##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2006
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
 Commission File No. 1-14771
 MICROFINANCIAL INCORPORATED
  Massachusetts
    
    04-2962824(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 
 
 þ o
  o o þ
 o þ




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##### 



MICROFINANCIAL INCORPORATED
TABLE OF CONTENTS
 PagePart I- FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (unaudited):Condensed Consolidated Balance Sheets December 31, 2005 and March 31, 2006
    
    
    3Condensed Consolidated Statements of Operations Three months ended March 31, 2005 and 2006
    
    
    4Condensed Consolidated Statements of Cash Flows Three months ended March 31, 2005 and 2006
    
    
    5-6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    21Item 4.
    
    Controls and Procedures
    
    
    21Part II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    22Item 1A.
    
    Risk Factors
    
    
    23Item 6.
    
    Exhibits
    
    
    23Signatures
    
    
    24EX-31.1 Section 302 Certification of CEOEX-31.2 Section 302 Certification of CFOEX-32.1 Section 906 Certification of CEOEX-32.2 Section 906 Certification of CFO




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##### Table of Contents



MICROFINANCIAL INCORPORATED
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands, except share and per share data)
  December 31,
    
    
    March 31,2005
    
    
    2006ASSETSCash and cash equivalents
    
    $
    32,926
    
    
    $
    31,690Net investment in leases and loans:Receivables due in installments
    
    
    29,139
    
    
    
    27,830Estimated residual value
    
    
    3,865
    
    
    
    2,908Initial direct costs
    
    
    98
    
    
    
    113Less:Advance lease payments and deposits
    
    
    (35
    )
    
    
    (36
    )Unearned income
    
    
    (3,658
    )
    
    
    (4,743
    )Allowance for credit losses
    
    
    (8,714
    )
    
    
    (7,548
    )Net investment in leases and loans
    
    
    20,695
    
    
    
    18,524Investment in service contracts, net
    
    
    1,626
    
    
    
    1,238Investment in rental contracts, net
    
    
    3,025
    
    
    
    1,752Property and equipment, net
    
    
    719
    
    
    
    733Other assets
    
    
    1,315
    
    
    
    1,100Deferred income taxes, net
    
    
    4,882
    
    
    
    4,392Total assets
    
    $
    65,188
    
    
    $
    59,429LIABILITIES AND STOCKHOLDERS EQUITYNotes payable
    
    $
    161
    
    
    $
    201Subordinated notes payable
    
    
    2,602
    
    
    
    802Accounts payable
    
    
    1,099
    
    
    
    525Dividends payable
    
    
    4,114
    
    
    
    689Other liabilities
    
    
    2,094
    
    
    
    1,913Income taxes payable
    
    
    431
    
    
    
    281Total liabilities
    
    
    10,501
    
    
    
    4,411Stockholders equity:Preferred stock, $.01 par value; 5,000,000 shares authorized;
no shares issued at December 31, 2005 and March 31, 2006
    
    
    
    
    
    
    Common stock, $.01 par value; 25,000,000 shares authorized;
13,713,899 and 13,785,273 shares issued at December 31, 2005 and March 31, 2006, respectively
    
    
    137
    
    
    
    138Additional paid-in capital
    
    
    43,839
    
    
    
    44,098Retained earnings
    
    
    10,711
    
    
    
    10,782Total stockholders equity
    
    
    54,687
    
    
    
    55,018Total liabilities and stockholders equity
    
    $
    65,188
    
    
    $
    59,429
  3




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MICROFINANCIAL INCORPORATED
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except share and per share data)
  For the Three Months EndedMarch 31,2005
    
    
    2006Revenues:Income on financing leases and loans
    
    $
    1,508
    
    
    $
    672Rental income
    
    
    6,429
    
    
    
    5,721Income on service contracts
    
    
    1,088
    
    
    
    555Loss and damage waiver fees
    
    
    819
    
    
    
    551Service fees and other
    
    
    1,017
    
    
    
    1,418Total revenues
    
    
    10,861
    
    
    
    8,917Expenses:Selling, general and administrative
    
    
    6,348
    
    
    
    4,207Provision for credit losses
    
    
    5,810
    
    
    
    1,610Depreciation and amortization
    
    
    2,484
    
    
    
    1,765Interest
    
    
    205
    
    
    
    81Total expenses
    
    
    14,847
    
    
    
    7,663Income (loss) before provision (benefit) for income taxes
    
    
    (3,986
    )
    
    
    1,254Provision (benefit) for income taxes
    
    
    (1,322
    )
    
    
    490Net income (loss)
    
    
    ($2,664
    )
    
    $
    764Net income (loss) per common share  basic
    
    
    ($0.20
    )
    
    $
    0.06Net income (loss) per common share  diluted
    
    
    ($0.20
    )
    
    $
    0.05Weighted-average shares:Basic
    
    
    13,254,838
    
    
    
    13,762,979Diluted
    
    
    13,254,838
    
    
    
    13,905,902
  4




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MICROFINANCIAL
INCORPORATED
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  (In thousands)
 For the Three Months EndedMarch 31,2005
    
    
    2006Cash flows from operating activities:Cash received from customers
    
    $
    16,074
    
    
    $
    12,178Cash paid to suppliers and employees
    
    
    (5,961
    )
    
    
    (4,587
    )Cash received (paid) for income taxes
    
    
    14
    
    
    
    (150
    )Interest paid
    
    
    (123
    )
    
    
    (70
    )Interest received
    
    
    32
    
    
    
    315Net cash provided by operating activities
    
    
    10,036
    
    
    
    7,686Cash flows from investing activities:Investment in lease and rental contracts
    
    
    (1,040
    )
    
    
    (2,922
    )Investment in inventory
    
    
    (2
    )
    
    
    Investment in direct costs
    
    
    (7
    )
    
    
    (54
    )Investment in property and equipment
    
    
    (44
    )
    
    
    (68
    )Net cash used in investing activities
    
    
    (1,093
    )
    
    
    (3,044
    )Cash flows from financing activities:Proceeds from secured debt
    
    
    45
    
    
    
    40Repayment of subordinated debt
    
    
    
    
    
    
    (1,800
    )Repayment of capital leases
    
    
    (32
    )
    
    
    Payment of dividends
    
    
    (659
    )
    
    
    (4,118
    )Net cash used in financing activities
    
    
    (646
    )
    
    
    (5,878
    )Net increase (decrease) in cash and cash equivalents
    
    
    8,297
    
    
    
    (1,236
    )Cash and cash equivalents, beginning of period
    
    
    9,709
    
    
    
    32,926Cash and cash equivalents, end of period
    
    $
    18,006
    
    
    $
    31,690
 
 5




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MICROFINANCIAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  (In thousands)
 For the Three Months EndedMarch 31,2005
    
    
    2006Reconciliation of net income (loss) to net cash provided
by operating activities:Net income (loss)
    
    $
    (2,664
    )
    
    $
    764Adjustments
to reconcile net income (loss) to netcash provided by operating activities:Amortization of unearned income, net of initial direct costs
    
    
    (1,508
    )
    
    
    (672
    )Depreciation and amortization
    
    
    2,484
    
    
    
    1,765Provision for credit losses
    
    
    5,810
    
    
    
    1,610Recovery of equipment cost and residual value
    
    
    6,407
    
    
    
    4,159Stock-based compensation expense
    
    
    752
    
    
    
    84Non-cash interest expense (amortization of debt discount)
    
    
    49
    
    
    
    11Change in assets and liabilities:Current taxes payable
    
    
    14
    
    
    
    (150
    )Deferred income taxes
    
    
    (1,322
    )
    
    
    490Other assets
    
    
    240
    
    
    
    205Accounts payable
    
    
    (771
    )
    
    
    (595
    )Other liabilities
    
    
    545
    
    
    
    15Net cash provided by operating activities
    
    $
    10,036
    
    
    $
    7,686Supplemental disclosure of non-cash activities:Fair market value of stock issued
    
    $
    
    
    
    $
    199
  6




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MICROFINANCIAL INCORPORATED
 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Tables in thousands, except share and per share data)
    Basis of Presentation
   Allowance for Credit Losses
   7




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MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tables in thousands, except share and per share data)
   Allowance for credit losses at December 31, 2005
    
    
    
    
    
    $
    8,714Provision for credit losses
    
    
    
    
    
    
    1,610Charge-offs
    
    
    (4,329
    )Recoveries
    
    
    1,553Charge-offs, net of recoveries
    
    
    
    
    
    
    (2,776
    )Allowance for credit losses at March 31, 2006
    
    
    
    
    
    $
    7,548
 Net Income (Loss) Per Share
  For Three Months EndedMarch 31,2005
    
    2006Net income (loss)
    
    
    ($2,664
    )
    
    $
    764Shares used in computation:Weighted average common shares
outstanding used in computation
of net income (loss) per common share
    
    
    13,254,838
    
    
    
    13,762,979Dilutive effect of common stock
options, warrants and restricted stock
    
    
    
    
    
    
    142,923Shares used in computation of net
income (loss) per common share 
assuming dilution
    
    
    13,254,838
    
    
    
    13,905,902Net income (loss) per common share  basic
    
    
    ($0.20
    )
    
    $
    0.06Net income (loss) per common share  diluted
    
    
    ($0.20
    )
    
    $
    0.05
 Stock-Based Employee Compensation
 Share-Based Payment
 8




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MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tables in thousands, except share and per share data)
    Outstanding
    
    
    ExercisableWeighted-
    
    
    
    
    
    
    Weighted-Average
    
    
    Intrinsic
    
    
    Average
    
    
    
    
    
    
    IntrinsicExercise Price
    
    
    Shares
    
    
    Life (Years)
    
    
    Value
    
    
    Exercise Price
    
    
    
    Shares
    
    
    Value$12.31
    
    
    359,391
    
    
    
    2.91
    
    
    $
    
    
    
    $
    12.31
    
    
    
    359,391
    
    
    $
    $13.54
    
    
    40,609
    
    
    
    2.91
    
    
    
    
    
    
    $
    13.54
    
    
    
    40,609
    
    
    
    $9.78
    
    
    350,000
    
    
    
    3.91
    
    
    
    
    
    
    $
    9.78
    
    
    
    350,000
    
    
    
    $13.10
    
    
    90,000
    
    
    
    4.89
    
    
    
    
    
    
    $
    13.10
    
    
    
    90,000
    
    
    
    $6.70
    
    
    235,000
    
    
    
    5.92
    
    
    
    
    
    
    $
    6.70
    
    
    
    188,000
    
    
    
    $1.59
    
    
    167,500
    
    
    
    6.66
    
    
    
    371
    
    
    $
    1.59
    
    
    
    137,500
    
    
    
    3051,242,500
    
    
    
    4.41
    
    
    $
    371
    
    
    $
    9.49
    
    
    
    1,165,500
    
    
    $
    305
    9




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MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tables in thousands, except share and per share data)
  Original grant date
    
    
    11/25/2002
    
    
    
    2/28/2002
    
    
    
    2/20/2001
    
    
    
    2/24/2000
    
    
    
    2/25/1999
    
    
    
    2/25/1999Exercise price
    
    $
    1.59
    
    
    $
    6.70
    
    
    $
    13.10
    
    
    $
    9.78
    
    
    $
    13.54
    
    
    $
    12.31Expected life (in years)
    
    
    3.25
    
    
    
    3.25
    
    
    
    2.75
    
    
    
    2.25
    
    
    
    1.75
    
    
    
    1.75Annualized volatility
    
    
    78
    %
    
    
    78
    %
    
    
    78
    %
    
    
    78
    %
    
    
    78
    %
    
    
    78
    %Dividend yield
    
    
    5.26
    %
    
    
    5.26
    %
    
    
    5.26
    %
    
    
    5.26
    %
    
    
    5.26
    %
    
    
    5.26
    %Risk free rate
    
    
    4.84
    %
    
    
    4.84
    %
    
    
    4.84
    %
    
    
    4.84
    %
    
    
    4.84
    %
    
    
    4.84
    %
  Debt
  Interest
    
    December 31,
    
    March 31,Rate
    
    2005
    
    2006Revolving credit facility
    
    prime + 1.5%
    
    $
    161
    
    
    $
    201Subordinated notes
    
    
    8.0%-12.0
    %
    
    
    2,602
    
    
    
    802$
    2,763
    
    
    $
    1,003
  Dividends
   10




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MICROFINANCIAL INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tables in thousands, except share and per share data)
 Commitments and Contingencies
   11




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ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Three months ended March 31, 2006 as compared to the three months ended March 31, 2005
 Results of Operations
 Revenue
 For the Three Months EndedMarch 31,2005
    
    
    Change
    
    
    2006(Dollars in thousands)Income on financing leases and loans
    
    $
    1,508
    
    
    
    (55.4
    )%
    
    $
    672Rental income
    
    
    6,429
    
    
    
    (11.0
    )%
    
    
    5,721Income on service contracts
    
    
    1,088
    
    
    
    (49.0
    )%
    
    
    555Service fees and other
    
    
    1,836
    
    
    
    7.2
    %
    
    
    1,969Total revenues
    
    $
    10,861
    
    
    
    (17.9
    )%
    
    $
    8,917
   12




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##### Table of Contents



Selling, General and Administrative
 For the Three Months EndedMarch 31,2005
    
    Change
    
    2006(Dollars in thousands)Selling, general and administrative
    
    $
    6,348
    
    
    
    (33.7
    )%
    
    $
    4,207As a percent of revenue
    
    
    58.4
    %
    
    
    
    
    
    
    47.2
    %
  Provision for Credit Losses
 For the Three Months EndedMarch 31,2005
    
    Change
    
    2006(Dollars in thousands)Provision for credit losses
    
    $
    5,810
    
    
    
    (72.3
    )%
    
    $
    1,610As a percent of revenue
    
    
    53.5
    %
    
    
    
    
    
    
    18.1
    %
  Depreciation and Amortization
 For the Three Months EndedMarch 31,2005
    
    
    Change
    
    
    2006(Dollars in thousands)Depreciation  fixed assets
    
    $
    118
    
    
    
    (51.7
    )%
    
    $
    57Depreciation and amortization  rentals
    
    
    1,429
    
    
    
    (7.8
    )%
    
    
    1,317Depreciation and amortization  contracts
    
    
    937
    
    
    
    (58.3
    )%
    
    
    391Total depreciation and amortization
    
    
    2,484
    
    
    
    (28.9
    )%
    
    
    1,765As a percent of revenue
    
    
    22.9
    %
    
    
    
    
    
    
    19.8
    %
  13




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Interest Expense
 For the Three Months EndedMarch 31,2005
    
    Change
    
    2006(Dollars in thousands)Interest
    
    $
    205
    
    
    
    (60.5
    )%
    
    $
    81As a percent of revenue
    
    
    1.9
    %
    
    
    
    
    
    
    0.9
    %
  Provision (Benefit) for Income Taxes
 For the Three Months EndedMarch 31,2005
    
    2006(Dollars in thousands)Provision (benefit) for income taxes
    
    
    ($1,322
    )
    
    $
    490As a percent of revenue
    
    
    (12.2
    )%
    
    
    5.5
    %As a percent of income (loss) before taxes
    
    
    (33.2
    )%
    
    
    39.1
    %
  14




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Other Operating Data
  Critical Accounting Policies
  Revenue Recognition
   15




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Allowance for Credit Losses
   Income Taxes
   16




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##### Table of Contents



Share-Based Compensation
  Exposure to Credit Losses
  (dollars in thousands)
    
    December 31, 2005
    
    March 31, 2006Cumulative amounts billed
    
    $
    220,796
    
    
    
    
    
    
    $
    202,40931-60 days past due
    
    $
    991
    
    
    
    0.4
    %
    
    $
    931
    
    
    
    0.5
    %61-90 days past due
    
    
    997
    
    
    
    0.5
    %
    
    
    899
    
    
    
    0.4
    %Over 90 days past due
    
    
    16,101
    
    
    
    7.3
    %
    
    
    13,412
    
    
    
    6.6
    %Total past due
    
    $
    18,089
    
    
    
    8.2
    %
    
    $
    15,242
    
    
    
    7.5
    %
  17




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##### Table of Contents



(dollars in thousands)
    
    December 31, 2005
    
    
    March 31, 2006Current
    
    $
    8,486
    
    
    
    29.1
    %
    
    $
    10,276
    
    
    
    36.9
    %31-60 days past due
    
    
    637
    
    
    
    2.2
    %
    
    
    599
    
    
    
    2.1
    %61-90 days past due
    
    
    601
    
    
    
    2.1
    %
    
    
    521
    
    
    
    1.9
    %Over 90 days past due
    
    
    19,415
    
    
    
    66.6
    %
    
    
    16,434
    
    
    
    59.1
    %Gross receivables due in installments
    
    $
    29,139
    
    
    
    100.0
    %
    
    $
    27,830
    
    
    
    100.0
    %
 Liquidity and Capital Resources
 General
      Borrowings
  18




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##### Table of Contents



December 31, 2005
    
    
    March 31, 2006MaximumAmounts
    
    
    Interest
    
    
    Amounts
    
    
    Interest
    
    
    Unused
    
    
    Facility(dollars in thousands)
    
    Outstanding
    
    
    Rate
    
    
    Outstanding
    
    
    Rate
    
    
    Capacity
    
    
    AmountRevolving credit facility (1)
    
    $
    161
    
    
    
    8.75
    %
    
    $
    201
    
    
    
    9.25
    %
    
    $
    29,799
    
    
    $
    30,000Subordinated notes payable
    
    
    2,602
    
    
    
    8.0%-12.5
    %
    
    
    802
    
    
    
    8.0%-12.0
    %
    
    
    
    
    
    
    $
    2,763
    
    
    
    
    
    
    $
    1,003
    
    
    
    
    
    
    $
    29,799
    
    
    $
    30,000
 
 (1)
    
    The unused capacity is subject to lease eligibility and the borrowing base formula.  Financial Covenants
  Contractual Obligations, Commercial Commitments and Contingencies
 Contractual Obligations
  RevolvingCredit
    
    Long-Term
    
    OperatingYear Ending December 31,
    
    Facility(1)
    
    Debt
    
    Leases
    
    Total2006
    
    $
    201
    
    
    $
    802
    
    
    $
    178
    
    
    $
    1,1812007
    
    
    
    
    
    
    
    
    
    
    237
    
    
    
    2372008
    
    
    
    
    
    
    
    
    
    
    237
    
    
    
    2372009
    
    
    
    
    
    
    
    
    
    
    237
    
    
    
    2372010
    
    
    
    
    
    
    
    
    
    
    237
    
    
    
    237Thereafter
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    201
    
    
    $
    802
    
    
    $
    1,126
    
    
    $
    2,129
 
 (1)
    
    The Companys obligation to repay the revolving credit facility in the
current year is subject to lease collateral availability and the borrowing base formula.
The credit facility expires on September 29, 2007. Commitments
  19




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Contingencies
  Note on Forward-Looking Information
  20




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##### Table of Contents



ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
     
 ITEM 4. Controls and Procedures
   21




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Part II  Other Information
 
 ITEM 1. Legal Proceedings
     22




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##### Table of Contents



ITEM 1A. Risk Factors
  
 ITEM 6. Exhibits
  31.1*
    
    Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1*
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2*
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 *
    
    Filed herewith 23




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##### Table of Contents



SIGNATURES
  MicroFinancial IncorporatedBy:

/s/
Richard F. LatourPresident and Chief Executive OfficerBy:

/s/
James R. Jackson Jr.Vice President and Chief Financial Officer  24