SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) September 18, 1997
Mercury Finance Company
(Exact name of registrant as specified in charter)
Delaware 1-10176 36-3627010
(State of other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
100 Field Drive, Lake Forest, Illinois 60045
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (847) 295-8600
N/A
(Former name or former address, if changed since last report)
Item 5. Other Events.
The Registrant hereby files its Consolidated Financial Statements for the
three month and six month periods ended June 30, 1997, along with an explanatory
discussion of certain factors affecting the Financial Statements, copies of
which are attached as Exhibits 99.1 and 99.2, respectively, to this Form 8-K and
incorporated herein by reference.
Item 7. Financial Statements and Exhibits.
(c) Exhibits.
Exhibit No. Description of Document
99.1 The Registrant's Consolidated Financial Statements for
the three month and six month periods ended June 30,
1997.
99.2 Management's Discussion.
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 hereunto duly authorized.
Mercury Finance Company
Date: September 19, 1997 By: William A. Brandt, Jr.
Its: President
EXHIBIT 99.1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
of Mercury Finance Company
We have reviewed the accompanying consolidated balance sheet of Mercury Finance
Company and subsidiaries as of June 30, 1997, and the related consolidated
statements of income for the three month and six month periods then ended, and
the changes in shareholders' equity and cash flows for the six-month period then
ended. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 15 to the
financial statements, on January 29, 1997 the Company announced accounting
irregularities, discovered subsequent to December 31, 1996, causing it to
violate its debt covenants which curtailed the availability of credit and caused
the Company to miss scheduled debt payments. Also, as discussed in Note 15, the
Company incurred significant losses in 1996 and is continuing to incur losses in
1997. In addition, as further described in Note 8, the Company has been named
as a defendant in litigation generally arising from the restatement of earnings
for 1995 and interim earnings for 1996 as a result of the accounting
irregularities. The Securities and Exchange Commission and the United States
Attorney for the Northern District of Illinois have also commenced
investigations. Management's plans with regard to these matters are described
in Notes 8 and 15 to the consolidated financial statements. As discussed in our
auditors' report on the December 31, 1996 balance sheet dated May 13, 1997, and
as discussed further in Notes 8 and 15 to the accompanying financial statements,
there are several matters that raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Chicago, Illinois
August 26, 1997
<TABLE>
Mercury Finance Company & Subsidiaries
Consolidated Balance Sheets
<CAPTION>
As of As of
June 30, December 31,
1997 1996
(dollars in thousands) (unaudited)
<S> <C> <C>
Assets
Cash and cash equivalents (restricted cash - note #2) $ 130,909 $ 20,957
Short-term investments (at amortized cost which approximates
fair value) - 43,411
Investments available-for-sale, at fair value - 161,781
Investments held-to-maturity, at cost (fair value of
$0 and $8,025) - 7,765
Finance Receivables 1,095,779 1,160,423
Less allowance for finance credit losses (123,604) (97,762)
Less nonrefundable dealer reserves (71,365) (89,378)
Finance receivables, net 900,810 973,283
Deferred income taxes, net 48,320 33,356
Income taxes receivable 50,638 53,764
Premises and equipment (at cost, less accumulated depreciation
of $9,774 and $9,157) 6,263 7,266
Goodwill 14,034 14,463
Reinsurance receivable - 93,458
Deferred acquisition costs and present value of future profits - 62,809
Other assets (including repossessions) 29,808 71,047
Total Assets $ 1,180,782 $ 1,543,360
Liabilities and Shareholders' Equity
Liabilities
Senior debt, commercial paper and notes $ 493,619 $ 525,051
Senior debt, term notes 488,625 488,625
Subordinated notes 22,500 22,500
Accounts payable and other liabilities 60,682 81,282
Unearned premium and claim reserves - 239,573
Reinsurance payable - 17,444
Total Liabilities 1,065,426 1,374,475
Contingencies (Note 8)
Shareholders' Equity
Common stock - $1.00 par value per share:
300,000 shares authorized
June 30, 1997 - 177,900,671 shares outstanding
December 31, 1996 - 177,719,447 shares outstanding 177,901 177,719
Paid in capital 8,244 6,539
Retained earnings (deficit) (17,125) 37,349
Unrealized appreciation on available-for-sale securities, net
of tax - 942
Treasury stock - 5,402,957 shares at cost (53,664) (53,664)
Total Shareholders' Equity 115,356 168,885
Total Liabilities and Shareholders' Equity $ 1,180,782 $ 1,543,360
See accompanying notes to consolidated financial statements
</TABLE>
<TABLE>
Mercury Finance Company & Subsidiaries
Consolidated Statements of Income
<CAPTION>
(unaudited) 3 months ended 6 months ended
June 30, June 30,
1997 1997
(dollars in thousands, except per share amounts)
<S> <C> <C>
Interest Income
Finance charges and loan fees $ 59,736 $ 123,227
Investment income 2,769 6,058
Total finance charges, fees and investment income 62,505 129,285
Interest expense 23,549 44,265
Interest income before provision for finance credit losses 38,956 85,020
Provision for finance credit losses 24,544 55,006
Net interest income 14,412 30,014
Other Income
Insurance commissions 1,683 3,395
Insurance premiums 9,871 33,091
Fees and other income 1,385 3,176
Total other income 12,939 39,662
Other Expenses
Salaries and employee benefits 15,775 30,419
Occupancy expense 1,589 3,144
Equipment expense 973 1,825
Data processing expense 549 1,092
Incurred insurance claims and other underwriting expense 3,540 20,255
Other operating expenses 10,258 18,950
Total other expenses 32,684 75,685
Operating loss (5,333) (6,009)
Income from Lyndon due to buyer (2,025) (2,025)
Loss on sale of Lyndon - (29,528)
Other non-operating expenses (5,453) (10,582)
Loss before income taxes (12,811) (48,144)
Credit for income taxes (4,442) (6,607)
Net Loss $ (8,369) $ (41,537)
Net Loss Per Common Share $ (0.05) $ (0.24)
See accompanying notes to consolidated financial statements
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY & SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(unaudited)
<CAPTION>
(dollars in thousands)
Retained Unrealized
Common Paid in Earnings Appreciation Treasury
Stock Capital (Deficit) (Depreciation) Stock Total
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $ 177,719 $ 6,539 $ 37,349 $ 942 $(53,664) $ 168,885
Net loss (41,537) (41,537)
Stock options exercised 182 1,705 1,887
Dividends declared ($0.075 per share) (12,937) (12,937)
Unrealized depreciation on available
for sale securities, net of taxes (942) (942)
Balance at June 30, 1997 $ 177,901 $ 8,244 $ (17,125) $ - $(53,664) $ 115,356
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
Mercury Finance Company & Subsidiaries
Consolidated Statement of Cash Flows
<CAPTION>
6 Months ended
June 30,
1997
(dollars in thousands) (unaudited)
<S> <C>
Cash Flows From Operating Activities
Net loss $ (41,537)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for finance credit losses 55,006
Credit for deferred income taxes (9,356)
Loss on sale of Lyndon 29,528
Gain on sale of securities (12)
Depreciation and amortization 1,477
Net increase in reinsurance receivable (6,287)
Net decrease in deferred acquisition costs and present value of future profits 15,473
Net decrease in other assets 12,352
Net increase in reinsurance payable 12,582
Net decrease in unearned premium and claim reserves (12,388)
Net decrease in other liabilities (29,805)
Net decrease in nonrefundable dealer reserves (18,013)
Net cash provided by operating activities 9,020
Cash Flows From Investing Activities
Principal collected on finance receivables 374,258
Finance receivables originated or acquired (338,776)
Purchases of short term and available for sale investment securities (44,157)
Purchases of held to maturity investment securities (2,552)
Proceeds from sales and maturities of short term and available for sale 46,786
investment securities
Proceeds from maturities of held to maturity investment securities 6,476
Proceeds from sale of Lyndon, net of cash sold 88,884
Net purchase of premises and equipment (45)
Net cash provided by investing activities 130,874
Cash Flows From Financing Activities
Net repayments of senior debt, commercial paper and notes (31,432)
Stock options exercised 1,490
Net cash used in financing activities (29,942)
Net increase in cash and cash equivalents 109,952
Cash and Cash Equivalents at Beginning of Quarter 20,957
Cash and Cash Equivalents at End of Quarter $ 130,909
Supplemental Disclosures
Income taxes paid to federal and state government $ 35
Interest paid to creditors $ 40,249
See accompanying notes to consolidated financial statements.
</TABLE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997 (unaudited)
and December 31, 1996
(dollars in thousands except per share amounts)
1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Mercury Finance Company ("Mercury" or the "Company") is a consumer finance
company doing business in 31 states under its own name and through its
subsidiaries MFC Finance Company, MERC Finance Company, Gulfco Investment Inc.
and subsidiary and Midland Finance Co. (the "consumer finance subsidiaries").
The Company also offered certain insurance services through its subsidiary,
Lyndon Property Insurance Company and subsidiaries ("Lyndon"). The Company's
borrowers generally would not be expected to qualify for traditional financing,
such as that provided by commercial banks or automobile manufacturers' captive
finance companies.
BASIS OF PRESENTATION
The accounting and reporting policies of Mercury conform to generally accepted
accounting principles for the finance and insurance industries. The
consolidated financial statements include the accounts of the Company, the
consumer finance subsidiaries and Lyndon. All significant intercompany accounts
and transactions have been eliminated.
REVENUE RECOGNITION - CONSUMER FINANCE SUBSIDIARIES
Finance charges on precomputed loans and sales finance contracts (collectively
referred to as "precompute accounts") are credited to unearned finance charges
at the time the loans and sales finance contracts are made or acquired.
Interest income is calculated using the interest (actuarial) method to produce
constant rates of interest (yields). If a precompute account becomes greater
than 60 days contractually delinquent and no full contractual payment is
received in the month the account attains such delinquency status, the accrual
of income is suspended until one or more full contractual monthly payments are
received. Interest on interest bearing loans and sales finance contracts is
calculated on a 360-day basis and recorded on the accrual basis; accrual is
suspended when an account is 60 or more days contractually delinquent. Late
charges and deferment charges on all contracts are taken into income as
collected. Fees and other income are derived from the sale of other products
and services.
INSURANCE OPERATIONS
In conjunction with their lending practices, the consumer finance subsidiaries,
as agents for Lyndon and unaffiliated insurers, offer credit life, accident and
health and property insurance to borrowers who obtain finance receivables
directly from the consumer finance subsidiaries, and to borrowers under sales
finance contracts and financing contracts purchased from merchants and
automobile dealers. Commissions on credit life, accident and health and
property insurance from unaffiliated insurers are earned by Mercury over the
average terms of the related policies on the sum-of-the months digits method.
See Note 2 for a discussion of the disposition of Lyndon.
Lyndon is engaged in the business of reinsuring and direct writing of credit
life, accident and health and various other property and casualty insurance
policies issued to borrowers under direct consumer loan and sales finance
contracts originated by Mercury and other companies. The policies insure the
holder of a sales finance contract or other debt instrument for the outstanding
balance payable in the event of death or disability of the debtor. Insurance
premiums are earned over the life of the contracts principally using pro-rata
and sum-of-the months digits methods or in relation to anticipated benefits to
the policy holders.
Lyndon has established policy liabilities and claim reserves. The claim
reserves are based upon accumulated estimates of claims reported, plus estimates
of incurred but unreported claims.
FINANCE RECEIVABLES, ALLOWANCE FOR FINANCE CREDIT LOSSES AND NONREFUNDABLE
DEALER RESERVES
Mercury originates direct consumer loans and acquires individual sales finance
contracts from third party dealers. Finance receivables consist of
contractually scheduled payments from sales finance contracts net of unearned
finance charges, direct finance receivables and credit card receivables. The
Company's borrowers typically have limited access to traditional sources of
consumer credit due to past credit history or insufficient cash to make the
required down payment on an automobile. As a result, receivables originated or
acquired by the Company are generally considered to have a higher risk of
default and loss than those of other consumer financings.
SFAS 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases," requires
that loan origination and commitment fees and certain direct loan origination
costs be deferred and amortized as an adjustment to the related loan's yield.
Mercury has not adopted the provisions of this statement because adoption would
not have a material effect on the Company's reported results of operations or
financial condition.
Unearned finance charges represent the balance of finance income (interest)
remaining from the capitalization of the total interest to be earned over the
original term of the related precompute account.
Mercury acquires a majority of its sales finance contracts from dealers at a
discount. The level of discount is based on, among other things, the credit
risk of the borrower. The discount, which is the difference between the amount
financed and the acquisition cost, represents nonrefundable dealer reserves
which are available to absorb future credit losses over the life of the acquired
loan. Historical loss experience on the Company's sales finance receivables has
shown that the acquisition discount recorded as nonrefundable dealer reserves is
not adequate to cover potential losses over the life of the loans. Mercury uses
a new reserving methodology commonly referred to as "static pooling". The
static pooling reserving methodology allows Mercury to stratify components of
its sales finance receivables portfolio (i.e., non refundable dealer reserves,
principal loan balances, and related loan charge-offs) into separately
identified and chronologically ordered monthly pools. A portion of the dealer
reserve is made available to cover estimated credit losses for each identified
monthly pool based on a pro rata calculation over the weighted average term of
each specific pool.
The allowance for credit losses is maintained by direct charges to operations in
amounts that are intended to provide adequate reserves on the Company's finance
receivables portfolio to absorb possible credit losses incurred on loans that
are considered to be impaired in excess of the available nonrefundable dealer
reserves. Management evaluates the allowance requirements by examining current
delinquencies, the characteristics of the accounts, the value of the underlying
collateral, the availability of the nonrefundable dealer reserves to absorb
credit losses on impaired loans and general economic conditions and trends.
The Company applies SFAS 114 and 118, which address the accounting by creditors
for impairment of a loan and related income recognition and disclosures. In
accordance with SFAS 114, the Company's approach for estimating losses results
in a measure of impairment based on discounting expected future cash flows
(including the anticipated proceeds from repossessed collateral) at the loan's
original yield. If the measure of the impaired receivable is less than the net
recorded investment in the receivable, the Company recognizes an impairment by
creating an additional allowance for finance credit losses in excess of the
nonrefundable dealer reserves available to absorb losses, with a corresponding
charge to the provision for finance credit losses. Generally, the Company
considers receivables more than 60 days contractually delinquent to be impaired.
Direct installment loans on which no payment is received within 149 days, on a
recency basis, are charged off. Sales finance accounts (net of unearned finance
charges) which are contractually delinquent 150 days are charged off monthly
before they become 180 days delinquent. Accounts which are deemed uncollectable
prior to the maximum charge-off period are charged off immediately. Management
may authorize a temporary extension if collection appears imminent during the
next calendar month.
INVESTMENTS
The Company classifies its investments as held-to-maturity securities and
available-for-sale securities. Held-to-maturity securities are reported at
cost, adjusted for amortization of premium or discount, and available-for-sale
securities are reported at fair value with unrealized gains and losses excluded
from earnings and reported in a separate component of stockholder's equity, net
of applicable income taxes.
Fair values for held-to-maturity and available-for-sale fixed maturity
securities are based on quoted market prices, where available. For securities
not actively traded, fair values are estimated using values obtained from
independent pricing services. Short-term investments are carried at amortized
cost, which approximates their fair value. Realized gains and losses from sales
or liquidation of investments are determined using the specific identification
basis.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation, and
are depreciated on a straight-line basis over their estimated useful lives.
REINSURANCE ACTIVITIES
In the normal course of business, Lyndon assumes and cedes reinsurance on both a
pro rata and excess basis. Reinsurance provides greater diversification of
business and limits the maximum net loss potential arising from large claims.
Although the ceding of reinsurance does not discharge an insurer from its
primary legal liability to a policy holder, the reinsuring company assumes the
related insurance risk. Lyndon monitors the financial condition of its
reinsurers on a periodic basis.
DEFERRED ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS
Policy acquisition costs, representing commissions, premium taxes and certain
other underwriting expenses, are deferred and amortized over policy terms.
Estimates of future revenues, including investment income and tax benefits, are
compared to estimates of future costs, including amortization of policy
acquisition costs, to determine if business currently in force is expected to
result in a net loss. No revenue deficiencies have been determined in the
period presented. The present value of future profits represents the portion of
the purchase price of Lyndon allocated to the future profits attributable to the
insurance in force at the date of acquisition. The present value of future
profits is amortized in relationship to the expected emergence of such future
profits.
INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax return
and individual state tax returns in most states.
Mercury recognizes deferred tax assets and liabilities for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
The Company periodically evaluates deferred tax assets to determine whether they
are deemed to be likely of realization. In making its determination, management
considers the possible recovery of taxes already paid but does not assume the
generation of additional taxable income in the future. No reserves against
deferred tax assets were considered necessary.
IMPAIRMENT OF LONG-LIVED ASSETS
In March, 1995, the Financial Accounting Standards Board ("the FASB") issued
SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Assets to
be Disposed of," which is effective for financial statements issued for fiscal
years beginning after December 15, 1995. SFAS 121 requires that long-lived
assets and certain identifiable intangibles that are used in operations be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of assets might not be recoverable. The adoption of
SFAS 121 did not have a material effect on the Company's financial condition or
results of operations.
At each balance sheet date, the Company evaluates the realizability of goodwill
(and other intangibles) based on expectations of non-discounted cash flows and
operating income for each subsidiary having a material goodwill balance. Based
on the most recent analysis, the Company believes that no material impairment of
goodwill exists at June 30, 1997.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation under the provisions of SFAS
123. This statement defines a fair value based method of accounting for an
employee stock option or similar equity instrument and encourages all entities
to adopt that method of accounting. The Company has elected, as permitted under
SFAS 123, to continue to measure compensation cost for its plan using the
intrinsic value based method of accounting prescribed by Accounting Principles
Board ("APB") Opinion No. 25.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued SFAS 128, "Earnings per Share" and SFAS 129,
"Disclosure of Information about Capital Structure". SFAS 128 establishes
standards for computing and presenting earnings per share. SFAS 129 establishes
standards for disclosing information about an entity's capital structure. These
statements are effective for financial statements issued for periods ending
after December 15, 1997. Management does not expect the adoption of these
statements to have a significant impact on the financial position and results of
operations of the Company.
In July 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income" which
establishes standards for reporting and displaying comprehensive income.
Management does not expect the adoption of this statement to have a significant
impact on the financial position and results of operations of the Company. This
statement is effective for financial statements issued for periods ending after
December 15, 1997.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and
accompanying notes. The accounts which are subject to such estimation
techniques include the allowance for finance credit losses as more fully
discussed in Note 4. Actual results could differ from these estimates.
2) DISPOSITIONS
On June 3, 1997, Mercury sold all of the outstanding shares of Lyndon Insurance
Group and its subsidiaries to Frontier Insurance Group, Inc. ("Frontier")
pursuant to a Stock Purchase Agreement dated March 28, 1997. The aggregate
purchase price was $92 million. In order to assure the delivery of clear title
to Frontier, Mercury was required to deposit ten percent of the sales price, or
$9.2 million, into a cash escrow account. This is classified with cash and cash
equivalents on the balance sheet. The escrow deposit was subsequently released
to Mercury.
Earnings from Lyndon in the second quarter were $2,025. The 1997 consolidated
results of operations of Mercury include the operations of Lyndon through May
31, 1997 although the results since April 1, 1997 were attributable to the buyer
as an adjustment to the purchase price. Management has determined that it is in
the best interest of the Company to remain in the insurance business and formed
a new captive insurance subsidiary during 1997, MFN Insurance. As a result, the
sale of Lyndon is not considered the discontinuation of a business. The loss
associated with the sale of Lyndon will not be tax deductible to the Company as
a loss on the sale of a consolidated subsidiary is, under certain circumstances,
not deductible for tax purposes.
3) INVESTMENTS
All investments are securities held by Lyndon. See Note 2 for discussion of
disposition of Lyndon. The amortized cost, gross unrealized gains and losses
and approximate fair values for available-for-sale and held-to-maturity
securities by major security type at December 31, 1996 were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
<S> <C> <C> <C> <C>
December 31, 1996
AVAILABLE-FOR-SALE:
U.S. Treasury securities
and obligations of U.S.
Government corporations
and agencies $ 9,490 $ 13 $ (78) $ 9,425
Obligations of states and
political subdivisions 68,397 1,378 (391) 69,384
Corporate securities 63,629 882 (443) 64,068
Mortgage backed
securities 18,816 166 (78) 18,904
Total available-for-sale $160,332 $ 2,439 $(990) $161,781
HELD-TO-MATURITY:
U.S. Treasury securities
and obligations of U.S.
Government corporations
and agencies $2,833 $ 17 $(31) $2,819
Obligations of states and
political subdivisions 3,787 75 (1) 3,861
Corporate securities 850 33 0 883
Other securities 295 174 (7) 462
Total held-to-maturity $7,765 $299 $ (39) $8,025
</TABLE>
4) FINANCE RECEIVABLES
Direct loans generally have terms of 12 to 24 months with maximum terms of 36
months; secured loans are generally collateralized by real or personal
property. Sales finance contracts are generally accounted for on a discount
basis and generally have terms of 18 to 36 months with maximum terms of 48
months. Mercury Card receivables are mainly unsecured balances. The
Company's finance receivables are primarily with individuals located in the
southeastern, central and western United States. As of June 30, 1997,
approximately 16.8%, 16.1% and 8.8% of finance receivables were from
branches located in Florida, Texas and Louisiana respectively. Loans
outstanding were as follows:
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
<S> <C> <C>
DIRECT FINANCE RECEIVABLES
Interest bearing $ 22,224 $ 25,117
Precompute 128,553 127,516
Total direct finance receivables 150,777 152,633
SALES FINANCE RECEIVABLES
Total sales finance receivables 1,075,474 1,159,848
Total gross finance receivables 1,226,251 1,312,481
Less: Unearned finance charges (209,311) (228,405)
Unearned commissions,
insurance premiums and
insurance claim reserves (4,391) (7,253)
Total net finance receivables 1,012,549 1,076,823
UNSECURED CREDIT CARD
Total unsecured credit card 83,230 83,600
Total finance receivables $1,095,779 $1,160,423
</TABLE>
Included in finance receivables at June 30, 1997 and December 31, 1996 were
$87,073 and $69,507, respectively, of receivables for which interest accrual had
been suspended. Repossessed assets held for resale primarily consists of
repossessed vehicles awaiting liquidation. Repossessed assets are carried at
estimated fair value. At June 30, 1997 and December 31, 1996, repossessed
assets of approximately $5,700, and $6,700, respectively, were awaiting
liquidation. Included are vehicles held for resale, vehicles which have been
sold for which payment has not been received and unlocated vehicles (skips), the
value of which may be reimbursed from insurance. Contractual maturities of the
finance receivables by year are not readily available at June 30, 1997, but
experience has shown that such information is not an accurate forecast of the
timing of future cash collections due to the amount of renewals, conversions,
repossessions, or payoffs prior to actual maturity.
Principal cash collections (excluding finance charges earned) for the three
months ended June 30, 1997 and six months ended June 30, 1997 were as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1997 1997
<S> <C> <C>
DIRECT FINANCE RECEIVABLES
Principal cash collections $ 34,110 $ 66,767
Percent of average net balances 26.5% 25.9%
SALES FINANCE RECEIVABLES
Principal cash collections $ 172,259 $ 336,654
Percent of average net balances 19.0% 18.2%
</TABLE>
A summary of the activity in the allowance for finance credit losses for the
three months ended June 30, 1997 and six months ended June 30, 1997 was as
follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1997 1997
<S> <C> <C>
Balance at beginning of period $111,584 $ 97,762
Provision for finance credit losses 24,544 55,006
Finance receivables charged off,
net of recoveries (12,524) (29,164)
Balance at end of period $123,604 $123,604
</TABLE>
A summary of the activity in nonrefundable dealer reserves for the three months
ended June 30, 1997 and six months ended June 30, 1997 was as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1997 1997
<S> <C> <C>
Balance at beginning of period $ 80,677 $ 89,378
Discounts acquired on new volume 12,845 26,789
Losses absorbed, net of recoveries (22,157) (44,802)
Balance at end of period $ 71,365 $ 71,365
</TABLE>
5) SENIOR AND SUBORDINATED DEBT AND LINES OF CREDIT
As a result of the 1996 net loss, accounting irregularities, and related
matters, Mercury violated its debt and financial covenants permitting the
holders of its Senior Term Notes and Subordinated Debt to accelerate all such
debt which, if accelerated, would result in all of such debt being currently due
and payable. In addition, the Company is no longer permitted by the terms of
certain debt instruments to pay dividends. Senior and subordinated debt at June
30, 1997 and December 31, 1996, consisted of the following (assuming that the
Company remained in compliance with its debt covenants):
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
<S> <C> <C>
REVOLVING CREDIT FACILITY-$50,000
LINE, Interest at prime, secured by
generally all assets, due January
1998 $ - $ -
SENIOR DEBT, COMMERCIAL PAPER
AND NOTES $493,619 $525,051
SENIOR DEBT, TERM NOTES
Due 1997 - interest rate 7.67% 15,000 15,000
Due 1997 - interest rate 8.15% 17,500 17,500
Due 1997 - interest rate 6.29% 24,000 24,000
Due 1997 - interest rate 7.13% 125 125
Due 1997 - interest rate 6.41% 40,000 40,000
Due 1998 - interest rate 6.70% 35,000 35,000
Due 1998 - interest rate 6.16% 76,000 76,000
Due 1998 - interest rate 8.62% 20,000 20,000
Due 1998 - interest rate 8.50% 10,000 10,000
Due 1998 - interest rate 7.13% 1,000 1,000
Due 1998 - interest rate 7.16% 25,000 25,000
Due 1999 - interest rate 6.56% 20,000 20,000
Due 1999 - interest rate 6.76% 31,000 31,000
Due 1999 - interest rate 7.33% 30,000 30,000
Due 2000 - interest rate 6.66% 10,000 10,000
Due 2000 - interest rate 6.94% 15,000 15,000
Due 2000 - interest rate 7.42% 58,000 58,000
Due 2001 - interest rate 7.02% 10,000 10,000
Due 2001 - interest rate 7.50% 30,000 30,000
Due 2002 - interest rate 7.14% 4,000 4,000
Due 2002 - interest rate 7.59% 17,000 17,000
TOTAL SENIOR DEBT, TERM NOTES $488,625 $488,625
SUBORDINATED DEBT
Due 1997 - interest rate 9.76% 12,000 12,000
Due 1997 - interest rate 10.86% 3,000 3,000
Due 1998 - interest rate 10.86% 7,500 7,500
TOTAL SUBORDINATED DEBT $ 22,500 $22,500
</TABLE>
The following table sets forth information with respect to future maturities of
senior and subordinated debt at June 30, 1997 (assuming that the Company
remained in compliance with its debt covenants):
<TABLE>
<CAPTION>
Senior Debt
Commercial Senior Debt Subordinated
Paper & Notes Term Notes Debt Total
<S> <C> <C> <C> <C>
1997 $ 493,619 $ 96,625 $ 15,000 $ 605,244
1998 - 167,000 7,500 174,500
1999 - 81,000 - 81,000
2000 - 83,000 - 83,000
2001 - 40,000 - 40,000
2002 - 21,000 - 21,000
TOTAL $ 493,619 $488,625 $ 22,500 $1,004,744
</TABLE>
As noted above, the Company is in default of its credit agreements. The Company
continues to negotiate with all of its lenders in an attempt to reach a
consensual agreement and has a forbearance agreement through September 30,
1997. See Notes 8, 13 and 15 for additional information.
6) DIVIDEND RESTRICTIONS
Management does not expect that dividends will be paid in the foreseeable
future.
7) STOCK OPTIONS
Under the terms of Mercury's 1989 Stock Option and Incentive Compensation Plan
("the Plan"), 24,837,036 common shares were reserved for the future granting of
options to officers, non-employee directors and other key employees. Options
become exercisable in whole or in part up to two years after the date of grant
at the closing price of Mercury's common stock on the date of grant. Options
are forfeited upon termination of employment. Shares available for future
grants totaled 2,979,356 at June 30, 1997.
Activity with respect to stock options was as follows (as adjusted for all stock
splits):
<TABLE>
<CAPTION>
<S> <C>
Outstanding January 1, 1997 7,967,919
Options granted (average price of
$3.82 for six months ended June 30, 1997) 2,693,647
Options forfeited (2,215,374)
Options exercised (average price of
$8.21 for six months ended June 30, 1997) (181,224)
Outstanding June 30,1997 8,264,968
</TABLE>
The average option price under the plan was $8.50 at June 30,1997.
Under the provisions of SFAS 123, the Company has elected to continue to account
for the Plan under the provisions of APB Opinion No. 25 and make the necessary
pro forma net income and earnings per share disclosures required by SFAS 123.
Upon the announcement of the discovery of the accounting irregularities and
financial statement restatement described in Notes 8 and 15, the market value of
the Company's common stock declined dramatically. Management thus believes that
the market value of the Company's common stock during 1996 was overstated.
Because a key component of the fair value calculation (and the related pro forma
net income and earnings per share disclosures) is the market value of the
Company's stock, the fair value and other disclosures required under SFAS 123
for 1996.
On June 13, 1997, a number of the above options were cancelled. Most employees
were re-granted their existing options at a new price of $3 per share. New
options were also granted to certain employees on this date. Given the recent
reissuance of options, management is currently performing the calculation for
the potential liability to the Company.
8) CONTINGENCIES AND LEGAL MATTERS
The Company has been named as a defendant in a variety of lawsuits generally
arising from the Company's announcement on January 29, 1997 that it would
restate previously reported financial information for prior years and interim
earnings for 1996 as a result of the discovery of accounting irregularities. To
date, forty-four actions against the Company are pending in United States
District Court for the Northern District of Illinois, six cases are pending
against the Company in Illinois Chancery Court, and nine cases are pending in
the Delaware Chancery Court. One case is pending in Hamilton County, Ohio,
Municipal Court. The complaints seek compensatory damages, attorneys' fees and
costs.
Forty of the lawsuits pending in the Northern District of Illinois are class
actions which allege claims under Section 10 of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder. These lawsuits name one or more
officers or directors of the Company as additional defendants. One case pending
in the Northern District of Illinois alleges derivative claims seeking to
recover damages on behalf of the Company from certain of the Company's officers
and directors. Thirty-nine of the non-derivative cases pending in the Northern
District of Illinois were consolidated pursuant to a Stipulation entered on
April 30, 1997. Certain plaintiffs have filed motions for appointment of one or
more lead plaintiffs, each of which is pending. One of the cases pending in the
Northern District of Illinois seeks to represent a class of participants in
Mercury's employee retirement plan and alleges ERISA violations arising out of
the plan's investment in Mercury's allegedly overvalued stock. Two cases
pending in the Northern District of Illinois allege non-class securities fraud
and common law claims. Three of the Illinois state court actions are class
actions alleging claims under the Illinois Securities Act, the Illinois Consumer
Fraud and Deceptive Business Practices Act and common law claims of fraud and
negligent misrepresentation. The other Illinois state court actions are
derivative actions which seek to recover damages on behalf of the Company from
certain of the Company's officers and directors. Each of the Delaware state
court actions is a derivative action which seeks to recover damages on behalf of
the Company from certain of the Company's officers and directors. The case
pending in Municipal Court in Hamilton, Ohio, alleges violations of Ohio State
securities law and common law. The Company is unable to predict the potential
financial impact of the litigation.
The Securities and Exchange Commission is investigating the events giving rise
to the accounting irregularities. Those events are also under investigation by
the United States Attorney for the Northern District of Illinois and the Federal
Bureau of Investigation, which executed a search warrant on the Company's
premises on February 3, 1997. The Company is cooperating fully in these
investigations.
On January 10, 1997, the Company entered into an agreement (the "Agreement")
with BankBoston Corporation ("BankBoston") pursuant to which the Company was to
acquire all of the outstanding stock of Fidelity Acceptance Corporation, a
subsidiary of BankBoston, in return for the issuance of approximately 32.7
million shares of the Company's common stock. On January 30, 1997, BankBoston
notified the Company that it was terminating the Agreement as a result of
breaches of the Agreement resulting from the accounting irregularities described
above. On July 10, 1997, BankBoston notified Mercury that BankBoston intended
to seek appropriate compensation for its damages resulting from such breaches.
In the normal course of its business, Mercury and its subsidiaries are named as
defendants in legal proceedings. A number of such actions, including fifteen
cases which have been brought as putative class actions, are pending in the
various states in which subsidiaries of Mercury do business. It is the policy
of Mercury and its subsidiaries to vigorously defend litigation, but Mercury and
(or) its subsidiaries have and may in the future enter into settlements of
claims where management deems appropriate. Although management is of the
opinion that the resolution of these proceedings will not have a material effect
on the financial position of Mercury, it is not possible at this time to
estimate the amount of damages or settlement expenses that may be incurred.
No provision has been made in the consolidated income statements for the three
months and six months ended June 30, 1997 for the costs or expenses that have
been or will be incurred subsequent to June 30, 1997 with respect to any of the
above matters.
9) PENSION PLANS AND OTHER EMPLOYEE BENEFITS
Substantially all employees of Mercury are covered by non-contributory defined
benefit pension plans. Total pension expense aggregated $770 in 1996.
The following table sets forth the funded status of Mercury's qualified plans
amounts recognized in 1996 consolidated financial statements:
<TABLE>
<CAPTION>
1996
<S> <C>
Actuarial Present Value of
Benefit Obligation:
Accumulated benefit obligations,
including vested benefits of
$6,231 $ 7,024
Projected benefit obligation
for service rendered to date $(10,686)
Plan assets at fair value 13,638
Plan assets in excess of
projected benefit obligation 2,952
Unrecognized net asset
as of December 31, being
recognized over 15-22 years (391)
Unrecognized net gain (3,272)
Unrecognized prior service cost 100
Prepaid (accrued) pension expense $ (611)
Components of net pension expense:
Service cost-benefits earned
during the period $ 1,060
Interest cost on projected
benefit obligation 727
Actual return on plan assets (2,085)
Net amortization and deferral 1,068
Net periodic pension expense $ 770
</TABLE>
No actuarial information was available subsequent to December 31, 1996. The
weighted average discount rate used in determining the actuarial present value
of the projected benefit obligation was 7.5% at December 31, 1996. The rates of
increase in future compensation were 5.5% - 7.0% at December 31, 1996. The
expected long-term rate of return on plan assets in 1996 was 9.0%.
Mercury also maintains a nonqualified, unfunded pension benefit plan for certain
employees whose calculated benefit payments under the qualified plan are
expected to exceed the limits imposed by Federal tax law. The projected benefit
obligations of the plan, and the expenses related to this plan, are not
material.
Mercury has an employee stock purchase plan and a tax deferred Retirement
Savings Trust (401(k)) plan. Employees are eligible to participate in the plans
after having attained specified terms of service. Both plans cover
substantially all full time employees of Mercury and provide for employee
contributions and partial matching contributions by Mercury. The expenses
related to these plans are not material.
As discussed in Note 7, the market value of the Company's common stock declined
dramatically. The employee stock purchase plan held significant shares of
Mercury's stock at June 30, 1997. All Mercury stock held by the Retirement
Savings Trust (401(k)) was sold as of June 6, 1997.
10) INCOME TAXES
The components of the credit for income taxes for the three months ended June
30, 1997 and six months ended June 30, 1997 were as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1997 1997
<S> <C> <C>
CURRENT INCOME TAX EXPENSE
Federal $ (912) $ 2,532
State (78) 217
Total (990) 2,749
Deferred income tax benefit (3,452) (9,356)
Total income tax benefit $(4,442) $(6,607)
</TABLE>
The differences between the U.S. federal statutory income tax rate and the
Company's effective rate are:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1997 1997
<S> <C> <C>
Statutory federal income tax (35.0)% (35.0)%
State income taxes, net of
federal tax benefit (3.0)% (3.0)%
Loss on sale of Lyndon - 22.4 %
Income from Lyndon due to Buyer 2.0 1.5 %
Other, net 1.3 % 0.4 %
Total (34.7)% (13.7)%
</TABLE>
The total income tax benefit reflected in shareholders' equity for stock options
exercised was $397 for the quarter ended March 31, 1997. No options were
exercised for the quarter ended June 30, 1997. Temporary differences between
the amounts reported in the financial statements and the tax basis of assets and
liabilities result in deferred taxes. Deferred tax assets and liabilities at
June 30, 1997 and December 31, 1996, were as follows:
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
<S> <C> <C>
DEFERRED TAX ASSETS:
Allowance for finance credit losses
and prepaid pension expense $47,408 $ 37,382
Unearned premiums and ceding fees - 13,632
Other 912 2,919
Deferred tax assets 48,320 53,933
DEFERRED TAX LIABILITIES:
Policy acquisition costs - 18,011
Other - 2,566
Deferred tax liabilities - 20,577
Net deferred tax assets $48,320 $ 33,356
</TABLE>
No valuation allowance for deferred tax assets has been recorded at June 30,
1997, as Mercury believes it is more likely than not that the deferred tax
assets will be realized in the future under existing tax laws at June 30, 1997.
This conclusion is based on the extremely short period in which the existing
deductible temporary differences, primarily related to finance credit losses,
will reverse and the existence of sufficient taxable income within the carryback
period of three years available under the existing tax law at June 30, 1997.
However, under the new tax laws enacted in August 1997, the carryback period has
been shortened thereby limiting the source of taxable income available to
realize the Company's tax benefits for deductible temporary differences. See
footnote 13 for a discussion of changes in tax laws and the potential impact on
the carrying value of the deferred tax assets.
11) LEASES
Mercury and its subsidiaries lease office space generally under cancelable
operating leases expiring in various years through 2003. Most of these leases
are renewable for periods ranging from three to five years. Future minimum
payments, by year and in the aggregate, under operating leases with initial or
remaining terms of one year or more consisted of the following at June 30,1997:
<TABLE>
<CAPTION>
Year Amount
<S> <C>
1997 $ 2,328
1998 3,932
1999 2,724
2000 1,522
2001 and after 1,118
Total $11,624
</TABLE>
It is expected that in the normal course of business, office leases that expire
will be renewed or replaced by leases on other properties. Total rent expense
approximated $ 1,238 for the three months ended June 30, 1997 and $ 2,425 for
the six months ended June 30, 1997.
12) DISCLOSURES OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value. Fair value estimates are made at a specific point in time for Mercury's
financial instruments; they are subjective in nature and involve uncertainties,
and matters of significant judgment and, therefore, cannot be determined with
precision. Fair value estimates assume the continuation of Mercury as a going
concern.
CASH AND CASH EQUIVALENTS
Due to the short term nature of these items, management believes that the
carrying amount is a reasonable estimate of fair value.
INVESTMENTS
For bonds, the estimated fair value is based on quoted market price. For other
investments, which consist primarily of short-term money market instruments, the
carrying amount is a reasonable estimate of fair value.
FINANCE RECEIVABLES
The Company's financing program allows for the establishment of interest rates
on contracts which typically is the maximum rate allowable by the state in which
the branch is doing business. The Company's financing revenues are not
materially impacted by changes in interest rates given that the stated rates on
existing contracts are the highest allowed by law. As such, the finance
receivable balances recorded on a historical basis in the financial statements
approximate fair value.
SENIOR DEBT, COMMERCIAL PAPER
The debt consists principally of short term commercial paper for which the
carrying amount is a reasonable estimate of fair value.
SENIOR AND SUBORDINATED DEBT, TERM NOTES
Rates currently available to Mercury for debt with similar terms and remaining
maturities are used to discount the future cash flows related to existing debt
and arrive at an estimate of fair value.
The estimated fair values of Mercury's financial instruments at June 30, 1997
and December 31, 1996 have not been adjusted for the events disclosed in Notes 8
and 15 which have a substantial negative impact on these estimates, were as
follows:
<TABLE>
<CAPTION>
June 30, 1997
Carrying Fair
Amount Value
<S> <C> <C>
FINANCIAL ASSETS
Cash $ 130,909 $ 130,909
Investments - -
Finance Receivables 900,810 900,810
Total $1,031,719 $1,031,719
FINANCIAL LIABILITIES:
Senior Debt, Commercial Paper and
Notes $ 493,619 $ 493,619
Senior Debt, Term Notes 488,625 480,962
Subordinated Debt 22,500 22,781
Total $1,004,744 $ 997,362
December 31, 1996
Carrying Fair
Amount Value
FINANCIAL ASSETS:
Cash $ 20,957 $ 20,957
Investments 212,957 213,217
Finance Receivables 973,283 973,283
Total 1,207,197 $1,207,457
FINANCIAL LIABILITIES:
Senior Debt, Commercial Paper and
Notes $ 525,051 $ 525,051
Senior Debt, Term Notes 488,625 476,469
Subordinated Debt 22,500 22,711
Total $1,036,176 $1,024,231
</TABLE>
13) SUBSEQUENT EVENTS
Mercury entered into a forbearance agreement with its creditors in July 1997.
Under the agreement, Mercury agreed to reduce the principal of its outstanding
debt by $70 million and bring its interest payments current. The Company also
agreed to make additional periodic payments to reduce principal depending on
cash flow. The creditors agreed not to take action against the Company until
after September 30, 1997 at which time the agreement may be renewed.
The Taxpayer Relief Act of 1997 ("the Act") was signed into law in August 1997.
A provision of the Act is to reduce the Net Operating Loss carryback period from
three years to two years beginning after August 5, 1997. For tax reporting
purposes, this new law restricts net operating losses, if any, incurred in 1998
to be carried back to 1996, where the Company did not have taxable income versus
under the previous legislation, any 1998 net operating losses would carry back
to 1995, where the Company has reported significant taxable income. For
financial reporting purposes, the change in the tax law raises a question as to
the realizability of the deferred tax asset that is recorded in the financial
statements ($48,320 as of June 30, 1997) because as of January 1, 1998, the
reversal of the temporary differences that give rise to the deferred taxes,
primarily the allowance for credit losses, can no longer be carried back to
periods of taxable income. Accordingly, it is unlikely the Company will be able
to record deferred tax benefits for temporary differences experienced beginning
in the third quarter of 1997 and it is expected that any deferred tax assets on
the books at December 31, 1997 will require substantial, if not complete,
valuation allowances.
14) BUSINESS SEGMENT DATA
The Finance Segment consists of the noninsurance segment of Mercury. The
Insurance Segment consists of Lyndon and MFN Insurance. The following table
presents the business segment data of Mercury (dollars in millions):
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1997 1997
<S> <C> <C>
REVENUES
Finance $ 39.7 $ 86.1
Insurance 12.2 38.6
Total $ 51.9 $ 124.7
OPERATING PROFITS (LOSSES)
Finance $ (9.4) $ (16.8)
Insurance 4.1 10.8
Total $ (5.3) $ (6.0)
NET INCOME (LOSS)
Finance $ (11.6) $ (49.2)
Insurance 3.2 7.7
Total $ (8.4) $ (41.5)
June 30, December 31,
1997 1996
IDENTIFIABLE ASSETS
Finance $1,179.6 $1,123.4
Insurance 1.2 420.0
Total $1,180.8 $1,543.4
</TABLE>
15) GOING CONCERN
The Company incurred losses in the three months ended June 30, 1997, six months
ended June 30, 1997 and the twelve months ended December 31, 1996.
Substantially all of its outstanding debt is subject to acceleration or has
matured by its terms as a result of the Company's defaults of its various
lending agreements. In addition, the Company is under investigation by the U.S.
Attorney for the Northern District of Illinois and has been named as a defendant
in various lawsuits generally arising from the restatement of previously
reported financial information for 1995 and interim periods in 1996 as described
in Note 8. The Company is also incurring significant costs in relation to the
special investigation and the resolution of its debt restructuring.
As a result of the above matters, the Board has hired the services of a crisis
manager to assist in the turnaround of the business operations. In addition, an
investment banker was retained to assist in the refinancing of existing debt
and/or explore strategy alternatives. There can be no assurances that the
Company will be successful in its attempt to consummate a refinancing or
restructuring. Thus, there is substantial doubt about the Company's ability to
continue as a going concern. The accompanying financial statements have been
prepared on the basis that the Company is a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
16) NON-OPERATING EXPENSES
Non-operating expenses include the costs of the investigation, professional fees
related to the negotiations with the creditors, legal defense for the defense of
the Company with respect to the class action lawsuits, a portion of fees for the
crisis management team and costs of the audit examination of the 1996 balance
sheet and review of the quarterly financial statements for 1997.
17) COMMON STOCK
Earnings per share is computed by dividing net income by the total of weighted
average common shares and common stock equivalents outstanding during the
period, adjusted for all stock splits. The calculated averages were as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1997 1997
<S> <C> <C>
Weighted Average:
Common Shares 177,900,671 177,884,236
Treasury Shares (5,402,957) (5,402,957)
Total 172,497,714 172,481,279
</TABLE>
As the Company incurred a net loss for the three months and six months ended
June 30, 1997, common share equivalents would be anti-dilutive to earnings per
share and have not been included in the weighted average shares calculation.
The Company has determined that the implementation of SFAS 128 "Earnings Per
Share", would have had no effect on the calculated earnings per share for the
three months and six months ended June 30, 1997. This standard prescribes that
when computing the dilution of options, the Company is to use its average stock
price for the period, rather than the more dilutive greater of the average share
price or end-of-period share price required by APB Opinion 15. As the options
are excluded from the calculation due to the anti-dilutive characteristics
indicated above, there is no effect on the earnings per share calculation.
EXHIBIT 99.2
MERCURY FINANCE COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION
(dollars in thousands)
OVERVIEW
Mercury Finance Company ("Mercury") ("the Company") operates as a consumer
finance business engaged in the acquisition of individual installment sales
finance contracts from automobile dealers and retail vendors, extending
short-term installment loans directly to consumers and sales of credit
insurance and other related products.
As previously disclosed, on January 29, 1997 the Company announced that it
would restate previously reported financial information for prior years and
interim earnings for 1996 as a result of the discovery of accounting
irregularities which caused the overstatement of earnings in 1994, 1995 and
1996. On July 15, 1997 Mercury released its audited December 31, 1996
balance sheet. However, due to issues related to the allocation of the
recognition of credit loss expenses between the years 1994, 1995 and 1996,
the release of the 1996 income statement has been delayed. As a result, the
Company's discussion and analysis is limited to those analyses that can be
made using the June 30, 1997, March 31, 1997 and December 31, 1996 balance
sheets and the income statements for three months ended June 30, 1997 and the
three months ended March 31, 1997.
Following the announcement of the accounting irregularities, the Board of
Directors hired a crisis management firm to act as interim senior management
to 1) improve operations by stabilizing branch activity and plan for the
consolidation of duplicative or underperforming branches, 2) reduce expenses
particularly in the area of credit losses, 3) perform a thorough review of
the Company's financial records including the methodology utilized in
accounting for credit losses and 4) assist the Board in mapping the future of
Mercury.
A captive insurance company, MFN Insurance, was formed to participate in the
Company program which provides insurance to Mercury's customers who do not
provide proof of current insurance coverage on automobiles that are
collateral for the outstanding loans.
Summarized below is the activity in the number of operating branches:
<TABLE>
<CAPTION>
2nd Quarter 1st Quarter
<S> <C> <C>
At beginning of period 289 287
Opened 12 2
Closed (38) -
At end of period 263 289
</TABLE>
The branches closed in the second quarter were considered to be
duplicative or underperforming locations. The costs related to the
closings consisting primarily of lease settlements and write off of
leasehold improvements aggregated $325. The branches opened in the second
quarter are centralized loan recovery branches, which collect the balance
due on loans after the collateral has been liquidated and proceeds
applied.
The Taxpayer Relief Act of 1997 ("the Act") was signed into law in August
1997. A provision of the Act is to reduce the Net Operating Loss
carryback period from three years to two years beginning after August 5,
1997. For tax reporting purposes, this new law restricts net operating
losses, if any, incurred in 1998 to be carried back to 1996, where the
Company did not have taxable income versus under the previous legislation,
any 1998 net operating losses would have carried back to 1995, where the
Company has reported significant taxable income. For financial reporting
purposes, the change in the tax law raises a question as to the
realizability of the deferred tax asset that is recorded in the financial
statements ($48,320 as of June 30, 1997) because as of January 1, 1998,
the reversal of the temporary differences that give rise to the deferred
taxes, primarily the allowance for credit losses, can no longer be carried
back to periods of taxable income. Accordingly, it is unlikely the
Company will be able to record deferred tax benefits for temporary
differences experienced beginning in the third quarter of 1997 and it is
expected that any deferred tax assets on the books at December 31, 1997
will require substantial, if not complete, valuation allowances.
FINANCIAL CONDITION
Finance Receivables
Accounting for Credit Losses
Mercury originates direct consumer loans and acquires individual sales
finance contracts from third party dealers. The sales finance contracts
are generally acquired at a discount from the principal amount. This
discount is generally referred to as a non-refundable dealer reserve. The
amount of the discount is based on the credit risk of the borrower, the
note rate of the contract and the competition faced by the Company in
acquiring receivable contracts. In previous years, the non-refundable
dealer reserve was considered to be adequate to absorb the majority of
losses on the acquired receivables. However, as the sub-prime market has
evolved and become more competitive, the dealer reserve has proven to be
inadequate to absorb all of the credit losses.
Mercury uses a loss reserving methodology commonly referred to as "static
pooling". The static pooling methodology provides that the Company
stratify the components of its sales finance receivable portfolio (i.e.
dealer reserve, principal loan balances and related loan chargeoffs) into
separately identified pools based on the period that the loans were
acquired. Mercury defines a pool as loans acquired within a given month
whereas others in the industry may use a quarterly basis.
The dealer reserve is amortized and made available to absorb credit losses
over the life of the pool of receivables. The dealer reserve cannot be
utilized to offset provision for finance credit losses immediately, but
must be held to offset future losses. Management believes this method
provides for a more appropriate matching of finance charge income and
provision for finance credit losses. With the "pools" established on a
monthly basis and the "release" of the dealer reserve over time, the
financial statements are among the most conservative in the industry.
Reserve requirements for sales finance and direct receivables are
calculated based on the estimated losses inherent in each category of
delinquency (i.e. 30, 60, 90 and 120 days past due). These assumed
losses are utilized to determine the projected cash flows from each
impaired category. The projected cash flow is then discounted to estimate
the net present value of the impaired loans. A reserve is established in
an amount sufficient to reduce the book value of the impaired receivable
to its net present value. Repossessed collateral is valued at an estimate
of its net realizable value.
The finance receivables consist of direct financing and sales financing as
follows:
<TABLE>
<CAPTION>
June 30, % of March 31, % of December 31, % of
1997 Total 1997 Total 1996 Total
<S> <C> <C> <C> <C> <C> <C>
Direct financing receivable $ 150,777 12.29% $ 151,659 11.95% $ 152,633 11.63%
Sales financing receivable 1,075,474 87.71% 1,117,535 88.05% 1,159,848 88.37%
Gross finance receivable $1,226,251 100.00% 1,269,194 100.00% $1,312,481 100.00%
Unearned finance charges (209,311) (218,428) (228,405)
Unearned commissions,
insurance premiums and
insurance claim reserves (4,391) (8,326) (7,253)
Net finance receivables $1,012,549 $1,042,440 $1,076,823
</TABLE>
Certain activity that occurred during the periods:
<TABLE>
<CAPTION>
3 months ended 3 months ended
June 30, 1997 March 31, 1997
<S> <C> <C>
Originations $ 241,984 $235,014
Cash collections $ 197,052 $206,369
Chargeoffs $ 39,335 $ 34,681
</TABLE>
The outstanding balance of receivables continues to decline due to a lower
level of originations than in prior years. New management is attempting
to reduce credit losses by implementing stricter credit standards which
has resulted in lower originations.
Allowance for Credit losses and Non-refundable Dealer Reserves
The following tables summarizes balances and activity in the non-
refundable dealer reserves, allowance for credit losses, and charges to
dealer reserves and related ratios for June 30, 1997, March 31, 1997 and
December 31, 1996.
Allowance for finance credit losses and dealer reserves as of:
<TABLE>
<CAPTION>
June 30, March 31, December 31,
1997 1997 1996
<S> <C> <C> <C>
Allowance for credit losses $ 123,604 $111,584 $97,762
Allowance as a percentage of
total finance receivables outstanding
at end of period 11.28% 9.91% 8.42%
Dealer reserves $ 71,365 $ 80,677 89,378
Dealer reserves as a percentage
of total finance receivables out-
standing at end of period 6.51% 7.16% 7.70%
</TABLE>
The following activity occurred in the dealer reserves, allowance for
finance credit losses, and charges to dealer reserves:
<TABLE>
<CAPTION>
Allowances for Non-refundable
Credit losses Dealer reserve
<S> <C> <C>
Balance at December 31, 1996 $ 97,762 $ 89,378
Provision for finance credit
Losses 30,462 -
Chargeoffs/losses,
net of recoveries (16,640) (22,695)
Discounts acquired - 13,994
Balance March 31, 1997 $111,584 $ 80,677
Allowances for Non-refundable
Credit losses Dealer reserve
Balance at March 31, 1997 $111,584 $ 80,677
Provision for finance credit
Losses 24,544 -
Chargeoffs/losses,
net of recoveries (12,524) (22,157)
Discounts acquired - 12,845
Balance June 30, 1997 $123,604 $ 71,365
</TABLE>
The allowance for credit losses has increased during the first six months
of 1997 due to an increase in the past due accounts as a result of a
slowdown of chargeoffs for financial reporting purposes. The Company's
credit loss accounting methodology is based upon losses inherent in the
portfolio as demonstrated by the delinquency agings and as such the timing
of chargeoffs does affect the recording of the credit loss provision.
The balance of dealer reserves declined ratably over the first six months
of 1997 because the amount of dealer reserves acquired as a percentage of
originations have declined beginning in the latter part of 1996 and
because of the general decline in the portfolio balance. The dealer
reserve acquired as a percentage of originations was stabilized during the
second quarter of 1997, although the current level is below historic
levels. This decline in the balance of dealer reserves is expected to
continue through the end of 1997.
The Company believes that the allowance for finance credit losses at June
30, 1997 are adequate.
Delinquencies and Repossessions
The Company generally suspends the accrual of interest when an account
becomes 60 days or more contractually delinquent. The following table
sets forth certain information with respect to the contractually
delinquent receivables and repossessed assets (in thousands):
<TABLE>
<CAPTION>
June 30, March 31, December 31,
1997 1997 1996
<S> <C> <C> <C>
Delinquent gross receivables $ 52,798 $ 56,250 $50,460
Repossessed assets 5,700 5,685 6,700
Total $ 58,498 $ 61,935 $57,160
Delinquent gross receivables to
gross finance receivables 4.19% 4.16% 3.61%
Delinquent gross receivables and repossessed
assets to gross finance receivables plus
repossessed assets 4.64% 4.56% 4.08%
</TABLE>
Loan collateral is repossessed when debtors are 120 days late or more on
payments. Automobiles are generally sold within 60 days at auction.
Debt and liquidity
The debt of the Company is in the form of senior commercial paper, senior
term notes and subordinated debt, which totaled $1,005 million at June 30,
1997 and $1,015 million at March 31, 1997. As a result of the Company's
announcement regarding the discovery of the accounting irregularities, the
Company is in default of its credit agreements. Mercury currently has a
forbearance agreement with its lenders, which has a stated termination
date of September 30, 1997. The forbearance agreement required a
principal repayment of $70 million from the proceeds of the sale of Lyndon
Insurance Company ("Lyndon") and requires principal repayments based on
excess cash balances at each month end during the duration of the
forbearance agreement, $6 million escrow fund to be used to repay any due
and unpaid interest at the end of the forbearance period, and payment of
principal and interest from cash proceeds arising from the occurrence of a
significant event. Accrual and payment of interest is as follows.
<TABLE>
<CAPTION>
Interest to be paid
upon the earlier occur-
Stated Forbearance Forbearance ence of a significant
contract interest interest event(as defined below)
interest accrued currently paid or October 1, 1997
<S> <C> <C> <C> <C>
Senior debt,
commercial paper
and notes 5.5%-5.86% 9.0% 7.0% 2.0%
Forbearance inter-
Greater of Greater of est accrual less
Senior Debt, Default rate Contract rate forbearance
term notes 6.16%-8.62% or 9.0% or 7.0% interest up to 9%
Subordinated Debt 9.76%-10.86% 9.76%-10.86% 5.5% None
The default rate on senior debt, term notes is generally contract interest plus 2%.
</TABLE>
A significant event is defined as a sale of an asset with book value in
excess of $5 million or a tax refund. The sale of Lyndon on June 3, 1997
was deemed a significant event for which unpaid accrued interest of $5,727
was paid. In July, 1997, Mercury made a principal repayment of $70
million out of the proceeds from the sale of Lyndon. The Company has also
made principal payments of $25 million out of excess cash balances through
September 5, 1997.
In February 1997, Mercury entered into a separate agreement with Bank of
America Business Credit ("BABC") wherein BABC agreed to provide a $50
million line of credit collateralized by all of the finance receivables.
This facility expires January 6, 1998, subject to receipt of certain
waivers from leaders which expire September 30, 1997, and at June 30,
1997, no amounts are outstanding. The Company has positive cash flow and
anticipates no need for borrowing against this facility in the future to
fund operations.
Disposition of Lyndon
On March 28, 1997, Mercury executed a stock purchase agreement between
Mercury Finance Company and Frontier Insurance Group, Inc. for the sale of
Lyndon Insurance Company, a wholly owned subsidiary of Mercury. The
transaction was closed on June 3, 1997. The purchase price of $92,000
resulted in a loss on sale of $29,528, which was recorded in the first
quarter of 1997. The consolidated results of operations of Mercury
include the net income of Lyndon through closing of $6,550, however,
pursuant to the agreement, net income subsequent to the agreement's
execution of $2,025 was allocated to the buyer.
Credit card program
The Company has a portfolio of approximately $83 million of unsecured
receivables relating to a credit card program that originated in late 1995
and 1996. This program has generated losses prior to the allocation of
interest expense of $1.6 million dollars in the first six months of 1997,
of which $.6 million related to the second quarter.
RESULTS OF OPERATIONS
Summarized below are the results for the first two quarters of 1996
excluding activities relating to the Lyndon Insurance Company:
<TABLE>
<CAPTION>
3 Months 3 Months 6 Months
Ended Ended Ended
March 31, 1997 June 30, 1997 June 30, 1997
<S> <C> <C> <C>
Finance charges and fees $ 63,491 $ 59,736 $123,227
Investment income 237 643 880
Total finance charges, fees
and investment income 63,728 60,379 124,107
Interest expense (20,716) (23,549) (44,265)
Interest income before
provision for finance
credit losses 43,012 36,830 79,842
Loss Provision (30,462) (24,544) (55,006)
Net interest income 12,550 12,286 24,836
Insurance commissions 1,712 1,683 3,395
Insurance premiums - 1,222 1,222
Fees and other income 1,691 1,135 2,826
Total other income 3,403 4,040 7,443
Salaries and benefits 13,417 13,668 27,085
Occupancy 1,457 1,411 2,868
Equipment 852 973 1,825
Data processing 543 549 1,092
Other operating expenses 7,106 7,957 15,063
Total operating expenses 23,375 24,558 47,933
Loss from continuing
operations (7,422) (8,232) (15,654)
Non-operating expenses (5,129) (5,128) (10,257)
Store closing expenses - (325) (325)
Loss before income tax (12,551) (13,685) (26,236)
Credit for Income taxes 4,385 5,316 9,701
Net loss $ (8,166) $ (8,369) $(16,535)
</TABLE>
Descriptions of categories with significant variances are as follows:
Finance charges, fees and other interest
Finance charges and fees decreased $3,755 or 5.9% from the first quarter
to the second quarter. Approximately one-half of this reduction is
attributable to the decrease in net receivables outstanding. The
remaining reduction is due to a slight decrease in the yield of new
originations as a result of the acquisition of higher quality loans and
increased competition in the marketplace.
Investment income
Investment income increased by $406 from the first quarter to the second
quarter primarily due to the proceeds received from the sale of Lyndon of
$92 million on June 3, 1997 which was invested on a short-term basis.
Interest expense
Interest expense increased $2,833 or 13.7% in the second quarter versus
the first quarter. This increase is the result of the higher default rate
of interest expense being accrued beginning February 10, 1997 pursuant to
forbearance arrangements.
Provision for finance credit losses
The loss provision for the second quarter decreased 5,918 or 19.4% from
the first quarter. The lower loss provision relates to improvements in
loss experience and delinquencies over the previous period.
Insurance premiums
Insurance premiums earned in the second quarter relate to premiums earned
by the captive insurance company that was formed in the second quarter of
1997.
Other operating expenses
Other operating expenses increased by $851 or 12% in the second quarter.
Increases in collection expense from the new credit scoring application
and corporate insurance premiums account for the bulk of the increase.
