-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Oc0YmjP6lVzTpfQBbHD7TYOHPVA7JuSoe3sn9+EDvQdeG5d0/e9+tkgTpvAimIpG baAEDPMrw5PWNbD7HKnmwg== 0000908662-99-000061.txt : 19990402 0000908662-99-000061.hdr.sgml : 19990402 ACCESSION NUMBER: 0000908662-99-000061 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MICROFINANCIAL INC CENTRAL INDEX KEY: 0000827230 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS BUSINESS CREDIT INSTITUTION [6159] IRS NUMBER: 042962824 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-14771 FILM NUMBER: 99581043 BUSINESS ADDRESS: STREET 1: 950 WINTER STREET CITY: WALTHAM STATE: MA ZIP: 02154 BUSINESS PHONE: 7818900177 MAIL ADDRESS: STREET 1: 950 WINTER STREET CITY: WALTHAM STATE: MA ZIP: 02154 FORMER COMPANY: FORMER CONFORMED NAME: BOYLE LEASING TECHNOLOGIES INC DATE OF NAME CHANGE: 19980605 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Fiscal Year Ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. MICROFINANCIAL INCORPORATED (Exact name of Registrant as Specified in its Charter) Massachusetts 04-2962824 (State or other jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 950 Winter Street Waltham, MA 02451 (Address of Principal Executive Offices) (zip code) Registrant's Telephone Number, Including Area Code: (781) 890-0177 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Shares, $0.01 par value per share New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [ ] Yes [X] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the closing price of such stock as of March 12, 1999, was approximately $85,060,444. As of March 12, 1999, 13,313,166 shares of the registrant's common stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE None Table of Contents Description Page Number Part I Item 1 Business............................................3 Item 2 Properties..........................................7 Item 3 Legal Proceedings...................................7 Item 4 Submission of Matters to a Vote of Security Holders...................................7 Part II Item 5 Market for the Registrant's Common Stock and Related Stockholders Matters...................7 Item 6 Selected Financial Data............................10 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations.....................................13 Item 7A Quantitative and Qualitative Disclosures about Market Risk.................................19 Item 8 Financial Statements and Supplementary Data..............................................20 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..........................20 Part III Item 10 Directors and Executive Officers of the Registrant....................................20 Item 11 Executive Compensation.............................23 Item 12 Security Ownership of Certain Beneficial Owners and Management.............................28 Item 13 Certain Relationships and Related Transactions......................................30 Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K...........................31 Signatures...................................................34 -2- PART I ITEM 1. BUSINESS General MicroFinancial Incorporated ("MicroFinancial" or the "Company") was formed as a Massachusetts corporation on January 27, 1987. The Company, which operates primarily through its wholly-owned subsidiary, Leasecomm Corporation, is a specialized commercial finance company that leases and rents "microticket" equipment and provides other financing services in amounts generally ranging from $900 to $2,500, with an average amount financed of approximately $1,400 and an average lease term of 45 months. Leasecomm Corporation started originating leases in January 1986. The Company has used proprietary software in developing a sophisticated, risk-adjusted pricing model and automating its credit approval and collection systems, including a fully-automated Internet-based application, credit scoring and approval process. The Company targets owner-operated or other small commercial enterprises, with little business credit history and limited or poor personal credit history at the owner level. The Company provides financing to these lessees who may have few other sources of credit. The Company primarily leases and rents low-priced commercial equipment with limited residual value which is used by these lessees in their daily operations. The Company does not market its services directly to lessees, but sources leasing transactions through a nationwide network of over 1,100 independent sales organizations and other dealer-based origination networks ("Dealers"). The majority of the Company's leases are currently for authorization systems for point-of-sale card-based payments by, for example, debit, credit and charge cards ("POS authorization systems"). POS authorization systems require the use of a POS terminal capable of reading a cardholder's account information from the card's magnetic stripe and combining this information with the amount of the sale entered via a POS terminal keypad. The terminal electronically transmits this information over a communications network to a computer data center and then displays the returned authorization or verification response on the POS terminal. The Company continues to develop other product lines, including leasing other commercial products and acquiring payment streams from service contracts. Leasing, Servicing and Financing Programs The Company originates leases for products that typically have limited distribution channels and high selling costs. The Company facilitates sales of such products by making them available to Dealers' customers for a small monthly lease payment rather than a high initial purchase price. The Company primarily leases and rents low-priced commercial equipment with limited residual value to small merchants. The Company purchases or originates monthly payment streams without regard to the residual value of the leased product. The majority of the Company's leases are currently for POS authorization systems, however, the Company also leases a wide variety of other equipment including advertising and display equipment, coffee machines, paging systems, water coolers and restaurant equipment. In addition, the Company also acquires service contracts and opportunistically seeks to enter various other financing markets. The Company's residential financings include acquiring service contracts from Dealers that provide security monitoring services and various other types of residential finance products. The Company's residential portfolio in past years primarily included leases of satellite television equipment. Despite significant origination volume in this market, the Company made a strategic decision in July 1996 to de-emphasize the satellite television equipment business and has greatly reduced originations of these leases since that time. -3- The Company originates and services leases, contracts and loans in all 50 states of the United States and its territories. As of December 31, 1998, leases in California, Florida, Texas and New York accounted for approximately 35% of the Company's portfolio, with none of the remaining states accounting for more than 3% of such total. Terms of Equipment Leases Substantially all equipment leases originated or acquired by the Company are non-cancelable. In a typical lease transaction, the Company originates leases referred to it by the Dealer and buys the underlying equipment from the referring Dealer upon funding of an approved application. Leases are structured with limited recourse to the Dealer, with risk of loss in the event of default by the lessee residing with the Company in most cases. The Company performs all processing, billing and collection functions under its leases. During the term of a typical lease, the Company is scheduled to receive payments sufficient, in the aggregate, to cover the Company's borrowing costs and the costs of the underlying equipment, and to provide the Company with an appropriate profit. Throughout the term of the lease, the Company charges late fees, prepayment penalties, loss and damage waiver fees and other service fees, when applicable, which enhance the profitability of the lease. The initial non-cancelable term of the lease is equal to or less than the equipment's estimated economic life. Initial terms of the leases in the Company's portfolio generally range from 12 to 48 months, with an average initial term of 45 months as of December 31, 1998. The terms and conditions of all of the Company's leases are substantially similar. In most cases, the contracts require lessees to: (i) maintain, service and operate the equipment in accordance with the manufacturer's and government-mandated procedures; (ii) insure the equipment against property and casualty loss; (iii) pay all taxes associated with the equipment; and (iv) make all scheduled contract payments regardless of the performance of the equipment. The Company's standard lease forms provide that in the event of a default by the lessee, the Company can require payment of liquidated damages and can seize and remove the equipment for subsequent sale, refinancing or other disposal at its discretion. Any additions, modifications or upgrades to the equipment, regardless of the source of payment, are automatically incorporated into and deemed a part of the equipment financed. The Company seeks to protect itself from credit exposure relating to poor quality Dealers by entering into recourse agreements with its Dealers, under which the Dealer agrees to reimburse the Company for payment of defaulted amounts under certain circumstances, primarily defaults within the first month following origination and upon evidence of Dealer errors or misrepresentations in originating a lease or contract. In case of Dealer error or misrepresentation, the Company will charge-back the Dealer for both the lessee's delinquent amounts and attorney and court fees. Residual Interests in Underlying Equipment The Company typically owns a residual interest in the equipment covered by a lease. At the end of the lease term, the lease typically converts into a month-to-month rental contract. If the lease does not convert, the lessee either buys the equipment at a price quoted by the Company or returns the equipment. If the equipment is returned, the Company may place the equipment into its used equipment rental and leasing program. The Company may also sell the used equipment through equipment brokers and remarketers in order to maximize the net proceeds from such sale. Service Contracts In a typical transaction for the acquisition of service contracts, a homeowner will purchase a security system and simultaneously sign a contract with the Dealer for the monitoring of that system for a monthly fee. The Dealer will then sell the right to payment under that contract to the Company for a multiple of the monthly payments. The Company performs all processing, billing and collection functions under these contracts. -4- Dealers The Company provides financing to obligors under microticket leases, contracts and loans through its Dealers. Since the Company relies primarily on its network of Dealers for its origination volume, the Company considers them its customers. The Company had over 1,242 different Dealers originating 67,080 Company leases, contracts and loans in 1998. E-Commerce accounted for approximately 11.6% of all originations in 1998. No other Dealer accounted for more than 10% of the Company's origination volume during such year. The Company does not sign exclusive agreements with its Dealers. Dealers interact with merchants directly and typically market not only POS authorization systems but also financing through the Company and ancillary POS processing services. Use of Technology The Company's business is operationally intensive, due in part to the small average amount financed. Accordingly, technology and automated processes are critical in keeping servicing costs to a minimum while providing quality customer service. The Company has developed LeasecommDirect(TM), an Internet-based application processing, credit approval and Dealer information tool. Using LeasecommDirect(TM), a Dealer can input an application directly to the Company via the Internet and obtain almost instantaneous approval automatically over the Internet through the Company's computer system, all without any contact with any employee of the Company. The Company also offers Instalease(R), a program that allows a Dealer to submit applications by telephone, telecopy or e-mail to a Company representative, receive approval, and complete a sale from a lessee's location. By assisting the Dealers in providing timely, convenient and competitive financing for their equipment or service contracts and offering Dealers a variety of value-added services, the Company simultaneously promotes equipment and service contract sales and the utilization of the Company as the finance provider, thus differentiating the Company from its competitors. The Company has used its proprietary software to develop a multi-dimensional credit scoring model which generates pricing of its leases, contracts and loans commensurate with the risk assumed. This software does not produce a binary "yes or no" decision, but rather determines the price at which the lease, contract or loan can be profitably underwritten. The Company uses credit scoring in most, but not all, of its extension of credit. Underwriting The nature of the Company's business requires two levels of review, the first focused on the ultimate end-user of the equipment or service and the second focused on the Dealer. The approval process begins with the submission by telephone, facsimile or electronic transmission of a credit application by the Dealer. Upon submission, the Company, either manually or through LeasecommDirect(TM) over the Internet, conducts its own independent credit investigation of the lessee through its own proprietary data base and recognized commercial credit reporting agencies such as Dun & Bradstreet, TRW, Equifax and TransUnion. The Company's software evaluates this information on a two-dimensional scale, examining both credit depth (how much information exists on an applicant) and credit quality (past payment history). The Company is thus able to analyze both the quality and amount of credit history available with respect to both obligors and Dealers and to assess the credit risk. The Company uses this information to underwrite a broad range of credit risks and provide financing in situations where its competitors may be unwilling to provide such financing. The credit scoring model is complex and automatically adjusts for different transactions. In situations where the amount financed is over $3,000, the Company may go beyond its own data base and recognized commercial credit reporting agencies and obtain information from less readily available sources such as banks. In certain instances, the Company will require the lessee to provide verification of employment and salary. -5- The second aspect of the credit decision involves an assessment of the originating Dealer. Dealers undergo both an initial screening process and ongoing evaluation, including an examination of Dealer portfolio performance, lessee complaints, cases of fraud or misrepresentation, aging studies, number of applications and conversion rates for applications. This ongoing assessment enables the Company to manage its Dealer relationships, including ending relationships with poor-performing Dealers. Upon credit approval, the Company requires receipt of signed lease documentation on the Company's standard or other pre-approved lease form before funding. Once the equipment is shipped and installed, the Dealer invoices the Company, and thereafter the Company verifies that the lessee has received and accepted the equipment. Upon the lessee authorizing payment to the Dealer, the lease is forwarded to the Company's funding and documentation department for funding, transaction accounting and billing procedures. Bulk and Portfolio Acquisitions In addition to originating leases through its Dealer relationships, the Company from time to time has purchased lease portfolios from Dealers. The Company purchases leases from Dealers on an ongoing basis in packages ranging from $20,000 to $200,000. While certain of these leases initially do not meet the Company's underwriting standards, the Company will often purchase the leases once the lessee demonstrates a payment history. The Company will only acquire these smaller lease portfolios in situations where the company selling the portfolio will continue to act as a Dealer following the acquisition. The Company also completed the acquisition of three large POS authorization system lease and rental portfolios, two in 1996 and one in 1998. The first acquisition, completed in May 1996, consisted of over 8,000 rental contracts with total fundings of $1.9 million. The second acquisition was for approximately 8,200 leases in December 1996 with fundings of $7.9 million. The Company acquired 4,841 rental contracts in July 1998 with fundings of $2.8 million. Servicing and Collections The Company performs all servicing functions on its leases, contracts and loans, including its securitized leases, through its automated servicing and collection system. Servicing responsibilities generally include billing, processing payments, remitting payments to Dealers and investors in the Company's securitization programs (the "Securitizations"), preparing investor reports, paying taxes and insurance and performing collection and liquidation functions. The Company differentiates itself from its competitors in the way in which it pursues delinquent accounts that it believes its competitors would not pursue due to the costs of collection. The Company's automated lease administration system handles application tracking, invoicing, payment processing, automated collection queuing, portfolio evaluation and report writing. The system is linked with bank accounts for payment processing and provides for direct withdrawal of lease, contract and loan payments. The Company monitors delinquent accounts using its automated collection process. The Company uses several computerized processes in its collection efforts, including the generation of daily priority call lists and scrolling for daily delinquent account servicing, generation and mailing of delinquency letters, routing of incoming calls to appropriate employees with instant computerized access to account details, generation of delinquent account lists eligible for litigation, generation of pleadings and litigation monitoring. Collection efforts commence immediately, with repeated reminder letters and telephone calls upon payments becoming 10 days past due, with a lawsuit generally filed if an account is more than 85 days past due. 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 where necessary and obtaining and enforcing judgments. Competition The microticket leasing and financing industry is highly competitive. The Company competes for customers with a number of national, regional and local banks and finance companies. The Company's competitors also include equipment manufacturers that lease or finance the sale of their own products. While the -6- market for microticket financing has traditionally been fragmented, the Company could also be faced with competition from small or large-ticket leasing companies that could use their expertise in those markets to enter and compete in the microticket financing market. The Company's competitors include larger, more established companies, some of which may possess substantially greater financial, marketing and operational resources than the Company, including a lower cost of funds and access to capital markets and to other funding sources which may be unavailable to the Company. Employees As of December 31, 1998, the Company had 248 full-time employees, of which 51 were engaged in the credit activities and Dealer service, 123 were engaged in servicing and collection activities, 9 were engaged in marketing activities, and 65 were engaged in general administrative activities. Management believes that its relationship with its employees is good. No employees of the Company are members of a collective bargaining unit in connection with their employment by the Company. ITEM 2. PROPERTIES The Company's corporate headquarters and operations center are located in leased space of 34,851 square feet at 950 Winter Street, Waltham, Massachusetts 02451. The lease for this space expires on June 30, 1999. The Company plans to renew 21,656 square feet at 950 Winter Street, Waltham, Massachusetts 02451 for an additional 5 years which will expire on July 31, 2004. The Company also leases 2,933 square feet of office space for its West Coast office in Newark, California under a lease which expires on August 31, 2001. The Company recently signed a lease for 44,659 square feet of office space in Woburn, Massachusetts which commenced on December 15, 1998 and expires on December 14, 2003. The Company plans to relocate, from corporate headquarters, its collection, credit and computer operations to the Woburn location and plans to utilize this location for any further employee expansion. ITEM 3. LEGAL PROCEEDINGS The Company and its subsidiaries are frequently parties to various claims, lawsuits and administrative proceeding arising in the ordinary course of business. Although the outcome of these lawsuits cannot be predicted with certainty, the Company does not expect such matters to have material adverse effect on the financial condition or results of operations of the Company. There are no material pending legal proceedings to which the Company or its subsidiaries or their respective properties are a party or were a party during the fourth quarter of the Company's fiscal year ended December 31, 1998. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the security holders of the Company during the fourth quarter of its fiscal year ended December 31, 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) Market Information The Company's common stock, par value $0.01 per share (the "Common Stock"), is listed on the New York Stock Exchange under the symbol "MFI." The Common Stock was listed on the New York Stock Exchange in February 1999. Accordingly, the high and low sales price for the Common Stock on such exchange for each full quarter in the Company's fiscal years ending December 31, 1997 and 1998 is not available. -7- (b) Holders At March 12, 1999, there were approximately 91 stockholders of record of the Common Stock. (c) Dividends The Company paid the following quarterly cash dividends on the Common Stock. The amounts indicated give effect to the 10-for-1 stock split of the Common Stock effected on June 16, 1997 and the 2-for-1 stock split of the Common Stock effected on February 10, 1999. Year ended December 31, 1997 Year ended December 31, 1998 First Quarter $0.025 $0.030 Second Quarter $0.030 $0.035 Third Quarter $0.030 $0.035 Fourth Quarter $0.030 $0.035 The Company currently intends to pay dividends in the future. 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. (d) Recent Sales of Unregistered Securities Except as set forth below, the Company did not sell any equity securities which were not registered under the Securities Act of 1933, as amended, during its fiscal year ended December 31, 1998.
No. of Shares of Aggregate Exemption Purchaser Issuance Date Common Stock Consideration Claimed* Richard F. Latour March, 1998 458 $ 291.98 Rule 701 Richard F. Latour March, 1998 21,198 41,336.10 Rule 701 Maureen Curran March, 1998 7,486 14,597.70 Rule 701 John Plumlee March, 1998 7,486 14,597.70 Rule 701 J. Gregory Hines March, 1998 7,486 14,597.70 Rule 701 Stephen Obana March, 1998 7,486 14,597.70 Rule 701 James Andersen March, 1998 7,486 14,597.70 Rule 701 Stephen Constantino March, 1998 3,732 7,277.40 Rule 701 Carol Salvo March, 1998 7,486 14,597.70 Rule 701 Kerry Frost March, 1998 3,732 7,277.40 Rule 701 Richard F. Latour June, 1998 2,762 1,760.78 Rule 701 J. Gregory Hines September, 1998 1,480 943.50 Rule 701 Richard F. Latour September, 1998 3,222 2,054.03 Rule 701 John Plumlee September, 1998 3,008 5,865.60 Rule 701 Carol Salvo September, 1998 3,008 5,865.60 Rule 701 Richard F. Latour December, 1998 12,622 24,612.90 Rule 701 J. Gregory Hines December, 1998 4,454 8,685.30 Rule 701 Stephen Obana December, 1998 4,454 8,685.30 Rule 701 John Plumlee December, 1998 1,446 2,819.70 Rule 701 Carol Salvo December, 1998 1,446 2,819.70 Rule 701 Stephen Constantino December, 1998 2,228 4,344.60 Rule 701 *Shares issued pursuant to exercises of options under the Company's 1987 Stock Option Plan.
-8- (e) Use of Proceeds from Registered Securities The Company filed a registration statement on Form S-1 (registration statement number 333-56639) with the Securities and Exchange Commission to register its offering of 4,000,000 shares of Common Stock (as amended, the "Registration Statement") (the "Offering") which included 600,000 shares offered by existing stockholders. The Registration Statement was declared effective on February 4, 1999. The Offering commenced on February 10, 1999 and terminated on such date after all of the registered shares of Common Stock had been sold. The managing underwriters for the Offering were Piper Jaffray Inc. and CIBC Oppenheimer Corp.
- --------------------------------------------------------- ----------------------------------------------------------- For the account of the Company For the account of the selling stockholders - ---------------- ------------- ------------- ------------- ------------- --------------- ------------- -------------- Aggregate Aggregate price of Aggregate Offering Aggregate Offering Offering price of Offering Amount amount Amount price of Amount amount Amount price of registered registered sold amount sold registered registered sold amount sold - ---------------- ------------- ------------- ------------- ------------- --------------- ------------- -------------- $3,400,000 $51,000,000 3,400,000 $51,000,000 1,200,000 $9,000,000 600,000 $9,000,000 - ---------------- ------------- ------------- ------------- ------------- --------------- ------------- --------------
The following table sets forth certain expenses incurred by the Company in connection with the Offering. None of such expenses constituted direct or indirect payments to directors or officers of the Company, to persons owning ten percent or more of any class of equity securities of the Company, or to affiliates of the Company. Expense Amount Underwriting discount and commissions........................... $4,200,000 Finders' Fees................................................... $0 Other Expenses.................................................. $1,313,891 Total Expenses.................................................. $5,513,891 The net proceeds of the Offering to the Company after deducting all the expenses of the Offering were $45,486,109, which was used to repay indebtedness. This amount does not include the $8,370,000 paid to the selling stockholders. The Company applied its net proceeds of the Offering as set forth in the following table. None of such proceeds constituted direct or indirect payments to directors officers of the Company or their associates, to persons owning ten percent or more of any class of equity securities of the Company, or to affiliates of the Company. Construction of plant building and facilities................... $0 Purchase and installation of machinery and equipment............ $0 Purchase of real estate......................................... $0 Acquisition of other business(es)............................... $0 Repayment of indebtedness.......................................$45,486,109 Working capital................................................. $0 Temporary investment............................................ $0 Other purposes (specify)........................................ $0 -9- ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected consolidated financial and operating data for the Company and its subsidiaries for the periods and at the dates indicated. The selected financial data were derived from the financial statements and accounting records of the Company. The data presented below should be read in conjunction with the consolidated financial statements, related notes and other financial information included herein.
Years Ended December 31, ------------------------------------------------------------------ 1994 1995 1996 1997 1998 ------------------------------------------------------------------ Income Statement Data: (Dollars in thousands except per share data) Revenues Income on financing leases and loans $ 15,949 $ 27,011 $ 38,654 $ 45,634 $ 47,341 Income on service contracts (1) 6 501 2,565 Rental income 2,058 3,688 8,250 10,809 16,118 Fee income (2) 3,840 5,446 8,675 11,236 10,476 -------------------------------------------------------------- Total revenues 21,847 36,145 55,585 68,180 76,500 -------------------------------------------------------------- Expenses: Selling, general and administrative 4,975 8,485 14,073 17,252 20,061 Provision for credit losses 8,179 13,388 19,822 (3) 21,713 (3) 19,075 Depreciation and amortization 827 1,503 2,981 3,787 5,076 Interest 5,009 8,560 10,163 11,890 12,154 -------------------------------------------------------------- Total expenses 18,990 31,936 47,039 54,642 56,366 -------------------------------------------------------------- Income before provision for income taxes 2,857 4,209 8,546 13,538 20,134 Net income 1,643 2,524 5,080 7,652 11,924 ============================================================== Net income per common share Basic (4) $ 0.33 $ 0.34 $ 0.52 $ 0.78 $ 1.21 Diluted (5) 0.19 0.27 0.52 0.76 1.19 Dividends per common share 0.00 0.06 0.10 0.12 0.14 December 31, ------------------------------------------------------------------ 1994 1995 1996 1997 1998 ------------------------------------------------------------------ Balance Sheet Data: (Dollars in thousands) Gross investment in leases and loans (6) $115,286 $ 189,698 $ 247,633 $258,230 $ 280,875 Unearned Income (33,807) (60,265) (76,951) (73,060) (74,520) Allowance for credit losses (7,992) (15,952) (23,826) (26,319) (24,850) Investment in service contracts (1) -- -- -- 2,145 8,920 Total Assets 83,484 126,479 170,192 179,701 210,254 Notes Payable 57,594 94,900 116,202 116,830 130,421 Subordinated notes payable 13,436 13,170 27,006 26,382 24,421 Total liabilities 77,652 118,568 158,013 160,935 180,771 Total stockholders' equity 5,750 7,911 12,179 18,766 29,483 -10- Years Ended December 31, ---------------------------------------------------------------- 1994 1995 1996 1997 1998 ---------------------------------------------------------------- Other Data: (Dollars in thousands, except statistical data) Operating Data: Total leases and loans originated (7) $ 85,627 $ 134,546 $ 143,200 $ 129,064 $ 153,819 Total service contracts acquired (8) --- 3,635 2,431 2,972 8,080 Dealer fundings (9) $ 52,745 $ 76,502 $ 73,659 $ 77,590 $ 105,200 Average yield on leases and loans (10) 29.9% 30.7% 32.4% 33.9% 35.2% Cash flows from (used in): Operating activities $ 26,288 41,959 60,104 77,393 95,973 Investing activities (51,528) (76,353) (86,682) (80,127) (108,111) Financing activities 27,803 36,155 33,711 (1,789) 9,703 ----------------------------------------------------------------- Total 2,563 1,761 7,133 (4,523) (2,435) Selected Ratios: Return on average assets 2.45% 2.40% 3.42% 4.37% 6.12% Return on average stockholders' equity 28.73 36.95 50.57 49.46 49.43 Operating margin (11) 50.51 48.68 51.04 51.70 51.25 Credit Quality Statistics: Net charge-offs $ 4,961 $ 5,428 $ 11,948 (12) $ 19,220 (12) $ 20,544 Net charge-offs as a percentage of average gross investment (13) 5.37% 3.56% 5.46%(12) 7.57%(12) 7.47% Provision for credit losses as a percentage of average gross investment (14) 8.85 8.78 9.07 8.55 6.93 Allowance for credit losses as a percentage of gross investment (15) 6.93 8.41 9.62 10.14 8.58
- ---------- (1) The Company began acquiring fixed-term service contracts in 1995. Until December 1996, the Company treated these fixed-term contracts as leases for accounting purposes. Accordingly, income from these service contracts is included in income on financing leases and loans for all periods prior to December 1996 and investments in service contracts were recorded as receivables due in installments on the balance sheet at December 31, 1996. Beginning in December 1996, the Company began acquiring month-to-month service contracts, the income from which is included as a separate category in the Consolidated Statements of Operations and the investment in which are recorded separately on the balance sheet. (2) Includes loss and damage waiver fees and service fees. (3) The provision for 1996 includes $5.0 million resulting from a reduction in the time period for charging off the Company's receivables from 360 to 240 days. The provision for 1997 includes a one-time write-off of securitized receivables of $9.5 million and $5.1 million in write-offs of satellite television equipment receivables. (4) Net income per common share (basic) is calculated based on weighted average common shares outstanding of 5,003,880, 7,352,189, 9,682,851, 9,793,140, and 9,859,127 for the years ended December 31, 1994, 1995, 1996, 1997, and 1998, respectively. (5) Net income per common share (diluted) is calculated based on weighted average common shares outstanding on a diluted basis of 8,713,065, 9,448,206, 9,770,613, 9,925,329 and 10,031,975 for the years ended December 31, 1994, 1995, 1996, 1997 and 1998, respectively. (6) Consists of receivables due in installments, estimated residual value, and loans receivable. -11- - ---------- (7) Represents the amount paid to Dealers upon funding of leases and loans plus the associated unearned income. (8) Represents the amount paid to Dealers upon the acquisition of service contracts, including both non-cancelable service contracts and month-to-month service contracts. (9) Represents the amount paid to Dealers upon funding of leases, contracts and loans. (10) Represents the aggregate of the implied interest rate on each lease and loan originated during the period weighted by the amount funded at origination for each such lease and loan. (11) Represents income before provision for income taxes and provision for credit losses as a percentage of total revenues. (12) Charge-offs in 1996 and 1997 were higher due to write-offs related to satellite television equipment lease receivables and due to a change in the write-off period from 360 to 240 days in the third quarter of 1996. (13) Represents net charge-offs as a percentage of average gross investment in leases and loans and investment in service contracts. (14) Represents provision for credit losses as a percentage of average gross investment in leases and loans and investment in service contracts. (15) Represents allowance for credit losses as a percentage of gross investment in leases and loans and investment in service contracts. -12- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion includes forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995). When used in this discussion, the words "believes," "anticipates," "expects" and similar expressions are intended to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of the Company, or industry results, to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks, uncertainties and other important factors include, among others: the Company's dependence on POS authorization systems and expansion into new markets; the Company's significant capital requirements; the risks of defaults on the Company's leases; adverse consequences associated with the Company's collection policy; risks associated with economic downturns; higher interest rates, intense competition, year 2000 non-compliance, governmental regulation, acquiring other portfolios and companies, dependence on key personnel, effect of sales of substantial amounts of the Common Stock, control by existing shareholders and certain anti-takeover provisions; risks associated with acquisitions; and other factors many of which are beyond the Company's control. The Company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained herein will in fact transpire. Overview The Company is a specialized commercial finance company that provides "microticket" equipment leasing and other financing services in amounts generally ranging from $900 to $2,500, with an average amount financed of approximately $1,400. The Company primarily leases POS authorization systems and other small business equipment to small commercial enterprises. For years ended December 31, 1997 and 1998, the Company had fundings to Dealers upon origination of leases, contracts and loans ("Dealer Fundings") of $77.6 million and $105.2 million, respectively, and revenues of $68.2 million and $76.5 million, respectively. The Company derives the majority of its revenues from leases originated and held by the Company, payments on service contracts, rental payments from lessees who continue to rent the equipment beyond the original lease term, and fee income. The Company funds the majority of leases, contracts and loans through its revolving credit and term loan facilities (the "Credit Facilities") and on-balance sheet Securitizations, and to a lesser extent, its subordinated debt program ("Subordinated Debt") and internally generated funds. In a typical lease transaction, the Company originates leases through its network of independent Dealers. Upon approval of a lease application by the Company and verification that the lessee has both received the equipment and signed the lease, the Company pays the Dealer the cost of the equipment plus the Dealer's profit margin. In a typical transaction for the acquisition of service contracts, a homeowner purchases a security system and simultaneously signs a contract with the Dealer for the monitoring of that system for a monthly fee. Upon credit approval of the monitoring application and verification with the homeowner that the system is installed, the Company purchases from the Dealer the right to the payment stream under that monitoring contract at a negotiated multiple of the monthly payments. -13- Substantially all leases originated or acquired by the Company are non-cancelable. During the term of the lease, the Company is scheduled to receive payments sufficient, in the aggregate, to cover the Company's borrowing costs and the costs of the underlying equipment, and to provide the Company with an appropriate profit. The Company enhances the profitability of its leases, contracts and loans by charging late fees, prepayment penalties, loss and damage waiver fees and other service fees, when applicable. The initial non-cancelable term of the lease is equal to, or less than, the equipment's estimated economic life, and often provides the Company with additional revenues based on the residual value of the equipment financed at the end of the initial term of the lease. Initial terms of the leases in the Company's portfolio generally range from 12 to 48 months, with an average initial term of 45 months as of December 31, 1998. Substantially all service and rental contracts are month-to-month contracts with an expected term of seven years for service contracts and 15 months for rental contracts. Certain Accounting Considerations The Company's lease contracts are accounted for as financing leases. At origination, the Company records the gross lease receivable, the estimated residual value of the leased equipment, initial direct costs incurred and the unearned lease income. Unearned lease income is the amount by which the gross lease receivable plus the estimated residual value exceeds the cost of the equipment. Unearned lease income and initial direct costs incurred are amortized over the related lease term using the interest method. Amortization of unearned lease income and initial direct costs is suspended if, in the opinion of management, full payment of the contractual amount due under the lease agreement is doubtful. In conjunction with the origination of leases, the Company may retain a residual interest in the underlying equipment upon termination of the lease. The value of such interests is estimated at inception of the lease and evaluated periodically for impairment. Other revenues such as loss and damage waiver fees, service fees relating to the leases, contracts and loans and rental revenues are recognized as they are earned. The Company's investments in cancelable service contracts are recorded at cost and amortized over the expected life of the service period. Income on service contracts from monthly billings is recognized as the related services are provided. The Company periodically evaluates whether events or circumstances have occurred that may affect the estimated useful life or recoverability of the investment in service contracts. Rental equipment is recorded at estimated residual value and depreciated using the straight-line method over a period of twelve months. Loans are reported at their outstanding principal balance. Interest income on loans is recognized as it is earned. The Company maintains an allowance for credit losses on its investment in leases, service contracts 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 future 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. 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. -14- Leases, service 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 and loans to be uncollectable when one of the following occur: (i) the obligor files for bankruptcy; (ii) the obligor dies and the equipment is returned; or (iii) when an account has become 360 days delinquent. The typical monthly payment under the Company's leases is between $30 and $50 per month. As a result of these small monthly payments, the Company's experience is that lessees will pay past due amounts later in the process because of the small amount necessary to bring an account current (at 360 days past due, a lessee will only owe lease payments of between $360 and $600). The Company has developed and regularly updates proprietary credit scoring systems designed to improve its risk based pricing. The Company uses credit scoring in most, but not all, of its extensions of credit. In addition, the Company aggressively employs collection procedures and a legal process to resolve any credit problems. Results of Operations Year Ended December 31, 1998 Compared to Year Ended December 31, 1997 Total revenues for the year ended December 31, 1998 were $76.5 million, an increase of $8.3 million, or 12.2%, from the year ended December 31, 1997, due primarily to increases of $7.4 million, or 65.5%, in rental and service contract income and $1.7 million, or 3.7%, in income on financing leases and loans over such amounts in the previous year's period. The increase in rental and service contract income came from an increase in the number of lessees that have continued renting the equipment beyond the original lease term and the increase in the number of service contracts in the Company's portfolio. The increase in income on financing leases and loans arose from the continued growth in the Company's lease and loan portfolio. Selling, general and administrative expenses increased $2.8 million, or 16.2%, for the year ended December 31, 1998 as compared to the year ended December 31, 1997. The increase was primarily attributable to an increase in personnel, resulting in a 19.8% increase in employee-related expenses, as the number of employees needed to maintain and manage the Company's growing portfolio and the general expansion of the Company's operations grew. Management expects that salaries and employee-related expenses, marketing expenses and other selling, general and administrative expenses will continue to increase as the portfolio grows because of the requirements of maintaining the Company's microticket portfolio and the Company's focus on collections. The Company's provision for credit losses decreased $2.6 million from the year ended December 31, 1997 to $19.1 million for the year ended December 31, 1998. This decrease resulted from an increase in recoveries and the Company's estimate of future losses. Depreciation and amortization expense increased by $1.3 million, or 34%, due to the increased number of rental contracts and the amortization of the investment associated with service contracts. Interest expense increased by $264,000, or 2.2%, from $11.9 million for the year ended December 31, 1997 to $12.2 million for the year ended December 31, 1998. This increase resulted from an increase in the average outstanding balance of the Company's Credit Facilities. As a result of the foregoing, the Company's net income increased by $4.3 million, or 55.8%, from $7.7 million for the year ended December 31, 1997 to $11.9 million for the year ended December 31, 1998. -15- Dealer Fundings were $105.2 million during the year ended December 31, 1998, an increase of $27.6 million, or 35.6%, compared to the year ended December 31, 1997. This increase primarily resulted from continued growth in leases of equipment other than POS authorization systems, acquisitions of service contracts and loans to commercial businesses. Receivable due in installments, estimated residual values, loans receivable and investment in service contracts also increased from $260 million for the year ended December 31, 1997 to $288.7 million for the year ended December 31, 1998, representing an increase of $28.7 million, or 11%. Cash collections increased by $20.8 million to $139.2 million during the year ended December 31, 1998, or 17.6%, from the year ended December 31, 1997 because of the increase in the size of the Company's overall portfolio as well as the Company's continued emphasis on collections. Unearned income increased $1.4 million, or 1.9%, from $73.1 million at December 31, 1997 to $74.5 million at December 31, 1998. This increase was due to the increased number of leases originated during 1998. Year Ended December 31, 1997 Compared to Year Ended December 31, 1996. Total revenues for the year ended December 31, 1997 were $68.2 million, an increase of $12.6 million, or 22.7%, from the year ended December 31, 1996, due to increases of $7.0 million, or 18.1%, in income on financing leases and loans, $2.6 million, or 31.0%, in rental income and $2.6 million, or 29.5%, in fee income. The increase in income on leases and loans was primarily the result of the continued growth in the Company's lease portfolio. The increase in rental income is due to the increased number of lessees who continued to rent the equipment beyond the original lease term. The increase in fee income was a result of the increase in the overall portfolio serviced by the Company. The Company completed two portfolio acquisitions, one in May 1996 for $1.9 million of rental contracts and a second in December 1996 for $7.9 million of leases. The income attributable to these acquired leases and rental contracts represented approximately $2.2 million, or 4.7%, of total income on leases and loans and rental income for 1996 and approximately $4.4 million, or 7.8%, of total income on leases and loans and rental income for 1997. Selling, general and administrative expenses increased $3.2 million, or 22.6%, for the year ended December 31, 1997 as compared to the year ended December 31, 1996. Such increase was primarily attributable to a 20% increase in the number of employees needed to maintain and manage the Company's increased portfolio, the general expansion of the Company's operations and the more competitive employment environment. The Company's provision for credit losses increased by $1.9 million, or 9.5%, from $19.8 million in 1996 to $21.7 million in 1997. The higher provision was due to a one-time write-off of securitized receivables of $9.5 million, $5.1 million in one-time write-offs of satellite television equipment receivables and growth in the overall size of the Company's portfolio. The Company's 1997 provision reflected a cumulative write-off of non-accruing fully reserved receivables in the Company's securitized portfolio. The Company wrote off the $5.1 million in satellite television equipment receivables in 1997 sooner than its normal 360-day policy because it was the Company's experience that certain characteristics of consumer receivables which were different from commercial receivables would render such receivables uncollectable under the Company's normal collection procedures. Depreciation and amortization expense increased by $806,000, or 27.0%, from 1996 to 1997 due to the increased number of rental contracts and the amortization of the investment costs associated with service contracts. Interest expense increased by $1.7 million, from $10.2 million for the year ended December 31, 1996 to $11.9 million in 1997. This increase was primarily due to an increase in the average outstanding balances of the Company's Credit Facilities and Subordinated Debt. -16- As a result of these factors, net income increased by $2.6 million, or 50.6%, from $5.1 million in the year ended December 31, 1996 to $7.7 million in the year ended December 31, 1997. Dealer Fundings were $77.6 million for the fiscal year ended December 31, 1997, an increase of $3.9 million, or 5.3%, compared to $73.7 million for the fiscal year ended December 31, 1996. The Company decided in July 1996 to scale back its Dealer Fundings of consumer satellite television equipment leases, funding to Dealers only $0.8 million of such leases in 1997 compared to $4.7 million in 1996. Excluding this factor, the Company had an increase in Dealer Fundings of $7.8 million, or 11.3%, over 1996. This increase primarily resulted from continued growth in leases of equipment other than POS authorization systems, acquisitions of service contracts and loans to commercial businesses. Gross investment in leases and loans also increased from $247.6 million in 1996 to $258.2 million at December 31, 1997, representing an increase of $10.6 million, or 4.3%. Cash collections increased by $31.3 million, or 35.9%, from $87.1 million in 1996 to $118.4 million in 1997 due to the increase in the size of the Company's overall portfolio, as well as the Company's continued emphasis on collections. Unearned income decreased $3.9 million, or 5.1%, from $77.0 million at December 31, 1996 to $73.1 million at December 31, 1997. This decrease resulted primarily from increased acquisitions of service contracts and originations of loans which are accounted for on a cost basis and as a result do not have any unearned income associated with them, as well as one-time write-offs in 1997 of approximately $5.0 million in consumer satellite television equipment lease receivables and $9.5 million of securitized receivables and the corresponding unearned income associated with those leases. Year Ended December 31, 1996 Compared to the Year Ended December 31, 1995. Total revenues for fiscal year 1996 were $55.6 million, an increase of $19.4 million, or 53.8% over fiscal year 1995, due to increases of $11.6 million, or 43.1%, in income on financing leases and loans, $4.6 million, or 123.9%, in rental income and $3.2 million, or 59.3%, in total fee income. The increase in income on leases and loans was the result of the continued growth in the Company's lease portfolio in 1996, while the increase in rental income was due to the increased number of lessees who continue to rent the equipment beyond the original lease term including as a result of two lease and rental portfolio acquisitions with fundings of $1.9 million in May 1996 and $7.9 million in December 1996. The income attributable to these acquired leases and rental contracts represented approximately $2.2 million, or 4.7%, of total income on leases and loans and rental income for 1996. Fee income increased as a result of the continued growth in the overall portfolio serviced by the Company. Selling, general and administrative expenses were $14.1 million in 1996, representing an increase of 65.9% over such expenses in 1995, due primarily to a 34% increase in the number of personnel and the significant growth in the Company's lease portfolio from 1995 to 1996. The Company's provision for credit losses increased by $6.4 million from $13.4 million in 1995 to $19.8 million in 1996. Approximately $5.0 million of the increase was to replenish the allowance for credit losses due to the change in the write-off period from 360 days to 240 days in the third quarter of 1996. Depreciation and amortization expense increased by $1.5 million from $1.5 million in 1995 to $3.0 million in 1996. This increase was due to the increased number of rental contracts in the Company's portfolio. Interest expense increased by $1.6 million, or 18.7%, from $8.6 million in 1995 to $10.2 million in 1996. This increase was primarily due to an increase in the average outstanding balances of the Company's Credit Facilities and Subordinated Debt. As a result of these factors, net income increased by $2.6 million, or 101.3%, from $2.5 million for the year ended December 31, 1995 to $5.1 million in the year ended December 31, 1996. -17- Dealer Fundings were $73.7 million in 1996, a decrease of $2.8 million, or 3.7%, over the $76.5 million funded during 1995. The decrease in Dealer Fundings in 1996, excluding portfolio purchases, was primarily attributable to management's focus on maintaining higher rates of return on POS authorization systems, exiting the business of origination of consumer satellite television equipment leases and performing developmental work to reposition the Company's efforts in other commercial and residential markets, including the design of more competitive products, a product-specific sales approach, and a renewed focus on service contracts. Gross investment in leases and loans also increased from $189.7 million at December 31, 1995, to $247.6 million at December 31, 1996, representing a 30.5% increase. Cash collected was $87.1 million during 1996, an increase of $26.5 million, or 43.7%, over the $60.6 million collected in 1995. This increase was due to the increase in the size of the Company's overall portfolio, as well as the Company's continued emphasis on collections. Unearned income increased $16.7 million, or 27.7%, from $60.3 million at December 31, 1995 to $77.0 million at December 31, 1996. This increase resulted from an increase in the size of the Company's lease portfolio. 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, issuances of Subordinated Debt and its on-balance sheet Securitizations. The Company will continue to require significant additional capital to maintain and expand its volume of leases, contracts and loans funded, as well as to fund any future acquisitions of leasing companies or portfolios. The Company's uses of cash include the origination and acquisition of leases, contracts and loans, payment of interest expenses, repayment of borrowings under its Credit Facilities, Subordinated Debt and Securitizations, payment of selling, general and administrative expenses, income taxes and capital expenditures. The Company utilizes its Credit Facilities to fund the origination and acquisition of leases that satisfy the eligibility requirements established pursuant to each facility. At December 31, 1998, the Company had an aggregate maximum of $140 million available for borrowing under two Credit Facilities, of which approximately $62.7 million was outstanding as of such date. On January 27, 1999, the Company reduced the amount available under the Credit Facilities to $110 million. The Company also uses 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 and for potential portfolio purchases. The Company used the proceeds from its initial public offering to repay $45,486,109 million owed under the Credit Facilities. To date, cash flow from its portfolio and other fees have been sufficient to repay amounts borrowed under the Credit Facilities and Subordinated Debt. The Company believes that cash flow from its operations, the net proceeds to the Company of the Offering and amounts available under its Credit Facilities will be sufficient to fund the Company's operations for the foreseeable future. Although the Company is not currently involved in negotiations and has no current commitments or agreements with respect to any acquisitions, to the extent that the Company successfully consummates acquisitions, it may be necessary to finance such acquisitions through the issuance of additional debt or equity securities, the incurrence of indebtedness or a combination of both. Recently Issued Accounting Pronouncements See Note B of the notes to the consolidated financial statements included herein for a discussion of the impact of recently issued accounting pronouncements. Year 2000 Many computer programs and microprocessors were designed and developed without consideration of the impact of the transition to the year 2000. As a result, these programs and microprocessors may not be able to differentiate between the year "1900" and "2000"; the year 2000 may be recognized as the two-digit number "00". If not corrected, this could cause difficulties in obtaining accurate system data and support. -18- The Company has designed and purchased numerous computer systems since its inception. The Company's owned software and hardware is substantially Year 2000 compliant. The costs associated with such compliance will not be material to the Company's liquidity or results of operations. The Company believes, based on written and verbal advice from its vendors, that its critical third party software is generally Year 2000 compliant, with minor issues, and will be capable of functioning after December 31, 1999. However, the Company does and will continue to interconnect certain portions of its network and systems with other companies' networks and systems, certain of which may not be as Year 2000 compliant as those installed by the Company. While the Company has discussed these matters with, and/or obtained written certifications from, such other companies as to their Year 2000 compliance, there can be no assurance that any potential impact associated with incompatible systems after December 31, 1999 would not have a material adverse effect on the Company's business, financial condition or results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market-Rate-Sensitive Instruments and Risk Management The following discussion about the Company's risk management activities includes "forward-looking statements" that involve risk and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. This analysis presents the hypothetical loss in earnings, cash flows, or fair value of the financial instrument and derivative instruments held by the Company at December 31, 1998, that are sensitive to changes in interest rates. The Company uses interest-rate swaps to manage the primary market exposures associated with underlying liabilities and anticipated transactions. The Company uses these instruments to reduce risk by creating offsetting market exposures. The instruments held by the Company are not held for trading purposes. In the normal course of operations, the Company also faces risks that are either nonfinancial or nonquantifiable. Such risks principally include country risk, credit risk, and legal risk, and are not represented in the analysis that follows. Interest Rate Risk Management This analysis presents the hypothetical loss in earnings of the financial instruments and derivative instruments held by the Company at December 31, 1998 that are sensitive to changes in interest rates. The Company enters into interest rate swaps to reduce exposure to interest-rate risk connected to existing liabilities. The Company does not hold or issue derivative financial instruments for trading purposes. Because the Company's net-earnings exposure under the combined debt and interest-rate swap was to 90-day LIBOR, the hypothetical loss was modeled by calculating the 10 percent adverse change in 90-day LIBOR and then multiplying it by the face amount of the debt (which equaled the face amount of the interest rate swap). The implicit yield to the Company on all of its leases, 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 Facilities. 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. -19- 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 December 31, 1998, the Company's outstanding fixed rate indebtedness, including indebtedness outstanding under the Company's Securitizations and indebtedness subject to the swap described below, represented 60.4% of the Company's outstanding indebtedness. In July 1997, the Company entered into an interest rate swap arrangement with one of its banks. This arrangement, which expires in July 2000, has a notional amount of $17.5 million which represented 9.5% of the Company's fixed rate indebtedness outstanding at December 31, 1998. The interest rate associated with the swap is capped at 6.6%. During the term of the swap, the Company has agreed to match the swap amount with 90-day LIBOR loans. If at any time the 90-day LIBOR rate exceeds the swap cap of 6.6%, the bank would pay the Company the difference. Through December 31, 1998, the Company had entered into LIBOR loans with interest rates ranging from 7.1938% to 7.4103%. This arrangement effectively changes the Company's floating interest rate exposure on the $17.5 million notional amount to a fixed rate of 8.45%. The aggregate hypothetical loss in earnings on an annual basis on all financial instruments and derivative instruments that would have resulted from a hypothetical increase of 10 percent in 90-day LIBOR, sustained for one month, is estimated to be $32,200. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Included in Exhibit 99 incorporated by reference herein. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Name Age Position Peter R. Bleyleben 45 President, Chief Executive Officer and Director Brian E. Boyle(1)(2) 50 Director Torrence C. Harder(1)(2) 55 Director Jeffrey P. Parker 55 Director Alan J. Zakon(1)(2) 63 Director Richard F. Latour 45 Executive Vice President, Chief Operating Officer, Chief Financial Officer, Treasurer, Clerk and Secretary J. Gregory Hines 38 Vice President, Funding John Plumlee 47 Vice President, MIS Carol A. Salvo 32 Vice President, Legal (1) Member of Audit Committee (2) Member of Compensation Committee Set forth below is a brief description of the business experience of the directors and executive officers of the Company. -20- Peter R. Bleyleben has served as President, Chief Executive Officer and Director of the Company or its predecessor since June 1987. Before joining the Company, Dr. Bleyleben was Vice President and Director of the Boston Consulting Group, Inc. ("BCG") in Boston. During his more than eight years with BCG, Dr. Bleyleben focused his professional strategic consulting practice on the financial services and telecommunications industries. Prior to joining BCG, Dr. Bleyleben earned an M.B.A. with distinction and honors from the Harvard Business School, an M.B.A. and a Ph.D. in Business Administration and Economics, respectively, from the Vienna Business School in Vienna, Austria and a B.S. in Computer Science from the Vienna Institute of Technology. Brian E. Boyle, the Chief Executive Officer of the Company from 1985 to 1987 and Chairman of the Board of Directors from 1985 to 1995, has served as a Director of the Company or its predecessor since 1985. He is currently the Vice Chairman and a Director of Boston Communications Group, Inc. ("Communications"), a Boston-based provider of switch-based call processing to the global wireless industry. Prior to joining Communications, Dr. Boyle was the Chairman and Chief Executive Officer of Credit Technologies, Inc., a Massachusetts-based provider of credit decision and customer acquisition software, from 1989 to 1993. He is also a Director of Saville Systems, a global telecommunications billing software company, with its United States headquarters in Burlington, Massachusetts, as well as of several private companies. Dr. Boyle earned his A.B. in Mathematics and Economics from Amherst College and a B.S. in Electrical Engineering and Computer Science, an M.S. in Operations Research, an E.E. in Electrical Engineering and Computer Science and a Ph.D. in Operations Research, all from the Massachusetts Institute of Technology. Torrence C. Harder has served as a Director of the Company since 1986 and has served as Chairman of the Compensation Committee since 1997. He has been the President and Director of Harder Management Company, Inc., a registered investment advisory firm, since its establishment in 1971. He has also been the President and Director of Entrepreneurial Ventures, Inc., a venture capital investment firm, since its founding in 1986. Mr. Harder is a Director of Lightbridge, Inc., a wireless industry software services provider, Dent-A-Med, Inc., RentGrow, Inc., GWA Information Systems, Inc., Trade Credit Corporation and UpToDate in Medicine, Inc. Mr. Harder earned an M.B.A. from the Wharton School of the University of Pennsylvania, and a B.A. with honors in the Philosophy of Economic Thought from Cornell University. Jeffrey P. Parker has served as a Director of the Company since 1992. He is the founder and has served since 1997 as the Chief Executive Officer of CCBN.COM, a world wide web information services company based in Boston. He is also the founder and has served since 1991 as the managing director of Private Equity Investments, a venture capital firm focusing on start-up and early stage companies. Mr. Parker is a Director of Boston Treasury Systems, FaxNet Corporation, Pacific Sun Industries, Vintage Partners and XcelleNet, Inc. Mr. Parker earned a B.A., an M.A. in Engineering and an M.B.A. from Cornell University. Alan J. Zakon has served as a Director of the Company since 1988 and has served as Chairman of the Audit Committee since 1997. Since 1995, he has been the Vice Chairman and a Director, and since November 1997, Chairman of the Executive Committee, of Autotote Corporation, a New York-based global gaming and simulcasting company. He served as Managing Director of Bankers Trust Corporation from 1989 to 1995 where he was Chairman of the Strategic Policy Committee. Dr. Zakon is a Director of Arkansas-Best Freight Corporation, a nationwide commercial transportation and trucking company. Dr. Zakon holds a B.A. from Harvard University, an M.S. in Industrial Management from the Sloane School at the Massachusetts Institute of Technology and a Ph.D. in Economics and Finance from the University of California at Los Angeles. -21- Richard F. Latour has served as Executive Vice President, Chief Operating Officer, Chief Financial Officer, Treasurer, Clerk and Secretary of the Company since 1995. From 1986 to 1995, Mr. Latour was Vice President of Finance and Chief Financial Officer of the Company. Prior to joining the Company, Mr. Latour was Vice President, Finance for TRAK, Incorporated, an international manufacturer and distributor of consumer products, where he was responsible for all financial and related administrative functions. J. Gregory Hines has served as Vice President, Funding since 1993. From the time he joined the Company in 1992 until 1993, Mr. Hines served as funds manager of the Company. Prior to joining the Company, Mr. Hines was an assistant vice president in the Equipment Finance Division at the Bank of New England, N.A. and Fleet National Bank. John Plumlee has served as Vice President, MIS, of the Company since 1990. Prior to joining the Company, Mr. Plumlee was Vice President of M.M.C., Inc., a firm focusing on the delivery of software services to local governments. Carol A. Salvo has served as Vice President, Legal, of the Company since 1996. From 1992 to 1995, Ms. Salvo served as Litigation Supervisor of the Company. From 1995 to 1996, Ms. Salvo served as Director of Legal Collection Services of the Company. Prior to joining the Company, Ms. Salvo was a junior accountant with InfoPlus Inc. The directors of the Company have been divided, with respect to the time for which they severally hold office, into three classes, as nearly equal in number as possible, with the term of office of the first class to expire at the 1999 annual meeting of the stockholders of the Company, the term of office of the second class to expire at the 2000 annual meeting of the stockholders of the Company and the term of office of the third class to expire at the 2001 annual meeting of the stockholders of the Company, with each director to hold office until his or her successor shall have been duly elected and qualified or until his or her earlier removal or resignation. At each annual meeting of stockholders of the Company, commencing with the 1999 annual meeting, directors elected to succeed those directors whose terms then expire shall be elected for a term of office to expire at the third succeeding annual meeting of the stockholders of the Company after their election. In accordance with the foregoing, Peter Bleyleben's term as a director of the Company expires at the 2001 annual meeting of the stockholders of the Company, Brian Boyle and Alan Zakon's respective terms as directors of the Company expire at the 2000 annual meeting of the stockholders of the Company and Torrence Harder and Jeffrey Parker's respective terms as directors of the Company expire at the 1999 annual meeting of the stockholders of the Company. -22- ITEM 11. EXECUTIVE COMPENSATION The following table sets forth the compensation of the Chief Executive Officer and the four most highly compensated executive officers for the years ended December 31, 1998, 1997 and 1996 (the "Named Executive Officers"). Determination of the most highly compensated executive officers is based upon compensation for the Company's fiscal year ended December 31, 1998 and does not necessarily reflect the most highly compensated executive officers for the Company's fiscal years ended December 31, 1997 and 1996.
Summary Compensation Table (1) Annual Compensation ------------------------- Name and Principal Position Year Salary Bonus (2) All Other Compensation ---- ------ -------- ---------------------- Peter R. Bleyleben.................... 1998 $250,888 $364,000 $ 65,245 (3) President, Chief Executive Officer 1997 218,798 276,730 71,072 and Director 1996 187,837 214,073 73,674 Richard F. Latour.................... 1998 198,446 244,568 45,690 (4) Executive Vice President, Chief 1997 169,495 153,755 (5) 49,680 Operating Officer, Chief Financial 1996 134,535 43,000 44,381 Officer, Treasurer, Clerk and Secretary J. Gregory Hines..................... 1998 106,951 42,095 4,281 (6) Vice President, Funding 1997 87,348 26,950 3,206 1996 79,853 10,320 2,256 John Plumlee......................... 1998 141,351 44,533 21,191 (7) Vice President, MIS 1997 124,624 29,769 20,687 1996 108,657 14,346 18,603 Carol Salvo.......................... 1998 84,677 34,734 4,022 (8) Vice President, Legal 1997 66,368 15,781 2,170 1996 47,190 3,817 1,502
(1) Columns required by the rules and regulations of the Securities and Exchange Commission that contain no entries have been omitted. (2) Bonuses are paid over a three-year period, with one-third payable each year. The remaining two-thirds is subject to discretionary review by the Company and, therefore, does not vest to the employee. The bonus amount set forth for each fiscal year thus represents the amount actually paid for such fiscal year, plus amounts relating to the prior two fiscal years. -23- (3) Amounts for Dr. Bleyleben include: (a) contributions by the Company under the Company's 401(k) retirement/profit sharing plan in 1998 ($4,000), 1997 ($4,470) and 1996 ($4,500); (b) split dollar life insurance premiums paid by the Company in 1998 ($54,156), 1997 ($62,461) and 1996 ($60,515) (in the event of the death of Dr. Bleyleben, the Company is entitled to the cash value under such plan with the beneficiary receiving the life insurance portion thereof); (c) executive disability insurance policy premiums paid by the Company in 1998 ($7,089), 1997 ($3,546) and 1996($3,546); and (d) the benefit to the executive of interest-free loans from the Company based on the applicable federal rate in effect on the date of issuance of each such loan, in 1997 ($595) and 1996 ($5,113). (4) Amounts for Mr. Latour include: (a) contributions by the Company under the Company's 401(k) retirement/profit sharing plan in 1998 ($4,000), 1997 ($4,500) and 1996 ($4,435); (b) split dollar life insurance premiums paid by the Company in 1998 ($34,917), 1997 ($40,501) and 1996 ($35,067) (in the event of the death of Mr. Latour, the Company is entitled to the cash value under such plan with the beneficiary receiving the life insurance portion thereof); (c) executive disability insurance policy premiums paid by the Company in 1998 ($3,028), 1997 ($1,586) and 1996 ($2,460); and (d) the benefit to the executive of interest-free loans from the Company based on the applicable federal rate in effect on the date of issuance of each such loan, in 1998 ($3,745), 1997 ($3,093) and 1996 ($2,419). (5) Does not include $179,745 which related to bonuses awarded in prior years and deferred until 1997 at Mr. Latour's option. (6) Amounts for Mr. Hines include: (a) contributions by the Company under the Company's 401(k) retirement/profit sharing plan in 1998 ($2,738), 1997 ($2,273) and 1996 ($1,963); (b) term life insurance premiums paid by the Company in 1998 ($84), 1997 ($84) and 1996 ($76); (c) executive disability insurance policy premiums paid by the Company in 1998 ($602), 1997 ($434) and 1996 ($217); and (d) the benefit to the executive of interest-free loans from the Company based on the applicable federal rate in effect on the date of issuance of each such loan, in 1998 ($857) and 1997 ($415). (7) Amounts for Mr. Plumlee include: (a) contributions by the Company under the Company's 401(k) retirement/profit sharing plan in 1998 ($3,870), 1997 ($3,722) and 1996 ($2,991); (b) split dollar life insurance premiums paid by the Company in 1998 ($15,000), 1997 ($15,113) and 1996 ($15,104) (in the event of the death of Mr. Plumlee, the Company is entitled to the cash value under such plan with the beneficiary receiving the life insurance portion thereof); (c) executive disability insurance policy premiums paid by the Company in 1998 ($1,016), 1997 ($1,016) and 1996 ($508); and (d) the benefit to the executive of interest-free loans from the Company based on the applicable federal rate in effect on the date of issuance of each such loan, in 1998 ($1,305) and 1997 ($836). (8) Amounts for Ms. Salvo include: (a) contributions by the Company under the Company's 401(k) retirement/profit sharing plan in 1998 ($2,597), 1997 ($1,686) and 1996 ($1,447); (b) term life insurance premiums paid by the Company in 1998 ($84), 1997 ($69) and 1996 ($55); (c) executive disability insurance policy premiums paid by the Company in 1998 ($485); and (d) the benefit to the executive of interest-free loans from the Company based on the applicable federal rate in effect on the date of issuance of each such loan, in 1998 ($857) and 1997 ($415). -24- The Board of Directors of the Company is comprised of five Directors, one of whom, Peter Bleyleben, is a salaried employee of the Company who receives no additional compensation for services rendered as a Director. The members of the Company's Board of Directors who are not employees of the Company ("Non-Employee Directors") received compensation under the Company's Board of Directors Stock Unit Compensation Plan (the "Stock Unit Plan") for their service on the Board of Directors. Directors also are reimbursed for out-of-state travel expenses incurred in connection with attendance at meetings of the Board of Directors and committees thereof. In addition, the Company pays for health care insurance for each Non-Employee Director. The Company adopted the Stock Unit Plan in February 1997. The Stock Unit Plan was terminated effective as of February 10, 1999. Under the Stock Unit Plan, Non-Employee Directors who did not serve as committee chairpersons received up to $30,000 per year, payable $3,750 per meeting in cash and $3,750 per meeting in stock units (the "Stock Units"). Committee chairpersons received up to $35,000 per year, payable $4,375 per meeting in cash and $4,375 per meeting in Stock Units. Under the Stock Unit Plan, the Company paid the participant the cash amount currently and credited Stock Units in the appropriate amounts to a deferred fee account on the date of the Board of Directors or Committee meeting. Each Stock Unit in the deferred fee account was valued at the time each such credit was made at the then-current value of the Common Stock, as that value was determined from time to time by the Board of Directors. The number of Stock Units credited to each Non-Employee Director's deferred fee account and the value placed on each Stock Unit was appropriately adjusted in the event of a stock dividend, stock split or other similar change affecting the Common Stock. As of December 31, 1998, Dr. Boyle, Mr. Harder, Mr. Parker and Dr. Zakon had 3,665.75, 4,276.71, 3,665.75 and 4,276.71 Stock Units in their respective accounts. Since the Stock Unit Plan has been terminated, each Non-Employee Director will receive a cash payment, in equal quarterly installments starting with the second quarter of 1999, in an amount equal to the number of Stock Units in their respective accounts multiplied by $13.95. There were no stock options awarded in 1998 under the Company's 1987 Stock Option Plan or the 1998 Equity Incentive Plan. The following table indicates the aggregate option exercises in 1998 by the Named Executive Officers and fiscal year-end option values: -25-
AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1998 AND FISCAL YEAR-END OPTION VALUES Number of Securities Value of Unexercised Underlying Unexercised Options In-The-Money Options at Fiscal at Fiscal Year-End Year-End(1) -------------------------------- ------------------------------- Shares Acquired On Exercise Value Name Realized(1) Exercisable Unexercisable Exercisable Unexercisable ------------- ----------- ------------- --------------- ------------ --------------- Peter R. Bleyleben.. 0 $0 0 0 $0 $0 Richard F. Latour... 40,262 354,244 0 38,778 0 395,835 J. Gregory Hines.... 13,420 116,842 0 14,920 0 153,719 John Plumlee........ 11,940 96,982 0 12,000 0 120,552 Carol Salvo......... 11,940 96,982 0 12,000 0 120,552
(1) The amounts in these columns are calculated using the difference between the fair market value of the Company's Common Stock at exercise or at the end of the Company's 1998 fiscal year, as the case may be, and the option exercise prices. The Board of Directors determines the fair market value of the Company's Common Stock in connection with the Stock Unit Plan based on a formula which values the Company at a multiple (determined by reference to an index of publicly traded companies) of the Company's most recent four quarters net income, multiplied by a discount factor to take into account the illiquidity of the Common Stock. The most recent value as so determined by the Board of Directors was used in such calculations. The Company pays annual bonuses and makes profit sharing payments as determined by the Compensation Committee of the Board of Directors. These payments are made under informal arrangements and are based on an employee's performance during the prior fiscal year. Historically, the Board of Directors has determined annual bonus and profit sharing payments for Dr. Bleyleben and Mr. Latour. The Board of Directors also establishes a pool to be allocated by Dr. Bleyleben and Mr. Latour on an annual basis among senior executives of the Company. Each employee is paid one-third of his or her bonus and profit sharing at the time such amount is determined. The remaining two-thirds is paid over the next two years in the discretion of the Board of Directors or Dr. Bleyleben and Mr. Latour based on Company and employee performance. The Company has entered into Employment Agreements with Dr. Bleyleben and Mr. Latour for a three-year period commencing June 12, 1998, subject to automatic successive one-year renewals unless terminated pursuant to the terms thereof. In the event of a termination of the Employment Agreements by the Company without cause, or by Dr. Bleyleben or Mr. Latour for specified good reason, the Employment Agreements provide for three years of severance payments to Dr. Bleyleben and Mr. Latour, respectively, on the basis of their highest base salary during the employment period. In addition, Dr. Bleyleben and Mr. Latour would also be entitled to a prorated payment of base salary and bonus to the date of termination, and the acceleration of deferred compensation and accrued but unpaid amounts under the Company's bonus and/or profit sharing plans. Dr. Bleyleben's and Mr. Latour's current base salaries, respectively, are $260,000 and $210,000. The bonus for the current fiscal year will be determined by the Board of Directors. If, in connection with a payment under their Employment Agreement, either Dr. Bleyleben or Mr. Latour shall incur any excise -26- tax liability on the receipt of "excess parachute payments" as defined in Section 280G of the Internal Revenue Code of 1986, as amended, the Employment Agreements provide for gross-up payments to return them to the after-tax position they would have been in if no excise tax had been imposed. As used in each Employment Agreement, "for good reason" means the assignment to the executive of duties inconsistent with the executive's position, authority, duties or responsibilities; the failure by the Company to pay the agreed base salary and provide the executive with benefits; moving the executive to a location outside of the metropolitan Boston, Massachusetts area; and the failure by the Company to require a successor to assume all obligations under the Employment Agreement. The Company has also entered into separate employment agreements with each of the remaining Named Executive Officers which are designed to provide an incentive to each executive to remain with the Company pending and following a Change in Control (as defined below). Each employment agreement has an initial term of one year following a Change in Control, with automatic extensions upon the expiration of the initial one-year term for successive one-month periods. Pursuant to each employment agreement, the executive will be entitled to receive an annual base salary of not less than twelve times the highest monthly base salary paid or payable to the executive within the twelve months preceding the Change in Control. If the employment agreement is terminated by the Board other than for cause, death or disability, or is terminated by the executive for specified good reason, the Company shall pay to the executive in a cash lump sum within 30 days after the date of termination, the aggregate of the following amounts: (i) the executive's annual base salary through the date of termination; (ii) a special bonus in the amount of $575,000, $600,000 and $585,000 for Messrs. Hines and Plumlee and Ms. Salvo, respectively; (iii) any other compensation previously deferred by the executive, together with any accrued interest or earnings thereon; and (iv) any accrued vacation pay. "Change in Control" means (i) the acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 50% or more of either the then outstanding shares of Common Stock or the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors; (ii) individuals who, as of the date of the Company's 1998 Equity Incentive Plan constitute the Board of Directors, cease for any reason to constitute at least a majority of the Board of Directors except with respect to any director who was approved by a vote of at least a majority of the directors then comprising the Board of Directors; (iii) approval by the shareholders of the Company of a reorganization, merger or consolidation, in each case, unless, following such reorganization, merger or consolidation, more than 60% of the then outstanding shares of Common Stock continues to be owned by the shareholders who were the beneficial holders of such stock prior to such transaction; or (iv) approval by the shareholders of the Company of a complete liquidation or dissolution of the Company or the sale or other disposition of all or substantially all of the assets of the Company. -27- ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information as of March 12, 1998 with respect to the beneficial ownership of Common Stock of each person known by the Company to be the beneficial owner of more than 5% of the 13,332,776 outstanding shares of Common Stock, each director and executive officer of the Company and all directors and executive officers of the Company (not including treasury stock) as a group. Each person named has sole voting and investment power with respect to the shares indicated, except as otherwise stated in the notes to the table.
Number of Shares Percentage Outstanding Name and Address of Beneficial Owner Beneficially Owned (1) of Common Stock Peter R. Bleyleben (2) 1,555,410 11.66% 66 Norfolk Road Chestnut Hill, Massachusetts 02464 Brian E. Boyle (3) 2,041,450 15.31% 11 Whispering Lane Weston, Massachusetts 02493 Torrence C. Harder (4) 2,108,402 15.81% Walden Woods 657 Sudbury Road Concord, Massachusetts 01742-4321 Jeffrey P. Parker (5) 340,840 2.56% 253 Meadowbrook Road Weston, Massachusetts 02493 Alan J. Zakon 40,000 * 31 Pumpkin Cay Road, Apartment A Key Largo, Florida 33037 Richard F. Latour 306,772 2.30% 29 Cherubs Way Hampstead, New Hampshire 03841 J. Gregory Hines 25,080 * 14 Tory Treasure Lane Sharon, Massachusetts 02067 John Plumlee 30,275 * 97 By-Pass 28 Derry, New Hampshire 03038 Carol Salvo 18,000 * 164 Albemarle Road Norwood, Massachusetts 02062 All directors and executive officers as a group 6,466,229 48.50% (9 persons) *Less than 1%
- ---------- (1) Unless otherwise indicated in the footnotes, each of the stockholders named in this table has sole voting and investment power with respect to the shares of Common Stock shown as beneficially owned by such stockholder, except to the extent that authority is shared by spouses under applicable law. (2) Includes 19,600 shares of Common Stock owned by Dr. Bleyleben's mother for which Dr. Bleyleben disclaims beneficial ownership. (3) Includes 636,750 shares of Common Stock owned by Dr. Boyle's former spouse over which Dr. Boyle retains voting control, for which Dr. Boyle disclaims beneficial ownership. -28- (4) Includes 92,200 shares of Common Stock held in trust for Mr. Harder's daughter, Lauren E. Harder, over which Mr. Harder retains sole voting and investment power as the sole trustee and for which Mr. Harder disclaims beneficial ownership; 92,200 shares of Common Stock held in trust for Mr. Harder's daughter, Ashley J. Harder, over which Mr. Harder maintains voting and investment power as the sole trustee and for which Mr. Harder disclaims beneficial ownership; 346,372 shares of Common Stock owned by Entrepreneurial Ventures, Inc. over which Mr. Harder retains shared voting and investment power through his ownership in, and positions as President and Director of, Entrepreneurial Ventures, Inc.; and 34,046 shares of Common Stock owned by Lightbridge, Inc. over which Mr. Harder retains shared voting and investment power through his ownership in, and position as Director of, Lightbridge, Inc., for which Mr. Harder disclaims beneficial ownership. (5) Owned by The Parker Family Limited Partnership over which Mr. Parker retains shared voting and investment power through his ownership in, and position as Director of, the general partner of the Parker Family Limited Partnership. -29- ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. During 1995, 1997 and 1998, Richard F. Latour, Executive Vice President, Chief Operating Officer and Chief Financial Officer of the Company, borrowed an aggregate of $152,776 from the Company to exercise vested options to purchase Common Stock (the "Exercised Options"). Mr. Latour repaid all outstanding indebtedness to the Company upon the closing of the Offering with the proceeds of shares of Common Stock sold by him. The loans were non-interest bearing unless the principal amount thereof was not paid in full when due, at which time interest accrued and was payable at a rate per annum equal to the prime rate published by The Wall Street Journal plus 4.0%. The outstanding principal balance of these loans was reduced by any dividends payable upon the stock underlying the Exercised Options. All principal amounts outstanding under such loans were due on the earlier of the end of employment or December 27, 2005. During the fiscal year ended December 31, 1998, the largest aggregate amount outstanding under these loans was $106,300. Mr. Latour also has an outstnading Demand Note issued to the Company. As at December 31, 1998, the balance payable to Mr. Latour under this Demand Note was $297,387 at an interest rate per annum equal to a bank prime rate plus 1%. The Parker Family Limited Partnership, controlled by Jeffrey Parker, a director of the Company, loaned the Company an aggregate of $2.4 million in the form of Junior Subordinated Notes, $2.2 million of which was outstanding as of December 31, 1998, as follows: $200,000 on September 1, 1994 at an interest rate per annum equal to the higher of 12% or a bank prime rate plus 3% maturing September 1, 1999; $200,000 on May 1, 1995 at an interest rate per annum equal to 12% or a bank prime rate plus 4% maturing May 1, 2000; $500,000 on June 1, 1996 at an interest rate per annum equal to the higher of 12% or a bank prime rate plus 3% maturing June 1, 2000; $250,000 on December 1, 1996 at an interest rate per annum equal to the higher of 12% or a bank prime rate plus 3% maturing December 1, 1999; $500,000 on December 1, 1996 at an interest rate per annum equal to the higher of 12% or a bank prime rate plus 3% maturing December 1, 2002; $250,000 on December 1, 1996 at an interest rate per annum equal to the higher of 12% or a bank prime rate plus 3% maturing December 1, 2001; $125,000 on September 1, 1997 at an interest rate per annum equal to 11% maturing September 1, 2001; and $125,000 on September 1, 1997 at an interest rate per annum equal to 11% maturing September 1, 2003. Peter R. Bleyleben, the President and Chief Executive Officer and a Director of the Company, loaned the Company an aggregate of $125,000 in the form of Junior Subordinated Notes as follows: $100,000 on December 1, 1996 at 12% interest per annum maturing December 1, 2001; and $25,000 on June 1, 1998 at 10.5% interest per annum maturing June 1, 2003. Mr. Bleyleben also loaned the Company an aggregate of $200,000 in the form of demand notes as follows: $100,000 on October 17, 1997 at an interest rate per annum equal to a bank prime rate minus 1%; and $100,000 on December 1, 1998 at an interest rate per annum equal to a bank prime rate minus 1%. Alan J. Zakon, a director of the Company, loaned the Company an aggregate of $200,000 in the form of Junior Subordinated Notes as follows: $100,000 on February 1, 1995 at 12% interest per annum maturing February 1, 2000; and $100,000 on March 18, 1998 at 10.5% interest per annum through his IRA maturing April 1, 1999. -30- Ingrid R. Bleyleben, the mother of Peter R. Bleyleben, the President and Chief Executive Officer and a Director of the Company, loaned the Company the following amounts in the form of Junior Subordinated Notes: $120,000 on February 16, 1996 at an interest rate per annum equal to 11.5% maturing March 1, 2001; $25,000 on December 17, 1996 at an interest rate per annum equal to 11.5% maturing January 1, 2002; $20,000 on June 4, 1997 at an interest rate per annum equal to 11.5% maturing May 1, 2002; and $25,000 on June 1, 1998 at an interest rate per annum equal to 10% maturing June 1, 2003. Torrence C. Harder, a director of the Company, loaned the Company $100,000 in the form a of Junior Subordinated Note on November 1, 1994 at an interest rate per annum equal to 12.0% or a bank prime rate plus 3% maturing November 1, 1999. Additionally, Torrence C. Harder Cultural Foundation, a entity related to Torrence C. Harder, loaned the Company $50,000 in the form a of Junior Subordinated Note on January 1, 1996 at an interest rate per annum equal to 11.5% maturing January 1, 2001. All of the foregoing transactions, with the exception of the loans to Mr. Latour, are on terms similar to those that would have been obtained through arms-length negotiations. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) Financial Statements Included in Exhibit 99 incorporated by reference herein. (2) None. (3) Exhibits Index Exhibit Number Description 3.1 Restated Articles of Organization, as amended. (1). 3.2 Bylaws. (1). 10.1 Amended and Restated Revolving Credit Agreement among The First National Bank of Boston, Commerzbank Bank AG, New York Branch, and Leasecomm Corporation dated August 6, 1996. (1). 10.2 Agreement and Amendment No. 1 to Amended and Restated Revolving Credit Agreement among The First National Bank of Boston, Commerzbank Bank AG, New York Branch, and Leasecomm Corporation dated September 23, 1997. (1). 10.3 Amended and Restated Loan Agreement between Leasecomm Corporation and NatWest Bank N.A. dated July 28, 1995. (1). 10.4 First Amendment to Amended and Restated Loan Agreement between Leasecomm Corporation and NatWest Bank N.A. dated October 30, 1995. (1). 10.5 Second Amendment to Amended and Restated Loan Agreement between Leasecomm Corporation and Fleet Bank, N.A. (formerly NatWest Bank N.A.) dated August 6, 1996. (1). 10.6 Third Amendment to Amended and Restated Loan Agreement between Leasecomm Corporation and Fleet Bank, N.A. dated August 11, 1997. (1). 10.7 Office Lease Agreement by and between AJ Partners Limited Partnership and Leasecomm Corporation dated July 12, 1993 for facilities in Newark, California. (1). -31- 10.8 Office Lease Agreement by and between MicroFinancial Incorporated and Desmond Taljaard and Howard Friedman, Trustees of London and Leeds Bay Colony I Realty Trust, dated April 14, 1994 for facilities in Waltham, Massachusetts. (1). **10.9 1987 Stock Option Plan. (1). **10.10 Forms of Grant under 1987 Stock Option Plan. (1). **10.11 Board of Directors Stock Unit Compensation Plan. (1). **10.12 1998 Equity Incentive Plan. (3). **10.13 Employment Agreement between the Company and Peter R. Bleyleben. (3). **10.14 Employment Agreement between the Company and Richard F. Latour. (3). 10.15 Standard Terms and Condition of Indenture dated as of November 1, 1994 governing the BLT Finance Corp. III 6.03% Lease-Backed Notes, Series 1998-A (the "1998-A Notes"), the BLT Finance Corp. III 6.42% Lease-Backed Notes, Series 1997-A (the "1997-A Notes") and the BLT Finance Corp. III 6.69% Lease-Backed Notes, Series 1996-A (the "1996-A Notes"). (2). 10.16 Second Amended and Restated Specific Terms and Conditions of Indenture dated as of October 1, 1998, governing the 1996-A Notes, the 1997-A Notes and the 1998-A Notes. (3). 10.17 Supplement to Indenture dated May 1, 1996 governing the 1996-A Notes. (2). 10.18 Supplement to Indenture dated August 1, 1997 governing the 1997-A Notes. (2). 10.19 Supplement to Indenture dated as of October 1, 1998 governing the 1998-A Notes. (3). 10.20 Specimen 1997-A Note. (2). 10.21 Specimen 1996-A Note. (2). 10.22 Specimen 1998-A Note. (3). 10.23 Standard Terms and Conditions of Servicing governing the 1996-A Notes, the 1997-A Notes and the 1998-A Notes. (2). 10.24 Specific Terms and Conditions of Servicing governing the 1996-A Notes, the 1997-A Notes and the 1998-A Notes. (2). 10.25 Commercial Lease, dated November 3, 1998, between Cummings Properties Management, Inc. and MicroFinancial Incorporated. (3). 10.26 Amendment to Lease #1, dated November 3, 1998, between Cummings Properties Management, Inc. and MicroFinancial Incorporated. (3). 10.27 Employment Agreement between the Company and J. Gregory Hines. (3). 10.28 Employment Agreement between the Company and John Plumlee. (3). 10.29 Employment Agreement between the Company and Carol Salvo. (3). 10.30 Fourth Amendment to Amended and Restated Loan Agreement, dated July 31, 1998, among Leasecomm Corporation, the lenders parties thereto and Fleet Bank, National Association, as agent. (4) 10.31 Fifth Amendment to Amended and Restated Loan Agreement, dated January 27, 1999, among Leasecomm Corporation, the lenders parties thereto and Fleet Bank, National Association, as agent for such lenders. (4) 10.32 Second Amended and Restated Revolving Credit Agreement, dated January 27, 1999, among Leasecomm Corporation, the lenders parties thereto and BankBoston, N.A., as agent. (4) -32- 21.1 Subsidiaries of Registrant. (1). *27 Financial Data Schedule. *99 Consolidated Financial Statements and Notes to Consolidated Financial Statements - ---------------- * Filed herewith. ** Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of this Report. (1) Incorporated by reference to the Exhibit with the same exhibit number in the Registrant's Registration Statement on Form S-1 (Registration Statement No. 333-56639) filed with the Securities and Exchange Commission on June 9, 1998. (2) Incorporated by reference to the Exhibit with the same exhibit number in the Registrant's Amendment No. 1 to Registration Statement on Form S-1 (Registration Statement No. 333-56639) filed with the Securities and Exchange Commission on August 3, 1998. (3) Incorporated by reference to the Exhibit with the same exhibit number in the Registrant's Amendment No. 2 to Registration Statement on Form S-1 (Registration Statement No. 333-56639) filed with the Securities and Exchange Commission on January 11, 1999. (4) Incorporated by reference to the Exhibit with the same exhibit number in the Registrant's Amendment No. 3 to Registration Statement on Form S-1 (Registration Statement No. 333-56639) filed with the Securities and Exchange Commission on February 4, 1999. (b) No reports have been filed on Form 8-K. (c) See (a)(3) above. (d) None. -33- SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MICROFINANCIAL INCORPORATED. By: /s/ PETER R. BLEYLEBEN ---------------------------------------- Peter R. Bleyleben President, Chief Executive Officer and Director Date: March 31, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE /s/ PETER R. BLEYLEBEN President, Chief Executive Officer March 31, 1999 - ------------------------------------- and Director Peter R. Bleyleben /s/ RICHARD F. LATOUR Executive Vice President, Chief March 31, 1999 - ------------------------------------- Operating Officer, Chief Financial Richard F. Latour Officer, Treasurer, Clerk and Secretary /s/ BRIAN E. BOYLE Director March 31, 1999 - ------------------------------------- Brian E. Boyle /s/ TORRENCE C. HARDER Director March 31, 1999 - ------------------------------------- Torrence C. Harder /s/ JEFFREY P. PARKER Director March 31, 1999 - ------------------------------------- Jeffrey P. Parker /s/ ALAN J. ZAKON Director March 31, 1999 - ------------------------------------- Alan J. Zakon
-34- EX-99 2 EXHIBIT 99 Exhibit 99 MICROFINANCIAL INCORPORATED INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Accountants F-2 Financial Statements: Consolidated Balance Sheets as of December 31, 1997 and 1998 F-3 Consolidated Statements of Operations for the years ended December 31, 1996, 1997 and 1998 F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1997 and 1998 F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998 F-6 Notes to Consolidated Financial Statements F-8 F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of MicroFinancial Incorporated: In our opinion, the accompanying consolidated balance sheets and the related statements of operations, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of MicroFinancial Incorporated and its subsidiaries (the "Company") at December 31, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Boston, Massachusetts February 19, 1999 F-2 MICROFINANCIAL INCORPORATED CONSOLIDATED BALANCE SHEETS (in thousands)
December 31, --------------------------------- 1997 1998 ASSETS Net investment in leases and loans: Receivables due in installments $238,979 $251,060 Estimated residual value 16,784 17,562 Initial direct costs 2,777 4,260 Loans receivable 2,467 12,253 Less: Advance lease payments and deposits (334) (1,081) Unearned income (73,060) (74,520) Allowance for credit losses (26,319) (24,850) --------------------------------- Net investment in leases and loans: $161,294 $184,684 Investment in service contracts 2,145 8,920 Cash and cash equivalents 9,252 6,817 Property and equipment, net 4,265 6,747 Other assets 2,745 3,086 ================================= Total assets $179,701 $210,254 =================================
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Notes payable $116,830 $130,421 Subordinated notes payable 26,382 24,421 Capitalized lease obligations 1,071 774 Accounts payable 89 149 Dividends payable 294 346 Other liabilities 5,300 5,481 Income taxes payable 0 625 Deferred income taxes payable 10,969 18,554 --------------------------------- Total liabilities 160,935 180,771 --------------------------------- Commitments and contingencies - - Redeemable convertible preferred stock (liquidation preference $12, at December 31, 1997 and 1998) - - Stockholders' equity: Common stock 98 99 Additional paid-in capital 1,604 1,816 Retained earnings 17,366 27,956 Treasury stock, at cost (138) (138) Notes receivable from officers and employees (164) (250) --------------------------------- Total stockholders' equity 18,766 29,483 ================================= Total liabilities and stockholders' equity $179,701 $210,254 ================================= The accompanying notes are an integral part of the consolidated financial statements
F-3 MICROFINANCIAL INCORPORATED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
For the years ended December 31, ---------------------------------------- 1996 1997 1998 Revenues: Income on financing leases and loans $38,654 $45,634 $47,341 Income on service contracts 6 501 2,565 Rental income 8,250 10,809 16,118 Loss and damage waiver fees 4,188 5,448 5,441 Service fees 4,487 5,788 5,035 ------------------------------------- Total revenues 55,585 68,180 76,500 ------------------------------------- Expenses: Selling general and administrative 14,073 17,252 20,061 Provision for credit losses 19,822 21,713 19,075 Depreciation and amortization 2,981 3,787 5,076 Interest 10,163 11,890 12,154 ------------------------------------- Total expenses 47,039 54,642 56,366 ------------------------------------- Income before provision for income taxes 8,546 13,538 20,134 Provision for income taxes 3,466 5,886 8,210 ------------------------------------- Net Income $5,080 $7,652 $11,924 ===================================== Net Income per common share - basic $0.52 $0.78 $1.21 ===================================== Net Income per common share - diluted $0.52 $0.76 $1.19 ===================================== Dividends per common share $0.10 $0.12 $0.14 ===================================== The accompanying notes are an integral part of the consolidated financial statements.
F-4
MICROFINANCIAL INCORPORATED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY for the years ended December 31, 1996, 1997, and 1998 (in thousands, except share data) Notes Common Stock Additional Receivable Total ------------------------- Paid-in Retained Treasury From Stockholders' Shares Amount Capital Earnings Stock Officers Equity ----------------------------------------------------------------------------------------- Balance at December 31, 1995 9,677,720 $ 97 $ 1,438 $ 6,681 $ (100) $ (205) $ 7,911 Exercise of stock options 5,620 4 4 Common stock dividends (920) (920) Notes receivable from officers 104 104 Net income 5,080 5,080 ----------------------------------------------------------------------------------------- Balance at December 31, 1996 9,683,340 97 1,442 10,841 (100) (101) 12,179 Exercise of stock options 120,910 1 162 163 Common stock dividends (1,127) (1,127) Purchase of treasury stock (5,250) (38) (38) Notes receivable from officers and employees (63) (63) Net income 7,652 7,652 ----------------------------------------------------------------------------------------- Balance at December 31, 1997 9,799,000 98 1,604 17,366 (138) (164) 18,766 Exercise of stock options 114,166 1 212 213 Common stock dividends (1,334) (1,334) Conversion of preferred stock to common stock 19,600 Notes receivable from officers and employees (86) (86) Net income 11,924 11,924 ----------------------------------------------------------------------------------------- Balance at December 31, 1998 9,932,766 $ 99 $ 1,816 $ 27,956 $ (138) $ (250) $ 29,483 ========================================================================================= The accompanying notes are an integral part of the consolidated financial statements.
F-5
MICROFINANCIAL INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) For the year ended December 31, ------------------------------- 1996 1997 1998 Cash flows from operating activities: Cash received from customers $ 87,130 $ 118,444 $ 139,215 Cash paid to suppliers and employees (16,708) (29,113) (31,993) Interest paid (10,724) (12,334) (11,648) Interest received 406 396 399 -------------------------------- Net cash provided by operating activities 60,104 77,393 95,973 -------------------------------- Cash flows from investing activities: Investment in leased equipment (81,303) (71,943) (83,786) Investment in direct costs (2,186) (2,354) (4,070) Investment in service contracts (2,431) (2,972) (8,080) Investment in loans receivable 0 (2,538) (11,683) Investment in fixed assets (628) (288) (459) Issuance of notes from officers and employees 0 (150) (145) Repayment of notes from officers 104 87 59 Investment in notes receivable (349) (160) (228) Repayment of notes receivable 111 191 281 -------------------------------- Net cash used in investing activities (86,682) (80,127) (108,111) -------------------------------- Cash flows from financing activities: Proceeds from secured debt 181,006 56,639 96,817 Repayment of secured debt (29,946) (56,194) (83,135) Proceeds from refinancing of secured debt 0 203,580 343,499 Prepayment of secured debt (129,049) (203,580) (343,499) Proceeds from short term demand notes payable 123 497 280 Repayment of short term demand notes payable (833) (315) (369) Proceeds from issuance of subordinated debt 15,410 2,123 1,200 Repayment of subordinated debt (1,740) (2,891) (3,261) Proceeds from exercise of common stock options 4 162 162 Repayment of capital leases (393) (697) (709) Purchase of treasury stock 0 (38) 0 Payment of dividends (871) (1,075) (1,282) --------------------------------- Net cash provided by (used in) financing activities 33,711 (1,789) 9,703 --------------------------------- Net increase (decrease) in cash and cash equivalents: 7,133 (4,523) (2,435) Cash and cash equivalents, beginning of period: 6,642 13,775 9,252 ================================= Cash and cash equivalents, end of period: $ 13,775 $ 9,252 $ 6,817 ================================= F-6 MICROFINANCIAL INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Continued) For the year ended December 31, ------------------------------- 1996 1997 1998 Reconciliation of net income to net cash provided by operating activities: Net Income $ 5,080 $ 7,652 $ 11,924 Adjustments to reconcile net income to cash provided by operating activities Depreciation and amortization 2,981 3,787 5,076 Provision for credit losses 19,822 21,713 19,075 Recovery of equipment cost and residual value, net of revenue recognized 29,378 41,334 51,271 Increase (decrease) in current taxes (379) (1,266) 1,285 Increase in deferred income taxes 1,892 4,897 7,585 Change in assets and liabilities: Decrease (increase) in other assets (603) (173) (809) (Decrease) increase in accounts payable 711 65 60 Increase (decrease) in accrued liabilities 1,222 (616) 506 ================================= Net cash provided by operating activities $ 60,104 $ 77,393 $ 95,973 ================================= Cash paid for income taxes $ 1,954 $ 2,254 $ 146 ================================= Supplemental disclosure of noncash activities: Property acquired under capital leases $ 985 $ 246 $ 412 Accrual of common stock dividends $ 242 $ 294 $ 346 The accompanying notes are an integral part of the consolidated financial statements. F-7
MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands) 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 leases and rents "microticket" equipment and provides other financing services in amounts generally ranging from $900 to $2,500, with an average amount financed of approximately $1,400 and an average lease term of 45 months. The Company does not market its services directly to lessees but sources leasing transactions through a network of independent sales organizations and other dealer-based origination networks nationwide. The Company funds its operations primarily through borrowings under its credit facilities, issuances of subordinated debt and securitizations. One dealer accounted for 11.6% of originations in the year ended December 31, 1998. In July 1998, the Company changed its name from Boyle Leasing Technologies, Inc. to MicroFinancial Incorporated. In December 1992, May 1993 and November 1994, Leasecomm Corporation created wholly-owned subsidiaries, BLT Finance Corporation I ("BLT I"), BLT Finance Corporation II ("BLT II") and BLT Finance Corporation III ("BLT III"), respectively, which are special purpose corporations for the securitization and financing of lease receivables. In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS No. 125"). SFAS No. 125 is effective for transactions entered into after December 31, 1996. Under SFAS No. 125, an entity will recognize the financial and servicing assets it controls and the liabilities it has incurred, derecognize financial assets when control has been surrendered and derecognize liabilities when extinguished. Effective January 1997, the Company adopted SFAS No. 125. While the Company generally does not sell its interests in leases, service contracts or loans to third parties after origination, the Company does, however, from time to time, contribute certain leases to special purpose corporations for purposes of obtaining financing in connection with its lease receivables. As these transfers do not result in a change in control over the lease receivables, sale treatment and related gain recognition under SFAS No. 125 does not occur. Accordingly, the lease receivable and related liability remain on the balance sheet. If SFAS No. 125 were effective for transactions prior to 1997, there would have been no change in the accounting for these financing transactions. During 1997 and 1996, the credit facilities related to the securitizations of BLT I and BLT II were paid off, respectively. Both of these subsidiaries were dissolved on December 31, 1997. B. Summary of Significant Accounting Policies Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. F-8 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) Stock Splits On June 16, 1997, the Company's Board of Directors authorized a ten-for-one stock split. This resulted in the issuance of 4,432,824 additional shares of common stock. On June 12, 1998, the Company's Board of Directors authorized a two-for-one stock split to be effective with the Company's initial public offering. All share and per share amounts have been restated to reflect these stock splits. The two-for-one stock split resulted in the issuance of 5,047,478 additional shares of common stock including the automatic conversion of 490 shares of preferred stock to 19,600 shares of common stock. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reported period. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid instruments purchased with initial maturities of less than three months to be cash equivalents. Cash equivalents consist principally of overnight investments. Leases and Loans 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 which results in a level rate of return on the net investment in leases. Amortization of unearned lease income and initial direct costs is suspended if, in the opinion of management, the lease agreement is determined to be impaired. It is management's opinion given the nature of its business and the large number of small balance lease receivables that a lease is impaired 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 past due. It is also management's policy to maintain an allowance for credit losses that will be sufficient to provide adequate protection against losses in its portfolio. Management regularly reviews the collectibility of its lease receivables based upon all of its communications with the individual lessees through its extensive collection efforts and through further review of the creditworthiness of the lessee. 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. An impairment is recognized when expected cash flows to be realized subsequent to the end of the lease are expected to be less than the residual value recorded. Other revenues such as loss and damage waiver and service fees relating to the leases, contracts and loans and rental revenues are recognized as they are earned. Loans are reported at their outstanding principal balance. Interest income on loans is recognized as it is earned. F-9 MICROFINANCIAL INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, except per share data) (Continued) 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 future 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. Investment in Service Contracts 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. Property and Equipment Rental equipment is recorded at estimated residual value and depreciated using the straight-line method over a period of twelve months. Office furniture, equipment and capital leases are recorded at cost and depreciated using the straight-line method over a period of three to five years. Leasehold improvements are amortized over the shorter of the life of the lease or the asset. Upon retirement or other disposition, the cost and related accumulated depreciation of the assets are removed from the accounts and the resulting gain or loss is reflected in income. Fair Value of Financial Instruments For financial instruments including cash and cash equivalents, investments in financing leases and loans, accounts payable, and accrued expenses, it is assumed that the carrying amount approximates fair value due to their short maturity. F-10 MICROFINANCIAL INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, except per share data) (Continued) Interest-Rate Hedging Agreements The Company enters into interest-rate hedging agreements to hedge against potential increases in interest rates on the Company's outstanding borrowings. The Company's policy is to accrue amounts receivable or payable under such agreements as reductions or increases in interest expense, respectively. Debt Issue Costs Debt issuance costs incurred in securing credit facility financing are capitalized and subsequently amortized over the term of the credit facility. Income Taxes Deferred income taxes are determined under the liability method. Differences between the financial statement and tax bases af assets and liabilities are measured using the currently enacted tax rates expected to be in effect when these differences reverse. Deferred tax expense is the result of changes in the liability for deferred taxes. The principal differences between assets and liabilities for financial statement and tax return purposes are the treatment of leased assets, accumulated depreciation and provisions for doubtful accounts. The deferred tax liability is reduced by loss carryforwards and alternative minimum tax credits available to reduce future income taxes. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement requires that changes in comprehensive income be shown in a financial statement that is displayed with the same prominence as other financial statements. The statement is effective for fiscal years beginning after December 15, 1997 and the Company has adopted its provisions in 1998. The Company has evaluated the impact this statement will have on its financial statements and determined that no additional disclosure is required. In March 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, "Internal Use Software," ("SOP 98-1") which provides guidance on the accounting for the costs of software developed or obtained for internal use. SOP 98-1 is effective for fiscal years beginning after December 15, 1998. The Company does not expect the statement to have a material impact on its financial position or results of operations. F-11 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data (Continued) In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting standards for derivative instruments and requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. SFAS No. 133 is effective for companies with fiscal years beginning after June 15, 1999 and the Company will adopt its provisions in 2000. The Company has not yet evaluated the impact this statement will have on its financial position or results of operations. Reclassification of Prior Year Balances Certain reclassifications have been made to prior years' consolidated financial statements to conform to the current presentation. Net Income Per Common Share The Company has adopted Statement of Financial Accounting Standard No. 128, "Earnings Per Share," ("SFAS No. 128") which specifies the computation, presentation and disclosure requirements for net income per common share. Basic net income per common share is computed based on the weighted average number of common shares outstanding during the period, adjusted for a 10-to-1 stock split effected in 1997 and a 2-to-1 stock split which became effective with the Company's initial public offering on February 5, 1999, each as described in Note H. Dilutive net income per common share gives effect to all dilutive potential common shares outstanding during the period. Under SFAS No. 128, the computation of diluted earnings per share does not assume the issuance of common shares that have an antidilutive effect on net income per common share.
For the year ended December 31, --------------------------------------------------- 1996 1997 1998 --------------------------------------------------- Net income $ 5,080 $ 7,652 $ 11,924 --------------------------------------------------- Shares used in computation: Weighted average common shares outstanding used in computation of net income per common share 9,682,851 9,793,140 9,859,127 Dilutive effect of redeemable convertible preferred stock 39,200 19,600 19,600 Dilutive effect of common stock options 48,562 112,589 153,248 --------------------------------------------------- Shares used in computation of net income per common share - assuming dilution 9,770,613 9,925,329 10,031,975 =================================================== Net income per common share $ 0.52 $ 0.78 $ 1.21 =================================================== Net income per common share - assuming dilution $ 0.52 $ 0.76 $ 1.19 ===================================================
F-12 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) C. Leases and Loans At December 31, 1998, future minimum payments on the Company's lease receivables are as follows: For the year ended December 31, 1999 ............................. $117,315 2000 ............................. 75,220 2001 ............................. 44,229 2002 ............................. 13,633 2003 ............................. 600 Thereafter ........................ 63 ======== Total ........................... $251,060 ======== At December 31, 1998, the weighted average remaining life of leases in the Company's lease portfolio is approximately 45 months and the implicit rate of interest is approximately 35%. The Company's business is characterized by a high incidence of delinquencies which in turn may lead to significant levels of defaults. The Company evaluates the collectibility of leases and loans based on the level of recourse provided, if any, delinquency statistics, historical lease experience, current economic conditions and other relevant factors. The Company provides an allowance for credit losses for leases which are considered impaired. The Company historically took charge-offs against its receivables when such receivables were 360 days past due. During this period, cumulative net charge-offs after recoveries from the Company's inception to December 31, 1998 have totaled 7.8% of total cumulative receivables plus total billed fees over such period. In September and October 1996, the Company reduced the time period for charging off its non-securitized receivables from 360 to 240 days and, as a result, increased its charge-offs by a total of approximately $5.0 million. As a result of this change, recoveries increased significantly, indicating that a 240-day charge-off period was too early in the collection process to determine ultimate collectibility. As such, during 1997 net charge-offs after recoveries were not significantly different than the Company's historical net charge-off experience. For this reason, in January 1998, the Company changed its charge-off policy for its receivables back to 360 days to better reflect the Company's collection experience. The following table sets forth the Company's allowance for credit losses as of December 31, 1995, 1996, 1997 and 1998 and the related provisions, charge-offs and recoveries for the years ended December 31, 1996, 1997 and 1998. Balance at December 31, 1995...................... $15,952 Provision for credit losses ...................... 19,822 Charge-offs ...................................... 15,675 Recoveries........................................ 3,727 -------- Charge-offs, net of recoveries................... 11,948 ------ Balance at December 31, 1996...................... $23,826 Provision for credit losses....................... 21,713 Charge-offs....................................... 24,290 Recoveries........................................ 5,070 -------- Charge-offs, net of recoveries................... 19,220 ------- F-13 Balance at December 31, 1997...................... $26,319 Provision for credit losses....................... 19,075 Charge-offs....................................... 28,750 Recoveries........................................ 8,206 -------- Charge-offs, net of recoveries................... 20,544 ------- Balance at December 31, 1998...................... $24,850 ======= 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. The following table sets forth the Company's estimated residual value as of December 31, 1995, 1996, 1997 and 1998 and changes in the Company's estimated residual value as a result of new originations, and lease terminations for the years ended December 31, 1996, 1997 and 1998. Balance of Estimated Residual Value at December 31, 1995... $10,967 New Originations........................................... 6,335 Lease Terminations......................................... (2,600) Balance of Estimated Residual Value at December 31, 1996... $14,702 New Originations........................................... 6,056 Lease Terminations......................................... (3,974) Balance of Estimated Residual Value at December 31, 1997... $16,784 New Originations........................................... 6,424 Lease Terminations......................................... (5,646) Balance of Estimated Residual Value at December 31, 1998... $17,562 F-14 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) New originations represent the residual value added to the Company's estimated residual value upon origination of new leases. Lease terminations represent the residual value deducted from the Company's estimated residual value upon the termination of a lease (i) that is bought out during or at the end of the lease term; (ii) upon expiration of the original lease term when the lease converts to an extended rental contract and (iii) that has been charged off by the Company. D. Property and Equipment At December 31, 1997 and 1998, property and equipment consisted of the following: December 31, ---------------------- 1997 1998 Rental Equipment.................................... $ 5,588 $ 9,676 Computer Equipment.................................. 2,998 2,821 Office Equipment.................................... 634 968 Leasehold improvements.............................. 224 218 ---------------------- 9,444 13,683 Less accumulated depreciation and amortization....... 5,179 6,936 ---------------------- Total................................................ $ 4,265 $ 6,747 ====================== Depreciation and amortization expense totaled $2,981,000, $3,787,000 and $5,076,000 for the years ended December 31, 1996, 1997 and 1998, respectively. At December 31, 1997 and 1998, computer equipment includes $2,339,000 and $2,141,000 respectively, under capital leases. Accumulated amortization related to capital leases amounted to $1,306,000 and $1,393,000, respectively. At December 31, 1997 and 1998, accumulated depreciation related to rental equipment amounted to $3,060,000 and $4,408,000, respectively. E. Notes Payable Notes Payable The Company has a revolving line of credit and term loan facility with a group of financial institutions whereby it may borrow a maximum of $105,000,000 based upon qualified lease receivables. Outstanding borrowings with respect to the revolving line of credit bear interest based either at Prime for Prime Rate loans or London Interbank Offered Rate (LIBOR) plus 1.85% for LIBOR Loans. If the LIBOR loans are not renewed upon their maturity then they automatically convert into prime rate loans. The prime rates at December 31, 1996, 1997 and 1998 were 8.25%, 8.50% and 7.75% respectively. The 90-day LIBOR at December 31, 1996, 1997 and 1998 were 5.76%, 5.91% and 5.28% respectively. F-15 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) At December 31, 1998, the Company had borrowings outstanding under the agreement with the following terms: Type Rate Amount Prime.......................... 7.7500% $572 LIBOR.......................... 7.4068% 15,000 LIBOR.......................... 7.3939% 20,000 Fixed.......................... 7.7500% 3,709 ---------- Total Outstanding $39,281 ========== At December 31, 1997, the Company had borrowings outstanding under the agreement with the following terms: Type Rate Amount Prime.......................... 8.5000% $6,634 LIBOR.......................... 7.7250% 12,000 Fixed.......................... 8.3000% 5,798 Fixed.......................... 7.7500% 9,273 ---------- Total Outstanding $33,705 ========== Outstanding borrowings are collateralized by leases and service contracts pledged specifically to the financial institutions. All balances under the revolving line of credit will be automatically converted to a term loan on July 31, 1999 provided the line of credit is not renewed and no event of default exists at that date. All converted term loans are repayable over the term of the underlying leases, but not in any event to exceed 48 monthly installments. The most restrictive covenants of the agreement have minimum net worth and income requirements and limit payment of dividends to no more than 50% of consolidated net income, as defined, for the immediately preceding fiscal year. F-16 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) The Company has an additional revolving credit agreement and term loan with a group of financial institutions whereby it may borrow up to a maximum of $35,000,000 based on eligible lease receivables. Outstanding borrowings with respect to the revolving line of credit bear interest based either at prime for prime rate loans or LIBOR plus 1.85% for LIBOR Loans. If the LIBOR loans are not renewed upon their maturity then they automatically convert into prime rate loans. At December 31, 1998, the Company had borrowings outstanding under the agreement with the following terms: Type Rate Amount Prime.......................... 7.7500% $5,943 LIBOR.......................... 7.1938% 10,001 LIBOR.......................... 7.4103% 7,499 ---------- Total Outstanding $23,443 ========== At December 31, 1997, the Company had borrowings outstanding under the agreement with the following terms: Type Rate Amount Prime.......................... 8.5000% $2,816 LIBOR.......................... 7.5688% 17,500 LIBOR.......................... 8.4375% 5,000 LIBOR.......................... 7.6273% 3,000 Fixed.......................... 8.3000% 68 Fixed.......................... 7.7500% 797 ---------- Total Outstanding $29,181 ========== F-17 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) Outstanding borrowings are collateralized by leases and service contracts pledged specifically to the financial institutions. All balances under the revolving line of credit will be automatically converted to a term loan on July 31, 1999 provided the line of credit is not renewed and no event of default exists at that date. All converted term loans are repayable over the term of the underlying leases, but not in any event to exceed 24 monthly installments. The most restrictive covenants of the agreement have minimum net worth and income requirements and limit payment of dividends to no more than 50% of consolidated net income, as defined, for the immediately preceding fiscal year. BLT III has five series of notes, the 1994-A Notes, the 1996-A Notes and the 1997-A Notes the 1998-A Notes and the Warehouse Notes. In November 1994, BLT III issued the 1994-A Notes in aggregate principal amount of $18,885,000. In May 1996, BLT III issued the 1996-A Notes in aggregate principal amount of $23,406,563. In August 1997, BLT III issued the 1997-A Notes in aggregate principal amount of $44,763,000 and in November 1998, BLT III issued the 1998-A Notes in aggregate principal amount of $40,769,000. Pursuant to the Master Financing Indenture the Company may issue one additional series of Term Notes, the warehouse notes, with a maximum principal amount of $20,000,000. The warehouse notes expired in August of 1997, at which time they were converted to BLT III 1997-A Notes. At December 31, 1998, BLT III had borrowings outstanding under the three series of notes with the following terms: Note Series Expiration Rate Amount 1996-A Notes.................. 5/16/00 6.6900% $ 4,752 1997-A Notes.................. 1/16/00 6.4200% 23,944 1998-A Notes.................. 5/17/04 6.0300% 38,703 ========== Total $ 67,399 ========== At December 31, 1997, BLT III had borrowings outstanding under the three series of notes with the following terms: Note Series Expiration Rate Amount 1994-A Notes................. 12/16/98 7.33% $ 721 1996-A Notes................. 5/16/00 6.69% 13,214 1997-A Notes................. 1/16/00 6.42% 39,620 ========= Total $ 53,555 ========= F-18 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) Outstanding borrowings are collateralized by a specific pool of lease receivables. At December 31, 1997 and 1998, the Company also had other notes payable which totaled $389,000 and $298,000, respectively. The notes are due on demand and bear interest at a rate of prime less 1.00%. Other notes payable include amounts due to stockholders of the Company at December 31, 1997 and 1998 of $197,000 and $248,000, respectively. Interest paid to Stockholders under such notes was not material for the years ended December 31, 1996, 1997 and 1998. Subordinated Notes Payable At December 31, 1997 and 1998, the Company also has senior subordinated and subordinated debt outstanding amounting to $26,382,000 and $24,421,000 net of unamortized discounts of $213,000 and $113,000, respectively. This debt is subordinated in the rights to the Company's assets to notes payable to the primary lenders as described above. Outstanding borrowings bear interest ranging from 8.5% to 14% for fixed rate financing and prime plus 3% to 4% for variable rate financing. These notes have maturity dates ranging from January 1998 to October 2003. The Company has three senior subordinated notes. The first was issued in August 1994 at 12% to a financial institution with an aggregate principal amount of $7,500,000. Cash proceeds from this note were $6,743,108, net of a discount of $756,892 which is being amortized over the life of the note. This senior note requires annual payments of $1,500,000 commencing on July 15, 1997 until the note matures in July 2001. The second senior subordinated note was issued in October 1996 at 12.25% to a financial institution with an aggregate principal amount of $5,000,000. This senior note requires monthly payments of (i)$125,000 for the period November 1, 1998 through October 1, 2000 and (ii) $166,667 for the period November 1, 2000 until the note matures in October 1, 2001. The third senior subordinated note was issued in October 1996 at 12.60% to a financial institution with an aggregate principal amount of $5,000,000. This senior note requires quarterly payments of $250,000 commencing on March 15, 1999 until the note matures in October 2003. The most restrictive covenants of the senior subordinated note agreements have minimum net worth and interest coverage ratio requirements and restrictions on payment of dividends. At December 31, 1998 subordinated notes payable include $3,697,000 due to shareholders. Interest paid to shareholders under such notes, at rates ranging between 8% and 14%, amounted to $183,000, $472,000 and $488,000 for the years ended December 31, 1996, 1997 and 1998, respectively. F-19 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) At December 31, 1998, the repayment schedule, assuming conversion of the revolving line of credit to a term loan, for outstanding notes and subordinated notes is as follows: Repayment Schedule For the year ended December 31, ------------------ 1999........................................ $ 62,295 2000........................................ 49,340 2001........................................ 29,614 2002........................................ 11,295 2003........................................ 2,411 Thereafter.................................. 0 ----------- 154,955 Unamortized discount on senior subordinated debt......................... (113) ----------- Total....................................... $ 154,842 =========== It is estimated that the carrying amounts of the Company's borrowings under its variable rate revolving credit agreements approximate their fair value. The fair value of the Company's short-term and long-term fixed rate borrowings is estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. At December 31, 1997 and 1998, the aggregate carrying value of the Company's fixed rate borrowings was approximately $96,900,000 and $95,500,000, respectively, with an estimated fair value of approximately $92,900,000 and $96,000,000, respectively. F. Notes Receivable from Officers and Employees During 1997 and 1998, the Company issued notes to certain officers and employees in connection with the exercise of common stock options amounting to $150,000 and $144,000 respectively, in exchange for recourse loans with fixed maturity dates prior to the expiration date of the original grant. The notes are non- interest bearing unless the principal amount thereof is not paid in full when due, at which time interest accrues and is payable at a rate per annum equal to the prime rate plus 4.0%. The notes can be repaid from the application of dividends paid on the common stock but in all cases are to be paid in full at the maturity date or upon the employee leaving the Company. At December 31, 1997 and 1998, notes receivable outstanding from officers and employees were $164,000 and $250,000, respectively. F-20 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) G. Redeemable Preferred Stock: At December 1997 and 1998, the Company had authorized 88,231 shares of convertible preferred stock ("preferred stock") with a par value of $1.00, of which 490 shares of the Series C Convertible Preferred Stock were issued and outstanding, respectively, at December 31, 1997 and 1998. Shares of preferred stock are convertible into shares of common stock at the option of the holder according to a conversion formula (which would currently result in a one-for-forty exchange) with mandatory conversion upon the completion of a public offering meeting certain minimum proceeds, as defined. Holders of the preferred stock are entitled to an annual cumulative dividend of $.765 per share, if and when declared. The holder of the preferred stock has a liquidation preference of $25.50 for preferred stock, plus earned and unpaid dividends. In addition, the preferred shareholder is entitled to vote as a class, proportional to the number of common shares into which his preferred shares are convertible. Upon completion of the Company's initial public offering on February 5, 1999, the 490 preferred shares were automatically converted to 19,600 common shares. H. Stockholders' Equity: Common Stock The Company had 10,000,000 and 25,000,000 authorized shares of common stock with a par value of $.01 per share of which 9,799,000 and 9,932,766 shares (giving effect to the two stock splits referred to below) were issued and outstanding at December 31, 1997 and 1998, respectively. Treasury Stock The Company had 142,590 shares of common stock in treasury at December 31, 1997 and 1998, and 490 shares of preferred stock in treasury at December 31, 1997 and 1998. F-21 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) H. Stockholders' Equity (Continued): Stock Options In 1987, the Company adopted its 1987 Stock Option Plan (the "Plan") which provided for the issuance of qualified or nonqualified options to purchase shares of the Company's common stock. In 1997, the Company's Board of Directors approved an amendment to the Plan, as a result of the stock split. Pursuant to this amendment, the aggregate number of shares issued shall not exceed 1,220,000 and the exercise price of any outstanding options issued pursuant to the Plan shall be reduced by a factor of ten and the number of outstanding options issued pursuant to the Plan shall be increased by a factor of ten. The Company adopted the 1998 Equity Incentive Plan (the "1998 Plan") on July 9, 1998. The 1998 Plan permits the Compensation Committee of the Company's Board of Directors to make various long-term incentive awards, generally equity-based, to eligible persons. The company intends to reserve 2,000,000 shares of the Company's common stock for issuance pursuant to the 1998 Plan. Qualified stock options, which are intended to qualify as "incentive stock options" under the Internal Revenue Code, may be issued to employees at an exercise price per share not less than the fair value of the common stock at the date granted as determined by the Board of Directors. Nonqualified stock options may be issued to officers, employees and directors of the Company as well as consultants and agents of the Company at an exercise price per share not less than fifty percent of the fair value of the common stock at the date of grant as determined by the Board. The vesting periods and expiration dates of the grants are determined by the Board of Directors. The option period may not exceed ten years. The following summarizes the stock option activity:
Weighted Average Shares Price Per Share Exercise Price ---------------- -------------------------- -------------------- Outstanding at December 31, 1994 1,466,680 $0.10625 to $0.6375 $ 0.275 Exercised (1,399,400) $0.10625 to $0.6375 $ 0.260 Granted 320,000 $0.6375 to $1.95 $ 1.910 Outstanding at December 31, 1995 387,280 $0.6375 to $1.95 $ 1.690 Exercised (5,620) $0.6375 $ 0.6375 Outstanding at December 31, 1996 381,660 $0.6375 to $1.95 $ 1.705 Exercised (120,910) $0.6375 to $1.95 $ 0.975 Canceled (9,750) $1.95 $ 1.950 Outstanding at December 31, 1997 251,000 $0.6375 to $1.95 $ 1.870 Exercised (114,166) $0.6375 to $1.95 $ 1.859 Canceled (16,454) $1.95 $ 1.950 Outstanding at December 31, 1998 120,380 $0.6375 to $1.95 $ 1.866
The options vest over five years and are exercisable only after they become fully vested. At December 31, 1997 and 1998, 65,988 and 6,682 of the outstanding options were fully vested. At December 31, 1997 and 1998, 270,000 and 139,980 shares of common stock were reserved for conversion of redeemable convertible preferred stock and common stock option exercises. F-22 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) H. Stockholders' Equity (Continued): Stock Options (Continued): Information relating to stock options at December 31, 1998, summarized by exercise price is as follows: Outstanding Exercisable - ------------------------------------------------- ---------------------------- Weighted Weighted Average Average Exercise Price Shares Life (Years) Exercise Price Shares - ------------------------------------------------- ---------------------------- $ 0.6375 7,698 2.7 $ 0.6375 0 $ 1.95 112,682 4.0 $ 1.95 6,682 ------- ------ $0.6375 to $1.95 120,380 3.9 $ 1.866 6,682 ======= ====== All stock options issued to 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. Effective for fiscal 1996, the Company adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS No. 123"). SFAS No. 123 requires that compensation under a fair value method be determined using a Black-Scholes option pricing model and disclosed in a pro forma effect on earnings and earnings per share. Had compensation cost for stock based compensation been determined based on the fair value at the grant dates consistent with the method of SFAS No. 123, the Company's pro forma net income applicable to common stock for the years ended December 31, 1996, 1997 and 1998 would have been $5,072,000, $7,644,000 and $11,918,000, respectively. Pro forma net income per common share would not have been different than net income per common share as reported. The fair value of option grants is estimated on the date of grant utilizing the Black-Scholes option-pricing model with the following weighted average assumptions for grants in 1995: an expected life of the options of seven years, a risk-free interest rate of approximately 5.5%, a dividend yield of 4%, and no volatility. The weighted average fair value at date of grant for options granted during 1995 approximated $.27 per option. There were no options granted in 1996, 1997 or 1998. F-23 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) I. Income Taxes The provision for income taxes consists of the following: For the years ended December 31, -------------------------------------------------- 1996 1997 1998 Current: Federal 1,556 898 500 State 18 91 125 -------------------------------------------------- 1,574 989 625 -------------------------------------------------- Deferred: Federal 1,100 3,703 6,447 State 792 1,194 1,138 -------------------------------------------------- 1,892 4,897 7,585 -------------------------------------------------- Total 3,466 5,886 8,210 ================================================== At December 31, 1997 and 1998, the components of the net deferred tax liability were as follows: 1997 1998 ------------------------------- Investment in leases, other than allowance 64,405 35,257 Allowance for credit losses (108) (986) Operating lease depreciation (45,001) (25,436) Debt issue costs 455 391 Other 1,947 13,549 Alternative minimum tax (3,983) (4,483) Loss carryforwards (6,746) 8,151 Deferred receivables 0 (7,889) ------------------------------- Total 10,969 18,554 =============================== F-24 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) The following is a reconciliation between the effective income tax rate and the applicable statutory federal income tax rate: For the years ended December 31, ------------------------------------ 1996 1997 1998 Federal statutory rate 34.0% 34.0% 35.0% State income taxes, net of federal benefit 6.3% 6.7% 5.7% Nondeductible expenses and other 0.3% 2.8% 0.1% ------------------------------------ Effective income tax rate 40.6% 43.5% 40.8% ==================================== At December 31, 1998, the Company had loss carryforwards of approximately $19,800,000 which may be used to offset future income. These loss carryforwards are available indefinitely for use against future income until they expire between the years 2015 and 2017. J. Commitments and Contingencies The Company's lease for its facility in Waltham, Massachusetts expires in 1999. This lease contains one five-year renewal option with escalation clauses for increases in the lessor's operating costs. The Company's lease for its facilities in Newark, California expires in 2001. The Company signed a lease for 44,659 square feet of office space in Woburn, Massachusetts which commenced on December 15, 1998 and expires on December 14, 2003. The monthly rent under this lease is $57,000. F-25 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) The Company has entered into various operating lease agreements ranging from three to four years for additional office equipment. At December 31, 1998, the future minimum lease payments under noncancelable operating leases with remaining terms in excess of one year are as follows: For the year ended December 31, ------------------- 1999.................................... $ 1,252 2000.................................... 738 2001.................................... 727 2002.................................... 685 Thereafter.............................. 628 ========== Total................................... $ 4,030 ========== Rental expense under operating leases totaled $788,000, $991,000, and $1,131,000 for the years ended December 31, 1996, 1997 and 1998, respectively. The Company has entered into various capital lease agreements ranging from three to four years for office equipment, computer equipment and telecommunication systems. At December 31, 1998 future minimum lease payments under capital leases were as follows: For the year ended December 31, ------------------- 1999..................................... $ 550 2000..................................... 209 2001..................................... 67 2002..................................... 0 ---------- Total minimum lease payments............. 826 Less amounts representing interest....... (52) ========= Total................................... $ 774 ========== The Company and its subsidiaries are frequent parties to various claims, lawsuits and administrative proceedings arising in the ordinary course of business. Although the outcome of these lawsuits cannot be predicted with certainty, the Company does not expect such matters to have a material effect on the financial condition or results of operations of the Company. K. Employee Benefit Plan: The Company has a defined contribution plan under Section 401 (k) of the Internal Revenue Code to provide retirement and profit sharing benefits covering substantially all full-time employees. Employees are eligible to contribute up to 15% of their gross salary. The Company will contribute $.50 for every $1.00 contributed by an employee up to 3% of the employee's salary. Vesting in the Company contributions is over a five-year period based upon 20% per year. The Company's contribution to the defined contribution plan were $72,000, $106,000 and $134,000 for the years ended December 31, 1996, 1997 and 1998. F-26 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) L. Interest Rate Swap The Company is exposed to market risks brought on by changes in interest rates. Derivative financial instruments are used by the Company to reduce those risks, as explained in this note. (a) Notional amounts and credit exposures of derivatives The notional amount of derivatives, as summarized in section (b) below, do not represent amounts that are exchanged by the parties, and thus are not a measure of the Company's exposure. The amounts exchanged are calculated on the basis of the notional or contract amounts, as well as on other terms of the interest rate swap derivatives, and the volatility of these rates and prices. The Company would be exposed to credit-related losses in the event of nonperformance by the counterparties that issued the financial instruments. The Company does not expect the counterparty to interest rate swaps to fail to meet their obligations, given its high credit rating. The credit exposure of derivative contracts is represented by the positive fair value of contracts at the reporting date, reduced by the effects of the master netting agreement. The Company does not give or receive collateral on its interest rate swaps due to its own credit rating and that of its counterparty. (b) Interest Rate Risk Management Interest rate swap contracts involve the exchange by the Company with another party of their respective commitments to pay or receive interest, e.g., and exchange of floating rate payments for fixed rate payments with respect to a notional amount of principal. The Company has entered into this contract to reduce the impact of changes in interest rates on its floating rate debt. The Company has entered into this interest rate swap agreement only on a net basis, which means that the two payment streams are netted out, with the Company receiving or paying, as the case may be, only the net amount of the two payments. Interest rate swaps do not involve the delivery of securities, other underlying assets or principal. Accordingly, the risk of loss with respect to interest rate swaps is limited to the net amount of payments that the Company is contractually entitled to receive, if any. Interest rate swaps entered into by the Company may not be readily marketable. At December 31, 1998, the Company had outstanding one interest rate swap agreement with one of its banks, having a total notional principal amount of $17,500,000. The agreement effectively changes the Company's interest rate exposure on $17,500,000 of its floating rate $35,000,000 revolving line of credit due July 31, 1999 to a fixed 8.45%. The interest rate swap matures on July 10, 2000. The interest differential paid or received on the swap agreement is recognized as an adjustment to interest expense. Interest expense related to the swap was $78,000 and $177,000 for the years ended December 31, 1997 and 1998, respectively. At December 31, 1998, the fair market value of this interest rate swap, which represents the amount the Company would receive or pay to terminate the agreement, is a net payable of $458,000, based on dealer quotes. F-27 MICROFINANCIAL INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tables in thousands, except per share data) (Continued) The market risk exposure from the interest rate swap is assessed in light of the underlying interest rate exposures. Credit risk exposure from the swap is minimized as the agreement is with a major financial institution. The Company monitors the creditworthiness of this financial institution and full performance is anticipated. M. Concentration of Credit Risk The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of lease and loan receivables and cash and cash equivalent balances. To reduce the risk to the Company, stringent credit policies are followed in approving leases and loans, and lease pools are closely monitored by management. In addition, the cash and cash equivalents are maintained with several high quality financial institutions. One dealer accounted for approximately 11.6% of all originations during the year ended December 31, 1998. No other dealer accounted for more than 10% of the Company's origination volume during the years ended December 31, 1996, 1997, or 1998. N. Subsequent Events On February 5, 1999, the Company was admitted to the New York Stock Exchange following its initial public offering of 4 million shares at $15 per share, 600,000 of which were sold by existing stockholders. The Company's stock trades under the ticker symbol MFI. Total costs of $1,313,891 related to the initial public offering offset the proceeds of $51,000,000. On June 12, 1998, the Company's Board of Directors authorized a two-for-one stock split to be effective with the Company's initial public offering. All share and per share amounts have been restated to reflect this stock split. In conjunction with the Initial Public Offering in February 1999, the Board of Directors of the Company authorized 5,000,000 shares of preferred stock, none of which has been issued. Shares of such preferred stock may be issued from time to time in one or more series and with such designations, voting powers, preferences, and relative participating optional or other special rights, and qualifications, limitations, and restrictions on such rights as the Board of Directors may authorize. On January 27, 1999, the Company amended and restated both of its revolving lines of credit and term loan facilities, whereby it may borrow a maximum of $55,000,000 under each facility based upon qualified lease receivables. Outstanding borrowings with respect to the revolving line of credit bear interest based either at prime for prime rate loans or LIBOR plus 1.75% for LIBOR loans. Outstanding borrowings are collateralized by leases, service contracts, and installment finance contracts pledged specifically to the financial institutions. All balances under the revolving line of credit will be automatically converted to a term loan on July 31, 2000 and September 30, 2000, respectively, provided the line of credit is not renewed and no event of default exists at that date. All converted term loans are repayable over the term of the underlying leases, but not in any event to exceed 36 monthly installments. The most restrictive covenants of the agreement have minimum net worth and income requirements and limit payment of dividends to no more than 50% of consolidated net income, as defined, for the immediately preceding fiscal year. F-28 EX-27 3 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE DECEMBER 31, 1998 AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000827230 MICROFINANCIAL INCORPORATED 1 U.S. Dollars 12-MOS Dec-31-1998 Jan-01-1998 Dec-31-1998 1 6,817 0 209,534 24,850 0 0 13,683 6,936 210,254 0 154,842 0 0 99 29,730 210,254 0 76,500 0 25,137 0 19,075 12,154 20,134 8,210 0 0 0 0 11,924 1.21 1.19
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