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