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, 1997 Commission File No. 1-10176
MERCURY FINANCE COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 36-3627010
(State or other jurisdiction of (I.R.S. Employer identification no.)
incorporation or organization)
100 FIELD DRIVE, SUITE 340, LAKE FOREST, ILLINOIS 60045
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (847) 295-8600
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing for the
past 90 days.
Yes No X
Indicate the number of shares outstanding of each issuer's class of common
stock, as of the latest practicable date.
Common Stock - $1 par value, 177,900,671 shares as of August 15, 1997.
Treasury Stock - 5,402,957 shares as of August 15, 1997
MERCURY FINANCE COMPANY
FORM 10-Q
INDEX
PAGE
PART I FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets . . . . . . . . . . . . 1
Consolidated Statements of Income . . . . . . . . . 2
Consolidated Statements of Changes i
Stockholders' Equity . . . . . . . . . . . . . . 3
Consolidated Statements of Cash Flows . . . . . . . 4
Notes to Condensed Consolidated Financial
Statements . . . . . . . . . . . . . . . . . . . 5
Consolidated Average Balance Sheets . . . . . . . . 11
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
CONSOLIDATED FINANCIAL CONDITION AND RESULTS
OF OPERATIONS . . . . . . . . . . . . . . . . . . . 12
PART II OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . 27
Item 2. Changes in Securities . . . . . . . . . . . . . . . 27
Item 3. Defaults Upon Senior Securities . . . . . . . . . . 27
Item 4. Submission of Matters to a Vote of Security
Holders . . . . . . . . . . . . . . . . . . . . . 27
Item 5. Other Information . . . . . . . . . . . . . . . . . 27
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . 27
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . 28
INDEX OF EXHIBITS . . . . . . . . . . . . . . . . . . . . . 29
Exhibit No. 11 - Computation of Net Income
Per Share . . . . . . . . . . . . . . . . . . . . 30
Exhibit No. 27 - Financial Data Schedule . . . . . 32
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED BALANCE SHEETS
<CAPTION>
(Dollars in thousands) June 30 December 31
1997 1996 1996
(unaudited)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents (restricted cash - Note 5) . . . . . $130,909 $4,890 $20,957
Investments . . . . . . . . . . . . . . . . . . . . . . . . . 0 211,773 212,957
Finance receivables . . . . . . . . . . . . . . . . . . . . . . 1,095,779 1,194,417 1,160,423
Less allowance for finance credit losses . . . . . . . . . . . (123,604) (73,659) (97,762)
Less nonrefundable dealer reserves . . . . . . . . . . . . . . (71,365) (53,650) (89,378)
Finance receivables, net . . . . . . . . . . . . . . . . . . . 900,810 1,067,108 973,283
Deferred income taxes, net . . . . . . . . . . . . . . . . . . 48,320 27,546 33,356
Income taxes receivable . . . . . . . . . . . . . . . . . . . . 50,638 19,247 53,764
Furniture, fixtures and equipment, net of accumulated
depreciation . . . . . . . . . . . . . . . . . . . . . . . . . 6,263 7,936 7,266
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,034 14,869 14,463
Reinsurance receivable . . . . . . . . . . . . . . . . . . . . 0 61,027 93,458
Deferred acquisition costs and present value of future
profits . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 45,512 62,809
Other assets (including repossessions) . . . . . . . . . . . . 29,808 73,874 71,047
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . $1,180,782 $1,533,782 $1,543,360
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Senior debt, commercial paper and notes . . . . . . . . . . . . $493,619 $414,918 $525,051
Senior debt, term notes . . . . . . . . . . . . . . . . . . . . 488,625 533,750 488,625
Subordinated debt . . . . . . . . . . . . . . . . . . . . . . . 22,500 26,000 22,500
Accounts payable and other liabilities . . . . . . . . . . . . 60,682 57,375 81,282
Unearned premium and claim reserves . . . . . . . . . . . . . . 0 201,999 239,573
Reinsurance payable . . . . . . . . . . . . . . . . . . . . . . 0 46,151 17,444
TOTAL LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . 1,065,426 1,280,193 1,374,475
Contingencies (See Note 6)
SHAREHOLDERS' EQUITY
Common stock - $1.00 par value per share:
300,000,000 shares authorized
Jun 30 1997 - 177,900,671 shares outstanding
Jun 30 1996 - 177,403,354 shares outstanding
Dec 31 1996 - 177,719,447 shares outstanding . . . . 177,901 177,403 177,719
Paid in capital . . . . . . . . . . . . . . . . . . . . . . . . 8,244 4,113 6,539
Retained earnings (deficit) . . . . . . . . . . . . . . . . . . (17,125) 110,428 37,349
Unrealized appreciation/(depreciation) on available-for-sale
securities, net of tax . . . . . . . . . . . . . . . . . . . 0 (130) 942
Treasury stock - Jun 30, 1997 - 5,402,957 shares at cost
Jun 30, 1996 - 3,996,557 shares at cost
Dec 31, 1996 - 5,402,957 shares at cost . . (53,664) (38,225) (53,664)
TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . 115,356 253,589 168,885
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY. . . . . . . . . . . $1,180,782 $1,533,782 $1,543,360
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED STATEMENTS OF INCOME
PERIODS ENDED JUNE 30
(Unaudited)
<CAPTION>
Three Months Ended Six Months Ended
(Dollars in thousands, except per share amounts) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
INTEREST INCOME
Finance charges and loan fees . . . . . . . . . . . . $59,736 $65,251 $123,227 $130,418
Investment income . . . . . . . . . . . . . . . . . . 2,769 2,916 6,058 5,798
Total finance charges, fees and
investment income . . . . . . . . . . . . . . . . . 62,505 68,167 129,285 136,216
Interest expense . . . . . . . . . . . . . . . . . . 23,549 15,983 44,265 32,020
Net interest income before provision for
finance credit losses . . . . . . . . . . . . . . . 38,956 52,184 85,020 104,196
Provision for finance credit losses . . . . . . . . . 24,544 40,498 55,006 59,109
Net interest income after provision for finance
credit losses . . . . . . . . . . . . . . . . . . . 14,412 11,686 30,014 45,087
OTHER INCOME
Insurance premiums . . . . . . . . . . . . . . . . . 9,871 21,357 33,091 37,428
Fees, commissions and other income . . . . . . . . . 3,068 4,212 6,571 8,152
Total other income . . . . . . . . . . . . . . . . . 12,939 25,569 39,662 45,580
OTHER EXPENSES
Salaries and employee benefits . . . . . . . . . . . 15,775 13,301 30,419 26,624
Occupancy expense . . . . . . . . . . . . . . . . . . 1,589 1,479 3,144 2,921
Equipment expense . . . . . . . . . . . . . . . . . . 973 798 1,825 1,493
Data processing expense . . . . . . . . . . . . . . . 549 627 1,092 1,350
Incurred insurance claims and other
underwriting expense . . . . . . . . . . . . . . . 3,540 11,199 20,255 16,555
Other operating expenses . . . . . . . . . . . . . . 10,258 8,008 18,950 14,296
Total other expenses . . . . . . . . . . . . . . . . 32,684 35,412 75,685 63,239
OPERATING INCOME (LOSS) . . . . . . . . . . . . . . . (5,333) 1,843 (6,009) 27,428
NON-OPERATING EXPENSES
Income from Lyndon due to buyer (Note 5) . . . . . . 2,025 0 2,025 0
Loss on sale of Lyndon (Note 5) . . . . . . . . . . . 0 0 29,528 0
Other non-operating expenses . . . . . . . . . . . . 5,453 0 10,582 0
Total non-operating expenses . . . . . . . . . . . . 7,478 0 42,135 0
Income/(loss) before income taxes . . . . . . . . . . (12,811) 1,843 (48,144) 27,428
Provision for income taxes/(credit for
income taxes) . . . . . . . . . . . . . . . . . . . (4,442) 175 (6,607) 9,252
NET INCOME/(LOSS) ($8,369) $1,668 ($41,537) $18,176
NET INCOME/(LOSS) PER COMMON SHARE . . . . . . . . . ($0.05) $0.01 ($0.24) $0.10
Weighted average number of common and common
share equivalents outstanding (Thousands) . . . . . 172,498 173,937 172,481 173,998
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY
PERIODS ENDED JUNE 30
(Unaudited)
<CAPTION>
Three Months Ended Six Months Ended
(Dollars in thousands) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
COMMON STOCK
Balance at beginning of period . . . . . . . . . . . $177,901 $176,580 $177,719 $176,478
Stock options exercised . . . . . . . . . . . . . . . 0 1,085 182 1,187
Stock traded in to exercise stock options . . . . . . 0 (262) 0 (262)
Balance at June 30 . . . . . . . . . . . . . . . . . $177,901 $177,403 $177,901 $177,403
PAID IN CAPITAL
Balance at beginning of period . . . . . . . . . . . $8,244 $621 $6,539 $39
Stock options exercised . . . . . . . . . . . . . . . 0 3,492 1,705 4,074
Balance at June 30 . . . . . . . . . . . . . . . . . $8,244 $4,113 $8,244 $4,113
RETAINED EARNINGS/(DEFICIT)
Balance at beginning of period . . . . . . . . . . . ($8,756) $121,709 $37,349 $118,138
Net income/(loss) . . . . . . . . . . . . . . . . . . (8,369) 1,668 (41,537) 18,176
Dividends . . . . . . . . . . . . . . . . . . . . . . 0 (12,949) (12,937) (25,886)
Balance at June 30 . . . . . . . . . . . . . . . . . ($17,125) $110,428 ($17,125) $110,428
UNREALIZED APPRECIATION/
(DEPRECIATION) ON AVAILABLE FOR
SALE SECURITIES
Balance at beginning of period . . . . . . . . . . . ($617) $341 $942 $1,969
Change during the period . . . . . . . . . . . . . . 617 (471) (942) (2,099)
Balance at June 30 . . . . . . . . . . . . . . . . . $0 ($130) $0 ($130)
TREASURY STOCK
Balance at beginning of period . . . . . . . . . . . ($53,664) ($38,225) ($53,664) ($37,137)
Purchases . . . . . . . . . . . . . . . . . . . . . . 0 0 0 (1,088)
Balance at June 30 . . . . . . . . . . . . . . . . . ($53,664) ($38,225) ($53,664) ($38,225)
Total stockholders' equity at June 30 . . . . . . . . $115,356 $253,589 $115,356 $253,589
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIODS ENDED JUNE 30
(Unaudited)
<CAPTION>
Three Months Ended Six Months Ended
(Dollars in thousands) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) . . . . . . . . . . . . . . . . . . $(8,369) $1,668 ($41,537) $18,176
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Provision for finance credit losses . . . . . . . 24,544 40,498 55,006 59,109
Credit for deferred income taxes . . . . . . . . . (3,452) (8,326) (9,356) (6,193)
Loss on sale of Lyndon . . . . . . . . . . . . . . 0 0 29,528 0
Gain/(loss) on sale of
available-for-sale securities . . . . . . . . . (12) (471) (12) (2,099)
Depreciation and amortization . . . . . . . . . . 738 1,492 1,477 2,220
Net change in reinsurance receivable . . . . . . . (1,392) (11,883) (6,287) 28,935
Net change in deferred acquisition costs and
present value of future profits . . . . . . . . (3,833) (8,233) 15,473 (22,270)
Net change in other assets . . . . . . . . . . . . (300) (13,945) 12,352 (6,335)
Net change in reinsurance payable . . . . . . . . 0 2,783 12,582 (58,930)
Net change in unearned premium and
claim reserves . . . . . . . . . . . . . . . . . (265) 13,763 (12,388) 6,238
Net change in other liabilities . . . . . . . . . (6,365) (17,386) (29,805) (22,154)
Net change in non refundable dealer reserves . . . (9,312) (4,511) (18,013) (8,311)
Net cash provided (used) in operating
activities . . . . . . . . . . . . . . . . (8,018) (4,551) 9,020 (11,614)
CASH FLOWS FROM INVESTING ACTIVITIES
Principal collected on finance receivables . . . . . 177,206 239,704 374,258 480,849
Finance receivables originated or acquired . . . . . (159,390) (243,021) (338,776) (509,306)
Net change in investments . . . . . . . . . . . . . . 16,181 10,423 6,553 30,270
Proceeds from sale of Lyndon, net of cash sold . . . 88,884 0 88,884 0
Net (purchases)/sales of premises and
equipment . . . . . . . . . . . . . . . . . . . . . 256 (1,372) (45) (2,729)
Net cash provided (used) in investing
activities . . . . . . . . . . . . . . . . 123,137 5,734 130,874 (916)
CASH FLOWS FROM FINANCING ACTIVITIES
Net (repayments)/issuances of senior debt,
commercial paper and notes . . . . . . . . . . . . (10,000) 7,291 (31,432) 16,428
Treasury stock acquired . . . . . . . . . . . . . . . 0 0 0 (1,088)
Dividends paid . . . . . . . . . . . . . . . . . . . 0 (12,949) 0 (25,886)
Stock options exercised . . . . . . . . . . . . . . . 0 4,315 1,490 4,999
Net cash provided/(used) in financing
activities . . . . . . . . . . . . . . . . (10,000) (1,343) (29,942) (5,547)
Net increase/(decrease) in cash and
equivalents . . . . . . . . . . . . . . . 105,119 (160) 109,952 (18,077)
CASH AND EQUIVALENTS AT BEGINNING
OF PERIOD . . . . . . . . . . . . . . . . . . . . . 25,790 5,050 20,957 22,967
CASH AND EQUIVALENTS AT END
OF PERIOD . . . . . . . . . . . . . . . . . . . . . $130,909 $4,890 $130,909 $4,890
SUPPLEMENTAL DISCLOSURES
Income taxes paid to federal and
state government . . . . . . . . . . . . . . . $35 $21,369 $35 $29,706
Interest paid to creditors . . . . . . . . . . . . $22,786 $7,935 $40,249 $12,932
See accompanying notes to consolidated financial statements.
</TABLE>
MERCURY FINANCE COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
1. Basis of Presentation.
The following (a) condensed balance sheet as of December 31, 1996, which has
been derived from audited financial statements, and (b) the unaudited interim
condensed financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission.
Certain information and note disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to those rules and regulations, although
Mercury Finance Company ("Mercury" or the "Company") believes that the
disclosures made are adequate to make the information presented not misleading.
The condensed financial statements of the Company, in the opinion of management,
reflect all necessary adjustments for a fair presentation of results as of the
dates and for the periods covered by the financial statements.
The results of the interim periods are not indicative of the results of
operations that are expected for the fiscal years as the Company had a net loss
of $28,968 for 1996 and expects a net loss for 1997 as well.
The Company's independent public accountants qualified their report on the
Company's 1996 financial statements due to their doubt as to the ability of the
Company to continue as a going concern. The independent public accountants also
referred to the Company's change in its methodology for evaluating the adequacy
of the allowance for finance credit losses by adopting a static pooling
methodology. It is suggested that the unaudited interim condensed consolidated
financial statements contained herein be used in conjunction with the financial
statements and the accompanying notes to the financial statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 1996.
2. Per Share Amounts.
Net income per common share amounts are based on the average number of common
shares and common stock equivalents outstanding. All per share amounts have
been adjusted to reflect all stock splits declared by the Company. As the
Company incurred a net loss for the three months and six months ended June 30,
1997, common share equivalents would be anti-dilutive to earnings per share and
have not been included in the weighted average shares calculation.
The Company has determined that the implementation of SFAS 128 "Earnings Per
Share", would have had no effect on the calculated earnings per share for the
three months and six months ended June 30, 1997. This standard prescribes that
when computing the dilution of options, the Company is to use its average stock
price for the period, rather than the more dilutive greater of the average share
price or end-of-period share price required by APB Opinion 15. As the options
are excluded from the calculation due to the anti-dilutive characteristics
indicated above, there is no effect on the earnings per share calculation.
3. Reclassification.
Certain data from the prior year has been reclassified to conform to the 1997
presentation.
4. Adoption in 3rd Quarter 1996 of "Static Pooling" Method for Determining
Finance Credit Losses.
Sales finance contracts are generally acquired at a discount from the principal
amount. This discount is normally referred to as a non-refundable dealer
reserve. The amount of the discount is based upon the credit risk of the
borrower, the note rate of the contract and competitive factors. In 1994 and
prior, the non-refundable dealer reserve was considered to be adequate to absorb
the majority of losses on the acquired receivables. However, as the sub-prime
market has evolved and become more competitive, the dealer reserve has proven to
be inadequate to absorb all of the credit losses. Through the second quarter of
1996, it was the Company's policy to maintain a balance of the combined non-
refundable dealer reserves and allowance for finance credit losses in an amount
sufficient to cover losses that were expected to be incurred on receivables that
had demonstrated a risk of loss based upon delinquency or bankruptcy status.
In the third quarter of 1996, Mercury adopted a loss reserving methodology
commonly referred to as "static pooling." The static pooling methodology
provides that the Company stratify the components of its sales finance
receivable portfolio (i.e. dealer reserve, principal loan balances and related
chargeoffs) into separately identified pools based upon the period the loans
were acquired (monthly). Under Mercury's application of static pooling, the
dealer reserve is amortized and made available to absorb credit losses over the
life of the pool of receivables. The dealer reserve cannot be utilized to
offset provision for finance credit losses immediately, but must be held to
offset future losses. See the Company's Annual Report on Form 10-K for the year
ended December 31, 1996, for more information regarding the impact of the
Company's adoption of the static pool methodology.
5. Disposition of Lyndon.
On June 3, 1997, Mercury sold all of the outstanding shares of Lyndon Insurance
Group and its subsidiaries pursuant to a Stock Purchase Agreement dated
March 28, 1997. The aggregate purchase price was $92 million. In order to
assure the delivery of clear title, Mercury was required to deposit ten percent
of the sales price, or $9.2 million, into a cash escrow account. This is
classified with cash and cash equivalents on the June 30, 1997 balance sheet.
The escrow deposit was subsequently released to Mercury.
Earnings from Lyndon in the second quarter were $2,025. The 1997 consolidated
results of operations of Mercury include the operations of Lyndon through
May 31, 1997 although the results since April 1, 1997 were attributable to the
buyer as an adjustment to the purchase price. Management has determined that it
is in the best interest of the Company to remain in the insurance business and
formed a new captive insurance subsidiary during 1997, MFN Insurance Company.
As a result, the sale of Lyndon is not considered the discontinuation of a
business. The loss associated with the sale of Lyndon will not be tax
deductible to the Company as a loss on the sale of a consolidated subsidiary is,
under certain circumstances, not deductible for tax purposes.
6. Contingencies and Legal Matters.
The Company has been named as a defendant in a variety of lawsuits generally
arising from the Company's announcement on January 29, 1997 that it would
restate previously reported financial information for prior years and interim
earnings for 1996 as a result of the discovery of accounting irregularities. As
of February 15, 1998, forty-four actions against the Company are pending in
United States District Court for the Northern District of Illinois, six cases
are pending against the Company in Illinois Chancery Court, and nine cases are
pending in the Delaware Chancery Court. One case is pending in Hamilton County,
Ohio, Municipal Court. The complaints seek compensatory damages, attorneys'
fees and costs.
Forty of the lawsuits pending in the Northern District of Illinois are class
actions which allege claims under Section 10 of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder. These lawsuits name one or more
officers or directors of the Company as additional defendants. One case pending
in the Northern District of Illinois alleges derivative claims seeking to
recover damages on behalf of the Company from certain of the Company's officers
and directors. Thirty-nine of the non-derivative cases pending in the Northern
District of Illinois were consolidated pursuant to a Stipulation entered on
April 30, 1997. In November, 1997, the Minnesota State Board of Investment was
appointed lead plaintiff in the federal class cases. One of the cases pending
in the Northern District of Illinois seeks to represent a class of participants
in Mercury's employee retirement plan and alleges ERISA violations arising out
of the plan's investment in Mercury's allegedly overvalued stock. Participants
in the proposed class may include certain officers and former officers of the
Company. Two cases pending in the Northern District of Illinois allege non-
class securities fraud and common law claims. Three of the Illinois state court
actions are class actions alleging claims under the Illinois Securities Act, the
Illinois Consumer Fraud and Deceptive Business Practices Act and common law
claims of negligence, fraud and negligent misrepresentation. The other Illinois
state court actions are derivative actions which seek to recover damages on
behalf of the Company from certain of the Company's officers and directors.
Each of the Delaware state court actions is a derivative action which seeks to
recover damages on behalf of the Company from certain of the Company's officers
and directors. The case pending in Municipal Court in Hamilton, Ohio, alleges
violations of Ohio state securities law and common law. The Company is unable
to predict the potential financial impact of the litigation.
The Securities and Exchange Commission is investigating the events giving rise
to the accounting irregularities. Those events are also under investigation by
the United States Attorney for the Northern District of Illinois and the Federal
Bureau of Investigation, which executed a search warrant on the Company's
premises on February 3, 1997. The Company is cooperating fully in these
investigations.
On January 10, 1997, the Company entered into an agreement (the "Agreement")
with BankBoston Corporation ("BankBoston") pursuant to which the Company was to
acquire all of the outstanding stock of Fidelity Acceptance Corporation, a
subsidiary of BankBoston, in return for the issuance of approximately 32.7
million shares of the Company's common stock. On January 30, 1997, BankBoston
notified the Company that it was terminating the Agreement as a result of
breaches of the Agreement resulting from the accounting irregularities described
above. On July 10, 1997, BankBoston notified Mercury that BankBoston intended
to seek appropriate compensation for its damages resulting from such breaches.
This claim was settled in January, 1998 for a payment in the amount of
$1,600,000. Such amount will be recorded as a charge to fourth quarter 1997
earnings.
In the normal course of its business, Mercury and its subsidiaries are named as
defendants in legal proceedings. A number of such actions, including fifteen
cases which have been brought as putative class actions, are pending in the
various states in which subsidiaries of Mercury do business. It is the policy
of Mercury and its subsidiaries to vigorously defend litigation, but Mercury and
(or) its subsidiaries have and may in the future enter into settlements of
claims where management deems appropriate. Although management is of the
opinion that the resolution of these proceedings will not have a material effect
on the financial position of Mercury, it is not possible at this time to
estimate the amount of damages or settlement expenses that may be incurred.
See Item 3 in the Company's Annual Report on Form 10-K for the year ended
December 31, 1996, for more information regarding the litigation arising from
the overstatement of earnings and the restatement of previously issued financial
statements.
No provision has been made in the consolidated financial statements for the
costs or expenses that have been or will be incurred subsequent to June 30, 1997
with respect to any of the above matters.
7. Income Taxes.
The Taxpayer Relief Act of 1997 (the "Act") was signed into law in August 1997.
A provision of the Act is to reduce the Net Operating Loss carryback period from
three years to two years beginning after August 5, 1997. For tax reporting
purposes, this new law restricts net operating losses, if any, incurred in 1998
to be carried back to 1996, where the Company did not have taxable income versus
under the previous legislation, any 1998 net operating losses would carry back
to 1995, where the Company has reported significant taxable income. For
financial reporting purposes, the change in the tax law raises a question as to
the realizability of the deferred tax asset that is recorded in the financial
statements ($48,320 as of June 30, 1997) because as of January 1, 1998, the
reversal of the temporary differences that give rise to the deferred taxes,
primarily the allowance for credit losses, can no longer be carried back to
periods of taxable income. Accordingly, it is likely that the Company will
record a full valuation allowance on all deferred tax assets for temporary
differences originated beginning in the third quarter of 1997 and it is expected
that any deferred tax assets on the books at December 31, 1997 will require
substantial, if not complete, valuation allowances.
In the third quarter of 1997, Mercury elected to be treated as a dealer in
securities under section 475 of the Internal Revenue Code. Pursuant to this
election, Mercury must recognize as taxable income or loss the difference
between the fair market value of its securities and the income tax basis of its
securities. This election has no impact on the recognition of pre-tax income
for financial reporting purposes. As a result of this election being effective
beginning in its 1996 tax year, the Company has increased the taxable loss
reported for the year ended December 31, 1996 and expects a taxable loss to be
reported for the year ended December 31, 1997. Accordingly, in the third quarter
of 1997 for financial reporting purposes, a portion of the previously recorded
deferred taxes have been reclassified as currently refundable.
8. Debt.
As a result of the 1996 net loss, accounting irregularities, and related
matters, Mercury violated certain covenants permitting the holders of its Senior
Term Notes and Subordinated Debt to accelerate all such debt which, if
accelerated, would result in all of such debt being currently due and payable.
In addition, the Company is no longer permitted by the terms of certain debt
instruments to pay dividends. None of the Company's debt which has matured by
its terms after January 29, 1997 has been repaid, except to the extent provided
below.
<TABLE>
<CAPTION>
JUNE 30, 1997 JUNE 30, 1996 DEC. 31, 1996
Balance Rate Balance Rate Balance Rate
<S> <C> <C> <C> <C> <C> <C>
Senior Debt:
Commercial paper . . . . . . . . . . . $493,619 5.6% $414,918 5.7% $525,051 5.6%
Term notes . . . . . . . . . . . . . . 488,625 7.0% 533,750 7.2% 488,625 7.0%
Subordinated debt . . . . . . . . . . . . 22,500 10.3% 26,000 10.2% 22,500 10.3%
Total . . . . . . . . . . . . . . $1,004,744 6.4% $974,668 6.5% $1,036,176 6.4%
</TABLE>
Under the terms of certain forbearance agreements, the Company made interest
payments on senior debt through the date of this report at default rates of
interest, subject to a maximum rate of nine percent (9%) and subordinated note
holders received interest at a rate of five and one-half percent (5.5%). In
addition, the agreement required the periodic payment of excess cash to be
applied as reduction of outstanding principal. Through February 15, 1998,
approximately $187 million of principal has been paid to creditors under the
forbearance agreements. The Company continues to negotiate with all of its
lenders in an attempt to reach a consensual restructuring agreement.
9. Recent Accounting Pronouncements.
In February, 1997, the FASB issued SFAS 128, "Earnings per Share" and SFAS 129,
"Disclosure of Information about Capital Structure". SFAS 128 establishes
standards for computing and presenting earnings per share. SFAS 129 establishes
standards for disclosing information about an entity's capital structure. These
statements are effective for financial statements issued for periods ending
after December 15, 1997. Management does not expect the adoption of these
statements to have a significant impact on the financial position and results of
operations of the Company.
In July, 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income" which
establishes standards for reporting and displaying comprehensive income.
Management does not expect the adoption of this statement to have a significant
impact on the financial position and results of operations of the Company. This
statement is effective for financial statements issued for periods beginning
after December 15, 1997.
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED AVERAGE BALANCE SHEETS
PERIODS ENDED JUNE 30
(Unaudited)
<CAPTION>
Three Months Ended Six Months Ended
(Dollars in thousands) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
ASSETS
Cash . . . . . . . . . . . . . . . . . . . . . . . . $78,350 $4,970 $59,219 $10,969
Investments . . . . . . . . . . . . . . . . . . . . . 110,711 216,985 144,793 225,337
Finance receivables . . . . . . . . . . . . . . . . . 1,110,949 1,200,767 1,127,440 1,199,770
Less allowance for finance credit losses . . . . . (117,594) (61,419) (110,983) (56,401)
Less nonrefundable dealer reserves . . . . . . . . (76,021) (55,906) (80,473) (57,924)
Finance receivables, net . . . . . . . . . . . . . 917,334 1,083,442 935,984 1,085,445
Income taxes receivable . . . . . . . . . . . . . . . 50,855 11,154 51,825 4,349
Deferred income taxes . . . . . . . . . . . . . . . . 43,790 23,383 40,312 22,706
Furniture, fixtures and equipment, net of
accumulated depreciation . . . . . . . . . . . . . 6,653 7,895 6,857 7,604
Reinsurance receivable . . . . . . . . . . . . . . . 49,177 55,086 63,936 66,711
Deferred acquisition costs and present value of
future profits . . . . . . . . . . . . . . . . . . 21,752 41,396 35,437 35,344
Other assets (including repossessions &
goodwill) . . . . . . . . . . . . . . . . . . . . . 59,587 89,965 68,229 93,997
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . $1,338,209 $1,534,276 $1,406,592 $1,552,462
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Senior debt, commercial paper . . . . . . . . . . . . $498,619 $439,523 $507,430 $456,345
Senior debt, term notes . . . . . . . . . . . . . . . 488,625 503,750 488,625 482,083
Subordinated debt . . . . . . . . . . . . . . . . . . 22,500 27,750 22,500 28,333
Accounts payable and other liabilities . . . . . . . 65,732 66,066 70,914 67,468
Unearned premium and claim reserve . . . . . . . . . 113,725 195,118 155,674 195,332
Reinsurance payable . . . . . . . . . . . . . . . . . 15,013 44,760 15,823 64,867
Reserve for loss on Lyndon . . . . . . . . . . . . . 14,764 0 9,843 0
TOTAL LIABILITIES . . . . . . . . . . . . . . . . 1,218,978 1,276,967 1,270,809 1,294,428
STOCKHOLDERS' EQUITY
Common stock . . . . . . . . . . . . . . . . . . . . 177,901 176,992 177,840 176,820
Paid in capital . . . . . . . . . . . . . . . . . . . 8,244 2,367 7,676 1,591
Retained earnings/(deficit) . . . . . . . . . . . . . (12,941) 116,069 3,823 116,758
Treasury stock . . . . . . . . . . . . . . . . . . . (53,664) (38,225) (53,664) (37,862)
Unrealized gain/(loss) on available for sale
investments . . . . . . . . . . . . . . . . . . . . (309) 106 108 727
TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . 119,231 257,309 135,783 258,034
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . $1,338,209 $1,534,276 $1,406,592 $1,552,462
NUMBER OF DAYS 91 92 181 182
MONTHS COMPLETED 3 3 6 6
RATIOS
Return on average equity . . . . . . . . . . . . . . (28.15)% 2.61% (61.69)% 14.17%
Return on average assets . . . . . . . . . . . . . . (2.51)% 0.44% (5.95)% 2.36%
Yield on average earning assets . . . . . . . . . . . 20.52% 19.34% 20.49% 19.22%
Rate on average interest bearing liabilities . . . . 9.35% 6.62% 8.76% 6.66%
Net interest margin . . . . . . . . . . . . . . . . . 12.79% 14.80% 13.48% 14.70%
</TABLE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Mercury Finance Company ("Mercury" or the "Company") is a consumer finance
company engaged, through its operating subsidiaries, in the business of
acquiring individual installment sales finance contracts from automobile dealers
and retail vendors, extending short term installment loans directly to consumers
and selling credit insurance and other related products.
OVERVIEW
In January 1997, Mercury discovered that certain improper adjustments had been
made to overstate earnings in previously issued financial statements. As a
result, a Special Committee of the Board of Directors commenced an investigation
of the misstatements of previously issued financial statements. As a result of
this investigation, Mercury has restated the financial statements for fiscal
1995, each of the 1995 quarters, and for the first three quarters of 1996. See
the Company's Annual Report on Form 10-K for the year ended December 31, 1996
for more information regarding the impact of the overstatement of earnings and
the restatement of previously issued financial statements.
During the first quarter of 1997, the Board of Directors hired the services of a
crisis manager to assist in the operation of the business. In addition, an
investment banker was retained to assist in the refinancing of existing debt
and/or explore strategic alternatives. The Company has also been named as a
defendant in a variety of lawsuits generally arising from the restatement of
previously reported financial information.
As a result of the net loss incurred in 1996, accounting irregularities, and
related matters, Mercury violated covenants thereby permitting the holders of
its debt to accelerate all such debt which, if accelerated, would result in all
of such debt being currently due and payable. Accordingly, the Company has been
accruing interest expense at default rates of interest since February 10, 1997.
Mercury continued to experience fierce competition in 1997 both from growing
specialty finance companies similar to Mercury and from traditional financial
institutions which reduced credit standards to obtain higher yields. Mercury
had previously responded to the competitive pressures by reducing its credit
standards while accepting lower pricing on sales finance contracts and
introducing new products that ultimately proved to be unprofitable. The Company
also continued to experience a high level of turnover at the branch manager and
staff levels. These factors resulted in a higher level of delinquencies and
charge-offs in 1997.
The high provision for credit losses as a result of higher delinquencies and
charge-offs combined with interest expense at default rates and the loss on the
sale of Lyndon caused the Company to incur an operating loss for the three and
six month periods ended June 30, 1997.
Mercury's operating subsidiaries commenced operations in February 1984 for the
purpose of penetrating the market for small dollar amount consumer loans
(average of $3,000 or less). The initial focus was toward small, short term,
direct installment loans made to 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 from periods from 3 months to
48 months at annual interest rates ranging, with minor exceptions, 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 schedule due date.
The following is management's discussion and analysis of the consolidated
financial condition of the Company at June 30, 1997 (unaudited) when compared
with June 30, 1996 (unaudited) and December 31, 1996, and the results of
operations for the three and six months ended June 30, 1997 and 1996
(unaudited). This discussion should be read in conjunction with the Company's
consolidated financial statements and notes thereto appearing elsewhere in this
quarterly report.
FINANCIAL CONDITION
ASSETS AND FINANCE RECEIVABLES
Total assets of the Company decreased 23% to $1,180.8 million from $1,533.8
million at June 30, 1996. Finance receivables decreased 8% to $1,095.8 million
at June 30, 1997 from $1,194.4 million at June 30, 1996. During the period from
December 31, 1996 through June 30, 1997, total assets and finance receivables
decreased 24% and 7%, respectively. Total assets decreased primarily due to the
sale of Lyndon. Finance receivables decreased as a result of lower level of
originations due to stricter credit standards and the disruption caused by the
accounting irregularities.
The Company's offices in Florida, Texas and Louisiana accounted for
approximately 16.8%, 16.1% and 8.8%, respectively, of all sales and direct
finance receivables, with the remainder being originated in the other 24 states
where offices are located. The total number of offices at June 30, 1997 was 263
compared to 287 at June 30, 1996 and 287 at December 31, 1996.
The Company closed 38 branches in the second quarter of 1997 which were
considered to be duplicative or under-performing. The costs related to the
closings consisted primarily of lease settlements and write-offs of leasehold
improvements aggregated $325,000.
In December, 1997, Mercury announced the implementation of a business plan that
included the closing of an additional 70 branches. These branches are being
closed because they are either unprofitable or considered redundant in view of
the location of nearby branches. The additional closings are estimated to
result in a decrease in the portfolio of approximately $250 million over the
next twelve to eighteen months. The closings will not be treated as
discontinued operations, however, a provision will be recorded in the fourth
quarter of 1997 to cover the costs of the closings which are estimated to be
$4,000,000.
The following table summarizes the composition of finance receivables at the
dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
JUNE 30, 1997 JUNE 30, 1996 DEC. 31, 1996
<S> <C> <C> <C>
GROSS FINANCE RECEIVABLES
Sales . . . . . . . . . . . . . . . . . . $1,075,474 $1,263,019 $1,159,848
Direct . . . . . . . . . . . . . . . . . 150,777 144,720 152,633
Total gross finance receivables . . . . . 1,226,251 1,407,739 1,312,481
Less: Unearned finance charges . . . . (209,311) (241,964) (228,405)
Unearned commissions, insurance
premiums and insurance
claim reserves . . . . . . . . (4,391) (8,096) (7,253)
Sales and direct finance receivables . . $1,012,549 $1,157,679 $1,076,823
Credit card . . . . . . . . . . . . . . . 83,230 36,738 83,600
Total finance receivables . . . . . . . . $1,095,779 $1,194,417 $1,160,423
</TABLE>
ALLOWANCE AND PROVISION FOR FINANCE CREDIT LOSSES
Mercury originates direct consumer loans, acquires individual sales finance
contracts from third party dealers and provides revolving credit to individuals
through a Visa affiliated program.
The Company continues to maintain an allowance for the direct and credit card
receivables to cover finance credit losses that are expected to be incurred on
receivables that have demonstrated a risk of loss based upon delinquency or
bankruptcy status.
The sales finance contracts are generally acquired at a discount from the
principal amount. This discount is normally referred to as a non-refundable
dealer reserve. The amount of the discount is based upon the credit risk of the
borrower, the note rate of the contract and competitive factors. In 1994 and
prior, the non-refundable dealer reserve was considered to be adequate to absorb
the majority of losses on the acquired receivables. However, as the sub-prime
market has evolved and become more competitive, the dealer reserve has proven to
be inadequate to absorb all of the credit losses. In 1995 and prior, the
Company maintained a balance of the combined non-refundable dealer reserves and
allowance for finance credit losses in an amount sufficient to cover losses that
were expected to be incurred on receivables that had demonstrated a risk of loss
based upon delinquency or bankruptcy status.
In the third quarter of 1996, Mercury adopted a loss reserving methodology
commonly referred to as "static pooling." The static pooling methodology
provides that the Company stratify the components of its sales finance
receivable portfolio (i.e., dealer reserve, principal loan balances and related
chargeoffs) into separately identified pools based upon the period the loans
were acquired. Mercury defines a pool as loans acquired within a given month
whereas others in the industry may use a quarterly basis.
The dealer reserve is amortized and made available to absorb credit losses over
the life of the pool of receivables. The dealer reserve cannot be utilized to
offset provision for finance credit losses immediately, but must be held to
offset future losses. Management believes this method provides for a more
appropriate matching of finance charge income and provision for finance credit
losses.
Reserve requirements for sales finance, direct receivables and credit card
receivables are calculated based on the estimated losses inherent in each
category of delinquency (i.e. 30, 60, 90 and 120 days past due). These assumed
losses are utilized to determine the projected cash flows from each impaired
category. The projected cash flow is then discounted to estimate the net
present value of the impaired loans. A reserve is established in an amount
sufficient to reduce the book value of the impaired receivable to its net
present value. Repossessed collateral is valued at an estimate of its net
realizable value.
The following table sets forth a reconciliation of the changes in the allowance
for finance credit losses for the three and six month periods ended June 30,
1997 and 1996 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Balance at beginning of period . . . . . . . . . . . . . $111,584 $49,178 $97,762 $46,366
Provision charged to expense . . . . . . . . . . . . . . 24,544 40,498 55,006 59,109
Finance receivables charged-off, net of recoveries . . . (12,524) (16,017) (29,164) (31,816)
Balance at June 30 . . . . . . . . . . . . . . . . . . . $123,604 $73,659 $123,604 $73,659
Allowance as a percent of sales and direct finance
receivables outstanding at end of period . . . . . . . 12.21% 6.36%
</TABLE>
The provision for credit losses in 1997 has been computed using the static pool
methodology whereas the 1996 provision was computed under the previous
methodology.
NONREFUNDABLE DEALER RESERVES
Mercury acquires a majority of its sales finance contracts from dealers at a
discount. Mercury negotiates the amount of the reserves with the dealers based
upon various criteria, one of which is the credit risk associated with the sales
finance contracts being acquired. The following table sets forth a
reconciliation of the changes in nonrefundable dealer reserves for the three and
six month periods ended June 30.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Balance at beginning of period . . . . . . . . . . . . . $80,677 $58,161 $89,378 $61,961
Discounts acquired on new volume . . . . . . . . . . . . 12,845 18,448 26,789 38,873
Losses absorbed, net of recoveries . . . . . . . . . . (22,157) (22,959) (44,802) (47,184)
Balance at June 30 . . . . . . . . . . . . . . . . . . . $71,365 $53,650 $71,365 $53,650
</TABLE>
Note that under the static pooling methodology adopted by Mercury, the
nonrefundable dealer reserves at June 30, 1997 are not available to offset
current losses but will be made available in the future. The June 30, 1996
nonrefundable reserves were computed under the previous methodology whereby they
are available for current losses. The reduction in discounts acquired in 1997
is due primarily to lower new loan volume and lower discounts acquired on a
percentage basis per loan.
DEBT
The primary source for funding the Company's finance receivables comes from the
issuance of debt. At June 30, 1997 the Company had total debt of $1,004.7
million which compares with $974.7 million at June 30, 1996.
In addition to the Company's outstanding debt the Company had available through
January 7, 1998 a $50 million revolving credit facility that is secured by all
of Mercury's finance receivables. No amounts were outstanding under this
facility at June 30, 1997.
As a result of the 1996 net loss, accounting irregularities, and related
matters, Mercury violated its covenants permitting the holders of its Senior
Term Notes and Subordinated Debt to accelerate all such debt which, if
accelerated, would result in all of such debt being currently due and payable.
In addition, the Company is no longer permitted by the terms of certain debt
instruments to pay dividends. None of the Company's debt which has matured by
its terms after January 29, 1997 has been repaid, except to the extent provided
below.
The following table presents the Company's debt instruments and the stated
interest rates on the debt at the periods indicated:
<TABLE>
<CAPTION>
JUNE 30, 1997 JUNE 30, 1996 DEC. 31, 1996
Balance Rate Balance Rate Balance Rate
<S> <C> <C> <C> <C> <C> <C>
Senior Debt:
Commercial paper . . . . . . . . . . . $493,619 5.6% $414,918 5.7% $525,051 5.6%
Term notes . . . . . . . . . . . . . . 488,625 7.0% 533,750 7.2% 488,625 7.0%
Subordinated debt . . . . . . . . . . . . 22,500 10.3% 26,000 10.2% 22,500 10.3%
Total . . . . . . . . . . . . . . $1,004,744 6.4% $974,668 6.5% $1,036,176 6.4%
</TABLE>
Under the terms of certain forbearance agreements, the Company made interest
payments on senior debt through the date of this report at default rates of
interest, subject to a maximum rate of nine percent (9%) and subordinated note
holders received interest at a rate of five and one-half percent (5.5%). In
addition, the agreement required the periodic payment of excess cash to be
applied as reduction of outstanding principal. Through February 15, 1998,
approximately $187 million of principal has been paid to creditors under the
forbearance agreements. The Company continues to negotiate with all of its
lenders in an attempt to reach a consensual restructuring agreement.
STOCKHOLDERS' EQUITY
Total stockholders' equity at June 30, 1997 was $115.4 million which compares
with $253.6 million at June 30, 1996 and $168.9 million at December 31, 1996.
For the three months ended June 30, 1997, the Company had a net loss of $8.4
million and did not declare any dividends. For the six months ended June 30,
1997 the Company had a net loss of $41.5 million and on January 14, 1997
declared dividends of $12.9 million (payment of such dividends was subsequently
suspended on February 6, 1997). Eligible employees of Mercury exercised options
to purchase shares resulting in $1.9 million being added to the equity of the
Company.
At June 30, 1997 stockholders' equity stated as a percent of total assets was
9.8% which compares with 16.5% at June 30, 1996 and 10.9% at December 31, 1996.
RESULTS OF OPERATIONS
NET INCOME/(LOSS)
For the three and six months ended June 30, 1997 the Company had a net loss of
$8.4 million and $41.5 million compared to $1.7 million and $18.2 million of net
income earned in 1996. The decrease in net income is primarily attributable to
the adoption of static pooling, decrease in finance receivables, the incurrence
of non-operating expenses relating to the investigation and restructuring of the
business, default rate of interest expense after February 10, 1997, and the lack
of earnings of the Lyndon insurance subsidiaries which were attributable to the
buyer after March 28, 1997.
INTEREST INCOME AND INTEREST EXPENSE
The largest single component of net income is net interest income which is the
difference between interest earned on finance receivables and interest paid on
borrowings. For the three and six months ended June 30, 1997 the Company's net
interest income was $39.0 million and $85.0 million compared to $52.2 million
and $104.2 million in 1996, respectively. The net interest margin which is the
ratio of net interest income before provision for credit losses divided by
average interest earning assets was 12.79% for the three months ended June 30,
1997 and 13.48% for the six months ended June 30, 1997. This compares with a
net interest margin of 14.80% and 14.70% for the three and six months ended June
30, 1996, respectively. The change in net interest margin is primarily
attributable to an increase in interest expense rates to default levels
beginning February 10, 1997. The following tables summarize the amount of the
net interest margin for the three and six months ended June 30 (dollars in
thousands):
<TABLE>
<CAPTION>
1997 1996
Annualized Annualized
THREE MONTHS ENDED Average Interest Rate Average Interest Rate
Out- Income/ Earned Out- Income/ Earned
standing Expense and Paid standing Expense and Paid
<S> <C> <C> <C> <C> <C> <C>
Interest earning assets . . . . $1,221,660 $62,505 20.52% $1,417,752 $68,167 19.34%
Interest bearing liabilities . 1,009,744 23,549 9.35% 971,023 15,983 6.62%
Net . . . . . . . . . . . . . . $211,916 $38,956 11.17% $446,729 $52,184 12.72%
Net interest margin as a
percentage of average interest
earning assets (annualized) . . 12.79% 14.80%
1997 1996
Annualized Annualized
SIX MONTHS ENDED Average Interest Rate Average Interest Rate
Out- Income/ Earned Out- Income/ Earned
standing Expense and Paid standing Expense and Paid
Interest earning assets . . . . $1,272,233 $129,285 20.49% $1,425,107 $136,216 19.22%
Interest bearing liabilities . 1,018,555 44,265 8.76% 966,761 32,020 6.66%
Net . . . . . . . . . . . . . . $253,678 $85,020 11.73% $458,346 $104,196 12.56%
Net interest margin as a
percentage of average interest
earning assets (annualized) . . 13.48% 14.70%
</TABLE>
OTHER INCOME
In addition to finance charges and interest, the Company derives commission
income from the sale of other credit related products. These products include
insurance relating to the issuance of credit life, accident and health and other
credit insurance policies to borrowers of the Company. Other credit-related
sources of revenue are derived from the sale of other products and services.
Insurance premiums are earned by the life insurance subsidiary as a reinsurer of
credit life and accident and health policies issued through the Company's branch
offices.
The following table summarizes the amounts earned from these products for the
three and six months ended June 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Insurance premiums . . . . . . . . . . . . . . . . . . . $9,871 $21,357 $33,091 $37,428
Fees, commissions and other . . . . . . . . . . . . . . . 3,068 4,212 6,571 8,152
Total . . . . . . . . . . . . . . . . . . . . . . . . . . $12,939 $25,569 $39,662 $45,580
Other income as a % of average interest
earnings assets (Annualized) . . . . . . . . . . . . . . 4.25% 7.25% 6.29% 6.43%
</TABLE>
The decrease in other income is primarily attributable to the sale of Lyndon in
the second quarter of 1997.
OTHER EXPENSES
In addition to interest expense and the provision for finance credit losses, the
Company incurs other operating expenses in the conduct of its business.
The following table summarizes the components of other expenses for the three
and six months ended June 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Salaries and employees benefits . . . . . . . . . . . . . $15,775 $13,301 $30,419 $26,624
Insurance claims expense . . . . . . . . . . . . . . . . 3,540 11,199 20,255 16,555
Other operating expenses . . . . . . . . . . . . . . . . 13,369 10,912 25,011 20,060
Total . . . . . . . . . . . . . . . . . . . . . . . . . . $32,684 $35,412 $75,685 $63,239
Other expenses as a % of average interest
earning assets (Annualized) . . . . . . . . . . . . . . 10.73% 10.05% 12.00% 8.92%
</TABLE>
OTHER NON-OPERATING EXPENSES
Non-operating expenses of $5.5 million and $10.6 million for the three and six
months ended June 30, 1997, respectively, include the costs of the investigation
of the accounting irregularities, professional fees related to the negotiations
with creditors, legal defense of the Company with respect to the class action
lawsuits, the costs of the interim financing facility, a portion of the fees for
the crisis management team and the costs of the audit examination of the 1996
financial statements.
INCOME TAXES
The Company recorded a benefit for income taxes in 1997 due to reporting a pre-
tax loss. The effective tax rate for the six months was 13.7% in 1997 and 33.7%
in 1996. The lower effective tax rate in 1997 is due to the loss recorded on
the sale of Lyndon being not deductible for tax purposes.
The Taxpayer Relief Act of 1997 (the "Act") was signed into law in August 1997.
A provision of the Act is to reduce the Net Operating Loss carryback period from
three years to two years beginning after August 5, 1997. For tax reporting
purposes, this new law restricts net operating losses, if any, incurred in 1998
to be carried back to 1996, where the Company did not have taxable income versus
under the previous legislation, any 1998 net operating losses would carry back
to 1995, where the Company has reported significant taxable income. For
financial reporting purposes, the change in the tax law raises a question as to
the realizability of the deferred tax asset that is recorded in the financial
statements ($48,320 as of June 30, 1997) because as of January 1, 1998, the
reversal of the temporary differences that give rise to the deferred taxes,
primarily the allowance for credit losses, can no longer be carried back to
periods of taxable income. Accordingly, it is likely that the Company will
record a full valuation allowance on all deferred tax assets for temporary
differences originated beginning in the third quarter of 1997 and it is expected
that any deferred tax assets on the books at December 31, 1997 will require
substantial, if not complete, valuation allowances.
In the third quarter of 1997, Mercury elected to be treated as a dealer in
securities under section 475 of the Internal Revenue Code. Pursuant to this
election, Mercury recognizes as taxable income or loss the difference between
the fair market value of its securities and the income tax basis of its
securities. This election has no impact on the recognition of pre-tax income
for financial reporting purposes. As a result of this election being effective
beginning in its 1996 tax year, the Company has increased the taxable loss
reported for the year ended December 31, 1996 and expects a taxable loss to be
reported for the year ended December 31, 1997. Accordingly, in the third quarter
of 1997 for financial reporting purposes, a portion of the previously recorded
deferred taxes have been reclassified as currently refundable.
CREDIT LOSSES AND DELINQUENCIES
CREDIT LOSSES
Direct finance receivables on which no payment is received within 149 days, on a
recency basis, are charged off. Sales finance receivable accounts which are
contractually delinquent 150 days are charged off monthly before they become 180
days delinquent. Accounts which are deemed uncollectible prior to the maximum
charge off period are charged off immediately. Management may authorize an
extension if collection appears imminent during the next calendar month. The
following table sets forth information relating to charge-offs, the allowance
for finance credit losses and dealer reserves:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Loss provision charged to income . . . . . . . . . . . . . . $24,544 $40,498 $55,006 $59,109
Net charge-offs against allowance . . . . . . . . . . . . . . 12,524 16,017 29,164 31,816
Net charge offs against nonrefundable dealer reserves . . . . 22,157 22,959 44,802 47,184
Allowance for finance credit losses at end of period . . . . 123,604 73,659
Dealer reserves at end of period . . . . . . . . . . . . . . 71,365 53,650
Ratios:
Net charge offs annualized against allowance
to average total finance receivables . . . . . . . . . . . 4.52% 5.36% 5.22% 5.33%
Net charge offs annualized against nonrefundable dealer
reserves to average total finance receivables . . . . . . . 8.00% 7.69% 8.01% 7.91%
Allowance for finance credit losses to total gross
finance receivables at end of period . . . . . . . . . . . 10.08% 5.23%
Dealer reserves to gross sales finance receivables
at end of period . . . . . . . . . . . . . . . . . . . . . 6.64% 4.25%
</TABLE>
DELINQUENCIES AND REPOSSESSIONS
If a borrower has filed for bankruptcy protection or if an account becomes 60 or
more days contractually delinquent and no full contractual payment is received
in the month the account attains such delinquency status, it is classified as
delinquent. The following table sets forth certain information regarding
contractually delinquent accounts at the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996 December 31, 1996
<S> <C> <C> <C>
Delinquent gross receivables $53,186 $55,890 $52,008
Bankrupt accounts 42,305 31,704 17,499
Repossessed assets 5,700 6,511 6,700
Total $101,191 $94,105 $76,207
Delinquent gross receivables and
bankrupt accounts to gross
finance receivables 7.79% 6.22% 5.30%
Delinquent gross receivables,
bankrupt accounts and repossessed
assets to gross finance
receivables plus repossessed assets 8.21% 6.65% 5.78%
</TABLE>
Loan collateral is repossessed when debtors are 120 days late or more on
payments. Automobiles are generally sold within 60 days at auction.
CREDIT CARD PROGRAM
The Company has a portfolio of approximately $83 million of receivables relating
to a credit card program that had originations in late 1995 and late 1996. This
program generated losses prior to the allocation of interest expense of $1.6
million in the first six months of 1997 of which $0.6 million was incurred in
the second quarter.
LIQUIDITY AND FINANCIAL RESOURCES
The Company has been acquiring loans by using the cash flow from cash
collections on finance receivables and with funds drawn on its revolving line of
credit. Prior to January 1997, Mercury also used commercial paper extensively
to fund its operations.
The primary debt of the Company is in the form of senior commercial paper,
senior term notes and subordinated debt, which totaled $1,005 million at
June 30, 1997, $1,036 million at December 31, 1996 and $975 million at June 30,
1996. As a result of the Company's announcement regarding the discovery of the
accounting irregularities, the Company is in default of its credit agreements.
Under the terms of certain forbearance agreements, the Company made interest
payments on senior debt through the date of this report at default rates of
interest, subject to a maximum rate of nine percent (9%) and subordinated note
holders received interest at a rate of five and one-half percent (5.5%). In
addition, the agreement required the periodic payment of excess cash to be
applied as reduction of outstanding principal. Through February 15, 1998,
approximately $187 million of principal has been paid to creditors under the
forbearance agreements. The Company continues to negotiate with all of its
lenders in an attempt to reach a consensual restructuring agreement.
In February 1997, Mercury entered into a separate agreement with Bank of America
Business Credit wherein Bank of America agreed to provide a $50 million line of
credit collateralized by all of the finance receivables. Mercury permitted the
facility to expire according to its terms in January, 1998.
DISPOSITION OF LYNDON
During 1997, Lyndon's claims paying ability was downgraded by A.M. Best to a
rating of B with negative implications. This action, together with regulatory
concerns and the liquidity needs of Mercury, caused Mercury to decide to dispose
of Lyndon. On March 28, 1997, Mercury executed a Stock Purchase Agreement with
Frontier Insurance Group, Inc. ("Frontier") for the sale of Lyndon to Frontier
for $92 million. The sale, which closed on June 3, 1997, resulted in a loss to
Mercury of approximately $25 million net of earnings through the date of sale.
This loss was reflected in Mercury's 1997 first quarter consolidated statement
of income. Management has determined that it is in the best interest of the
Company to remain in the insurance business and formed a new captive insurance
subsidiary during 1997, MFN Insurance Company. As a result, the sale of Lyndon
is not considered the discontinuation of a business. The loss associated with
the sale of Lyndon will not be tax deductible to the Company as a loss on the
sale of a consolidated subsidiary is, under certain circumstances, not
deductible for tax purposes.
CONTINGENCIES AND LEGAL MATTERS
The Company has been named as a defendant in a variety of lawsuits generally
arising from the Company's announcement on January 29, 1997 that it would
restate previously reported financial information for prior years and interim
earnings for 1996 as a result of the discovery of accounting irregularities. As
of February 15, 1998, forty-four actions against the Company are pending in
United States District Court for the Northern District of Illinois, six cases
are pending against the Company in Illinois Chancery Court, and nine cases are
pending in the Delaware Chancery Court. One case is pending in Hamilton County,
Ohio, Municipal Court. The complaints seek compensatory damages, attorneys'
fees and costs,.
Forty of the lawsuits pending in the Northern District of Illinois are class
actions which allege claims under Section 10 of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder. These lawsuits name one or more
officers or directors of the Company as additional defendants. One case pending
in the Northern District of Illinois alleges derivative claims seeking to
recover damages on behalf of the Company from certain of the Company's officers
and directors. Thirty-nine of the non-derivative cases pending in the Northern
District of Illinois were consolidated pursuant to a Stipulation entered on
April 30, 1997. In November, 1997, the Minnesota State Board of Investment was
appointed lead plaintiff in the federal class cases. One of the cases pending
in the Northern District of Illinois seeks to represent a class of participants
in Mercury's employee retirement plan and alleges ERISA violations arising out
of the plan's investment in Mercury's allegedly overvalued stock. Participants
in the proposed class may include certain officers and former officers of the
Company. Two cases pending in the Northern District of Illinois allege non-
class securities fraud and common law claims. Three of the Illinois state court
actions are class actions alleging claims under the Illinois Securities Act, the
Illinois Consumer Fraud and Deceptive Business Practices Act and common law
claims of negligence, fraud and negligent misrepresentation. The other Illinois
State court actions are derivative actions which seek to recover damages on
behalf of the Company from certain of the Company's officers and directors.
Each of the Delaware State court actions is a derivative action which seeks to
recover damages on behalf of the Company from certain of the Company's officers
and directors. The case pending in Municipal Court in Hamilton, Ohio, alleges
violations of Ohio State securities law and common law. The Company is unable
to predict the potential financial impact of the litigation.
The Securities and Exchange Commission is investigating the events giving rise
to the accounting irregularities. Those events are also under investigation by
the United States Attorney for the Northern District of Illinois and the Federal
Bureau of Investigation, which executed a search warrant on the Company's
premises on February 3, 1997. The Company is cooperating fully in these
investigations.
On January 10, 1997, the Company entered into an agreement (the "Agreement")
with BankBoston Corporation ("BankBoston") pursuant to which the Company was to
acquire all of the outstanding stock of Fidelity Acceptance Corporation, a
subsidiary of BankBoston, in return for the issuance of approximately 32.7
million shares of the Company's common stock. On January 30, 1997, BankBoston
notified the Company that it was terminating the Agreement as a result of
breaches of the Agreement resulting from the accounting irregularities described
above. On July 10, 1997, BankBoston notified Mercury that BankBoston intended
to seek appropriate compensation for its damages resulting from such breaches.
This claim was settled in January, 1998 for a payment in the amount of
$1,600,000. Such amount will be recorded as a charge to fourth quarter 1997
earnings.
In the normal course of its business, Mercury and its subsidiaries are named as
defendants in legal proceedings. A number of such actions, including fifteen
cases which have been brought as putative class actions, are pending in the
various states in which subsidiaries of Mercury do business. It is the policy
of Mercury and its subsidiaries to vigorously defend litigation, but Mercury and
(or) its subsidiaries have and may in the future enter into settlements of
claims where management deems appropriate. Although management is of the
opinion that the resolution of these proceedings will not have a material effect
on the financial position of Mercury, it is not possible at this time to
estimate the amount of damages or settlement expenses that may be incurred.
See Item 3 in the Company's Annual Report on Form 10-K for the year ended
December 31, 1996, for more information regarding the litigation arising from
the overstatement of earnings and the restatement of previously issued financial
statements.
No provision has been made in the consolidated financial statements for the
costs or expenses that have been or will be incurred subsequent to June 30, 1997
with respect to any of the above matters.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - See "Item 2 - Management's Discussion and Analysis
of Financial Condition and Results of Operations" which is
incorporated herein by reference.
Item 2. Changes in Securities - Not Applicable.
Item 3. Defaults Upon Senior Securities - See "Item 2 - Management's
Discussion and Analysis of Financial Condition and Results of
Operations" which is incorporated herein by reference.
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - Not Applicable
Item 6. (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 in the second quarter of 1997:
(i) Item 5 and Item 7 Current Report on Form 8-K filed
April 24, 1997
(ii) Item 5 and Item 7 Current Report on Form 8-K filed June 5,
1997
(iv) Item 5 and Item 7 Current Report on Form 8-K filed
June 12, 1997
(iii) Item 2 and Item 7 Current Report on Form 8-K filed June
18, 1997
(v) Item 5 and Item 7 Current Report on Form 8-K filed
June 25, 1997
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCURY FINANCE COMPANY
(Registrant)
Date: February 26, 1998 /s/ William A. Brandt, Jr.
William A. Brandt, Jr.
President and
Chief Executive Officer
Date: February 26, 1998 /s/ Patrick J. O'Malley
Patrick J. O'Malley
Principal Financial and
Accounting Officer
INDEX OF EXHIBITS
Exhibit No. Description
11. Computation of Net Income Per Share
27. Financial Data Schedule
MERCURY FINANCE COMPANY
EXHIBIT 11
COMPUTATION OF NET INCOME PER SHARE
THREE AND SIX MONTHS ENDED JUNE 30
(Unaudited)
Net income per share is computed by dividing net income by the total of the
weighted average common shares and common stock equivalents outstanding during
the period. Average common shares and common stock equivalents have been
adjusted to reflect the four-for-three stock splits of Mercury Finance Company
distributed to stockholders on December 28, 1989, October 31, 1990, June 10,
1991 and December 5, 1991, the two-for-one stock split distributed on June 19,
1992, the four-for-three stock split distributed on June 22, 1993 and the three-
for-two stock split distributed on October 31, 1995.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
(Dollars in thousands except per share amounts) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
INCOME DATA:
1. Net income/(loss) Mercury Finance Company . . . . ($8,369) $1,668 ($41,537) $18,176
2. Weighted average common shares
outstanding (adjusted for stock split) . . . . . . 177,901 176,782 177,884 176,651
3. Treasury stock . . . . . . . . . . . . . . . . . . (5,403) (3,997) (5,403) (3,997)
EFFECT OF COMMON STOCK EQUIVALENTS (C.S.E.):
4. Weighted average shares reserved for
stock options . . . . . . . . . . . . . . . . . . 0 1,152 0 1,344
NET INCOME PER COMMON SHARE:
5. Weighted average common share and
common stock equivalents (line 2+3+4) . . . . . . 172,498 173,937 172,481 173,998
6. Mercury Finance Company
net income/(loss) per share (line 1 / line 5) . . ($0.05) $0.01 ($0.24) $0.10
</TABLE>
As the Company incurred a net loss for the three months and six months ended
June 30, 1997, common share equivalents would be anti-dilutive to earnings per
share and have not been included in the weighted average shares calculation.
The Company has determined that the implementation of SFAS 128 "Earnings Per
Share", would have had no effect on the calculated earnings per share for the
three months and six months ended June 30, 1997. This standard prescribes that
when computing the dilution of options, the Company is to use its average stock
price for the period, rather than the more dilutive greater of the average share
price or end-of-period share price required by APB Opinion 15. As the options
are excluded from the calculation due to the anti-dilutive characteristics
indicated above, there is no effect on the earnings per share calculation.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<CASH> 130,909
<SECURITIES> 0
<RECEIVABLES> 1,095,779
<ALLOWANCES> (194,969)
<INVENTORY> 0
<CURRENT-ASSETS> 1,112,165
<PP&E> 16,037
<DEPRECIATION> (9,774)
<TOTAL-ASSETS> 1,180,782
<CURRENT-LIABILITIES> 1,065,426
<BONDS> 0
0
0
<COMMON> 177,901
<OTHER-SE> (62,545)
<TOTAL-LIABILITY-AND-EQUITY> 1,180,782
<SALES> 62,505
<TOTAL-REVENUES> 75,444
<CGS> 0
<TOTAL-COSTS> 32,684
<OTHER-EXPENSES> 7,478
<LOSS-PROVISION> 24,544
<INTEREST-EXPENSE> 23,549
<INCOME-PRETAX> (12,811)
<INCOME-TAX> (4,442)
<INCOME-CONTINUING> (8,369)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,369)
<EPS-PRIMARY> (0.05)
<EPS-DILUTED> (0.05)
</TABLE>
