FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
Commission File No. 1-14771
MICROFINANCIAL INCORPORATED
(Exact name of Registrant as specified in its Charter)
Massachusetts 04-2962824
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
10 M Commerce Way, Woburn, MA 01801
(Address of Principal Executive Offices)
(781) 994-4800
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(b) of the Securities and Exchange act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
As of May 2, 2003, 13,126,416 shares of the registrant's common stock
were outstanding.
MICROFINANCIAL INCORPORATED
TABLE OF CONTENTS
Page
Part I FINANCIAL INFORMATION
Item 1 Financial Statements (unaudited):
Condensed Consolidated Balance Sheets
December 31, 2002 and March 31, 2003 3
Condensed Consolidated Statements of Operations
Three months ended March 31, 2002 and 2003 4
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 2002 and 2003 5
Notes to Condensed Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3 Quantitative and Qualitative Disclosures about Market Risk 19
Item 4 Controls and Procedures 19
Part II OTHER INFORMATION
Item 1 Legal Proceedings 20
Item 3 Recent Sales of Unregistered Securities 22
Item 5 Other Information 22
Item 6 Exhibits and Reports on Form 8-K 23
Signatures 24
Certifications 25
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31, March 31,
------------ ---------
2002 2003
---- ----
ASSETS
Net investment in leases and loans:
Receivables due in installments $ 334,623 $ 299,442
Estimated residual value 30,754 28,404
Initial direct costs 4,891 4,057
Loans receivable 1,796 1,783
Less:
Advance lease payments and deposits (96) (77)
Unearned income (67,574) (55,666)
Allowance for credit losses (69,294) (66,359)
----------- -----------
Net investment in leases and loans $ 235,100 $ 211,584
Investment in service contracts 14,463 12,843
Cash and cash equivalents 5,494 9,803
Restricted cash 18,516 14,419
Property and equipment, net 9,026 8,103
Income taxes receivable 8,652 8,652
Other assets 3,834 4,288
----------- -----------
Total assets $ 295,085 $ 269,692
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable $ 168,927 $ 145,191
Subordinated notes payable 3,262 3,262
Capitalized lease obligations 471 356
Accounts payable 3,840 3,945
Other liabilities 6,776 6,343
Income taxes payable 1,400 1,392
Deferred income taxes payable 23,806 23,303
----------- -----------
Total liabilities 208,482 183,792
----------- -----------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized;
no shares issued at 12/31/02 and 3/31/03 - -
Common stock, $.01 par value; 25,000,000 shares authorized; 13,410,646
and 13,730,500 shares issued at 12/31/02 and 3/31/03, respectively 134 137
Additional paid-in capital 47,723 47,977
Retained earnings 45,089 44,334
Treasury stock (588,700 shares of common stock at 12/31/02
and 3/31/03), at cost (6,343) (6,343)
Unearned compensation 0 (205)
----------- -----------
Total stockholders' equity 86,603 85,900
----------- -----------
Total liabilities and stockholders' equity $ 295,085 $ 269,692
=========== ===========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
For the three months ended
March 31,
--------------------------
2002 2003
---- ----
Revenues:
Income on financing leases and loans $ 15,235 $ 9,821
Income on service contracts 2,395 2,251
Rental income 9,863 8,547
Loss and damage waiver fees 1,526 1,483
Service fees and other 6,266 3,469
-------------------------
Total revenues 35,285 25,571
-------------------------
Expenses:
Selling general and administrative 12,574 9,131
Provision for credit losses 10,964 10,799
Depreciation and amortization 3,639 4,270
Interest 2,747 2,629
-------------------------
Total expenses 29,924 26,829
-------------------------
Income/(loss) before provision for income taxes 5,361 (1,258)
Provision/(benefit) for income taxes 2,145 (503)
-------------------------
Net income/(loss) $ 3,216 ($ 755)
=========================
Net income/(loss) per common share - basic $ 0.25 ($ 0.06)
=========================
Net income/(loss) per common share - diluted $ 0.25 ($ 0.06)
=========================
Weighted-average shares used to compute:
Basic net income per share 12,821,946 12,854,642
-------------------------
Fully diluted net income per share 12,853,061 12,854,642
-------------------------
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the three months ended
March 31,
--------------------------
2002 2003
---- ----
Cash flows from operating activities:
Cash received from customers $ 46,729 $ 39,652
Cash paid to suppliers and employees (11,642) (10,796)
Cash paid for income taxes (988) (8)
Interest paid (2,310) (3,181)
Interest received 154 44
-------------------------
Net cash provided by operating activities 31,943 25,711
-------------------------
Cash flows from investing activities:
Investment in lease contracts (20,027) (1,423)
Investment in inventory (1,018) (71)
Investment in direct costs (1,296) (125)
Investment in service contracts (2,326) 0
Investment in fixed assets (138) (50)
Repayment of notes from officers 10 0
-------------------------
Net cash used in investing activities (24,795) (1,669)
-------------------------
Cash flows from financing activities:
Proceeds from secured debt 9,300 0
Repayment of secured debt (14,218) (23,736)
Proceeds from short term demand notes payable (85) 0
(Increase) decrease in restricted cash 98 4,097
Repayment of capital leases (101) (95)
Payment of dividends (642) 0
-------------------------
Net cash used in financing activities (5,648) (19,734)
-------------------------
Net (decrease) increase in cash and cash equivalents: 1,500 4,309
Cash and cash equivalents, beginning of period 146 5,494
-------------------------
Cash and cash equivalents, end of period $ 1,646 $ 9,803
=========================
(continued on following page)
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Continued)
For the three months ended
March 31,
--------------------------
2002 2003
---- ----
Reconciliation of net income to net cash provided
by operating activities:
Net income (loss) $ 3,216 ($ 755)
Adjustments to reconcile net income to cash
provided by operating activities
Depreciation and amortization 3,639 4,270
Provision for credit losses 10,964 10,799
Recovery of equipment cost and residual value,
net of revenue recognized 12,203 12,411
Decrease in current taxes (988) (172)
Decrease (increase) in deferred income taxes 2,145 (503)
Change in assets and liabilities:
Increase (decrease) in other assets 416 (563)
Increase (decrease) in accounts payable (16) 105
Increase in accrued liabilities 364 119
-------------------------
Net cash provided by operating activities $ 31,943 $ 25,711
=========================
Supplemental disclosure of noncash activities:
Accrual of common stock dividends $ 641 $ 0
The accompanying notes are an integral part of the condensed consolidated
financial statements.
6
(A) Nature of Business:
MicroFinancial Incorporated (the "Company") which operates primarily
through its wholly-owned subsidiary, Leasecomm Corporation, is a specialized
commercial finance company that primarily leases and rents "microticket"
equipment and provides other financing services in amounts generally ranging
from $400 to $15,000 with an average amount financed of approximately $3,500 and
an average lease term of 38 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 funded its operations primarily through borrowings under
its credit facilities, issuances of subordinated debt and on balance sheet
securitizations.
MicroFinancial incurred net losses of $22.1 million for the year ended
December 31, 2002. The net losses incurred by the Company during the third and
fourth quarters caused the Company to be in default of certain debt covenants in
its credit facility and securitization agreements. In addition, as of September
30, 2002, the Company's credit facility failed to renew and consequently, the
Company was forced to suspend new origination activity as of October 11, 2002.
On April 14, 2003, the Company entered into a long-term agreement with its
lenders. This long-term agreement waives the defaults described above, and in
consideration for this waiver, requires the outstanding balance of the loan to
be repaid over a term of 22 months beginning in April 2003 at an interest rate
of prime plus 2.0%. The Company received a waiver, which was set to expire on
April 15, 2003, for the covenant violations in connection with the
securitization agreement. Subsequently, the Company received a permanent waiver
of the covenant defaults and the securitization agreement was amended so that
going forward, the covenants are the same as those contained in the long-term
agreement entered into on April 14, 2003, for the senior credit facility. To
date, the Company has fulfilled all of its debt obligations, as agreed to by the
bank group, in a timely manner.
In an effort to improve its financial position, MicroFinancial has
taken certain steps including the engagement of a financial and strategic
advisory firm, Triax Capital Advisors, LLC. Management and its advisors are
actively considering various financing, restructuring and strategic
alternatives. In addition, Management has taken steps to reduce overhead,
including a reduction in headcount from 380 at December 31, 2001 to 203 at
December 31, 2002. During the three months ended March 31, 2003, the employee
headcount was further reduced to 186 in a continued effort to maintain an
appropriate cost structure.
Leasecomm Corporation periodically finances its lease and service
contracts, together with unguaranteed residuals, through securitizations using
special purpose vehicles. MFI Finance Corporation I and MFI Finance Corporation
II, LLC are special purpose companies. The assets of such special purpose
vehicles and cash collateral or other accounts created in connection with the
financings in which they participate are not available to pay creditors of
Leasecomm Corporation, MicroFinancial Incorporated, or other affiliates. While
Leasecomm Corporation generally does not sell its interests in leases, service
contracts or loans to third parties after origination, the Company does, from
time to time, contribute certain leases, service contracts, or loans to
special-purpose entities for purposes of obtaining financing in connection with
the related receivables. The contribution of such assets under the terms of such
financings are intended to constitute "true sales" of such assets for bankruptcy
purposes (meaning that such assets are legally isolated from Leasecomm
Corporation). However, the special purpose entities to which such assets are
contributed are not "qualifying special purpose entities" within the meaning
Statement of Financial Accounting Standards ("SFAS") SFAS No. 140, and are
required under generally accepted accounting principles to be consolidated in
the financial statements of the Company. As a result, such assets and the
related liability remain on the balance sheet and do not receive gain on sale
treatment.
(B) Summary of Significant Accounting Policies:
Basis of Presentation:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America and the rules and regulations of the Securities and
Exchange Commission for interim financial statements. Accordingly, the interim
statements do not include all of the information and disclosures required for
the annual financial statements. In the opinion of the
7
Company's management, the condensed consolidated financial statements contain
all adjustments, consisting only of normal recurring adjustments, considered
necessary for a fair presentation of these interim results. These financial
statements should be read in conjunction with the consolidated financial
statements and notes included in the Company's Annual Report and Form 10-K for
the year ended December 31, 2002. The results for the three-month period ended
March 31, 2003 are not necessarily indicative of the results that may be
expected for the full year ended December 31, 2003.
The balance sheet at December 31, 2002 has been derived from the
audited financial statements included in the Company's Annual Report on Form
10-K for the year ended December 31, 2002.
Allowance for Credit Losses:
The Company maintains an allowance for credit losses on its investment
in leases, service contracts and loans at an amount that it believes is
sufficient to provide adequate protection against losses in its portfolio. The
allowance is determined principally on the basis of the historical loss
experience of the Company and the level of recourse provided by such lease,
service contract or loan, if any, and reflects management's judgment of
additional loss potential considering current economic conditions and the nature
and characteristics of the underlying lease portfolio. The Company determines
the necessary periodic provision for credit losses, taking into account actual
and expected losses in the portfolio, as a whole, and the relationship of the
allowance to the net investment in leases, service contracts and loans.
The following table sets forth the Company's allowance for credit
losses as of December 31, 2002 and March 31, 2003 and the related provision,
charge-offs and recoveries for the three months ended March 31, 2003.
Balance of allowance for credit losses at December 31, 2002 $ 69,294
=========
Provision for credit losses 10,799
Total provisions for credit losses 10,799
Charge-offs 16,348
Recoveries 2,614
------
Charge-offs, net of recoveries 13,734
---------
Balance of allowance for credit losses at March 31, 2003 $ 66,359
=========
Earnings Per Share:
Basic net income per common share is computed based on the weighted-average
number of common shares outstanding during the period. Dilutive net income per
common share gives effect to all dilutive potential common shares outstanding
during the period. 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. Options to purchase 1,936,000 shares of common stock were not
included in the computation of diluted earnings per share for the three months
ended March 31, 2002, because their effects were antidilutive. All stock options
and unvested restricted stock were excluded from the computation of dilutive
earnings per share for the three months ended March 31, 2003, because their
inclusion would have had an antidilutive effect on earnings per share.
8
For three months ended
March 31,
--------------------------
2002 2003
Net income (loss) $ 3,216 ($ 755)
Shares used in computation:
Weighted average common shares
outstanding used in computation
of net income per common share 12,821,946 12,854,642
Dilutive effect of common stock
options 31,115 -
--------------------------
Shares used in computation of net
income per common share -
assuming dilution 12,853,061 12,854,642
--------------------------
Net income (loss) per common share $ 0.25 ($ 0.06)
Net income (loss) per common share
assuming dilution $ 0.25 ($ 0.06)
Stock-based Employee Compensation
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. The Company follows the disclosure requirements of SFAS
No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires that
compensation under a fair value method be determined using the Black-Scholes
option-pricing model and disclosed in a pro forma effect on earnings and
earnings per share. The Company accounts for stock-based employee compensation
plans under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. The
current period amortization of deferred compensation expense relating to the
restricted stock awards granted on February 12, 2003 is reflected in net income.
No other stock-based employee compensation cost is reflected in net income, as
either all options granted under those plans had an exercise price equal to the
market value of the underlying common stock on the date of grant or options
granted that result in a variable compensation costs had an exercise price
greater than the fair market value of the underlying common stock on March 31,
2003. The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
9
For the three months ended
March 31,
--------------------------
2002 2003
Net income (loss), as reported $3,216 ($ 755)
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (353) (218)
---------------------
Pro forma net income (loss) $2,863 ($ 973)
=====================
Earnings (loss) per share:
Basic - as reported $ 0.25 ($ 0.06)
=====================
Basic - pro forma $ 0.22 ($ 0.08)
=====================
Diluted - as reported $ 0.25 ($ 0.06)
=====================
Diluted - pro forma $ 0.22 ($ 0.08)
=====================
The fair value of option grants for options granted during the three
months ended March 31, 2003 was estimated on the date of grant utilizing the
Black-Scholes option-pricing model with the following weighted-average
assumptions.
Risk-free interest rate 3.34%
Expected dividend yield 0.00%
Expected life 7 years
Volatility 76.00%
The weighted-average fair value at the date of grant for options
granted during the three months ended March 31, 2003 approximated $0.62 per
option. The Company granted 200,000 options during the three months ended March
31, 2003.
Notes Payable:
On December 21, 1999, the Company entered into a revolving line of
credit and term loan facility with a group of financial institutions whereby it
may borrow a maximum of $150,000,000 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 the prevailing rate per
annum as offered in the interbank Eurodollar market (Eurodollar) plus 1.75% for
Eurodollar Loans. If the Eurodollar loans are not renewed upon their maturity
they automatically convert into prime rate loans. On August 22, 2000, the
revolving line of credit and term loan facility was amended and restated whereby
the Company may now borrow a maximum of $192,000,000 based upon qualified lease
receivables, loans, rentals and service contracts. Outstanding borrowings with
respect to the revolving line of credit bear interest based either at Prime
minus 0.25% for Prime Rate Loans or the prevailing rate per annum as offered in
the London Interbank Offered Rate (LIBOR) plus 1.75% for LIBOR Loans or the
seven-day Money Market rate plus 2.00% for Swing Line Advances. If the LIBOR
loans are not renewed upon their maturity they automatically convert into prime
rate loans. The Swing Line Advances have a seven-day maturity, and upon their
maturity they automatically convert into prime rate loans. In addition, the
Company's aggregate outstanding principal amount of Swing Line Advances shall
not exceed $10 million. The prime rate at both December 31, 2002, and March 31,
2003 was 4.25%. The 90-day LIBOR rates at December 31, 2002 and March 31, 2003
were 1.40% and 1.27875% respectively.
10
The Company had borrowings outstanding under this agreement with the
following terms:
December 31, 2002 March 31, 2003
----------------- --------------
Type Rate Amount Rate Amount
---- ---- ------ ---- ------
(in thousands) (in thousands)
Prime 4.7500% $ 31,556 5.2500% $ 65,051
LIBOR 4.1875% 50,000 4.1875% 50,000
LIBOR 4.1875% 45,000
-------- --------
Total Outstanding $126,556 $115,051
======== ========
Outstanding borrowings are collateralized by leases, loans, rentals,
and service contracts pledged specifically to the financial institutions. As of
September 30, 2002 the revolving credit line failed to renew and the Company has
been paying down the balance on the basis of a 36 month amortization plus
interest. Based on the terms of the agreement, interest rates increased from
Prime minus 0.25% to Prime plus 0.50% for prime based loans and from LIBOR plus
1.75% to LIBOR plus 2.50% for LIBOR based loans. In addition, based on the
covenant defaults described below, the outstanding borrowings on all loans bear
an additional 2.00% default interest. On January 3, 2003, the Company entered
into a Forbearance and Modification Agreement for the senior credit facility
which expired on February 7, 2003. Based on the terms of the Forbearance and
Modification Agreement, interest rates increased again on the prime based loans
to prime plus 1.00%.
At December 31, 2002, the Company was in default of certain of its debt
covenants in its senior credit facility. The covenants that were in default with
respect to the senior credit facility require that the Company maintain a fixed
charge ratio in an amount not less than 130% of consolidated earnings, a
consolidated tangible net worth minimum of $77.5 million plus 50% of net income
quarterly beginning with September 30, 2000 and compliance with the borrowing
base. On April 14, 2003, the Company entered into a long-term agreement with its
lenders. This long-term agreement waives the defaults described above, and in
consideration for this waiver, requires the outstanding balance of the loan to
be repaid over a term of 22 months beginning in April 2003 at an interest rate
of prime plus 2.0%. Based on the amortization schedule in the new agreement, the
Company is obligated to repay a minimum of $54 million, plus applicable
interest, over the next twelve months.
MFI I issued three series of notes, the 2000-1 Notes, the 2000-2 Notes,
and the 2001-3 Notes. In March 2000, MFI I issued the 2000-1 Notes in aggregate
principal amount of $50,056,686. In December 2000, MFI I issued the 2000-2 Notes
in aggregate principal amount of $50,561,633. In September 2001, MFI I issued
the 2001-3 Notes in aggregate principal amount of $39,397,354. Outstanding
borrowings are collateralized by specific pools of lease receivables. In
September 2001, MFI II, LLC was formed and issued one series of notes, the
2001-1 Notes in aggregate principal amount of $10,000,000. Outstanding
borrowings are collateralized by a specific pool of lease receivables as well as
the excess cash flow from the MFI I collateral. These notes are subordinate to
the three series of notes issued by MFI I.
At December 31, 2002, the Company was in default on two of its debt
covenants in its securitization agreements. The covenants that were in default
with respect to the securitization agreements require that the Company maintain
a fixed charge ratio in an amount not less than 125% of consolidated earnings
and a consolidated tangible net worth greater than $90 million plus 50% of net
income for each fiscal quarter after June 30, 2001. Additionally per the terms
of the securitization agreement, any default with respect to the senior credit
facility is considered a default under the terms of the agreement. The Company
received a waiver, which was set to expire on April 15, 2003, for the covenant
violations in connection with the securitization agreement. Subsequently, the
Company received a permanent waiver of the covenant defaults and the
securitization agreement was amended so that going forward, the covenants are
the same as those contained in the long-term agreement entered into on April 14,
2003, for the senior credit facility.
11
At December 31, 2002 and March 31, 2003, MFI I and MFI II had
borrowings outstanding under the series of notes with the following terms:
December 31, 2002 March 31, 2003
----------------- --------------
Series Rate Amount Rate Amount
------ ---- ------ ---- ------
(in thousands) (in thousands)
MFI I
2000-1 Notes 7.3750% 3,464 7.3750% -
2000-2 Notes 6.9390% 17,983 6.9390% 13,917
2001-3 Notes 5.5800% 17,019 5.5800% 13,593
MFI II LLC
2001-1 Notes 8.0000% 3,625 8.0000% 2,350
--------- --------
Total Outstanding $ 42,091 $ 29,860
========= ========
On February 18, 2003, the Company repaid $2.4 million in principal plus
accrued interest for the MFI Finance I series 2000-1 notes utilizing the clean
up call provision under its securitizations. The re-payment was made using cash
previously classified as restricted.
At December 31, 2002 and March 31, 2003, the Company also had other
notes payable which totaled $280,000. Of these notes, at December 2002 and March
31, 2003, $30,000 are notes that are due on demand and bear interest at a rate
of prime less 1.00%. As of December 31, 2002 and March 31, 2003, $250,000 are
two-year term notes that carry an interest rate of 7.5%.
Stock Options:
Under the 1998 Equity Incentive Plan (the "1998 Plan") which was
adopted on July 9, 1998 the Company had reserved 4,120,380 shares of the
Company's common stock for issuance pursuant to the 1998 Plan. The Company
granted a total of 200,000 options and a total of 135,000 options were
surrendered during the three months ended March 31, 2003. A total of 1,735,000
options were outstanding at March 31, 2003 of which 813,000 were vested.
On February 7, 2003, the Company offered non-director employees and
executives who had been granted stock options in the past the opportunity to
cancel any of the original option agreements in exchange for a grant of shares
of restricted stock. All option awards subject to the offer were converted to
restricted stock. In connection with this offer, on February 12, 2003, 1,325,000
options converted to 319,854 shares of common stock. The restricted stock vested
20% upon grant, and vests 5% on the first day of each quarter after the grant
date, with accelerated vesting if the price of the Corporation's common stock
exceeds certain thresholds during the vesting period. As of March 31, 2003,
63,971 of these shares were fully vested and $51,000 had been amortized from
deferred compensation expense to compensation expense.
Dividends:
During the fourth quarter of 2002, the Board of Directors suspended the
future payment of dividends to comply with the Company's banking agreements.
Provisions in certain of the Company's credit facilities and agreements
governing its subordinated debt contain, and the terms of any indebtedness
issued by the Company in the future are likely to contain, certain restrictions
on the payment of dividends on the Common Stock. The decision as to the amount
and timing of future dividends paid by the Company, if any, will be made at the
discretion of the Company's Board of Directors in light of the financial
condition, capital requirements, earnings and prospects of the Company and any
restrictions under the Company's credit facilities or subordinated debt
agreements, as well as other factors the Board of Directors may deem relevant,
and there can be no assurance as to the amount and timing of payment of future
dividends.
12
Reclassification of Prior Year Balances:
Certain reclassifications have been made to prior years' consolidated
financial Statements to conform to the current presentation.
Commitments and Contingencies:
Please refer to Part II Other Information, Item 1 Legal Proceedings for
information about pending litigation of the Company.
Subsequent Events:
The Company entered into a long-term agreement with its lenders on
April 14, 2003. This long-term agreement waives the covenant defaults, and in
consideration for this waiver, requires the outstanding balance of the loan to
be repaid over a term of 22 months beginning in April 2003 at an interest rate
of prime plus 2.0%. Based on the amortization schedule in the new agreement, the
Company is obligated to repay a minimum of $54 million, plus applicable
interest, over the next twelve months.
The Company received a waiver, which was set to expire on April 15,
2003, for the covenant violations in connection with the securitization
agreement. Subsequently, the Company received a permanent waiver of the covenant
defaults and the securitization agreement was amended so that going forward, the
covenants are the same as those contained in the long-term agreement entered
into on April 14, 2003, for the senior credit facility.
13
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Three months ended March 31, 2003 as compared to the three months ended March
31, 2002.
Net income for the three months ended March 31, 2003 was a loss of
approximately $755,000, a decrease of $4.0 million or 124% from the three months
ended March 31, 2002. This represents diluted earnings per share for the three
months ended March 31, 2003 of ($0.06) per share on weighted-average outstanding
shares of 12,854,642 as compared to $0.25 per share on weighted-average
outstanding shares of 12,821,946 for the three months ended March 31, 2002.
Total revenues for the three months ended March 31, 2003 were $25.6
million, a decrease of $9.7 million, or 28%, from the three months ended March
31, 2002. The decrease was primarily due to a decrease of $5.4 million, or 36%,
in financing leases and loans, $2.8 million or 45% in fee and other income, and
$1.3 million or 13% in rental income. The decrease in income on financing leases
and loans was due to the decreased number of leases originated primarily
resulting from the Company's decision during the third quarter of 2002 to
suspend the funding of new contracts. The decrease in fee income and other
income is the result of decreased fees from the lessees related to the
collection and legal process employed by the Company. The decrease in rental
income is the result of a decrease in originations of rental contracts.
Selling, general and administrative expenses decreased by $3.4 million,
or 27%, for the three months ended March 31, 2003, as compared to the three
months ended March 31, 2002. Compensation expenses decreased by $1.8 million or
34% primarily due to staff reductions. Collections expense decreased by $873,000
or 49%. Cost of goods sold expenses decreased $556,000 or 71%. Inventory
services expense decreased by $199,000 or 86%.
Depreciation and amortization increased by $631,000 or 17%, due to an
increase in the number of early terminations of monthly rental and service
contracts.
The Company's provision for credit losses decreased by $165,000 or 2%,
for the three months ended March 31, 2003 as compared to the three months ended
March 31, 2002, while net charge-offs increased 22% to $13.7 million. This
provision was based on the Company's historical policy, based on experience, of
providing a provision for credit losses based upon the dealer fundings and
revenue recognized in any period and reflects management's judgement of loss
potential considering current economic conditions and the nature of the
underlying receivables.
Interest expense decreased by $118,000, or 4%, for the three months
ended March 31, 2003 as compared to the three months ended March 31, 2002. This
decrease resulted primarily from an overall decrease in the level of borrowings.
Dealer fundings were $1.2 million for the three months ended March 31,
2003, down $21.4 million, or 95% as compared to the three months ended March 31,
2002. This decrease is a result of the Company's decision during the third
quarter of 2002 to suspend new contract originations until a new line of credit
is obtained. Total cash from customers decreased by $7.1 million or 15% to a
total of $39.7 million. This decrease is primarily the result of a decrease in
the size of the overall portfolio. Investment in lease and loan receivables due
in installments, estimated residuals, rental and service contracts were down
from $396.5 million in December of 2002 to $357.4 million in March of 2003.
14
Critical Accounting Policies
In response to the SEC's release No. 33-8040, "Cautionary Advice
regarding Disclosure About Critical Accounting Policies," Management identified
the most critical accounting principles upon which our financial status depends.
The Company determined the critical principles by considering accounting
policies that involve the most complex or subjective decisions or assessments.
We identified our most critical accounting policies to be those related to
revenue recognition and maintaining the allowance for credit losses. These
accounting policies are discussed below as well as within the notes to the
consolidated financial statements.
The Company's investments in cancelable service contracts are recorded
at cost and amortized over the expected life of the service period. Income on
service contracts from monthly billings is recognized as the related services
are provided. The Company periodically evaluates whether events or circumstances
have occurred that may affect the estimated useful life or recoverability of the
investment in service contracts. Rental equipment is either recorded at
estimated residual value and depreciated using the straight-line method over a
period of 12 months or at the acquisition cost and depreciated using the
straight line method over a period of 36 months. Loans are reported at their
outstanding principal balance. Interest income on loans is recognized as it is
earned.
The Company's lease contracts are accounted for as financing leases. At
origination, the Company records the gross lease receivable, the estimated
residual value of the leased equipment, initial direct costs incurred and the
unearned lease income. Unearned lease income is the amount by which the gross
lease receivable plus the estimated residual value exceeds the cost of the
equipment. Unearned lease income and initial direct costs incurred are amortized
over the related lease term using the interest method. Amortization of unearned
lease income and initial direct costs is suspended if, in the opinion of
management, full payment of the contractual amount due under the lease agreement
is doubtful. In conjunction with the origination of leases, the Company may
retain a residual interest in the underlying equipment upon termination of the
lease. The value of such interests is estimated at inception of the lease and
evaluated periodically for impairment. Other revenues such as loss and damage
waiver fees, service fees relating to the leases, contracts and loans, and
rental revenues are recognized as they are earned.
The Company maintains an allowance for credit losses on its investment
in leases, service contracts, rental contracts and loans at an amount that it
believes is sufficient to provide adequate protection against losses in its
portfolio. The allowance is determined principally on the basis of the
historical loss experience of the Company and the level of recourse provided by
such lease, service contract, rental contract or loan, if any, and reflects
management's judgment of additional loss potential considering current economic
conditions and the nature and characteristics of the underlying lease portfolio.
The Company determines the necessary periodic provision for credit losses taking
into account actual and expected losses in the portfolio as a whole and the
relationship of the allowance to the net investment in leases, service
contracts, rental contracts and loans. Such provisions generally represent a
percentage of funded amounts of leases, contracts and loans. The resulting
charge is included in the provision for credit losses.
Leases, service contracts, rental contracts and loans are charged
against the allowance for credit losses and are put on non-accrual when they are
deemed to be uncollectable. Generally, the Company deems leases, service
contracts, rental contracts and loans to be uncollectable when one of the
following occurs: (i) the obligor files for bankruptcy; (ii) the obligor dies,
and the equipment is returned; or (iii) when an account has become 360 days
delinquent without contact with the lessee. The typical monthly payment under
the Company's leases is between $30 and $50 per month. As a result of these
small monthly payments, the Company's experience is that lessees will pay past
due amounts later in the process because of the small amount necessary to bring
an account current (at 360 days past due, a lessee will typically only owe lease
payments of between $360 and $600).
The Company has developed and regularly updates proprietary credit
scoring systems designed to improve its risk-based pricing. The Company uses
credit scoring in most, but not all, of its extensions of credit. In addition,
the Company aggressively employs collection procedures and a legal process to
resolve any credit problems.
15
Exposure to Credit Losses
The following table sets forth certain information as of December 31,
2001 and 2002 and March 31, 2003 with respect to delinquent leases, service
contracts and loans. The percentages in the table below represent the aggregate
on such date of the actual amounts not paid on each invoice by the number of
days past due, rather than the entire balance of a delinquent receivable, over
the cumulative amount billed at such date from the date of origination on all
leases, service contracts, and loans in the Company's portfolio. For example, if
a receivable is 90 days past due, the portion of the receivable that is over 30
days past due will be placed in the 31-60 days past due category, the portion of
the receivable which is over 60 days past due will be placed in the 61-90 days
past due category and the portion of the receivable which is over 90 days past
due will be placed in the over 90 days past due category. The Company
historically used this methodology of calculating its delinquencies because of
its experience that lessees who miss a payment do not necessarily default on the
entire lease. Accordingly, the Company includes only the amount past due rather
than the entire lease receivable in each category.
As of As of
December 31 March
----------- -----
2001 2002 2003
---- ---- ----
Cumulative amounts billed (in thousands) $ 602,649 $ 600,637 $ 584,774
31-60 days past due 1.8% 1.0% 0.8%
61-90 days past due 1.7% 1.0% 0.8%
Over 90 days past due 13.4% 22.9% 22.7%
----------- ----------- -----------
Total past due 16.9% 24.9% 24.3%
=========== =========== ===========
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 nine banks, expiring on September 30, 2002. As
of September 30, 2002 the credit facility failed to renew and the Company has
been paying down the balance on the basis of a 36-month amortization plus
interest. Based on the terms of the agreement, interest rates increased from
Prime minus 0.25% to Prime plus 0.50% for prime based loans and from LIBOR plus
1.75% to LIBOR plus 2.50% for LIBOR based loans. In addition, based on the
covenant defaults described below, the outstanding borrowings on all loans bear
an additional 2.00% default interest. On January 3, 2003, the Company entered
into a Forbearance and Modification Agreement from the senior credit facility
which expired on February 7, 2003. Based on the terms of the Forbearance and
Modification Agreement, interest rates increased again on the prime based loans
to prime plus 1.00%. At March 31, 2003, the Company had approximately $115.1
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 senior credit facility and
16
subordinated debt, however, in October 2002, the Company suspended new contract
originations until a new source of funding is obtained.
At December 31, 2002, the Company was in default of certain of its debt
covenants in its senior credit facility and securitization agreements. The
covenants that were in default with respect to the senior credit facility,
require that the Company maintain a fixed charge ratio in an amount not less
than 130% of consolidated earnings, a consolidated tangible net worth minimum of
$77.5 million plus 50% of net income quarterly beginning with September 30,
2000, and compliance with the borrowing base. On April 14, 2003, the Company
entered into a long-term agreement with its lenders. This long-term agreement
waives the defaults described above, and in consideration for this waiver,
requires the outstanding balance of the loan to be repaid over a term of 22
months beginning in April 2003 at an interest rate of prime plus 2.0%. Based on
the amortization schedule in the new agreement, the Company is obligated to
repay a minimum of $54 million, plus applicable interest, over the next twelve
months. The covenants that were in default with respect to the securitization
agreements, require that the Company maintain a fixed charge ratio in an amount
not less than 125% of consolidated earnings and a consolidated tangible net
worth greater than $90 million plus 50% of net income for each fiscal quarter
after June 30, 2001. The Company received a waiver, which was set to expire on
April 15, 2003, for the covenant violations in connection with the
securitization agreement. Subsequently, the Company received a permanent waiver
of the covenant defaults and the securitization agreement was amended so that
going forward, the covenants are the same as those contained in the long-term
agreement entered into on April 14, 2003, for the senior credit facility.
The Company believes that cash flows from its portfolio will be
sufficient to fund the Company's operations for the foreseeable future, given
the satisfactory resolution of the Company's discussions with the lenders
involved in the senior credit facility and the securitized notes.
Contractual Obligations and Commercial Commitments
The Company has entered into various agreements, such as long term debt
agreements, capital lease agreements and operating lease agreements that require
future payments be made. Long term debt agreements include all debt outstanding
under the senior credit facility, securitizations, subordinated notes, demand
notes and other notes payable.
At March 31, 2003 the repayment schedules for outstanding long term
debt, minimum lease payments under non-cancelable operating leases and future
minimum lease payments under capital leases were as follows:
For the year ended Long-Term Operating Capital
December 31, Debt Leases Leases Total
------------------ ---- ------ ------ -----
2003 $ 67,924 $ 1,321 $ 132 $ 69,377
2004 60,776 867 169 61,812
2005 17,151 227 55 17,433
2006 2,600 - - 2,600
Thereafter 2 - - 2
----------- ----------- ----------- -----------
Total $ 148,453 $ 2,415 $ 356 $ 151,224
=========== =========== =========== ===========
Note on Forward-Looking Information
Statements in this document that are not historical facts are
forward-looking statements made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. In addition, words such as
"believes," "anticipates," "expects," and similar expressions are intended to
identify forward-looking statements. The Company cautions that a number of
important factors could cause actual results to differ materially from those
expressed in any forward-looking statements made by or on behalf of the Company.
Such statements contain a number of risks and uncertainties, including but not
limited to: the Company's dependence on point-of-sale authorization systems and
expansion into new markets; the Company's significant capital requirements;
risks associated with economic downturns; higher interest rates; intense
competition; change in regulatory environment
17
and risks associated with acquisitions. Readers should not place undue reliance
on forward-looking statements, which reflect the management's view only as of
the date hereof. The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect subsequent events or circumstances. The
Company cannot assure that it will be able to anticipate or respond timely to
changes which could adversely affect its operating results in one or more fiscal
quarters. Results of operations in any past period should not be considered
indicative of results to be expected in future periods. Fluctuations in
operating results may result in fluctuations in the price of the Company's
common stock. For a more complete description of the prominent risks and
uncertainties inherent in the Company's business, see the risks factors
described in the Company's Form S-1 Registration Statement and other documents
filed from time to time with the Securities and Exchange Commission.
18
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market-Rate-Sensitive Instruments and Risk Management
The following discussion about the Company's risk management activities
includes forward-looking statements that involve risk and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements.
In the normal course of operations, the Company also faces risks that
are either nonfinancial or nonquantifiable. Such risks principally include
country risk, credit risk, and legal risk, and are not represented in the
analysis that follows.
Interest Rate Risk Management
The implicit yield to the Company on all of its leases, contracts and
loans is on a fixed interest rate basis due to the leases, contracts and loans
having scheduled payments that are fixed at the time of origination of the
lease. When the Company originates or acquires leases, contracts, and loans it
bases its pricing in part on the spread it expects to achieve between the
implicit yield rate to the Company on each lease and the effective interest cost
it will pay when it finances such leases, contracts and loans through its credit
facility. Increases in interest rates during the term of each lease, contract or
loan could narrow or eliminate the spread, or result in a negative spread. The
Company has adopted a policy designed to protect itself against interest rate
volatility during the term of each lease, contract or loan.
Given the relatively short average life of the Company's leases,
contracts and loans, the Company's goal is to maintain a blend of fixed and
variable interest rate obligations. As of March 31, 2003, the Company's
outstanding fixed-rate indebtedness outstanding under the Company's
securitizations and subordinated debt represented 20.2% of the Company's total
outstanding indebtedness.
ITEM 4. CONTROLS AND PROCEDURES
(a) Disclosure controls and procedures. Within 90 days before filing this
report, we evaluated the effectiveness of the design and operation of our
disclosure controls and procedures. Our disclosure controls and procedures are
the controls and other procedures that we designed to ensure that we record,
process, summarize and report in a timely manner the information we must
disclose in reports that we file with or submit to the SEC. Richard F. Latour,
our President and Chief Executive Officer, and James R. Jackson Jr., our Vice
President and Chief Financial Officer, reviewed and participated in this
evaluation. Based on this evaluation, Messrs. Richard F. Latour and James R.
Jackson Jr. concluded that, as of the date of their evaluation, our disclosure
controls were effective.
(b) Internal controls. Since the date of the evaluation described above, there
have not been any significant changes in our internal accounting controls or in
other factors that could significantly affect those controls.
19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Management believes, after consultation with counsel, that the
allegations against the Company included in the lawsuits described below are
subject to substantial legal defenses, and the Company is vigorously defending
each of the allegations. The Company also is subject to claims and suits arising
in the ordinary course of business. At this time, it is not possible to estimate
the ultimate loss or gain, if any, related to these lawsuits, nor if any such
loss will have a material adverse effect on the Company's results of operations
or financial position.
A. The Company filed an action in the United States District Court for
the District of Massachusetts against Sentinel Insurance Company, Ltd.,
("Sentinel"), Premier Holidays International, Inc., ("Premier") and Daniel
DelPiano ("DelPiano") arising from Premier's October, 1999, default on its
repayment obligations to the Company under a Twelve Million Dollar ($12,000,000)
loan. Judgment has been entered in this case against Sentinel, which had issued
a business performance insurance policy guaranteeing repayment of the loan, in
the amount of Fourteen Million Dollars ($14,000,000). This judgment has not been
satisfied. Sentinel is currently undergoing liquidation proceedings, and a claim
in this amount has been filed with the bankruptcy court. Premier has asserted a
counterclaim against the Company for Seven Hundred Sixty Nine Million Three
Hundred Fifty Thousand dollars ($769,350,000) in actual and consequential
damages, and for Five Hundred Million Dollars ($500,000,000) in punitive
damages, plus interest, cost and attorney's fees. The counterclaim is based upon
an alleged representation by the Company that it would lend Premier an
additional Forty-Five Million Dollars ($45,000,000), when all documents
evidencing the Premier loan refer only to the Twelve Million ($12,000,000)
amount actually loaned and not repaid. The Company denies any liability on the
counterclaim, which the Company is vigorously contesting. The Company's motion
for summary judgment seeking dismissal of the counterclaim and the award of full
damages on the Company's claims was denied by Court Order, without a written
decision. The Company's motion for the appointment of a special master was also
denied without a written decision. Because of the uncertainties inherent in
litigation, we cannot predict whether the outcome will have a material adverse
effect.
B. On January 29, 2002, Leasecomm was served with an Amended Complaint
("Complaint") in an action entitled People v. Roma Computer Solutions, Inc., et
al., Ventura County Superior Court Case No. CIV207490. The Complaint asserts two
claims, one for violation of the California Business Professions Code Section
17500 (false advertising), and the other for violation of the California
Business and Professions Code Section 17200 (unfair or unlawful acts or
practices). The claims arise from the marketing and selling activities of other
defendants, including Roma Computer Solutions, Inc., and/or Maro Securities,
Inc. The Complaint seeks to have Leasecomm held liable for the acts of other
defendants, alleging that Leasecomm directly participated in those acts and
received proceeds and the assignment of lease contracts as a result of those
acts. The Complaint requests injunctive relief, rescission, restitution, and a
civil penalty. The Company has filed an Answer denying the claims. Because of
the uncertainties inherent in litigation, we cannot predict whether the outcome
will have a material adverse affect.
C. In October, 2002, the Company was served with a Complaint in an
action in the United States District Court for the Southern District of New York
filed by approximately 170 present and former lessees asserting individual
claims. The Complaint contains claims for violation of RICO (18 U.S.C. Section
1964), fraud, unfair and deceptive acts and practices, unlawful franchise
offerings, and intentional infliction of mental anguish. The claims purportedly
arise from Leasecomm's dealer relationships with Themeware, E-Commerce Exchange,
Cardservice International, Inc., and Online Exchange for the leasing of websites
and virtual terminals. The Complaint asserts that the Company is responsible for
the conduct of its dealers in trade shows, infomercials and web page
advertisements, seminars, direct mail, telemarketing, all which are alleged to
constitute unfair and deceptive acts and practices. Further, the Complaint
asserts that Leasecomm's lease contracts as well as its collection practices and
late fees are unconscionable. The Complaint seeks restitution, compensatory and
treble damages, and injunctive relief. The Company filed a Motion to Dismiss the
Complaint on January 31, 2003, and expects that the Motion will be argued
sometime after June 30, 2003. Because of the uncertainties inherent in
litigation, we cannot predict whether the outcome will have a material adverse
effect.
D. On March 31, 2002, plaintiffs Robert Hayden and Renono Wesley filed
a Complaint against Leasecomm Corporation alleging a violation of California
Business & Professions Code Section 17200. The Complaint was filed on behalf of
Hayden and Wesley individually, on behalf of a class of people similarly
situated, and on behalf of
20
the general public. The case is venued in San Francisco Superior Court.
Specifically, plaintiffs allege that Leasecomm's practice of filing suits
against lessees in Massachusetts courts constitutes an unfair business practice
under California law. On March 12, 2003, the San Francisco County Superior Court
granted Leasecomm's Motion to dismiss this action.
E. On August 22, 2002 plaintiff Aaron Cobb filed a Complaint against
Leasecomm Corporation and MicroFinancial, Inc. and another Entity known as
Galaxy Mall, Inc. alleging breach of contract; Fraud, Suppression and Deceit;
Unjust Enrichment; Conspiracy; Conversion; Theft by Deception; and violation of
Alabama Usury Laws. The Complaint was filed on behalf of Aaron Cobb
individually, and on behalf of a class of persons and entities similarly
situated in the State of Alabama. More specifically, the Plaintiff purports to
represent a class of persons and small business in the State of Alabama who
allegedly were induced to purchase services and/or goods from any of the
Defendants named in the Complaint. The case is venued in Bullock County,
Alabama. On March 31, 2003 the trial court entered an Order denying the
Company's Motion to Dismiss. An appeal of the Order was filed with the Alabama
Supreme Court on May 12, 2003. The Company continues to deny any wrongdoing and
plans to vigorously defend this claim. Because of the uncertainties inherent in
litigation, the company cannot predict whether the outcome will have a material
adverse affect.
F. In March, 2003, an action was filed by a shareholder against the
Company in United States District Court asserting a single count of common law
fraud and constructive fraud. The complaint alleges that the shareholder was
defrauded by untrue statements made to him by management, upon which he relied
in the purchase of Company stock for himself and for others. The complaint seeks
damages in an unspecified amount. Because of the uncertainties inherent in
litigation, we cannot predict whether the outcome will have a material adverse
effect.
G. In March, 2003, a purported class action was filed in Superior Court
in Massachusetts against Leasecomm and one of its dealers. The class sought to
be certified is a nationwide class (excluding certain residents of the State of
Texas) who signed identical or substantially similar lease agreements with
Leasecomm covering the same product. The complaint asserts claims for
declaratory relief, rescission, civil conspiracy, usury, breach of fiduciary
duty, and violation of Massachusetts General Laws Chapter 93A, Section 11
("Chapter 93A"). The claims concern the validity, enforceability, and alleged
unconscionability of agreements provided through the dealer, including a
Leasecomm lease, to acquire on line credit card processing services. The
complaint seeks rescission of the lease agreements with Leasecomm, restitution,
multiple damages and attorneys fees under Chapter 93A, and injunctive relief.
Because of the uncertainties inherent in litigation we cannot predict whether
the outcome will have a material adverse effect.
H. On April 29, 2003, Leasecomm was served with a Complaint filed in
the Orange County Superior Court for the State of California. In that Complaint,
Maria J. Smith purports to bring a claim against Leasecomm and two other
defendants (Galaxy Mall, Inc. and Electronic Commerce International, Inc.) for
unfair business practices and competition under California Business and
Professions Code section 17200 et seq. The essence of the claim is that Smith
and others who are similarly situated were defrauded in connection with their
acquisition of certain licenses that were financed by Leasecomm. Leasecomm
currently is expected to respond to the complaint by May 29, 2003. Management
expects to defend the action vigorously.
Leasecomm has been served with Civil Investigative Demands and
subpoenas by the Offices of the Attorney General for the states of Kansas,
Illinois, Florida, and Texas, and for the Commonwealth of Massachusetts. Those
Offices of the Attorney General, in conjunction with the Northwest Region Office
of the Federal Trade Commission, the Offices of the Attorney General for North
Carolina and North Dakota, and the Ventura County, California, District
Attorney's Office, have informed Leasecomm that they are seeking to coordinate
their investigations (collectively, the "Government Investigators"). At this
time, the principal focus of the investigations appears to be software license
leases (principally virtual terminals) and leases from certain vendor/dealers
whose activities included business opportunity seminars. Leasecomm has further
been informed that the investigations cover certain lease provisions, including
the forum selection clause and language concerning the non-cancellability of the
lease. In addition, the investigations include, among other things, whether
Leasecomm's lease termination, or rollover, provisions, are legally sufficient;
whether a Leasecomm lease is an enforceable lease; whether there were potential
problems with its leases of which Leasecomm had knowledge; whether the leases
are enforceable in accordance with their terms; whether three day right of
rescission notices were required and, if required, whether proper notices were
given; whether any lease prices were unconscionable; whether the lease of a
software license is the lease of a
21
service, not a good; whether any lease of satellites or computers are leases to
consumers which must comply with certain consumer statutes; whether electronic
fund transfer payments pursuant to a lease violate Reg. E; whether any Leasecomm
billing and collection practices or charges are unreasonable, or constitute
unfair or deceptive trade practices; whether Leasecomm's course of dealings with
its vendors/dealers makes Leasecomm liable for any of the activities of its
vendors/dealers. In April, 2002, Leasecomm and the Government Investigators
entered into provisional relief and tolling agreements which provide for
Leasecomm to take certain interim actions, toll the running of the statute of
limitations as of January 29, 2002, and require advance notice by Leasecomm of
its withdrawal from the provisional relief agreement and advance notice by each
of the Government Investigators of its intention to commence legal action. The
tolling agreement has been extended several times, and is currently to expire in
June, 2003. The parties have reached an agreement in principle, subject to
final approval by the Government Investigators, which would conclude the
investigations through the entry of consent judgments.
Additionally, from time-to-time Leasecomm receives complaints, requests
or directives from various state enforcement agencies with respect to individual
lessees or groups of lessees which are fewer than 100 in number. While these
requests or directives can occur regularly, they concern relatively few leases
and, therefore, are not likely to have a material adverse effect on the Company.
Since the investigations have not been concluded, and no legal action
has been commenced against Leasecomm, there can be no assurance as to the
eventual outcome.
ITEM 3. RECENT SALES OF UNREGISTERED SECURITIES
On April 14, 2003, the Company issued warrants to purchase an aggregate of
268,199 shares of the Company's common stock at an exercise price of $.825 per
share. The warrants were issued to the nine lenders in the Company's lending
syndicate in connection with a waiver of defaults and an extension of the
Company's term loan, and are only exercisable if the debt remains outstanding
as of June 30, 2004. The exemption from registration relied on by the Company
was Section 4(2) of the Securities Act of 1933. All investors were accredited
investors and the offering otherwise met the requirements of Regulation D under
the Securities Act.
ITEM 5. OTHER INFORMATION
The Company's chief executive officer and chief financial officer have furnished
to the SEC the certification with respect to this Form 10-Q that is required by
Section 906 of the Sarbanes-Oxley Act of 2002.
22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed herewith:
10.1 Second Amendment to Fourth Amended and Restated Revolving
Credit Agreement dated April 14, 2003 among Leasecomm
Corporation, Fleet National Bank, as agent, and the other
Lenders named therein
10.2 Warrant Purchase Agreement dated April 14, 2003 among the
Company, Fleet National Bank, as agent, and the other Lenders
named therein
10.3 Form of Warrants to purchase Common Stock of the Company
issued April 14, 2003, together with schedule of warrant
holders
10.4 Co-Sale Agreement dated April 14, 2003 among the Company,
Peter R. Bleyleben, Torrence C. Harder, Brian E. Boyle,
Richard F. Latour, Alan J. Zakon, and James R. Jackson, Jr.,
and the Lenders named therein
10.5 Registration Rights Agreement dated April 14, 2003 among the
Company and the Lenders named therein
10.6 Direction and Permanent Waiver of Trigger Events and Servicer
Events of Default dated April 15, 2003 among Ambac Assurance
Corporation, Wells Fargo Bank Minnesota, National Association
("Wells Fargo"), as indenture trustee, MFI Finance Corp. I and
Leasecomm Corporation waiving certain covenants under the
Amended and Restated Indenture dated as of September 1, 2001
and related documents thereto, all with respect to MFI Finance
Corp. I
10.7 MFI Finance II, LLC 8.00% Asset-Backed Notes, Series 2001-1:
MFI II Permanent Waiver dated April 15, 2003 between N M
Rothschild & Sons Limited and the Company waiving certain
covenants under the Amended and Restated Indenture dated as of
September 1, 2001 and related documents thereto, all with
respect to MFI Finance Corp. II
10.8 First Amendment to Amended and Restated Indenture dated April
15, 2003 among the Company, MFI Finance Corp I, Wells Fargo,
as back-up servicer and Wells Fargo, as indenture trustee
10.9 Third Amendment to Servicing Agreement dated April 15, 2003
among the Company, MFI Finance Corp I, Wells Fargo, as back-up
servicer and Wells Fargo, as indenture trustee
10.10 First Amendment to Fourth Amended and Restated Revolving
Credit Agreement dated September 21, 2001 among Leasecomm
Corporation, Fleet National Bank, as agent, and the other
Lenders named therein
10.11 Forbearance and Modification Agreement dated January 3, 2003
among Leasecomm Corporation, Fleet National Bank, as agent,
and the other Lenders named therein
10.12 Forbearance and Modification Agreement dated January 24, 2003
among Leasecomm Corporation, Fleet National Bank, as agent,
and the other Lenders named therein
10.13 Second Amendment to Servicing Agreement dated October 14,
2002 among the Company, MFI Finance Corp I, Wells Fargo, as
back-up servicer and Wells Fargo, as indenture trustee
10.14 Letter Agreement dated April 14, 2003 among Fleet National
Bank, as Agent, the Company, and the holders of the Company's
7.5% Term Notes
10.15 Letter Agreement dated April 14, 2003 among Fleet National
Bank, as Agent, the Company, and the holders of the Company's
Subordinated Capital Notes
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) A form 8-K was filed on March 11, 2003, to announce the results for the
year ended December 31, 2002. A second report on Form 8-K was filed on
March 19, 2003 disclosing other events. A third report on Form 8-K was
filed on April 16, 2003 to announce the results for the quarter and
year ended December 31, 2002 and that the Company has secured an
amendment to its Credit Agreement and received permanent waivers under
its securitization facility.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MicroFinancial Incorporated
By: /s/ Richard F. Latour
------------------------------------------
President and Chief Executive Officer
By: /s/ James R. Jackson Jr.
------------------------------------------
Vice President and Chief Financial Officer
Date: May 15, 2003
24
CERTIFICATION
I, Richard F. Latour, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MicroFinancial
Incorporated;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
/s/ RICHARD F. LATOUR
------------------------------------------
Richard F. Latour
President and Chief Executive Officer
Date: May 15, 2003
25
CERTIFICATION
I, James R. Jackson Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of MicroFinancial
Incorporated;
3. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
7. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
/s/ JAMES R. JACKSON JR.
------------------------------------------
James R. Jackson Jr.
Vice President and Chief Financial Officer
Date: May 15, 2003
26