<PAGE>
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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 September 30, 1998 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
incorporation or organization) no.)
100 FIELD DRIVE, SUITE 340, LAKE FOREST, 60045
ILLINOIS (Zip Code)
(Address of Principal Executive Offices)
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 /X/ No / /
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 November 10, 1998.
Treasury Stock--5,402,957 shares as of November 10, 1998.
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<PAGE>
MERCURY FINANCE COMPANY
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets......................................................... 1
Condensed Consolidated Statements of Income and Other Comprehensive Income.................... 2
Consolidated Statements of Changes in Stockholders' Equity.................................... 3
Condensed Consolidated Statements of Cash Flows............................................... 4
Notes to Condensed Consolidated Financial Statements.......................................... 5
Report of Independent Public Accountants...................................................... 12
Condensed Consolidated Average Balance Sheets................................................. 13
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS......... 15
PART II OTHER INFORMATION
Item 1. Legal Proceedings............................................................................. 29
Item 2. Changes in Securities......................................................................... 29
Item 3. Defaults Upon Senior Securities............................................................... 29
Item 4. Submission of Matters to a Vote of Security Holders........................................... 29
Item 5. Other Information............................................................................. 29
Item 6. Exhibits and Reports on Form 8-K.............................................................. 29
SIGNATURES................................................................................................ 30
INDEX OF EXHIBITS......................................................................................... 31
Exhibit No. 11--Computation of Net Income Per Share........................................... 32
Exhibit No. 27--Financial Data Schedule....................................................... 33
</TABLE>
<PAGE>
PART 1--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCURY FINANCE COMPANY
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30 DEC. 31
------------------------ ----------
1998 1997 1997
---------- ------------ ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents.................................................. $ 102,027 $ 50,528 $ 53,896
Finance receivables........................................................ 729,252 1,046,157 971,377
Less: Allowance for finance credit losses.................................. (67,089) (120,131) (102,204)
Less: Nonrefundable dealer reserves........................................ (36,561) (61,306) (52,731)
---------- ------------ ----------
Finance receivables, net................................................... 625,602 864,720 816,442
Income tax receivable...................................................... 52,823 76,525 79,941
Deferred income taxes, net................................................. 0 10,500 0
Furniture, fixtures and equipment, net of accumulated depreciation......... 4,187 6,073 5,899
Goodwill................................................................... 12,960 13,819 13,604
Other assets (including repossessions)..................................... 7,350 26,986 9,622
---------- ------------ ----------
TOTAL ASSETS............................................................... $ 804,949 $ 1,049,151 $ 979,404
---------- ------------ ----------
---------- ------------ ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Post-petition liabilities and pre-petition liabilities not subject to
compromise under reorganization.......................................... $ 18,523 $ 0 $ 0
Liabilities subject to compromise under reorganization (Note 3)............ 719,075 0 0
Senior debt, commercial paper and notes (Note 4)........................... 0 445,878 416,731
Senior debt, term notes (Note 4)........................................... 0 441,364 412,514
Subordinated debt (Note 4)................................................. 0 22,500 22,500
Accounts payable and other liabilities..................................... 0 51,620 44,959
---------- ------------ ----------
TOTAL LIABILITIES.......................................................... $ 737,598 $ 961,362 $ 896,704
---------- ------------ ----------
CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY
Common stock--$1.00 par value:
300,000,000 shares authorized
177,900,671 shares outstanding......................................... $ 177,901 $ 177,901 $ 177,901
Paid in capital............................................................ 8,244 8,244 8,244
Retained deficit........................................................... (65,130) (44,692) (49,781)
Treasury stock--5,402,957 shares at cost................................... (53,664) (53,664) (53,664)
---------- ------------ ----------
TOTAL STOCKHOLDERS' EQUITY................................................. $ 67,351 $ 87,789 $ 82,700
---------- ------------ ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................. $ 804,949 $ 1,049,151 $ 979,404
---------- ------------ ----------
---------- ------------ ----------
</TABLE>
The accompanying notes to the condensed consolidated financial statements
are an integral part of these statements.
<PAGE>
MERCURY FINANCE COMPANY
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND OTHER COMPREHENSIVE INCOME
PERIODS ENDED SEPTEMBER 30
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
NINE MONTHS ENDED
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
UNAUDITED UNAUDITED
<S> <C> <C> <C> <C>
INTEREST INCOME
Finance charges and loan fees............................................. $ 42,820 $ 56,850 $ 138,560 $ 180,078
Investment income......................................................... 333 737 1,712 6,794
--------- --------- --------- ---------
Total finance charges, fees and investment income......................... 43,153 57,587 140,272 186,872
Interest expense (Note 4)................................................. 2,766 21,554 37,871 65,819
--------- --------- --------- ---------
Net interest income before provision for finance credit losses............ 40,387 36,033 102,401 121,053
Provision for finance credit losses....................................... 11,467 27,080 39,691 82,085
--------- --------- --------- ---------
Net interest income after provision for finance credit losses............. 28,920 8,953 62,710 38,968
--------- --------- --------- ---------
OTHER INCOME
Fees, commissions and other............................................... 2,236 1,913 6,817 8,484
Insurance premiums........................................................ 859 1,416 3,114 34,507
--------- --------- --------- ---------
Total other income........................................................ 3,095 3,329 9,931 42,991
--------- --------- --------- ---------
OTHER OPERATING EXPENSES
Salary and employee benefits.............................................. 11,778 13,022 37,127 43,441
License and fees expense.................................................. 1,510 1,555 4,300 4,662
Occupancy and office expense.............................................. 2,429 2,856 7,462 8,918
Reorganization expense, net (Note 5)...................................... 1,668 0 1,668 0
Insurance claims expense.................................................. 462 0 1,169 20,255
Other operating expenses.................................................. 4,242 6,385 13,409 22,228
--------- --------- --------- ---------
Total other operating expenses............................................ 22,089 23,818 65,135 99,504
--------- --------- --------- ---------
OPERATING INCOME/(LOSS)................................................... 9,926 (11,536) 7,506 (17,545)
--------- --------- --------- ---------
NON-OPERATING INCOME/(EXPENSES)
Other non-operating expenses.............................................. (1,731) (4,115) (24,820) (14,697)
Other non-operating income................................................ 0 1,102 1,965 1,102
Income from Lyndon due to Buyer (Note 11)................................. 0 0 0 (2,025)
Loss on sale of Lyndon (Note 11).......................................... 0 0 0 (29,528)
--------- --------- --------- ---------
Total net non-operating expenses.......................................... (1,731) (3,013) (22,855) (45,148)
--------- --------- --------- ---------
Income/(loss) before income taxes......................................... 8,195 (14,549) (15,349) (62,693)
Provision for income taxes................................................ 0 (13,018) 0 (6,411)
--------- --------- --------- ---------
NET INCOME/(LOSS) ATTRIBUTABLE TO COMMON SHARES........................... $ 8,195 ($ 27,567) ($ 15,349) ($ 69,104)
--------- --------- --------- ---------
OTHER COMPREHENSIVE INCOME
Unrealized depreciation on available for sale securities.................. 0 0 0 (942)
--------- --------- --------- ---------
COMPREHENSIVE INCOME/(LOSS)............................................... $ 8,195 ($ 27,567) ($ 15,349) ($ 70,046)
--------- --------- --------- ---------
--------- --------- --------- ---------
Weighted average common shares outstanding:
Basic................................................................... 172,498 172,498 172,498 172,479
--------- --------- --------- ---------
--------- --------- --------- ---------
Diluted................................................................. 172,498 172,498 172,498 172,479
--------- --------- --------- ---------
--------- --------- --------- ---------
Per share net income/(loss) attributable to common shares:
Basic................................................................... $ 0.05 ($ 0.16) ($ 0.09) ($ 0.40)
--------- --------- --------- ---------
--------- --------- --------- ---------
Diluted................................................................. $ 0.05 ($ 0.16) ($ 0.09) ($ 0.40)
--------- --------- --------- ---------
--------- --------- --------- ---------
Dividends per share declared.............................................. $ 0.00 $ 0.00 $ 0.00 $ 0.075
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The accompanying notes to the condensed consolidated financial statements
are an integral part of these statements.
2
<PAGE>
MERCURY FINANCE COMPANY
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY
PERIODS ENDED SEPTEMBER 30
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------- ----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
COMMON STOCK
Balance at beginning of period................................... $ 177,901 $ 177,901 $ 177,901 $ 177,719
Stock options exercised.......................................... 0 0 0 182
---------- ---------- ---------- ----------
Balance at September 30.......................................... $ 177,901 $ 177,901 $ 177,901 $ 177,901
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
PAID IN CAPITAL
Balance at beginning of period................................... $ 8,244 $ 8,244 $ 8,244 $ 6,539
Stock options exercised.......................................... 0 0 0 1,705
---------- ---------- ---------- ----------
Balance at September 30.......................................... $ 8,244 $ 8,244 $ 8,244 $ 8,244
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
RETAINED EARNINGS/(DEFICIT)
Balance at beginning of period................................... ($ 73,325) ($ 17,125) ($ 49,781) $ 37,349
Net income/(loss)................................................ 8,195 (27,567) (15,349) (69,104)
Dividends declared............................................... 0 0 0 (12,937)
---------- ---------- ---------- ----------
Balance at September 30.......................................... ($ 65,130) ($ 44,692) ($ 65,130) ($ 44,692)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of period................................... $ 0 $ 0 $ 0 $ 942
Change during the period......................................... 0 0 0 (942)
---------- ---------- ---------- ----------
Balance at September 30.......................................... $ 0 $ 0 $ 0 $ 0
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
TREASURY STOCK
Balance at beginning of period and at September 30............... ($ 53,664) ($ 53,664) ($ 53,664) ($ 53,664)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Total stockholders' equity at September 30....................... $ 67,351 $ 87,789 $ 67,351 $ 87,789
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
The accompanying notes to the condensed consolidated financial statements
are an integral part of these statements.
3
<PAGE>
MERCURY FINANCE COMPANY
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIODS ENDED SEPTEMBER 30
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income/(loss).................................................. $ 8,195 ($ 27,567) ($ 15,349) ($ 69,104)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Provision for finance credit losses.............................. 11,467 27,080 39,691 82,086
Decrease in income tax receivable................................ 0 0 27,590 0
Credit for deferred income taxes................................. 0 38,217 0 28,861
Loss on sale of available-for-sale securities.................... 0 0 0 (12)
Loss on sale of Lyndon........................................... 0 0 0 29,528
Depreciation and amortization.................................... 546 700 1,849 2,177
Increase in reinsurance receivable............................... 0 0 0 (6,287)
Decrease in deferred acquisition costs and present value of
future profits................................................. 0 0 0 15,473
(Increase)/decrease in other assets.............................. 881 (23,461) 1,800 (11,109)
Increase in reinsurance payable.................................. 0 0 0 12,582
Decrease in unearned premium and claim reserves.................. 0 0 0 (12,388)
Increase/(decrease) in other liabilities......................... 3,623 (9,059) (4,224) (38,864)
--------- --------- --------- ---------
Net cash provided by operating activities...................... 24,712 5,910 51,357 32,943
--------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Principal collected on finance receivables....................... 138,376 229,652 457,834 585,897
Finance receivables originated or acquired....................... (107,977) (220,644) (306,685) (559,420)
Proceeds from the sale of Lyndon................................. 0 0 0 88,884
Net (increases)/decreases in investments securities.............. 0 (46,738) 0 40,185
Net purchases of property and equipment.......................... (70) (295) (375) (340)
--------- --------- --------- ---------
Net cash provided by/(used in) investing activities............ 30,329 (38,025) 150,774 74,836
--------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net repayments of senior debt, commercial paper and notes........ 0 (95,002) (154,000) (126,434)
Stock options exercised.......................................... 0 0 0 1,490
--------- --------- --------- ---------
Net cash used in financing activities.......................... 0 (95,002) (154,000) (124,944)
Net increase/(decrease) in cash and cash equivalents........... 55,041 (127,117) 48,131 (17,165)
Cash and equivalents at beginning of period.................... 46,986 130,909 53,896 20,957
--------- --------- --------- ---------
Cash and equivalents at end of period.......................... $ 102,027 $ 3,792 $ 102,027 $ 3,792
--------- --------- --------- ---------
--------- --------- --------- ---------
SUPPLEMENTAL DISCLOSURES
Income taxes paid to federal and state governments............... $ 320 $ 0 $ 481 $ 35
--------- --------- --------- ---------
--------- --------- --------- ---------
Interest paid to creditors....................................... $ 0 $ 28,021 $ 36,874 $ 68,270
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The accompanying notes to the condensed consolidated financial statements
are an integral part of these statements.
4
<PAGE>
MERCURY FINANCE COMPANY
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
1. BASIS OF PRESENTATION.
The accompanying (a) condensed consolidated balance sheet as of December 31,
1997, which has been derived from audited financial statements, and (b)
unaudited interim condensed consolidated 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. See Note 2 for
information regarding the Company's voluntary petition (the "Voluntary Case") in
the United States Bankruptcy Court for the Northern District of Illinois (the
"Bankruptcy Court" or the "Court") for relief under Chapter 11 of Title 11 of
the United States Code along with a plan of reorganization, which were filed
with the Court by the Company on July 15, 1998. On October 17, 1998, the Company
filed its First Amended Plan of Reorganization (the "Plan" or "Plan of
Reorganization").
Since the date of the filing of the Voluntary Case, the Company has been
operating as a debtor-in-possession in accordance with the Code. As a
debtor-in-possession, the Company is authorized to operate its business, but may
not engage in transactions outside the normal course of business without
approval, after notice and hearing, of the Court.
The Company's financial statements as of September 30, 1998 have been
presented in conformity with the AICPA's Statement of Position 90-7 "Financial
Reporting By Entities In Reorganization Under The Bankruptcy Code" ("SOP 90-7").
Accordingly, during the Voluntary Case, all prepetition liabilities of the
Company that are subject to compromise, as defined by Note 3, are listed in the
Company's consolidated balance sheet as "Liabilities subject to compromise under
reorganization". These liabilities are recorded at the amounts expected to be
allowed as claims by the Court rather than estimates of amounts for which the
claims may be settled as a result of approval of the Plan of Reorganization by
the Court. All liabilities incurred since the filing of the Voluntary Case, as
well as liabilities not subject to compromise according to the Plan are listed
on the balance sheet as "Post-petition liabilities and pre-petition liabilities
not subject to compromise under reorganization". In addition, as required by SOP
90-7, all income and expenses relating to the Voluntary Case are included, net,
as Reorganization expenses in the Company's statement of income and other
comprehensive income. See Note 5 for more information and description of these
amounts.
If the Plan of Reorganization is approved by the Court, the Company will
adopt, as of the effective date of the Plan, "fresh start" reporting pursuant to
SOP 90-7. Under fresh start reporting, the reorganization fair value of the
Company is allocated to the entity's assets, the Company's retained deficit is
eliminated, and the equity in the new company is issued according to the Plan.
As a result of adopting fresh start reporting and emerging from Chapter 11
status, the Company's financial statements will not be comparable with those
prepared before the Plan is confirmed, including the historical financial
statements included in this quarterly report.
As prescribed by SOP 90-7, prior period's balances have not been
reclassified to conform with the current period's balances. The most significant
difference between prior period and current presentations is the
reclassification of all of the Company's outstanding debt to "Liabilities
subject to compromise under reorganization". See Note 3 for a detailed
description of liabilities subject to compromise at September 30, 1998.
5
<PAGE>
The Company's independent public accountants qualified their report on the
Company's 1997 financial statements due to their doubt as to the ability of the
Company to continue as a going concern. 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, 1997.
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. Actual
results could differ for these estimates.
2. RESTRUCTURING AND CHAPTER 11 PROCEEDINGS.
On July 15, 1998 the Company filed the Voluntary Case along with its Plan of
Reorganization. The filing of the Voluntary Case and the Plan of Reorganization
conformed to the terms previously agreed upon between Mercury and substantially
all of its lenders on May 14, 1998. On July 6, 1998, several of the litigants in
the pending securities lawsuits filed an involuntary petition in the Bankruptcy
Court asking the Court to place the Company into a Chapter 11 proceeding (the
"Involuntary Case"). The Involuntary Case was consolidated with the Voluntary
Case and is proceeding under Case No. 98-20763. Mercury continues to operate its
business as a debtor-in-possession under the Bankruptcy Code.
None of the Company's subsidiaries were included in the Voluntary Case or
the Involuntary Case. The Company continues to conduct its operations in the
normal course through its subsidiaries, and has paid all trade debt and dealer
contracts in the ordinary course, without interruption.
On October 15, 1998, the Bankruptcy Court approved the Company's First
Amended Disclosure Statement (the "Disclosure Statement") in connection with its
Plan of Reorganization as containing adequate information as defined in the
Bankruptcy Code. Under the Plan, which has been revised since the Disclosure
Statement was initially filed with the Bankruptcy Court, the Company's senior
lenders will receive new senior secured notes equal to 75 percent of the face
value of their then current outstanding balance after the receipt of Excess Cash
(as defined in the Plan) and all of the initial equity of the reorganized
company. The holders of subordinated notes will receive $22.5 million in new
junior unsecured subordinated notes.
The shareholders, the securities class action claimants and holders of
dividend claims, as a combined group, will receive three series of warrants,
each exercisable for five percent of the common stock of the reorganized
company, with expiration dates of three, four and five years, respectively, from
approval of the Plan. The exercise prices will be set at increasing levels. The
first series will contain an exercise price reflective of a market price for the
common stock which results in the senior lender(s) having received total value
from both common stock and senior secured notes equal to 100% of their claims.
The second and third series will contain exercise prices reflective of a market
price for the common stock which translates into a 10% and a 20% premium,
respectively, of the total amount of such claims. Consequently, it is
anticipated that the exercise prices will be significantly in excess of the
initial market price of the common stock of the reorganized company. In
addition, the Company's senior lenders have agreed to accept from any Person (as
defined in the Plan), in satisfaction of their claims, an amount in cash equal
to 98.5% of the senior lenders' claims, provided that any Person seeking to
acquire more than 15% of such claims must commit to acquiring all of such
claims.
The above summary of the Plan does not purport to be complete and is
qualified in its entirety by reference to the Plan. A copy of the Plan, which is
an exhibit to the Disclosure Statement, may be obtained from the Bankruptcy
Court.
6
<PAGE>
On November 5, 1998, the Company began its solicitation of votes for
acceptance of the Plan. The tentative date for the beginning of the hearing (the
"Confirmation Hearing") in the Bankruptcy Court with respect to confirmation of
the Plan is December 21, 1998. There is no guarantee that the Confirmation
Hearing will begin on December 21, 1998, or that the Plan will be confirmed.
The Company incurred losses for the years ended December 31, 1997 and 1996
and year to date 1998. As a result, the Company has experienced a significant
reduction in capital. In addition, the Company is currently a defendant in
various litigation arising from the restatement of previously reported financial
information for 1995 and interim periods in 1996.
There can be no assurance that the Company will be successful in its attempt
to complete the financial restructuring of the Company and return to profitable
operations. 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 and do not include any
adjustments that might result from the outcome of this uncertainty.
3. LIABILITIES SUBJECT TO COMPROMISE UNDER REORGANIZATION.
The following table shows liabilities subject to compromise under
reorganization at September 30, 1998. These liabilities are shown as amounts
expected to be allowed as claims by the Court rather than estimates of amounts
for which the claims may be settled. There were no liabilities subject to
compromise under reorganization at either September 30, 1997 or December 31,
1997.
<TABLE>
<CAPTION>
SEP. 30, 1998
-------------
<S> <C>
Senior Debt:
Commercial paper and short-term loans.................................................. $ 339,340
Term notes............................................................................. 335,905
Subordinated debt........................................................................ 22,500
Accrued interest......................................................................... 8,393
Dividends Payable........................................................................ 12,937
-------------
Total................................................................................ $ 719,075
-------------
-------------
</TABLE>
4. DEBT.
As a result of net losses incurred, accounting irregularities, the
bankruptcy filing 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.
The Company had a forbearance agreement with its lenders which, including
extensions (the "Forbearance Agreements"), expired July 15, 1998. In connection
with the execution of an extension to the previous forbearance agreement, the
participating senior lenders received a fee of 2.25% of the outstanding balance.
The fee, aggregating $14.5 million, was expensed and paid in the second quarter
and is included in non-operating expenses.
Under the terms of the Forbearance Agreements, the Company made interest
payments on senior debt at default rates of interest, subject to a maximum rate
of nine percent (9.0%) and subordinated note holders received interest at a rate
of five and one-half percent (5.5%). In addition, the agreements required the
periodic payment of excess cash to be applied as reduction of outstanding
principal. Through May 5, 1998, approximately $307 million of principal was paid
to creditors under the Forbearance Agreements, of which $154 million was paid
during 1998. Subsequent to May 5, 1998, no payments of principal have been made
to creditors.
7
<PAGE>
As described in Note 4 all of the Company's debt is subject to compromise
under the Plan of Reorganization. Therefore, the entire amount of outstanding
debt as of September 30, 1998 of $697.7 million is identified as "Liabilities
subject to compromise under reorganization" in the Company's financial
statements.
Pursuant to the Voluntary Case, no interest has been accrued or paid on the
Company's debt subsequent to July 15, 1998, the date the Voluntary Case was
filed. This has resulted in the reduction of interest expense by approximately
$12.6 million from what the Company would have expected to incur had the
Voluntary Case not been filed.
The following table represents Mercury's debt instruments and the
corresponding stated rates at the end of the periods indicated (dollars in
thousands):
<TABLE>
<CAPTION>
SEP. 30, 1997 DEC. 31, 1997
--------------------- ---------------------
BALANCE RATE BALANCE RATE
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Senior Debt:
Commercial paper and short-term loans............................... $ 445,878 5.6% $ 416,731 5.7%
Term notes.......................................................... 441,364 7.0% 412,514 7.0%
Subordinated debt..................................................... 22,500 10.3% 22,500 10.3%
---------- --------- ---------- ---------
Total............................................................. $ 909,742 6.4% $ 851,745 6.5%
---------- --------- ---------- ---------
---------- --------- ---------- ---------
</TABLE>
5. REORGANIZATION EXPENSES.
The Company has adopted SOP 90-7 which requires interest earned on funds
held on deposit that would have been paid to debt holders if the Company had not
filed the Voluntary Case, to be classified with expenses related to the
Voluntary Case. The following table represents the Company's reorganization
expenses, net, for periods ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Professional Fees.......................................................... $ 2,250 $ 0 $ 2,250 $ 0
Interest Income............................................................ (582) 0 (582) 0
--------- --------- --------- ---------
Total.................................................................... $ 1,668 $ 0 $ 1,668 $ 0
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The Company has estimated the professional fees which relate specifically to
the Voluntary Case and related restructuring that the Company is currently
undergoing.
6. CONTINGENCIES AND LEGAL MATTERS.
On July 15, 1998 the Company filed the Voluntary Case in connection with its
Plan of Reorganization. See Note 2--"Restructuring and Chapter 11 Proceedings"
for more information.
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 its earnings for certain prior periods as a result of the discovery of
accounting irregularities. To date, forty-five actions have been filed against
the Company in the 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. The complaints seek
compensatory damages, attorneys' fees and costs.
Forty-one of the lawsuits filed 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
8
<PAGE>
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. Seven of these
cases were dismissed in the third and fourth quarter of 1998. 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. One case
pending in the Northern District of Illinois alleges non-class securities fraud
and common law claims. A second case alleging similar claims was dismissed on
September 9, 1998. The ERISA action and the two non-class securities fraud cases
were consolidated in February, 1998, with the cases in which the Minnesota State
Board of Investment is lead plaintiff. 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. One
of the derivative actions was amended to include allegations of RICO violations.
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 Company is unable to predict the potential financial impact
of the litigation. Pursuant to Section 362(a) of the Bankruptcy Code, all of the
pending lawsuits against the Company are currently stayed.
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. 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. Such
claims were settled for a cash payment of $1,600,000 in January, 1998, which was
accrued at December 31, 1997.
In the normal course of its business, Mercury and its subsidiaries are named
as defendants in legal proceedings. A number of such actions, including eleven
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.
The Company recognizes the expense for litigation when the incurrence of
loss is probable and the amount of such loss is estimable. Because of the
uncertainty that surrounds the above described litigation, no accrual has been
made for the majority of these lawsuits.
9
<PAGE>
7. INCOME TAXES.
The Company recorded a full valuation allowance related to the tax benefit
for the losses recorded during the first, second and third quarters of 1998 as
the Company is unable to carryback the losses to prior periods of taxable
income.
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 years ended December 31, 1996 and December 31, 1997.
Accordingly, in the third quarter of 1997 for financial reporting purposes, a
portion of the previously recorded deferred taxes were reclassified as currently
refundable. During 1998, the Company received $27.4 million in tax refunds, net
of payments, but is unable to provide an estimate as to the expected date of
receipt of the remaining tax receivable at September 30, 1998 of $52.8 million.
8. COMMON STOCK AND PER SHARE AMOUNTS.
In February, 1997, following the announcement of the discovery of accounting
irregularities which caused the overstatement of the previously released
earnings for 1995 and interim earnings for 1996, the market value of the
Company's common stock was significantly reduced. Since the announcement, the
market value of the common stock has not exceeded the exercise price of the
stock options granted or regranted under the revised stock option program. As a
result, the calculation of the common share equivalents becomes not meaningful
for the quarter and nine months ended September 30, 1998 and 1997, and the
weighted average numbers of basic and diluted common shares outstanding are the
same.
9. RECLASSIFICATIONS.
Certain data from the prior periods has been reclassified to conform to the
1998 presentation.
10. RECENT ACCOUNTING PRONOUNCEMENTS.
In June, 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities" which establishes standards for reporting
and displaying derivatives and hedging. This statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. As the Company
has no hedging activities or financial instruments considered derivatives as
defined by this statement, the application of this statement will not have a
significant impact on the financial position, results of operations or financial
statement disclosures of the Company.
11. DISPOSITION OF LYNDON.
On March 28, 1997, Mercury executed a Stock Purchase Agreement for the sale
of Lyndon in the amount of approximately $92 million. The sale, which closed on
June 3, 1997, resulted in a loss to Mercury of approximately $29.5 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 was not tax deductible to the Company as a loss on the sale of a
consolidated subsidiary is, under certain circumstances, not deductible for tax
purposes.
10
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
of Mercury Finance Company
We have reviewed the accompanying condensed consolidated balance sheets of
Mercury Finance Company and subsidiaries as of September 30, 1998 and September
30, 1997, and the related condensed consolidated statements of income and other
comprehensive income, changes in stockholders' equity and cash flows for the
three-month and nine-month periods ended September 30, 1998 and 1997. These
financial statements are the responsibility of the Company's management.
We conducted our reviews 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 reviews, 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.
We have previously audited, in accordance with generally accepted auditing
standards, the balance sheet of Mercury Finance Company and subsidiaries as of
December 31, 1997 (not presented herein), and in our report dated March 17,
1998, we expressed a qualified opinion on that statement. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 31, 1997, is fairly stated, in all material respects, in relation
to the balance sheet from which it has been derived.
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has incurred losses for the years ended
December 31, 1997 and 1996 and year to date 1998. In addition, all of the
Company's debt is subject to acceleration or has matured by its terms as a
result of the Company's defaults of its various lending agreements. Also, the
Company is currently the defendant in various litigation arising from the
restatement of previously reported financial information for 1995 and interim
earnings in 1996. Furthermore, as described in Note 2, on July 15, 1998, the
Company filed a voluntary petition in the United States Bankruptcy Court for the
Northern District of Illinois for relief under Chapter 11 of Title 11 of the
United States Code along with its Plan of Reorganization. In the event the Plan
of Reorganization is confirmed, the Company will adopt fresh-start accounting
and continuation of the business thereafter is dependent on the Company's
ability to achieve sufficient cash flow to meet its restructured debt
obligations. These matters 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.
Chicago, Illinois ARTHUR ANDERSEN LLP
November 13, 1998
11
<PAGE>
MERCURY FINANCE COMPANY
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED AVERAGE BALANCE SHEETS
PERIODS ENDED SEPTEMBER 30
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------- ----------------------
1998 1997 1998 1997
-------- ---------- -------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Cash....................................................................... $ 74,507 $ 67,351 67,051 $ 45,362
Investments................................................................ 0 23,368 0 120,279
Finance receivables........................................................ 757,192 1,070,968 836,586 1,107,120
Less allowance for finance credit losses................................. (72,952) (121,868) (84,075) (113,270)
Less nonrefundable dealer reserves....................................... (37,705) (66,336) (42,952) (75,682)
-------- ---------- -------- ----------
Finance receivables, net................................................. 646,535 882,764 709,559 918,168
Income taxes receivable.................................................... 52,674 63,582 59,410 58,000
Reinsurance receivable..................................................... 0 0 0 47,953
Deferred acquisition costs and present value of profits.................... 0 0 0 26,578
Deferred income taxes...................................................... 0 29,410 0 32,859
Furniture, fixtures and equipment, net of accumulated depreciation......... 4,318 6,168 4,861 6,661
Other assets (including repossessions & goodwill).......................... 21,008 42,324 21,592 61,374
-------- ---------- -------- ----------
TOTAL ASSETS....................................................... $799,042 $1,114,967 $862,473 $1,317,234
-------- ---------- -------- ----------
-------- ---------- -------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Post petition liabilities and liabilities not subject to compromise under
reorganization (Note 1)................................................... $ 16,712 $ 0 $ 26,934 $ 0
Liabilities subject to compromise under reorganization (Note 1)............ 719,075 0 762,932 0
Senior debt, commercial paper (Note 1)..................................... 0 469,749 0 492,042
Senior debt, term notes (Note 1)........................................... 0 464,995 0 476,810
Subordinated debt (Note 1)................................................. 0 22,500 0 22,500
Accounts payable and other liabilities (Note 1)............................ 0 56,151 0 66,091
Unearned premium and claim reserve......................................... 0 0 0 116,756
Reinsurance payable........................................................ 0 0 0 11,868
Reserve for loss on sale of Lyndon......................................... 0 0 0 7,382
-------- ---------- -------- ----------
TOTAL LIABILITIES.................................................. 735,787 1,013,395 789,866 1,193,449
-------- ---------- -------- ----------
STOCKHOLDERS' EQUITY
Common stock............................................................... 177,901 177,901 177,901 177,856
Paid in capital............................................................ 8,244 8,244 8,244 7,818
Retained earnings (deficit)................................................ (69,226) (30,909) (59,874) (8,306)
Accumulated other comprehensive income/(loss).............................. 0 0 0 81
Treasury stock............................................................. (53,664) (53,664) (53,664) (53,664)
-------- ---------- -------- ----------
TOTAL STOCKHOLDERS' EQUITY......................................... $ 63,255 $ 101,572 $ 72,607 $ 123,785
-------- ---------- -------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......................... $799,042 $1,114,967 $862,473 $1,317,234
-------- ---------- -------- ----------
-------- ---------- -------- ----------
NUMBER OF DAYS............................................................. 92 92 273 273
MONTHS COMPLETED........................................................... 3 3 9 9
RATIOS (Annualized)
Return on average equity................................................... 51.40% (107.68)% (28.26)% (74.64)%
Return on average assets................................................... 0.41% (9.81)% (2.38)% (7.01)%
Yield on earning assets.................................................... 22.61% 20.88% 22.42% 20.36%
Rate on interest bearing liabilities (Note 2).............................. 9.76% 8.93% 9.98% 8.88%
Net interest margin........................................................ 14.57% 13.06% 14.36% 13.19%
</TABLE>
The accompanying notes to the condensed consolidated average balance sheets
are an integral part of this statement.
12
<PAGE>
NOTES TO CONDENSED CONSOLIDATED AVERAGE BALANCE SHEET
1. DEBT AND LIABILITIES SUBJECT TO COMPROMISE
Average amounts for liabilities have been computed based upon
classifications as if the Voluntary Case had been filed at the beginning of
1998.
2. INTEREST ON DEBT AND LIABILITIES SUBJECT TO COMPROMISE
Due to the non-accrual of interest expense since the filing date of the
Voluntary Case, the computation of actual net interest income is not meaningful.
For comparative analysis purposes, management has computed an estimate of the
amount of interest expense that would have been incurred had the Voluntary Case
not been filed.
13
<PAGE>
ITEM 2--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
"SAFE HARBOR" STATEMENT UNDER THE SECURITIES LITIGATION REFORM ACT OF 1995: This
Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, contains
certain forward-looking statements pertaining to the outcome of the Company's
voluntary petition (the "Voluntary Case") for relief under Chapter 11 of Title
11 of the United States Code which was filed in the United States Bankruptcy
Court for the Northern District of Illinois (the "Bankruptcy Court"), the
Company's First Amended Plan of Reorganization (the "Plan" or "Plan of
Reorganization"), the expected operating results, loss provisions and other
matters. These statements are subject to uncertainties and other factors. Should
one or more of these uncertainties or other factors materialize, or should
underlying assumptions prove incorrect, actual events or results may vary
materially from those anticipated. Such uncertainties and other factors include
the outcome of the Company's Voluntary Case, approval by the Bankruptcy Court of
the Company's Plan of Reorganization and other documents related thereto,
objections of third parties, as well as the Company's ability to acquire finance
receivables on terms it deems acceptable, changes in the quality of finance
receivables, trends in the automobile and finance industries, and general
economic conditions. The Company undertakes no obligation to update any such
factor or to publicly announce the results of any revisions to any
forward-looking statements contained herein to reflect future events or
developments.
BACKGROUND
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.
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 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.
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
and the Company's Annual Report on Form 10-K for the year ended December 31,
1997 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
14
<PAGE>
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 losses incurred in 1996, 1997 and year to date 1998,
accounting irregularities, the bankruptcy filing and related matters, Mercury
violated certain debt 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 was accruing interest
expense at default rates of interest from February 10, 1997 until the filing of
the Voluntary Case.
Mercury continues to experience fierce competition 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 Company has since implemented stricter underwriting criteria and
during 1998 has experienced an improvement in delinquencies and charge-offs, but
at the expense of new volume.
The Company's challenge is to acquire sufficient sales finance contracts
within the stricter underwriting standards to support the current Company
structure and return to profitable operations. It is anticipated that the
Company will need to significantly increase new volume from current levels to
achieve this minimum level.
The following is management's discussion and analysis of the consolidated
financial condition of the Company at September 30, 1998 (unaudited) when
compared with September 30, 1997 (unaudited) and December 31, 1997 and the
results of operations for the three and nine month periods ended September 30,
1998 and 1997 (unaudited). This discussion should be read in conjunction with
the Company's condensed consolidated financial statements and notes thereto
appearing elsewhere in this quarterly report.
RESTRUCTURING AND CHAPTER 11 PROCEEDINGS
On July 15, 1998 the Company filed the Voluntary Case along with its Plan of
Reorganization. The filing of the Voluntary Case and the Plan of Reorganization
conformed to the terms previously agreed upon between Mercury and substantially
all of its lenders on May 14, 1998. On July 6, 1998, several of the litigants in
the pending securities lawsuits filed an involuntary petition in the Bankruptcy
Court asking the Court to place the Company into a Chapter 11 proceeding (the
"Involuntary Case"). The Involuntary Case was consolidated with the Voluntary
Case and is proceeding under Case No. 98-20763. Mercury continues to operate its
business as a debtor-in-possession under the Bankruptcy Code.
None of the Company's subsidiaries were included in the Voluntary Case or
the Involuntary Case. The Company continues to conduct its operations in the
normal course through its subsidiaries, and has paid all trade debt and dealer
contracts in the ordinary course, without interruption.
On October 15, 1998, the Bankruptcy Court approved the Company's First
Amended Disclosure Statement (the "Disclosure Statement") in connection with its
Plan of Reorganization as containing adequate information as defined in the
Bankruptcy Code. Under the Plan, which has been revised since the Disclosure
Statement was initially filed with the Bankruptcy Court, the Company's senior
lenders will receive new senior secured notes equal to 75 percent of the face
value of their then current outstanding balance after the receipt of Excess Cash
(as defined in the Plan) and all of the initial equity of the reorganized
company. The holders of subordinated notes will receive $22.5 million in new
junior unsecured subordinated notes.
The shareholders, the securities class action claimants and holders of
dividend claims, as a combined group, will receive three series of warrants,
each exercisable for five percent of the common stock of the
15
<PAGE>
reorganized company, with expiration dates of three, four and five years,
respectively, from approval of the Plan. The exercise prices will be set at
increasing levels. The first series will contain an exercise price reflective of
a market price for the common stock which results in the senior lender(s) having
received total value from both common stock and senior secured notes equal to
100% of their claims. The second and third series will contain exercise prices
reflective of a market price for the common stock which translates into a 10%
and a 20% premium, respectively, of the total amount of such claims.
Consequently, it is anticipated that the exercise prices will be significantly
in excess of the initial market price of the common stock of the reorganized
company. In addition, the Company's senior lenders have agreed to accept from
any Person (as defined in the Plan), in satisfaction of their claims, an amount
in cash equal to 98.5% of the senior lenders' claims, provided that any Person
seeking to acquire more than 15% of such claims must commit to acquiring all of
such claims.
The above summary of the Plan does not purport to be complete and is
qualified in its entirety by reference to the Plan. A copy of the Plan, which is
an exhibit to the Disclosure Statement, may be obtained from the Bankruptcy
Court.
On November 5, 1998, the Company began its solicitation of votes for
acceptance of the Plan. The tentative date for the beginning of the hearing (the
"Confirmation Hearing") in the Bankruptcy Court with respect to confirmation of
the Plan is December 21, 1998. There is no guarantee that the Confirmation
Hearing will begin on December 21, 1998, or that the Plan will be confirmed.
The Company incurred losses for the years ended December 31, 1997 and 1996
and year to date 1998. As a result, the Company has experienced a significant
reduction in capital. In addition, the Company is currently a defendant in
various litigation arising from the restatement of previously reported financial
information for 1995 and interim periods in 1996.
There can be no assurance that the Company will be successful in its attempt
to complete the financial restructuring of the Company and return to profitable
operations. 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 and do not include any
adjustments that might result from the outcome of this uncertainty.
FINANCIAL CONDITION
PRO FORMA STATEMENTS
Under the requirements of AICPA's Statement of Position 90-7 "Financial
Reporting By Entities In Reorganization Under the Bankruptcy Code" ("SOP 90-7"),
the Company has reclassified items in the Condensed Consolidated Balance Sheets
and Condensed Consolidated Statement of Income and Other Comprehensive Income.
Also, due to the filing of the Voluntary Case and consistent with the Plan of
Reorganization, interest expense did not accrue for 90 days subsequent to the
filing date of the Voluntary Case. In addition, during the bankruptcy
proceeding, Mercury is not able to pay down debt with excess cash and short-term
investment balances. Accordingly, the financial results for the quarter ended
September 30, 1998, are not comparable to prior periods nor indicative of
results that would have occurred in the absence of the filing of the Voluntary
Case. To assist the reader in analysis, management has prepared the following
pro forma statement showing the results of the Company had the filing of the
Voluntary Case not occurred.
16
<PAGE>
In preparing the pro forma operating results, management has made certain
assumptions and estimates which may not have occurred if the Voluntary Case had
not been filed.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1998
------------------------
FINANCIAL PRO FORMA
STATEMENTS STATEMENTS
----------- -----------
<S> <C> <C>
Total finance charges, fees and investment income....................................... $ 43,153 $ 43,153
Interest expense........................................................................ 2,766 15,339
Provision for finance credit losses..................................................... 11,467 11,467
----------- -----------
Net interest income after provision for finance credit losses........................... 28,920 16,347
Other operating income.................................................................. 3,095 3,095
Other operating expense................................................................. 22,089 20,921
----------- -----------
Operating income (loss)................................................................. $ 9,926 $ (1,479)
----------- -----------
----------- -----------
</TABLE>
ASSETS AND FINANCE RECEIVABLES
Total assets of the Company decreased 23% to $804.9 million at September 30,
1998 from $1,049.2 million at September 30, 1997. Finance receivables decreased
30% to $729.3 million at September 30, 1998 from $1,046.2 million at September
30, 1997. During the period from December 31, 1997 through September 30, 1998,
total assets and finance receivables decreased 18% and 25% respectively. Total
assets decreased primarily due to the reduction in finance receivables. Finance
receivables decreased due to lower originations which is a result of stricter
underwriting criteria and branch closings.
The Company's offices in Texas, Florida and Illinois accounted for
approximately 14%, 14% and 10%, respectively, of all sales and direct finance
receivables at September 30, 1998. The total number of offices was 175 at
September 30, 1998 versus 263 at September 30, 1997 and 218 at December 31,
1997. In 1998, Mercury implemented a business plan that included the closing of
unprofitable branches or branches considered redundant in view of location. The
closings are estimated to result in a decrease in the loan portfolio of
approximately $61 million from the September 30, 1998 level over the following
six to nine months. The closings will not be treated as discontinued operations,
however, a provision of $3.7 million was recorded in 1997 to cover the costs of
the closings of which $1.3 million is expected to be incurred subsequent to
September 30, 1998. See "Restructuring Charges."
In the first quarter of 1998, the Company initiated 16 regional centralized
purchasing offices that review and approve the origination of loans and
acquisitions of sales finance contracts for the majority of the Company's
volume. Through this process, management believes that underwriting criteria
will be applied more consistently while still allowing for flexibility to be
responsive to local market conditions. In addition, the realignment will release
branch personnel from making credit decisions and will allow for greater
emphasis to be placed on cash collections and expanding dealer relationships.
17
<PAGE>
The following table summarizes the composition of finance receivables at the
dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
SEP. 30, SEP. 30, DEC. 31,
1998 1997 1997
------------ ------------ ------------
<S> <C> <C> <C>
DIRECT FINANCE RECEIVABLES
Interest bearing..................................................... $ 16,820 $ 20,790 $ 20,504
Precompute........................................................... 102,426 129,210 129,120
------------ ------------ ------------
Total direct finance receivables....................................... 119,246 150,000 149,624
SALES FINANCE RECEIVABLES
Total sales finance receivables...................................... 707,492 1,023,244 954,319
------------ ------------ ------------
Total gross finance receivables........................................ 826,738 1,173,224 1,103,943
Less: Unearned Finance Charges......................................... (149,556) (204,551) (200,820)
Unearned commissions and insurance premiums.......................... (2,692) (3,388) (3,242)
------------ ------------ ------------
Sales and Direct Finance Receivables................................... $ 674,490 $ 965,285 $ 899,881
------------ ------------ ------------
CREDIT CARD
Total credit card.................................................... 54,762 80,872 71,496
------------ ------------ ------------
Total finance receivables.............................................. $ 729,252 $1,046,157 $ 971,377
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The following sets forth a summary of gross originations and acquisitions
(including precomputed interest and prior to deduction for nonrefundable dealer
reserves), excluding activity of the credit card portfolio, for the three and
nine month periods ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTH ENDED
---------------------- ----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Direct finance receivables....................................... $ 34,267 $ 44,798 $ 94,199 $ 130,328
Sales finance receivables........................................ $ 107,739 $ 180,580 $ 283,839 $ 572,049
</TABLE>
The decrease in new volume is a result of the previously discussed branch
closings as well as the implementation of stricter underwriting criteria. While
management believes that the implementation of the above has significantly
improved the quality of new originations and acquisitions, the changes may have
reduced new volume to a level below that which is required to provide for
profitable operations. Management is hopeful that as Company personnel and the
dealers become accustomed to the new buying organizational structure, volume
will increase, however, at this time, there is no assurance of that occurring.
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 maintains an allowance 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.
The Company utilizes 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 charge-offs) into separately
18
<PAGE>
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 different 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 fair value less selling
costs.
The following table sets forth a reconciliation of the changes in the
allowance for finance credit losses for the periods ended September 30 (dollars
in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------- ----------------------
1998 1997 1998 1997
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balance at beginning of period.................................... $ 78,815 $ 123,604 $ 102,204 $ 97,762
Provision charged to expense...................................... 11,467 27,080 39,691 82,085
Finance receivables charged-off, net of recoveries................ (23,193) (30,553) (74,806) (59,716)
--------- ---------- ---------- ----------
Balance at September 30........................................... $ 67,089 $ 120,131 $ 67,089 $ 120,131
--------- ---------- ---------- ----------
--------- ---------- ---------- ----------
Allowance as a percent of sales and direct finance receivables
outstanding at end of period.................................... 9.95% 12.45%
---------- ----------
---------- ----------
</TABLE>
The reduction in the amount of provision for credit losses recorded for the
nine months ended September 30, 1998 in relation to the same period in 1997 is
primarily due to the decrease in the size of the loan portfolio and an
improvement in the relative delinquency of the remaining portfolio. Management
believes that the change in the relative delinquency of the portfolio
experienced during 1998 is an indication of an overall improvement in the credit
quality of the portfolio due to the implementation of stricter underwriting
standards, greater emphasis on collections by branch personnel and a focus on
generating volume in the more profitable regions.
Mercury's loss reserving methodology is sensitive to changes in
delinquencies. As such, an improvement in relative delinquencies will generally
have a direct impact on the estimated reserve required as the amount of loans
requiring higher reserve percentages has decreased. Accordingly, the reduction
of the provision for finance credit losses recognized during 1998 due to the
improvement in the relative delinquency is considered to be a non-recurring
event unless significant delinquency changes are experienced in future periods.
The results of this nine-month period are not necessarily indicative of future
results.
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
19
<PAGE>
reconciliation of the changes in nonrefundable dealer reserves for the periods
ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Balance at beginning of period........................................ $ 38,848 $ 71,365 $ 52,731 $ 89,378
Dealer reserves acquired on new volume................................ 6,136 10,116 17,509 36,905
Losses absorbed, net of recoveries.................................... (8,423) (20,175) (33,679) (64,977)
--------- --------- --------- ---------
Balance at September 30............................................... $ 36,561 $ 61,306 $ 36,561 $ 61,306
--------- --------- --------- ---------
--------- --------- --------- ---------
Dealer reserves acquired as a percentage of sales finance receivables
originated.......................................................... 5.70% 5.60% 6.17% 6.45%
--------- --------- --------- ---------
--------- --------- --------- ---------
Reserves as a percentage of sales finance receivables................. 5.17% 5.99%
--------- ---------
--------- ---------
</TABLE>
The reduction in dealer reserves acquired in 1998 is due primarily to lower
new loan volume.
DEBT
The primary source for funding the Company's finance receivables was
provided by the issuance of debt. At September 30, 1997 the Company had total
debt of $909.7 million which compares $851.7 million of December 31, 1997.
As a result of net losses incurred, accounting irregularities, the
bankruptcy filing 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.
The Company had a forbearance agreement with its lenders which, including
extensions (the "Forbearance Agreements"), expired July 15, 1998. In connection
with the execution of an extension to the previous forbearance agreement, the
participating senior lenders received a fee of 2.25% of the outstanding balance.
The fee, aggregating $14.5 million, was expensed and paid in the second quarter
and is included in non-operating expenses.
Under the terms of the Forbearance Agreements, the Company made interest
payments on senior debt at default rates of interest, subject to a maximum rate
of nine percent (9.0%) and subordinated note holders received interest at a rate
of five and one-half percent (5.5%). In addition, the agreements required the
periodic payment of excess cash to be applied as reduction of outstanding
principal. Through May 5, 1998, approximately $307 million of principal was paid
to creditors under the Forbearance Agreements, of which $154 million was paid
during 1998. Subsequent to May 5, 1998, no payments of principal have been made
to creditors.
As described in Note 4 all of the Company's debt is subject to compromise
under the Plan of Reorganization. Therefore, the entire amount of outstanding
debt as of September 30, 1998 of $697.7 million has been reclassified as
"Liabilities subject to compromise under reorganization" in the Company's
financial statements.
Pursuant to the Voluntary Case, no interest has been accrued or paid on the
Company's debt subsequent to July 15, 1998, the date the Voluntary Case was
filed. This has resulted in the reduction of interest expense by approximately
$12.6 million from what the Company would have expected to incur had the
Voluntary Case not been filed.
20
<PAGE>
The following table represents Mercury's debt instruments and the
corresponding stated rates at the end of the periods indicated (dollars in
thousands):
<TABLE>
<CAPTION>
SEP. 30, 1997 DEC. 31, 1997
--------------------- ---------------------
BALANCE RATE BALANCE RATE
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Senior Debt:
Commercial paper and short-term loans.................................... $ 445,878 5.6% $ 416,731 5.7%
Term notes............................................................... 441,364 7.0% 412,514 7.0%
Subordinated debt.......................................................... 22,500 10.3% 22,500 10.3%
---------- --- ---------- ---
Total.................................................................. $ 909,742 6.4% $ 851,745 6.5%
---------- --- ---------- ---
---------- --- ---------- ---
</TABLE>
STOCKHOLDERS' EQUITY
Total stockholders' equity at September 30, 1998 was $67.4 million which
compares with $87.8 million at September 30, 1997 and $82.7 million at December
31, 1997.
The Plan of Reorganization also provides for significant changes to the
existing Common Stock of the Company held by the stockholders. See
"Restructuring and Chapter 11 Proceedings" and the Plan of Reorganization for
more information.
At September 30, 1998, stockholders' equity stated as a percent of total
assets was 8.4% which compares with 8.4% at September 30, 1997 and 8.4% at
December 31, 1997.
On January 14, 1997, the Company declared dividends of $12.9 million.
Payment of such dividends was subsequently suspended on February 6, 1997 and the
amount is now subject to compromise under the Plan of Reorganization filed by
the Company. Based on existing defaults and events of default under the
Company's Senior and Subordinated Note Agreements and the filing of the
Voluntary Case, no dividends may be paid on the capital stock of the Company.
RESULTS OF OPERATIONS
NET RESULTS
For the three months ended September 30, 1998 the Company's net income was
$8.2 million compared to a net loss of $27.6 million for the three months ended
September 30, 1997. The change is primarily attributable to the Company not
incurring interest expense during the bankruptcy proceeding, a lower charge to
the provision for finance credit losses and the income tax charge recorded in
1997 in the amount of $12.0 million. Management has estimated that if the
Company had not filed the Voluntary Case, the interest expense of the Company
would have been an additional $12.6 million. For the nine months ended September
30, 1998 the Company incurred a net loss of $15.3 million compared to $69.1
million for the nine months ended September 30, 1997. The decrease in net loss
for the nine month period is primarily attributable to the inclusion in 1997 of
a charge for the loss on the sale of Lyndon of $29.5 million and the reduction
of the interest expense during the bankruptcy proceeding.
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. Due to the non-accrual of interest expense since the filing date,
the computation of actual net interest income is not meaningful. For comparative
analysis purposes, management has computed an estimate of the amount of interest
expense that would have been incurred had the Voluntary Case not been filed. On
a proforma basis, for the three and nine month periods ended September 30, 1998,
the amount of the Company's net interest income decreased 22.8% and 25.8%,
respectively, when compared to the 1997 periods. The net interest margin
21
<PAGE>
improved due to the sale of Lyndon in the second quarter of 1997, which had
substantial amounts of investments earning relatively low yields.
The following tables summarize the amount of the net interest margin for the
periods ended September 30 and pro forma tables which include management's
estimate of interest expense if the Voluntary Case had not been filed (dollars
in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------------
1998 (PRO FORMA) 1997
----------------------------------- ------------------------------------
INTEREST INTEREST
AVERAGE INCOME/ ANNUALIZED AVERAGE INCOME/ ANNUALIZED
OUTSTANDING EXPENSE RATE OUTSTANDING EXPENSE RATE
----------- --------- ----------- ------------ --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Interest bearing assets................ $ 757,192 $ 43,153 22.61% $ 1,094,336 $ 57,587 20.88%
Interest bearing liabilities........... 623,239 15,339 9.76% 957,244 21,554 8.93%
----------- --------- ----------- ------------ --------- -----------
Net interest income.................... $ 133,953 $ 27,814 12.85% $ 137,092 $ 36,033 11.95%
----------- --------- ----------- ------------ --------- -----------
----------- --------- ----------- ------------ --------- -----------
Net interest margin as a percentage of
average interest earning assets
(Annualized).......................... 14.57% 13.06%
----------- -----------
----------- -----------
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
---------------------------------------------------------------------------
1998 (PRO FORMA) 1997
------------------------------------ -------------------------------------
INTEREST INTEREST ANNUALIZED
AVERAGE INCOME/ ANNUALIZED AVERAGE INCOME/ RATE EARNED
OUTSTANDING EXPENSE RATE OUTSTANDING EXPENSE AND PAID
----------- ---------- ----------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Interest bearing assets............. $ 836,586 $ 140,272 22.42% $ 1,227,399 $ 186,872 20.36%
Interest bearing liabilities........ 675,489 50,444 9.98% 991,352 65,819 8.88%
----------- ---------- ----------- ------------ ---------- -----------
Net interest income................. $ 161,097 $ 89,828 12.44% $ 236,047 $ 121,053 11.48%
----------- ---------- ----------- ------------ ---------- -----------
----------- ---------- ----------- ------------ ---------- -----------
Net interest margin as a percentage
of average interest earning assets
(Annualized)....................... 14.36% 13.19%
----------- -----------
----------- -----------
</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.
For the three months ended September 30, 1998 the Company experienced a
decrease in insurance premiums compared to the same period in 1997 due primarily
to the lower volume of originations. For the nine months ended September 30,
1998, the Company experienced substantial decreases in its insurance premiums
compared to the comparable year earlier period due to the sale of Lyndon in the
second quarter of 1997. The following table summarizes the amounts earned from
these products for the periods ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Fees, commissions and other........................................... $ 2,236 $ 1,913 $ 6,817 $ 8,484
Insurance premiums.................................................... 859 1,416 3,114 34,507
--------- --------- --------- ---------
Total................................................................. $ 3,095 $ 3,329 $ 9,931 $ 42,991
--------- --------- --------- ---------
Other income as a % of average interest earning assets................ 1.62% 1.21% 1.59% 4.68%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
22
<PAGE>
OTHER EXPENSES (EXCLUDING RESTRUCTURING CHARGES)
In addition to interest expense and the provision for finance credit losses,
the Company incurs other operating expenses in the conduct of its business.
For the three and nine month periods ended September 30, 1998, other
expenses decreased 7.3% and 34.5%, respectively, compared to the 1997 periods,
primarily related to the sale of Lyndon in the second quarter of 1997 and the
lower operating costs of the company resulting from the closing of branches. The
following table summarizes the components of other expenses for the periods
ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Salaries and employees benefits....................................... $ 11,778 $ 13,022 $ 37,127 $ 43,411
Insurance claims expense.............................................. 462 0 1,169 20,255
Other operating expenses.............................................. 9,849 10,796 26,839 35,808
--------- --------- --------- ---------
Total............................................................... $ 22,089 $ 23,818 $ 65,135 $ 99,504
--------- --------- --------- ---------
--------- --------- --------- ---------
Other expenses as a % of average interest earning assets
(Annualized)........................................................ 11.57% 8.63% 10.41% 10.84%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
RESTRUCTURING CHARGES
During 1997, the Company closed a number of branches and implemented a plan
to close additional branches for a total closure of approximately 110 branches
and to reduce approximately 260 branch personnel. The amount charged during the
year ended December 31, 1997 was $3.7 million ($0.02 per common share) of which
$2.4 million has been utilized to date. These charges and their utilization to
September 30, 1998 are summarized in the following table (dollars in thousands):
<TABLE>
<CAPTION>
AMOUNTS TO BE
UTILIZED
AMOUNTS AMOUNTS AMOUNTS SUBSEQUENT TO
CHARGED UTILIZED UTILIZED SEPTEMBER 30,
IN 1997 IN 1997 IN 1998 1998
--------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Asset and leasehold write-offs.................................... $ 1,200 $ 200 $ 968 $ 32
Lease buyouts and other expenses.................................. 1,025 101 614 310
Employee severance and retention.................................. 1,500 0 558 942
--------- ----- ----------- ------
$ 3,725 $ 301 $ 2,140 $ 1,284
--------- ----- ----------- ------
--------- ----- ----------- ------
</TABLE>
The Company believes that the amounts provided in 1997 remain adequate to
complete the reductions as planned. Further, the Company does not believe that
reclassification of any amounts are required as of September 30, 1998.
The Company records restructuring charges against operations and provides a
reserve based on the best information available at the time the commitment is
made to undertake the restructuring action. The reserves are considered utilized
when specific restructuring criteria are met, indicating the planned
restructuring action has occurred. Work-force-related reserves are considered
utilized at payment for termination or acceptance of other contractual
arrangements.
The reserve for lease buyouts is utilized when the remaining lease
obligations are settled or the space has been vacated and made available for
sublease. It is the Company's policy to continue to charge depreciation, rental,
and other operating costs relating to excess space to ongoing operations while
they
23
<PAGE>
remain in business use. Salaries and benefits are charged to operations while
the employee is actively employed.
Reserves for assets and leasehold improvements written-off are utilized at
the date of disposal or the final date of the lease.
OTHER NON-OPERATING INCOME AND EXPENSES
Other non-operating expenses of $1.7 million for the third quarter of 1998
are lower than the $4.1 million for the three months ended September 30, 1997
because of the reclassification of professional fees associated with the filing
of the Voluntary Case. The other non-operating expenses are substantially higher
for the nine month period ended September 30, 1998 compared to the same period
last year because of a $14.5 million payment of a forbearance fee to creditors
who participated in the May, 1998 forbearance agreement. The remainder of the
other non-operating expenses 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 and
derivative lawsuits, a portion of the fees for the crisis management team and
non-recurring costs relating to financial and tax matters.
INCOME TAXES
The Company had previously recorded a benefit for income taxes due to
reporting a pre-tax loss that was able to be carried back to previous periods of
taxable income to generate tax refunds. The Company recorded a full valuation
allowance related to the tax benefit for the losses recorded during 1998 as the
Company is unable to carryback the losses to prior periods of taxable income.
24
<PAGE>
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 years ended December 31, 1996 and December 31, 1997.
Accordingly, in the third quarter of 1997 for financial reporting purposes, a
portion of the previously recorded deferred taxes were reclassified as currently
refundable. During the first quarter of 1998, the Company received $27.4 million
in tax refunds, but is unable to provide an estimate as to the expected date of
receipt of the remaining tax receivable at September 30, 1998 of $52.8 million.
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 for the periods ended September 30
(dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Loss provision charged to income...................................... $ 11,467 $ 27,080 $ 39,691 $ 82,086
Net charge-offs against allowance..................................... 23,193 30,553 74,806 59,718
Net charge-offs against nonrefundable dealer reserves................. 8,423 20,175 33,679 64,977
Allowance for finance credit losses at end of period.................. 67,089 120,131
Dealer reserves at end of period...................................... 36,561 61,306
Ratios:
Net charge-offs against allowance annualized to average total finance
receivables......................................................... 12.15% 11.32% 11.96% 7.21%
Net charge-offs against nonrefundable dealer reserves annualized to
average total finance receivables................................... 4.41% 7.47% 5.38% 7.85%
Allowance for finance credit losses to total gross finance receivables
at end of period.................................................... 8.11% 10.24%
Dealer reserves to gross sales finance receivables at end of period... 5.17% 5.99%
</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
25
<PAGE>
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>
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997 DECEMBER 31, 1997
------------------ ------------------ -----------------
<S> <C> <C> <C>
Delinquent gross receivables........................... $ 28,372 $ 53,102 $ 41,970
Bankrupt accounts...................................... 26,702 39,034 37,037
Repossessed assets..................................... 3,996 5,517 5,167
------- ------- -------
Total.................................................. $ 59,070 $ 97,653 $ 84,174
------- ------- -------
------- ------- -------
Delinquent gross receivables and bankrupt accounts to
gross finance receivables............................ 6.66% 7.85% 7.16%
------- ------- -------
------- ------- -------
Delinquent gross receivables, bankrupt accounts and
repossessed assets to gross finance receivables plus
repossessed asset.................................... 7.11% 8.28% 7.59%
------- ------- -------
------- ------- -------
</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 $54.7 million of receivables
relating to a credit card program that had originations in both late 1995 and
late 1996. This program generated a loss of $1.1 million prior to the allocation
of interest expense during the third quarter of 1998 compared to losses of $1.5
million in the third quarter of 1997.
LIQUIDITY AND FINANCIAL RESOURCES
The Company has been acquiring loans by using the cash flow from cash
collections on finance receivables. Prior to January 1997, Mercury also used
commercial paper extensively to fund its operations.
As a result of net losses incurred, accounting irregularities, the
bankruptcy filing 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.
The Company had a forbearance agreement with its lenders which, including
extensions (the "Forbearance Agreements"), expired July 15, 1998. In connection
with the execution of an extension to the previous forbearance agreement, the
participating senior lenders received a fee of 2.25% of the outstanding balance.
The fee, aggregating $14.5 million, was expensed in the second quarter and is
included in non-operating expenses.
Under the terms of the Forbearance Agreements, the Company made interest
payments on senior debt at default rates of interest, subject to a maximum rate
of nine percent (9.0%) and subordinated note holders received interest at a rate
of five and one-half percent (5.5%). In addition, the agreements required the
periodic payment of excess cash to be applied as reduction of outstanding
principal. Through May 5, 1998, approximately $307 million of principal was paid
to creditors under the Forbearance Agreements, of which $154 million was paid
during 1998. Subsequent to May 5, 1998, no payments of principal have been made
to creditors.
As described in Note 4 all of the Company's debt is subject to compromise
under the Plan of Reorganization. Therefore, the entire amount of outstanding
debt as of September 30, 1998 of $697.7 million is identified as "Liabilities
subject to Compromise under Reorganization" in the Company's financial
statements.
26
<PAGE>
Pursuant to the Voluntary Case, no interest has been accrued or paid on the
Company's debt subsequent to July 15, 1998, the date the Voluntary Case was
filed. This has resulted in the reduction of interest expense by approximately
$12.6 million from what the Company would have expected to incur had the
Voluntary Case not been filed.
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. 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 on
sale of approximately $29.5 million which was recorded in the first quarter of
1997. 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 was not 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
On July 15, 1998 the Company filed the Voluntary Case in connection with its
Plan of Reorganization. See Note 2--"Restructuring and Chapter 11 Proceedings"
for more information.
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 its earnings for certain prior periods as a result of the discovery of
accounting irregularities. To date, forty-five actions have been filed against
the Company in the 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. The complaints seek
compensatory damages, attorneys' fees and costs.
Forty-one of the lawsuits filed 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. Seven of these cases were dismissed in the third and
fourth quarter of 1998. 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. One case pending in the Northern District of Illinois
alleges non-class securities fraud and common law claims. A second case alleging
similar claims was dismissed on September 9, 1998. The ERISA action and the two
non-class securities fraud cases were consolidated in February, 1998, with the
cases in which the Minnesota State Board of Investment is lead plaintiff. 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
27
<PAGE>
recover damages on behalf of the Company from certain of the Company's officers
and directors. One of the derivative actions was amended to include allegations
of RICO violations. 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 Company is unable to predict the
potential financial impact of the litigation. Pursuant to Section 362(a) of the
Bankruptcy Code, all of the pending lawsuits against the Company are currently
stayed.
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. 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. Such
claims were settled for a cash payment of $1,600,000 in January, 1998, which was
accrued at December 31, 1997.
In the normal course of its business, Mercury and its subsidiaries are named
as defendants in legal proceedings. A number of such actions, including eleven
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.
The Company recognizes the expense for litigation when the incurrence of
loss is probable and the amount of such loss is estimable. Because of the
uncertainty that surrounds the above described litigation, no accrual has been
made for the majority of these lawsuits.
YEAR 2000 COMPLIANCE
The Company has undertaken a review of its exposure to computer malfunctions
relating to the Year 2000. The Year 2000 issue exists because many computer
systems and applications currently use two-digit date fields to designate a
year. As the century date change occurs, date-sensitive systems will recognize
the year 2000 as 1900, or not at all. This inability to recognize or properly
treat the Year 2000 may cause systems to process critical financial and
operational information incorrectly.
The Company has two major information systems, the branch system and the
financial/reporting system. Each system is currently Year 2000 compliant or
ready. The Company does, however, expect to incur certain expenditures in the
ordinary course with respect to routine upgrades to hardware and operating
systems which costs are not expected to be material. Mercury utilizes computer
software developed by external vendors and has received Year 2000 compliant
upgrades which will allow the Company more than sufficient time for an orderly
transition.
Maintenance or modification costs will be expensed as incurred, while the
costs of new software will be capitalized and amortized over the software's
useful life. To minimize risk of interruption of telecommunication service,
which could materially impact the operations of the Company, the Company has
diversified its telecommunications providers. The Company is also instituting a
communications back-up procedure, which the Company expects to have in place by
the end of the first quarter of 1999.
28
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "Item 2--Management's Discussion and Analysis of Financial Condition and
Results of Operations--Contingencies and Legal Matters" which is incorporated
herein by reference.
ITEM 2. CHANGES IN SECURITIES
See "Item 2--Management's Discussion and Analysis of Financial Condition and
Results of Operations--Restructuring and Chapter 11 Proceedings" which is
incorporated herein by reference.
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 second
quarter of 1998:
(i) Item 5 and Item 7 Current Report on Form 8-K filed July 10, 1998.
(ii) Item 5 and Item 7 Current Report on Form 8-K filed July 23, 1998.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCURY FINANCE COMPANY
(REGISTRANT)
<TABLE>
<S> <C>
Date: November 16, 1998 /s/William A. Brandt, Jr.
William A. Brandt, Jr.
PRESIDENT AND
CHIEF EXECUTIVE OFFICER
Date: November 16, 1998 /s/Patrick J. O'Malley
Patrick J. O'Malley
PRINCIPAL FINANCIAL AND
ACCOUNTING OFFICER
</TABLE>
30
<PAGE>
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------------------ ---------------------------------------------------------------------------------------
<S> <C>
11 Computation of Net Income Per Share
27 Financial Data Schedule
</TABLE>
31
<PAGE>
EXHIBIT 11
MERCURY FINANCE COMPANY
COMPUTATION OF NET INCOME PER SHARE
PERIODS ENDED SEPTEMBER 30
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 NINE MONTHS ENDED
---------------------- ----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
INCOME DATA:
1. Net income/(loss) Mercury Finance Company................... $ 8,195 $ (27,567) $ (15,349) $ (69,104)
2. Weighted average common shares outstanding (adjusted for
stock split)................................................. 177,901 177,901 177,901 177,882
3. Treasury stock.............................................. (5,403) (5,403) (5,403) (5,403)
EFFECT OF COMMON STOCK EQUIVALENTS (C.S.E.):
4. Weighted average shares reserved for stock options.......... 0 0 0 0
NET INCOME PER COMMON SHARE:
5. Weighted average common share and common stock
equivalents (line 2+3+4)................................... 172,498 172,498 172,498 172,479
6. Mercury Finance Company net income/(loss) per
share (line 1 DIVIDED BY line 5).......................... $ 0.05 $ (0.16) $ (0.09) $ (0.40)
</TABLE>
In February, 1997, following the announcement of the discovery of accounting
irregularities which caused the overstatement of the previously released
earnings for 1995 and interim earnings for 1996, the market value of the
Company's common stock was significantly reduced. Since the announcement, the
market value of the common stock has not exceeded the exercise price of the
stock options granted or regranted under the revised stock option program. As a
result, the calculation of the common share equivalents becomes meaningless for
the quarter ended September 30, 1998.
32
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 102,027
<SECURITIES> 0
<RECEIVABLES> 729,252
<ALLOWANCES> (103,650)
<INVENTORY> 0
<CURRENT-ASSETS> 787,802
<PP&E> 14,181
<DEPRECIATION> (9,994)
<TOTAL-ASSETS> 804,949
<CURRENT-LIABILITIES> 737,598
<BONDS> 0
0
0
<COMMON> 177,901
<OTHER-SE> (110,550)
<TOTAL-LIABILITY-AND-EQUITY> 804,949
<SALES> 43,153
<TOTAL-REVENUES> 46,248
<CGS> 0
<TOTAL-COSTS> 22,089
<OTHER-EXPENSES> 1,731
<LOSS-PROVISION> 11,467
<INTEREST-EXPENSE> 2,766
<INCOME-PRETAX> 8,195
<INCOME-TAX> 0
<INCOME-CONTINUING> 8,195
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,195
<EPS-PRIMARY> 0.05
<EPS-DILUTED> 0.05
</TABLE>
