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MFI > SEC Filings for MFI > Form 10-Q on 14-Nov-2012All Recent SEC Filings

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Form 10-Q for MICROFINANCIAL INC


14-Nov-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Introduction

The following information should be read in conjunction with our condensed consolidated financial statements and notes thereto in Part I, Item 1 of this Quarterly Report and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2011.

Forward-Looking Information

Statements in this document that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, words such as "believes" "anticipates" "expects," "intends" and similar expressions are intended to identify forward-looking statements. We caution that a number of important factors could cause actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf. Such statements contain a number of risks and uncertainties, including but not limited to those associated with: the demand for the equipment types we finance; our significant capital requirements; our inability to obtain the financing we need, or to use internally generated funds, in order to continue originating contracts; the risks of defaults on our leases; our provision for credit losses; our residual interests in underlying equipment; possible adverse consequences associated with our collection policy; the effect of higher interest rates on our portfolio; increasing competition; increased governmental regulation of the rates and methods we use in financing and collecting on our leases and contracts; acquiring other portfolios or companies; dependence on key personnel; changes to accounting standards for equipment leases; adverse results in litigation and regulatory matters, or promulgation of new or enhanced legislation or regulations; information technology systems disruptions; and general economic and business conditions. Readers should not place undue reliance on forward-looking statements, which reflect our view only as of the date hereof. We undertake no obligation to publicly revise these forward-looking statements to reflect subsequent events or circumstances. We cannot assure that we will be able to anticipate or respond timely to changes which could adversely affect our operating results. Results of operations in any past period should not be considered indicative of results to be expected in future periods. Fluctuations in operating results may result in fluctuations in the price of our common stock. Statements relating to past dividend payments or our current dividend policy should not be construed as a guarantee that any future dividends will be paid. For a more complete description of the prominent risks and uncertainties inherent in our business, see the risk factors included in our most recent Annual Report on Form 10-K and other documents we file from time to time with the Securities and Exchange Commission.

Overview

We are a specialized commercial/consumer finance company that provides "microticket" equipment leasing and other financing services. The average amount financed by TimePayment during 2012 year to date has been approximately $5,300, compared to the 2011 average of $5,900. LeaseComm historically financed contracts of approximately $1,900. Our existing portfolio primarily consists of business equipment leased or rented to small commercial enterprises.

We finance the origination of our leases and contracts primarily through cash provided by operating activities and borrowings under our revolving line of credit. On August 2, 2007, we entered into a revolving line of credit with a bank syndicate led by Sovereign Bank ("Sovereign") based on qualified TimePayment lease receivables. The commitment under this facility has been increased at various times, most recently in July 2010, to $100 million. Outstanding borrowings are collateralized by eligible lease contracts and a security interest in all of our other assets. As a part of the July 2010 amendment, the interest rate was lowered to Prime plus 1.25% or LIBOR plus 3.25%. In October 2011, the credit facility was amended to reduce the rate to Prime plus 0.75% or LIBOR plus 2.75%, and to extend the maturity date of the facility to August 2, 2014. Under the terms of the facility, loans are Prime Rate Loans, unless we elect LIBOR Loans. If a LIBOR Loan is not renewed at maturity, it automatically converts to a Prime Rate Loan. At our option upon maturity, the unpaid principal balance may be converted to a six-month term loan.


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In a typical lease transaction, we originate a lease through our nationwide network of equipment vendors, independent sales organizations and brokers. Upon our approval of a lease application and verification that the lessee has received the equipment and signed the lease, we pay the dealer for the cost of the equipment, plus the dealer's profit margin.

Substantially all leases originated or acquired by us are non-cancelable. During the term of the lease, we are scheduled to receive payments sufficient to cover our borrowing costs and the cost of the underlying equipment and provide us with an appropriate profit. We pass along some of the costs of our leases and contracts by charging late fees, prepayment penalties, loss and damage waiver fees and other service fees, when applicable. Collection fees are imposed based on our estimate of the costs of collection. The loss and damage waiver fees are charged if a customer fails to provide proof of insurance and are reasonably related to the cost of replacing the lost or damaged equipment or product. The initial non-cancelable term of the lease is equal to or less than the equipment's estimated economic life and often provides us with additional revenues based on the residual value of the equipment at the end of the lease. Initial terms of the leases in our portfolio generally range from 12 to 60 months, with an average initial term of 44 months as of December 31, 2011.

Operating Data

Dealer funding was $23.3 million and $68.8 million for the three and nine months ended September 30, 2012, respectively; compared to $19.6 million and $56.7 million for the comparable periods in 2011. We continue to concentrate on our business development efforts, which include increasing the size of our vendor base and sourcing a larger number of applications from those vendors. Receivables due in installments, estimated residual values, net investment in service contracts and investment in rental contracts increased from $226.8 million at December 31, 2011, to $240.1 million at September 30, 2012. Net cash provided by operating activities increased by $2.9 million during the three months ended September 30, 2012, as compared to the three months ended September 30, 2011, and increased by $2.4 million during the first nine months of 2012 as compared to the equivalent period in 2011.

Critical Accounting Policies

Our significant accounting policies are more fully described in Note B to the condensed consolidated financial statements included in this Quarterly Report and in Note B to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission. Certain accounting policies are particularly important to the portrayal of our consolidated financial position and results of operations. These policies require the application of significant judgment by us and as a result, are subject to an inherent degree of uncertainty. In applying these policies, we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures. We base our estimates and judgments on historical experience, terms of existing contracts, observance of trends in the industry, information obtained from dealers and other sources, and on various other assumptions that we believe to be reasonable and appropriate under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our critical accounting policies, including revenue recognition, maintaining the allowance for credit losses, determining provisions for income taxes, and accounting for share-based compensation are each discussed in more detail in our Annual Report on Form 10-K. We have reviewed those policies and determined that they remain our critical accounting policies and that we did not make any changes in those policies during the nine months ended September 30, 2012.


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Results of Operations - Three months ended September 30, 2012, compared to the three months ended September 30, 2011

Revenue



                                                    Three Months Ended
                                                      September 30,
                                              2012       Change         2011
                                                  (Dollars in thousands)
            Income on financing leases      $ 10,160         9.2 %    $  9,306
            Rental income                      2,462        12.3         2,192
            Income on service contracts           95        (2.1 )          97
            Loss and damage waiver fees        1,370        10.4         1,241
            Service fees and other income        950         1.6           935

            Total revenues                  $ 15,037         9.2 %    $ 13,771

Our lease contracts are accounted for as financing leases. At origination, we record 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. Other revenues such as loss and damage waiver fees, service fees relating to the leases and contracts, and rental revenues are recognized as they are earned.

Total revenues for the three months ended September 30, 2012, were $15.0 million, an increase of $1.3 million, or 9.2%, from the three months ended September 30, 2011. The overall increase was due to an increase of $0.9 million in income on financing leases, an increase of $0.3 million in rental income and an increase of $0.1 million in revenue from loss and damage waiver fees. The increase in income on financing leases is a result of the continued growth in new lease originations. The increase in rental income is the result of TimePayment lease contracts coming to term and converting to rentals. The increase in loss and damage waiver fees is related to an increase in the number of leases subject to such fees as the overall lease portfolio grows. Most of our service contract revenue is derived from our LeaseComm portfolio, for which we have not purchased any new security service contracts since 2004. Consequently, our service contract revenue from LeaseComm represents a less significant portion of our revenue stream over time. Beginning in the second quarter of 2012, TimePayment has been acquiring a limited number of service contracts.

Selling, General and Administrative Expenses



                                                      Three Months Ended
                                                         September 30,
                                                2012        Change        2011
                                                    (Dollars in thousands)
         Selling, general and administrative   $ 4,466         14.5 %    $ 3,900
         As a percent of revenue                  29.7 %                    28.3 %

Our selling, general and administrative (SG&A) expenses include costs of maintaining corporate functions including accounting, finance, collections, legal, human resources, sales and underwriting, and information systems. SG&A expenses also include commissions, service fees and other marketing costs associated with our portfolio of leases and rental contracts. SG&A expenses increased by $0.6 million for the three months ended September 30, 2012, as compared to the three months ended September 30, 2011. The increase in SG&A during the third quarter of 2012 was attributable to increases in compensation-related expenses of $326,000, marketing and promotion costs of $75,000, cost of equipment sales of $68,000, and other net increases of $97,000. The number of employees as of September 30, 2012, was 145 compared to 133 as of September 30, 2011.


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Provision for Credit Losses



                                                  Three Months Ended
                                                    September 30,
                                           2012         Change        2011
                                                (Dollars in thousands)
            Provision for credit losses   $ 4,847           7.3 %    $ 4,517
            As a percent of revenue          32.2 %                     32.8 %

We maintain an allowance for credit losses on our investment in leases, service contracts and rental contracts at an amount that we believe is sufficient to provide adequate protection against losses in our portfolio. Our provision for credit losses increased by $0.3 million for the three months ended September 30, 2012, as compared to the three months ended September 30, 2011, while net charge-offs increased by 7.0% to $4.5 million. The provision was based on providing a general allowance on leases funded during the period and our analysis of actual and expected losses in our portfolio. The decrease in the allowance as a percentage of revenue reflects improvements in delinquency levels of the lease portfolio.

Depreciation and Amortization



                                                               Three Months Ended
                                                                  September 30,
                                                          2012        Change       2011
                                                             (Dollars in thousands)
 Depreciation - property and equipment                   $   149         11.2 %    $ 134
 Depreciation - rental equipment and service contracts       934         26.4        739

 Total depreciation and amortization                     $ 1,083         24.1 %    $ 873

 As a percent of revenue                                     7.2 %                   6.3 %

Depreciation and amortization expense consists of depreciation on property and equipment and rental equipment and the amortization of service contracts. Property and equipment are recorded at cost and depreciated over their expected useful lives. Certain rental contracts are originated as a result of the renewal provisions of our lease agreements where at the end of lease term, the customer may elect to continue to rent the leased equipment on a month-to-month basis. The rental equipment is recorded at its residual value and depreciated over a term of 12 months. This term represents the estimated life of a previously leased piece of equipment and is based upon our historical experience. In the event the contract terminates prior to the end of the 12 month period, the remaining net book value is expensed. Investments in service contracts are amortized over the expected life of the contract.

Depreciation expense on rental contracts increased by $0.2 million during the three months ended September 30, 2012, as compared to the three months ended September 30, 2011. The increase in depreciation is due to the increase in the overall size of our portfolio of rental equipment due to the increase in the number of TimePayment lease contracts reaching maturity and converting to rentals. Depreciation and amortization of property and equipment increased by $15,000 for the three months ended September 30, 2012.

Interest Expense



                                                Three Months Ended
                                                   September 30,
                                           2012        Change       2011
                                              (Dollars in thousands)
                Interest                  $  747           6.7 %    $ 700
                As a percent of revenue      5.0 %                    5.1 %

We pay interest on borrowings under our revolving line of credit. Interest expense increased by $47,000 for the three months ended September 30, 2012, as compared to the three months ended September 30, 2011. This increase resulted primarily from an increase in the level of borrowing on our revolving line of credit. At September 30, 2012, the balance on our revolving line of credit was $69.3 million compared to $60.5 million at September 30, 2011. The interest rate on our loans at September 30, 2012 was between 3.19% and 4.00%, as compared to interest rates between 3.53% and 4.50% at September 30, 2011.


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Provision for Income Taxes



                                                      Three Months Ended
                                                        September 30,
                                               2012         Change        2011
                                                    (Dollars in thousands)
        Provision for income taxes            $ 1,587           9.0 %    $ 1,456
        As a percent of revenue                  10.6 %                     10.6 %
        As a percent of income before taxes      40.8 %                     38.5 %

The provision for income taxes, deferred tax assets and liabilities and any necessary valuation allowance recorded against net deferred tax assets, involves summarizing temporary differences resulting from the different treatment of items, such as leases, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded on the balance sheet. We then assess the likelihood that deferred tax assets will be recovered from future taxable income or tax carry-back availability and to the extent we believe recovery is more likely than not, a valuation allowance is unnecessary. The provision for income taxes increased by $0.1 million for the three months ended September 30, 2012, as compared to the three months ended September 30, 2011. This increase resulted primarily from the $0.1 million increase in pre-tax income combined with an increase in the accrual rate from 38.5% at September 30, 2011 to 40.8% at September 30, 2012 due to the utilization of federal and certain state net operating loss carryforwards in prior periods that are no longer available.

As of December 31, 2011, we had a liability of $17,000 for unrecognized tax benefits and a liability of $4,000 for accrued interest and penalties related to various state income tax matters. As of September 30, 2012, we had a liability of $20,000 for unrecognized tax benefits and a liability of $4,000 for accrued interest and penalties related to a state income tax matter. The increase in the unrecognized tax benefit relates to additional exposure related to an ongoing audit. It is reasonably possible that the total amount of unrecognized tax benefits may change significantly within the next 12 months; however, at this time we are unable to estimate the change.

Our federal income tax returns are subject to examination for tax years ended on or after December 31, 2009, and our state income tax returns are subject to examination for tax years ended on or after December 31, 2008.

Fair Value of Financial Instruments

For financial instruments including cash and cash equivalents, restricted cash, accounts payable, and other liabilities, we believe that the carrying amount approximates fair value due to their short-term nature. The fair value of the revolving line of credit is calculated based on the incremental borrowing rates currently available on loans with similar terms and maturities. During the third quarter of 2011, we amended our revolving line of credit which reduced our interest rate to a more current rate. We have determined that the fair value of our revolving line of credit at September 30, 2012 approximates its carrying value.

Results of Operations - Nine months ended September 30, 2012, compared to the nine months ended September 30, 2011

Revenue



                                                    Nine Months Ended
                                                      September 30,
                                              2012       Change         2011
                                                  (Dollars in thousands)
            Income on financing leases      $ 29,715         7.9 %    $ 27,543
            Rental income                      7,181        14.5         6,271
            Income on service contracts          265       (14.0 )         308
            Loss and damage waiver fees        3,978         8.6         3,662
            Service fees and other income      2,837         1.4         2,798

            Total revenues                  $ 43,976         8.4 %    $ 40,582


Table of Contents

Our lease contracts are accounted for as financing leases. At origination, we record 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. Other revenues such as loss and damage waiver fees, service fees relating to the leases and contracts, and rental revenues are recognized as they are earned.

Total revenues for the nine months ended September 30, 2012, were $44.0 million, an increase of $3.4 million, or 8.4%, from the nine months ended September 30, 2011. The overall increase was due to an increase of $2.2 million in income on financing leases, an increase of $0.9 million in rental income and a $0.3 million increase in loss and damage waiver fees. The increase in income on financing leases is a result of the continued growth in new lease originations. The increase in loss and damage waiver fees is related to an increase in the number of leases subject to such fees as the overall lease portfolio grows. The increase in rental income is the result of TimePayment lease contracts coming to term and converting to rentals.

Selling, General and Administrative Expenses



                                                      Nine Months Ended
                                                        September 30,
                                               2012         Change         2011
                                                    (Dollars in thousands)
       Selling, general and administrative   $ 12,847           8.0 %    $ 11,890
       As a percent of revenue                   29.2 %                      29.3 %

Our selling, general and administrative (SG&A) expenses include costs of maintaining corporate functions including accounting, finance, collections, legal, human resources, sales and underwriting, and information systems. SG&A expenses also include commissions, service fees and other marketing costs associated with our portfolio of leases and rental contracts. SG&A expenses increased by $1.0 million for the nine months ended September 30, 2012, as compared to the nine months ended September 30, 2011. The increase was primarily driven by increases in compensation related expenses of $0.8 million and an increase in marketing expenses of $146,000.

Provision for Credit Losses



                                                  Nine Months Ended
                                                    September 30,
                                           2012         Change         2011
                                                (Dollars in thousands)
           Provision for credit losses   $ 14,291           5.7 %    $ 13,520
           As a percent of revenue           32.5 %                      33.3 %

We maintain an allowance for credit losses on our investment in leases, service contracts and rental contracts at an amount that we believe is sufficient to provide adequate protection against losses in our portfolio. Our provision for credit losses increased by $0.8 million for the nine months ended September 30, 2012, as compared to the nine months ended September 30, 2011. Net charge-offs increased by 4.8% to $14.1 million. The provision is based on providing a general allowance on leases funded during the period and our analysis of actual and expected losses in our portfolio. The decrease in the allowance as a percentage of revenue reflects improvements in delinquency levels of the lease portfolio.


Table of Contents

Depreciation and Amortization



                                                                    Nine Months Ended
                                                                      September 30,
                                                           2012          Change          2011
                                                                 (Dollars in thousands)
Depreciation - property and equipment                     $   452           20.5 %      $   375
Depreciation - rental equipment and service contracts       2,704           37.8          1,962

Total depreciation and amortization                       $ 3,156           35.0 %      $ 2,337

As a percent of revenue                                       7.2 %                         5.8 %

Depreciation and amortization expense consists of depreciation on property and equipment and rental equipment, and the amortization of service contracts. Property and equipment are recorded at cost and depreciated over their expected useful lives. Certain rental contracts are originated as a result of the renewal provisions of our lease agreements where at the end of lease term, the customer may elect to continue to rent the leased equipment on a month-to-month basis. The rental equipment is recorded at its residual value and depreciated over a term of 12 months. This term represents the estimated life of a previously leased piece of equipment and is based upon our historical experience. In the event the contract terminates prior to the end of the 12 month period, the remaining net book value is expensed. Investments in service contracts are amortized over the expected life of the contract.

Depreciation expense on rental contracts increased by $0.7 million for the nine months ended September 30, 2012, as compared to the six months ended . . .

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