<PAGE>
                                    FORM 10-Q
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

   (Mark One)
      [X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
           SECURITIES AND EXCHANGE ACT OF 1934
           For the Quarterly Period Ended September 30, 2003

                                       OR

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

                           Commission File No. 1-14771

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

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

                     10 M Commerce Way, Woburn, MA 01801
                   (Address of Principal Executive Offices)

                                (781) 994-4800
             (Registrant's Telephone Number, Including Area Code)


      Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(b) of the Securities and 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. [X] Yes [ ] No

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

      As of October 31, 2003, 13,176,416 shares of the registrant's common stock
were outstanding.


<PAGE>


                           MICROFINANCIAL INCORPORATED
                                TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                                                                Page
<S>              <C>                                                            <C>
Part I                  FINANCIAL INFORMATION

      Item 1     Financial Statements (unaudited):
                    Condensed Consolidated Balance Sheets
                       December 31, 2002 and September 30, 2003                  3
                    Condensed Consolidated Statements of Operations
                     Three months ended September 30, 2002 and 2003              4
                    Condensed Consolidated Statements of Cash Flows
                     Nine months ended September 30, 2002 and 2003               5

                    Notes to Condensed Consolidated Financial Statements         7

      Item 2     Management's Discussion and Analysis of Financial
                    Condition and Results of Operations                         14

      Item 3     Quantitative and Qualitative Disclosures about Market Risk     20

      Item 4     Controls and Procedures                                        20

 Part II                 OTHER INFORMATION

      Item 1     Legal Proceedings                                              21

      Item 2     Changes in Securities and Use of Proceeds                      23

      Item 5     Other Information                                              23

      Item 6     Exhibits and Reports on Form 8-K                               24

      Signatures                                                                25
</TABLE>




<PAGE>


                           MICROFINANCIAL INCORPORATED
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                        (In thousands, except share data)

<TABLE>
<CAPTION>
                                                                      December 31,   September 30,
                                                                          2002           2003
                                                                          ----           ----
                                     ASSETS
<S>                                                                   <C>            <C>
Net investment in leases and loans:
 Receivables due in installments                                      $ 334,623       $ 227,528
 Estimated residual value                                                30,754          22,927
 Initial direct costs                                                     4,891           2,515
 Loans receivable                                                         1,796               0
 Less:
  Advance lease payments and deposits                                       (96)            (43)
  Unearned income                                                       (67,574)        (34,883)
  Allowance for credit losses                                           (69,294)        (56,470)
                                                                      ---------       ---------
Net investment in leases and loans                                    $ 235,100       $ 161,574
Investment in service contracts                                          14,463          10,054
Cash and cash equivalents                                                 5,494           7,282
Restricted cash                                                          18,516           8,731
Property and equipment, net                                               9,026           5,953
Income taxes receivable                                                   8,652               0
Other assets                                                              3,834           3,577
                                                                      ---------       ---------
  Total assets                                                        $ 295,085       $ 197,171
                                                                      =========       =========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Notes payable                                                         $ 168,927       $  85,535
Subordinated notes payable                                                3,262           3,262
Capitalized lease obligations                                               471             253
Accounts payable                                                          3,840           2,888
Other liabilities                                                         6,776           5,273
Income taxes payable                                                      1,400           2,012
Deferred income taxes payable                                            23,806          18,681
                                                                      ---------       ---------
  Total liabilities                                                     208,482         117,904
                                                                      ---------       ---------
Stockholders' equity:
  Preferred stock, $.01 par value; 5,000,000 shares authorized;
   no shares issued at 12/31/02 and 9/30/03                                  --              --
  Common stock, $.01 par value; 25,000,000 shares authorized;
   13,410,646 shares issued at 12/31/02 and 9/30/03, respectively           134             134
  Additional paid-in capital                                             47,723          44,245
  Retained earnings                                                      45,089          37,403
  Treasury stock (588,700 and 234,230 shares of common stock at
   12/31/02 and 9/30/03), at cost                                        (6,343)         (2,515)
                                                                      ---------       ---------
     Total stockholders' equity                                          86,603          79,267
                                                                      ---------       ---------
     Total liabilities and stockholders' equity                       $ 295,085       $ 197,171
                                                                      =========       =========
</TABLE>


   The accompanying notes are an integral part of the condensed consolidated
                             financial statements.



                                       3
<PAGE>



                           MICROFINANCIAL INCORPORATED
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                 (In thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                 For the three months ended         For the nine months ended
                                                         September 30,                    September 30,
                                                 --------------------------         --------------------------
                                                    2002             2003            2002              2003
                                                    ----             ----            ----              ----
<S>                                            <C>              <C>              <C>               <C>
Revenues:
  Income on financing leases and loans            $12,819           $7,173          $41,845           $25,372
  Income on service contracts                       2,479            2,067            7,332             6,653
  Rental income                                     9,212            8,589           28,295            25,763
  Loss and damage waiver fees                       1,633            1,365            4,691             4,271
  Service fees and other                            4,406            2,863           16,632             9,533
                                               ----------       ----------       ----------        ----------
   Total revenues                                  30,549           22,057           98,795            71,592
                                               ----------       ----------       ----------        ----------
Expenses:
  Selling general and administrative               10,306            7,837           34,289            25,677
  Provision for credit losses                      44,672           13,852           66,460            39,900
  Depreciation and amortization                     5,713            4,106           14,203            12,463
  Interest                                          2,458            1,589            7,823             6,364
                                               ----------       ----------       ----------        ----------
   Total expenses                                  63,149           27,384          122,775            84,404
                                               ----------       ----------       ----------        ----------
Income/(loss) before provision for
 income taxes                                     (32,600)          (5,327)         (23,980)          (12,812)
Provision/(benefit) for income taxes              (13,042)          (2,131)          (9,593)           (5,125)
                                               ----------       ----------       ----------        ----------
Net income/(loss)                                ($19,558)         ($3,196)        ($14,387)          ($7,687)
                                               ==========       ==========       ==========        ==========
Net income/(loss) per common share -
 basic                                             ($1.53)          ($0.25)          ($1.12)           ($0.59)
                                               ==========       ==========       ==========        ==========
Net income/(loss) per common share -
 diluted                                           ($1.53)          ($0.25)          ($1.12)           ($0.59)
                                               ==========       ==========       ==========        ==========
Weighted-average shares used to compute:

   Basic net income (loss) per share           12,821,946       12,999,035       12,821,946        12,999,035
                                               ----------       ----------       ----------        ----------
   Fully diluted net income (loss) per
    share                                      12,821,946       12,999,035       12,821,946        12,999,035
                                               ----------       ----------       ----------        ----------
</TABLE>

   The accompanying notes are an integral part of the condensed consolidated
                             financial statements.



                                       4
<PAGE>


                           MICROFINANCIAL INCORPORATED
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                   For the three months ended      For the nine months ended
                                                          September 30,                   September 30,
                                                   --------------------------      -------------------------
                                                      2002            2003            2002            2003
                                                      ----            ----            ----            ----
<S>                                                <C>             <C>             <C>             <C>
Cash flows from operating activities:
 Cash received from customers                      $  43,289       $  32,420       $ 135,021       $ 107,575
 Cash paid to suppliers and employees                (10,339)         (8,087)        (32,130)        (31,125)
 Cash (paid) received for income taxes                  (475)         (1,826)         (3,734)          9,264
 Interest paid                                        (3,024)         (1,700)         (7,913)         (7,632)
 Interest received                                        80              24             322              98
                                                   ---------       ---------       ---------       ---------
   Net cash provided by operating
    activities                                        29,531          20,831          91,566          78,180
                                                   ---------       ---------       ---------       ---------
Cash flows from investing activities:
 Investment in lease contracts                       (19,042)           (460)        (62,426)         (2,159)
 Investment in inventory                                (625)            (25)         (2,701)           (103)
 Investment in direct costs                           (1,098)              0          (3,811)           (137)
 Investment in service contracts                      (2,131)              0          (6,538)              0
 Investment in fixed assets                              (90)            (63)           (208)           (205)
 Repayment of notes from officers                          0               0              33               0
 Repayment of notes receivable                             0               4               0               4
                                                   ---------       ---------       ---------       ---------
   Net cash used in investing activities             (22,986)           (544)        (75,651)         (2,600)
                                                   ---------       ---------       ---------       ---------
Cash flows from financing activities:
 Proceeds from secured debt                           12,292               0          33,521               0
 Repayment of secured debt                           (14,204)        (24,616)        (42,156)        (83,361)
 Repayment of short term demand notes payable            (30)              0            (315)            (30)
 Decrease in restricted cash                             681           3,465             854           9,785
 Repayment of capital leases                            (101)            (44)           (308)           (186)
 Payment of dividends                                   (641)              0          (1,924)              0
                                                   ---------       ---------       ---------       ---------
   Net cash used in financing activities              (2,103)        (21,195)        (10,428)        (73,792)
                                                   ---------       ---------       ---------       ---------
Net increase (decrease) in cash and cash
 equivalents:                                          4,442            (908)          5,487           1,788
Cash and cash equivalents, beginning of
 period                                                5,474           8,190           4,429           5,494
                                                   ---------       ---------       ---------       ---------
Cash and cash equivalents, end of period           $   9,916       $   7,282       $   9,916       $   7,282
                                                   =========       =========       =========       =========
</TABLE>

                          (continued on following page)

   The accompanying notes are an integral part of the condensed consolidated
                             financial statements.



                                       5
<PAGE>

                           MICROFINANCIAL INCORPORATED
               CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                                   (Continued)

<TABLE>
<CAPTION>
                                             For the three months ended     For the nine months ended
                                                September 30, 2003             September 30, 2003
                                             --------------------------     -------------------------
                                                2002           2003           2002           2003
                                                ----           ----           ----           ----
<S>                                           <C>            <C>            <C>            <C>
Reconciliation of net income to net
 cash provided by operating activities:
 Net income (loss)                            ($19,558)      ($ 3,196)      ($14,387)      ($ 7,687)
 Adjustments to reconcile net income
  (loss) to cash provided by operating
  activities
 Depreciation and amortization                   5,713          4,106         14,203         12,463
 Provision for credit losses                    44,672         13,852         66,460         39,900
 Recovery of equipment cost and residual
  value, net of revenue recognized              10,399          9,874         35,969         49,911
 Change in assets and liabilities:
  Decrease (increase) in current taxes             (40)        (1,826)        (2,552)           448
   payable
 Increase (decrease) in current taxes                0              0              0         (8,652)
  receivable
 Decrease (increase) in deferred income        (13,042)        (2,131)       (10,340)        (5,125)
  taxes
 Increase (decrease) in other assets               263            564          1,181         (1,892)
 Increase (decrease) in accounts payable           (65)          (253)           (42)          (952)
 Increase in accrued liabilities                 1,189           (159)         1,074           (234)
                                              --------       --------       --------       --------
  Net cash provided by operating
   activities                                 $ 29,531       $ 20,831       $ 91,566       $ 78,180
                                              ========       ========       ========       ========

Supplemental disclosure of noncash
 activities:
 Property acquired under capital leases       $      0       $      0       $     68       $      0
 Accrual of common stock dividends            $    641       $      0       $    641       $      0
</TABLE>

   The accompanying notes are an integral part of the condensed consolidated
                             financial statements.



                                       6
<PAGE>

                           MICROFINANCIAL INCORPORATED
        NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(A)   Nature of Business:

      MicroFinancial Incorporated (the "Company") which operates primarily
through its wholly-owned subsidiary, Leasecomm Corporation, is a specialized
commercial finance company that primarily 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 $1,700 and
an average lease term of 44 months. The Company does not market its services
directly to lessees but sources leasing transactions through a network of
independent sales organizations and other dealer-based origination networks
nationwide. The Company has funded its operations primarily through borrowings
under its credit facilities, the issuance of subordinated debt and on balance
sheet securitizations.

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

      In an effort to improve its financial position, MicroFinancial has taken
certain steps including the engagement of a financial and strategic advisory
firm, Triax Capital Advisors, LLC. Management and its advisors are actively
considering various financing, restructuring and strategic alternatives. In
addition, Management has taken steps to reduce overhead, including a reduction
in headcount from 380 at December 31, 2001 to 203 at December 31, 2002. During
the nine months ended September 30, 2003, the employee headcount was further
reduced to 144 in a continued effort to maintain an appropriate cost structure.

      Leasecomm Corporation periodically finances its lease and service
contracts, together with unguaranteed residuals, through securitizations using
special purpose vehicles. MFI Finance Corporation I and MFI Finance Corporation
II, LLC are special purpose companies. The assets of such special purpose
vehicles 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. While
Leasecomm Corporation generally does not sell its interests in leases, service
contracts or loans to third parties after origination, the Company does, from
time to time, contribute certain leases, service contracts, or loans to
special-purpose entities for purposes of obtaining financing in connection with
the related receivables. The contribution of such assets under the terms of such
financings are intended to constitute "true sales" of such assets for bankruptcy
purposes (meaning that such assets are legally isolated from Leasecomm
Corporation). However, the special purpose entities to which such assets are
contributed are not "qualifying special purpose entities" within the meaning of
Statement of Financial Accounting Standards ("SFAS") SFAS No. 140, and 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.



                                       7
<PAGE>



                           MICROFINANCIAL INCORPORATED
         NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(B)   Summary of Significant Accounting Policies:


Basis of Presentation:

      The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America and the rules and regulations of the Securities and
Exchange Commission for interim financial statements. Accordingly, the interim
statements do not include all of the information and disclosures required for
the annual financial statements. In the opinion of the Company's management, the
condensed consolidated financial statements contain all adjustments, consisting
only of normal recurring adjustments, considered necessary for a fair
presentation of these interim results. These financial statements should be read
in conjunction with the consolidated financial statements and notes included in
the Company's Annual Report and Form 10-K for the year ended December 31, 2002.
The results for the nine-month period ended September 30, 2003 are not
necessarily indicative of the results that may be expected for the full year
ended December 31, 2003.

      The balance sheet at December 31, 2002 has been derived from the audited
financial statements included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2002.

Allowance  for Credit Losses:

      The Company maintains an allowance for credit losses on its investment in
leases, service contracts and loans at an amount that it believes is sufficient
to provide adequate protection against losses in its portfolio. The allowance is
determined principally on the basis of the historical loss experience of the
Company and the level of recourse provided by such lease, service contract or
loan, if any, and reflects management's judgment of additional loss potential
considering 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 and loans.

      The following table sets forth the Company's allowance for credit losses
as of December 31, 2002 and September 30, 2003 and the related provision,
charge-offs and recoveries for the nine months ended September 30, 2003.

Balance of allowance for credit losses at December
 31, 2002                                                              $69,294
                                                                       =======
Provision for credit losses                                39,900
 Total provisions for credit losses                                     39,900
Charge-offs                                               (58,389)
Recoveries                                                  5,665
                                                          -------
 Charge-offs, net of recoveries                                        (52,724)
                                                                       -------
Balance of allowance for credit losses at September
 30, 2003                                                              $56,470
                                                                       =======

Earnings (Loss) Per Share:

      Basic net income (loss) per common share is computed based on the
weighted-average number of common shares outstanding during the period. Dilutive
net income (loss) per common share gives effect to all dilutive potential common
shares outstanding during the period. The computation of diluted earnings (loss)
per share does not assume the issuance of common shares that have an
antidilutive effect on net income per common share. Stock options were not
included in the computation of diluted earnings per share for the three months
and six months ended September 30, 2002 because their effects were antidilutive.
All stock options, common stock warrants, and


                                       8
<PAGE>
                           MICROFINANCIAL INCORPORATED
         NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


unvested restricted stock were excluded from the computation of dilutive
earnings (loss) per share for the three and nine months ended September 30,
2003, because their inclusion would have had an antidilutive effect on earnings
(loss) per share.

<TABLE>
<CAPTION>
                                     For three months ended      For nine months ended
                                          September 30,            September 30,
                                     ----------------------      ---------------------
                                       2002          2003        2002          2003
                                       ----          ----        ----          ----
<S>                                 <C>          <C>          <C>          <C>
Net income (loss)                     ($19,558)     ($3,196)    ($14,387)     ($7,687)
Shares used in computation:
 Weighted average common shares
  outstanding used in computation
  of net income (loss) per
   common share                     12,821,946   12,999,035   12,821,946   12,999,035

Dilutive effect of common stock
  options                                    0            0            0            0
                                    ----------   ----------   ----------   ----------
Shares used in computation of net
 income (loss) per common share-
 assuming dilution                  12,821,946   12,999,035   12,821,946   12,999,035
                                    ----------   ----------   ----------   ----------
Net income (loss) per common
 share                                  ($1.53)      ($0.25)      ($1.12)      ($0.59)
Net income (loss) per common
 share assuming dilution                ($1.53)      ($0.25)      ($1.12)      ($0.59)
</TABLE>

Stock Options

      Under the 1998 Equity Incentive Plan (the "1998 Plan") which was adopted
on July 9, 1998 the Company had reserved 4,120,380 shares of the Company's
common stock for issuance pursuant to the 1998 Plan. The Company granted a total
of 200,000 options during the nine months ended September 30, 2003. A total of
195,000 options were surrendered during the nine months ended September 30,
2003. A total of 1,675,000 options were outstanding at September 30, 2003 of
which 813,000 were vested.

      On February 7, 2003, the Company offered non-director employees and
executives who had been granted stock options in the past the opportunity to
cancel any of the original option agreements in exchange for a grant of
restricted stock. All option awards subject to the offer were converted to
restricted stock. In connection with this offer, on February 12, 2003, 1,325,000
options converted to 319,854 shares of restricted common stock. In addition, on
March 17, 2003 one non-employee director was granted 50,000 shares of restricted
stock. The restricted stock vested 20% upon grant, and vests 5% on the first day
of each quarter after the grant date, with accelerated vesting if the price of
the Company's common stock exceeds certain thresholds during the vesting period.
As of September 30, 2003, 15,384 shares had been cancelled, 354,470 shares were
fully vested, and $272,000 had been amortized from unearned compensation to
compensation expense.

Stock-based Employee Compensation

      All stock options issued to directors and employees have an exercise price
not less than the fair market value of the Company's common stock on the date of
grant. In accordance with accounting for such options utilizing the
intrinsic-value method, there is no related compensation expense recorded in the
Company's financial statements. The Company follows the disclosure requirements
of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires
that compensation under a fair value method be determined using the
Black-Scholes option-


                                       9
<PAGE>
                           MICROFINANCIAL INCORPORATED
         NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

pricing model and disclosed in a pro forma effect on earnings and earnings per
share. The Company accounts for stock-based employee compensation plans under
the recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related Interpretations. The current period
amortization of unearned compensation expense relating to the restricted stock
awards is reflected in net income (loss). No other stock-based employee
compensation cost is reflected in net income (loss), as either all options
granted under those plans had an exercise price equal to the market value of the
underlying common stock on the date of grant or options granted that result in
variable compensation costs had an exercise price greater than the fair market
value of the underlying common stock on September 30, 2003. The following table
illustrates the effect on net income (loss) and earnings per share if the
Company had applied the fair value recognition provisions of SFAS No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.

<TABLE>
<CAPTION>
                                         For the three months ended   For the nine months ended
                                               September 30,              September 30,
                                         --------------------------   -------------------------
                                              2002       2003           2002         2003
                                              ----       ----           ----         ----
<S>                                         <C>        <C>            <C>          <C>
Net income (loss), as reported              ($19,558)  ($3,196)       ($14,387)    ($7,687)
Add: Stock-based employee compensation
 expense included in reported net
 income, net of related tax effects                0        94               0         256
Deduct: Total stock-based employee
 compensation expense determined
 under fair value based method
 for all awards, net of related tax
 effects                                        (322)     (288)           (998)       (853)
                                            --------   -------        --------     -------
Pro forma net income (loss)                 ($19,880)  ($3,390)       ($15,385)    ($8,284)
                                            ========   =======        ========     =======
Earnings (loss) per share:
Basic - as reported                           ($1.53)   ($0.25)         ($1.12)     ($0.59)
                                            ========   =======        ========     =======
Basic - pro forma                             ($1.55)   ($0.26)         ($1.20)     ($0.64)
                                            ========   =======        ========     =======
Diluted - as reported                         ($1.53)   ($0.25)         ($1.12)     ($0.59)
                                            ========   =======        ========     =======
Diluted - pro forma                           ($1.55)   ($0.26)         ($1.20)     ($0.64)
                                            ========   =======        ========     =======
</TABLE>

   The fair value of option grants for options granted during the nine months
ended September 30, 2003 was estimated on the date of grant utilizing the
Black-Scholes option-pricing model with the following weighted-average
assumptions.

<TABLE>
<S>                                    <C>
             Risk-free interest rate    3.34%
             Expected dividend yield    0.00%
             Expected life             7 years
             Volatility                76.00%
</TABLE>

      The weighted-average fair value at the date of grant for options granted
during the nine months ended September 30, 2003 approximated $0.62 per option.
The Company granted 200,000 options during the nine months ended September 30,
2003. There were no options granted during the three months ended September 30,
2003.

Notes Payable:

      On August 22, 2000, the Company entered into a revolving line of credit
and term loan facility with a group of financial institutions whereby it may
borrow a maximum of $192,000,000 based upon qualified lease receivables, loans,
rentals and service contracts. As of September 30, 2002 the Company's senior
credit facility failed to renew. While cash flows from its portfolio and other
fees have been sufficient to repay amounts borrowed under the senior credit
facility, securitizations and subordinated debt, in October 2002, the Company
was forced to suspend new contract originations until a new source of liquidity
is obtained.



                                       10
<PAGE>



                           MICROFINANCIAL INCORPORATED
        NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

      According to the agreement, outstanding borrowings with respect to the
revolving line of credit bear interest based either at Prime minus 0.25% for
Prime Rate Loans or the prevailing rate per annum as offered in the London
Interbank Offered Rate (LIBOR) plus 1.75% for LIBOR Loans or the seven-day Money
Market rate plus 2.00% for Swing Line Advances. If the LIBOR loans are not
renewed upon their maturity they automatically convert into prime rate loans.
The Swing Line Advances have a seven-day maturity, and upon their maturity they
automatically convert into prime rate loans. In addition, the Company's
aggregate outstanding principal amount of Swing Line Advances shall not exceed
$10 million. The prime rate at December 31, 2002, and September 30, 2003 was
4.25% and 4.00%. The 90-day LIBOR rate at December 31, 2002 and September 30,
2003 was 1.40% and 1.16% respectively.

      As of September 30, 2002 the revolving credit line failed to renew and the
Company began paying down the balance on the basis of a 36-month amortization
plus interest. Based on the terms of the agreement, interest rates increased
from Prime minus 0.25% to Prime plus 0.50% for prime based loans and from LIBOR
plus 1.75% to LIBOR plus 2.50% for existing LIBOR based loans. In addition,
based on the covenant defaults described below, the outstanding borrowings on
all loans bear an additional 2.00% default interest. On January 3, 2003, the
Company entered into a Forbearance and Modification Agreement for the senior
credit facility which expired on February 7, 2003. Based on the terms of the
Forbearance and Modification Agreement, interest rates increased again on the
prime based loans to prime plus 1.00%.

      At December 31, 2002, the Company was in default of certain of its debt
covenants in its senior credit facility. The covenants that were in default with
respect to the senior 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 on June 30, 2003, the Company is obligated to repay a
minimum of $56.1 million, plus applicable interest, over the next twelve months.

      The Company had borrowings outstanding under the senior credit facility
with the following terms:

<TABLE>
<CAPTION>
                        December 31, 2002          September 30, 2003
                      ---------------------       -------------------
Type                  Rate           Amount       Rate        Amount
----                  ----           ------       ----        ------
                                 (in thousands)            (in thousands)
<S>                   <C>           <C>          <C>          <C>
Prime                 4.7500%       $31,556      6.0000%      $73,529
LIBOR                 4.1875%        50,000
LIBOR                 4.1875%        45,000
                                   --------                   -------
  Total Outstanding                $126,556                   $73,529
                                   ========                   =======
</TABLE>



      On April 14, 2003, the Company issued warrants to purchase an aggregate of
268,199 shares of the Company's common stock at an exercise price of $.825 per
share. The warrants were issued to the nine lenders in the Company's lending
syndicate in connection with the waiver of defaults and an extension of the
Company's term loan. The warrants will be automatically terminated if all of the
obligations owed by the Company to the lenders pursuant to the loan agreement
have been paid in full prior to June 30, 2004. If all of the Company's
obligations to the Lenders have not been paid in full prior to June 30, 2004,
the warrants will become 50% exercisable as of that date. If all of the
Company's obligations to the Lenders have not been paid in full prior to
September 30, 2004, the warrants will then become 100% exercisable as of that
date. Unless the warrants are automatically terminated or exercised pursuant to
the above criteria, they will expire on September 30, 2014. The fair market
value of the warrants, as determined using the Black-Scholes option-pricing
model, was accounted for as additional paid in


                                       11
<PAGE>
                           MICROFINANCIAL INCORPORATED
        NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

capital. The resulting cost of the warrants was $77,000, which is being
amortized to interest expense under the interest method. As of September 30,
2003, $38,000 had been accreted to interest expense and the resulting effective
interest rate on the senior credit facility was prime plus 2.09%.

      MFI I issued three series of notes, the 2000-1 Notes, the 2000-2 Notes,
and the 2001-3 Notes. In March 2000, MFI I issued the 2000-1 Notes in aggregate
principal amount of $50,056,686. In December 2000, MFI I issued the 2000-2 Notes
in aggregate principal amount of $50,561,633. In September 2001, MFI I issued
the 2001-3 Notes in aggregate principal amount of $39,397,354. Outstanding
borrowings are collateralized by specific pools of lease receivables. In
September 2001, MFI II, LLC was formed and issued one series of notes, the
2001-1 Notes in aggregate principal amount of $10,000,000. Outstanding
borrowings are collateralized by a specific pool of lease receivables as well as
the excess cash flow from the MFI I collateral. These notes are subordinate to
the three series of notes issued by MFI I.

      At December 31, 2002, the Company was in default on two of its debt
covenants in its securitization agreements. 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. Additionally per the terms
of the securitization agreement, any default with respect to the senior credit
facility is considered a default under the terms of the agreement. 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.

      At December 31, 2002 and September 30, 2003, MFI I and MFI II had
borrowings outstanding under the series of notes with the following terms:
<TABLE>
<CAPTION>
                         December 31, 2002            September 30, 2003
                       --------------------          --------------------
Series                 Rate          Amount          Rate          Amount
------                 ----          ------          ----          ------
                                 (in thousands)                 (in thousands)
<S>                   <C>        <C>                <C>         <C>
MFI I
2000-1 Notes          7.3750%         3,464         7.3750%              -
2000-2 Notes          6.9390%        17,983         6.9390%          5,163
2001-3 Notes          5.5800%        17,019         5.5800%          6,593
MFI II LLC
2001-1 Notes          8.0000%         3,625         8.0000%              0
                                    -------                        -------
  Total Outstanding                 $42,091                        $11,756
                                    =======                        =======
</TABLE>

      On February 18, 2003, the Company repaid $2.4 million in principal plus
accrued interest for the MFI Finance I series 2000-1 notes utilizing the clean
up call provision under its securitizations. The re-payment was made using cash
previously classified as restricted.

      On October 16, 2003, the Company repaid $5.2 million in principal plus
accrued interest for the MFI Finance I series 2000-2 notes utilizing the clean
up call provision under its securitizations. The re-payment was made using cash
previously classified as restricted.

      At December 31, 2002 and September 30, 2003, the Company also had other
notes payable which totaled $280,000 and $250,000 respectively. Of these notes,
at December 31, 2002 and September 30, 2003, $250,000 were term notes that carry
an interest rate of 7.5% and are due on February 1, 2005. As of December 2002,
there was also a demand note in the amount of $30,000, bearing an interest rate
of prime less 1.0%, outstanding. The Company had repaid the $30,000 demand note
as of June 30, 2003.

                                       12
<PAGE>
                           MICROFINANCIAL INCORPORATED
        NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Dividends:

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

New Accounting Pronouncements:

      The FASB issued SFAS No. 149, "Amendments of Statement 133 on Derivative
Instruments and Hedging Activities." This Statement amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities. The Company has determined that the adoption SFAS No. 149 does not
have a material impact on its results of operations or consolidated financial
position.

      The FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." The statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. Some of the provisions of this Statement
are consistent with the current definition of liabilities in FASB Concepts
Statement No. 6, Elements of Financial Statements. The Company has not completed
its evaluation of SFAS No. 150 and has not yet determined the effect on its
consolidated financial statements.

Reclassification of Prior Year Balances:

      Certain reclassifications have been made to prior years' Consolidated
Financial Statements to conform to the current presentation.

Commitments and Contingencies:

      Please refer to Part II Other Information, Item 1 Legal Proceedings for
information about pending litigation of the Company.

Subsequent Events:

      On October 16, 2003, the Company repaid $5.2 million in principal plus
accrued interest for the MFI Finance I series 2000-2 notes utilizing the clean
up call provision under its securitizations. The re-payment was made using cash
previously classified as restricted.



                                       13
<PAGE>

ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS


Three months ended September 30, 2003 as compared to the three months ended
September 30, 2002.

      Net loss for the three months ended September 30, 2003 was approximately
$3.2 million, a reduction in net loss of $16.4 million or 84% from the three
months ended September 30, 2002. This represents a loss per share for the three
months ended September 30, 2003 of ($0.25) per share on weighted-average
outstanding shares of 12,999,035 as compared to ($1.53) per share on
weighted-average outstanding shares of 12,821,946 for the three months ended
September 30, 2002.

      Total revenues for the three months ended September 30, 2003 were $22.1
million, a decrease of $8.5 million, or 28%, from the three months ended
September 30, 2002. The decrease was primarily due to a decrease of $5.6
million, or 44%, in financing leases and loans, $1.5 million or 35% in fee and
other income, and $623,000 or 7% in rental income. 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 decrease in rental
income is the result of a decrease in the origination of rental contracts.

      Selling, general and administrative expenses decreased by $2.5 million, or
24%, for the three months ended September 30, 2003, as compared to the three
months ended September 30, 2002. Compensation expenses decreased by $1.5 million
or 42% primarily due to staff reductions. Collections expense decreased by
$718,000 or 47%. Rent expense decreased by $246,000 or 49% due to the
consolidation of office space.

      Depreciation and amortization decreased by $1.6 million or 28%, due to a
decrease in the number of early terminations and a decrease in the overall size
of the portfolio of monthly rental and service contracts.

      The Company's provision for credit losses decreased by $30.8 million or
69%, for the three months ended September 30, 2003 as compared to the three
months ended September 30, 2002, while net charge-offs increased 69% to $16.6
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.

      Interest expense decreased by $869,000, or 35%, for the three months ended
September 30, 2003 as compared to the three months ended September 30, 2002.
This decrease resulted primarily from an overall decrease in the level of
borrowings.

      Dealer fundings were $147,000 for the three months ended September 30,
2003, down $21.2 million, or 99% as compared to the three months ended September
30, 2002. This decrease is a result of the Company's decision during the third
quarter of 2002 to suspend new contract originations until a new line of credit
is obtained. Total cash from customers decreased by $10.9 million or 25% to a
total of $32.4 million. This decrease is primarily the result of a decrease in
the size of the overall portfolio. Investment in lease and loan receivables due
in installments, estimated residuals, rental and service contracts were down
from $396.5 million in December of 2002 to $274.7 million in September of 2003.



                                       14
<PAGE>



Nine months ended September 30, 2003 as compared to the nine months ended
September 30, 2002.

      Net loss for the nine months ended September 30, 2003 was approximately
$7.7 million, a reduction in net loss of $6.7 million or 47% from the nine
months ended September 30, 2002. This represents diluted earnings per share for
the nine months ended September 30, 2003 of ($0.59) per share on
weighted-average outstanding shares of 12,999,035 as compared to ($1.12) per
share on weighted-average outstanding shares of 12,821,946 for the nine months
ended September 30, 2002.

      Total revenues for the nine months ended September 30, 2003 were $71.6
million, a decrease of $27.2 million, or 28%, from the nine months ended
September 30, 2002. The decrease was primarily due to a decrease of $16.5
million, or 39%, in financing leases and loans, $7.1 million or 43% in fee and
other income, and $3.2 million or 9% in rental and service contract income. The
decrease in income on financing leases and loans was due to the decreased number
of leases originated primarily resulting from the Company's change in its credit
approval process. 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 decrease in rental and service contract income is a
result of the decreased number of lessees that have continued to rent their
equipment beyond their original lease term and a decrease in originations in
rental and service contracts.

      Selling, general and administrative expenses decreased by $8.6 million, or
25%, for the nine months ended September 30, 2003, as compared to the nine
months ended September 30, 2002. Compensation expenses decreased by $4.5 million
or 38% primarily due to staff reductions. Headcount decreased to 144 as of
September 30, 2003 from 300 as of September 30, 2002. Cost of goods sold
expenses decreased $1.5 million or 67%. Collection expense decreased by $2.0
million or 44%.

      Depreciation and amortization decreased by $1.7 million, or 12% due to a
decrease in the number of early terminations and new originations of monthly
rental and service contracts.

      The Company's provision for credit losses decreased by $26.6 million, or
40%, for the nine months ended September 30, 2003 as compared to the nine months
ended September 30, 2002. This increase is a result of the Company's historical
policy, based on experience, of providing a provision for credit losses based
upon the dealer fundings and revenue recognized in any period and reflects
management's judgement of loss potential considering current economic conditions
and the nature of the underlying receivables.

      Interest expense decreased by $1.5 million, or 19%, for the nine months
ended September 30, 2003 as compared to the nine months ended September 30,
2002. This decrease resulted primarily from an overall decrease in the level of
borrowings.

      Dealer fundings were $1.5 million for the nine months ended September 30,
2003, down $68.0 million, or 98% as compared to the nine months ended September
30, 2002. This decrease is a result of the Company's decision during the third
quarter of 2002 to suspend new contract originations until a new line of credit
is obtained. Total cash from customers decreased by $27.4 million or 20% to a
total of $107.6 million. This decrease is primarily the result of a decrease in
the size of the overall portfolio. Investment in lease and loan receivables due
in installments, estimated residuals, rental and service contracts were down
from $396.5 million in December of 2002 to $274.7 million in September of 2003.



                                       15
<PAGE>

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.

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

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

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


                                       16
<PAGE>
Exposure to Credit Losses

      The following table sets forth certain information as of December 31, 2001
and 2002 and September 30, 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.

<TABLE>
<CAPTION>
                                                             As of                       As of
                                                          December 31,                September 30,
                                                 -----------------------------        -------------
                                                    2001               2002               2003
                                                 ----------         ----------         ----------
<S>                                              <C>                <C>                <C>
Cumulative amounts billed ( in thousands)        $  602,649         $  600,637         $  527,243
31-60 days past due                                     1.8%               1.0%               0.8%
61-90 days past due                                     1.7%               1.0%               0.8%
Over 90 days past due                                  13.4%              22.9%              21.4%
                                                 ----------         ----------         ----------
  Total past due                                       16.9%              24.9%              23.0%
                                                 ==========         ==========         ==========
</TABLE>

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, on-balance sheet
securitizations, subordinated debt and an initial public offering completed in
February of 1999. As of September 30, 2002 the Company's senior credit facility
failed to renew. While cash flows from its portfolio and other fees have been
sufficient to repay amounts borrowed under the senior credit facility,
securitizations and subordinated debt, in October 2002, the Company was forced
to suspend new contract originations until a new source of liquidity is
obtained.

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

      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 $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 balance on the basis of a 36-month amortization plus interest.
Based on the terms of the agreement, interest rates increased from Prime minus
0.25% to Prime plus 0.50% for prime based loans and from LIBOR plus 1.75% to
LIBOR plus 2.50% for LIBOR based loans. In addition, based on the covenant
defaults described below, the outstanding borrowings on all loans bear an
additional 2.00% default interest. On January 3, 2003, the Company entered into
a Forbearance and Modification Agreement from the senior credit facility, which
expired on February 7, 2003. Based on the terms of the Forbearance and
Modification Agreement, interest rates increased again on the prime based loans
to prime plus 1.00%. At September 30, 2003, the Company had approximately $73.5
million outstanding under the facility. The Company also may use its
subordinated debt program as a source of funding for potential acquisitions of
portfolios and leases which otherwise are not eligible for funding under the
credit facilities.


                                       17
<PAGE>
      At December 31, 2002, the Company was in default of certain of its debt
covenants in its senior credit facility and securitization agreements. The
covenants that were in default with respect to the senior 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 on June
30, 2003, the Company is obligated to repay a minimum of $56.1 million, plus
applicable interest, over the next twelve months. The covenants that were in
default with respect to the securitization agreements, require that the Company
maintain a fixed charge ratio in an amount not less than 125% of consolidated
earnings and a consolidated tangible net worth greater than $90 million plus 50%
of net income for each fiscal quarter after June 30, 2001. The Company received
a waiver, which was set to expire on April 15, 2003, for the covenant violations
in connection with the securitization agreement. Subsequently, the Company
received a permanent waiver of the covenant defaults and the securitization
agreement was amended so that going forward, the covenants are the same as those
contained in the long-term agreement entered into on April 14, 2003, for the
senior credit facility. The Company is continuing its efforts to secure various
financing, restructuring and strategic alternatives that will enable the
Company to reenter the financing market.

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

Contractual Obligations and Commercial Commitments

      The Company has entered into various agreements, such as 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 senior credit facility, securitizations, subordinated notes, demand
notes and other notes payable.

      At September 30, 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:

<TABLE>
<CAPTION>
For the year ended    Long-Term     Operating       Capital
   December 31,         Debt          Leases         Leases         Total
   ------------         ----          ------         ------         -----
<S>                   <C>           <C>             <C>            <C>
      2003            $21,079        $   234        $    30        $21,343
      2004             60,577            876            169         61,622
      2005              4,541            759             54          5,354
      2006              2,600             --             --          2,600
Thereafter                 --             --             --             --
                      -------        -------        -------        -------
        Total         $88,797        $ 1,869        $   253        $90,919
                      =======        =======        =======        =======
</TABLE>

Note on Forward-Looking Information

   Statements in this document that are not historical facts are forward-looking
statements made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. In addition, words such as "believes"
"anticipates" "expects" and similar expressions are intended to identify
forward-looking statements. The Company cautions that a number of important
factors could cause actual results to differ materially from those expressed in
any forward-looking statements made by or on behalf of the Company. Such
statements contain a number of risks and uncertainties, including but not
limited to: the Company's dependence on point-of-sale authorization systems and
expansion into new markets; the Company's significant capital requirements;
risks associated with economic downturns; higher interest rates; intense
competition; change in regulatory environment


                                       18
<PAGE>
and risks associated with acquisitions. Readers should not place undue reliance
on forward-looking statements, which reflect the management's view only as of
the date hereof. The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect subsequent events or circumstances. The
Company cannot assure that it will be able to anticipate or respond timely to
changes which could adversely affect its operating results in one or more fiscal
quarters. Results of operations in any past period should not be considered
indicative of results to be expected in future periods. Fluctuations in
operating results may result in fluctuations in the price of the Company's
common stock. For a more complete description of the prominent risks and
uncertainties inherent in the Company's business, see the risks factors
described in the Company's Form S-1 Registration Statement and other documents
filed from time to time with the Securities and Exchange Commission.


                                       19
<PAGE>
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market-Rate-Sensitive Instruments and Risk Management

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

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

Interest Rate Risk Management

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

      Given the relatively short average life of the Company's leases, contracts
and loans, the Company's goal is to maintain a blend of fixed and variable
interest rate obligations. As of September 30, 2003, the Company's outstanding
fixed-rate indebtedness outstanding under the Company's securitizations and
subordinated debt represented 16.9% of the Company's total outstanding
indebtedness.

ITEM 4   CONTROLS AND PROCEDURES

Disclosure controls and procedures: As of the end of the period covered by this
report, the Company carried out an evaluation, under the supervision and with
the participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15. Based upon the evaluation, the Company's
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective. Disclosure controls and
procedures are controls and procedure that are designed to ensure that
information required to be disclosed in Company reports filed or submitted under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.

Internal controls: As of 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.


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<PAGE>
PART II. OTHER INFORMATION

ITEM 1   LEGAL PROCEEDINGS

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

      A. The Company filed an action in the United States District Court for the
District of Massachusetts against Sentinel Insurance Company, Ltd.,
("Sentinel"), Premier Holidays International, Inc., ("Premier") and Daniel
DelPiano ("DelPiano") arising from Premier's October, 1999, default on its
repayment obligations to the Company under a Twelve Million Dollar ($12,000,000)
loan. Judgment has been entered in this case against Sentinel, which had issued
a business performance insurance policy guaranteeing repayment of the loan, in
the amount of Fourteen Million Dollars ($14,000,000). This judgment has not been
satisfied. Sentinel is currently undergoing liquidation proceedings, and a claim
in this amount has been filed with the bankruptcy court. Premier has asserted a
counterclaim against the Company for Seven Hundred Sixty Nine Million Three
Hundred Fifty Thousand dollars ($769,350,000) in actual and consequential
damages, and for Five Hundred Million Dollars ($500,000,000) in punitive
damages, plus interest, cost and attorney's fees. The counterclaim is based upon
an alleged representation by the Company that it would lend Premier an
additional Forty-Five Million Dollars ($45,000,000), when all documents
evidencing the Premier loan refer only to the Twelve Million ($12,000,000)
amount actually loaned and not repaid. The Company denies any liability on the
counterclaim, which the Company is vigorously contesting. The Company's motion
for summary judgment seeking dismissal of the counterclaim and the award of full
damages on the Company's claims was denied by Court Order, without a written
decision. The Company's motion for the appointment of a special master was also
denied without a written decision. The case is currently scheduled to be tried
in November 2003. Because of the uncertainties inherent in litigation, we cannot
predict whether the outcome will have a material adverse effect.

      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. Section 1964), fraud,
unfair and deceptive acts and practices, unlawful franchise offerings, and
intentional infliction of mental anguish. The claims purportedly arise from
Leasecomm's dealer relationships with Themeware, E-Commerce Exchange,
Cardservice International, Inc., and Online Exchange for the leasing of websites
and virtual terminals. The Complaint asserts that the Company is responsible for
the conduct of its dealers in trade shows, 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 no later than
November 3, 2003. 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.


                                       21
<PAGE>
      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 has filed an answer denying the
allegations. Because of the uncertainties inherent in litigation, we cannot
predict whether the outcome will have a material adverse effect.

      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. The complaint asserts claims for
declaratory relief, rescission, civil conspiracy, usury, breach of fiduciary
duty, and violation of Massachusetts General Laws Chapter 93A, Section 11
("Chapter 93A"). The claims concern the validity, enforceability, and alleged
unconscionability of agreements provided through the dealer, including a
Leasecomm lease, to acquire on line credit card processing services. The
complaint seeks rescission of the lease agreements with Leasecomm, restitution,
multiple damages and attorneys fees under Chapter 93A, and injunctive relief.
The Company has filed a motion to dismiss the complaint, which is scheduled to
be heard by the Court in November, 2003. Because of the uncertainties inherent
in litigation we cannot predict whether the outcome will have a material adverse
effect.

      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 and intends to
vigorously defend this suit. It is expected that the Court will soon hold a
hearing on Leasecomm's motion to dismiss. The court has not yet addressed the
Plaintiff's class certification allegations. Because of the uncertainties
inherent in litigation, the company cannot predict whether the outcome will have
a material adverse affect.

      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 continued the
hearing on various venue related actions to December 12, 2003 in order to allow
the parties time to explore possible settlement. Because of the uncertainties
inherent in litigation we cannot predict whether the outcome will have a
material adverse effect.

      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.


                                       22
<PAGE>
      In February 2003, Leasecomm received a 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 2     CHANGES IN SECURITIES AND USE OF PROCEEDS

      On April 14, 2003, the Company issued warrants to purchase an aggregate of
268,199 shares of the Company's common stock at an exercise price of $.825 per
share. The warrants were issued to the nine lenders in the Company's lending
syndicate in connection with a waiver of defaults and an extension of the
Company's term loan, and are only exercisable if the debt remains outstanding as
of June 30, 2004. The exemption from registration relied on by the Company was
Section 4(2) of the Securities Act of 1933. All investors were accredited
investors and the offering otherwise met the requirements of Regulation D under
the Securities Act.


                                       23
<PAGE>
ITEM 5 OTHER INFORMATION

      The Company's Chief Executive Officer and Chief Financial Officer have
furnished to the SEC the certification with respect to this Form 10-Q that is
required by Section 906 of the Sarbanes-Oxley Act of 2002.

ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K

(a)   The following exhibits are filed herewith:

      10.1  Lease Extension for the facility at 10-M Commerce Way, Woburn, MA
            dated September 16, 2003 among MicroFinancial Incorporated and
            Cummings Properties, LLC.

      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 2002

      32.2  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

(b)   A form 8-K was filed on July 22, 2003, to announce second quarter 2003
      results. A second report on Form 8-K was filed on August 19, 2003 to
      disclose that cash collection activity remains strong. On September
      15,2003, a third report on Form 8-K was filed announcing that the Company
      continues to reduce its debt obligation and that its corporate
      headquarters lease has been extended for two years.


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<PAGE>
                                   SIGNATURES

Pursuant to the requirements 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
                                     -------------------------
                                     President and Chief Executive Officer


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


Date:  November 14, 2003


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