SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For The Quarter Ended March 31, 1997 Commission File No. 1-10176
MERCURY FINANCE COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 36-3627010
(State or other jurisdiction of (I.R.S. Employer identification no.)
incorporation or organization)
100 FIELD DRIVE, SUITE 340, LAKE FOREST, ILLINOIS 60045
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (847) 295-8600
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing for the
past 90 days.
Yes No X
Indicate the number of shares outstanding of each issuer's class of common
stock, as of the latest practicable date.
Common Stock - $1 par value, 177,900,671 shares as of April 11, 1997.
Treasury Stock - 5,402,957 shares as of April 11, 1997.
MERCURY FINANCE COMPANY
FORM 10-Q
INDEX
PAGE
PART I FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets . . . . . . . . . . . 1
Consolidated Statements of Income . . . . . . . . 2
Consolidated Statements of Changes in Stockholders'
Equity . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Cash Flows . . . . . . 4
Notes to Condensed Consolidated Financial
Statements . . . . . . . . . . . . . . . . . . . 5
Consolidated Average Balance Sheets . . . . . . . 11
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
CONSOLIDATED FINANCIAL CONDITION AND RESULTS
OF OPERATIONS . . . . . . . . . . . . . . . . . . 12
PART II OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . 26
Item 2. Changes in Securities . . . . . . . . . . . . . . 26
Item 3. Defaults Upon Senior Securities . . . . . . . . . 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information . . . . . . . . . . . . . . . . 26
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . 26
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . 28
INDEX OF EXHIBITS . . . . . . . . . . . . . . . . . . . . . 29
Exhibit No. 11 - Computation of Net Income
Per Share . . . . . . . . . . . . . . . . . . . 30
Exhibit No. 27 - Financial Data Schedule . . . . . 32
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED BALANCE SHEETS
<CAPTION>
March 31 Dec. 31
(Dollars in thousands) 1997 1996 1996
(Unaudited)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . $25,790 $5,050 $20,957
Investments . . . . . . . . . . . . . . . . . . . . . . . . . . 221,421 222,196 212,957
Finance receivables . . . . . . . . . . . . . . . . . . . . . . 1,126,119 1,207,117 1,160,423
Less allowance for finance credit losses . . . . . . . . . . . (111,584) (49,178) (97,762)
Less nonrefundable dealer reserves . . . . . . . . . . . . . . (80,677) (58,161) (89,378)
Finance receivables, net . . . . . . . . . . . . . . . . . . . 933,858 1,099,778 973,283
Income tax receivable . . . . . . . . . . . . . . . . . . . . . 51,072 3,061 53,764
Deferred income taxes, net . . . . . . . . . . . . . . . . . . 39,260 19,220 33,356
Furniture, fixtures and equipment, net of
accumulated depreciation . . . . . . . . . . . . . . . . 7,043 7,854 7,266
Reinsurance receivable . . . . . . . . . . . . . . . . . . . . 98,353 49,144 93,458
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,248 15,071 14,463
Deferred acquisition costs and present value of
future profits . . . . . . . . . . . . . . . . . . . . . 43,503 37,279 62,809
Other assets (including repossessions) . . . . . . . . . . . . 61,087 76,115 71,047
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . $1,495,635 $1,534,768 $1,543,360
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Senior debt, commercial paper and notes . . . . . . . . . . . . $503,619 $464,127 $525,051
Senior debt, term notes . . . . . . . . . . . . . . . . . . . . 488,625 473,750 488,625
Subordinated debt . . . . . . . . . . . . . . . . . . . . . . . 22,500 29,500 22,500
Accounts payable and other liabilities . . . . . . . . . . . . 70,779 74,761 81,282
Unearned premium and claim reserves . . . . . . . . . . . . . . 227,450 188,236 239,573
Reinsurance payable . . . . . . . . . . . . . . . . . . . . . . 30,026 43,368 17,444
Reserve for loss on sale of Lyndon (Note 5) . . . . . . . . . . 29,528 0 0
TOTAL LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . $1,372,527 $1,273,742 $1,374,475
Contingencies (Note 6)
STOCKHOLDERS' EQUITY
Common stock - $1.00 par value:
300,000,000 shares authorized
Mar 31 1997 - 177,900,671 shares outstanding
Mar 31 1996 - 176,579,863 shares outstanding
Dec 31 1996 - 177,719,447 shares outstanding . . . . 177,901 176,580 177,719
Paid in capital . . . . . . . . . . . . . . . . . . . . . . . . 8,244 621 6,539
Retained earnings/(deficit) . . . . . . . . . . . . . . . . . . (8,756) 121,709 37,349
Unrealized appreciation/(depreciation) on available-for-sale
securities, net of tax . . . . . . . . . . . . . . . . . . . . (617) 341 942
Treasury stock - Mar 31, 1997 - 5,402,957 shares at cost
Mar 31, 1996 - 3,996,557 shares at cost
Dec 31, 1996 - 5,402,957 shares at cost . . (53,664) (38,225) (53,664)
TOTAL STOCKHOLDERS' EQUITY. . . . . . . . . . . . . . . . . . . 123,108 261,026 168,885
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY. . . . . . . . . . . $1,495,635 $1,534,768 $1,543,360
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY CONSOLIDATED
STATEMENTS OF INCOME
PERIODS ENDED MARCH 31
(Unaudited)
<CAPTION>
Three Months Ended
(Dollars in thousands except per share amounts) 1997 1996
<S> <C> <C>
INTEREST INCOME
Finance charges and loan fees . . . . . . . . . . . . . . . . . . . . . . . . . . $63,491 $65,167
Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,289 2,882
Total finance charges, fees and investment income . . . . . . . . . . . . . . . . 66,780 68,049
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,716 16,037
Net interest income before provision for finance credit losses . . . . . . . . . 46,064 52,012
Provision for finance credit losses . . . . . . . . . . . . . . . . . . . . . . . 30,462 18,611
Net interest income after provision for
finance credit losses . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,602 33,401
OTHER INCOME
Insurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,220 16,071
Fees, commissions and other . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,503 3,940
Total other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,723 20,011
OTHER OPERATING EXPENSES
Salaries and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . 14,644 13,323
Occupancy expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,555 1,442
Equipment expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 852 695
Data processing expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 543 723
Insurance claims expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,715 5,356
Other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,692 6,288
Total other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . 43,001 27,827
OPERATING INCOME/(LOSS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (676) 25,585
NON-OPERATING EXPENSES
Loss on sale of Lyndon (Note 5) . . . . . . . . . . . . . . . . . . . . . . . . . 29,528 0
Other non-operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 5,129 0
Total non-operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 34,657 0
Income/(loss) before income taxes . . . . . . . . . . . . . . . . . . . . . . . . (35,333) 25,585
Provision/(credit) for income taxes . . . . . . . . . . . . . . . . . . . . . . . (2,165) 9,077
NET INCOME/(LOSS) ($33,168) $16,508
NET INCOME/(LOSS) PER COMMON SHARE . . . . . . . . . . . . . . . . . . . . . . . ($0.19) $0.09
Weighted average number of common and
common share equivalents outstanding (Thousands) . . . . . . . . . . . . . . . 172,465 174,058
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY
PERIODS ENDED MARCH 31
(Unaudited)
<CAPTION>
Three Months Ended
(Dollars in thousands) 1997 1996
<S> <C> <C>
COMMON STOCK
Balance at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . $177,719 $176,478
Stock options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 102
Balance at March 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $177,901 $176,580
PAID IN CAPITAL
Balance at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . $6,539 $39
Stock options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,705 582
Balance at March 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,244 $621
RETAINED EARNINGS/(DEFICIT)
Balance at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . $37,349 $118,138
Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (33,168) 16,508
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (12,937) (12,937)
Balance at March 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($8,756) $121,709
UNREALIZED APPRECIATION/(DEPRECIATION) ON
AVAILABLE FOR SALE SECURITIES
Balance at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . $942 $1,969
Change during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,559) (1,628)
Balance at March 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($617) $341
TREASURY STOCK
Balance at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . ($53,664) ($37,137)
Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 (1,088)
Balance at March 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($53,664) ($38,225)
Total stockholders' equity at March 31 . . . . . . . . . . . . . . . . . . . . . $123,108 $261,026
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIODS ENDED MARCH 31
(Unaudited)
<CAPTION>
Three Months Ended
(Dollars in thousands) 1997 1996
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($33,168) $16,508
Adjustments to reconcile net loss to net cash
provided by operating activities:
Provision for finance credit losses . . . . . . . . . . . . . . . . . . . . 30,462 18,611
Credit for deferred income taxes . . . . . . . . . . . . . . . . . . . . . . (5,904) 2,133
Loss on sale of Lyndon . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,528 0
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . 739 728
Net (increase)/decrease in reinsurance receivable . . . . . . . . . . . . . (4,895) 40,818
Net (increase)/decrease in deferred acquisition costs and present
value of future profits . . . . . . . . . . . . . . . . . . . . . . . . . 19,306 (14,037)
Net decrease in other assets . . . . . . . . . . . . . . . . . . . . . . . . 12,652 7,610
Net increase/(decrease) in reinsurance payable . . . . . . . . . . . . . . . 12,582 (61,713)
Net decrease in unearned premium and claim reserves . . . . . . . . . . . . (12,123) (7,525)
Net decrease in other liabilities . . . . . . . . . . . . . . . . . . . . . (23,440) (4,768)
Net decrease in nonrefundable dealer reserves . . . . . . . . . . . . . . . (8,701) (3,800)
Gain/(loss) on sale of available-for-sale securities . . . . . . . . . . . 0 (1,628)
Net cash provided (used) by operating activities . . . . . . . . . . . . 17,038 (7,063)
CASH FLOWS FROM INVESTING ACTIVITIES
Principal collected on finance receivables . . . . . . . . . . . . . . . 197,052 241,145
Finance receivables originated or acquired . . . . . . . . . . . . . . . (179,386) (266,285)
Purchase of short term and available for sale investment securities . . (43,448) 0
Purchase of held to maturity investment securities . . . . . . . . . . . (306) (1,435)
Proceeds from sales and maturities of short term and available for
sale investment securities . . . . . . . . . . . . . . . . . . . . . . 34,102 21,282
Proceeds from maturities of held to maturity investment securities . . . 24 0
Net (purchases)/sales of property and equipment . . . . . . . . . . . . (301) (1,357)
Net cash provided (used) in investing activities . . . . . . . . 7,737 (6,650)
CASH FLOWS FROM FINANCING ACTIVITIES
Net (repayments)/issuances of senior debt, commercial paper and notes . (21,432) 9,137
Treasury stock acquired . . . . . . . . . . . . . . . . . . . . . . . . 0 (1,088)
Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 (12,937)
Stock options exercised . . . . . . . . . . . . . . . . . . . . . . . . 1,490 684
Net cash used in financing activities . . . . . . . . . . . . . (19,942) (4,204)
Net increase/(decrease) in cash and cash equivalents . . . . . . 4,833 (17,917)
Cash and equivalents at beginning of quarter . . . . . . . . . . . . . . 20,957 22,967
Cash and equivalents at end of quarter . . . . . . . . . . . . . . . . . $25,790 $5,050
SUPPLEMENTAL DISCLOSURES
Income taxes paid to federal and state government . . . . . . . . . . . $0 $8,337
Interest paid to creditors . . . . . . . . . . . . . . . . . . . . . . . $17,463 $4,997
See accompanying notes to consolidated financial statements.
</TABLE>
MERCURY FINANCE COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997
1. Basis of Presentation.
The following (a) condensed balance sheet as of December 31, 1996, which has
been derived from audited financial statements, and (b) the unaudited interim
condensed financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission.
Certain information and note disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to those rules and regulations, although
Mercury Finance Company ("Mercury" or the "Company") believes that the
disclosures made are adequate to make the information presented not misleading.
The condensed financial statements of the Company, in the opinion of management,
reflect all necessary adjustments for a fair presentation of results as of the
dates and for the periods covered by the financial statements.
The results of the interim periods are not indicative of the results of
operations that are expected for the fiscal years as the Company had a net loss
of $28,968 for 1996 and expects a net loss for 1997 as well.
The Company's independent public accountants qualified their report on the
Company's 1996 financial statements due to their doubt as to the ability of the
Company to continue as a going concern. The independent public accountants also
referred to the Company's change in its methodology for evaluating the adequacy
of the allowance for finance credit losses by adopting a static pooling
methodology. It is suggested that the unaudited interim condensed consolidated
financial statements contained herein be used in conjunction with the financial
statements and the accompanying notes to the financial statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 1996.
2. Per Share Amounts.
Net income per common share amounts are based on the average number of common
shares and common stock equivalents outstanding. All per share amounts have
been adjusted to reflect all stock splits declared by the Company. As the
Company incurred a net loss for the three months ended March 31, 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 ended March 31, 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.
3. Reclassifications.
Certain data from the prior year has been reclassified to conform to the 1997
presentation.
4. Adoption in 3rd Quarter 1996 of "Static Pooling" Method for Determining
Finance Credit Losses.
Sales finance contracts are generally acquired at a discount from the principal
amount. This discount is normally referred to as a non-refundable dealer
reserve. The amount of the discount is based upon the credit risk of the
borrower, the note rate of the contract and competitive factors. In 1994 and
prior, 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. Through the second quarter of
1996, it was the Company's policy to maintain a balance of the combined non-
refundable dealer reserves and allowance for finance credit losses in an amount
sufficient to cover losses that were expected to be incurred on receivables that
had demonstrated a risk of loss based upon delinquency or bankruptcy status.
In the third quarter of 1996, Mercury adopted 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
chargeoffs) into separately identified pools based upon the period the loans
were acquired (monthly). Under Mercury's application of static pooling, 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. See the Company's Annual Report on Form 10-K for the year
ended December 31, 1996, for more information regarding the impact of the
Company's adoption of the static pool methodology.
5. Disposition of Lyndon.
On March 28, 1997, Mercury executed a stock purchase agreement for the sale of
Lyndon in the amount of $92 million. The sale, which closed on June 3, 1997,
resulted in a loss to Mercury of approximately $25 million net of earnings
through the date of sale. This loss was reflected on Mercury's 1997 first
quarter consolidated statement of income.
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 Company. 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.
6. 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. As
of February 15, 1998, 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. In November, 1997, the Minnesota State Board of Investment was
appointed lead plaintiff in the federal class cases. 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. Participants
in the proposed class may include certain officers and former officers of the
Company. 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 negligence, 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.
This claim was settled in January, 1998 for a payment in the amount of
$1,600,000. Such amount will be recorded as a charge to fourth quarter 1997
earnings.
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.
See Item 3 in the Company's Annual Report on Form 10-K for the year ended
December 31, 1996, for more information regarding the litigation arising from
the overstatement of earnings and the restatement of previously issued financial
statements.
No provision has been made in the consolidated financial statements for the
costs or expenses that have been or will be incurred subsequent to March 31,
1997 with respect to any of the above matters.
7. Income Taxes.
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 ($39,260 as of March 31, 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 likely that the Company will
record a full valuation allowance on all deferred tax assets for temporary
differences originated 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.
In the third quarter of 1997, Mercury elected to be treated as a dealer in
securities under section 475 of the Internal Revenue Code. Pursuant to this
election, Mercury must recognize as taxable income or loss the difference
between the fair market value of its securities and the income tax basis of its
securities. This election has no impact on the recognition of pre-tax income
for financial reporting purposes. As a result of this election being effective
beginning in its 1996 tax year, the Company has increased the taxable loss
reported for the year ended December 31, 1996 and expects a taxable loss to be
reported for the year ended December 31, 1997. Accordingly, in the third quarter
of 1997 for financial reporting purposes, a portion of the previously recorded
deferred taxes have been reclassified as currently refundable.
8. Debt.
As a result of the 1996 net loss, accounting irregularities, and related
matters, Mercury violated certain 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. None of the Company's debt which has matured by
its terms after January 29, 1997 has been repaid, except to the extent provided
below. None of the Company's debt which has matured by its terms after
January 29, 1997 has been repaid, except to the extent provided below.
<TABLE>
<CAPTION>
MARCH 31, 1997 MARCH 31, 1996 DEC. 31, 1996
Balance Rate Balance Rate Balance Rate
<S> <C> <C> <C> <C> <C> <C>
Senior Debt:
Commercial paper and short-term loans $503,619 5.6% $464,127 5.5% $525,051 5.6%
Term notes . . . . . . . . . . . . . . 488,625 7.0% 473,750 7.0% 488,625 7.0%
Subordinated debt . . . . . . . . . . . . 22,500 10.3% 29,500 10.2% 22,500 10.3%
Total . . . . . . . . . . . . . . $1,014,744 6.4% $967,377 6.4% $1,036,176 6.4%
</TABLE>
Under the terms of certain forbearance agreements, the Company made interest
payments on senior debt through the date of this report at default rates of
interest, subject to a maximum rate of nine percent (9%) and subordinated note
holders received interest at a rate of five and one-half percent (5.5%). In
addition, the agreement required the periodic payment of excess cash to be
applied as reduction of outstanding principal. As of February 15, 1998,
approximately $187 million of principal has been paid to creditors under the
forbearance agreement. The Company continues to negotiate with all of its
lenders in an attempt to reach a consensual restructuring agreement.
9. 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 beginning
after December 15, 1997.
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED AVERAGE BALANCE SHEETS
PERIODS ENDED MARCH 31
(Unaudited)
<CAPTION>
Three Months Ended
(Dollars in thousands) 1997 1996
<S> <C> <C>
ASSETS
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $23,374 $14,009
Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217,189 232,120
Finance receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,143,272 1,202,447
Less allowance for finance credit losses . . . . . . . . . . . . . . . . . . . (104,673) (47,772)
Less nonrefundable dealer reserves . . . . . . . . . . . . . . . . . . . . . . (85,028) (60,061)
Finance receivables, net . . . . . . . . . . . . . . . . . . . . . . . . . . . 953,571 1,094,614
Income taxes receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52,418 0
Reinsurance receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95,906 69,553
Deferred acquisition costs and present value of profits . . . . . . . . . . . . . 53,156 30,261
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,308 20,287
Furniture, fixtures and equipment, net of accumulated depreciation . . . . . . . 7,155 7,438
Other assets (including repossessions & goodwill) . . . . . . . . . . . . . . . . 80,423 96,624
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,519,500 $1,564,906
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Senior debt, commercial paper . . . . . . . . . . . . . . . . . . . . . . . . . . $514,335 $477,059
Senior debt, term notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488,625 456,250
Subordinated debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,500 29,500
Accounts payable and other liabilities . . . . . . . . . . . . . . . . . . . . . 76,031 72,516
Unearned premium and claim reserve . . . . . . . . . . . . . . . . . . . . . . . 233,512 191,999
Reinsurance payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,735 74,225
Reserve for loss on sale of Lyndon . . . . . . . . . . . . . . . . . . . . . . . 14,764 0
Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 3,100
TOTAL LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,373,502 1,304,649
STOCKHOLDERS' EQUITY
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177,810 176,529
Paid in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,392 330
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,297 119,924
Unrealized gain on available for sale securities . . . . . . . . . . . . . . . . 163 1,155
Treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (53,664) (37,681)
TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . . . . . . . . . . . . . 145,998 260,257
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,519,500 $1,564,906
NUMBER OF DAYS 90 91
MONTHS COMPLETED 3 3
RATIOS (Annualized)
Return on average equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . (92.13)% 25.51%
Return on average assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8.85)% 4.24%
Yield on earning assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19.91% 19.08%
Rate on interest bearing liabilities . . . . . . . . . . . . . . . . . . . . . . 8.19% 6.70%
Net interest margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.73% 14.58%
</TABLE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Mercury Finance Company ("Mercury" or the "Company") is a consumer finance
concern engaged, through its operating subsidiaries, in the business of
acquiring individual installment sales finance contracts from automobile dealers
and retail vendors, extending short-term installment loans directly to consumers
and selling credit insurance and other related products.
OVERVIEW
In January 1997, Mercury discovered that certain improper adjustments had been
made to overstate earnings in previously issued financial statements. As a
result, a Special Committee of the Board of Directors commenced an investigation
of the misstatements of previously issued financial statements. As a result of
this investigation, Mercury has restated the financial statements for fiscal
1995, each of the 1995 quarters, and for the first three quarters of 1996. See
the Company's Annual Report on Form 10-K for the year ended December 31, 1996
for more information regarding the impact of the overstatement of earnings and
the restatement of previously issued financial statements.
During the first quarter of 1997, the Board of Directors hired the services of a
crisis manager to assist in the operation of the business. In addition, an
investment banker was retained to assist in the refinancing of existing debt
and/or explore strategic alternatives. The Company has also been named as a
defendant in a variety of lawsuits generally arising from the restatement of
previously reported financial information.
As a result of the net loss incurred in 1996, accounting irregularities, and
related matters, Mercury violated covenants thereby permitting the holders of
its debt to accelerate all such debt which, if accelerated, would result in all
of such debt being currently due and payable. Accordingly, the Company has been
accruing interest expense at default rates of interest since February 10, 1997.
Mercury continued to experience fierce competition in 1997 both from growing
specialty finance companies similar to Mercury and from traditional financial
institutions which reduced credit standards to obtain higher yields. Mercury
had previously responded to the competitive pressures by reducing its credit
standards while accepting lower pricing on sales finance contracts and
introducing new products that ultimately proved to be unprofitable. The Company
also continued to experience a high level of turnover at the branch manager and
staff levels. These factors resulted in a higher level of delinquencies and
charge-offs in 1997.
The high provision for credit losses as a result of higher delinquencies and
charge-offs combined with interest expense at default rates caused the Company
to incur an operating loss for the three month period ended March 31, 1997.
Mercury's operating subsidiaries commenced operations in February 1984 for the
purpose of penetrating the market for small dollar amount consumer loans
(average of $3,000 or less). The initial focus was toward small, short term,
direct installment loans made to the U.S. military servicemen. Building on this
direct lending niche, Mercury has also built a substantial, diversified consumer
finance portfolio by acquiring individual installment sales finance contracts
from automobile dealers and retail vendors. Substantially all of Mercury's
borrowers are "non-prime" borrowers. These are borrowers which generally would
not be expected to qualify for traditional financing such as that provided by
commercial banks or automobile manufacturers' captive finance companies.
Mercury's sales finance contracts and loans range for periods from 3 months to
48 months at annual interest rates ranging, with minor exception, from 18% to
40%. Generally all loans are repayable in monthly installments. Late payment
fees generally are assessed to accounts which fail to make their scheduled
payments within 10 days of the scheduled due date.
The following is management's discussion and analysis of the consolidated
financial condition of the Company at March 31, 1997 (unaudited) when compared
with March 31, 1996 (unaudited) and December 31, 1996 and the results of
operations for the three months ended March 31, 1997 and 1996 (unaudited). This
discussion should be read in conjunction with the Company's consolidated
financial statements and notes thereto appearing elsewhere in this quarterly
report.
FINANCIAL CONDITION
ASSETS AND FINANCE RECEIVABLES
Total assets of the Company decreased 3% to $1,495.6 million from $1,534.8
million at March 31, 1996. Finance receivables decreased 6.71% to $1,126.1
million at March 31, 1997 from $1,207.1 million at March 31, 1996. During the
period from December 31, 1996 through March 31, 1997, total assets and finance
receivables decreased 3.1% and 4.1%, respectively. Total assets and finance
receivables decreased as a result of lower level of originations due to stricter
credit standards and the disruption caused by the accounting irregularities.
The Company's offices in Florida, Texas and Louisiana accounted for
approximately 17.0%, 16.5%, and 8.6%, respectively, of all sales and direct
finance receivables. The total number of offices at March 31, 1997 was 289
compared to 282 at March 31, 1996 and 287 at December 31, 1996.
The Company closed 38 branches in the second quarter of 1997 which were
considered to be duplicative or under-performing. The costs related to the
closings consisted primarily of lease settlements and write-offs of leasehold
improvements aggregated $325,000.
In December, 1997, Mercury announced the implementation of a business plan that
included the closing of an additional 70 branches. These branches are being
closed because they are either unprofitable or considered redundant in view of
the location of nearby branches. The additional closings are estimated to
result in a decrease in the portfolio of approximately $250 million over the
next twelve to eighteen months. The closings will not be treated as
discontinued operations, however, a provision will be recorded in the fourth
quarter of 1997 to cover the costs of the closings which are estimated to be
$4,000,000.
The following table summarizes the composition of finance receivables at the
dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
MARCH 31, MARCH 31, DECEMBER 31,
1997 1996 1996
<S> <C> <C> <C>
GROSS FINANCE RECEIVABLES
Sales . . . . . . . . . . . . . . . . . . . . . . . $1,117,535 $1,282,264 $1,159,848
Direct . . . . . . . . . . . . . . . . . . . . . . 151,659 141,876 152,633
Total gross finance receivables . . . . . . . . . . 1,269,194 1,424,140 1,312,481
Less: Unearned finance charges . . . . . . . . . (218,428) (243,868) (228,405)
Unearned commissions, insurance
premiums and insurance claim
reserves . . . . . . . . . . . . . . . . (8,326) (8,400) (7,253)
Sales and direct finance receivables . . . . . . . 1,042,440 1,171,872 1,076,823
Credit card 83,679 35,245 83,600
Total finance receivables $1,126,119 $1,207,117 $1,160,423
</TABLE>
ALLOWANCE AND PROVISION FOR FINANCE CREDIT LOSSES
Mercury originates direct consumer loans, acquires individual sales finance
contracts from third party dealers and provides revolving credit to individuals
through a Visa affiliated program.
The Company continues to maintain an allowance for the direct and credit card
receivables to cover finance credit losses that are expected to be incurred on
receivables that have demonstrated a risk of loss based upon delinquency or
bankruptcy status.
The sales finance contracts are generally acquired at a discount from the
principal amount. This discount is normally referred to as a non-refundable
dealer reserve. The amount of the discount is based upon the credit risk of the
borrower, the note rate of the contract and competitive factors. In 1994 and
prior, 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. In 1995 and prior, the
Company maintained a balance of the combined non-refundable dealer reserves and
allowance for finance credit losses in an amount sufficient to cover losses that
were expected to be incurred on receivables that had demonstrated a risk of loss
based upon delinquency or bankruptcy status.
In the third quarter of 1996, Mercury adopted 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
chargeoffs) into separately identified pools based upon the period 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.
Reserve requirements for sales finance, direct receivables and credit card
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 following table sets forth a reconciliation of the changes in the allowance
for finance credit losses for the three month periods ended March 31 (dollars in
thousands):
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Balance at beginning of period . . . . . . . . . . . . . . . . . . $97,762 $46,366
Provision charged to expense . . . . . . . . . . . . . . . . . . . 30,462 18,611
Finance receivables charged-off, net of recoveries . . . . . . . . (16,640) (15,799)
Balance at March 31 . . . . . . . . . . . . . . . . . . . . . . . . $111,584 $49,178
Allowance as a percent of sales and direct finance
receivables outstanding at end of period . . . . . . . . . . . . 10.70% 4.20%
</TABLE>
The provision for credit losses in 1997 has been compiled using the static
pooling methodology, whereas the 1996 provision was compiled under a previous
methodology.
NONREFUNDABLE DEALER RESERVES
Mercury acquires a majority of its sales finance contracts from dealers at a
discount. Mercury negotiates the amount of the reserves with the dealers based
upon various criteria, one of which is the credit risk associated with the sales
finance contracts being acquired. The following table sets forth a
reconciliation of the changes in nonrefundable dealer reserves for the three
month periods ended March 31.
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Balance at beginning of period . . . . . . . . . . . . . . . . . . . . . $ 89,378 $ 61,961
Discounts acquired on new volume . . . . . . . . . . . . . . . . . . . . 13,994 20,425
Losses absorbed, net of recoveries . . . . . . . . . . . . . . . . . . . (22,695) (24,225)
Balance at March 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 80,677 $ 58,161
</TABLE>
Note that under the static pooling methodology adopted by Mercury, the
nonrefundable dealer reserves at March 31, 1997 are not available to offset
current losses but will be made available in the future. The March 31, 1996
nonrefundable reserves were computed under the previous methodology whereby they
are available for current losses. The reduction in discounts acquired in 1997
is due primarily to lower new loan volume and lower discounts acquired on a
percentage basis per loan.
DEBT
The primary source for funding the Company's finance receivables comes from the
issuance of debt. At March 31, 1997 the Company had total debt of $1,014.7
million which compares with $967.4 million at March 31, 1996.
In addition to the Company's outstanding debt the Company had available through
January 7, 1998 a $50 million revolving credit facility that is secured by all
of Mercury's finance receivables. $10 million was outstanding under this
facility at March 31, 1997 which was repaid during the second quarter of 1997.
As a result of the 1996 net loss, accounting irregularities, and related
matters, Mercury violated its 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. None of the Company's debt which has matured by
its terms after January 29, 1997 has been repaid, except to the extent provided
below.
The following table presents the Company's debt instruments and the stated
interest rates on the debt at the periods indicated:
<TABLE>
<CAPTION>
MARCH 31, 1997 MARCH 31, 1996 DEC. 31, 1996
Balance Rate Balance Rate Balance Rate
<S> <C> <C> <C> <C> <C> <C>
Senior Debt:
Commercial paper and short-term loans $503,619 5.6% $464,127 5.5% $525,051 5.6%
Term notes . . . . . . . . . . . . . . 488,625 7.0% 473,750 7.0% 488,625 7.0%
Subordinated debt . . . . . . . . . . . . 22,500 10.3% 29,500 10.2% 22,500 10.3%
Total . . . . . . . . . . . . . . $1,014,744 6.4% $967,377 6.4% $1,036,176 6.4%
</TABLE>
Under the terms of certain forbearance agreements, the Company made interest
payments on senior debt through the date of this report at default rates of
interest, subject to a maximum rate of nine percent (9%) and subordinated note
holders received interest at a rate of five and one-half percent (5.5%). In
addition, the agreement required the periodic payment of excess cash to be
applied as reduction of outstanding principal. Through February 15, 1998,
approximately $187 million of principal has been paid to creditors under the
forbearance agreements. The Company continues to negotiate with all of its
lenders in an attempt to reach a consensual restructuring agreement.
STOCKHOLDERS' EQUITY
Total stockholders' equity at March 31, 1997 was $123.1 million which compares
with $261.0 million at March 31, 1996 and $168.9 million at December 31, 1996.
For the three months ended March 31, 1997 the Company had a net loss of $33.2
million and on January 14, 1997, declared dividends of $12.9 million (payment of
such dividends was subsequently suspended on February 6, 1997). Eligible
employees of Mercury exercised options to purchase shares resulting in $1.9
million being added to the equity of the Company.
At March 31, 1997 stockholders' equity stated as a percent of total assets was
8.2% which compares with 17.0% at March 31, 1996 and 10.9% at December 31, 1996.
RESULTS OF OPERATIONS
NET INCOME/(LOSS)
For the three months ended March 31, 1997 the Company had a net loss of $33.2
million compared to net income of $16.5 million for the three months ended
March 31, 1996. The decrease in net income is primarily attributable to the
increase in the provision for credit losses, the incurrence of non-operating
expenses relating to the investigation and restructuring of the business, the
recording of the loss on the sale of Lyndon and the default rate of interest
expense beginning February 10, 1997.
INTEREST INCOME AND INTEREST EXPENSE
The largest single component of net income is net interest income which is the
difference between interest earned on finance receivables and interest paid on
borrowings. For the three months ended March 31, 1997 the Company's net
interest income decreased 11% to $46.1 million when compared with $52.0 million
in 1996. The net interest margin (annualized) which is the ratio of net
interest income before provision for finance credit losses divided by average
interest earning assets was 13.73% in 1997 compared with 14.58% in 1996. The
change in net interest margin is primarily attributable to increase in interest
rates to default levels beginning February 10, 1997. The following table
summarizes the amount of the net interest margin for the three months ended
March 31 (dollars in thousands):
<TABLE>
<CAPTION>
1997 1996
Annualized Annualized
THREE MONTHS ENDED Average Interest Rate Average Interest Rate
Out- Income/ Earned Out- Income/ Earned
standing Expense and Paid standing Expense and Paid
<S> <C> <C> <C> <C> <C> <C>
Interest bearing assets . . . . $1,360,461 $66,780 19.91% $1,434,567 $68,049 19.08%
Interest bearing liabilities . 1,025,460 20,716 8.19% 962,809 16,037 6.70%
Net . . . . . . . . . . . . . . $335,001 $46,064 11.72% $471,758 $52,012 12.38%
Net interest margin as a
percentage of average interest
earning assets . . . . . . . . 13.73% 14.58%
</TABLE>
OTHER INCOME
In addition to finance charges and interest, the Company derives commission
income from the sale of other credit related products. These products include
insurance relating to the issuance of credit life, accident and health and other
credit insurance policies to borrowers of the Company. Other credit-related
sources of revenue are derived from the sale of other products and services.
Insurance premiums are earned by the life insurance subsidiaries as reinsurers
of credit life and accident and health policies issued through the Company's
branch offices.
For the three months ended March 31, 1997, the Company experienced increases in
its insurance premiums compared to the comparable year earlier period due to
increased volume at Lyndon. The following table summarizes the amounts earned
from these products for the three months ended March 31 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
1997 1996
<S> <C> <C>
Insurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,220 16,071
Fees, commissions and other . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,503 3,940
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $26,723 $20,011
Other income as a % of average interest
earning assets (Annualized) . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.97% 5.61%
</TABLE>
OTHER EXPENSES
In addition to interest expense and the provision for finance credit losses, the
Company incurs other operating expenses in the conduct of its business.
During 1997 other operating expenses increased 54.5% over 1996. The increase
was primarily related to increased volume at Lyndon. The following table
summarizes the components of other expenses for the three months ended March 31
(dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
1997 1996
<S> <C> <C>
Salaries and employees benefits . . . . . . . . . . . . . . . . . . . . . . . . . $14,644 $13,323
Insurance claims expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,715 5,356
Other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,642 9,148
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $43,001 $27,827
Other expenses as a % of average interest
earning assets (Annualized) . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.82% 7.80%
</TABLE>
OTHER NON-OPERATING EXPENSES
Non-operating expenses of $5.1 million for the three months ended March 31,
1997, include the costs of the investigation of the accounting irregularities,
professional fees related to the negotiations with creditors, legal defense of
the Company with respect to the class action lawsuits, the costs of the interim
financing facility, a portion of the fees for the crisis management team and the
costs of the audit examination of the 1996 financial statements.
INCOME TAXES
The Company recorded a benefit for income taxes in 1997 due to reporting a pre-
tax loss. The effective tax rate was 6.1% in 1997 and 35.5% in 1996. The lower
effective tax rate in 1997 is due to the loss recorded on the sale of Lyndon
being not deductible for tax purposes.
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 ($39,260 as of March 31, 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 likely that the Company will
record a full valuation allowance on all deferred tax assets for temporary
differences originated 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.
In the third quarter of 1997, Mercury elected to be treated as a dealer in
securities under section 475 of the Internal Revenue Code. Pursuant to this
election, Mercury recognizes as taxable income or loss the difference between
the fair market value of its securities and the income tax basis of its
securities. This election has no impact on the recognition of pre-tax income
for financial reporting purposes. As a result of this election being effective
beginning in its 1996 tax year, the Company has increased the taxable loss
reported for the year ended December 31, 1996 and expects a taxable loss to be
reported for the year ended December 31, 1997. Accordingly, in the third quarter
of 1997 for financial reporting purposes, a portion of the previously recorded
deferred taxes have been reclassified as currently refundable.
CREDIT LOSSES AND DELINQUENCIES
CREDIT LOSSES
Direct finance receivables on which no payment is received within 149 days, on a
recency basis, are charged off. Sales finance receivable accounts which are
contractually delinquent 150 days are charged off monthly before they become 180
days delinquent. Accounts which are deemed uncollectible prior to the maximum
charge off period are charged off immediately. Management may authorize an
extension if collection appears imminent during the next calendar month. The
following table sets forth information relating to charge-offs, the allowance
for finance credit losses and dealer reserves:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
1997 1996
<S> <C> <C>
Loss provision charged to income . . . . . . . . . . . . . . . . . . . . . . . . $30,462 $18,611
Net charge-offs against allowance . . . . . . . . . . . . . . . . . . . . . . . . 16,640 15,799
Net charge offs against nonrefundable dealer reserves . . . . . . . . . . . . . . 22,695 24,225
Allowance for finance credit losses at end of period . . . . . . . . . . . . . . 111,584 49,178
Dealer reserves at end of period . . . . . . . . . . . . . . . . . . . . . . . . 80,677 58,161
Ratios:
Net charge offs annualized against allowance
to average total finance receivables . . . . . . . . . . . . . . . . . . . . . 5.90% 5.28%
Net charge offs annualized against nonrefundable dealer
reserves to average total finance receivables . . . . . . . . . . . . . . . . . 8.05% 8.10%
Allowance for finance credit losses to total gross finance
receivables at end of period . . . . . . . . . . . . . . . . . . . . . . . . . 8.79% 3.45%
Dealer reserves to gross sales finance receivables
at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.22% 4.54%
</TABLE>
DELINQUENCIES AND REPOSSESSIONS
If a borrower has filed for bankruptcy protection or if an account becomes 60 or
more days contractually delinquent and no full contractual payment is received
in the month the account attains such delinquency status, it is classified as
delinquent. The following table sets forth certain information regarding
contractually delinquent accounts at the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
March 31, 1997 March 31, 1996 December 31, 1996
<S> <C> <C> <C>
Delinquent gross receivables 40,331 47,072 52,008
Bankrupt accounts 41,036 25,948 17,499
Repossessed assets 5,688 4,925 6,700
Total $87,055 $77,945 76,207
Delinquent gross receivables and
bankrupt accounts to gross
finance receivables 6.41% 5.13% 5.30%
Delinquent gross receivables,
bankrupt accounts and repossessed
assets to gross finance
receivables plus repossessed assets 6.83% 5.45% 5.78%
</TABLE>
Loan collateral is repossessed when debtors are 120 days late or more on
payments. Automobiles are generally sold within 60 days at auction.
CREDIT CARD PROGRAM
The Company has a portfolio of approximately $84 million of receivables relating
to a credit card program that had originations in both late 1995 and late 1996.
This program generated losses prior to the allocations of interest expense of
$1.0 million in the first three months of 1997.
LIQUIDITY AND FINANCIAL RESOURCES
The Company has been acquiring loans by using the cash flow from cash
collections on finance receivables and with funds drawn on its revolving line of
credit. Prior to January 1997, Mercury also used commercial paper extensively
to fund its operations.
The primary debt of the Company is in the form of senior commercial paper,
senior term notes and subordinated debt, which totaled $1,015 million at
March 31, 1997, $1,036 million at December 31, 1996 and $967 million at
March 31, 1996. As a result of the Company's announcement regarding the
discovery of the accounting irregularities, the Company is in default of its
credit agreements.
Under the terms of certain forbearance agreements, the Company made interest
payments on senior debt through the date of this report at default rates of
interest, subject to a maximum rate of nine percent (9%) and subordinated note
holders received interest at a rate of five and one-half percent (5.5%). In
addition, the agreement required the periodic payment of excess cash to be
applied as reduction of outstanding principal. Through February 15, 1998,
approximately $187 million of principal has been paid to creditors under the
forbearance agreements. The Company continues to negotiate with all of its
lenders in an attempt to reach a consensual restructuring agreement.
In February 1997, Mercury entered into a separate agreement with Bank of America
Business Credit wherein Bank of America agreed to provide a $50 million line of
credit collateralized by all of the finance receivables which expires January 7,
1998. At March 31, 1997, $10 million was outstanding. The $10 million was
repaid in the second quarter of 1997 and Mercury permitted the facility to
expire according to its terms in January, 1998.
DISPOSITION OF LYNDON
During 1997, Lyndon's claims paying ability was downgraded by A.M. Best to a
rating of B with negative implications. This action, together with regulatory
concerns and the liquidity needs of Mercury, caused Mercury to decide to dispose
of Lyndon. On March 28, 1997, Mercury executed a Stock Purchase Agreement with
Frontier Insurance Group, Inc. ("Frontier") for the sale of Lyndon to Frontier
for $92 million. The sale, which closed on June 3, 1997, resulted in a loss to
Mercury of approximately $25 million net of earnings through the date of sale
and is reflected in the financial statements included in this filing.
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 Company. 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.
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. As
of February 15, 1998, 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. In November, 1997, the Minnesota State Board of Investment was
appointed lead plaintiff in the federal class cases. 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. Participants
in the proposed class may include certain officers and former officers of the
Company. 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 negligence, 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.
This claim was settled in January, 1998 for a payment in the amount of
$1,600,000. Such amount will be recorded as a charge to fourth quarter 1997
earnings.
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.
See Item 3 in the Company's Annual Report on Form 10-K for the year ended
December 31, 1996, for more information regarding the litigation arising from
the overstatement of earnings and the restatement of previously issued financial
statements.
No provision has been made in the consolidated financial statements for the
costs or expenses that have been or will be incurred subsequent to March 31,
1997 with respect to any of the above matters.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - See "Item 2 - Management's Discussion and Analysis
of Financial Condition and Results of Operations" which is
incorporated herein by reference.
Item 2. Changes in Securities - Not Applicable.
Item 3. Defaults Upon Senior Securities - See "Item 2 - Management's
Discussion and Analysis of Financial Condition and Results of
Operations" which is incorporated herein by reference.
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - See Exhibit Index following the signature page
(b) Reports on Form 8-K - The following Current Reports on Form 8-K
were filed during the first quarter of 1997:
(i) Item 5 and Item 7 Current Report on Form 8-K filed
January 14, 1997
(ii) Item 5 and Item 7 Current Report on Form 8-K filed
January 29, 1997
(iii) Item 5 and Item 7 Current Report on Form 8-K filed
February 3, 1997
(iv) Item 5 and Item 7 Current Report on Form 8-K filed
February 6, 1997
(v) Item 5 and Item 7 Current Report on Form 8-K filed
February 11, 1997
(vi) Item 2, Item 5 and Item 7 Current Report on Form 8-K filed
February 13, 1997
(vii) Item 5 and Item 7 Current Report on Form 8-K filed
February 19, 1997
(viii) Item 4 and Item 7 Current Report on Form 8-K filed
February 25, 1997
(ix) Item 5 and Item 7 Current Report on Form 8-K filed
February 27, 1997
(x) Item 5 and Item 7 Current Report on Form 8-K filed
March 4, 1997
(xi) Item 5 and Item 7 Current Report on Form 8-K filed
March 5, 1997
(xii) Item 5 and Item 7 Current Report on Form 8-K filed
March 11, 1997
(xiii) Item 5 and Item 7 Current Report on Form 8-K filed
March 11, 1997
(xiv) Item 5 and Item 7 Current Report on Form 8-K filed
March 13, 1997
(xv) Item 5 and Item 7 Current Report on Form 8-K filed
March 28, 1997
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.
MERCURY FINANCE COMPANY
(Registrant)
Date: February 26, 1998 /s/ William A. Brandt, Jr.
William A. Brandt, Jr.
President and
Chief Executive Officer
Date: February 26, 1998 /s/ Patrick J. O'Malley
Patrick J. O'Malley
Principal Financial and
Accounting Officer
INDEX OF EXHIBITS
Exhibit No. Description
11. Computation of Net Income Per Share
27. Financial Data Schedule
MERCURY FINANCE COMPANY
EXHIBIT 11
COMPUTATION OF NET INCOME PER SHARE
THREE MONTHS ENDED MARCH 31
(Unaudited)
Net income per share is computed by dividing net income by the total of the
weighted average common shares and common stock equivalents outstanding during
the period. Average common shares and common stock equivalents have been
adjusted to reflect the four-for-three stock splits of Mercury Finance Company
distributed to stockholders on December 28, 1989, October 31, 1990, June 10,
1991 and December 5, 1991, the two-for-one stock split distributed on June 19,
1992, the four-for-three stock split distributed on June 22, 1993 and the three-
for-two stock split distributed on October 31, 1995.
<TABLE>
<CAPTION>
Three Months Ended
(Dollars in thousands except per share amounts) 1997 1996
<S> <C> <C>
INCOME DATA:
1. Net income/(loss) Mercury Finance Company . . . . . . . . . . . . . . . . ($33,168) $16,508
2. Weighted average common shares
outstanding (adjusted for stock split) . . . . . . . . . . . . . . . . . . 177,868 176,518
3. Treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,403) (3,997)
EFFECT OF COMMON STOCK EQUIVALENTS (C.S.E.):
4. Weighted average shares reserved for
stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 1,537
NET INCOME PER COMMON SHARE:
5. Weighted average common share and
common stock equivalents (line 2+3+4) . . . . . . . . . . . . . . . . . . 172,465 174,058
6. Mercury Finance Company
net income/(loss) per share (line 1 / line 5) . . . . . . . . . . . . . . ($0.19) $0.09
</TABLE>
As the Company incurred a net loss for the three months ended March 31, 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 ended March 31, 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.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> MAR-31-1997
<CASH> 25,790
<SECURITIES> 28,484
<RECEIVABLES> 1,126,119
<ALLOWANCES> (192,261)
<INVENTORY> 0
<CURRENT-ASSETS> 1,198,644
<PP&E> 16,724
<DEPRECIATION> (9,681)
<TOTAL-ASSETS> 1,495,635
<CURRENT-LIABILITIES> 1,372,527
<BONDS> 0
0
0
<COMMON> 177,901
<OTHER-SE> (54,793)
<TOTAL-LIABILITY-AND-EQUITY> 1,495,635
<SALES> 66,780
<TOTAL-REVENUES> 93,503
<CGS> 0
<TOTAL-COSTS> 43,001
<OTHER-EXPENSES> 34,657
<LOSS-PROVISION> 30,462
<INTEREST-EXPENSE> 20,716
<INCOME-PRETAX> (35,333)
<INCOME-TAX> (2,165)
<INCOME-CONTINUING> (33,168)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (33,168)
<EPS-PRIMARY> (0.19)
<EPS-DILUTED> (0.19)
</TABLE>
