MICROFINANCIAL INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NO.

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MICROFINANCIAL INCORPORATED
(Exact name of Registrant as Specified in its Charter)

MASSACHUSETTS 04-2962824
(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

10M COMMERCE WAY, WOBURN, MA 01801
(Address of Principal Executive Offices) (zip code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(781) 994-4800

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

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. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]

The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant, computed by reference to the closing price
of such stock as of June 28 2002, was approximately $63,960,000.

As of March 31, 2003, 13,141,800 shares of the registrant's common stock
were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
NONE
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TABLE OF CONTENTS

1

PART I

ITEM 1. BUSINESS

GENERAL

MicroFinancial Incorporated ("MicroFinancial" or the "Company") was formed
as a Massachusetts corporation on January 27, 1987. The Company, which operates
primarily through its wholly-owned subsidiary Leasecomm Corporation, is a
specialized commercial finance company that leases and rents "microticket"
equipment and provides other financing services in amounts generally ranging
from $400 to $15,000, with an average amount financed of approximately $1,500
and an average lease term of 44 months. Leasecomm Corporation started
originating leases in January 1986. The Company has used proprietary software in
developing a sophisticated, risk-adjusted pricing model and in automating its
credit approval and collection systems, including a fully-automated,
Internet-based application, credit scoring and approval process.

The Company provides financing to lessees which may have few other sources
of credit. The Company primarily leases and rents low-priced commercial
equipment which is used by these lessees in their daily operations. The Company
does not market its services directly to lessees, but sources leasing
transactions through a nationwide network of over 1,000 independent sales
organizations and other dealer-based origination networks ("Dealers").

The majority of the Company's leases are currently for authorization
systems for point-of-sale, card-based payments by, for example, debit, credit
and charge cards ("POS authorization systems"). POS authorization systems
require the use of a POS terminal capable of reading a cardholder's account
information from the card's magnetic strip and combining this information with
the amount of the sale entered via a POS terminal keypad, or POS software used
on a personal computer to process a sale. The terminal electronically transmits
this information over a communications network to a computer data center and
then displays the returned authorization or verification response on the POS
terminal.

As of September 30, 2002, the Company's credit facility failed to renew. As
a result, in October 2002, the Company made the decision to suspend new contract
originations until a source of funding is obtained. The Company is currently
working with a capital advisory firm in an effort to obtain a new line of credit
in order to resume funding activity. The Company remains hopeful that a new
funding facility can be in place in a reasonable period of time.

LEASING, SERVICING AND FINANCING PROGRAMS

The Company originates leases for products that typically have limited
distribution channels and high selling costs. The Company facilitates sales of
such products by making them available to Dealers' customers for a small monthly
lease payment rather than a high initial purchase price. The Company primarily
leases and rents low-priced commercial equipment to small merchants. The
majority of the Company's leases are currently for POS authorization systems;
however, the Company also leases a wide variety of other equipment including
advertising and display equipment, coffee machines, paging systems, water
coolers and restaurant equipment. In addition, the Company also acquires service
contracts and contracts in certain other financing markets. The Company
opportunistically seeks to enter various other financing markets.

The Company's residential financings include acquiring service contracts
from Dealers that provide security monitoring services, primarily.

The Company originates and services leases, contracts and loans in all 50
states of the United States and its territories. As of December 31, 2001 and
2002, leases in California, Florida, Texas, Massachusetts and New York accounted
for approximately 42% of the Company's portfolio. Only California accounted for
more than 10% of the total portfolio as of December 31, 2001 and 2002 at
approximately 14%. None of the remaining states accounted for more than 4% of
such total.

2

TERMS OF EQUIPMENT LEASES

Substantially all equipment leases originated or acquired by the Company
are non-cancelable. In a typical lease transaction, the Company originates
leases referred to it by the Dealer and buys the underlying equipment from the
referring Dealer upon the funding of an approved application. Leases are
structured with limited recourse to the Dealer, with risk of loss in the event
of default by the lessee residing with the Company in most cases. The Company
performs all processing, billing and collection functions under its leases.

During the term of a typical lease, the Company is scheduled to receive
payments sufficient, in the aggregate, to cover the Company's borrowing costs
and the costs of the underlying equipment, and to provide the Company with an
appropriate profit. Throughout the term of the lease, the Company charges late
fees, prepayment penalties, loss and damage waiver fees and other service fees,
when applicable. Initial terms of the leases in the Company's portfolio
generally range from 12 to 48 months, with an average initial term of 44 months
as of December 31, 2002.

The terms and conditions of all of the Company's leases are substantially
similar. In most cases, the contracts require lessees to: (i) maintain, service
and operate the equipment in accordance with the manufacturer's and
government-mandated procedures; (ii) insure the equipment against property and
casualty loss; (iii) pay all taxes associated with the equipment; and (iv) make
all scheduled contract payments regardless of the performance of the equipment.
The Company's standard lease forms provide that in the event of a default by the
lessee, the Company can require payment of liquidated damages and can seize and
remove the equipment for subsequent sale, refinancing or other disposal at its
discretion. Any additions, modifications or upgrades to the equipment,
regardless of the source of payment, are automatically incorporated into, and
deemed a part of, the equipment financed.

The Company seeks to protect itself from credit exposure relating to
poor-quality Dealers by entering into limited recourse agreements with its
Dealers, under which the Dealer agrees to reimburse the Company for payment of
defaulted amounts under certain circumstances, primarily defaults within the
first month following origination, and upon evidence of Dealer errors or
misrepresentations in originating a lease or contract.

RESIDUAL INTERESTS IN UNDERLYING EQUIPMENT

The Company typically owns a residual interest in the equipment covered by
a lease. At the end of the lease term, the lease typically converts into a
month-to-month rental contract. If the lease does not convert, the lessee either
buys the equipment at a price quoted by the Company or returns the equipment. If
the equipment is returned, the Company may either sell the equipment, or place
it into its used equipment rental or leasing program.

SERVICE CONTRACTS

In a typical transaction for the acquisition of service contracts, a
homeowner will purchase a security system and simultaneously sign a contract
with the Dealer for the monitoring of that system for a monthly fee. The Dealer
will then sell the right to payment under that contract to the Company for a
multiple of the monthly payments. The Company performs all processing, billing
and collection functions under these contracts.

DEALERS

The Company provides financing to obligors under microticket leases,
contracts and loans through its Dealers. The Company had over 1,000 different
Dealers originating 50,106 Company leases, contracts and loans in 2002. One
dealer accounted for approximately 10.6%, 4.5%, and .22% of all originations
during the years ended December 31, 2000, 2001, and 2002, respectively. Another
dealer accounted for approximately 4.89%, 7.38%, and 10.98% of all originations
during the years ended December 31, 2000, 2001, and 2002, respectively. No other
dealer accounted for more than 10% of the Company's origination volume during
the years ended December 31, 2000, 2001, or 2002.

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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 multidimensional
credit-scoring model which generates pricing of its leases, contracts and loans
commensurate with the risk assumed. This software does not produce a binary "yes
or no" decision, but rather, determines the price at which the lease, contract
or loan can be profitably underwritten. The Company uses credit scoring in most,
but not all, of its extension of credit.

UNDERWRITING

The nature of the Company's business requires two levels of review: the
first focused on the ultimate end-user of the equipment or service and the
second focused on the Dealer. The approval process begins with the submission by
telephone, facsimile or electronic transmission of a credit application by the
Dealer. Upon submission, the Company, either manually or through
LeasecommDirect(TM) over the Internet, conducts its own independent credit
investigation of the lessee through its own proprietary database and recognized
commercial credit reporting agencies such as Dun & Bradstreet, Experian, Equifax
and TransUnion. The Company's software evaluates this information on a
two-dimensional scale, examining both credit depth (how much information exists
on an applicant) and credit quality (past payment history). The Company is thus
able to analyze both the quality and amount of credit history available with
respect to both obligors and Dealers and to assess the credit risk. The Company
uses this information to underwrite a broad range of credit risks and provide
financing in situations when its competitors may be unwilling to provide such
financing. The credit-scoring model is complex and automatically adjusts for
different transactions. In situations where the amount financed is over $6,000,
the Company may go beyond its own data base and recognized commercial credit
reporting agencies to obtain information from less readily available sources
such as banks. In certain instances, the Company will require the lessee to
provide verification of employment and salary.

The second aspect of the credit decision involves an assessment of the
originating Dealer. Dealers undergo both an initial screening process and
ongoing evaluation, including an examination of Dealer portfolio credit quality
and performance, lessee complaints, cases of fraud or misrepresentation, aging
studies, number of applications and conversion rates for applications. This
ongoing assessment enables the Company to manage its Dealer relationships,
including ending relationships with poorly performing Dealers.

Upon credit approval, the Company requires receipt of signed lease
documentation on the Company's, standard or other pre-approved, lease form
before funding. Once the equipment is shipped and installed, the Dealer invoices
the Company, and thereafter, the Company verifies that the lessee has received
and accepted the equipment. Upon the lessee authorizing payment to the Dealer,
the lease is forwarded to the Company's funding and documentation department for
funding, transaction accounting, and billing procedures.
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BULK AND PORTFOLIO ACQUISITIONS

In addition to originating leases through its Dealer relationships, the
Company, from time to time, has purchased lease portfolios from Dealers. The
Company purchases leases from Dealers on an ongoing basis in packages ranging
from $20,000 to $200,000. While certain of these leases initially do not meet
the Company's underwriting standards, the Company often will purchase the leases
once the lessee demonstrates a payment history. The Company will only acquire
these smaller lease portfolios in situations where the company selling the
portfolio will continue to act as a Dealer following the acquisition. The
Company has also completed the acquisition of six large POS authorization system
lease and rental portfolios: two in 1996, one in 1998, one in 1999, one in 2000
and the acquisition of the rental and lease portfolio of Resource Leasing in
2001. The acquisition, completed in September of 1999, consisted of 2,148 leases
with fundings of $3.2 million. The acquisition, completed in April of 2000,
consisted of 7,085 rental contracts and 1,996 lease contracts, together totaling
fundings of $5.5 million. On January 3, 2001, the Company acquired the rental
and lease portfolio of Resource Leasing Corporation ("Resource") along with
certain other assets. The acquisition consisted of 7,862 rental contracts and
326 lease contracts.

SERVICING AND COLLECTIONS

The Company performs all servicing functions on its leases, contracts and
loans, including its securitized leases, through its automated servicing and
collection system. Servicing responsibilities generally include billing,
processing payments, remitting payments to Dealers and investors in the
Company's securitization programs (the "Securitizations"), preparing investor
reports, paying taxes and insurance and performing collection and liquidation
functions.

The Company'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
customer service and collection efforts, including the generation of daily
priority call lists and scrolling for daily delinquent account servicing,
generation and mailing of delinquency letters, and routing of incoming customer
service calls to appropriate employees with instant computerized access to
account details. The Company's collection efforts include one or more of the
following: sending collection letters, making collection calls, reporting
delinquent accounts to credit reporting agencies, and litigating delinquent
accounts when necessary and obtaining and enforcing judgments. The Company also
has started to use a collectability scoring model to determine if the benefits
from further collection efforts will out weigh the costs associated with those
efforts.

COMPETITION

The microticket leasing and financing industry is highly competitive. The
Company competes for customers with a number of national, regional and local
banks and finance companies. The Company's competitors also include equipment
manufacturers that lease or finance the sale of their own products. While the
market for microticket financing has traditionally been fragmented, the Company
could also be faced with competition from small- or large-ticket leasing
companies that could use their expertise in those markets to enter and compete
in the microticket financing market. The Company's competitors include larger,
more established companies, some of which may possess substantially greater
financial, 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, 2002, the Company had 203 full-time employees, of whom 7
were engaged in credit activities and Dealer service, 136 were engaged in
servicing and collection activities, 1 was engaged in marketing activities, and
59 were engaged in general administrative activities. Management believes that
its

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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.

AVAILABILITY OF INFORMATION

The Company will provide without charge to each of its stockholders upon
the written request of such person, a copy of the Company's Annual Report on
Form 10K for its fiscal year ended December 31, 2002, including the financial
statements and the financial statement schedules, required to be filed with the
Securities and Exchange Commission. Requests for such document should be
directed to Richard F. Latour, Chief Executive Officer, at 10M Commerce Way,
Woburn, Massachusetts 01801.

ITEM 2. PROPERTIES

The Company's corporate headquarters and operations center are located in
leased space of 44,659 square feet of office space at 10M Commerce Way, Woburn
Massachusetts 01801. The lease for this space expires on December 14, 2003. The
Company also leases 5,133 square feet of office space for its West Coast office
in Newark, California, under a lease that expires on May 1, 2005. The Company
also leases 21,656 square feet of office space in Waltham, Massachusetts, under
a lease that expires on July 31, 2004.

On January 3, 2001, the Company acquired certain assets and assumed certain
liabilities of Resource Leasing Corporation. As a result of this transaction,
the Company occupied 15,399 square feet of office space in Herndon, Virginia.

The Company is no longer utilizing the facilities in Newark, California and
Herndon, Virginia. Also, the Company is in the process of moving its
headquarters from Waltham, Massachusetts to its facility in Woburn,
Massachusetts.

ITEM 3. LEGAL PROCEEDINGS

Management believes, after consultation with counsel, that the allegations
against the Company included in the lawsuits described below are subject to
substantial legal defenses, and the Company is vigorously defending each of the
allegations. The Company also is subject to claims and suits arising in the
ordinary course of business. At this time, it is not possible to estimate the
ultimate loss or gain, if any, related to these lawsuits, nor if any such loss
will have a material adverse effect on the Company's results of operations or
financial position.

A. The Company filed an action in the United States District Court for the
District of Massachusetts against Sentinel Insurance Company, Ltd.,
("Sentinel"), Premier Holidays International, Inc., ("Premier") and Daniel
DelPiano ("DelPiano") arising from Premier's October, 1999, default on its
repayment obligations to the Company under a Twelve Million Dollar ($12,000,000)
loan. Judgment has been entered in this case against Sentinel, which had issued
a business performance insurance policy guaranteeing repayment of the loan, in
the amount of Fourteen Million Dollars ($14,000,000). This judgment has not been
satisfied. Sentinel is currently undergoing liquidation proceedings, and a claim
in this amount has been filed with the bankruptcy court. Premier has asserted a
counterclaim against the Company for Seven Hundred Sixty Nine Million Three
Hundred Fifty Thousand dollars ($769,350,000) in actual and consequential
damages, and for Five Hundred Million Dollars ($500,000,000) in punitive
damages, plus interest, cost and attorney's fees. The counterclaim is based upon
an alleged representation by the Company that it would lend Premier an
additional Forty-Five Million Dollars ($45,000,000), when all documents
evidencing the Premier loan refer only to the Twelve Million ($12,000,000)
amount actually loaned and not repaid. The Company denies any liability on the
counterclaim, which the Company is vigorously contesting. The Company's motion
for summary judgment seeking dismissal of the counterclaim and the award of full
damages on the Company's claims was denied by Court Order, without a written
decision. The Company's motion for the appointment of a special master was also
denied without a written decision. Because of the uncertainties inherent in
litigation, we cannot predict whether the outcome will have a material adverse
effect.

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B. On January 29, 2002, Leasecomm was served with an Amended Complaint
("Complaint") in an action entitled People v. Roma Computer Solutions, Inc., et
al., Ventura County Superior Court Case No. CIV207490. The Complaint asserts two
claims, one for violation of the California Business Professions Code Section
17500 (false advertising), and the other for violation of the California
Business and Professions Code Section 17200 (unfair or unlawful acts or
practices). The claims arise from the marketing and selling activities of other
defendants, including Roma Computer Solutions, Inc., and/or Maro Securities,
Inc. The Complaint seeks to have Leasecomm held liable for the acts of other
defendants, alleging that Leasecomm directly participated in those acts and
received proceeds and the assignment of lease contracts as a result of those
acts. The Complaint requests injunctive relief, rescission, restitution, and a
civil penalty. The Company has filed an Answer denying the claims. Because of
the uncertainties inherent in litigation, we cannot predict whether the outcome
will have a material adverse affect.

C. On May 8, 2000, Plaintiff Efraim Bason brought an action in the Supreme
Court of the State of New York, County of Nassau, seeking compensatory damages
in the amount of $450,000 and punitive damages under various legal theories for
Leasecomm's refusal to promptly release him from an equipment lease to which he
claims his name was forged (the "Bason Complaint"). The Bason Complaint alleged
that Leasecomm's failure to promptly release him from the lease, and subsequent
negative reports to credit agencies, ruined his credit and prevented him from
securing certain financing that he allegedly needed to purchase merchandise
which he claims he could have then re-sold at a $450,000 profit. Leasecomm has
subsequently settled this matter with Court approval.

D. On January 29, 2002, Leasecomm was served with an Amended Complaint
("Complaint") in an action entitled Rae Lynn Copitka v. Leasecomm Corp., et al.,
Travis County (Texas) District Court Case No. GN-102292. The Complaint asserts
that the original action, filed mid-2001 by a single plaintiff should proceed as
a class action. In the original action, Ms. Copitka sought to rescind her
finance lease with Leasecomm and to recover economic damages arising from prior
payments under the lease. Ms. Copitka alleges that her proposed class includes
all persons in Texas who have executed Leasecomm finance leases for "virtual
terminal" type credit card software during the years 1998, 1999, 2000, and 2001.
On November 25, 2002 Leasecomm and E-Commerce Exchange agreed to settle the case
with Ms. Copitka and a class of residents of Texas who leased Quickcommerce or
QuickcommercePro software licenses from Leasecomm. The Travis County District
Court entered its order approving the class settlement and entered its final
judgement in the case on January 24, 2003. Leasecomm has satisfied its
obligations under the Settlement, and the time to appeal has expired.

E. On April 3, 2000, a purported class action suit was filed in Superior
Court of the State of California, County of San Mateo against Leasecomm and
MicroFinancial as well as a number of other defendants with whom Leasecomm and
MicroFinancial are alleged to have done business, directly or indirectly. The
complaint seeks certification of a subclass of those class members who entered
into any lease agreement contracts with Leasecomm for the purposes of financing
the goods or services allegedly purchased from other defendant entities. The
class action complaint alleges multiple causes of action, including: fraud and
deceit; negligent misrepresentation; unfair competition; false advertising;
unjust enrichment; fraud in the inducement and the inception of contract; lack
of consideration for contact; and breach of the contractual covenant of good
faith and fair dealing.

The Court granted final approval of the class action Settlement on December
2, 2002. Leasecomm has satisfied its obligations under the Settlement, and the
time to appeal has expired. The Court retains jurisdiction to oversee any issues
that may arise regarding administration of the settlement.

F. In October, 2002, the Company was served with a Complaint in an action
in the United States District Court for the Southern District of New York filed
by approximately 170 present and former lessees asserting individual claims. The
Complaint contains claims for violation of RICO (18 U.S.C. sec. 1964), fraud,
unfair and deceptive acts and practices, unlawful franchise offerings, and
intentional infliction of mental anguish. The claims purportedly arise from
Leasecomm's dealer relationships with Themeware, E-Commerce Exchange,
Cardservice International, Inc., and Online Exchange for the leasing of websites
and virtual terminals. The Complaint asserts that the Company is responsible for
the conduct of its dealers in trade shows,

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infomercials and web page advertisements, seminars, direct mail, telemarketing,
all which are alleged to constitute unfair and deceptive acts and practices.
Further, the Complaint asserts that Leasecomm's lease contracts as well as its
collection practices and late fees are unconscionable. The Complaint seeks
restitution, compensatory and treble damages, and injunctive relief. The Company
filed a Motion to Dismiss the Complaint on January 31, 2003, and expects that
the Motion will be argued sometime after May 6, 2003. Because of the
uncertainties inherent in litigation, we cannot predict whether the outcome will
have a material adverse effect.

G. On March 31, 2002, plaintiffs Robert Hayden and Renono Wesley filed a
Complaint against Leasecomm Corporation alleging a violation of California
Business & Professions Code Section 17200. The Complaint was filed on behalf of
Hayden and Wesley individually, on behalf of a class of people similarly
situated, and on behalf of the general public. The case is venued in San
Francisco Superior Court. Specifically, plaintiffs allege that Leasecomm's
practice of filing suits against lessees in Massachusetts courts constitutes an
unfair business practice under California law. On March 12, 2003, the San
Francisco County Superior Court granted Leasecomm's Motion to dismiss this
action.

H. On August 22, 2002 plaintiff Aaron Cobb filed a Complaint against
Leasecomm Corporation and MicroFinancial, Inc. and another Entity known as
Galaxy Mall, Inc. alleging breach of contract; Fraud, Suppression and Deceit;
Unjust Enrichment; Conspiracy; Conversion; Theft by Deception; and violation of
Alabama Usury Laws. The Complaint was filed on behalf of Aaron Cobb
individually, and on behalf of a class of persons and entities similarly
situated in the State of Alabama. More specifically, the Plaintiff purports to
represent a class of persons and small business in the State of Alabama who
allegedly were induced to purchase services and/or goods from any of the
Defendants named in the Complaint. The case is venued in Bullock County,
Alabama. On March 31, 2003 the trial court entered an Order denying the
Company's Motion to Dismiss. This Order is currently being reviewed and in all
likelihood will be appealed to the Alabama Supreme Court. The appeal must be
filed within 45 days of the entry of the Order. Should the appeal not be filed
or should the Company otherwise be unsuccessful with its appeal the discovery in
this case would commence with the first efforts being directed toward the Class
Certification issues. The Company continues to deny any wrongdoing and plans to
vigorously defend this claim. Because of the uncertainties inherent in
litigation, the company cannot predict whether the outcome will have a material
adverse affect.

I. In March, 2003, an action was filed by a shareholder against the
Company in United States District Court asserting a single count of common law
fraud and constructive fraud. The complaint alleges that the shareholder was
defrauded by untrue statements made to him by management, upon which he relied
in the purchase of Company stock for himself and for others. The complaint seeks
damages in an unspecified amount. Because of the uncertainties inherent in
litigation, we cannot predict whether the outcome will have a material adverse
effect.

J. In March, 2003, a purported class action was filed in Superior Court in
Massachusetts against Leasecomm and one of its dealers. The class sought to be
certified is a nationwide class (excluding certain residents of the State of
Texas) who signed identical or substantially similar lease agreements with
Leasecomm covering the same product. The complaint asserts claims for
declaratory relief, rescission, civil conspiracy, usury, breach of fiduciary
duty, and violation of Massachusetts General Laws Chapter 93A, Section 11
("Chapter 93A"). The claims concern the validity, enforceability, and alleged
unconscionability of agreements provided through the dealer, including a
Leasecomm lease, to acquire on line credit card processing services. The
complaint seeks rescission of the lease agreements with Leasecomm, restitution,
multiple damages and attorneys fees under Chapter 93A, and injunctive relief.
Because of the uncertainties inherent in litigation we cannot predict whether
the outcome will have a material adverse effect.

Leasecomm has been served with Civil Investigative Demands by the Offices
of the Attorney General for the states of Kansas, Illinois, Florida, and Texas,
and for the Commonwealth of Massachusetts. Those Offices of the Attorney
General, in conjunction with the Northwest Region Office of the Federal Trade
Commission, the Offices of the Attorney General for North Carolina and North
Dakota, and the Ventura County, California, District Attorney's Office, have
informed Leasecomm that they are seeking to coordinate their investigations
(collectively, the "Government Investigators"). At this time, the principal
focus of the

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investigations appears to be software license leases (principally virtual
terminals) and leases from certain vendor/dealers whose activities included
business opportunity seminars. Leasecomm has further been informed that the
investigations cover certain lease provisions, including the forum selection
clause and language concerning the non-cancellability of the lease. In addition,
the investigations include, among other things, whether Leasecomm's lease
termination, or rollover, provisions, are legally sufficient; whether a
Leasecomm lease is an enforceable lease; whether there were potential problems
with its leases of which Leasecomm had knowledge; whether the leases are
enforceable in accordance with their terms; whether three day right of
rescission notices were required and, if required, whether proper notices were
given; whether any lease prices were unconscionable; whether the lease of a
software license is the lease of a service, not a good; whether any lease of
satellites or computers are leases to consumers which must comply with certain
consumer statutes; whether electronic fund transfer payments pursuant to a lease
violate Reg. E; whether any Leasecomm billing and collection practices or
charges are unreasonable, or constitute unfair or deceptive trade practices;
whether Leasecomm's course of dealings with its vendors/dealers makes Leasecomm
liable for any of the activities of its vendors/dealers. In April, 2002,
Leasecomm and the Government Investigators entered into provisional relief and
tolling agreements which provide for Leasecomm to take certain interim actions,
temporarily stop the running of the statute of limitations as of January 29,
2002, and require advance notice by Leasecomm of its withdrawal from the
provisional relief agreement and advance notice by each of the Government
Investigators of its intention to commence legal action. The tolling agreement
has been extended several times and is set to expire in May, 2003.

In February, 2003, Leasecomm received a Civil Investigative Demand from the
Office of the Attorney General, State of Washington, to which a response is
currently due in April, 2003. The Civil Investigative Demand concerns an
investigation of monitoring agreements between Priority One, Inc. and various
State of Washington consumers, as to which Leasecomm appears to be the assignee
of the right to receive monthly payments.

Since the investigations are in process, and no legal action has been
commenced against Leasecomm, there can be no assurance as to the eventual
outcome.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the security holders of the Company
during the fourth quarter of its fiscal year ended December 31, 2002.

9

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."

(b) Holders

At March 14, 2003, there were approximately 825 stockholders of record of
the Common Stock.

(c) Dividends

The Company paid the following quarterly cash dividends on the Common
Stock.

During the fourth quarter of 2002, the Board of Directors suspended the
future payment of dividends to comply with the Company's banking agreements.
Provisions in certain of the Company's credit facilities and agreements
governing its subordinated debt contain, and the terms of any indebtedness
issued by the Company in the future are likely to contain, certain restrictions
on the payment of dividends on the Common Stock. The decision as to the amount
and timing of future dividends paid by the Company, if any, will be made at the
discretion of the Company's Board of Directors in light of the financial
condition, capital requirements, earnings and prospects of the Company and any
restrictions under the Company's credit facilities or subordinated debt
agreements, as well as other factors the Board of Directors may deem relevant,
and there can be no assurance as to the amount and timing of payment of future
dividends.

(d) Recent Sales of Unregistered Securities

Not applicable

(e) Use of Proceeds from Registered Securities

Not applicable

10

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.

- ---------------

(1) Includes loss and damage waiver fees, service fees, interest income, and
equipment sales revenue.

(2) The provision for 1999 includes a special provision of $12.7 million for a
loan made to one company, collateralized by approximately 3,500 microticket
consumer contracts, and guaranteed by, among other security, an insurance
performance bond. MicroFinancial is currently involved in litigation with
the Company and the insurance company. Charge-offs against the special
reserve were $6.4 and $7.1 million for the years ended December 31, 2000
and 2001, respectively.

(3) The provision for 2002 includes an additional provision of $35.0 million to
reserve against certain dealer receivables as well as delinquent portfolio
assets. In the past, dealer receivables had been offset, in some instances,
against the funding of new contracts. Since the Company has suspended the
funding of new deals, Management feels that the collection of these
receivables will be more difficult. Although the Company will continue to
pursue collections on these accounts, management believes that the cost
associated with the legal enforcement would outweigh the benefits realized.

(4) Net income per common share (basic) is calculated based on weighted-average
common shares outstanding of 9,859,127, 12,795,809, 12,728,441, 12,789,605,
and 12,821,946 for the years ended December 31, 1998, 1999, 2000, 2001, and
2002, respectively.

(5) Net income per common share (diluted) is calculated based on
weighted-average common shares outstanding on a diluted basis of
10,031,975, 12,904,231, 12,807,814, 12,945,243, and 12,862,834 for the
years ended December 31, 1998, 1999, 2000, 2001, and 2002 respectively.

(6) Consists of receivables due in installments, estimated residual value, and
loans receivable.
12

(7) Represents the amount paid to Dealers upon funding of leases and loans,
plus the associated unearned income.

(8) Represents the amount paid to Dealers upon the acquisition of service
contracts, including both noncancelable service contracts and
month-to-month service contracts.

(9) Represents the amount paid to Dealers upon funding of leases, contracts and
loans.

(10) Represents the aggregate of the implied interest rate on each lease and
loan originated during the period weighted by the amount funded at
origination for each such lease and loan.

(11) Represents income before provision for income taxes and provision for
credit losses as a percentage of total revenues.

(12) Represents net charge-offs as a percentage of average gross investment in
leases and loans and investment in service contracts.

(13) Represents provision for credit losses as a percentage of average gross
investment in leases and loans and investment in service contracts.

(14) Represents allowance for credit losses as a percentage of gross investment
in leases and loans and investment in service contracts.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion includes forward-looking statements (as such term
is defined in the Private Securities Litigation Reform Act of 1995). When used
in this discussion, the words "believes," "anticipates," "expects" and similar
expressions are intended to identify forward-looking statements. Such
forward-looking statements involve known and unknown risks, uncertainties and
other important factors that could cause the actual results, performance or
achievements of the Company, or industry results, to differ materially from any
future results, performance or achievements expressed or implied by such
forward-looking statements. Such risks, uncertainties and other important
factors include, among others: the Company's dependence on POS authorization
systems and expansion into new markets; the Company's significant capital
requirements; the risks of defaults on the Company's leases; adverse
consequences associated with the Company's collection policy; risks associated
with economic downturns; the effect on the Company's portfolio of higher
interest rates; intense competition; increased governmental regulation of the
rates and methods used by the Company in financing and collecting its leases and
loans; risks associated with acquiring other portfolios and companies;
dependence on key personnel; and other factors, many of which are beyond the
Company's control. The Company expressly disclaims any obligation or undertaking
to disseminate any updates or revisions to any forward-looking statement
contained herein to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any such
statement is based. In light of these risks and uncertainties, there can be no
assurance that the forward-looking information contained herein will in fact
transpire.

OVERVIEW

The Company is a specialized commercial finance company that provides
"microticket" equipment leasing and other financing services in amounts
generally ranging from $400 to $15,000, with an average amount financed of
approximately $1,500. The Company primarily leases POS authorization systems and
other small business equipment to small commercial enterprises. For the years
ended December 31, 2001 and 2002, the Company had fundings to Dealers upon
origination of leases, contracts and loans ("Dealer Fundings") of $111.1 million
and $74.0 million, respectively, and revenues of $154.0 million and $126.4
million, respectively.

The Company derives the majority of its revenues from leases originated and
held by the Company, payments on service contracts, rental payments, and fee
income. The Company funds the majority of leases, contracts and loans through
its revolving-credit and term loan facilities (the "Credit Facilities") and on-
balance sheet securitizations, and to a lesser extent, its subordinated debt
program ("Subordinated Debt") and internally generated funds. As of September
30, 2002, the credit facility failed to renew and the Company

13

has been paying down the balance on the basis of a 36 month amortization plus
interest. At December 31, 2002, the Company was in default of certain of its
debt covenants in its credit facility and securitization agreements. The
covenants that were in default with respect to the credit facility, require that
the Company maintain a fixed charge ratio in an amount not less than 130% of
consolidated earnings, a consolidated tangible net worth minimum of $77.5
million plus 50% of net income quarterly beginning with September 30, 2000 and
compliance with the borrowing base. The covenants that were in default with
respect to the securitization agreements, require that the Company maintain a
fixed charge ratio in an amount not less than 125% of consolidated earnings and
a consolidated tangible net worth greater than $90 million plus 50% of net
income for each fiscal quarter after June 30, 2001. On April 14, 2003, the
Company entered into a long-term agreement with its lenders. This long-term
agreement waives the defaults described above, and in consideration for this
waiver, requires the outstanding balance of the loan to be repaid over a term of
22 months beginning in April 2003 at an interest rate of prime plus 2.0%. The
Company received a waiver, which was set to expire on April 15, 2003, for the
covenant violations in connection with the securitization agreement.
Subsequently, the Company received a permanent waiver of the covenant defaults
and the securitization agreement was amended so that going forward, the
covenants are the same as those contained in the long-term agreement entered
into on April 14, 2003, for the senior credit facility. In October 2002, the
Company made the decision to suspend new contract originations until a source of
funding is obtained. The Company is currently in the process of pursuing
alternative financing sources.

The Company has been advised by the New York Stock Exchange (NYSE) that it
is currently not in compliance with the NYSE's continued listing standards.
Specifically, the Company does not meet the following requirements based on a
consecutive thirty (30) day trading period; average market capitalization of not
less than $15 million and a share price of not less than $1.00. In accordance
with the continued listing criteria set forth by the NYSE, the Company has
presented a plan which management believes has the potential to bring the
Company back into compliance with the listing standards within the required
timeframes. The NYSE is currently reviewing the plan that was submitted on April
1, 2003.

In a typical lease transaction, the Company originates leases through its
network of independent Dealers. Upon approval of a lease application by the
Company and verification that the lessee has both received the equipment and
signed the lease, the Company pays the Dealer the cost of the equipment, plus
the Dealer's profit margin. In a typical transaction for the acquisition of
service contracts, a homeowner purchases a security system and simultaneously
signs a contract with the Dealer for the monitoring of that system for a monthly
fee. Upon credit approval of the monitoring application and verification with
the homeowner that the system is installed, the Company purchases from the
Dealer the right to the payment stream under that monitoring contract at a
negotiated multiple of the monthly payments.

Substantially all leases originated or acquired by the Company are
noncancelable. During the term of the lease, the Company is scheduled to receive
payments sufficient, in the aggregate, to cover the Company's borrowing costs
and the costs of the underlying equipment, and to provide the Company with an
appropriate profit. The Company enhances the profitability of its leases,
contracts and loans by charging late fees, prepayment penalties, loss and damage
waiver fees and other service fees, when applicable. The initial noncancelable
term of the lease is equal to or less than the equipment's estimated economic
life and often provides the Company with additional revenues based on the
residual value of the equipment financed at the end of the initial term of the
lease. Initial terms of the leases in the Company's portfolio generally range
from 12 to 48 months, with an average initial term of 44 months as of December
31, 2002. Substantially all service and rental contracts are month-to-month
contracts with expected terms of 7 years for service contracts, 15 months for
lessees that continue to rent their equipment beyond the original term, and 22
months for other types of rental contracts.

CRITICAL ACCOUNTING POLICIES

In response to the SEC's release No. 33-8040, "Cautionary Advice regarding
Disclosure About Critical Accounting Policies," Management identified the most
critical accounting principles upon which our financial status depends. The
Company determined the critical principles by considering accounting policies
that involve the most complex or subjective decisions or assessments. We
identified our most critical accounting
14

policies to be those related to revenue recognition and maintaining the
allowance for credit losses. These accounting policies are discussed below as
well as within the notes to the consolidated financial statements.

The Company's lease contracts are accounted for as financing leases. At
origination, the Company records the gross lease receivable, the estimated
residual value of the leased equipment, initial direct costs incurred and the
unearned lease income. Unearned lease income is the amount by which the gross
lease receivable plus the estimated residual value exceeds the cost of the
equipment. Unearned lease income and initial direct costs incurred are amortized
over the related lease term using the interest method. Amortization of unearned
lease income and initial direct costs is suspended if, in the opinion of
management, full payment of the contractual amount due under the lease agreement
is doubtful. In conjunction with the origination of leases, the Company may
retain a residual interest in the underlying equipment upon termination of the
lease. The value of such interests is estimated at inception of the lease and
evaluated periodically for impairment. Other revenues such as loss and damage
waiver fees, service fees relating to the leases, contracts and loans, and
rental revenues are recognized as they are earned.

The Company's investments in cancelable service contracts are recorded at
cost and amortized over the expected life of the service period. Income on
service contracts from monthly billings is recognized as the related services
are provided. The Company periodically evaluates whether events or circumstances
have occurred that may affect the estimated useful life or recoverability of the
investment in service contracts. Rental equipment is either recorded at
estimated residual value and depreciated using the straight-line method over a
period of 12 months or at the acquisition cost and depreciated using the
straight line method over a period of 36 months. Loans are reported at their
outstanding principal balance. Interest income on loans is recognized as it is
earned.

The Company maintains an allowance for credit losses on its investment in
leases, service contracts, rental contracts and loans at an amount that it
believes is sufficient to provide adequate protection against losses in its
portfolio. The allowance is determined principally on the basis of the
historical loss experience of the Company and the level of recourse provided by
such lease, service contract, rental contract or loan, if any, and reflects
management's judgment of additional loss potential considering current economic
conditions and the nature and characteristics of the underlying lease portfolio.
The Company determines the necessary periodic provision for credit losses taking
into account actual and expected losses in the portfolio as a whole and the
relationship of the allowance to the net investment in leases, service
contracts, rental contracts and loans. Such provisions generally represent a
percentage of funded amounts of leases, contracts and loans. The resulting
charge is included in the provision for credit losses.

Leases, service contracts, rental contracts and loans are charged against
the allowance for credit losses and are put on non-accrual when they are deemed
to be uncollectable. Generally, the Company deems leases, service contracts,
rental contracts and loans to be uncollectable when one of the following occurs:
(i) the obligor files for bankruptcy; (ii) the obligor dies, and the equipment
is returned; or (iii) when an account has become 360 days delinquent without
contact with the lessee. The typical monthly payment under the Company's leases
is between $30 and $50 per month. As a result of these small monthly payments,
the Company's experience is that lessees will pay past due amounts later in the
process because of the small amount necessary to bring an account current (at
360 days past due, a lessee will 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, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001

Total revenues for the year ended December 31, 2002 were $126.8 million, a
decrease of $27.3 million, or 17.7%, from the year ended December 31, 2001, due
primarily to decreases of $17.9 million, or 25.3%, in

15

income on financing leases and loans and $9.8 million, or 32.2%, in service fee
and other income; offset by an increase of $559,000, or 1.2% in rental and
service contract income over such amounts in the previous year's period. The
decrease in income on financing leases and loans was due to the decreased number
of leases originated primarily resulting from the Company's decision during the
third quarter of 2002 to suspend the funding of new contracts. The decrease in
fee income and other income is the result of decreased fees from the lessees
related to the collection and legal process employed by the Company. The
increase in rental and service contract income is a result of the increased
number of lessees that have continued to rent their equipment beyond their
original lease term, the acquisition of the rental portfolio of Resource Leasing
Corporation, and increased originations in rental and service contracts.

Selling, general and administrative expenses increased by $636,000 or 1.4%,
for the year ended December 31, 2002 as compared to the year ended December 31,
2001. Marketing programs increased by $1.4 million or 117.2%, due to increased
dealer payments made on a portfolio of leases acquired in 2002. Legal services
increased by $2.2 million or 198.2%, primarily due to costs incurred for the
different class actions and investigations and in conjunction with the workout
on the Company's credit facility and securitization covenant defaults.
Compensation expenses decreased by $2.1 million or 11.3% primarily due to staff
reductions.

The Company's provision for credit losses increased by $34.9 million, or
64.4%, for the year ended December 31, 2002 as compared to the year ended
December 31, 2001, while net charge-offs increased 26.6% to $65.1 million. This
provision was based on the Company's historical policy, based on experience, of
providing a provision for credit losses based upon the dealer fundings and
revenue recognized in any period and reflects management's judgement of loss
potential considering current economic conditions and the nature of the
underlying receivables. The Company took an additional provision of $35 million
during the third quarter of 2002 to reserve against certain dealer receivables
as well as delinquent portfolio assets. In the past, dealer receivables had been
offset, in some instances, against the funding of new contracts. Since the
Company has suspended the funding of new deals, the Company feels that the
collection of these receivables will be more difficult. Although the Company
will continue to pursue collections on these accounts, management believes that
the cost associated with the legal enforcement would outweigh the benefits
realized.

Depreciation and amortization increased by $4.0 million, or 27.9%, due to
the increased number of rental contracts and amortization of the Company's
investment in service contracts.

Interest expense decreased by $3.5 million, or 24.6%, for the year ended
December 31, 2002 as compared to the year ended December 31, 2001. This decrease
resulted primarily from the Company's declining cost of funds as well as a
decreased level of borrowings.

Dealer Fundings were $74.0 million during the year ended December 31, 2002,
a decrease of $37.1 million, or 33.4%, compared to the year ended December 31,
2001. This decrease is a result of the Company's decision during the third
quarter of 2002 to suspend new contract originations until a new line of credit
is obtained. Receivables due in installments, estimated residual values, loans
receivable, investment in service contracts, and investment in rental equipment
also decreased from $470.6 million for the year ended December 31, 2001 to
$396.5 million for the year ended December 31, 2002, representing a decrease of
$74.1 million, or 15.7%. Net cash provided by operating activities decreased by
$1.7 million to $120.6 million during the year ended December 31, 2002, or 1.4%,
from the year ended December 31, 2001 because of the decrease in the size of the
Company's overall portfolio. Unearned income decreased by $37.0 million, or
35.4%, from $104.5 million at December 31, 2001 to $67.6 million at December 31,
2002. This decrease was primarily due to the 33.4% decrease in dealer fundings
during 2002.

YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000

Total revenues for the year ended December 31, 2001 were $154.1 million, an
increase of $14.6 million, or 10.5%, from the year ended December 31, 2000, due
primarily to increases of $1.1 million, or 1.6%, in income on financing leases
and loans; $10.0 million, or 27.5%, in rental and service contract income, and
$3.2 million, or 11.8%, in service fee and other income over such amounts in the
previous year's period. The increase in income on financing leases and loans was
due to the increased number of leases originated. The
16

increase in rental and service contract income is a result of the increased
number of lessees that have continued to rent their equipment beyond their
original lease term, the acquisition of the rental portfolio of Resource Leasing
Corporation, and increased originations in rental and service contracts. The
increase in fee income and other income is the result of increased fees from the
lessees related to the collection and legal process employed by the Company, and
the addition of a new line of business of selling equipment out of existing
inventory.

Selling, general and administrative expenses increased by $6.5 million or
17%, for the year ended December 31, 2001 as compared to the year ended December
31, 2000. Compensation and personnel-related expenses increased by $3.4 million,
due to an increase in overall compensation levels and an increase in the number
of employees needed to maintain the Company's portfolio, including the addition
of the personnel employed by Resource Leasing Corporation. Management expects
that salaries and employee-related expenses, marketing expenses and other
selling, general and administrative expenses will continue to increase as the
portfolio grows because of the requirements of maintaining the Company's
microticket portfolio and the Company's focus on collections. Also, cost of
goods sold increased by $3.6 million, or 100%, due to the Company's acquisition
of the assets of Resource Leasing Corporation, and the addition of a new line of
business of selling equipment.

The Company's provision for credit losses increased by $15.2 million, or
39.0%, for the year ended December 31, 2001 as compared to the year ended
December 31, 2000. This increase is a result of the Company's historical policy,
based on experience, of providing a provision for credit losses based upon the
dealer fundings and revenue recognized in any period and reflects management's
judgement of loss potential considering current economic conditions and the
nature of the underlying receivables.

Depreciation and amortization increased by $4.2 million, or 40.6%, due to
the increased number of rental contracts, including the addition of the Resource
Leasing portfolio of rental contracts, and amortization of the Company's
investment in service contracts.

Interest expense decreased by $1.6 million, or 9.8%, for the year ended
December 31, 2001 as compared to the year ended December 31, 2000. This decrease
resulted primarily from the Company's declining cost of funds, offset by an
increased level of borrowings.

Dealer Fundings were $111.1 million during the year ended December 31,
2001, a decrease of $34.3 million, or 23.6%, compared to the year ended December
31, 2000. This decrease is a result of the Company's decision during the second
quarter of 2000 to increase pricing and tighten its credit approval standards.
The new credit policies were put into place in August of 2000. This is an
ongoing effort, and is expected to continue going forward. Receivables due in
installments, estimated residual values, loans receivable, investment in service
contracts, and investment in rental equipment also decreased from $477.4 million
for the year ended December 31, 2000 to $470.6 million for the year ended
December 31, 2001, representing an decrease of $6.8 million, or 1.4%. Net cash
provided by operating activities increased by $5.9 million to $122.3 million
during the year ended December 31, 2001, or 5.1%, from the year ended December
31, 2000 because of the increase in the size of the Company's overall portfolio
as well as the Company's continued emphasis on collections. Unearned income
decreased by $28.2 million, or 21.2%, from $132.7 million at December 31, 2000
to $104.5 million at December 31, 2001. This decrease was primarily due to the
23.6% decrease in dealer fundings during 2001.

The terrorist attacks of September 11, 2001 caused a significant loss of
life and property. Fortunately, the Company has not experienced any significant
losses as a direct result of the September 11 events. There can be no assurance
that any potential impact associated with the September 11 events would not have
a material adverse effect on the Company's business, financial condition, or
results of operations.

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
17

its operations primarily through borrowings under its credit facilities, its
on-balance sheet securitizations, the issuance of subordinated debt and an
initial public offering completed in February of 1999. The Company will continue
to require significant additional capital to maintain and expand its volume of
leases, contracts and loans funded, as well as to fund any future acquisitions
of leasing companies or portfolios.

The Company's uses of cash include the origination and acquisition of
leases, contracts and loans, payment of interest expenses, repayment of
borrowings under its credit facilities, subordinated debt and securitizations,
payment of selling, general and administrative expenses, income taxes and
capital expenditures.

The Company utilizes its credit facilities to fund the origination and
acquisition of leases that satisfy the eligibility requirements established
pursuant to each facility. On August 22, 2000, the Company entered into a new
$192 million credit facility with seven banks, expiring on September 30, 2002.
As of September 30, 2002 the credit facility failed to renew and the Company has
been paying down the balance on the basis of a 36 month amortization plus
interest. Based on the terms of the agreement, interest rates increased from
Prime minus 0.25% to Prime plus 0.50% for prime based loans and from LIBOR plus
1.75% to LIBOR plus 2.50% for LIBOR based loans. In addition, based on the
covenant defaults described below, the outstanding borrowings on all loans bear
an additional 2.00% default interest. On January 3, 2003, the Company entered
into a Forbearance and Modification Agreement from the senior credit facility
which expired on February 7, 2003. Based on the terms of the Forbearance and
Modification Agreement, interest rates increased again on the prime based loans
to prime plus 1.00%. At December 31, 2002, the Company had approximately $126.6
million outstanding under the facility. The Company also may use its
subordinated debt program as a source of funding for potential acquisitions of
portfolios and leases which otherwise are not eligible for funding under the
credit facilities and for potential portfolio purchases. To date, cash flows
from its portfolio and other fees have been sufficient to repay amounts borrowed
under the credit facilities and subordinated debt, however, in October 2002, the
Company made the decision to suspend new contract originations until a source of
funding is obtained.

At December 31, 2002, the Company was in default of certain of its debt
covenants in its credit facility and securitization agreements. The covenants
that were in default with respect to the credit facility, require that the
Company maintain a fixed charge ratio in an amount not less than 130% of
consolidated earnings, a consolidated tangible net worth minimum of $77.5
million plus 50% of net income quarterly beginning with September 30, 2000, and
compliance with the borrowing base. On April 14, 2003, the Company entered into
a long-term agreement with its lenders. This long-term agreement waives the
defaults described above, and in consideration for this waiver, requires the
outstanding balance of the loan to be repaid over a term of 22 months beginning
in April 2003 at an interest rate of prime plus 2.0%. Based on the amortization
schedule in the new agreement, the Company is obligated to repay a minimum of
$54 million, plus applicable interest, over the next twelve months. The
covenants that were in default with respect to the securitization agreements,
require that the Company maintain a fixed charge ratio in an amount not less
than 125% of consolidated earnings and a consolidated tangible net worth greater
than $90 million plus 50% of net income for each fiscal quarter after June 30,
2001. The Company received a waiver, which was set to expire on April 15, 2003,
for the covenant violations in connection with the securitization agreement.
Subsequently, the Company received a permanent waiver of the covenant defaults
and the securitization agreement was amended so that going forward, the
covenants are the same as those contained in the long-term agreement entered
into on April 14, 2003, for the senior credit facility.

The Company believes that cash flows from its operations will be sufficient
to fund the Company's operations for the foreseeable future, given the
satisfactory resolution of the Company's discussions with the lenders involved
in the senior credit facility and the securitized notes.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

The Company has entered into various agreements, such as the long-term debt
agreements, capital lease agreements and operating lease agreements that require
future payments be made. Long-term debt agree-

18

ments include all debt outstanding under the credit facility, securitizations,
subordinated notes, demand notes and other notes payable.

At December 31, 2002 the repayment schedules for outstanding long-term
debt, minimum lease payments under noncancelable operating leases and future
minimum lease payments under capital leases were as follows:

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

See Note B of the notes to the consolidated financial statements included
herein for a discussion of the impact of recently issued accounting
pronouncements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

GENERAL RISKS

MicroFinancial incurred net losses of $22.1 million for the year ended
December 31, 2002. The net losses incurred by the Company during the third and
fourth quarters caused the Company to be in default of certain debt covenants in
its credit facility and securitization agreements. In addition, as of September
30, 2002, the Company's credit facility failed to renew and consequently, the
Company was forced to suspend new origination activity as of October 11, 2002.
On April 14, 2003, the Company entered into a long-term agreement with its
lenders. This long-term agreement waives the covenant defaults as of December
31, 2002, and in consideration for this waiver, requires the outstanding balance
of the loan to be repaid over a term of 22 months beginning in April 2003 at an
interest rate of prime plus 2.0%. The Company received a waiver, which was set
to expire on April 15, 2003, for the covenant violations in connection with the
securitization agreement. Subsequently, the Company received a permanent waiver
of the covenant defaults and the securitization agreement was amended so that
going forward, the covenants are the same as those contained in the long-term
agreement entered into on April 14, 2003, for the senior credit facility. To
date, the Company has fulfilled all of its debt obligations, as agreed to by the
bank group, in a timely manner.

In an effort to improve its financial position, MicroFinancial has taken
certain steps including the engagement of a financial and strategic advisory
firm, Triax Capital Advisors, LLC. Management and its advisors are actively
considering various financing, restructuring and strategic alternatives as well
as continuing to work closely with the Company's lenders to obtain long-term
agreements. In addition, Management has taken steps to reduce overhead,
including a reduction in headcount from 380 to 203. The failure or inability of
MicroFinancial to successfully carry out these plans could ultimately have a
material adverse effect on the Company's financial position and its ability to
meet its obligations when due. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

MARKET-RATE-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT

The following discussion about the Company's risk management activities
includes forward-looking statements that involve risk and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements.

This analysis presents the hypothetical loss in earnings, cash flows, and
fair value of the financial instruments held by the Company at December 31, 2002
that are sensitive to changes in interest rates. The Company has used
interest-rate swaps to manage the primary market exposures associated with
underlying
19

liabilities and anticipated transactions. The Company used these instruments to
reduce risk by creating offsetting market exposures. The instruments held by the
Company are not held for trading purposes.

In the normal course of operations, the Company also faces risks that are
either nonfinancial or nonquantifiable. Such risks principally include country
risk, credit risk, and legal risk, and are not represented in the analysis that
follows.

INTEREST RATE RISK MANAGEMENT

The implicit yield to the Company on all of its leases, contracts and loans
is on a fixed interest rate basis due to the leases, contracts and loans having
scheduled payments that are fixed at the time of origination of the lease. When
the Company originates or acquires leases, contracts, and loans it bases its
pricing in part on the spread it expects to achieve between the implicit yield
rate to the Company on each lease and the effective interest cost it will pay
when it finances such leases, contracts and loans through its credit facility.
Increases in interest rates during the term of each lease, contract or loan
could narrow or eliminate the spread, or result in a negative spread. The
Company has adopted a policy designed to protect itself against interest rate
volatility during the term of each lease, contract or loan.

Given the relatively short average life of the Company's leases, contracts
and loans, the Company's goal is to maintain a blend of fixed and variable
interest rate obligations. As of December 31, 2002, the Company's outstanding
fixed-rate indebtedness outstanding under the Company's securitizations and
subordinated debt represented 26.5% of the Company's total outstanding
indebtedness. In July 1997, the Company entered into an interest rate swap
arrangement with one of its banks. This arrangement expired in July 2000.

The Company's credit facility bears interest at rates, which fluctuate with
changes in the prime rate or the 90-day LIBOR. The Company's interest expense on
its credit facility and the fair value of its fixed rate debt is sensitive to
changes in market interest rates. The effect of a 10% adverse change in market
interest rates, sustained for one year, on the Company's interest expense and
the fair value of its fixed rate debt would be $801,000 and $428,000,
respectively.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, INCLUDING SELECTED
QUARTERLY FINANCIAL DATA (UNAUDITED)

MicroFinancial Incorporated's Financial Statements, together with the
related Independent Auditors' Report, appear at pages F-1 through F-31 of this
Form 10-K.

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

DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS

BACKGROUNDS OF DIRECTORS AND EXECUTIVE OFFICERS

Peter R. Bleyleben serves as Chairman of the Board of Directors of the
Corporation. He served as President, Chief Executive Officer and Director of the
Corporation or its predecessor since June 1987 until January 2002, and Chief
Executive Officer until October 2002. He is also a director of UpToDate in
Medicine, Inc. Before joining the Corporation, 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. Dr. Bleyleben's term as a Director expires in 2004.

Brian E. Boyle, the Chief Executive Officer of the Corporation from 1985 to
1987 and Chairman of the MicroFinancial Board from 1985 to 1995, has served as a
Director of the Corporation or its predecessor since 1985 and has been a member
of the Audit Committee and the Compensation Committee since 1997. He is
currently the Vice Chairman and a Director of Boston Communications Group, Inc.
("Communications"), a Boston-based provider of call processing to the global
wireless industry. He has also served as Chairman of GoldK, Inc. since 1999 and
was the Chief Executive Officer of GoldK, Inc. from 1999 until November 2002.
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. From 1995 to 1999
he was a Director of Saville Systems, a global telecommunications billing
software company, with its United States headquarters in Burlington,
Massachusetts, and served as a member of its Compensation Committee from 1995 to
October 1999. Dr. Boyle is also a director 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. Mr.
Boyle's term as a Director expires in 2003.

Torrence C. Harder has served as a Director of the Corporation since 1986,
served as Chairman of the Compensation Committee since 1997 and has been a
member of the Audit Committee since 1997. He has been the President and Director
of Harder Management Corporation, Inc., a registered investment advisory firm,
since its establishment in 1971. He has also been the President and Director of
Entrepreneurial Ventures, Inc., a private equity investment firm, since its
founding in 1986. Mr. Harder is a Director of RentGrow, Inc., Trade Credit
Corporation and UpToDate in Medicine, Inc., a privately held company. Mr. Harder
earned an M.B.A. from the Wharton School of the University of Pennsylvania, and
a B.A. with honors from Cornell University. Mr. Harder's term as a Director
expires in 2005.

Richard F. Latour has served as President, Chief Executive Officer, Chief
Financial Officer, Treasurer, Clerk and Secretary of the Company since October
2002 and as President, Chief Operating Officer, Chief Financial Officer,
Treasurer, Clerk and Secretary, as well as a director of the Corporation, since
February 2002. From 1995 to January 2002, he served as Executive Vice President,
Chief Operating Officer, Chief Financial Officer, Treasurer, Clerk and
Secretary. From 1986 to 1995 Mr. Latour served as Vice President of Finance and
Chief Financial Officer. Prior to joining the Company, Mr. Latour was Vice
President of Finance for eleven years with Trak Incorporated, an international
manufacturer and distributor of consumer goods, where he was responsible for all
financial and operational functions. Mr. Latour earned a B.S. in accounting from
Bentley College in Waltham, Massachusetts. Mr. Latour's term as a Director
expires in 2004.

21

Alan J. Zakon has served as a Director of the Corporation 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 Scientific Games Corporation, a New York-based global
gaming and simulcasting company. Dr. Zakon 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 and a
Director of InfraRedx, a privately held medical research and development
company. Dr. Zakon holds a B.A. from Harvard University, an M.S. in Industrial
Management from the Sloan School at the Massachusetts Institute of Technology
and a Ph.D. in Economics and Finance from the University of California at Los
Angeles. Mr. Zakon's term as a Director expires in 2003.

James R. Jackson Jr. has served as Vice President and Chief Financial
Officer of the Company since April 2002. Prior to joining the Company, from 1999
to 2001, Mr. Jackson was Vice President of Finance for Deutsche Financial
Services Technology Leasing Group. From 1992 to 1999, Mr. Jackson held positions
as Manager of Pricing and Structured Finance and Manager of Business Planning
with AT&T Capital Corporation.

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 1995 to 1996, Ms. Salvo served as Director of Legal Collection
Services of the Company. From 1992 to 1995, Ms. Salvo served as Litigation
Supervisor of the Company. Prior to joining the Company, Ms. Salvo was a junior
accountant with InfoPlus Inc.

Mark S. Belinsky has served as Vice President, Sales and Marketing of the
Company since June 2001. Prior to joining the Company, from June 1999 to April
2001 Mr. Belinsky was the Vice President of Marketing and Business Development
for Iwant.com, an Internet-based Application Service Provider, which owns a
patent for Online advertising technology, used by the Internet's top websites.
Prior to that, he served as President, Club Development for TransNational Group,
an affinity marketing company.

COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

Section 16(a) of the Securities Exchange Act of 1934 (as amended, the
"Exchange Act") requires the Corporation's directors, officers and persons who
beneficially own more than ten percent (10%) of the Common Shares (each, a
"Reporting Person") to file reports of ownership and changes of ownership with
the Securities and Exchange Commission. Copies of all filed reports are required
to be furnished to the Corporation pursuant to Section 16(a) of the Exchange
Act. Based solely upon a review of Forms 3 and 4 and amendments thereto
furnished to the Corporation pursuant to Rule 16a-3(e) of the Exchange Act
during fiscal year ending December 31, 2002 and on written representations from
Reporting Persons, the Corporation believes that each Reporting Person complied
with all applicable filing requirements during its fiscal year ended December
31, 2002, with the exception of Dr. Boyle, who inadvertently failed to report
the sales of 39,000 shares from June to September 2002. These transactions were
subsequently reported by the Reporting Person.

ITEM 11. EXECUTIVE COMPENSATION

EXECUTIVE COMPENSATION

The following table sets forth the compensation of (i) Messrs. Bleyleben
and Latour, both of whom served as the Chief Executive Officer of the
Corporation during 2002, (ii) the four most highly compensated executive
officers, other than Messrs. Bleyleben and Latour who were serving as executive
officers of the Corporation as of December 31, 2002 (collectively, the "Named
Executive Officers"), in each case for the years ended December 31, 2002, 2001
and 2000. Determination of the most highly compensated executive officers is
based upon compensation for the Corporation's fiscal year ended December 31,
2002 and does not

22

necessarily reflect the most highly compensated executive officers for the
Corporation's fiscal years ended December 31, 2001 and 2000.

SUMMARY COMPENSATION TABLE(1)

- ---------------

(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
Corporation 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.

(3) Amounts for Dr. Bleyleben include: (a) contributions by the Corporation
under the Corporation's 401(k) retirement/profit sharing plan in 2002
($4,411), 2001 ($3,200) and 2000 ($3,199); (b) split dollar life insurance
premiums paid by the Corporation in 2001 ($90,382) and 2000 ($65,259) (this
policy was terminated in 2002 and the Corporation was repaid the cash value
under the policy) and (c) executive disability insurance policy premiums
paid by the Corporation in 2002 ($7,816), 2001 ($4,054) and 2000 ($3,546).

(4) Amounts for Mr. Latour include: (a) contributions by the Corporation under
the Corporation's 401(k) retirement/profit sharing plan in 2002 ($3,200),
2001 ($3,200) and 2000 ($3,323); (b) split dollar life insurance premiums
paid by the Corporation in 2001 ($50,782) and 2000 ($49,318) (this policy
was terminated in 2002 and the Corporation was repaid the cash value under
the policy) and (c) executive disability insurance policy premiums paid by
the Corporation in 2002 ($3,091), 2001 ($874) and 2000 ($874).

(5) Mr. Jackson joined the Company in 2002. Amounts for Mr. Jackson include
contributions by the Corporation under the Corporation's 401(k)
retirement/profit sharing plan in 2002 ($3,143).

(6) Amounts for Mr. Plumlee include: (a) contributions by the Corporation under
the Corporation's 401(k) retirement/profit sharing plan in 2002 ($4,213),
2001 ($3,440), and 2000 ($4,111); (b) split dollar life insurance premiums
paid by the Corporation in 2001 ($15,000), and 2000 ($15,084) (this policy
was

23

terminated in 2002 and the Corporation was repaid the cash value under the
policy) and (c) executive disability insurance policy premiums paid by the
Corporation in 2002 ($1,016), 2001 ($1,016) and 2000 ($1,016).

(7) Amounts for Ms. Salvo include: (a) contributions by the Corporation under
the Corporation's 401(k) retirement/profit sharing plan in 2002 ($3,673),
2001 ($3,440) and 2000 ($3,090); (b) executive disability insurance policy
premiums paid by the Corporation in 2002 ($686), 2001 ($658) and 2000
($630); and (c) the benefit to the executive of interest-free loans from the
Corporation based on the applicable federal rate in effect on the date of
issuance of each such loan, in 2000 ($981). This loan was repaid to the
Corporation as of December 31, 2002.

(8) Mr. Belinsky joined the Corporation in 2001. Amounts for Mr. Belinsky
include: (a) contributions by the Corporation under the Corporation's 401(k)
retirement/profit sharing plan in 2002 ($5,072); and (b) executive
disability insurance policy premiums paid by the Corporation in 2002
($1,255).

1998 EQUITY INCENTIVE PLAN

The following table indicates the aggregate options granted in 2002 to the
Named Executive Officers:

OPTION/SAR GRANTS IN LAST FISCAL YEAR

- ---------------

(1) Stock options were granted under the Plan. No stock appreciation rights were
awarded with these grants. All options granted other than those that expire
on November 25, 2012 first become exercisable, in five equal annual
installments, beginning one year from the grant date, and have a ten-year
term. The options that expire on November 25, 2012 vested 20% on the date of
grant and 5% every three months in arrears, and have a ten-year term. If a
change of control of MicroFinancial were to occur, the options would become
immediately exercisable in full.

All options outstanding to Messrs. Jackson, Plumlee and Belinsky and Ms.
Salvo were cancelled in February 2003, and replaced by a smaller number of
shares of restricted stock which vested 20% upon grant, and vests 5% on the
first day of each quarter after the grant date, with accelerated vesting if
the price of the Corporation's common stock exceeds certain thresholds
during the vesting period. The number of shares of restricted stock for each
Names Executive Officer is included in "Item 12. Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder Matters."

(2) The percentages in the table for the stock options granted in 2002 are based
on a total of 970,000 stock options granted in 2002 to MicroFinancial
employees, all of which were granted on the same material terms described in
footnote (1) above.

24

(3) The dollar amounts under these columns represent the potential realizable
value of each grant assuming that the market value of the Common Stock
appreciates from the date of grant to the expiration of the option at
annualized rates of 5% and 10%. These assumed rates of appreciation have
been specified by the SEC for illustrative purposes only and are not
intended to forecast future financial performance or possible future
appreciation in the price of the Common Stock. The actual amount the
executive officer may realize will depend on the extent to which the stock
price exceeds the exercise price of the options on the date the option is
exercised.

The following table indicates the fiscal year-end option values for options
held by the Named Executive Officers at December 31, 2002. No options were
exercised in 2002.

FISCAL YEAR-END OPTION VALUES

- ---------------

(1) The exercise price of all unexercised options exceeded the fair market value
of the Common Stock on December 31, 2002.

(2) The value of unexercised in-the-money stock options at December 31, 2002 is
presented to comply with regulations of the Securities and Exchange
Commission. The actual amount realized upon exercise of stock options (if
any) will depend upon the excess of the fair market value of the Common
Stock over the exercise price at the time the stock option is exercised.
There is no assurance that the values of unexercised stock options reflected
in this table will be realized.

PROFIT SHARING PLAN AND DISCRETIONARY BOARD OF DIRECTOR BONUS PROGRAMS

The Corporation pays annual bonuses and makes profit sharing payments as
determined by the Compensation Committee of the MicroFinancial Board. Each year
the Compensation Committee indicates to the executive officers the percentage of
the following year's pre-tax profits on which profit sharing plan payments will
be based. Upon the conclusion of the audit of the prior year's financial
results, the Compensation Committee determines the total percentage of pre-tax
profits eligible for profit-sharing plan payments, and awards payments to all
Named Executive Officers, as well as ten other employees. To enhance long-term
retention of these executives, only one-third of the amount awarded is paid at
that point in time. The remaining two-thirds may be paid out over the next two
years in the discretion of the Compensation Committee and are subject to
separate annual approvals of the Compensation Committee. In March 2003, the
Board of Directors voted to issue promissory notes to these executives to cover
the deferred portion of the profit-sharing plan payments.

EMPLOYMENT AGREEMENTS

The Corporation 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
Corporation 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

25

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
Corporation's bonus and/or profit sharing plans. Dr. Bleyleben's and Mr.
Latour's current base salaries, respectively, are $130,000 and $250,000. The
bonus for the current fiscal year will be determined by the MicroFinancial
Board. If, in connection with a payment under their Employment Agreement, either
Dr. Bleyleben or Mr. Latour shall incur any excise 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
Corporation 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 Corporation to require a successor to
assume all obligations under the Employment Agreement.

The Corporation has also entered into separate employment agreements with
Messrs. Jackson and Plumlee and Ms. Salvo, as well as six other employees, which
are designed to provide an incentive to each executive to remain with the
Corporation 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 (such date and each annual anniversary
thereof, the "Renewal Date"). 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 MicroFinancial Board other than for cause, death
or disability, or is terminated by the executive for specified good reason, the
Corporation shall pay to the executive, the aggregate of the following amounts:
(i) one times annual base salary in the case of Mr. Jackson and one and one-half
times the annual base salary in the case of Mr. Plumlee and Ms. Salvo; (ii) any
other compensation or bonus previously deferred by the executive, together with
any accrued interest or earnings thereon; and (iii) any accrued vacation pay.
Pursuant to each employment agreement, if the Executive's employment is
terminated during the Change of Control employment period, the Company shall pay
the amounts referenced above to the Executive in a lump sum in cash within 30
days after the date of termination. If the Executive's employment is terminated
prior to the first day of the Change of Control employment period, the Company
is obligated to pay the amounts referenced above, however, payments of the
Executive's annual base salary would be payable over twelve months, in the case
of Mr. Jackson and eighteen months in the case of Mr. Plumlee and Ms. Salvo with
payment to be made at the same time that the Company pays other peer executives
of the Company.

"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 Corporation
entitled to vote generally in the election of directors; (ii) individuals who,
as of the date of the original employment agreements constitute the
MicroFinancial Board, cease for any reason to constitute at least a majority of
the MicroFinancial Board or are divested of possession by appointment of a
trustee pursuant to Chapter 7 or 11 of the United States Bankruptcy Code, except
with respect to any director who was approved by a vote of at least a majority
of the directors then comprising the MicroFinancial Board; (iii) approval by the
shareholders of the Corporation or, in the instance of proceedings for the
Corporation pursuant to Chapter 7 or Chapter 11 of the United States Bankruptcy
Code, approval by the bankruptcy judge, of a reorganization, merger or
consolidation, in each case, unless, following such reorganization, merger or
consolidation, more than 60% of, respectively, the then outstanding shares of
Common Stock of the corporation resulting from such reorganization, merger or
consolidation and the combined voting power of the then outstanding voting
securities of such corporation entitled to vote generally in the election of
directors 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 or, in the instance of
26

proceedings for the Company pursuant to Chapter 7 or Chapter 11 of the United
States Bankruptcy Code, approval by the bankruptcy judge, of the Corporation of
a complete liquidation or dissolution of the Corporation or the sale or other
disposition of all or substantially all of the assets of the Corporation.

DIRECTOR COMPENSATION

The MicroFinancial Board is comprised of five Directors, two of whom, Peter
Bleyleben and Richard F. Latour, are salaried employees of the Corporation who
receive no additional compensation for services rendered as Directors. The
members of the MicroFinancial Board who were not employees of the Corporation
("Non-Employee Directors") received stock options to purchase 50,000 shares of
Common Stock in 1999 and stock options to purchase 50,000 shares of Common Stock
in 2000 for their service on the MicroFinancial Board. In 2001, the Non-Employee
Directors each received stock options to purchase 25,000 shares of Common Stock.
In February 2002, the options granted in 2001 were voluntarily cancelled, and
each of the Directors received new options to purchase 45,000 shares of Common
Stock. In November 2002, the Non-Employee Directors each received stock options
to purchase 50,000 shares of Common Stock. Directors also are reimbursed for
out-of-state travel expenses incurred in connection with attendance at meetings
of the MicroFinancial Board and committees thereof. In addition, the Corporation
pays for health care insurance for each Non-Employee Director.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS AS OF
DECEMBER 31, 2002