent in litigation, the Company cannot
predict whether the outcome will have a material adverse effect.

D. In October 2003, the Company was served with a purported class action
complaint which was filed in United States District Court for the District of
Massachusetts alleging violations of the federal securities laws. The purported
class would consist of all persons who purchased Company securities between
February 5, 1999 and October 30, 2002. The Complaint asserts that during this
period the Company made a series of materially false or misleading statements
about the Company's business, prospects and operations, including with respect
to certain lease provisions, the Company's course of dealings with its
vendor/dealers, and the Company's reserves for credit losses. In April 2004, an
Amended Class Action Complaint was filed which added additional defendants and
expanded upon the prior allegations with respect to the Company. The Company has
filed a Motion to Dismiss the Amended Complaint, which is awaiting decision by
the Court. Because of the uncertainties inherent in litigation, the Company
cannot predict whether the outcome will have a material adverse effect.

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ITEM 6 EXHIBITS

Exhibits index

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

- ----------------
* Filed herewith

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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
-------------------------------------------------
Richard F. Latour
President and Chief Executive Officer

By: /s/ James R. Jackson Jr.
-------------------------------------------------
James R. Jackson, Jr.
Vice President and Chief Financial Officer

Date: May 16, 2005

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