10-K 1 b42274mfe10-k.txt MICROFINANCIAL CORPORATION 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, 2001 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. [X] Yes [ ] 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. [ ] 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 15, 2002, was approximately $60,520,500 As of March 15, 2002, 12,821,946 shares of the registrant's common stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement for the 2002 Special Meeting in lieu of the Annual Meeting of Stockholders (to be filed with the Securities and Exchange Commission on or before April 30, 2002) is incorporated by reference in Part III hereof. TABLE OF CONTENTS
Description Page Number PART I ............................................................................. 1 Item 1. Business..................................................................... 1 Item 2. Properties................................................................... 7 Item 3. Legal Proceedings............................................................ 7 Item 4. Submission of Matters to a Vote of Security Holders.......................... 10 PART II ............................................................................. 11 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........ 11 Item 6. Selected Financial Data...................................................... 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................. 15 Item 7a. Quantitative and Qualitative Disclosures about Market Risk................... 22 Item 8. Financial Statements and Supplementary Data, Including Selected Selected Quarterly Financial Data (Unaudited)............................ 23 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure....................................... 23 PART III ............................................................................. 24 Item 10. Directors and Executive Officers of the Registrant........................... 24 Item 11. Executive Compensation....................................................... 24 Item 12. Security Ownership of Certain Beneficial Owners and Management............... 24 Item 13. Certain Relationships and Related Transactions............................... 24 PART IV ............................................................................. 25 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............. 25 SIGNATURES ............................................................................. 29
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 $400 to $3,000, with an average amount financed of approximately $1,100 and an average lease term of 43 months. Leasecomm Corporation started originating leases in January 1986. The Company has used proprietary software in developing a sophisticated, risk-adjusted pricing model and in automating its credit approval and collection systems, including a fully-automated, Internet-based application, credit scoring and approval process. The Company provides financing to lessees which may have few other sources of credit. The Company primarily leases and rents low-priced commercial equipment 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 strip and combining this information with the amount of the sale entered via a POS terminal keypad, or POS software used on a personal computer to process a sale. 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 to small merchants. 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 contracts in certain other financing markets. The Company opportunistically seeks to enter various other financing markets. -1- The Company's residential financings include acquiring service contracts from Dealers that provide security monitoring services, primarily. The Company originates and services leases, contracts and loans in all 50 states of the United States and its territories. As of December 31, 2000 and 2001, leases in California, Florida, Texas, Massachusetts and New York accounted for approximately 44% and 42% of the Company's portfolio, respectively. Only California accounted for more than 10% of the total portfolio as of December 31, 2000 and 2001 at approximately 15% as of December 31, 2000 and 14% as of December 31, 2001. None of the remaining states accounted for more than 4% 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 the 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. Initial terms of the leases in the Company's portfolio generally range from 12 to 48 months, with an average initial term of 43 months as of December 31, 2001. 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 limited 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. -2- 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 either sell the equipment, or place it into its used equipment rental or leasing program. 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. DEALERS The Company provides financing to obligors under microticket leases, contracts and loans through its Dealers. The Company had over 1,100 different Dealers originating 79,840 Company leases, contracts and loans in 2001. One dealer accounted for approximately 14.7%, 10.6%, and 4.5% of all originations during the years ended December 31, 1999, 2000, and 2001, respectively. Another dealer accounted for approximately 10.1%, 3.8%, and 2.4% of all originations during the years ended December 31, 1999, 2000, and 2001, respectively. No other dealer accounted for more than 10% of the Company's origination volume during the years ended December 31, 1999, 2000, or 2001. 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. -3- The Company has used its proprietary software to develop a multidimensional 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 database and recognized commercial credit reporting agencies such as Dun & Bradstreet, Experian, 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 when 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 $6,000, the Company may go beyond its own data base and recognized commercial credit reporting agencies to 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. 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 credit quality and 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 poorly 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 often will purchase the leases once the -4- 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 has also completed the acquisition of six large POS authorization system lease and rental portfolios: two in 1996, one in 1998, one in 1999, one in 2000 and the acquisition of the rental and lease portfolio of Resource Leasing in 2001. The acquisition, completed in September of 1999, consisted of 2,148 leases with fundings of $3.2 million. The acquisition, completed in April of 2000, consisted of 7,085 rental contracts and 1,996 lease contracts, together totaling fundings of $5.5 million. On January 3, 2001, the Company acquired the rental and lease portfolio of Resource Leasing Corporation ("Resource") along with certain other assets. The acquisition consisted of 7,862 rental contracts and 326 lease contracts. 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, and generally with a lawsuit 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 when 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 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, -5- 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, 2001, the Company had 380 full-time employees, of whom 67 were engaged in the credit activities and Dealer service, 170 were engaged in servicing and collection activities, 20 were engaged in marketing activities, and 123 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. EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AGE POSITION ---- --- -------- Peter R. Bleyleben.......... 48 Chairman and Chief Executive Officer Richard F. Latour........... 48 President, Chief Operating Officer, Chief Financial Officer, Treasurer, Clerk and Secretary Mark S. Belinsky............ 40 Vice President, Marketing and Sales John Plumlee................ 50 Vice President, MIS Carol A. Salvo.............. 35 Vice President, Legal
Set forth below is a brief description of the business experience of the executive officers of the Company. 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. Dr. Bleyleben is also a Director of UpToDate in Medicine, Inc. and serves on the advisory board at GoldK. He earned an M.B.A. with distinction and honors from 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. 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. Mark S. Belinsky has served as Vice President, Sales and Marketing of the Company since June 2001. Prior to joining the Company, Mr. Belinsky was the Vice President of Marketing and Business Development for Iwant.com, an Internet-based Application Service Provider, which owns a patent for Online advertising technology, used by the Internet's top websites. -6- 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. AVAILABILITY OF INFORMATION The Company will provide without charge to each of its stockholders upon the written request of such person, a copy of the Company's Annual Report on Form 10K for its fiscal year ended December 31, 2001, including the financial statements and the financial statement schedules, required to be filed with the Securities and Exchange Commission. Requests for such document should be directed to Richard F. Latour, Clerk of MicroFinancial Incorporated, at 950 Winter Street, Waltham, Massachusetts 02451. ITEM 2. PROPERTIES The Company's corporate headquarters are located in leased space of 21,656 square feet at 950 Winter Street, Waltham, Massachusetts 02451. The lease for this space expires on July 31, 2004. The Company also leases 5,133 square feet of office space for its West Coast office in Newark, California, under a lease which expires on May 1, 2005. The Company also leases 44,659 square feet of office space in Woburn, Massachusetts, under a lease which expires on December 14, 2003. The Company's collection, credit, marketing, computer operations, and other administrative functions are located at the Woburn location. On January 3, 2001, the Company acquired certain assets and assumed certain liabilities of Resource including the assumption of Resource's lease on 15,399 square feet of office space in Herndon, Virginia which expires on May 31, 2005. ITEM 3. LEGAL PROCEEDINGS Management believes, after consultation with counsel, that the allegations against the Company included in the lawsuits described below are subject to substantial legal defenses, and the Company is vigorously defending each of the allegations. The Company also is subject to claims and suits arising in the ordinary course of business. At this time, it is not possible to estimate the ultimate loss or gain, if any, related to these lawsuits, nor if any such loss will have a material adverse effect on the Company's results of operations or financial position. A. The Company filed an action in the United States District Court for the District of Massachusetts against Sentinel Insurance Company, Ltd., ("Sentinel"), Premier Holidays International, Inc., ("Premier") and Daniel DelPiano ("DelPiano") arising from Premier's October, 1999, default on its repayment obligations to the Company under a Twelve Million Dollar ($12,000,000) loan. Judgment -7- has been entered in this case against Sentinel, which had issued a business performance insurance policy guaranteeing repayment of the loan, in the amount of Fourteen Million Dollars ($14,000,000). This judgment has not been satisfied. Sentinel is currently undergoing liquidation proceedings, and a claim in this amount has been filed with the bankruptcy court. As part of the Massachusetts litigation, Premier has asserted a counterclaim against the Company for Seven Hundred Sixty Nine Million Three Hundred Fifty Thousand dollars ($769,350,000) in actual and consequential damages, and for Five Hundred Million Dollars ($500,000,000) in punitive damages, plus interest, cost and attorney's fees. The counterclaim is based upon an alleged representation by the Company that it would lend Premier an additional Forty-Five Million Dollars ($45,000,000), when all documents evidencing the Premier loan refer only to the Twelve Million ($12,000,000) amount actually loaned and not repaid. The Company denies any liability on the counterclaim, which the Company is vigorously contesting. Because of the uncertainties inherent in litigation, the Company cannot predict whether the outcome will have a material adverse effect. B. On January 29, 2002, Leasecomm was served with an Amended Complaint ("Complaint") in an action entitled People v. Roma Computer Solutions, Inc., et al., Ventura County (California) Superior Court Case No. CIV207490. The Complaint asserts two claims, one for violation of the California Business Professions Code Section 17500 (false advertising), and the other for violation of the California Business and Professions Code Section 17200 (unfair or unlawful acts or practices). The claims arise from the marketing and selling activities of other defendants, including Roma Computer Solutions, Inc., and/or Maro Securities, Inc. The Complaint seeks to have Leasecomm held liable for the acts of other defendants, alleging that Leasecomm directly participated in those acts and received proceeds and the assignment of lease contracts as a result of those acts. The Complaint requests injunctive relief, rescission, restitution, and a civil penalty. No answer or motion has been filed. Because of the uncertainties inherent in litigation, the Company cannot predict whether the outcome will have a material adverse affect. C. On May 8, 2000, Plaintiff Efraim Bason brought an action in the Supreme Court of the State of New York, County of Nassau, seeking compensatory damages in the amount of $450,000 and punitive damages under various legal theories for Leasecomm's refusal to promptly release him from an equipment lease to which he claims his name was forged (the "Bason Complaint"). The Bason Complaint alleges that Leasecomm's failure to promptly release him from the lease, and subsequent negative reports to credit agencies, ruined his credit and prevented him from securing certain financing that he allegedly needed to purchase merchandise which he claims he could have then re-sold at a $450,000 profit. The Company has filed a motion for summary judgment, which Bason has opposed. The Court has not yet ruled on the motion. Because of the uncertainties inherent in litigation, the Company cannot predict whether the outcome will have a material adverse effect. D. On January 29, 2002, Leasecomm was served with an Amended Complaint ("Complaint") in an action entitled Rae Lynn Copitka v. Leasecomm Corp., et al., Travis County (Texas) District Court Case No. GN-102292. The Complaint asserts that the original action, filed mid-2001 by a single plaintiff should proceed as a class action. In the original action, Ms Copitka sought to rescind her finance lease with Leasecomm and to recover economic damages arising from prior payments under the lease. Ms Copitka alleges that her proposed class includes all persons in Texas who have executed Leasecomm finance leases for "virtual terminal" type credit card software during the years 1998, 1999, 2000, and 2001. Leasecomm intends to vigorously contest both the class certification and the substantive merits of -8- the lawsuit. No answer or motion has been filed. Because of the uncertainties inherent in litigation, the Company cannot predict whether the outcome will have a material adverse affect. E. On April 3, 2000, a purported class action suit was filed in Superior Court of the State of California, County of San Mateo against Leasecomm and MicroFinancial as well as a number of other defendants with whom Leasecomm and MicroFinancial are alleged to have done business, directly or indirectly. The complaint seeks certification of a subclass of those class members who entered into any lease agreement contracts with Leasecomm for the purposes of financing the goods or services allegedly purchased from other defendant entities. The class action complaint alleges multiple causes of action, including: fraud and deceit; negligent misrepresentation; unfair competition; false advertising; unjust enrichment; fraud in the inducement and the inception of contract; lack of consideration for contact; and breach of the contractual covenant of good faith and fair dealing. On February 1, 2002, the parties entered into stipulation of settlement to the class action litigation. The stipulation of settlement will be effective only if and when it is approved by the San Mateo Superior Court as fair and reasonable to the members of the plaintiff class and as a good faith settlement pursuant to Section 877.6 of the California Code of Civil Procedure. It is unclear at this point how long this process will take. F. On October 29, 2001, a purported class action suit was filed in Superior Court of the State of California, County of Orange against Leasecomm and MicroFinancial and another entity known as Prospecting Services of America, Inc. ("PSOA"). The plaintiffs purport to represent a class of customers who were allegedly solicited by PSOA to enter into leases with Leasecomm for the lease of a "virtual link point gateway" and "I-phone." Plaintiffs alleged that PSOA made numerous misrepresentations and omissions during the course of solicitation for which Leasecomm and MicroFinancial Incorporated should be responsible. On January 25, 2002, the trial court granted the motion of Leasecomm and MicroFinancial to stay the claims against them, on the grounds that the forum selection clause contained in the lease agreements required plaintiffs to litigate any claims against those entities in Massachusetts. In the event that this matter cannot be resolved, Leasecomm and MicroFinancial intend to vigorously defend the action. Because of the uncertainties inherent in litigation, the Company cannot predict whether the outcome will have a material adverse affect. G. On January 25, 2002, a purported class action suit was filed in Superior Court of the State of California, County of Los Angeles against Leasecomm. The complaint alleges that, two individuals were acting as agents of Leasecomm, and that they solicited plaintiff to enter into a lease agreement with Leasecomm. The complaint seeks declaratory and injunctive relief against all defendants based upon alleged violations of California law. The plaintiff purports to represent two subclasses comprised of: business entities who entered into commercial lease agreements with Leasecomm, all California residents who entered into lease agreements with Leasecomm for consumer goods. Leasecomm intends to vigorously defend the action. Because of the uncertainties inherent in litigation, the Company cannot predict whether the outcome will have a material adverse affect. Leasecomm has been served with Civil Investigative Demands by the Offices of the Attorney General for the states of Kansas, Illinois, and Florida, and for the Commonwealth of Massachusetts. Those Offices of the Attorney General, in conjunction with the Northwest Region Office of the Federal Trade Commission and the Offices of the Attorney General for Texas and North Dakota, have informed -9- Leasecomm that they are coordinating their investigations jointly. The investigations raise a number of issues concerning Leasecomm's vendors and Leasecomm's leases, covering without limitation, enforceability, noncancellability, unconscionability, forum selection, rights of rescission, lease termination provisions, electronic funds transfer, software license leases, leases of satellites and computers, billing and collection practices, and business opportunity seminars. Since the investigations are at an early stage, and no legal action has been commenced against Leasecomm, there can be no assurance as to the eventual outcome. 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, 2001. -10- 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."
By quarter 2000 2001 ---------------------------------------- ---------------------------------------- First Second Third Fourth First Second Third Fourth Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Stock Price High 12.38 10.75 10.13 11.75 14.00 17.00 16.75 14.00 Low 8.50 9.38 8.25 8.75 10.50 11.00 12.40 9.48
(b) Holders At March 15, 2002, there were approximately 33 stockholders of record of the Common Stock. (c) Dividends The Company paid the following quarterly cash dividends on the Common Stock.
Year ended Year ended December 31, 2000 December 31, 2001 ----------------- ----------------- First Quarter.......................... $0.040 $0.045 Second Quarter......................... $0.045 $0.050 Third Quarter.......................... $0.045 $0.050 Fourth Quarter......................... $0.045 $0.050
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. -11- (d) Recent Sales of Unregistered Securities Not applicable (e) Use of Proceeds from Registered Securities Not applicable -12- 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, ----------------------------------------------------------- 1997 1998 1999 2000 2001 ------ ------ ------ ------ ------ Income Statement Data: (Dollars in thousands, except per share data) Revenues Income on financing leases and loans.... $45,634 $47,341 $55,545 $69,847 $70,932 Income on service contracts (1)......... 501 2,565 6,349 8,687 8,665 Rental income........................... 10,809 16,118 21,582 27,638 37,664 Other income (2)........................ 16,506 18,248 24,802 33,305 36,830 ------ ------ ------ ------ ------ Total revenues.......................... 73,450 84,272 108,278 139,477 154,091 ------ ------ ------- ------- ------- Expenses: Selling, general and administrative..... 22,126 27,434 33,827 38,371 44,899 Provision for credit losses............. 21,713 (3) 19,075 37,836 (3) 38,912 54,092 Depreciation and amortization........... 3,787 5,076 7,597 10,227 14,378 Interest................................ 12,286 12,553 10,781 15,858 14,301 ------ ------ ------ ------ ------ Total expenses.......................... 59,912 64,138 90,041 103,368 127,670 ------ ------ ------ ------- ------- Income before provision for income taxes..... $13,538 $20,134 $18,237 $36,109 $26,421 ======= ======= ======= ======= ======= Net income................................... $ 7,652 $11,924 $10,728 $20,860 $16,317 ======= ======= ======= ======= ======= Net income per common share Basic (4)............................... $0.78 $1.21 $0.84 $1.64 $1.28 Diluted (5)............................. 0.76 1.19 0.83 1.63 1.26 Dividends per common share................... 0.12 0.14 0.16 0.18 0.20
December 31, ------------------------------------------------------------- 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- Balance Sheet Data: (Dollars in thousands) Gross investment in leases and loans (6)..... $258,230 $280,875 $362,721 $452,885 $438,723 Unearned income.............................. (73,060) (74,520) (100,815) (132,687) (104,538) Allowance for credit losses.................. (26,319) (24,850) (41,719) (40,924) (45,026) Investment in service contracts (1).......... 2,145 8,920 14,250 12,553 14,126 Total assets............................ 179,701 210,254 265,856 342,602 361,728 Notes payable................................ 116,830 130,421 144,871 201,991 203,053 Subordinated notes payable................... 26,382 24,421 9,238 4,785 3,262 Total liabilities....................... 160,935 180,771 187,018 246,579 251,172 Total stockholders' equity.............. 18,766 29,483 78,838 96,023 110,556
-13-
December 31, --------------------------------------------------------------- 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- Other Data: (Dollars in thousands, except statistical data) Operating Data: Total leases and loans originated (7)... $129,064 $153,819 $223,446 $236,763 $155,308 Total service contracts acquired (8).... 2,972 8,080 9,105 4,138 6,658 Total rental contracts originated....... 2,893 4,306 220 5,686 12,379 Dealer fundings (9)..................... 77,590 105,200 137,300 145,400 111,100 Average yield on leases and loans (10).. 33.9% 35.2% 36.8% 38.0% 38.1% Cash Flows From (used in): Operating activities.................... 77,393 95,973 114,723 116,360 122,280 Investing activities.................... (80,127) (108,111) (147,587) (157,947) (116,860) Financing activities.................... (1,789) 9,703 37,109 48,482 (2,732) -------- -------- -------- -------- -------- Total................................... (4,523) (2,435) 4,245 6,895 2,688 Selected Ratios: Return on average assets................ 4.37% 6.12% 4.51% 6.86% 4.63% Return on average stockholders' equity............................... 49.46 49.43 19.81 23.86 15.80 Operating margin (11)................... 47.99 46.53 51.79 53.79 52.25 Credit Quality Statistics: Net charge-offs......................... $19,220(12) $20,544 $20,967 $36,824 $49,991 Net charge-offs as a percentage of average gross investment (13)........ 7.57%(12) 7.47% 6.29% 8.74% 10.89% Provision for credit losses as a percentage of average gross investment (14)...................... 8.55 6.93 11.35 9.24 11.78 Allowance for credit losses as a percentage of gross investment (15).. 10.14 8.58 11.07 8.79 9.94
---------- (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 is recorded separately on the balance sheet. (2) Includes loss and damage waiver fees, service fees, interest income, and equipment sales revenue. (3) 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. The provision for 1999 includes a special provision of $12.7 million for a loan made to one company, collateralized by approximately 3,500 microticket consumer contracts, and guaranteed by, among other security, an insurance performance bond. MicroFinancial is currently involved in litigation with the Company and the insurance company. Charge-offs against the special reserve were $6.4 and $7.1 million for the years ended December 31, 2000 and 2001, respectively. (4) Net income per common share (basic) is calculated based on weighted-average common shares outstanding of 9,793,140, 9,859,127, 12,795,809, 12,728,441and 12,789,605 for the years ended December 31, 1997, 1998, 1999, 2000 and 2001, respectively. -14- (5) Net income per common share (diluted) is calculated based on weighted-average common shares outstanding on a diluted basis of 9,925,329, 10,031,975, 12,904,231, 12,807,814, and 12,945,243 for the years ended December 31, 1997, 1998, 1999, 2000 and 2001, respectively. (6) Consists of receivables due in installments, estimated residual value, and loans receivable. (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 noncancelable 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 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. The write-off period was changed back to 360 days in January 1998. (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. 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; the effect on the Company's portfolio of higher interest rates; intense competition; increased governmental regulation of the rates and methods used by the Company in financing and collecting its leases and loans; risks associated with acquiring other portfolios and companies; dependence on key personnel; 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. -15- OVERVIEW The Company is a specialized commercial finance company that provides "microticket" equipment leasing and other financing services in amounts generally ranging from $400 to $3,000, with an average amount financed of approximately $1,100. The Company primarily leases POS authorization systems and other small business equipment to small commercial enterprises. For the years ended December 31, 2000 and 2001, the Company had fundings to Dealers upon origination of leases, contracts and loans ("Dealer Fundings") of $145.4 million and $111.1 million, respectively, and revenues of $139.5 million and $154.0 million, respectively. The Company derives the majority of its revenues from leases originated and held by the Company, payments on service contracts, rental payments, 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. Substantially all leases originated or acquired by the Company are noncancelable. 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 noncancelable 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 43 months as of December 31, 2001. Substantially all service and rental contracts are month-to-month contracts with expected terms of 7 years for service contracts, 15 months for lessees that continue to rent their equipment beyond the original term, and 22 months for other types of rental contracts. CRITICAL ACCOUNTING POLICIES In response to the SEC's release No. 33-8040, "Cautionary Advice regarding Disclosure About Critical Accounting Policies," Management identified the most critical accounting principles upon which our financial status depends. The Company determined the critical principles by considering accounting policies that involve the most complex or subjective decisions or assessments. We identified our most critical accounting policies to be those related to revenue recognition and maintaining the -16- allowance for credit losses. These accounting policies are discussed below as well as within the notes to the consolidated financial statements. 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 either recorded at estimated residual value and depreciated using the straight-line method over a period of 12 months or at the acquisition cost and depreciated using the straight line method over a period of 36 months. Loans are reported at their outstanding principal balance. Interest income on loans is recognized as it is earned. The Company maintains an allowance for credit losses on its investment in leases, service contracts, rental contracts and loans at an amount that it believes is sufficient to provide adequate protection against losses in its portfolio. The allowance is determined principally on the basis of the historical loss experience of the Company and the level of recourse provided by such lease, service contract, rental contract or loan, if any, and reflects management's judgment of additional loss potential considering current economic conditions and the nature and characteristics of the underlying lease portfolio. The Company determines the necessary periodic provision for credit losses taking into account actual and expected losses in the portfolio as a whole and the relationship of the allowance to the net investment in leases, service contracts, rental contracts and loans. Such provisions generally represent a percentage of funded amounts of leases, contracts and loans. The resulting charge is included in the provision for credit losses. Leases, service contracts, rental contracts and loans are charged against the allowance for credit losses and are put on non-accrual when they are deemed to be uncollectable. Generally, the Company deems leases, service contracts, rental contracts and loans to be uncollectable when one of the following occurs: (i) the obligor files for bankruptcy; (ii) the obligor dies, and the equipment is returned; or (iii) when an account has become 360 days delinquent. 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). -17- 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, 2001 Compared to Year Ended December 31, 2000 Total revenues for the year ended December 31, 2001 were $154.1 million, an increase of $14.6 million, or 10.5%, from the year ended December 31, 2000, due primarily to increases of $1.1 million, or 1.6%, in income on financing leases and loans; $10.0 million, or 27.5%, in rental and service contract income, and $3.2 million, or 11.8%, in service fee and other income over such amounts in the previous year's period. The increase in income on financing leases and loans was due to the increased number of leases originated. The increase in rental and service contract income is a result of the increased number of lessees that have continued to rent their equipment beyond their original lease term, the acquisition of the rental portfolio of Resource Leasing Corporation, and increased originations in rental and service contracts. The increase in fee income and other income is the result of increased fees from the lessees related to the collection and legal process employed by the Company, and the addition of a new line of business of selling equipment out of existing inventory. Selling, general and administrative expenses increased by $6.5 or 17%, for the year ended December 31, 2001 as compared to the year ended December 31, 2000. Compensation and personnel-related expenses increased by $3.4 million, due to an increase in overall compensation levels and an increase in the number of employees needed to maintain the Company's portfolio, including the addition of the personnel employed by Resource Leasing Corporation. 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. Also, cost of goods sold increased by $3.6 million, or 100%, due to the Company's acquisition of the assets of Resource Leasing Corporation, and the addition of a new line of business of selling equipment. The Company's provision for credit losses increased by $15.2 million, or 39.0%, for the year ended December 31, 2001 as compared to the year ended December 31, 2000. This increase is a result of the Company's historical policy, based on experience, of providing a provision for credit losses based upon the dealer fundings and revenue recognized in any period and reflects management's judgement of loss potential considering current economic conditions and the nature of the underlying receivables. Depreciation and amortization increased by $4.2 million, or 40.6%, due to the increased number of rental contracts, including the addition of the Resource Leasing portfolio of rental contracts, and amortization of the Company's investment in service contracts. -18- Interest expense decreased by $1.6 million, or 10.1%, for the year ended December 31, 2001 as compared to the year ended December 31, 2000. This decrease resulted primarily from the Company's declining cost of funds, offset by an increased level of borrowings. Dealer Fundings were $111.1 million during the year ended December 31, 2001, an decrease of $34.3 million, or 23.6%, compared to the year ended December 31, 2000. This decrease is a result of the Company's decision during the second quarter of 2000 to increase pricing and tighten its credit approval standards. The new credit policies were put into place in August of 2000. This is an ongoing effort, and is expected to continue going forward. Receivables due in installments, estimated residual values, loans receivable, investment in service contracts, and investment in rental equipment also decreased from $477.4 million for the year ended December 31, 2000 to $470.6 million for the year ended December 31, 2001, representing an decrease of $6.8 million, or 1.4%. Net cash provided by operating activities increased by $5.9 million to $122.3 million during the year ended December 31, 2001, or 5.1%, from the year ended December 31, 2000 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 decreased by $28.2 million, or 21.2%, from $132.7 million at December 31, 2000 to $104.5 million at December 31, 2001. This decrease was primarily due to the 23.6% decrease in dealer fundings during 2001. The terrorist attacks of September 11, 2001 caused a significant loss of life and property. Fortunately, the Company has not experienced any significant losses as a direct result of the September 11 events. There can be no assurance that any potential impact associated with the September 11 events would not have a material adverse effect on the Company's business, financial condition, or results of operations. Year Ended December 31, 2000 Compared to Year Ended December 31, 1999 Total revenues for the year ended December 31, 2000 were $139.5 million, an increase of $30.9 million, or 28.5%, from the year ended December 31, 1999, due primarily to increases of $14.3 million, or 25.8%, in income on financing leases and loans; $8.4 million, or 30.1%, in rental and service contract income, and $8.2 million, or 32.8%, in service fee income over such amounts in the previous year's period. The increase in income on financing leases and loans was due to the increased number of leases originated. The increase in rental and service contract income is a result of the increased number of lessees that have continued to rent their equipment beyond their original lease term, a rental portfolio of 7,085 accounts purchased during the second quarter of 2000, and the increased number of service contracts originated. The increase in fee income is the result of increased fees from the lessees related to the collection and legal process employed by the Company. Selling, general and administrative expenses increased $4.3 million, or 12.6%, for the year ended December 31, 2000 as compared to the year ended December 31, 1999. The increase was primarily attributable to an increase in personnel, resulting in a 21.1% 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. Additionally, the Company accrued approximately $1.1 million for Company contributions to the employee 401(k) plan and discretionary management bonuses which are contingent upon the Board of Directors' approval after the close of the fiscal year. Management expects that salaries and employee-related expenses, marketing expenses and -19- 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 increased $1.1 million from the year ended December 31, 1999 to $38.9 million for the year ended December 31, 2000. The provision for 1999 included a special provision of $12.7 million for a loan made to one company, collateralized by approximately 3,500 microticket consumer contracts and guaranteed by an insurance performance bond. The Company is currently involved in litigation with the company and the insurance company, see "Legal Proceedings." Charge-offs against the special reserve were $6.4 million for the year ended December 31, 2000. Excluding the special provision, the Company's provision for credit losses increased $13.8 million from the year ended December 31, 1999 to $38.9 million for the year ended December 31, 2000. This increase is a result of the Company's historical policy of providing a provision for credit losses based upon the dealer fundings and revenue recognized in any period and reflects management's judgement of loss potential considering economic conditions and the nature of the underlying receivables. Dealer fundings increased $8.1 million, or 5.9%, and total revenues increased by $28.8 million, or 29.2%, for the year ended December 31, 2000 as compared to the year ended December 31, 1999. Depreciation and amortization expense increased by $2.6 million, or 34.2%, due to the increased number of rental contracts and amortization of the Company's investment in service contracts. Interest expense increased by $5.1 million, or 47.1%, from $10.8 million for the year ended December 31, 1999 to $15.9 million for the year ended December 31, 2000. This increase resulted from an increase in the average outstanding balance of the Company's credit facilities as well as rising interest rates. As a result of the foregoing, the Company's net income increased by $10.2 million, or 95.3%, from $10.7 million for the year ended December 31, 1999 to $20.9 million for the year ended December 31, 2000. Dealer Fundings were $145.4 million during the year ended December 31, 2000, an increase of $8.1 million, or 5.9%, compared to the year ended December 31, 1999. This increase primarily resulted from continued growth in leases of POS authorization systems. Receivables due in installments, estimated residual values, loans receivable and investment in service contracts also increased from $377.0 million for the year ended December 31, 1999 to $465.5 million for the year ended December 31, 2000, representing an increase of $88.4 million, or 23.5%. Net cash provided by operating activities increased by $1.6 million to $116.4 million during the year ended December 31, 2000, or 1.4%, from the year ended December 31, 1999 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 $31.9 million, or 31.6%, from $100.8 million at December 31, 1999 to $132.7 million at December 31, 2000. This increase was due to the increased number of leases originated during 2000. -20- 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, its on-balance sheet securitizations, the issuance of subordinated debt and an initial public offering completed in February of 1999. The Company will continue to require significant additional capital to maintain and expand its volume of leases, 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. On August 22, 2000, the Company entered into a new $192 million credit facility with seven banks, expiring on September 30, 2002. At December 31, 2001, the Company had approximately $104.6 million outstanding under the facility. The Company also may use its subordinated debt program as a source of funding for potential acquisitions of portfolios and leases which otherwise are not eligible for funding under the credit facilities and for potential portfolio purchases. To date, cash flows from its portfolio and other fees have been sufficient to repay amounts borrowed under the credit facilities and subordinated debt. At December 31, 2000, the Company was in default on one of its debt covenants in its senior subordinated notes. The covenant that was in default requires that the Company maintain an allowance for credit losses in an amount not less than 100% of the delinquent billed lease receivables. The covenant default was waived as of December 31, 2000. In consideration of the waiver, the Company repaid one of the notes in full on March 2, 2001. The Company believes that cash flows from its operations and amounts available under its credit facilities will be sufficient to fund the Company's operations for the foreseeable future. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The Company has entered into various agreements, such as the long-term debt agreements, capital lease agreements and operating lease agreements that require future payments be made. Long-term debt agreements include all debt outstanding under the revolving credit line, securitizations, subordinated notes, demand notes and other notes payable. At December 31, 2001 the repayment schedules for outstanding long-term debt, minimum lease payments under noncancelable operating leases and future minimum lease payments under capital leases were as follows: -21-
For the year ended Long Term Operating Capital December 31, Debt Leases Leases Total ------------------ -------- -------- -------- -------- 2002 $ 55,583 $ 1,787 $ 468 $ 57,838 2003 37,550 1,754 267 39,571 2004 5,126 835 154 6,115 2005 -- 214 44 258 Thereafter 3,416 -- -- 3,416 -------- -------- -------- -------- 101,675 4,590 933 107,198 Outstanding balance of revolving credit facility 104,640 -- -- 104,640 -------- -------- -------- -------- Total $206,315 $ 4,590 $ 933 $211,838 ======== ======== ======== ========
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. 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, and fair value of the financial instruments held by the Company at December 31, 2001 that are sensitive to changes in interest rates. The Company has used interest-rate swaps to manage the primary market exposures associated with underlying liabilities and anticipated transactions. The Company used 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 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 -22- through its credit facility. Increases in interest rates during the term of each lease, contract or loan could narrow or eliminate the spread, or result in a negative spread. The Company has adopted a policy designed to protect itself against interest rate volatility during the term of each lease, contract or loan. Given the relatively short average life of the Company's leases, contracts and loans, the Company's goal is to maintain a blend of fixed and variable interest rate obligations. As of December 31, 2001, the Company's outstanding fixed-rate indebtedness outstanding under the Company's securitizations and subordinated debt represented 49.1% of the Company's total outstanding indebtedness. In July 1997, the Company entered into an interest rate swap arrangement with one of its banks. This arrangement expired in July 2000. The Company's credit facility bears interest at rates, which fluctuate with changes in the prime rate or the 90-day LIBOR. The majority of the Company's long term debt is at fixed interest rates. The Company's interest expense on its credit facility and the fair value of its fixed rate debt is sensitive to changes in market interest rates. The effect of a 10% adverse change in market interest rates, sustained for one year, on the Company's interest expense and the fair value of its fixed rate debt would be $410,000 and $714,000, respectively. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, INCLUDING SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) Included in Exhibit 99 and incorporated by reference herein. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. -23- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The sections, "Election of Directors," "Certain Information Regarding the MicroFinancial Board," and "Section 16(a) Beneficial Ownership Reporting Compliance," included in the Company's proxy statement for its 2002 Special Meeting in lieu of the Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission on or before April 30, 2002, are hereby incorporated by reference. ITEM 11. EXECUTIVE COMPENSATION The sections "Compensation of Executive Officers," and "Certain Information Regarding the MicroFinancial Board," included in the Company's proxy statement for its 2002 Special Meeting in lieu of the Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission on or before April 30, 2002, are hereby incorporated by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The section "Security Ownership of Certain Beneficial Owners and Management," included in the Company's proxy statement for its 2002 Special Meeting in lieu of the Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission on or before April 30, 2002, is hereby incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The section "Other Information Relating to Directors, Nominees and Executive Officers," included in the Company's proxy statement for its 2002 Special Meeting in lieu of the Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission on or before April 30, 2002, is hereby incorporated by reference. -24- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) Financial Statements Included in Exhibit 99 and 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 Standard Terms and Condition of Indenture, dated as of March 21, 2000 governing the MFI Finance Corp. I 7.375% Lease-Backed Notes, Series 2000-1 (the "2000-1 Notes") and the MFI Finance Corp. I 6.939% Lease-Backed Notes, Series 2000-2 (the "2000-2 Notes") (6) 10.2 Supplement to Indenture, dated March 21, 2000, governing the 2000-1 Notes (6) 10.3 Specimen 2000-1 Note (6) 10.4 Standard Terms and Conditions of Servicing governing the 2000-1 Notes (6) 10.5 Office Lease Agreement by and between WXI/AJP Real Estate Limited Partnership and Leasecomm Corporation dated, May 3, 2000, for facilities in Newark, California (7) 10.6 Fourth Amended and Restated Revolving Credit Agreement, dated August 22, 2000, among Leasecomm Corporation, the lenders parties thereto, and Fleet National Bank as agent (8) 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) 10.12** 1998 Equity Incentive Plan (3) -25- 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 Amended and Restated Standard Terms and Condition of Indenture dated as of September 2001 governing the MFI Finance Corp. I, 5.5800% Lease-Backed Notes, Series 2000-3 (the "2001-3 Notes") (9) 10.16 Supplement to Indenture dated September 2001 governing the 2001-3 Notes. (9) 10.17 Specimen 2001-3 Note. (9) 10.18 Standard Terms and Conditions of Servicing governing the 2001-3 Notes. (9) 10.19 Standard Terms and Condition of Indenture dated as of September 2001 governing the MFI Finance Corp. II, LLC, 8.0000% Lease-Backed Notes, Series 2001-1 (the "2001-1 Notes") (9) 10.20 Supplement to Indenture dated September 2001 governing the 2001-1 Notes. (9) 10.21 Specimen 2001-1 Note. (9) 10.22 Standard Terms and Conditions of Servicing governing the 2001-1 Notes. (9) 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) 10.28 Employment Agreement between the Company and John Plumlee (3) 10.29 Employment Agreement between the Company and Carol Salvo (3) 10.30 Supplement to Indenture, dated December 1, 2000, governing the 2000-2 Notes (9) 10.31 Specimen, 2000-2 Notes (9) 10.33 Third Amended and Restated Revolving Credit Agreement, dated December 21, 1999, among Leasecomm Corporation, the lenders parties thereto, and BankBoston, N.A. as agent (5) 10.34 Fifth Amendment to Office Lease Agreement by and between MicroFinancial Incorporated and Leasecomm Corporation and Bay Colony Corporate Center LLC, dated June 29, 1999, for facilities in Waltham, Massachusetts (5) -26- 21.1* Subsidiaries of Registrant 23.1* Consent of Deloitte & Touche LLP 23.2* Consent of PricewaterhouseCoopers LLP 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. (5) Incorporated by reference to the Exhibit with the same exhibit number in the Registrant's Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2000. (6) Incorporated by reference to the Exhibit with the same exhibit number in the Registrant's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 22, 2000. (7) Incorporated by reference to the Exhibit with the same exhibit number in the Registrant's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 14, 2000. (8) Incorporated by reference to the Exhibit with the same exhibit number in the Registrant's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 14, 2000. -27- (9) Incorporated by reference to the Exhibit with the same exhibit number in the Registrant's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 14, 2001. (b) One report on Form 8-K was filed on October 16, 2001 to discuss the third quarter results and a second report on Form 8-K was filed on February 13, 2002, to announce the results for the year ended December 31, 2001. (c) See (a)(3) above. (d) None. -28- 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 Chairman of the Board of Directors, and Chief Executive Officer Date: March 29, 2002 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 Chairman of the Board of Directors March 29, 2002 ------------------------ and Chief Executive Officer Peter R. Bleyleben /s/ RICHARD F. LATOUR President, Chief Operating Officer, March 29, 2002 ------------------------ Chief Financial Officer, Treasurer, Richard F. Latour Clerk, Secretary and Director /s/ BRIAN E. BOYLE Director March 29, 2002 ------------------------ Brian E. Boyle /s/ TORRENCE C. HARDER Director March 29, 2002 ------------------------ Torrence C. Harder /s/ JEFFREY P. PARKER Director March 29, 2002 ------------------------ Jeffrey P. Parker /s/ ALAN J. ZAKON Director March 29, 2002 ------------------------ Alan J. Zakon
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