SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For The Quarter Ended September 30, 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 (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 November 14, 1997.
Treasury Stock - 5,402,957 shares as of November 14, 1997
MERCURY FINANCE COMPANY
FORM 10-Q
INDEX
PAGE
PART I FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets . . . . . . . . . . . 1
Consolidated Statements of Income . . . . . . . . 2
Consolidated Statements of Changes in Stockholders'
Equity . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Cash Flows . . . . . . 4
Notes to Condensed Consolidated Financial
Statements. . . . . . . . . . . . . . . . . . . . 5
Consolidated Average Balance Sheets . . . . . . . . 11
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
CONSOLIDATED FINANCIAL CONDITION AND RESULTS
OF OPERATIONS . . . . . . . . . . . . . . . . . . 12
PART II OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . 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) As of As of As of
September 30, September 30, December 31,
1997 1996 1996
(unaudited) (unaudited)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . $3,792 $13,221 $20,957
Investments . . . . . . . . . . . . . . . . . . . . . . 46,736 216,344 212,957
Finance receivables . . . . . . . . . . . . . . . . . . . 1,046,157 1,164,532 1,160,423
Less allowance for finance credit losses . . . . . . . . (120,131) (112,487) (97,762)
Less nonrefundable dealer reserves . . . . . . . . . . . (61,306) (103,512) (89,378)
Finance receivables, net . . . . . . . . . . . . . . . . 864,720 948,533 973,283
Deferred income taxes, net . . . . . . . . . . . . . . . 10,500 41,555 33,356
Income taxes receivable . . . . . . . . . . . . . . . . . 76,525 51,427 53,764
Furniture, fixtures and equipment (at cost, less
accumulated depreciation) . . . . . . . . . . . . . . . 6,073 7,594 7,266
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . 13,819 14,666 14,463
Reinsurance receivable . . . . . . . . . . . . . . . . . 0 79,043 93,458
Deferred acquisition costs and present value of
future profits . . . . . . . . . . . . . . . . . . . . 0 58,896 62,809
Other assets (including repossessions) . . . . . . . . . 26,986 80,880 71,047
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . $1,049,151 $1,512,159 $1,543,360
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Senior debt, commercial paper and notes . . . . . . . . . $445,878 $443,307 $525,051
Senior debt, term notes . . . . . . . . . . . . . . . . . 441,364 518,750 488,625
Subordinated notes . . . . . . . . . . . . . . . . . . . 22,500 26,000 22,500
Accounts payable and other liabilities . . . . . . . . . 51,620 59,244 81,282
Unearned premium and claim reserves . . . . . . . . . . . 0 231,257 239,573
Reinsurance payable . . . . . . . . . . . . . . . . . . . 0 49,703 17,444
TOTAL LIABILITIES . . . . . . . . . . . . . . . . . . . . 961,362 1,328,261 1,374,475
Contingencies (Note 6)
SHAREHOLDERS' EQUITY
Common stock - $1.00 par value per share:
300,000,000 shares authorized
Sep 30 1997 - 177,900,671 shares outstanding
Sep 30 1996 - 177,608,090 shares outstanding
Dec 31 1996 - 177,719,447 shares outstanding . . . . 177,901 177,608 177,719
Paid in capital . . . . . . . . . . . . . . . . . . . . . 8,244 5,798 6,539
Retained earnings (deficit) . . . . . . . . . . . . . . . (44,692) 44,804 37,349
Unrealized appreciation on available-for-sale
securities, net of tax . . . . . . . . . . . . . . . . 0 64 942
Treasury stock -
Sep 30 1997 - 5,402,957 shares at cost
Sep 30 1996 - 4,566,557 shares at cost
Dec 31 1996 - 5,402,957 shares at cost . . . . . (53,664) (44,376) (53,664)
TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . . 87,789 183,898 168,885
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY. . . . . . . . . . . . . . . . . . . . . . . . . $1,049,151 $1,512,159 $1,543,360
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED STATEMENTS OF INCOME
PERIODS ENDED SEPTEMBER 30
(Unaudited)
<CAPTION>
Three Months Ended Nine 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 . . . . . . . . . . . . $56,850 $63,329 $180,078 $193,747
Investment income . . . . . . . . . . . . . . . . . . 737 3,312 6,794 9,110
Total finance charges, fees and investment
income . . . . . . . . . . . . . . . . . . . . . . 57,587 66,641 186,872 202,857
Interest expense . . . . . . . . . . . . . . . . . . 21,554 16,154 65,819 48,174
Net interest income before provision for
finance credit losses . . . . . . . . . . . . . . . 36,033 50,487 121,053 154,683
Provision for finance credit losses . . . . . . . . . 27,080 124,220 82,085 183,329
Net interest income/(loss) after provision for
finance credit losses . . . . . . . . . . . . . . . 8,953 (73,733) 38,968 (28,646)
OTHER OPERATING INCOME
Insurance commissions . . . . . . . . . . . . . . . . 943 853 4,338 2,902
Insurance premiums . . . . . . . . . . . . . . . . . 1,416 22,907 34,507 60,335
Fees and other . . . . . . . . . . . . . . . . . . . 970 3,262 4,146 9,365
Total other operating income . . . . . . . . . . . . 3,329 27,022 42,991 72,602
OTHER OPERATING EXPENSES
Salaries and employee benefits . . . . . . . . . . . 13,022 13,715 43,441 40,339
Occupancy expense . . . . . . . . . . . . . . . . . . 1,378 1,495 4,522 4,416
Equipment expense . . . . . . . . . . . . . . . . . . 1,036 813 2,861 2,306
Data processing expense . . . . . . . . . . . . . . . 442 671 1,535 2,021
Insurance claims expense . . . . . . . . . . . . . . 0 14,181 20,255 30,736
Other operating expenses . . . . . . . . . . . . . . 7,940 7,154 26,890 21,450
Total other operating expenses . . . . . . . . . . . 23,818 38,029 99,504 101,268
OPERATING INCOME/(LOSS) . . . . . . . . . . . . . . . (11,536) (84,740) (17,545) (57,312)
NON-OPERATING EXPENSES
Income from Lyndon due to buyer (Note 5) . . . . . . 0 0 2,025 0
Loss on sale of Lyndon (Note 5) . . . . . . . . . . . 0 0 29,528 0
Other non-operating expenses . . . . . . . . . . . . 3,013 0 13,595 0
Total non-operating expenses . . . . . . . . . . . . 3,013 0 45,148 0
Income/(loss) before income taxes . . . . . . . . . . (14,549) (84,740) (62,693) (57,312)
Provision/(credit) for income taxes . . . . . . . . . 13,018 (32,115) 6,411 (22,863)
NET INCOME/(LOSS) ($27,567) ($52,625) ($69,104) ($34,449)
NET INCOME/(LOSS) PER
COMMON SHARE . . . . . . . . . . . . . . . . . . . ($0.16) ($0.30) ($0.40) ($0.20)
Weighted average number of common and common
share equivalents outstanding (Thousands) . . . . . 172,498 173,526 172,479 173,740
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY
PERIODS ENDED SEPTEMBER 30
(Unaudited)
Three Months Ended Nine Months Ended
(Dollars in thousands) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
COMMON STOCK
Balance at beginning of period . . . . . . . . . . . $177,901 $177,403 $177,719 $176,478
Stock options exercised . . . . . . . . . . . . . . . 0 205 182 1,392
Stock traded in to exercise stock options . . . . . . 0 0 0 (262)
Balance at September 30 . . . . . . . . . . . . . . . $177,901 $177,608 $177,901 $177,608
PAID IN CAPITAL
Balance at beginning of period . . . . . . . . . . . $8,244 $4,113 $6,539 $39
Stock options exercised . . . . . . . . . . . . . . . 0 1,685 1,705 5,759
Balance at September 30 . . . . . . . . . . . . . . . $8,244 $5,798 $8,244 $5,798
RETAINED EARNINGS/(DEFICIT)
Balance at beginning of period . . . . . . . . . . . ($17,125) $110,428 $37,349 $118,138
Net income/(loss) . . . . . . . . . . . . . . . . . . (27,567) (52,625) (69,104) (34,449)
Dividends . . . . . . . . . . . . . . . . . . . . . . 0 (12,999) (12,937) (38,885)
Balance at September 30 . . . . . . . . . . . . . . . ($44,692) $44,804 ($44,692) $44,804
UNREALIZED APPRECIATION/(DEPRECIATION)
ON AVAILABLE FOR SALE SECURITIES
Balance at beginning of period . . . . . . . . . . . $0 ($130) $942 $1,969
Change during the period . . . . . . . . . . . . . . 0 194 (942) (1,905)
Balance at end of period . . . . . . . . . . . . . . $0 $64 $0 $64
TREASURY STOCK
Balance at beginning of period . . . . . . . . . . . ($53,664) ($38,225) ($53,664) ($37,137)
Purchases . . . . . . . . . . . . . . . . . . . . . . 0 (6,151) 0 (7,239)
Balance at September 30 . . . . . . . . . . . . . . . ($53,664) ($44,376) ($53,664) ($44,376)
Total stockholders' equity at September 30 . . . . . $87,789 $183,898 $87,789 $183,898
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIODS ENDED SEPTEMBER 30
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
(Dollars in thousands) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income/(loss) . . . . . . . . . . . . . . . . . . ($27,567) ($52,625) ($69,104) ($34,449)
Adjustments to reconcile net income/(loss) to net
cash provided by operating activities:
Provision for finance credit losses . . . . . . . 27,080 124,220 82,086 183,329
Credit for deferred income taxes . . . . . . . . . 38,217 (14,009) 28,861 (20,202)
Loss on sale of Lyndon . . . . . . . . . . . . . . 0 0 29,528 0
Gain/(loss) on sale of available-for-sale securities 0 194 (12) (1,905)
Depreciation and amortization . . . . . . . . . . 700 1,493 2,177 3,713
Net change in reinsurance receivable . . . . . . . 0 (18,016) (6,287) 10,919
Net change in deferred acquisition costs and
present value of future profits . . . . . . . . 0 (13,384) 15,473 (35,654)
Net change in other assets . . . . . . . . . . . . (23,461) (39,186) (11,109) (54,782)
Net change in reinsurance payable . . . . . . . . 0 3,552 12,582 (55,378)
Net change in unearned premium and
claim reserves . . . . . . . . . . . . . . . . . 0 29,258 (12,388) 35,496
Net change in other liabilities . . . . . . . . . (9,059) 1,869 (38,864) (11,024)
Net change in nonrefundable dealer reserves . . . 18,013 49,862 0 41,551
Net cash provided/(used) in operating
activities . . . . . . . . . . . . . . . . 23,923 73,228 32,943 61,614
CASH FLOWS FROM INVESTING ACTIVITIES
Principal collected on finance receivables . . . . . 211,639 241,721 585,897 722,570
Finance receivables originated or acquired . . . . . (220,644) (297,228) (559,420) (806,534)
(Increase)/decrease in investments . . . . . . . . . (46,738) (4,571) (40,185) 25,699
Proceeds from sale of Lyndon, net of cash sold . . . 0 0 88,884 0
Net purchase of premises and equipment . . . . . . . (295) (948) (340) (3,677)
Net cash provided by investing activities . (56,038) (61,026) 74,836 (61,942)
CASH FLOWS FROM FINANCING ACTIVITIES
Net (repayments)/issuance of senior debt,
commercial paper and notes . . . . . . . . . . . . (95,002) 13,389 (126,434) 29,817
Dividends paid . . . . . . . . . . . . . . . . . . . 0 (12,999) 0 (38,885)
Treasury stock acquired . . . . . . . . . . . . . . . 0 (6,151) 0 (7,239)
Stock options exercised . . . . . . . . . . . . . . . 0 1,890 1,490 6,889
Net cash provided/(used) in financing
activities . . . . . . . . . . . . . . . . (95,002) (3,871) (124,944) (9,418)
Net increase/(decrease) in cash. . . . . . . (127,117) 8,331 (17,165) (9,746)
CASH AT BEGINNING OF PERIOD . . . . . . . . . . . . . 130,909 4,890 20,957 22,967
CASH AT END OF PERIOD . . . . . . . . . . . . . . . . $3,792 $13,221 $3,792 $13,221
SUPPLEMENTAL DISCLOSURES
Income tax paid to federal and
state governments . . . . . . . . . . . . . . . $0 $14,305 $35 $44,011
Interest paid to creditors . . . . . . . . . . . . $28,021 $10,833 $68,270 $23,765
See accompanying notes to consolidated financial statements.
</TABLE>
MERCURY FINANCE COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 nine months ended September
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 nine months ended September 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.
Management believes that this method provides for a more appropriate matching of
finance charge income and provision for credit losses. The adoption of static
pooling increased the provision for finance credit losses in 1996 by
approximately $89 million.
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.
Earnings from Lyndon in the second quarter of 1997 were $2,025. The 1997
consolidated results of operations of Mercury include the operations of Lyndon
through May 31, 1997 although the results since April 1, 1997 were attributable
to the buyer as an adjustment to the purchase price. Management has determined
that it is in the best interest of the Company to remain in the insurance
business and formed a new captive insurance subsidiary during 1997, MFN
Insurance. As a result, the sale of Lyndon is not considered the
discontinuation of a business. The loss associated with the sale of Lyndon will
not be tax deductible to the Company as a loss on the sale of a consolidated
subsidiary is, under certain circumstances, not deductible for tax purposes.
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 September 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 ($10,500 as of September 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, a partial valuation allowance on
deferred tax assets of $18,500 has been recorded at September 30, 1997. In
addition, 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.
Mercury has 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, 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>
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996 DEC. 31, 1996
Balance Rate Balance Rate Balance Rate
<S> <C> <C> <C> <C> <C> <C>
Senior Debt:
Commercial paper . . . . . . . . . . . $445,878 5.6% $443,307 5.6% $525,051 5.6%
Term notes . . . . . . . . . . . . . . 441,364 7.0% 518,750 7.0% 488,625 7.0%
Subordinated debt . . . . . . . . . . . . 22,500 10.3% 26,000 10.3% 22,500 10.3%
Total . . . . . . . . . . . . . . $909,742 6.4% $988,057 6.4% $1,036,176 6.4%
</TABLE>
Under the terms of certain forbearance agreements, the Company made interest
payments on senior debt through the date of this report at default rates of
interest, subject to a maximum rate of nine percent (9%) and subordinated note
holders received interest at a rate of five and one-half percent (5.5%). In
addition, the agreement required the periodic payment of excess cash to be
applied as reduction of outstanding principal. As of February 15, 1998,
approximately $187 million of principal has been paid to creditors under the
forbearance agreement. The Company continues to negotiate with all of its
lenders in an attempt to reach a consensual restructuring agreement.
9. Recent Accounting Pronouncements.
In February, 1997, the FASB issued SFAS 128, "Earnings per Share" and SFAS 129,
"Disclosure of Information about Capital Structure". SFAS 128 establishes
standards for computing and presenting earnings per share. SFAS 129 establishes
standards for disclosing information about an entity's capital structure. These
statements are effective for financial statements issued for periods ending
after December 15, 1997. Management does not expect the adoption of these
statements to have a significant impact on the financial position and results of
operations of the Company.
In July, 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income" which
establishes standards for reporting and displaying comprehensive income.
Management does not expect the adoption of this statement to have a significant
impact on the financial position and results of operations of the Company. This
statement is effective for financial statements issued for periods beginning
after December 15, 1997.
<TABLE>
MERCURY FINANCE COMPANY
CONSOLIDATED AVERAGE BALANCE SHEETS
PERIODS ENDED SEPTEMBER 30
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
(Dollars in thousands) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
ASSETS
Cash . . . . . . . . . . . . . . . . . . . . . . . . $67,351 $9,056 $45,362 $11,532
Investments . . . . . . . . . . . . . . . . . . . . . 23,368 214,059 120,279 223,089
Finance receivables . . . . . . . . . . . . . . . . . 1,070,968 1,179,475 1,107,120 1,190,961
Less allowance for finance credit losses . . . . . (121,868) (93,073) (113,270) (70,423)
Less nonrefundable dealer reserves . . . . . . . . (66,336) (78,581) (75,682) (69,321)
Finance receivables, net . . . . . . . . . . . . . 882,764 1,007,821 918,168 1,051,217
Income taxes receivable . . . . . . . . . . . . . . . 63,582 35,337 58,000 16,119
Deferred income taxes . . . . . . . . . . . . . . . . 29,410 34,551 32,859 27,419
Furniture, fixtures and equipment, net of
accumulated depreciation . . . . . . . . . . . . . 6,168 7,765 6,661 7,602
Reinsurance receivable . . . . . . . . . . . . . . . 0 70,035 47,953 69,794
Deferred acquisition costs and present value of
future profits . . . . . . . . . . . . . . . . . . 0 52,204 26,578 41,232
Other assets (including repossessions & goodwill) . . 42,324 92,144 61,374 94,383
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . $1,114,967 $1,522,972 $1,317,234 $1,542,387
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Senior debt, commercial paper . . . . . . . . . . . . $469,749 $429,113 $492,042 $453,086
Senior debt, term notes . . . . . . . . . . . . . . . 464,995 526,250 476,810 491,250
Subordinated debt . . . . . . . . . . . . . . . . . . 22,500 26,000 22,500 27,750
Accounts payable and other liabilities . . . . . . . 56,151 58,310 66,091 65,412
Unearned premium and claim reserve . . . . . . . . . 0 216,628 116,756 204,313
Reinsurance payable . . . . . . . . . . . . . . . . . 0 47,927 11,868 61,076
Reserves for loss on Lyndon . . . . . . . . . . . . . 0 0 7,382 0
TOTAL LIABILITIES . . . . . . . . . . . . . . . . 1,013,395 1,304,228 1,193,449 1,302,887
STOCKHOLDERS' EQUITY
Common stock . . . . . . . . . . . . . . . . . . . . 177,901 177,506 177,856 177,017
Paid in capital . . . . . . . . . . . . . . . . . . . 8,244 4,956 7,818 2,643
Retained earnings/(deficit) . . . . . . . . . . . . . (30,909) 77,616 (8,306) 98,770
Unrealized appreciation/(depreciation) on
available for sale securities . . . . . . . . . . . 0 (33) 81 561
Treasury stock . . . . . . . . . . . . . . . . . . . (53,664) (41,301) (53,664) (39,491)
TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . 101,572 218,744 123,785 239,500
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . $1,114,967 $1,522,972 $1,317,234 $1,542,387
NUMBER OF DAYS . . . . . . . . . . . . . . . . . . . 92 92 273 274
MONTHS COMPLETED . . . . . . . . . . . . . . . . . . 3 3 9 9
RATIOS
Return on average equity . . . . . . . . . . . . . . (107.68)% (95.71)% (74.64)% (19.21)%
Return on average assets . . . . . . . . . . . . . . (9.81)% (13.75)% (7.01)% (2.98)%
Yield on earning assets . . . . . . . . . . . . . . . 20.88% 19.02% 20.36% 19.16%
Rate on interest bearing liabilities . . . . . . . . 8.93% 6.55% 8.88% 6.62%
Net interest margin . . . . . . . . . . . . . . . . . 13.06% 14.41% 13.19% 14.61%
</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 delinquencies and charge-offs combined with interest expense at default
rates caused the Company to incur an operating loss for the period.
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 September 30, 1997 (unaudited) when
compared with September 30, 1996 (unaudited) and December 31, 1996, and the
results of operations for the three and nine months ended September 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 31% to $1,049.2 million at September 30,
1997 from $1,512.2 million at September 30, 1996. Finance receivables decreased
10% to $1,046.2 million at September 30, 1997 from $1,164.5 million at
September 30, 1996. During the period from December 31, 1996 through
September 30, 1997, total assets and finance receivables decreased 32% and 10%,
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 16.4%, 16.1% and 8.9%, respectively, of all sales and direct
finance receivables. The total number of offices at September 30, 1997 was 262
compared to 287 at September 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 closing 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>
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996 DEC. 31, 1996
<S> <C> <C> <C>
GROSS FINANCE RECEIVABLES
Sales . . . . . . . . . . . . . . . . . . $1,023,224 $1,220,336 $1,159,848
Direct . . . . . . . . . . . . . . . . . 150,000 147,868 152,633
Total gross finance receivables . . . . . 1,173,224 1,368,204 1,312,481
Less: Unearned finance charges . . . . (204,551) (234,913) (228,405)
Unearned commissions, insurance
premiums and insurance
claim reserves . . . . . . . . (3,388) (7,698) (7,253)
Sales and direct finance receivables. . . $965,285 $1,125,593 $1,076,823
Credit card . . . . . . . . . . . . . . . 80,872 38,939 83,600
Total finance receivables . . . . . . . . $1,046,157 $1,164,532 $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 nine month periods ended
September 30, 1997 and 1996 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Balance at beginning of period . . . . . . . . . . . . . $123,604 $73,659 $97,762 $46,366
Provision charged to expense . . . . . . . . . . . . . . 27,080 124,220 82,085 183,329
Finance receivables charged-off, net of recoveries . . . (30,553) (10,943) (59,718) (42,759)
Transfer to nonrefundable dealer reserves . . . . . . . . 0 (74,449) 0 (74,449)
Balance at September 30 . . . . . . . . . . . . . . . . . $120,131 $112,487 $120,131 $112,487
Allowance as a percent of sales and direct finance
receivables outstanding at end of period . . . . . . . 12.45% 9.99%
</TABLE>
The provision for finance credit losses in 1996 includes the adoption of the
static pool method of accounting for loss reserves.
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 purchased. The following table sets forth a
reconciliation of the changes in nonrefundable dealer reserves for the three and
nine month periods ended September 30.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Balance at beginning of period . . . . . . . . . . $ 71,365 $ 53,650 $ 89,378 $ 61,961
Discounts acquired on new volume . . . . . . . . . 10,116 15,108 36,905 53,981
Losses absorbed, net of recoveries . . . . . . . . (20,175) (39,695) (64,977) (86,879)
Transfer from allowance for credit losses . . . . . 0 74,449 0 74,449
Balance at September 30 . . . . . . . . . . . . . . $ 61,306 $ 103,512 $ 61,306 $ 103,512
</TABLE>
Note that under the static pooling methodology adopted by Mercury, the
nonrefundable dealer reserves at September 30, 1997 are not available to offset
current losses but will be made available in the future. 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 September 30, 1997 the Company had total debt of $909.7
million which compares with $988.1 million at September 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 September 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>
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996 DEC. 31, 1996
Balance Rate Balance Rate Balance Rate
<S> <C> <C> <C> <C> <C> <C>
Senior Debt:
Commercial paper . . . . . . . . . . . $445,878 5.6% $443,307 5.6% $525,051 5.6%
Term notes . . . . . . . . . . . . . . 441,364 7.0% 518,750 7.0% 488,625 7.0%
Subordinated debt . . . . . . . . . . . . 22,500 10.3% 26,000 10.3% 22,500 10.3%
Total . . . . . . . . . . . . . . $909,742 6.4% $988,057 6.4% $1,036,176 6.4%
</TABLE>
Under the terms of certain forbearance agreements, the Company made interest
payments on senior debt through the date of this report at default rates of
interest, subject to a maximum rate of nine percent (9%) and subordinated note
holders received interest at a rate of five and one-half percent (5.5%). In
addition, the agreement required the periodic payment of excess cash to be
applied as reduction of outstanding principal. Through February 15, 1998,
approximately $187 million of principal has been paid to creditors under the
forbearance agreements. The Company continues to negotiate with all of its
lenders in an attempt to reach a consensual restructuring agreement.
STOCKHOLDERS' EQUITY
Total stockholders' equity at September 30, 1997 was $87.8 million which
compares with $183.9 million at September 30, 1996 and $168.9 million at
December 31, 1996. For the three months ended September 30, 1997, the Company
had a net loss of $27.6 million and did not declare any dividends. For the nine
months ended September 30, 1997 the Company had a net loss of $69.1 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 September 30, 1997 stockholders' equity stated as a percent of total assets
was 8.3% which compares with 12.2% at September 30, 1996 and 10.9% at December
31, 1996.
RESULTS OF OPERATIONS
NET INCOME/(LOSS)
For the three and nine months ended September 30, 1997 the Company had a net
loss of $27.6 million and $69.1 million compared to a net loss of $52.6 million
and $34.4 million in 1996. 1997 net loss is adversely impacted by the
incurrence of non-operating expenses relating to the investigation and
restructuring of the business, default rate of interest expense after
February 10, 1997, the loss on the sale of Lyndon and the lack of earnings of
the Lyndon insurance subsidiaries which were attributable to the buyer after
March 28, 1997. The 1996 net loss includes the provision for the adoption of
the static pooling methodology for determining the provision for credit losses.
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 nine months ended September 30, 1997 the
Company's net interest income was $36.0 million and $121.0 million, a decrease
of 29% and 22% from 1996, respectively. The net interest margin, which is the
ratio of net interest income before provision for finance credit losses divided
by average interest earning assets, was 13.06% for the three months ended
September 30, 1997 and 13.19% for the nine months ended September 30, 1997.
This compares with a net interest margin of 14.41% and 14.61% for the three and
nine months ended September 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 nine months ended
September 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 . . . $1,094,336 $57,587 20.88% $1,393,534 $66,641 19.02%
Interest bearing liabilities 957,244 21,554 8.93% 981,363 16,154 6.55%
Net . . . . . . . . . . . . . $137,092 $36,033 11.95% $412,171 $50,487 12.48%
Net interest margin as a
percentage of average
interest earning assets
(annualized) . . . . . . . 13.06% 14.41%
1997 1996
Annualized Annualized
NINE 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 . . . $1,227,399 $186,872 20.36% $1,414,050 $202,857 19.16%
Interest bearing liabilities 991,352 65,819 8.88% 972,086 48,174 6.62%
Net . . . . . . . . . . . . . $236,047 $121,053 11.48% $441,964 $154,683 12.54%
Net interest margin as a
percentage of average
interest earning assets
(annualized) . . . . . . . 13.19% 14.61%
</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 nine months ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Insurance premiums . . . . . . . . . . . . . . . . . . . $1,416 $22,907 $34,507 $60,335
Fees, commissions and other . . . . . . . . . . . . . . . 1,913 4,115 8,484 12,267
Total . . . . . . . . . . . . . . . . . . . . . . . . . . $3,329 $27,022 $42,991 $72,602
Other income as a % of average interest
earnings assets (Annualized) . . . . . . . . . . . . . . 1.21% 7.71% 4.68% 6.86%
</TABLE>
The decrease in insurance premiums 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 nine months ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Salaries and employees benefits . . . . . . . . . . . . . $13,022 $13,715 $43,441 $40,339
Insurance claims expense . . . . . . . . . . . . . . . . 0 14,181 20,255 30,736
Other operating expenses . . . . . . . . . . . . . . . . 10,796 10,133 35,808 30,193
Total . . . . . . . . . . . . . . . . . . . . . . . . . . $23,818 $38,029 $99,504 $101,268
Other expenses as a % of average interest
earning assets (Annualized) . . . . . . . . . . . . . . 8.63% 10.86% 10.84% 9.57%
</TABLE>
The decrease in insurance claims expense is primarily attributable to the sale
of Lyndon during the second quarter of 1997.
OTHER NON-OPERATING EXPENSES
Non-operating expenses of $3.0 million and $13.6 million for the three and nine
months ended September 30, 1997 include the costs of the investigation of the
accounting irregularities, professional fees related to the negotiations with
creditors, legal defense of the Company with respect to the class action
lawsuits, the costs of the interim financing facility, a portion of the fees for
the crisis management team and the costs of the audit examination of the 1996
financial statements and the reviews of the 1997 quarterly financial statements.
INCOME TAXES
The effective tax rate for the nine months was 10.2% in 1997 and 39.9% 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 ($10,500 as of September 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, a partial valuation allowance on
deferred tax assets of $18,500 has been recorded at September 30, 1997. In
addition, 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.
Mercury has 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, 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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Loss provision charged to income . . . . . . . . . . . . . . $27,080 $124,220 $82,086 $183,329
Net charge-offs against allowance . . . . . . . . . . . . . . 30,553 10,943 59,718 42,759
Net charge offs against nonrefundable dealer reserves . . . . 20,175 39,695 64,977 86,879
Allowance for finance credit losses at end of period . . . . 120,131 112,487
Dealer reserves at end of period . . . . . . . . . . . . . . 61,306 103,512
Ratios:
Net charge offs annualized against allowance
to average total finance receivables . . . . . . . . . . . 11.32% 3.69% 7.21% 4.80%
Net charge offs annualized against nonrefundable dealer
reserves to average total finance receivables . . . . . . . 7.47% 13.39% 7.85% 9.74%
Allowance for finance credit losses to total gross finance
receivables at end of period . . . . . . . . . . . . . . . 10.24% 8.22%
Dealer reserves to gross sales finance receivables
at end of period . . . . . . . . . . . . . . . . . . . . . 5.99% 8.48%
</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>
September 30, 1997 September 30, 1996 December 31, 1996
<S> <C> <C> <C>
Delinquent gross receivables $53,102 $61,340 $52,008
Bankrupt accounts 39,034 36,412 17,499
Repossessed assets 5,517 6,758 6,700
Total $97,653 $104,510 $76,207
Delinquent gross receivables and
bankrupt accounts to gross
finance receivables 7.85% 7.14% 5.30%
Delinquent gross receivables,
bankrupt accounts and repossessed
assets to gross finance
receivables plus repossessed assets 8.28% 7.60% 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 $81 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 $3.1
million in the first nine months of 1997 of which $1.5 million was incurred in
the third quarter.
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 $910 million at September
30, 1997, and $1,036 million at December 31, 1996 and $988 at September 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 September 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
July 16, 1997. Mercury's Consolidated Balance Sheet for
the year ended December 31, 1996 was filed as Exhibit 99.5
and as part of Exhibit 99.6 thereto.
(ii) Item 5 and Item 7 Current Report on Form 8-K filed
July 22, 1997. Mercury's Consolidated Balance Sheets at
March 31, 1997 and December 31, 1996 were filed as part of
Exhibit 99.1 thereto.
(iii) Item 5 and Item 7 Current Report on Form 8-K filed
August 11, 1997. Mercury's Consolidated Financial
Statements for the three months ended March 31, 1997 were
filed as Exhibit 99.1 thereto.
(iv) Item 5 and Item 7 Current Report on Form 8-K filed
September 2, 1997. Mercury's Consolidated Statements of
Income for the three months and six months ended June 30,
1997, and Consolidated Balance Sheet at June 30, 1997 were
filed as part of Exhibit 99.1 thereto.
(v) Item 5 and Item 7 Current Report on Form 8-K filed
September 19, 1997. Mercury's Consolidated Financial
Statements for the three and six month periods ended June
30, 1997 were filed as Exhibit 99.1 thereto.
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 NINE MONTHS ENDED SEPTEMBER 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 Nine 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 ($27,567) ($52,625) ($69,104) ($34,449)
2. Weighted average common shares
outstanding (adjusted for stock split) 177,901 177,506 177,882 176,936
3. Treasury stock . . . . . . . (5,403) (4,266) (5,403) (4,087)
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) 172,498 173,240 172,479 172,849
6. Mercury Finance Company
net income/(loss) per share (line 1 / line 5) ($0.16) ($0.30) ($0.40) ($0.20)
</TABLE>
As the Company incurred a net loss for the three months and nine months ended
September 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 nine months ended September 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> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 3,792
<SECURITIES> 46,736
<RECEIVABLES> 1,046,157
<ALLOWANCES> (181,437)
<INVENTORY> 0
<CURRENT-ASSETS> 1,018,759
<PP&E> 16,333
<DEPRECIATION> (10,260)
<TOTAL-ASSETS> 1,049,151
<CURRENT-LIABILITIES> 961,362
<BONDS> 0
0
0
<COMMON> 177,901
<OTHER-SE> (90,112)
<TOTAL-LIABILITY-AND-EQUITY> 1,049,151
<SALES> 57,587
<TOTAL-REVENUES> 60,916
<CGS> 0
<TOTAL-COSTS> 23,818
<OTHER-EXPENSES> 3,013
<LOSS-PROVISION> 27,080
<INTEREST-EXPENSE> 21,554
<INCOME-PRETAX> (14,549)
<INCOME-TAX> 13,018
<INCOME-CONTINUING> (27,567)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (27,567)
<EPS-PRIMARY> (0.16)
<EPS-DILUTED> (0.16)
</TABLE>
