MICROFINANCIAL INC - 10-K Annual Report

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

FORM 10-K

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

OR

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

COMMISSION FILE NO.

MICROFINANCIAL INCORPORATED
(Exact name of registrant as specified in its Charter)

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

10M COMMERCE WAY 01801
WOBURN, MA (Zip Code)
(Address of principal executive offices)

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
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

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 registrant's voting and non-voting common
equity held by non-affiliates of the registrant was approximately $15,217,000,
computed by reference to the closing price of such stock as of June 30, 2003,
which is the last business day of the registrant's most recently completed
second fiscal quarter.

As of March 19, 2004, 13,176,416 shares of the registrant's common stock
were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's proxy statement to be filed pursuant to
Regulation 14A within 120 days after the Registrant's fiscal year end of
December 31, 2003, is incorporated by reference in Part III hereof.

TABLE OF CONTENTS

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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 $1,900
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 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.
Renewal of the credit facility required 100% participation from the nine
lenders, and one of the lenders chose not to renew. As a result, in October
2002, the Company was forced to suspend virtually all new contract originations
until a source of funding is obtained or at such time that the senior credit
facility has been paid in full. During 2003, the Company was able to fund a very
limited number of new contracts using its own free cash flow. The amount and
timing of the new originations is restricted by both the amount of available
cash, and the terms of the Company's banking agreements. 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 higher 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 primarily provide security monitoring services.

Prior to the suspension of new contract originations in October, 2002, the
Company originated leases, contracts and loans in all 50 states of the United
States and its territories. The Company continues to service leases, contracts
and loans in all 50 states of the United States and its territories. As of
December 31, 2002 and
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2003, leases in California, Florida, Texas, Massachusetts and New York accounted
for approximately 42% and 40% of the Company's portfolio respectively. Only
California accounted for more than 10% of the total portfolio as of December 31,
2002 and 2003 at approximately 14%. None of the remaining states accounted for
more than 4% of such total.

TERMS OF EQUIPMENT LEASES

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

During the term of a typical lease, the Company is scheduled to receive
payments sufficient, in the aggregate, to cover the Company's borrowing costs
and the costs of the underlying equipment, and to provide the Company with an
appropriate profit. Throughout the term of the lease, the Company charges late
fees, prepayment penalties, loss and damage waiver fees and other service fees,
when applicable. Initial terms of the leases in the Company's portfolio
generally range from 12 to 48 months, with an average initial term of 44 months
as of December 31, 2003.

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

Prior to the suspension of new contract originations in October 2002, the
Company provided financing to obligors under microticket leases, contracts and
loans through a network of independent Dealers. Historically, the Company has
had over 1,000 different Dealers originating leases, contracts and loans. One
dealer

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accounted for approximately 7.38%, 10.98% and 56.14% of all originations during
the years ended December 31, 2001, 2002, and 2003, respectively. Another dealer
accounted for approximately 23.38% of all originations during the year ended
December 31, 2003 and a third dealer accounted for 10.79% of all originations
during the year ended December 31, 2003. No other dealer accounted for more than
10% of the Company's origination volume during the years ended December 31,
2001, 2002, or 2003.

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 might be profitably underwritten. The Company uses credit scoring in
most, but not all, of its extensions 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.
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Upon credit approval, the Company requires receipt of signed lease
documentation on the Company's standard, or other pre-approved, lease form
before funding. Once the equipment is shipped and installed, the Dealer invoices
the Company, and thereafter, the Company verifies that the lessee has received
and accepted the equipment. Upon the lessee authorizing payment to the Dealer,
the lease is forwarded to the Company's funding and documentation department for
funding, transaction accounting and billing procedures.

BULK AND PORTFOLIO ACQUISITIONS

In addition to originating leases through its Dealer relationships, the
Company, from time to time, has purchased lease portfolios from Dealers. 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.

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
uses 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.

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EMPLOYEES

As of December 31, 2003, the Company had 136 full-time employees, of whom 4
were engaged in credit activities and Dealer service, 93 were engaged in
servicing and collection activities, and 39 were engaged in general
administrative activities. Management believes that its relationship with its
employees is good. No employees of the Company are members of a collective
bargaining unit in connection with their employment by the Company.

EXECUTIVE OFFICERS

Backgrounds of Executive Officers

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.

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.

Steven J. LaCreta has served as Vice President, Lessee Relations since May
2000. From November 1996 to May 2000, Mr. LaCreta served as Director of Lessee
Relations of the Company. Prior to joining the Company, Mr. LaCreta was a
Leasing Collection Manager with Bayer Corporation.

Stephen J. Constantino has served as Vice President, Human Resources since
May 2000. From 1994 to May 2000, Mr. Constantino served as Director of Human
Resources of the Company. From 1992 to 1994, Mr. Constantino served as the
Controller of the Company. From 1991 to 1992, Mr. Constantino served as the
Accounting Manager of the Company. From 1989 to 1991, Mr. Constantino served as
a Senior Accountant of

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the Company. Prior to joining the Company, Mr. Constantino was a Senior
Accountant with Child World, Inc.

AVAILABILITY OF INFORMATION

The Company maintains an Internet website at http://www.microfinancial.com.
The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to such reports filed or furnished
pursuant to Section 13 (a) or 15(d) of the Securities Exchange Act of 1934, as
well as Section 16 reports on Form 3, 4, or 5, are available free of charge on
this site as soon as is reasonably practicable after the Company files or
furnishes these reports with the Securities and Exchange Commission (SEC). The
Company's Guidelines on Corporate Governance, Code of Business Conduct and
Ethics and charters for its Board Committees are also available on its internet
site. The Guidelines, Code of Ethics and charters are also available in print to
any shareholder upon request. Requests for such documents should be directed to
Richard F. Latour, Chief Executive Officer, at 10M Commerce Way, Woburn,
Massachusetts 01801. The Company's Internet site and the information contained
therein or connected thereto are not incorporated by reference into this Form
10-K.

ITEM 2. PROPERTIES

At December 31, 2003, the Company's corporate headquarters and operations
center occupied 44,659 square feet of office space at 10M Commerce Way, Woburn,
Massachusetts 01801. The lease for this space expires on December 31, 2005.

During 2003, the Company also leased 5,133 square feet of office space for
its West Coast office in Newark, California, under a lease expiring on May 1,
2005, and 21,656 square feet of office space in Waltham, Massachusetts, under a
lease expiring on July 31, 2004 and occupied 15,399 square feet of office space
in Herndon, Virginia. As of December 31, 2003, the Company had negotiated early
terminations of the leases related to the facilities in Newark, California,
Herndon, Virginia and Waltham, 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. The Company's case
against Premier and DelPiano was tried in November, 2003 and was decided by the
Court in March, 2004. The Court entered a judgment for the Company against
Premier and DelPiano, jointly and severally, on all of the Company's counts,
including fraud and violation of Massachusetts General Laws, Chapter 9A, and
dismissing with prejudice all of Premier and DelPiano's claims and
counterclaims. The Court awarded the Company Twenty Three Million Dollars
($23,000,000) in damages. Collection of this award is not assumed and therefore
it is not reflected in the financial statements as of December 31, 2003.

B. 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
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anguish. The claims purportedly arise from Leasecomm's dealer relationships with
Themeware, E-Commerce Exchange, Cardservice International, Inc., and Online
Exchange for the leasing of websites and virtual terminals. The Complaint
asserts that the Company is responsible for the conduct of its dealers in trade
shows, infomercials and web page advertisements, seminars, direct mail,
telemarketing, all which are alleged to constitute unfair and deceptive acts and
practices. Further, the Complaint asserts that Leasecomm's lease contracts as
well as its collection practices and late fees are unconscionable. The Complaint
seeks restitution, compensatory and treble damages, and injunctive relief. The
Company filed a Motion to Dismiss the Complaint on January 31, 2003. By decision
dated September 30, 2003, the court dismissed the complaint with leave to file
an amended complaint. An Amended Complaint was filed in November, 2003. The
Company filed a Motion to Dismiss the Amended Complaint, which is awaiting
decision by the Court. Because of the uncertainties inherent in litigation, we
cannot predict whether the outcome will have a material adverse effect.

C. On August 22, 2002 plaintiff Aaron Cobb filed a Complaint against
Leasecomm Corporation and MicroFinancial, Inc. and another Entity known as
Galaxy Mall, Inc. alleging breach of contract; Fraud, Suppression and Deceit;
Unjust Enrichment; Conspiracy; Conversion; Theft by Deception; and violation of
Alabama Usury Laws. The Complaint was filed on behalf of Aaron Cobb
individually, and on behalf of a class of persons and entities similarly
situated in the State of Alabama. More specifically, the Plaintiff purports to
represent a class of persons and small business in the State of Alabama who
allegedly were induced to purchase services and/or goods from any of the
Defendants named in the Complaint. The case is venued in Bullock County,
Alabama. On March 31, 2003 the trial court entered an Order denying the
Company's Motion to Dismiss. An appeal of the Order was filed with the Alabama
Supreme Court on May 12, 2003. The Company continues to deny any wrongdoing and
plans to vigorously defend this claim. Because of the uncertainties inherent in
litigation, the company cannot predict whether the outcome will have a material
adverse affect.

D. 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. The Company filed an answer denying the
allegations. In December, 2003, upon motion filed by the plaintiff shareholder,
the Court dismissed the action without prejudice.

E. 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. After the Company had filed a motion to
dismiss, but before the motion to dismiss was heard by the Court, plaintiffs
filed an Amended Complaint. The Amended Complaint asserts claims against the
Company for declaratory relief, absence of consideration, unconscionability, and
violation of Massachusetts General Laws Chapter 93A, Section 11. The Company
filed a motion to dismiss the Amended Complaint. The Court allowed the Company's
motion to dismiss the Amended Complaint in March, 2004.

F. On April 28, 2003 plaintiff Wallace Dickey filed a purported class
action against Leasecomm Corporation, Cardservice International, Linkpoint
International and Clear Commerce Corporation alleging that he lease-financed
through Leasecomm the right to use certain computer software manufactured,
distributed and sold by the other defendants. The plaintiff does not allege that
Leasecomm failed to provide the lease financing contemplated by the Leasecomm
lease. Instead, the Plaintiff alleges that the software failed to operate as he
believed it would, and he has sued for a declaration that would allow him to
rescind his contract, to recover money paid in the course of the transaction and
to recover damages allegedly caused by unspecified deceptive trade practices.
The plaintiff asserts his claims "on behalf of himself and all others similarly
situated." Leasecomm denies all of the Plaintiff's allegations. The parties have
reached an agreement on settlement terms and are currently drafting the
settlement documents. The settlement, if finalized and signed by the parties,
will require court approval to become effective. Because of the uncertainties
inherent in litigation, the company cannot predict whether the outcome will have
a material adverse affect.
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G. On April 29, 2003, Leasecomm was served with a Complaint filed in the
Orange County Superior Court for the State of California. In that Complaint,
Maria J. Smith purports to bring a claim against Leasecomm and two other
defendants (Galaxy Mall, Inc. and Electronic Commerce International, Inc.) for
unfair business practices and competition under California Business and
Professions Code section 17200 et seq. The essence of the claim is that Smith
and others who are similarly situated were defrauded in connection with their
acquisition of certain licenses that were financed by Leasecomm. In May 2003,
Leasecomm filed a motion to stay the action in favor of a Massachusetts forum
based on a forum selection clause contained in plaintiff's lease agreement with
Leasecomm. After filing the motion, Leasecomm entered into settlement
negotiations with plaintiff's counsel to explore the possibility of resolving
the matter on a class wide basis without the need for further litigation
(meaning the settlement would, if accepted, apply not only to the named
plaintiff but to others similarly situated). The parties have reached agreement
on settlement terms and are currently drafting the settlement documents. The
settlement, if finalized and signed by the parties, will require Court approval
to become effective. Because of the uncertainties inherent in litigation, the
company cannot predict whether the outcome will have a material adverse affect.

H. In October, 2003, the Company was served with a purported class action
complaint which was filed in United States District Court for the District of
Massachusetts alleging violations of federal securities law. The purported class
would consist of all persons who purchased Company securities between February
5, 1999 and October 30, 2002. The Complaint asserts that during this period the
Company made a series of materially false or misleading statements about the
Company's business, prospects and operations, including with respect to certain
lease provisions, the Company's course of dealings with its vendor/dealers, and
the Company's reserves for credit losses. No motion or answer has been filed in
response to the Complaint. Because of the uncertainties inherent in litigation,
we cannot predict whether the outcome will have a material adverse effect.

I. In February, 2004, a purported class action was filed in Superior Court
in Massachusetts against Leasecomm, a dealer, and a party purportedly related to
the dealer. The class sought to be certified is a nationwide class who signed
lease agreements identical to, or substantially similar to, the plaintiff's
lease agreement with Leasecomm, and covering the same product. The Complaint
asserts claims for declaratory judgment, absence of consideration,
unconscionability, and violation of Massachusetts General Laws Chapter 93A,
Section 11. The claims concern the validity, enforceability, and alleged
unconscionability of this Leasecomm lease of a product which enabled a merchant
to process credit card payments. The Complaint seeks rescission of 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. As of the date of this filing, the Company has not been served with this
complaint.

J. In February, 2003, Leasecomm received a Civil Investigative Demand
("CID") from the Office of the Attorney General, State of Washington, to which
it has responded. The CID 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 investigation has not been concluded, 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, 2003.

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, 2004, there were approximately 120 stockholders of record of
the common stock. However, many holders' shares are listed under their brokerage
firms' names. We estimate that our number of beneficial shareholders to be
approximately 850.

(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.
Currently, the terms of the Company's senior credit facility prohibit the
payment of dividends, so long as there is a balance outstanding on the debt. The
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

None

(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 has obtained judgements against the
Company and the Insurance Company in the amounts of $23.0 million and $14.0
million, respectively. 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 12,795,809, 12,728,441, 12,789,605, 12,821,946
and 13,043,744 for the years ended December 31, 1999, 2000, 2001, 2002, and
2003 respectively.

12

(5) Net income per common share (diluted) is calculated based on
weighted-average common shares outstanding on a diluted basis of
12,904,231, 12,807,814, 12,945,243, 12,821,946 and 13,043,744 for the years
ended December 31, 1999, 2000, 2001, 2002 and 2003 respectively.

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

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

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

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

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

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

(12) 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 inability to obtain financing in
order to continue originating new contracts; 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 $1,900. The Company primarily leases POS authorization systems and
other small business equipment to small commercial enterprises.

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. Historically, the Company funded the majority of leases, contracts and
loans through its revolving-credit and term loan facilities (the "Credit

13

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
began paying down the balance of the debt. 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 waived the defaults described above, and in
consideration for the waiver, required 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 was forced to suspend virtually all new contract originations until a
new source of financing is obtained or until such time as the credit facility
has been paid in full. The Company is currently in the process of pursuing
alternative financing sources.

In February 2003, the Company was advised by the New York Stock Exchange
(NYSE) that it was not in compliance with the NYSE's continued listing
standards. Specifically, the Company did 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,
on April 1, 2003, the Company presented a plan which management believed had the
potential to bring the Company back into compliance with the listing standards
within the required timeframes. Subsequently, the Company was able to achieve
and maintain compliance with the continued listing criteria. The Company
continues to work closely with the NYSE in the execution of its plan objectives.

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
non-cancelable. During the term of the lease, the Company is scheduled to
receive payments sufficient, in the aggregate, to cover the Company's borrowing
costs and the costs of the underlying equipment, and to provide the Company with
an appropriate profit. The Company enhances the profitability of its leases,
contracts and loans by charging late fees, prepayment penalties, loss and damage
waiver fees and other service fees, when applicable. Collection fees are imposed
based on the Company's estimate of the costs of collection. The Company may only
impose late fees on the first four months of late payments and is prohibited
from imposing compound late fees or from assessing late fees as a percentage of
the total outstanding late payments including outstanding late fees. The loss
and damage waiver fees are charged if a customer fails to provide proof of
insurance and are reasonably related to the cost of replacing the lost or
damaged equipment or product. The initial non-cancelable term of the lease is
equal to or less than the equipment's estimated economic life and often provides
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, 2003. Substantially all
service and rental contracts are

14

month-to-month contracts with expected terms of 7 years for service contracts,
15 months for lessees that continue to rent their equipment beyond the original
term, and 22 months for other types of rental contracts.

CRITICAL ACCOUNTING POLICIES

In response to the SEC's release No. 33-8040, "Cautionary Advice regarding
Disclosure About Critical Accounting Policies," Management identified the most
critical accounting principles upon which our financial status depends. The
Company determined the critical principles by considering accounting policies
that involve the most complex or subjective decisions or assessments. We
identified our most critical accounting policies to be those related to revenue
recognition and maintaining the allowance for credit losses. These accounting
policies are discussed below as well as within the notes to the consolidated
financial statements.

Revenue Recognition

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.

Allowance for Credit Losses

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

15

amount necessary to bring an account current (at 360 days past due, a lessee may
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

Revenue

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. 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.

Total revenues for the year ended December 31, 2003 were $91.6 million, a
decrease of $35.2 million, or 27.8%, from the year ended December 31, 2002. The
decline in revenue was due to decreases of $22.1 million, or 41.7%, in income on
financing leases and loans and $9.1 million, or 34.0%, in service fee and other
income. In addition, rental revenue decreased $2.9 million or 7.7% and income on
service contracts decreased $1.1 million, or 11.7%, as compared to such amounts
in the previous year's period. The overall decrease in revenue can be attributed
to the decrease in the overall size of the Company's portfolio of leases,
rentals and service contracts. The shrinking portfolio is a direct result of the
Company's decision during the third quarter of 2002 to cease funding new
originations as a result of its Lenders not renewing the revolving credit
facility on September 30, 2002. Revenues are expected to continue to decline so
long as the Company is not originating new contracts.

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 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 in 2002.

16

Selling, General and Administrative

Our selling, general and administrative (SG&A) expenses include costs of
maintaining corporate functions including accounting, finance, collections,
legal, human resources, information systems and communications. SG&A expenses
also include commissions, service fees and other marketing costs associated with
the Company's portfolio of leases and rental contracts. SG&A expenses decreased
by $11.7 million, or 25.6%, for the year ended December 31, 2003, as compared to
the year ended December 31, 2002. The decrease was primarily driven by a
reduction in personnel related expenses of approximately $5.8 million, as
management reduced headcount from 203 to 136, $2.0 million decrease in
collection related expenses, $1.8 million in cost of goods sold, and $700,000
reduction in rent expense. The expense reductions were achieved as management
continued to align the Company's infrastructure with the current business
conditions.

SG&A 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 service fees paid
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.

Provision for Credit Losses

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 Company's provision for credit losses decreased by $29.2 million,
or 32.8%, for the year ended December 31, 2003, as compared to the year ended
December 31, 2002, while net charge-offs increased 32.0% to $86.0 million. The
provision was based on the Company's historical policy of providing a provision
for credit losses based upon the dealer fundings and revenue recognized in any
period, as well as 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.

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.

17

Depreciation and Amortization

Depreciation and amortization expenses consist primarily of the
depreciation taken against fixed assets and rental equipment, and the
amortization of the Company's investment in service contracts. The Company's
investment in fixed assets is recorded at cost and amortized over the expected
life of the service period of the asset. 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. Service contracts are recorded
at cost and amortized over 84 months. The Company periodically evaluates whether
events or circumstances have occurred that may affect the estimated useful life
or recoverability of the asset and any resulting charge is made to depreciation
and amortization expense. Depreciation and amortization decreased by $1.8
million, or 9.8%, for the year ended December 31, 2003, as compared to the year
ended December 31, 2002, primarily due to the decrease in the overall portfolio
of service and rental contracts.

For the year ended December 31, 2002 as compared to the year ended December
31, 2001, 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

The Company pays interest on borrowings under the senior credit facility,
subordinated debt and the on balance sheet securitizations. Interest expense
decreased by $3.3 million, or 30.3%, for the year ended December 31, 2003, as
compared to the year ended December 31, 2002. This decrease resulted primarily
from the Company's decreased level of borrowings. At December 31, 2003, the
Company had notes payable of $58,843, compared to $168,927 at December 31, 2002.

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.

Other Operating Data

Dealer Fundings were $1.6 million during the year ended December 31, 2003,
a decrease of $72.4 million, or 97.8%, compared to the year ended December 31,
2002. . This decrease is a result of the failure of the credit facility to
renew, which, in turn, forced the Company to suspend virtually all new contract
originations in the third quarter of 2002. Receivables due in installments,
estimated residual values, loans receivable, investment in service contracts,
and investment in rental equipment also decreased from $396.5 million for the
year ended December 31, 2002 to $218.3 million for the year ended December 31,
2003, representing a decrease of $178.2 million, or 44.9%. Unearned income
decreased by $43.9 million, or 64.9%, from $67.6 million at December 31, 2002 to
$23.7 million at December 31, 2003. This decrease was primarily due to continued
amortization and a lack of new lease originations in 2003. Net cash provided by
operating activities decreased by $22.5 million, or 18.7%, to $98.1 million
during the year ended December 31, 2003, from the year ended December 31, 2002,
because of the decrease in the size of the Company's overall portfolio.

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 failure of the credit facility to renew,
which in turn, forced the Company to suspend virtually all new contract

18

originations in the third quarter of 2002. 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%. 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. 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.

EXPOSURE TO CREDIT LOSSES

The following table sets forth certain information as of December 31, 2001,
2002 and 2003, with respect to delinquent leases, service contracts and loans.
The percentages in the table below represent the aggregate on such date of the
actual amounts not paid on each invoice by the number of days past due, rather
than the entire balance of a delinquent receivable, over the cumulative amount
billed at such date from the date of origination on all leases, service
contracts, and loans in the Company's portfolio. For example, if a receivable is
90 days past due, the portion of the receivable that is over 30 days past due
will be placed in the 31-60 days past due category, the portion of the
receivable which is over 60 days past due will be placed in the 61-90 days past
due category and the portion of the receivable which is over 90 days past due
will be placed in the over 90 days past due category. The Company historically
used this methodology of calculating its delinquencies because of its experience
that lessees who miss a payment do not necessarily default on the entire lease.
Accordingly, the Company includes only the amount past due rather than the
entire lease receivable in each category.

LIQUIDITY AND CAPITAL RESOURCES

General

The Company's lease and finance business is capital-intensive and requires
access to substantial short-term and long-term credit to fund new leases,
contracts and loans. Since inception, the Company has funded its operations
primarily through borrowings under its credit facilities, its on-balance sheet
securitizations, the issuance of subordinated debt and an initial public
offering completed in February of 1999. The Company will continue to require
significant additional capital to maintain and expand its volume of leases,
contracts and loans funded, as well as to fund any future acquisitions of
leasing companies or portfolios.

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

The Company utilizes its credit facilities to fund the origination and
acquisition of leases that satisfy the eligibility requirements established
pursuant to each facility. On August 22, 2000, the Company entered into a new
$192 million credit facility with nine banks, expiring on September 30, 2002. As
of September 30, 2002, the credit facility failed to renew and the Company began
paying down the outstanding balance. As a result of the failure to renew, the
Company was forced to suspend essentially all new contract originations until a
new source of financing is obtained or at such time that the senior credit
facility has been paid in full. At

19

December 31, 2002, the Company was in default of certain of its debt covenants
in its credit facility. 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, as subsequently amended in
June and November 2003, as of December 31, 2003, the Company is obligated to
repay a minimum of $54.8 million, plus applicable interest, over the next twelve
months. At December 31, 2003, the Company had approximately $55.4 million
outstanding under the facility.

The Company, through its wholly owned subsidiary, Leasecomm Corporation,
periodically finances its lease and service contracts, together with
unguaranteed residuals, through securitizations using special purpose entities.
The assets of such special purpose entities and cash collateral or other
accounts created in connection with the financings in which they participate are
not available to pay creditors of Leasecomm Corporation, MicroFinancial
Incorporated, or other affiliates. However, the special purpose entities to
which such assets are contributed are required under generally accepted
accounting principles to be consolidated in the financial statements of the
Company. As a result, such assets and the related liability remain on the
balance sheet and do not receive gain on sale treatment. At December 31, 2002,
the Company was in default of certain of its debt covenants in its
securitization agreements. The covenants that were in default with respect to
the securitization agreements, required 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 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, cash flows from its portfolio and other fees have been
sufficient to repay amounts borrowed under the securitization agreements. At
December 31, 2003, the Company had approximately $3.2 million outstanding under
its securitizations.

MicroFinancial has taken certain steps in an effort to improve its
financial position. Management continues to actively consider various financing,
restructuring and strategic alternatives as well as continuing to work closely
with the Company's lenders to ensure continued compliance with the terms of the
long term agreement. In addition, management has taken steps to reduce overhead
and align its infrastructure with current business conditions, including a
reduction in headcount from 380 at December 31, 2001 to 136 at December 31,
2003. 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.

Provided that the Company continues to comply with the terms of the long
term bank agreement, including the suspension of new contract originations, the
Company believes that cash flows from its existing portfolio will be sufficient
to fund the Company's operations for the foreseeable future.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

The Company has entered into various agreements, such as the long-term debt
agreements, capital lease agreements and operating lease agreements that require
future payments be made. Long-term debt agreements include all debt outstanding
under the credit facility, securitizations, subordinated notes, demand notes and
other notes payable.

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At December 31, 2003 the repayment schedules for outstanding long-term
debt, minimum lease payments under non-cancelable operating leases and future
minimum lease payments under capital leases were as follows:

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 and $15.7 million for
the years ended December 31, 2002 and 2003, respectively. The net losses
incurred by the Company during the third and fourth quarters of 2002 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.

MicroFinancial has taken certain steps in an effort to improve its
financial position. Management continues to actively consider various financing,
restructuring and strategic alternatives as well as continuing to work closely
with the Company's lenders to ensure continued compliance with the terms of the
long term agreement. In addition, Management has taken steps to reduce overhead
and align its infrastructure with current business conditions, including a
reduction in headcount from 380 at December 31, 2001 to 136 at December 31,
2003. 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.

21

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,
2003, that are sensitive to changes in interest rates. The Company has used
interest-rate swaps to manage the primary market exposures associated with
underlying liabilities and anticipated transactions. The Company used these
instruments to reduce risk by creating offsetting market exposures. The
instruments held by the Company are not held for trading purposes.

In the normal course of operations, the Company also faces risks that are
either nonfinancial or nonquantifiable. Such risks principally include 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. Currently, given the fixed repayment schedules of the
Company's outstanding debt, the Company is limited in its ability to manage the
blend of fixed and variable rate interest obligations. As of December 31, 2003,
the Company's outstanding fixed-rate indebtedness outstanding under the
Company's securitizations and subordinated debt represented 10.9% of the
Company's total outstanding indebtedness.

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 $332,000 and $275,000,
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-27 of this
Form 10-K.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure controls and procedures

We evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as of December 31, 2003. Our disclosure
controls and procedures are the controls and other procedures that we designed
to ensure that we record, process, summarize and report in a timely manner the
information we must disclose in reports that we file with or submit to the SEC.
Richard F. Latour, our President and Chief

22

Executive Officer, and James R. Jackson, our Vice President and Chief Financial
Officer, reviewed and are responsible for conducting this evaluation. Based on
this evaluation, Messrs. Richard F. Latour and James R. Jackson concluded that,
as of the date of their evaluation, our disclosure controls were effective.

Internal controls

Since the date of the evaluation described above, there have not been any
significant changes in the Company's internal controls or in other factors that
could significantly affect those controls.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The sections, "Section 16(a) Beneficial Ownership Reporting Compliance,"
"Governance of the Corporation" and "Proposal 1 -- Election of Directors,"
included in the Company's proxy statement for its 2004 Special Meeting in Lieu
of Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission on or before April 29, 2004, are hereby incorporated by reference.

ITEM 11. EXECUTIVE COMPENSATION

The sections, "Compensation of Executive Officers," "Governance of the
Corporation," "Compensation Committee Report," and "Performance Graph" included
in the Company's proxy statement for its 2004 Special Meeting in Lieu of Annual
Meeting of Stockholders to be filed with the Securities and Exchange Commission
on or before April 29, 2004, are hereby incorporated by reference.

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

The section "Security Ownership of Certain Beneficial Owners and
Management," included in the Company's proxy statement for its 2004 Special
Meeting in Lieu of Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission on or before April 29, 2004, is hereby
incorporated by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The section "Governance of the Corporation," included in the Company's
proxy statement for its 2004 Special Meeting in Lieu of Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission on or
before April 29, 2004, is hereby incorporated by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The section "Proposal 2 -- Ratification of the Selection of
MicroFinancial's Independent Auditors," included in the Company's proxy
statement for its 2004 Special Meeting in Lieu of Annual Meeting of Stockholders
to be filed with the Securities and Exchange Commission on or before April 29,
2004, is hereby incorporated by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) (1) Financial Statements MicroFinancial Incorporated's Financial Statements,
together with the related Independent Auditors' Report, appear at pages
F-1 through F-27 of this Form 10-K

(2) None

23

(3) Exhibits Index

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

+ Filed herewith.

* Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to Item 14(c) of this Report.

(b) Reports on Form 8-K

The Company filed a current report on Form 8-K, dated October 24, 2003,
announcing financial results for the quarter ended September 30, 2003. The
Company filed a second current report on Form 8-K, dated March 10, 2004,
announcing financial results for the year ended December 31, 2003.

(c) See (a)(3) above.

(d) None.

27

SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.

MICROFINANCIAL INCORPORATED

By: /s/ RICHARD F. LATOUR
------------------------------------
Richard F. Latour
President and Chief Executive
Officer

By: /s/ JAMES R. JACKSON JR.
------------------------------------
James R. Jackson Jr.
Vice President and Chief Financial
Officer

Date: March 30, 2004

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.