<PAGE>
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 June 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 no.)
incorporation or organization)
100 FIELD DRIVE, SUITE 340, LAKE FOREST, ILLINOIS 60045
------------------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (847) 295-8600
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing for the
past 90 days.
Yes 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 August 10, 1998.
Treasury Stock - 5,402,957 shares as of August 10, 1998.
<PAGE>
MERCURY FINANCE COMPANY
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets. . . . . . . . . . . . . . . . . . . . . . . . 1
Condensed Consolidated Statements of Income and Other
Comprehensive Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 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. . . . . . . . . . . . . . . . . . . . 14
PART II OTHER INFORMATION
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Item 2. Changes in Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . . 34
Item 5. Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . 34
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
INDEX OF EXHIBITS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
Exhibit No. 11 - Computation of Net Income Per Share. . . . . . . . . . . . . . . 37
Exhibit No. 27 - Financial Data Schedule. . . . . . . . . . . . . . . . . . . . . 38
</TABLE>
<PAGE>
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCURY FINANCE COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30 Dec. 31
- ----------------------------------------------------------------- ---------------------- --------
(Dollars in thousands, except per share amounts) 1998 1997 1997
(Unaudited)
- ----------------------------------------------------------------- -------- ---------- --------
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . $46,986 $129,993 $53,896
Finance receivables . . . . . . . . . . . . . . . . . . . . . . . 785,131 1,095,779 971,377
Less: Allowance for finance credit losses. . . . . . . . . . . . (78,815) (123,604) (102,204)
Less: Nonrefundable dealer reserves. . . . . . . . . . . . . . . (38,848) (71,365) (52,731)
-------- ---------- --------
Finance receivables, net. . . . . . . . . . . . . . . . . . . . . 667,468 900,810 816,442
Income tax receivable . . . . . . . . . . . . . . . . . . . . . . 52,524 50,638 79,941
Deferred income taxes, net. . . . . . . . . . . . . . . . . . . . 0 48,320 0
Furniture, fixtures and equipment, net of
accumulated depreciation. . . . . . . . . . . . . . . . . . . 4,449 6,263 5,899
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,175 14,034 13,604
Other assets (including repossessions). . . . . . . . . . . . . . 8,530 16,141 9,622
-------- ---------- --------
TOTAL ASSETS. . . . . . . . . . . . . . . . . . . . . . . . . . . $793,132 $1,166,199 $979,404
-------- ---------- --------
-------- ---------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Senior debt, commercial paper and notes (Notes 7 and 9) . . . . . $339,340 $493,619 $416,731
Senior debt, term notes (Notes 7 and 9) . . . . . . . . . . . . . 335,905 488,625 412,514
Subordinated debt (Notes 7 and 9) . . . . . . . . . . . . . . . . 22,500 22,500 22,500
Accounts payable and other liabilities. . . . . . . . . . . . . . 36,231 46,099 44,959
-------- ---------- --------
TOTAL LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . $733,976 $1,050,843 $896,704
-------- ---------- --------
Contingencies (Note 5)
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. . . . . . . . . . . . . . . . . . . . . . . . . (73,325) (17,125) (49,781)
Treasury stock - 5,402,957 shares at cost . . . . . . . . . . . . (53,664) (53,664) (53,664)
-------- ---------- --------
TOTAL STOCKHOLDERS' EQUITY. . . . . . . . . . . . . . . . . . . . $59,156 $115,356 $82,700
-------- ---------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY. . . . . . . . . . . . $793,132 $1,166,199 $979,404
-------- ---------- --------
-------- ---------- --------
</TABLE>
The accompanying notes to the condensed consolidated financial statements
are an integral part of these statements.
<PAGE>
MERCURY FINANCE COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND
OTHER COMPREHENSIVE LOSS
PERIODS ENDED JUNE 30
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
- ----------------------------------------------------------- ----------------------- ----------------------
(In thousands except per share amounts) 1998 1997 1998 1997
(Unaudited) (Unaudited)
- ----------------------------------------------------------- ----------------------- ----------------------
<S> <C> <C> <C> <C>
INTEREST INCOME
Finance charges and loan fees . . . . . . . . . . . . . . . $45,242 $59,736 $95,740 $123,227
Investment income . . . . . . . . . . . . . . . . . . . . . 737 2,769 1,379 6,058
--------- -------- --------- ---------
Total finance charges, fees and investment income . . . . . 45,979 62,505 97,119 129,285
Interest expense. . . . . . . . . . . . . . . . . . . . . . 16,509 23,549 35,105 44,265
--------- -------- --------- ---------
Net interest income before provision for finance
credit losses . . . . . . . . . . . . . . . . . . . . . . 29,470 38,956 62,014 85,020
Provision for finance credit losses . . . . . . . . . . . . 15,265 24,544 28,224 55,006
--------- -------- --------- ---------
Net interest income after provision for finance
credit losses . . . . . . . . . . . . . . . . . . . . . . 14,205 14,412 33,790 30,014
--------- -------- --------- ---------
OTHER INCOME
Fees, commissions and other . . . . . . . . . . . . . . . . 2,013 3,068 4,582 6,571
Insurance premiums. . . . . . . . . . . . . . . . . . . . . 897 9,871 2,255 33,091
--------- -------- --------- ---------
Total other income. . . . . . . . . . . . . . . . . . . . . 2,910 12,939 6,837 39,662
--------- -------- --------- ---------
OTHER OPERATING EXPENSES
Salaries and employee benefits. . . . . . . . . . . . . . . 12,347 15,775 25,349 30,419
Occupancy expense . . . . . . . . . . . . . . . . . . . . . 1,145 1,589 2,360 3,144
Equipment expense . . . . . . . . . . . . . . . . . . . . . 813 973 1,721 1,825
Data processing expense . . . . . . . . . . . . . . . . . . 472 549 952 1,092
Insurance claims expense. . . . . . . . . . . . . . . . . . (26) 3,540 706 20,255
Other operating expenses. . . . . . . . . . . . . . . . . . 5,596 10,258 11,960 18,950
Total other operating expenses. . . . . . . . . . . . . . . 20,347 32,684 43,048 75,685
--------- -------- --------- ---------
OPERATING LOSS. . . . . . . . . . . . . . . . . . . . . . . (3,232) (5,333) (2,421) (6,009)
--------- -------- --------- ---------
NON-OPERATING (INCOME)/EXPENSES
Income from Lyndon due to Buyer (Note 4). . . . . . . . . . 0 2,025 0 2,025
Loss on sale of Lyndon (Note 4) . . . . . . . . . . . . . . 0 0 0 29,528
Other Non-operating expenses. . . . . . . . . . . . . . . . 18,834 5,453 23,088 10,582
Other Non-operating income. . . . . . . . . . . . . . . . . 0 0 (1,965) 0
--------- -------- --------- ---------
Total non-operating expenses. . . . . . . . . . . . . . . . 18,834 7,478 21,123 42,135
--------- -------- --------- ---------
Loss before income taxes. . . . . . . . . . . . . . . . . . (22,066) (12,811) (23,544) (48,144)
Credit for income taxes . . . . . . . . . . . . . . . . . . 0 (4,442) 0 (6,607)
--------- -------- --------- ---------
NET LOSS ATTRIBUTABLE TO COMMON SHARES. . . . . . . . . . . (22,066) (8,369) (23,544) (41,537)
--------- -------- --------- ---------
OTHER COMPREHENSIVE GAINS/(LOSSES)
Unrealized appreciation/(depreciation)
on available for sale securities. . . . . . . . . . . . . 0 617 0 (942)
--------- -------- --------- ---------
COMPREHENSIVE LOSS. . . . . . . . . . . . . . . . . . . . . ($22,066) ($7,752) ($23,544) ($42,479)
--------- -------- --------- ---------
--------- -------- --------- ---------
Weighted average common shares outstanding:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . 172,498 172,498 172,498 172,481
--------- -------- --------- ---------
--------- -------- --------- ---------
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . 172,498 172,498 172,498 172,481
--------- -------- --------- ---------
--------- -------- --------- ---------
Per share net loss attributable to common shares:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . ($0.13) ($0.05) ($0.14) ($0.24)
--------- -------- --------- ---------
--------- -------- --------- ---------
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . ($0.13) ($0.05) ($0.14) ($0.24)
--------- -------- --------- ---------
--------- -------- --------- ---------
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
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY
PERIODS ENDED JUNE 30
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
- -------------------------------------------------- ---------------------- ----------------------
(In thousands except per share amounts) 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 June 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 June 30 . . . . . . . . . . . . . . . . $8,244 $8,244 $8,244 $8,244
-------- -------- -------- --------
-------- -------- -------- --------
RETAINED EARNINGS/(DEFICIT)
Balance at beginning of period . . . . . . . . . . ($51,259) ($8,756) ($49,781) $37,349
Net loss . . . . . . . . . . . . . . . . . . . . . (22,066) (8,369) (23,544) (41,537)
Dividends declared . . . . . . . . . . . . . . . . 0 0 0 (12,937)
-------- -------- -------- --------
Balance at June 30 . . . . . . . . . . . . . . . . ($73,325) ($17,125) ($73,325) ($17,125)
-------- -------- -------- --------
-------- -------- -------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of period . . . . . . . . . . $0 ($617) $0 $942
Change during the period . . . . . . . . . . . . . 0 617 0 (942)
-------- -------- -------- --------
Balance at June 30 . . . . . . . . . . . . . . . . $0 $0 $0 $0
-------- -------- -------- --------
-------- -------- -------- --------
TREASURY STOCK
Balance at beginning of period and at June 30. . . ($53,664) ($53,664) ($53,664) ($53,664)
-------- -------- -------- --------
-------- -------- -------- --------
Total stockholders' equity at June 30. . . . . . . $59,156 $115,356 $59,156 $115,356
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The accompanying notes to the condensed consolidated financial statements
are an integral part of these statements.
-3-
<PAGE>
MERCURY FINANCE COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIODS ENDED JUNE 30
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
- ------------------------------------------------------- ------------------------ ------------------------
(In thousands except per share amounts) 1998 1997 1998 1997
(Unaudited) (Unaudited)
- ------------------------------------------------------- ------------------------ ------------------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss . . . . . . . . . . . . . . . . . . . . . . . ($22,066) ($8,369) ($23,544) ($41,537)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Provision for finance credit losses. . . . . . . . 15,265 24,544 28,224 55,006
Decrease in income tax receivable. . . . . . . . . 0 0 27,590 0
Credit for deferred income taxes . . . . . . . . . 0 (3,452) 0 (9,356)
Loss on sale of available-for-sale securities. . . 0 (12) 0 (12)
Loss on sale of Lyndon . . . . . . . . . . . . . . 0 0 0 29,528
Depreciation and amortization. . . . . . . . . . . 630 738 1,303 1,477
Net increase in reinsurance receivable . . . . . . 0 (1,392) 0 (6,287)
Net change in deferred acquisition costs and
present value of future profits . . . . . . . . 0 (3,833) 0 15,473
Net change in other assets. . . . . . . . . . . . (965) 13,367 919 26,019
Net increase in reinsurance payable . . . . . . . 0 0 0 12,582
Net decrease in unearned premium and
claim reserves. . . . . . . . . . . . . . . . . 0 (265) 0 (12,388)
Net decrease in other liabilities . . . . . . . . (1,995) (20,948) (7,847) (44,388)
Net decrease in nonrefundable dealer reserves . . 0 (9,312) 0 (18,013)
-------- -------- -------- --------
Net cash provided by operating activities . . . (9,131) (8,934) 26,645 8,104
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Principal collected on finance receivables . . . . . 160,146 177,206 319,458 374,258
Finance receivables originated or acquired . . . . . (114,152) (159,390) (198,708) (338,776)
Proceeds from the sale of Lyndon . . . . . . . . . . 0 88,884 0 88,884
Proceeds from investment securities. . . . . . . . . 0 16,181 0 6,553
Net (purchases)/sales of property and equipment. . . (173) 256 (305) (45)
-------- -------- -------- --------
Net cash provided by investing activities . . . 45,821 123,137 120,445 130,874
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net repayments of senior debt, commercial
paper and notes . . . . . . . . . . . . . . . . . (55,000) (10,000) (154,000) (31,432)
Stock options exercised. . . . . . . . . . . . . . . 0 0 0 1,490
-------- -------- -------- --------
Net cash used in financing activities . . . . . (55,000) (10,000) (154,000) (29,942)
Net increase in cash and cash equivalents . . . (18,310) 104,203 (6,910) 109,036
Cash and equivalents at beginning of quarter . . . . 65,296 25,790 53,896 20,957
-------- -------- -------- --------
Cash and equivalents at end of quarter . . . . . . . $46,986 $129,993 $46,986 $129,993
-------- -------- -------- --------
-------- -------- -------- --------
SUPPLEMENTAL DISCLOSURES
Income taxes paid to federal and state government. . $9 $35 $9 $35
-------- -------- -------- --------
-------- -------- -------- --------
Interest paid to creditors . . . . . . . . . . . . . $15,678 $22,786 $36,874 $40,249
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The accompanying notes to the condensed consolidated financial statements
are an integral part of these statements.
-4-
<PAGE>
MERCURY FINANCE COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
1. BASIS OF PRESENTATION.
The accompanying (a) condensed balance sheet as of December 31, 1997, which
has been derived from audited financial statements, and (b) unaudited interim
condensed financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information
and note disclosures normally included in annual financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted pursuant to those rules and regulations, although
Mercury Finance Company ("Mercury" or the "Company") believes that the
disclosures made are adequate to make the information presented not
misleading. The condensed financial statements of the Company, in the
opinion of management, reflect all necessary adjustments for a fair
presentation of results as of the dates and for the periods covered by the
financial statements. See Note 9 for information regarding the Company's
voluntary petition in the United States Bankruptcy Court for the Northern
District of Illinois (the "Court") for relief under chapter 11 of Title 11 of
the United States Code and Plan of Reorganization ("Plan of Reorganization"
or the "Plan") which were filed with the Court by the Company on July 15,
1998. If the Company effectuates a restructuring, as is contemplated, the
Company will adopt fresh-start accounting.
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. COMMON STOCK AND PER SHARE AMOUNTS.
-5-
<PAGE>
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 and six months ended June 30, 1998 and
1997.
3. RECLASSIFICATIONS.
Certain data from the prior periods has been reclassified to conform to the
1998 presentation.
4. 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.
5. CONTINGENCIES AND LEGAL MATTERS.
On July 6, 1998, several of the litigants in the pending securities lawsuits
filed a petition in the United States Bankruptcy Court (the "Court") for the
Northern District of Illinois asking the Court to place the Company into a
chapter 11 proceeding (the "Involuntary Case"). On July 15, 1998 the Company
filed a voluntary petition ("Voluntary Case") with the Court for relief under
chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in
connection with its Plan of Reorganization. The Involuntary Case was
consolidated with the Voluntary Case and is proceeding under Case No.
98-20763. See Note 9 "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 against the
Company are pending in United States District Court for the Northern District
of Illinois, six cases are pending against the Company in Illinois Chancery
Court, and nine cases are pending in the Delaware Chancery Court. The
complaints seek compensatory damages, attorneys' fees and costs.
-6-
<PAGE>
Forty-one of the lawsuits pending in the Northern District of Illinois are
class actions which allege claims under Section 10 of the Securities Exchange
Act of 1934 and Rule 10b-5 promulgated thereunder. These lawsuits name one
or more officers or directors of the Company as additional defendants. One
case pending in the Northern District of Illinois alleges derivative claims
seeking to recover damages on behalf of the Company from certain of the
Company's officers and directors. Thirty-nine of the non-derivative cases
pending in the Northern District of Illinois were consolidated pursuant to a
Stipulation entered on April 30, 1997. In November, 1997, the Minnesota State
Board of Investment was appointed lead plaintiff in the federal class cases.
One of the cases pending in the Northern District of Illinois seeks to
represent a class of participants in Mercury's employee retirement plan and
alleges ERISA violations arising out of the plan's investment in Mercury's
allegedly overvalued stock. Participants in the proposed class may include
certain officers and former officers of the Company. Two cases pending in
the Northern District of Illinois allege non-class securities fraud and
common law claims. 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.
-7-
<PAGE>
In the normal course of its business, Mercury and its subsidiaries are named
as defendants in legal proceedings. A number of such actions, including
thirteen 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.
6. INCOME TAXES.
The Company recorded a full valuation allowance related to the tax benefit
for the losses recorded during the first and second 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 June 30, 1998 of $52.5 million.
7. DEBT.
As a result of net losses incurred, accounting irregularities, and related
matters, Mercury violated certain covenants permitting the holders of its
Senior Term Notes and Subordinated Debt to accelerate all such debt which, if
accelerated, would result in all of such debt being currently due and
payable. In addition, the Company is no longer permitted by the terms of
certain debt instruments to pay dividends. The following table represents
Mercury's debt instruments and the corresponding stated rates at the end of
the periods indicated (dollars in thousands):
-8-
<PAGE>
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1997 DEC. 31, 1997
------------- ------------- -------------
BALANCE RATE BALANCE RATE BALANCE RATE
-------- ----- ---------- ----- -------- -----
<S> <C> <C> <C> <C>
Senior Debt:
Commercial paper and short-term loans . . $339,340 5.6% $493,619 5.6% $416,731 5.7%
Term notes. . . . . . . . . . . . . . . . 335,905 7.0% 488,625 7.0% 412,514 7.0%
Subordinated debt . . . . . . . . . . . . . 22,500 10.3% 22,500 10.3% 22,500 10.3%
-------- ----- ---------- ----- -------- -----
Total . . . . . . . . . . . . . . . . . . $697,745 6.4% $1,004,744 6.4% $851,745 6.5%
-------- ----- ---------- ----- -------- -----
-------- ----- ---------- ----- -------- -----
</TABLE>
The Company had a forbearance agreement with its lenders which, including
extensions (the "Forbearance Agreements"), expired July 15, 1998. 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. 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. See Note 9 - "Restructuring and
Chapter 11 Proceedings" and the Company's Current Report on Form 8-K filed on
May 15, 1998 for more information.
8. 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 standard
will not have a significant impact on the financial position, results of
operations or financial statement disclosures of the Company.
9. RESTRUCTURING AND CHAPTER 11 PROCEEDINGS.
The Company incurred losses for the years ended December 31, 1997 and 1996
and continues to incur losses in 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.
On May 14, 1998, the Company entered into an agreement with certain senior
lenders which included the principal terms of a financial restructuring of
the Company. The agreement
-9-
<PAGE>
contemplates that the restructuring will be accomplished pursuant to the Plan
of Reorganization which was filed in the United States Bankruptcy Court for
the Northern District of Illinois on July 15, 1998. The Company conducts its
operations through its subsidiaries. None of the Company's subsidiaries were
included in the Voluntary Case (as hereinafter defined). As a result, all
trade debt and dealer contracts are unimpaired and are being paid and honored
in the ordinary course without interruption. Under the Plan, 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 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 and the securities class action claimants, as a combined
group, will receive three series of warrants, each exercisable for five
percent of the common stock of the restructured 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 on the
effective date of the Plan. 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 restructured company. Stockholders as of May 14, 1998 will also have the
right to purchase from the Company their pro rata amount of the debt
comparable to the senior lenders' debt at a price, in cash, equal to 98.5% of
the senior lenders' claims, subject to specific provisions detailed in the
Plan. For a complete description of the proposed restructuring arrangement,
see the Company's Current Report on Form 8-K filed with the Securities and
Exchange Commission on May 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.
On July 6, 1998, several of the litigants in the pending securities lawsuits
filed a petition in the United States Bankruptcy Court for the Northern
District of Illinois asking the Court to place the Company into a chapter 11
proceeding (the "Involuntary Case"). See the Company's Current Report on
Form 8-K filed on July 10, 1998 for more information.
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 (the "Bankruptcy Code") along with its
Plan of Reorganization (the "Voluntary Case").
-10-
<PAGE>
See the Company's Current Report or Form 8-K filed on July 23, 1998 for more
information. The filing of the Voluntary Case and the Plan of Reorganization
conform to the terms previously agreed upon between Mercury and substantially
all of its lenders on May 14, 1998. 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.
The Company's day-to-day operations are not affected by the filing and
Mercury has continued to conduct business as usual and has paid all trade
debt and dealer contracts in the ordinary course, without interruption.
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, nor, if a restructuring is accomplished, what the
eventual terms of the restructuring will be. 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.
-11-
<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 June 30, 1998 and June 30,
1997, and the related condensed consolidated statements of income and other
comprehensive loss, changes in stockholder's equity and cash flows for the
three-month and six-month periods ended June 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 9 to the financial
statements, the Company has incurred losses in 1997 and 1996 and is
continuing to incur losses in 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 9, 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
August 13, 1998
-12-
<PAGE>
MERCURY FINANCE COMPANY
CONDENSED CONSOLIDATED AVERAGE BALANCE SHEETS
PERIODS ENDED JUNE 30
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
- ------------------------------------------------------------ ----------------------- -----------------------
(Dollars in thousands) 1998 1997 1998 1997
(Unaudited) (Unaudited)
- ------------------------------------------------------------ ----------------------- -----------------------
<S> <C> <C> <C> <C>
ASSETS
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . $56,141 $77,892 $55,393 $58,913
Investments. . . . . . . . . . . . . . . . . . . . . . . . . 0 110,711 0 144,793
Finance receivables. . . . . . . . . . . . . . . . . . . . . 822,858 1,110,949 872,364 1,127,440
Less allowance for finance credit losses. . . . . . . . . (83,503) (117,594) (89,737) (110,983)
Less nonrefundable dealer reserves. . . . . . . . . . . . (41,258) (76,021) (45,082) (80,473)
-------- ---------- -------- ----------
Finance receivables, net. . . . . . . . . . . . . . . . . 698,097 917,334 737,545 935,984
Income taxes receivable. . . . . . . . . . . . . . . . . . . 52,438 50,855 61,605 51,825
Reinsurance receivable . . . . . . . . . . . . . . . . . . . 0 49,177 0 63,936
Deferred acquisition costs and present value of profits 0 21,752 0 35,437
Deferred income taxes. . . . . . . . . . . . . . . . . . . . 0 43,790 0 40,312
Furniture, fixtures and equipment, net of accumulated
depreciation . . . . . . . . . . . . . . . . . . . . . . . 4,679 6,653 5,085 6,857
Other assets (including repossessions & goodwill). . . . . . 21,416 52,752 22,019 63,674
-------- ---------- -------- ----------
TOTAL ASSETS. . . . . . . . . . . . . . . . . . . . . . . $832,771 $1,330,916 $881,647 $1,401,731
-------- ---------- -------- ----------
-------- ---------- -------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Senior debt, commercial paper. . . . . . . . . . . . . . . . $353,160 $498,619 $374,350 $507,430
Senior debt, term notes. . . . . . . . . . . . . . . . . . . 349,585 488,625 370,561 488,625
Subordinated debt. . . . . . . . . . . . . . . . . . . . . . 22,500 22,500 22,500 22,500
Accounts payable and other liabilities . . . . . . . . . . . 37,337 58,439 39,877 66,053
Unearned premium and claim reserve . . . . . . . . . . . . . 0 113,725 0 155,674
Reinsurance payable. . . . . . . . . . . . . . . . . . . . . 0 15,013 0 15,823
Reserve for loss on sale of Lyndon . . . . . . . . . . . . . 0 14,764 0 9,843
-------- ---------- -------- ----------
TOTAL LIABILITIES . . . . . . . . . . . . . . . . . . . . $762,582 $1,211,685 $807,288 $1,265,948
-------- ---------- -------- ----------
STOCKHOLDERS' EQUITY
Common stock . . . . . . . . . . . . . . . . . . . . . . . . $177,901 $177,901 $177,901 $177,840
Paid in capital. . . . . . . . . . . . . . . . . . . . . . . 8,244 8,244 8,244 7,676
Retained earnings (deficit). . . . . . . . . . . . . . . . . (62,292) (12,941) (58,122) 3,823
Accumulated other comprehensive income/(loss). . . . . . . . 0 (309) 0 108
Treasury stock . . . . . . . . . . . . . . . . . . . . . . . (53,664) (53,664) (53,664) (53,664)
-------- ---------- -------- ----------
TOTAL STOCKHOLDERS' EQUITY. . . . . . . . . . . . . . . . $70,189 $119,231 $74,359 $135,783
-------- ---------- -------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY. . . . . . . . . . . . . . . . . . $832,771 $1,330,916 $881,647 $1,401,731
-------- ---------- -------- ----------
-------- ---------- -------- ----------
NUMBER OF DAYS . . . . . . . . . . . . . . . . . . . . . . . 91 91 181 181
MONTHS COMPLETED . . . . . . . . . . . . . . . . . . . . . . 3 3 6 6
RATIOS (Annualized)
Return on average equity . . . . . . . . . . . . . . . . . . (126.10)% (28.15)% (63.85)% (61.69)%
Return on average assets . . . . . . . . . . . . . . . . . . (10.63)% (2.52)% (5.39)% (5.98)%
Yield on earning assets. . . . . . . . . . . . . . . . . . . 22.41% 20.52% 22.45% 20.49%
Rate on interest bearing liabilities . . . . . . . . . . . . 9.13% 9.35% 9.22% 8.76%
Net interest margin. . . . . . . . . . . . . . . . . . . . . 14.37% 12.79% 14.34% 13.48%
</TABLE>
-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 June 30, 1998,
contains certain forward-looking statements pertaining to the outcome of the
Company's voluntary petition for relief under chapter 11 of Title 11 of the
United States Code, the Company's 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.
-14-
<PAGE>
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 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 1998, accounting
irregularities, 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 has been accruing interest expense at
default rates of interest since February 10, 1997.
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 June 30, 1998 (unaudited) when compared
with June 30, 1997 (unaudited) and December 31, 1997 and the results of
operations for the three and six month periods ended
-15-
<PAGE>
June 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.
RECENT DEVELOPMENTS
The Company incurred losses for the years ended December 31, 1997 and 1996
and continues to incur losses in 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.
On May 14, 1998, the Company entered into an agreement with certain senior
lenders which included the principal terms of a financial restructuring of
the Company. The agreement contemplates that the restructuring will be
accomplished pursuant to the Plan of Reorganization (the "Plan") which was
filed in the United States Bankruptcy Court for the Northern District of
Illinois on July 15, 1998. The Company conducts its operations through its
subsidiaries. None of the Company's subsidiaries were included in the
Voluntary Case (as hereinafter defined). As a result, all trade debt and
dealer contracts are unimpaired and are being paid and honored in the
ordinary course without interruption. Under the Plan, 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 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 and the securities class action claimants, as a combined
group, will receive three series of warrants, each exercisable for five
percent of the common stock of the restructured 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 on the
effective date of the plan. 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 restructured company. Stockholders as of May 14, 1998 will also have the
right to purchase from the Company their pro rata amount of debt comparable
to the senior lenders' debt at a price, in cash, equal to 98.5% of the senior
lenders' claims, subject to specific provisions detailed in the Plan. For a
complete description of the proposed restructuring arrangement, see the
Company's Current Report on Form 8-K filed with the Securities and Exchange
Commission on May 15, 1998.
In connection with the execution of an extension of the previous forbearance
agreement, the participating senior lenders received a fee of 2.25% of the
outstanding balance. The fee,
-16-
<PAGE>
aggregating $14.5 million, was expensed in the second quarter and is included
in non-operating expenses.
On July 6, 1998, several of the litigants in the pending securities lawsuits
filed a petition in the United States Bankruptcy Court for the Northern
District of Illinois asking the Court to place the Company into a chapter 11
proceeding (the "Involuntary Case"). See the Company's Current Report on
Form 8-K filed on July 10, 1998 for more information.
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 (the "Bankruptcy Code")
along with its Plan of Reorganization (the "Voluntary Case"). See the
Company's Current Report or Form 8-K filed on July 23, 1998 for more
information. The filing of the Voluntary Case and the Plan of Reorganization
conform to the terms previously agreed upon between Mercury and substantially
all of its lenders on May 14, 1998. 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.
The Company's day-to-day operations are not affected by the filing and
Mercury has continued to conduct business as usual and has paid all trade
debt and dealer contracts in the ordinary course, without interruption.
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, nor, if a restructuring is accomplished, what the
eventual terms of the restructuring will be. 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
ASSETS AND FINANCE RECEIVABLES
Total assets of the Company decreased 32% to $793.1 million at June 30, 1998
from $1,166.2 million at June 30, 1997. Finance receivables decreased 28% to
$785.1 million at June 30, 1998 from $1,095.8 million at June 30, 1997.
During the period from December 31, 1997 through June 30, 1998, total assets
and finance receivables both decreased 19%. Total assets decreased primarily
due to the receipt of income tax refunds, the reduction in finance
receivables and the use of excess cash to pay down debt.
-17-
<PAGE>
The Company's offices in Texas, Florida and Illinois accounted for
approximately 16%, 14% and 11%, respectively, of all sales and direct finance
receivables at June 30, 1998. The total number of offices was 185 at June
30, 1998 versus 263 at June 30, 1997 and 218 at December 31, 1997. In
December, 1997, Mercury announced the implementation of a business plan that
included the closing of an additional 70 branches. The number of additional
branch closings was subsequently increased to 83. Upon completion of the
program, Mercury is expected to have 179 branches. Branches are being closed
because they are either unprofitable or considered redundant in view of the
location of nearby branches. The additional closings are estimated to result
in a decrease in the loan portfolio of approximately $117 million from the
June 30, 1998 level over the following nine to twelve months. The closings
will not be treated as discontinued operations, however, a provision of $3.4
million was recorded in the fourth quarter of 1997 to cover the costs of the
closings of which $1.4 million is expected to be incurred subsequent to June
30, 1998. See "Restructuring Expenses."
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.
-18-
<PAGE>
The following table summarizes the composition of finance receivables at the
dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
JUNE 30, JUNE 30, DECEMBER 31,
1998 1997 1997
<S> <C> <C> <C>
DIRECT FINANCE RECEIVABLES
Interest bearing. . . . . . . . . . . $ 17,280 $ 22,224 $ 20,504
Precompute. . . . . . . . . . . . . . 108,089 128,553 129,120
-------- ---------- ----------
Total direct finance receivables. . . . 125,369 150,777 149,624
SALES FINANCE RECEIVABLES
Total sales finance receivables . . . 762,981 1,075,474 954,319
Total gross finance receivables . . . . 888,350 1,226,251 1,103,943
Less: Unearned Finance Charges . . . . (159,752) (209,311) (200,820)
Unearned commissions and insurance
premiums. . . . . . . . . . . . . . . (2,791) (4,391) (3,242)
-------- ---------- ----------
Sales and Direct Finance Receivables. . 725,807 1,012,549 899,881
-------- ---------- ----------
CREDIT CARD
Total credit card . . . . . . . . . . 59,324 83,230 71,496
-------- ---------- ----------
Total finance receivables . . . . . . . $785,131 $1,095,779 $ 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 six months ended June 30 (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Month Ended
------------------ ---------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Direct finance receivables $35,460 $45,113 $59,932 $85,530
Sales finance receivables 98,539 189,901 182,100 391,469
-------- -------- -------- --------
$133,999 $235,014 $242,032 $476,999
-------- -------- -------- --------
-------- -------- -------- --------
</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 the existing portfolio, the changes
have reduced new volume to a level below
-19-
<PAGE>
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 continues to
maintain an allowance for the direct and credit card receivables to cover
finance credit losses that are expected to be incurred on receivables that
have demonstrated a risk of loss based upon delinquency or bankruptcy status.
The sales finance contracts are generally acquired at a discount from the
principal amount. This discount is normally referred to as a non-refundable
dealer reserve. The amount of the discount is based upon the credit risk of
the borrower, the note rate of the contract and competitive factors.
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 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 its
net realizable value.
-20-
<PAGE>
The following table sets forth a reconciliation of the changes in the
allowance for finance credit losses for the periods ended June 30 (dollars in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Balance at beginning of period . . . . . . . . . . . . $88,191 $111,584 $102,204 $97,762
Provision charged to expense . . . . . . . . . . . . . 15,265 24,544 28,224 55,006
Finance receivables charged-off, net of recoveries . . (24,641) (12,524) (51,613) (29,164)
-------- ---------- --------- ---------
Balance at June 30 . . . . . . . . . . . . . . . . . . $78,815 $123,604 $78,815 $123,604
-------- ---------- --------- ---------
-------- ---------- --------- ---------
Allowance as a percent of sales and direct finance
receivables outstanding at end of period . . . . . . 10.86% 12.21%
-------- ---------
-------- ---------
</TABLE>
The reduction in the amount of provision for credit losses recorded for the
six months ended June 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 in the first half of 1998 is an indication of an
overall improvement in the credit quality of the portfolio due to the
implementation of stricter underwriting standards 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 in the first half of 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 six-month period is 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
-21-
<PAGE>
sets forth a reconciliation of the changes in nonrefundable dealer reserves
for the periods ended June 30 (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
----------------------- ------------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Balance at beginning of period. . . . . . . . $43,667 $80,677 $52,731 $89,378
Discounts acquired on new volume. . . . . . . 6,043 12,845 11,373 26,789
Losses absorbed, net of recoveries. . . . . . (10,862) (22,157) (25,256) (44,802)
-------- -------- -------- --------
Balance at June 30. . . . . . . . . . . . . . $38,848 $71,365 $38,848 $71,365
-------- -------- -------- --------
-------- -------- -------- --------
Reserves as a percentage of sales
finance receivables . . . . . . . . . . . . 5.09% 6.64%
-------- --------
-------- --------
Discounts acquired as a percentage of sales
finance receivables originated. . . . . . . 6.13% 6.76% 6.25% 6.84%
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The reduction in discounts 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 June 30, 1998 the Company had total debt of
$697.7 million which compares with $1,004.7 million at June 30, 1997 and
$851.7 million of December 31, 1997.
In addition to the Company's outstanding debt, the Company had available
through January 7, 1998, a $50 million revolving credit facility that was
secured by all of Mercury's finance receivables. The Company allowed the
facility to expire on its own terms.
As a result of the 1996 and 1997 net losses, accounting irregularities, and
related matters, Mercury violated its debt 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.
-22-
<PAGE>
The following table presents the Company's debt instruments and the stated
interest rates on the debt at the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1997 DEC. 31, 1997
------------- ------------- -------------
Balance Rate Balance Rate Balance Rate
-------- ----- ---------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Senior Debt:
Commercial paper and short-term loans. $339,340 5.6% $493,619 5.6% $416,731 5.7%
Term notes . . . . . . . . . . . . . . 335,905 7.0% 488,625 7.0% 412,514 7.0%
Subordinated debt . . . . . . . . . . . . 22,500 10.3% 22,500 10.3% 22,500 10.3%
-------- ----- ---------- ----- -------- -----
Total . . . . . . . . . . . . . . . . $697,745 6.4% $1,004,744 6.4% $851,745 6.5%
-------- ----- ---------- ----- -------- -----
-------- ----- ---------- ----- -------- -----
</TABLE>
The Company had a forbearance agreement with its lenders which, including
extensions (the "Forbearance Agreements"), expired July 15, 1998. 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. 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. See Note 9 - "Restructuring and
Chapter 11 Proceedings" and the Company's Current Report on Form 8-K filed on
May 15, 1998 for more information.
STOCKHOLDERS' EQUITY
Total stockholders' equity at June 30, 1998 was $59.2 million which compares
with $115.4 million at June 30, 1997 and $82.7 million 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.
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.
At June 30, 1998 stockholders' equity stated as a percent of total assets was
7.5% which compares with 9.9% at June 30, 1997 and 8.4% at December 31, 1997.
-23-
<PAGE>
RESULTS OF OPERATIONS
NET LOSS
For the three months ended June 30, 1998 the Company incurred a net loss of
$22.1 million compared to a net loss of $8.4 million for the three months
ended June 30, 1997. The increase in net losses is primarily attributable to
the increase in non-operating expenses which relate to costs incurred in
connection with the restructuring of the Company. For the six months ended
June 30, 1998 the Company incurred a net loss of $23.5 million compared to
$41.5 million for the six months ended June 30, 1997. The decrease in net
loss for the six 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.
INTEREST INCOME AND INTEREST EXPENSE
The largest single component of net income is net interest income which is
the difference between interest earned on finance receivables and interest
paid on borrowings. For the three and six months ended June 30, 1998 the
amount of the Company's net interest income decreased 24.4% and 27.1%,
respectively, when compared to the 1997 period. The net interest margin
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 June 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED 1998 1997
- ------------------ ---- ----
Annualized Annualized
Average Interest Rate Average Interest Rate
Out- Income/ Earned Out- Income/ Earned
standing expense and paid standing expense and paid
-------- ------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest bearing assets. . . . . . . . . $822,858 $45,979 22.41% $1,221,660 $62,505 20.52%
Interest bearing liabilities . . . . . . 725,245 16,509 9.13% 1,009,744 23,549 9.35%
-------- ------- ------ ---------- ------- -------
Net interest income. . . . . . . . . . . $97,613 $29,470 13.28% $ 211,916 $38,956 11.17%
-------- ------- ------ ---------- ------- -------
-------- ------- ------ ---------- ------- -------
Net interest margin as a
percentage of average interest
earning assets (Annualized). . . . . . . 14.37% 12.79%
------ ------
------ ------
</TABLE>
-24
<PAGE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED 1998 1997
- ---------------- ---- ----
Annualized Annualized
Average Interest Rate Average Interest Rate
Out- Income/ Earned Out- Income/ Earned
Standing Expense and Paid Standing Expense and Paid
-------- ------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest bearing assets. . . . . . . . . $872,364 $ 97,119 22.45% $1,272,233 $129,285 20.49%
Interest bearing liabilities . . . . . . 767,411 35,105 9.22% 1,018,555 44,265 8.76%
-------- -------- ------ ---------- -------- ------
Net interest income. . . . . . . . . . . $104,953 $62,014 13.23% $253,678 $85,020 11.73%
-------- -------- ------ ---------- -------- ------
-------- -------- ------ ---------- -------- ------
Net interest margin as a
percentage of average interest
earning assets (Annualized). . . . . . . 14.34% 13.48%
------ ------
------ ------
</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 and six months ended June 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 June 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
1998 1997 1998 1997
------ ------- ------ -------
<S> <C> <C> <C> <C>
Fees, commissions and other. . . . . . . . . . . . $2,013 $ 3,068 $4,582 $ 6,571
Insurance premiums . . . . . . . . . . . . . . . . 897 9,871 2,255 33,091
------ ------- ------ -------
Total. . . . . . . . . . . . . . . . . . . . . . . $2,910 $12,939 $6,837 $39,662
------ ------- ------ -------
------ ------- ------ -------
Other income as a % of average interest
earning assets . . . . . . . . . . . . . . . . . . 1.42% 4.25% 1.58% 6.29%
------ ------- ------ -------
------ ------- ------ -------
</TABLE>
-25-
<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 six months ended June 30, 1998, other expenses decreased
37.7% and 43.1%, respectively, compared to the 1997 periods, primarily
related to the sale of Lyndon in the second quarter of 1997. The following
table summarizes the components of other expenses for the periods ended June
30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Salaries and employee's benefits . . . . . . . . . $12,347 $15,775 $25,349 $30,419
Insurance claims expense . . . . . . . . . . . . . (26) 3,540 706 20,255
Other operating expenses . . . . . . . . . . . . . 8,026 13,369 16,990 25,011
------- ------- ------- -------
Total. . . . . . . . . . . . . . . . . . . . . . . $20,347 $32,684 $43,045 $75,685
------- ------- ------- -------
------- ------- ------- -------
Other expenses as a % of average interest
earning assets (Annualized). . . . . . . . . . . 9.92% 10.73% 9.95% 12.00%
------- ------- ------- -------
------- ------- ------- -------
</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 $3.725 million ($0.02 per
common share) of which $2.315 million has been utilized to date. These
charges and their utilization to June 30, 1998 are summarized in the
following table (dollars in thousands):
<TABLE>
<CAPTION>
Amounts to be
Amounts Amounts Amounts Utilized
Charged Utilized Utilized Subsequent to
in 1997 in 1997 in 1998 June 30, 1998
<S> <C> <C> <C> <C>
Asset and leasehold write-offs $ 1,200 $ 200 $ 964 $ 36
Lease buyouts and other expenses 1,025 101 498 426
Employee severance and retention 1,500 0 552 948
-------- -------- -------- --------
$ 3,725 $ 301 $ 2,014 $ 1,410
-------- -------- -------- --------
-------- -------- -------- --------
</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 June 30, 1998.
-26-
<PAGE>
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 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 $18.8 million for the second quarter of 1998
are substantially higher than the $5.5 million for the three months ended
June 30, 1997 because of the payment of a $14.5 million forbearance fee to
those 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.
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
-27-
<PAGE>
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 June 30, 1998 of
$52.5 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 June 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Loss provision charged to income. . . . . . . . . . . . . $15,265 $24,544 $28,224 $ 55,006
Net charge-offs against allowance . . . . . . . . . . . . 24,641 12,524 51,613 29,164
Net charge offs against nonrefundable dealer reserves . . 10,862 22,157 25,256 44,802
Allowance for finance credit losses at end of period. . . 78,815 123,604
Dealer reserves at end of period. . . . . . . . . . . . . 38,848 71,365
Ratios:
Net charge offs annualized against allowance
to average total finance receivables. . . . . . . . . 12.01% 4.52% 11.93% 5.22%
Net charge offs annualized against nonrefundable dealer
reserves to average total finance receivables . . . . 5.29% 8.00% 5.84% 8.01%
Allowance for finance credit losses to total gross finance
receivables at end of period. . . . . . . . . . . . . 8.87% 10.08%
Dealer reserves to gross sales finance receivables
at end of period. . . . . . . . . . . . . . . . . . . 5.09% 6.64%
</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
-28-
<PAGE>
attains such delinquency status, it is classified as delinquent. The
following table sets forth certain information regarding contractually
delinquent accounts at the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1997 DECEMBER 31, 1997
------------- ------------- -----------------
<S> <C> <C> <C>
Delinquent gross receivables $29,170 $53,186 $41,970
Bankrupt accounts 31,081 42,305 37,037
Repossessed assets 3,711 5,700 5,167
------- -------- -------
Total $63,962 $101,191 $84,174
------- -------- -------
------- -------- -------
Delinquent gross receivables and
bankrupt accounts to gross
finance receivables 6.78% 7.79% 7.16%
------- -------- -------
------- -------- -------
Delinquent gross receivables,
bankrupt accounts and repossessed
assets to gross finance
receivables plus repossessed asset 7.17% 8.21% 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 $59 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 second quarter of 1998 compared to
losses of $0.6 million in the second 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.
The primary debt of the Company is in the form of senior commercial paper,
senior term notes and subordinated debt, which totaled $698 million at June
30, 1998, $852 million at December 31, 1997 and $1,005 million at June 30,
1997. As a result of the Company's announcement regarding the discovery of
the accounting irregularities, the Company is in default of its credit
agreements.
-29-
<PAGE>
The Company had a forbearance agreement with its lenders which, including
extensions (the "Forbearance Agreements"), expired July 15, 1998. 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. 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. See Note 9 - "Restructuring and
Chapter 11 Proceedings" and the Company's Current Report on Form 8-K filed on
May 15, 1998 for more information.
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.
-30-
<PAGE>
CONTINGENCIES AND LEGAL MATTERS
On July 6, 1998, several of the litigants in the pending securities lawsuits
filed a petition in the United States Bankruptcy Court (the "Court") for the
Northern District of Illinois asking the Court to place the Company into a
chapter 11 proceeding (the "Involuntary Case"). On July 15, 1998 the Company
filed a voluntary petition (the "Voluntary Case") 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 (the "Bankruptcy Code") in
connection with its Plan of Reorganization. The Involuntary Case was
consolidated with the Voluntary Case and is proceeding under Case No.
98-20763. See "Item 2 - Recent Developments" 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 against the
Company are pending in United States District Court for the Northern District
of Illinois, six cases are pending against the Company in Illinois Chancery
Court, and nine cases are pending in the Delaware Chancery Court. The
complaints seek compensatory damages, attorneys' fees and costs.
Forty-one of the lawsuits pending in the Northern District of Illinois are
class actions which allege claims under Section 10 of the Securities Exchange
Act of 1934 and Rule 10b-5 promulgated thereunder. These lawsuits name one
or more officers or directors of the Company as additional defendants. One
case pending in the Northern District of Illinois alleges derivative claims
seeking to recover damages on behalf of the Company from certain of the
Company's officers and directors. Thirty-nine of the non-derivative cases
pending in the Northern District of Illinois were consolidated pursuant to a
Stipulation entered on April 30, 1997. In November, 1997, the Minnesota
State Board of Investment was appointed lead plaintiff in the federal class
cases. One of the cases pending in the Northern District of Illinois seeks
to represent a class of participants in Mercury's employee retirement plan
and alleges ERISA violations arising out of the plan's investment in
Mercury's allegedly overvalued stock. Participants in the proposed class may
include certain officers and former officers of the Company. Two cases
pending in the Northern District of Illinois allege non-class securities
fraud and common law claims. 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.
-31-
<PAGE>
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.
In the normal course of its business, Mercury and its subsidiaries are named
as defendants in legal proceedings. A number of such actions, including
thirteen 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. Mercury is expected to
incur expenditures over the next two years to address this issue.
The Company has several information system improvement initiatives under way
that will require increased expenditures during the next two years. These
initiatives, which began in 1997, include the conversion of certain Company
computer systems to be Year 2000 compliant.
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<PAGE>
Mercury utilizes computer software developed by external vendors and has
received assurances from these vendors that Year 2000 compliant upgrades are
available which will allow the Company more than sufficient time for an
orderly transition before the year 2000.
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. The costs of the upgrade to compliance is not expected to be
material.
-33-
<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 - Recent
Developments" 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 April
6, 1998.
(ii) Item 5 and Item 7 Current Report on Form 8-K filed May
11, 1998.
(iii) Item 5 and Item 7 Current Report on Form 8-K filed May
15, 1998.
(iv) Item 5 and Item 7 Current Report on Form 8-K filed May
19, 1998.
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<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCURY FINANCE COMPANY
(REGISTRANT)
Date: AUGUST 13, 1998 /s/ William A. Brandt, Jr.
--------------------------
William A. Brandt, Jr.
President and
Chief Executive Officer
Date: AUGUST 13, 1998 /s/ Patrick J. O'Malley
--------------------------
Patrick J. O'Malley
Principal Financial and
Accounting Officer
-35-
<PAGE>
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
11. Computation of Net Income Per Share
27. Financial Data Schedule
</TABLE>
-36-
<PAGE>
MERCURY FINANCE COMPANY
EXHIBIT 11
COMPUTATION OF NET INCOME PER SHARE
PERIODS ENDED JUNE 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 Six Months Ended
- -------------------------------------------------------------- ------------------ --------------------
(In thousands except per share amounts) 1998 1997 1998 1997
(Unaudited) (Unaudited)
- -------------------------------------------------------------- ------------------ --------------------
<S> <C> <C> <C> <C>
INCOME DATA:
1. Net income/(loss) Mercury Finance Company. . . . . ($22,066) ($8,369) ($23,544) ($41,537)
2. Weighted average common shares
outstanding (adjusted for stock split) . . . . . . 177,901 177,901 177,901 177,884
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). . . . . . . 172,498 172,498 172,498 172,481
6. Mercury Finance Company
net income/(loss) per share (line 1 DIVIDED BY line 5) ($0.13) ($0.05) ($0.14) ($0.24)
</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 June 30, 1998.
-37-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 46,986
<SECURITIES> 0
<RECEIVABLES> 785,131
<ALLOWANCES> (117,663)
<INVENTORY> 0
<CURRENT-ASSETS> 775,508
<PP&E> 14,111
<DEPRECIATION> (9,662)
<TOTAL-ASSETS> 793,132
<CURRENT-LIABILITIES> 733,976
<BONDS> 0
0
0
<COMMON> 177,901
<OTHER-SE> (118,745)
<TOTAL-LIABILITY-AND-EQUITY> 793,132
<SALES> 45,979
<TOTAL-REVENUES> 48,889
<CGS> 0
<TOTAL-COSTS> 20,347
<OTHER-EXPENSES> 18,834
<LOSS-PROVISION> 15,265
<INTEREST-EXPENSE> 16,509
<INCOME-PRETAX> (22,066)
<INCOME-TAX> 0
<INCOME-CONTINUING> (22,066)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (22,066)
<EPS-PRIMARY> $(0.13)
<EPS-DILUTED> $(0.13)
</TABLE>
