<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For The Quarter Ended September 30, 1999 Commission File No. 1-10176
MFN Financial Corporation
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 36-3627010
- ------------------------------- ----------------------------------
(State or other jurisdiction of (I.R.S. Employer identification no.)
incorporation or organization)
100 Field Drive, Suite 340, Lake Forest, Illinois 60045
- ------------------------------------------------- -------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (847)295-8600
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing for the
past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
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 - $.01 par value, 10,000,000 shares as of November 10, 1999.
<PAGE>
MFN FINANCIAL CORPORATION
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I FINANCIAL INFORMATION
---------------------
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets................................................. 3
Condensed Consolidated Statements of Income........................................... 4
Condensed Consolidated Statements of Changes in Stockholders' Equity.................. 5
Condensed Consolidated Statements of Cash Flows....................................... 6
Notes to Condensed Consolidated Financial Statements.................................. 7
Report of Independent Public Accountants.............................................. 17
Condensed Consolidated Average Balance Sheets......................................... 18
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......................................... 19
Item 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK ........................................................................... 35
PART II OTHER INFORMATION
-----------------
Item 1. Legal Proceedings.......................................................................... 36
Item 2. Changes in Securities...................................................................... 36
Item 3. Defaults Upon Senior Securities............................................................ 36
Item 4. Submission of Matters to a Vote of Security Holders........................................ 36
Item 5. Other Information.......................................................................... 36
Item 6. Exhibits and Reports on Form 8-K........................................................... 36
SIGNATURES ...... .................................................................................. 37
INDEX OF EXHIBITS .................................................................................. 38
</TABLE>
2
<PAGE>
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MFN FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
Reorganized Predecessor
Company Company
September 30, December 31,
(Dollars in thousands) 1999 1998
ASSETS ----------- -----------
<S> <C> <C>
Cash and cash equivalents $ 105,453 $ 186,350
Finance receivables 541,369 642,872
Less: Allowance for finance credit losses 42,158 53,485
Less: Nonrefundable dealer reserves 36,501 36,820
----------- -----------
Finance receivables, net 462,710 552,567
Income taxes receivable 28,591 8,599
Furniture, fixtures and equipment, net of accumulated depreciation 1,645 3,709
Goodwill, net of amortization 0 12,745
Credit card portfolio held for sale, at net realizable value 0 27,894
Other assets (including repossessions) 8,755 6,819
----------- -----------
TOTAL ASSETS $ 607,154 $ 798,683
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Liabilities not subject to compromise under reorganization $ 0 $ 30,833
Liabilities subject to compromise under reorganization 0 719,770
Senior secured debt (Notes 2 and 8) 381,242 0
Senior subordinated debt (Notes 2 and 8) 22,500 0
Income taxes 37,692 0
Litigation accrual 241 18,950
Other liabilities 19,391 0
Excess of revalued net assets over stockholders' investment 44,461 0
----------- -----------
TOTAL LIABILITIES 505,527 769,553
----------- -----------
CONTINGENCIES (Note 6) - -
STOCKHOLDERS' EQUITY
Common stock - September 30, 1999-$.01 par value; 50,000,000 shares
authorized; 10,000,000 shares outstanding December 31, 1998-$1 par
value; 300,000,000 shares authorized; 177,900,671 shares outstanding 100 177,901
Paid in capital 84,900 8,244
Retained earnings (deficit) 16,627 (103,351)
Treasury stock - September 30, 1999 - 0 shares;
December 31, 1998 - 5,402,957 shares at cost 0 (53,664)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 101,627 29,130
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 607,154 $ 798,683
=========== ===========
</TABLE>
The accompanying notes to condensed consolidated financial statements
are an integral part of these statements.
3
<PAGE>
MFN FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION> Reorganized Predecessor Predecessor
Company Company Company
1999 1999 1998
------------------------ ---------- ---------------------
Three Six Three Three Nine
Months Months Months Months Months
Ended Ended Ended Ended Ended
(Amounts in thousands, except per share data) Sept 30, Sept 30, March 31, Sept 30, Sept 30,
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Finance charges, fees and investment income $ 35,180 $ 72,998 $ 37,620 $ 43,153 $ 140,272
Interest expense 10,825 22,101 474 2,766 37,871
----------- ----------- ---------- ---------- -----------
Net interest income before provision for finance
credit losses 24,355 50,897 37,146 40,387 102,401
Provision for finance credit losses 9,232 17,658 9,857 11,467 39,691
----------- ----------- ---------- ---------- -----------
Net interest income after provision for finance
credit losses 15,123 33,239 27,289 28,920 62,710
----------- ----------- ---------- ---------- -----------
OTHER INCOME
Fees, insurance commissions and premiums 1,875 4,350 2,084 1,513 5,467
Credit card related revenue and other 333 661 998 1,118 3,295
Gain on sale of finance receivables and assets 7,058 7,058 0 0 0
----------- ----------- ---------- --------- -----------
Total other income 9,266 12,069 3,082 2,631 8,762
----------- ----------- ---------- --------- -----------
OTHER OPERATING EXPENSES
Salaries and employee benefits 10,774 22,189 13,150 11,720 37,069
Occupancy expense 896 1,868 999 1,162 3,522
Equipment expense 388 740 767 794 2,515
Data processing expense 251 702 469 473 1,425
Amortization (2,470) (4,940) 215 214 644
Restructuring expenses 9 1,950 0 1,668 1,668
Other operating expenses 3,246 7,333 4,389 5,594 15,158
----------- ----------- ---------- --------- -----------
Total other operating expenses 13,094 29,842 19,989 21,625 62,001
----------- ----------- ---------- --------- -----------
OPERATING INCOME 11,295 15,466 10,382 9,926 9,471
Reorganization items 0 0 36,717 1,731 24,820
Income (loss) before income taxes ----------- ----------- ---------- --------- -----------
and extraordinary credit 11,295 15,466 (26,335) 8,195 (15,349)
Income taxes (benefit) (313) 359 (5,287) 0 0
----------- ----------- ---------- --------- -----------
Net income (loss) before extraordinary credit 11,608 15,107 (21,048) 8,195 (15,349)
Extraordinary credits:
Gain on early retirement of debt, net of taxes 0 0 45,570 0 0
Gain on discharge of indebtedness, net of taxes 1,520 1,520 0 0 0
----------- ----------- ---------- --------- -----------
NET INCOME (LOSS) $ 13,128 $ 16,627 $ 24,522 $ 8,195 $ (15,349)
=========== =========== ========== ========= ===========
Weighted average common shares outstanding:
Basic 10,000 10,000 ** ** **
Diluted 10,054 10,087 ** ** **
Per share net income attributable to common shares:
Basic $1.31 $1.66 ** ** **
Diluted $1.31 $1.65 ** ** **
Dividends per share declared $0.00 $0.00 ** ** **
</TABLE>
** Income per common share and dividend per common share amounts as they relate
to the Predecessor Company are not meaningful due to the reorganization. See
notes 2 and 3.
The accompanying notes to condensed consolidated financial
statements are an integral part of these statements.
4
<PAGE>
MFN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY
(Unaudited)
<TABLE>
<CAPTION>
Retained Total
(Dollars in thousands) Common Paid In Earnings Treasury Stockholders'
Stock Capital (Deficit) Stock Equity
--------- --------- --------- --------- -------------
<S> <C> <C> <C> <C> <C>
PREDECESSOR COMPANY
Balance December 31, 1997 $ 177,901 $ 8,244 $ (49,781) $ (53,664) $ 82,700
Net loss - - (15,349) - (15,349)
----------- ---------- ------------ ---------- ------------
Balance September 30, 1998 $ 177,901 $ 8,244 $ (65,130) $ (53,664) $ 67,351
=========== ========== ============ ========== ============
Balance June 30, 1998 $ 177,901 $ 8,244 $ (73,325) $ (53,664) $ 59,156
Net income - - 8,195 - 8,195
----------- ---------- ------------ ---------- ------------
Balance September 30, 1998 $ 177,901 $ 8,244 $ (65,130) $ (53,664) $ 67,351
=========== ========== ============ ========== ============
Balance December 31, 1998 $ 177,901 $ 8,244 $ (103,351) $ (53,664) $ 29,130
Net income - - 24,522 - 24,522
Effect of Reorganization and
Fresh Start Reporting:
Extinguishment of old stock (177,901) (8,244) 78,829 53,664 (53,652)
Issuance of new stock 100 84,900 - - 85,000
----------- ---------- ------------ ---------- ------------
Balance March 31, 1999 100 84,900 - - 85,000
POST-EMERGENCE REORGANIZED COMPANY
Net income - - 3,499 - 3,499
----------- ---------- ------------ ---------- ------------
Balance June 30, 1999 100 84,900 3,499 - 88,499
Net income - - 13,128 - 13,128
----------- ---------- ------------ ---------- ------------
Balance September 30, 1999 $ 100 $ 84,900 $ 16,627 $ - $ 101,627
=========== ========== ============ ========== ============
</TABLE>
The accompanying notes to the condensed consolidated financial statements are an
integral part of these statements.
5
<PAGE>
MFN FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Reorganized Predecessor Predecessor
Company Company Company
1999 1999 1998
--------------------- ------------ ----------------------
Three Six Three Three Nine
Months Months Months Months Months
Ended Ended Ended Ended Ended
(Dollars in thousands) Sept 30, Sept 30, March 31, Sept 30, Sept 30,
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 13,128 $ 16,627 $ 24,522 $ 8,195 $ (15,349)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Provision for finance credit losses 9,232 17,658 9,857 11,467 39,691
Gain on sale of finance receivables (7,058) (7,058) 0 0 0
Gain on early retirement of debt (2,513) (2,513) 0 0 0
Decrease in income tax receivable 0 0 0 0 27,590
Deferred income tax provision 0 0 17,372 0 0
Net gain on discharge of indebtedness 0 0 (68,228) 0 0
Extinguishment of dividend payable 0 0 (12,937) 0 0
Write-off of goodwill and fixed assets, net 0 0 16,022 0 0
Depreciation and amortization (2,424) (4,894) 607 546 1,849
Net (increase) decrease in other assets (8,228) (4,636) (2,866) 881 1,800
Net increase (decrease) in other liabilities 10,773 (33,830) 13,564 3,623 (4,224)
--------- --------- ---------- --------- ---------
Net cash provided by (used in) operating activities 12,910 (18,646) (2,087) 24,712 51,357
CASH FLOWS FROM INVESTING ACTIVITIES
Principal collected on finance receivables 95,846 210,863 123,936 138,376 457,834
Finance receivables originated or acquired (80,935) (185,407) (113,559) (107,977) (306,685)
Proceeds from sale of finance receivables 35,214 35,214 0 0 0
Proceeds from credit card portfolio 0 0 22,414 0 0
Purchases of furniture, fixtures and equipment (865) (1,691) (175) (70) (375)
--------- --------- ---------- --------- ---------
Net cash provided by investing activities 49,260 58,979 32,616 30,329 150,774
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments of senior debt and commercial paper (50,278) (150,985) (774) 0 (154,000)
--------- --------- ---------- --------- ---------
Net cash used in financing activities (50,278) (150,985) (774) 0 (154,000)
--------- --------- ---------- --------- ---------
Net increase (decrease) in cash and
cash equivalents 11,892 (110,652) 29,755 55,041 48,131
Cash and equivalents at beginning of period 93,561 216,105 186,350 46,986 53,896
--------- --------- ---------- --------- ---------
Cash and equivalents at end of period $ 105,453 $ 105,453 $ 216,105 $ 102,027 $ 102,027
========= ========= ========== ========= =========
SUPPLEMENTAL CASH DISCLOSURES
Income taxes paid to federal and
state governments $ 38 $ 202 $ 13,133 $ 320 $ 481
Interest paid 10,022 41,844 44 0 36,874
SUPPLEMENTAL NON-CASH DISCLOSURES
Cancellation of indebtedness 0 0 148,978 0 0
Extinguishment of old stock 0 0 (53,652) 0 0
Issuance of new stock 0 0 85,000 0 0
</TABLE>
The accompanying notes to condensed consolidated financial statements
are an integral part of these statements.
6
<PAGE>
MFN FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
1. Basis of Presentation.
---------------------
The accompanying (a) condensed consolidated balance sheet as of December 31,
1998, which has been derived from audited consolidated financial statements, and
(b) unaudited interim condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and note disclosures normally included in annual
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to those rules and
regulations, although MFN Financial Corporation, f/k/a Mercury Finance Company
("MFN" or the "Company") believes that the disclosures made are adequate to make
the information presented not misleading. The condensed consolidated financial
statements of the Company, in the opinion of management, reflect all necessary
adjustments (consisting solely of normal recurring matters, except as discussed
in the following paragraph and except for the restructuring charge, gain on sale
of assets and gain on early retirement of debt) for a fair presentation of
results as of the dates and for the periods covered by the financial statements.
Due to the Company's emergence from the Voluntary Case (as hereinafter defined)
and implementation of Fresh Start Reporting, Condensed Consolidated Financial
Statements for the Reorganized Company as of March 31, 1999 and for the periods
subsequent to March 31, 1999 (the "Reorganized Company") are not comparable to
those of the Company for the periods prior to March 31, 1999 (the "Predecessor
Company"). For financial reporting purposes, the effective date (the "Fresh
Start Effective Date") of the Plan of Reorganization (as hereinafter defined) is
considered to be the close of business on March 31, 1999. The effective date of
the Plan of Reorganization was March 23, 1999. The results of operations for the
period from March 23, 1999 through March 31, 1999 were not material.
A black line has been drawn between the accompanying Condensed Consolidated
Balance Sheets as of September 30, 1999 and December 31, 1998, and the Condensed
Consolidated Statement of Income and Cash Flows for the three-month and
six-month periods ended September 30, 1999 and all prior periods to distinguish
between the Reorganized Company and the Predecessor Company.
7
<PAGE>
The results for the interim periods shown for the Reorganized Company and the
Predecessor Company are not to be considered as being indicative of the results
that are expected for the full year.
The independent public accountants of the Company as of December 31, 1998, have
qualified their report on the Company's 1998 financial statements due to their
doubt as to the ability of the Company to continue as a going concern. It is
suggested that 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, 1998.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the condensed consolidated financial statements
and accompanying notes. The amounts which are subject to such estimation
techniques include the allowance for finance credit losses. Actual results could
differ from these estimates.
2. Chapter 11 Proceedings.
----------------------
On July 15, 1998, the Company filed a voluntary petition (the "Voluntary Case")
in the United States Bankruptcy Court for the Northern District of Illinois (the
"Bankruptcy Court" or the "Court") for relief under chapter 11 of title 11 of
the United States Code.
On March 10, 1999, the Court entered an order confirming the Company's Second
Amended Plan of Reorganization (the "Plan" or "Plan of Reorganization"). The
effective date of the Plan was March 23, 1999 (the "Effective Date"). The Plan
provided for the Company's senior lenders to receive new senior secured notes
("New Senior Secured Notes") equal to 75 percent of the face value of their then
current outstanding balance after the receipt of Excess Cash (as defined in the
Plan) of $100,707,261 and their pro rata share of 9,500,000 shares (95% of the
outstanding) of the new Common Stock (the "New Common Stock"), $.01 par value
per share, of MFN. The Plan provided for the holders of subordinated notes to
receive $22.5 million in new senior unsecured subordinated notes ("New Senior
Subordinated Notes").
The New Senior Secured Notes are comprised of (i) Series A Senior Secured Notes
Due March 23, 2001, (the "Series A Notes") which have a 10% annual fixed rate of
interest, payable quarterly and (ii) Series B Senior Secured Notes Due March 23,
2001, (the "Series B Notes") which have a floating rate of interest based on the
three month LIBOR (London Interbank Offering Rate), payable quarterly. The
Company's senior lenders prior to the Effective Date were given the option to
receive either Series A Notes or Series B Notes in connection with the Plan.
During the three-month period ended June 30, 1999, holders of the old senior
debt elected to receive $232,829,482 of the Series A Notes and $201,335,561 of
the Series B Notes totaling an aggregate principal amount of the New Senior
Secured Notes of $434,165,043. During the three-month period ended September 30,
1999, MFN retired debt with a face value of $52,923,298 prior to scheduled
maturity. The principal amount of Series A Notes and Series B
8
<PAGE>
Notes outstanding at September 30, 1999 was $202,829,482 and $178,412,263,
respectively, for a total of $381,241,745. Principal payments on the New Senior
Secured Notes are not due until maturity on March 23, 2001. The New Senior
Subordinated Notes, with an aggregate principal amount of $22.5 million, have an
11% annual fixed rate of interest, payable quarterly and are due March 23, 2002.
See Notes 8 and 11.
The $52.9 million early retirement of debt resulted in a gain of $2.5 million
before tax and was treated as an extraordinary item in the accompanying
Condensed Consolidated Statement of Income for the three-month and six-month
periods ended September 30, 1999. See Note 11.
Under the Plan, the shareholders of record as of March 22, 1999, of the
Company's old Common Stock, $1 par value per share, were entitled to receive,
subject to certain minimum threshold requirements, their pro rata share of
500,000 shares (5% of the outstanding) of the New Common Stock and three series
(Series A, B and C) of warrants (the "New Warrants"), each exercisable for
580,000 shares of the New Common Stock, with expiration dates of March 23, 2002,
March 23, 2003 and March 23, 2004, respectively. The exercise price of the
Series A Warrants is $15.34, the exercise price of the Series B Warrants is
$21.81 and the exercise price of the Series C Warrants is $28.27.
The Plan provided for the Company to transfer to a certain trust established
under the Plan (the "Liquidating Trust"), (i) $5 million in cash, (ii) the
Company's claims against KPMG Peat Marwick and (iii) $250,000 in cash for fees
and costs to be incurred in connection with the Liquidating Trust. The Plan also
provided for the holders of Securities Fraud Claims to receive a share of the
beneficial interests in the Liquidating Trust in complete settlement,
satisfaction and discharge of their claims. In addition, the Plan provided for
the Company to pay (i) $13.35 million into funds established for the benefit of
holders of certain indemnification claims against the Company and (ii) up to an
aggregate amount of $250,000, for costs and expenses of certain officers, agents
and employees who were no longer employed by the Company as of the first day
immediately following March 23, 1999, in connection with their participation in
a government investigation. The Company also agreed to pay a former employee
$100,000 in connection with a mutual release. All of these costs were fully
provided for as of March 31, 1999.
The Plan also provided for the grant of options to purchase 1,500,000 shares of
New Common Stock under the Amended and Restated 1989 Stock Option Plan or under
the Company's employment agreement with its Chief Executive Officer as of March
23, 1999 at $8.50 per share, the estimated reorganization value per share. See
Note 9.
The above summary of the Plan does not purport to be complete and is qualified
in its entirety by reference to the Plan which is incorporated herein by
reference to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998. See the Company's Current Report on Form 8-K filed on
March 25, 1999, for more information.
9
<PAGE>
3. Fresh Start Reporting.
---------------------
As of March 31, 1999, the Company adopted Fresh Start Reporting in accordance
with the American Institute of Certified Public Accountants' Statement of
Position 90-7 "Financial Reporting by Entities in Reorganization under the
Bankruptcy Code" (SOP 90-7). The adoption of Fresh Start Reporting resulted in
material changes to the Condensed Consolidated Balance Sheet, including
valuation of assets at fair value in accordance with principles of the purchase
method of accounting, valuation of liabilities pursuant to provisions of the
Plan and valuation of equity based on the appraised reorganization value of the
ongoing business.
The reorganization value of $85.0 million (the approximate fair value) was based
on the consideration of many factors and various valuation methods, including
discounted cash flows, selected publicly traded company market multiples and
other applicable ratios and valuation techniques believed by the Company and its
financial advisors to be representative of the Company's business and industry.
The Predecessor Company's equity was eliminated in Fresh Start Reporting.
In accordance with Fresh Start Reporting guidelines, certain noncurrent assets,
including goodwill, recorded on the Company's Condensed Consolidated Balance
Sheet at the Fresh Start Effective Date aggregating $16.0 million were reduced
to zero as a result of the fair value of the Company's assets exceeding the fair
value of its liabilities and stockholders' investment. In addition, as a result
of reorganization, the dividends payable liability in the amount of $12.9
million was extinguished. The net result of the adjustment of assets and
liabilities to fair value was a charge to earnings of $3.1 million during the
period ended March 31, 1999. After reducing the fair value of certain noncurrent
assets to zero, the excess of the fair value of the remaining assets over the
fair value of liabilities and stockholders' investment, totaling $49.4 million,
was recorded as a deferred credit, "Excess of Revalued Net Assets Over
Stockholders' Investment". This balance will be amortized over 5 years.
10
<PAGE>
The Company's emergence from the Voluntary Case and the adoption of Fresh Start
Reporting resulted in the following adjustments to the Company's Condensed
Consolidated Balance Sheet as of March 31, 1999:
<TABLE>
<CAPTION>
In thousands Predecessor Fresh Reorganized
Company Start Adjustments Company
March 31, 1999 Debit Credit March 31, 1999
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 216,105 $ - $ - $ 216,105
Finance receivables, net 535,523 - - 535,523
Other assets (including repossessions) 31,200 - - 31,200
-------------- ----------------- ---------------- ------------------
TOTAL ASSETS $ 782,828 $ - $ - $ 782,828
============== ================= ================ ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Senior debt $ 674,471 $ 240,306 (a) $ - $ 434,165
Excess cash payment to
senior debt holders - - 100,707 (b) 100,707
Subordinated debt 22,500 - - 22,500
Interest payable 30,552 9,008 (a) - 21,544
Accounts payable and other liabilities 23,801 371 (c) - 23,430
Income taxes 4,472 - 22,659 (d) 27,131
Litigation accrual 18,950 - - 18,950
Excess of revalued net assets over
stockholders' investment - - 49,401 (e) 49,401
-------------- ----------------- ---------------- ------------------
TOTAL LIABILITIES 774,746 249,685 172,767 697,828
Stockholders' Equity:
Common stock 177,901 177,901 (f) 100 (g) 100
Paid in capital 8,244 8,244 (f) 84,900 (g) 84,900
Accumulated deficit (124,399) - 78,829 (f) -
45,570 (h)
Treasury stock (53,664) - 53,664 (f) -
-------------- ----------------- ---------------- ------------------
TOTAL STOCKHOLDERS' EQUITY 8,082 186,145 263,063 85,000
-------------- ----------------- ---------------- ------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 782,828 $ 435,830 $ 435,830 $ 782,828
============== ================= ================ ==================
</TABLE>
(a) To reflect the cancellation of the old debt and related accrued
interest.
(b) To setup a payable of Excess Cash to Senior Debt Holders in accordance
with the Plan of Reorganization. Payment occurred subsequent to the
balance sheet date.
(c) To write-off cancelled liabilities of the Company.
(d) To establish deferred income tax liability on the cancellation of
indebtedness.
(e) The excess of revalued net assets over stockholders' investment is
calculated below:
Fair value of identifiable assets $782,828
Less: reorganized value of new debt 456,665
Less: reorganized value of new equity 85,000
Less: fair value of identifiable liabilities 191,762
--------
$ 49,401
========
11
<PAGE>
(f) To eliminate stockholders' equity of the Predecessor Company.
(g) To record the issuance of 10,000,000 shares of new common stock (par
value $0.01) at $8.50 per share.
(h) To record the extraordinary gain resulting from discharge of
indebtedness. The extraordinary gain, net of taxes is calculated below:
Historical carrying value of
old debt securities $ 696,971
Historical carrying value of
related accrued interest 29,405
Value exchanged for old debt:
Excess Cash Payment, including interest (121,104)
New Senior Secured Notes (434,165)
New Senior Subordinated Notes (22,500)
New Common Stock (9.5
million shares to creditors) (80,750)
Other 372
--------
68,229
Tax Provision 22,659
--------
Extraordinary Gain $ 45,570
========
4. Earnings Per Share.
------------------
Basic earnings per share is computed by dividing net income by the weighted
average number of shares of the Company's common stock outstanding during the
period. Diluted earnings per share is computed by dividing net income by the
weighted average number of shares of common stock outstanding and the dilutive
common stock equivalents during the period. Common stock equivalents include
options granted to executive officers and directors and warrants outstanding
convertible into shares of common stock of the Company using the treasury stock
method.
<TABLE>
<CAPTION>
(Dollars in thousands, except per share amounts) Three Months Ended Six Months Ended
September 30, 1999 September 30, 1999
------------------ ------------------
<S> <C> <C>
BASIC
Net income $ 13,128 $ 16,627
Average common shares outstanding 10,000,000 10,000,000
Earnings before extraordinary credit $ 1.16 $ 1.51
Extraordinary gain from early retirement of debt 0.15 0.15
----------- -----------
Net income per common share $ 1.31 $ 1.66
=========== ===========
DILUTED
Net income $ 13,128 $ 16,627
Average common shares and equivalents outstanding 10,054,269 10,087,248
Earnings before extraordinary credit $ 1.16 $ 1.50
Extraordinary gain from early retirement of debt 0.15 0.15
----------- -----------
Net income per common share $ 1.31 $ 1.65
=========== ===========
</TABLE>
12
<PAGE>
Due to the Company's emergence from the Voluntary Case and the implementation of
Fresh Start Reporting, the presentation of earnings per share for the
Predecessor Company is not meaningful in the accompanying financial statements.
5. Reclassifications.
-----------------
Certain data from the prior periods has been reclassified to conform to the
current period presentation.
6. Contingencies and Legal Matters.
-------------------------------
Prior to the filing of the Voluntary Case, the Company had been named as a
defendant in a variety of lawsuits ("Securities Fraud Claims") generally arising
from the Company's announcement on January 29, 1997 that it would restate its
earnings for certain prior periods as a result of the discovery of accounting
irregularities. The Plan provided that the Company transfer to a certain trust
established under the Plan (the "Liquidating Trust"), (i) $5 million in cash,
(ii) the Company's claims against KPMG Peat Marwick and (iii) $250,000 in cash
for fees and costs to be incurred in connection with the Liquidating Trust. The
Plan also provided for holders of Securities Fraud Claims to receive a share of
the beneficial interests in the Liquidating Trust in complete settlement,
satisfaction and discharge of their claims. All of these costs were fully
provided for as of March 31, 1999.
The Securities and Exchange Commission is investigating the events giving rise
to the accounting irregularities. Those events are also under investigation by
the United States Attorney for the Northern District of Illinois and the Federal
Bureau of Investigation. The Company is cooperating fully in these
investigations.
In the normal course of its business, MFN and its subsidiaries are named as
defendants in legal proceedings. A number of such actions, including cases which
have been brought as putative class actions, are pending in the various states
in which subsidiaries of MFN do business. It is the policy of MFN and its
subsidiaries to vigorously defend litigation, but MFN 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
MFN, 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, 1998, for more information regarding the litigation arising from
the overstatement of earnings and the restatement of previously issued financial
statements.
The Company recognizes the expense for litigation when the incurrence of loss is
probable and the amount of such loss is estimable. Because of the uncertainty
that surrounds the above described litigation, no accrual has been made for the
majority of these lawsuits. An accrual was recorded at March 31, 1999 in the
amount of $250,000 for costs and expenses of certain officers,
13
<PAGE>
agents and employees who were no longer employed by the Company as of the first
day immediately following March 23, 1999, in connection with their participation
in a government investigation. As of September 30, 1999, the remaining amount of
this accrual to utilize is $241,000.
7. Income Taxes.
------------
The 1999 provision for income taxes was calculated using a 39.5% tax rate on
earnings before income taxes adjusted for (1) the amortization of the excess of
revalued net assets over stockholders' investment, which is a permanent
difference between book and tax income, and (2) an unrealized benefit related to
the first quarter of 1999 book loss (before extraordinary credit). The
unrealized benefit of the first quarter of 1999 book loss (before extraordinary
credit) was then believed to be limited. The Company believes that any current
year book loss, adjusted as discussed above, will be utilized against the
deferred taxes associated with the first quarter gain on cancellation of debt or
future taxable income.
The Company recorded a full valuation allowance related to the tax benefit for
the loss recorded during the first nine months of 1998. At that time, the
Company was unable to carryback the losses to prior periods of taxable income.
8. Debt.
----
In connection with the Plan of Reorganization, the Company issued New Senior
Secured Notes and New Senior Subordinated Notes. See Note 2 - Chapter 11
Proceedings. The New Senior Secured Notes are comprised of (i) Series A Notes
Due March 23, 2001, which have a 10% annual fixed rate of interest, payable
quarterly and (ii) Series B Notes Due March 23, 2001, which have a floating rate
of interest based on three month LIBOR (London Interbank Offering Rate), payable
quarterly. Principal payments on the New Senior Secured Notes are not due until
maturity on March 23, 2001.
The Company's senior lenders prior to the Effective Date were given the option
to receive either Series A Notes or Series B Notes in connection with the Plan.
During the three-month period ended June 30, 1999, holders of the old senior
debt elected to receive $232,829,482 of the Series A Notes and $201,335,561 of
the Series B Notes totaling an aggregate principal amount of the New Senior
Secured Notes of $434,165,043. During the three-month period ended September 30,
1999, MFN retired debt with a face value of $52,923,298 prior to scheduled
maturity. The principal amount of Series A Notes and Series B Notes outstanding
at September 30, 1999 was $202,829,482 and $178,412,263, respectively, for a
total of $381,241,745. While the Series B Notes bear a variable rate of
interest, the Company has purchased interest rate protection to cap the annual
rate of interest at 10.0%, the cost of which is amortized in determining the
spread to LIBOR. The total interest cost of either series of Senior Secured
Notes will not exceed a 10.0% annual rate to the Company.
As of March 31, 1999, the Company's senior lenders were due a payment of
$100,707,261, representing the Excess Cash as defined in the Plan. Payment of
the Excess Cash to the debt indenture trustee occurred on April 1, 1999.
14
<PAGE>
The Company's Senior Secured Notes are secured by substantially all of the
assets of the Company and its domestic subsidiaries, which have guaranteed the
Company's obligations under the Senior Secured Notes.
The New Senior Subordinated Notes, with an aggregate principal amount of $22.5
million, have an 11% annual fixed rate of interest, payable quarterly and are
due March 23, 2002.
No dividends may be paid on the common stock of the Company unless certain
conditions in the indentures governing the New Senior Secured Notes and the New
Senior Subordinated Notes are satisfied.
9. Stock Options.
-------------
Under the Plan of Reorganization, options to purchase 950,000 shares of the
Company's authorized and unissued New Common Stock were reserved under the
Amended and Restated 1989 Stock Option Plan ("Stock Option Plan"). Under the
Stock Option Plan, options to purchase 500,000 shares were granted to officers
and directors, effective March 23, 1999 ("Grant Date"), at an exercise price of
$8.50 per share (the estimated reorganization value per share). Of the shares
granted, fifty percent (50%) vested and became exercisable on the Grant Date,
twenty-five percent (25%) vest and become exercisable in twelve (12) equal
monthly portions, beginning with the first anniversary of the Grant Date and
twenty-five percent (25%) vest and become exercisable in twelve (12) equal
monthly portions, beginning with the second anniversary of the Grant Date. The
options shall remain in full force and effect for a period of ten (10) years
from the Grant Date.
In addition to shares granted under the Stock Option Plan, an option to purchase
1,000,000 shares was granted to the new chief executive officer of the Company
pursuant to an employment agreement approved as part of the Plan of
Reorganization. The terms and conditions of the option granted are identical to
the options granted under the Stock Option Plan as described above. Shares
issued under the employment agreement do not count against the 950,000 aggregate
number of options to purchase shares of New Common Stock that may be granted
under the Stock Option Plan.
10. Reorganization Items.
--------------------
In accordance with SOP 90-7, expenses resulting from the Plan of Reorganization
should be reported separately as reorganization items in the Condensed
Consolidated Statement of Income. These expenses were incurred by the
Predecessor Company and are summarized below:
15
<PAGE>
<TABLE>
<CAPTION>
Predecessor Company
Three Months Three Months Nine Months
Ended Ended Ended
March 31, 1999 Sept 30, 1998 Sept 30, 1998
-------------- ------------- -------------
<S> <C> <C> <C>
Forbearance fee $ 0 $ 0 $ 14,480
Other including professional fees 36,717 1,731 10,340
-------- ------- --------
$ 36,717 $ 1,731 $ 24,820
======== ======= ========
</TABLE>
11. Extraordinary Item.
------------------
During August, 1999, MFN retired debt with a face value of $52.9 million prior
to scheduled maturity. The debt repurchases resulted in an extraordinary gain of
$2.51 million less tax of $0.99 million.
See note 4 for the impact of the extraordinary item on basic and diluted
earnings per share was as follows:
12. Sale of Finance Receivables and Certain Other Assets.
----------------------------------------------------
On July 29, 1999, the Company announced it had entered into a definitive
agreement to sell substantially all of the non-automotive loan accounts and
certain other assets of 47 direct loan offices of subsidiaries located in Texas,
Louisiana, Mississippi, and Alabama to First Tower Corp. of Jackson,
Mississippi. The sale was completed in September, 1999 for targeted assets held
at 39 of the 47 direct loan offices resulting in a gain of $7.1 million. The
remaining eight offices which are all located in Texas are expected to close
during the fourth quarter of 1999 pending regulatory approval.
Gross receivables and certain assets with a book value of $41.8 million were
sold for $35.2 million in cash net of a post-closing adjustment of up to $2.2
million which is payable to MFN in 12 equal monthly installments, plus interest,
beginning October 1, 1999. Cash proceeds were applied to the book value of the
gross receivables net of related unearned interest and insurance balances,
dealer and loan loss reserves and other related transaction costs to record the
gain.
Gross receivables at the eight Texas locations expected to close in the fourth
quarter of 1999 are approximately $2.9 million. The anticipated financial impact
of this transaction is immaterial.
16
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
Board of Directors and Stockholders
MFN Financial Corporation (f/k/a Mercury Finance Company)
We have reviewed the accompanying condensed consolidated balance sheet of MFN
Financial Corporation and subsidiaries (Reorganized Company) f/k/a Mercury
Finance Company as of September 30, 1999 and the condensed consolidated
statements of income, changes in stockholders' equity and cash flows for the
three-month and six-month period then ended. The condensed consolidated
statements of income, changes in stockholders' equity and cash flows for Mercury
Finance Company for the three-month and nine-month periods ended September 30,
1998 were reviewed by other auditors who issued their reports dated May 14,
1999 and November 13, 1998, respectively. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical review procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying financial statements as of September 30, 1999 and
for the three-month and six-month periods then ended for them to be in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company emerged from chapter 11 of title 11 of the
United States Code on March 23, 1999 and has not had significant operations as a
restructured entity. These matters raise substantial doubt about the ability of
MFN Financial Corporation to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
The condensed consolidated balance sheet as of December 31, 1998, and the
related condensed consolidated statements of income, stockholders' equity and
cash flows for the year then ended (not presented herein) were audited by other
auditors whose report dated March 10, 1999, expressed an unqualified opinion.
Grant Thornton LLP
Chicago, Illinois
November 3, 1999
17
<PAGE>
MFN FINANCIAL CORPORATION
CONDENSED CONSOLIDATED AVERAGE BALANCE SHEETS
<TABLE>
<CAPTION>
Reorganized Predecessor Predecessor
Company Company Company
1999 1999 1998
---------------------- ----------- ---------------------
Three Six Three Three Nine
Months Months Months Months Months
Ended Ended Ended Ended Ended
(Dollars in thousands) Sept 30, Sept 30, March 31, Sept 30, Sept 30,
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents $ 99,507 $ 138,373 $ 201,228 $ 74,507 $ 67,051
Finance receivables 572,246 589,152 633,126 756,329 835,620
Less allowance for finance credit losses 45,433 46,934 51,711 72,952 84,075
Less nonrefundable dealer reserves 37,182 37,289 37,162 37,705 42,952
---------- ---------- --------- --------- ---------
Finance receivables, net 489,631 504,929 544,253 645,672 708,593
Income taxes receivable 23,908 22,347 13,912 52,674 59,410
Furniture, fixtures and equipment, net of
accumulated depreciation 1,236 824 3,600 4,318 4,861
Other assets (including repossessions & goodwill) 8,569 9,704 35,775 21,871 22,558
---------- ---------- --------- --------- ---------
TOTAL ASSETS $ 622,851 $ 676,177 $ 798,768 $ 799,042 $ 862,473
========== ========== ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Post petition liabilities and liabilities not subject
to compromise under reorganization $ 0 $ 0 $ 0 $ 112,548 $ 114,377
Liabilities subject to compromise under
reorganization 0 0 0 623,239 675,489
Interest bearing liabilities 430,204 472,593 708,371 0 0
Other liabilities 97,584 111,875 70,249 0 0
---------- ---------- --------- --------- ---------
TOTAL LIABILITIES 527,788 584,468 778,620 735,787 789,866
TOTAL STOCKHOLDERS' EQUITY 95,063 91,709 20,148 63,255 72,607
---------- ---------- --------- --------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 622,851 $ 676,177 $ 798,768 $ 799,042 $ 862,473
========== ========== ========= ========= =========
RATIOS (annualized)
Return on average equity 54.79% 36.16% 493.60% 51.40% (28.26)%
Return on average assets 8.36% 4.90% 12.45% 4.07% (2.38)%
Yield on interest earning assets 20.78% 20.01% 18.29% 20.61% 20.78%
Rate on interest bearing liabilities 10.06% 9.35% 0.27% 9.84% 9.96%
Net interest margin 14.38% 13.95% 18.06% 13.28% 13.30%
</TABLE>
18
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
"Safe Harbor" Statement under the Securities Litigation Reform Act of 1995: This
Quarterly Report on Form 10-Q for the quarter ended September 30, 1999, contains
certain forward-looking statements pertaining to the outcome of the Company's
Plan of Reorganization, branch closings, expected operating results, loan
originations, loss provisions and other matters. These statements are subject to
uncertainties and other factors. Should one or more of these uncertainties or
other factors materialize, or should underlying assumptions prove incorrect,
actual events or results may vary materially from those anticipated. Such
uncertainties and other factors include the Company's ability to acquire finance
receivables on terms it deems acceptable, changes in the quality of finance
receivables, trends in the automobile and finance industries, and general
economic conditions. The Company undertakes no obligation to update any such
factor or to publicly announce the results of any revisions to any
forward-looking statements contained herein to reflect future events or
developments.
Background
MFN Financial Corporation, f/k/a Mercury Finance Company ("MFN" or the
"Company") is a consumer finance concern engaged, through its operating
subsidiaries, in the business of acquiring individual installment sales finance
contracts from automobile dealers and retail vendors, extending short-term
installment loans directly to consumers and selling credit insurance and other
related products.
MFN'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, MFN 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 MFN'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.
MFN's sales finance contracts and loans generally range for periods from 3
months to 48 months at annual interest rates ranging, with minor exception, from
18% to 40%. Generally all sales finance contracts and loans are repayable in
monthly installments. Late payment fees generally are assessed to accounts which
fail to make their scheduled payments within 10 days of the scheduled due date.
Today MFN's primary strategic focus is the purchasing of installment retail
sales finance contracts from automobile dealers. MFN does this through its
Centralized Purchasing Offices ("CPOs"), branch network and the use of Dealer
Development Managers ("DDMs"). DDMs
19
<PAGE>
service the automobile dealers both in markets where MFN has a branch and where
it does not maintain a physical location.
All purchases of automobile retail installment contracts are handled through
CPOs which serve as the centralized underwriter of credit. The CPOs have
helped the Company apply consistent underwriting standards, which has resulted
in reduced charge-offs on 1998 and 1999 originations as compared to older
accounts.
Overview
In January 1997, MFN discovered that certain improper adjustments had been made
to overstate earnings in previously issued financial statements. See the
Company's Annual Report on Form 10-K for the year ended December 31, 1998 for
more information regarding the impact of the overstatement of earnings and the
restatement of previously issued financial statements.
On July 15, 1998, the Company filed a voluntary petition (the "Voluntary Case")
in the United States Bankruptcy Court for the Northern District of Illinois (the
"Bankruptcy Court" or the "Court") for relief under chapter 11 of title 11 of
the United States Code (the "Bankruptcy Code") along with a Plan of
Reorganization. On March 10, 1999, the Court entered an order confirming the
Company's Second Amended Plan of Reorganization (the "Plan" or "Plan of
Reorganization"). The effective date of the Plan was March 23, 1999 (the
"Effective Date"). On the Effective Date, the Company cancelled its existing
senior and subordinated debt, and its equity securities, including common stock
and options to purchase common stock and distributed to its exchange agent (the
"Exchange Agent"), for the benefit of holders of Senior Debt Claims (as defined
in the Plan), $434.2 million principal amount of its New Senior Secured Notes
due March 23, 2001 (the "Senior Secured Notes"), and 9.5 million shares of new
common stock, par value $0.01 per share ("New Common Stock"). On the Effective
Date, the Company also distributed to the Exchange Agent $22.5 million principal
amount of its 11.0% New Senior Subordinated Notes due March 23, 2002 (the
"Senior Subordinated Notes") for the benefit of the holders of the Company's
subordinated debt. In addition, the Company distributed to the Exchange Agent
$121.1 million in cash on April 1, 1999 for the benefit of holders of Senior
Debt Claims. On the Effective Date, the Company also distributed to the Exchange
Agent, for the benefit of former shareholders of record on March 22, 1999,
500,000 shares of the New Common Stock and three series of warrants (580,000 of
each series) to purchase New Common Stock. The Series A Warrants expire March
23, 2002 and have an exercise price of $15.34, the Series B Warrants expire
March 23, 2003 and have an exercise price of $21.81 and the Series C Warrants
expire March 23, 2004 and have an exercise price of $28.27. The emergence from
the Voluntary Case resulted in a reduction of approximately $161.9 million in
the liabilities of the Company.
As of March 31, 1999, the Company adopted Fresh Start Reporting in accordance
with the American Institute of Certified Public Accountants' Statement of
Position 90-7 "Financial Reporting by Entities in Reorganization under the
Bankruptcy Code" (SOP 90-7). Fresh Start Reporting resulted in material changes
to the Condensed Consolidated Balance Sheet, including valuation of assets at
fair value in accordance with principles of the purchase method of
20
<PAGE>
accounting, valuation of liabilities pursuant to provisions of the Plan and
valuation of equity based on the appraised reorganization value of the ongoing
business.
Due to the Company's emergence from the Voluntary Case and implementation of
Fresh Start Reporting, Condensed Consolidated Financial Statements for the
Reorganized Company as of March 31, 1999 and for the periods subsequent to March
31, 1999 (the "Reorganized Company") are not comparable to those of the Company
for the periods prior to March 31, 1999 (the "Predecessor Company"). For
financial reporting purposes, the effective date (the "Fresh Start Effective
Date") of the Plan of Reorganization is considered to be the close of business
on March 31, 1999. The results of operations for the period from March 23, 1999
through March 31, 1999 were not material.
To facilitate a comparison of the Company's quarterly and year-to-date operating
performance in fiscal years 1999 and 1998, the following discussion of
consolidated financial information may be presented on a traditional comparative
basis for all periods. Consequently, the current year's information presented
below on a year-to-date basis is not in accordance with accounting requirements
for companies upon emergence from bankruptcy which calls for separate reporting
for the reorganized company and the predecessor company.
A black line has been drawn between the accompanying Condensed Consolidated
Balance Sheets as of September 30, 1999 and December 31, 1998, and the Condensed
Consolidated Statement of Income and Cash Flows for the three-month and
six-month periods ended September 30, 1999 and all previous periods to
distinguish between the Reorganized Company and the Predecessor Company.
The results for the interim periods shown for the Reorganized Company and the
Predecessor Company are not to be considered as being indicative of the results
that are expected for the full year.
The following is management's discussion and analysis of the consolidated
financial condition of the Reorganized Company at September 30, 1999 (unaudited)
and the Predecessor Company at December 31, 1998. Consolidated results of
operations are for the three-month and six-month periods ended September 30,
1999 (unaudited) for the Reorganized Company and for the three-month and
nine-month periods ended September 30, 1998 (unaudited) for the Predecessor
Company. Consolidated results of operations for the nine months ended September
30, 1999 (unaudited) represent a combination of Reorganized Company and the
Predecessor Company and careful analysis should be used when interpreting these
results. This discussion should be read in conjunction with the Company's
condensed consolidated financial statements and notes thereto appearing
elsewhere in this quarterly report. Again, the results of operations are for
----------------------------------------
both the Reorganized Company and the Predecessor Company and are not necessarily
- --------------------------------------------------------------------------------
indicative of future results of the Reorganized Company.
- -------------------------------------------------------
21
<PAGE>
FINANCIAL CONDITION
As of March 31, 1999, the Company adopted Fresh Start Reporting in accordance
with the American Institute of Certified Public Accountants' Statement of
Position 90-7 "Financial Reporting by Entities in Reorganization under the
Bankruptcy Code" (SOP 90-7). Fresh Start Reporting resulted in material changes
to the Condensed Consolidated Balance Sheet as previously noted in the Notes to
the Condensed Consolidated Financial Statements.
Assets and Finance Receivables
During the nine month period ended September 30, 1999, total assets of the
Company decreased to $607.2 million from $798.7 million at December 31, 1998.
The decline in total assets was primarily attributable to a required payment
under the Plan of accrued interest and Excess Cash (as defined in the Plan)
totaling $121.1 million and a decrease in finance receivables of $89.9 million.
The Company's offices in Illinois, Florida and Virginia accounted for
approximately 15%, 11%, and 8%, respectively, of all sales and direct finance
receivables outstanding at September 30, 1999. The total number of operating
branches at September 30, 1999 was 66 compared to 105 at June 30, 1999 and 158
at December 31, 1998. The Company closed or stopped acquiring new contracts at
46 branches during the second quarter of 1999. These branches were closed
because of their size, location with respect to other branches or their profit
potential. In addition, the Company believes it can be successful in serving the
dealers within certain of the markets through the efforts of its DDMs, which
will continue to offer MFN's services to automobile dealers in many of the
former locations. The costs related to the closings, consist primarily of lease
settlement, severance and relocation costs. The cost of closing these offices
resulted in a restructuring charge to second quarter earnings of approximately
$1.9 million.
On July 29, 1999, the Company announced it had entered into a definitive
agreement to sell substantially all of the non-automotive loan accounts and
certain other assets of 47 direct loan offices of subsidiaries located in Texas,
Louisiana, Mississippi and Alabama. See Note 12 to the Condensed Consolidated
Financial Statements. The sale was completed in September, 1999 for targeted
assets held at 39 of the 47 direct loan offices resulting in a gain of $7.1
million. After the sale of targeted assets held at the eight remaining Texas
direct loan offices which is expected to close during the fourth quarter of
1999, the Company will have 58 active subsidiary branches located in 20 states.
The 47 direct loan offices sold or pending sale did not fit the strategic focus
of the Company which is the purchasing of automobile retail installment
contracts.
On March 2, 1999, the Company closed on the sale of its credit card portfolio.
As of December 31, 1998, this portfolio had been reduced to its net realizable
value and was classified as held for sale in the December 31, 1998 Condensed
Consolidated Balance Sheet of the Company.
22
<PAGE>
The following table summarizes the composition of finance receivables at the
dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
September 30, June 30, December 31,
1999 1999 1998
---- --- ----
<S> <C> <C> <C>
Gross Finance Receivables
Direct $ 45,637 $ 91,942 $117,136
Sales 632,793 662,779 675,299
--------- -------- --------
Total gross finance receivables 678,430 754,721 792,435
Less: Unearned finance charges 136,448 149,881 146,978
Less: Unearned commissions, insurance
premiums and insurance claim reserves 613 1,718 2,585
--------- -------- --------
Total Sales and Direct Finance Receivables $ 541,369 $603,122 $642,872
========= ======== ========
</TABLE>
Gross sales finance contracts outstanding declined $30.0 million during the
three month period ended September 30, 1999 with $14.8 million of the total
decline attributable to exiting seven targeted markets in Texas and Oklahoma.
Also, $5.5 million of the total decline was attributable to non-automobile sales
finance contracts sold during the quarter.
The following sets forth a summary of gross originations and acquisitions,
excluding activity of the credit card portfolio, for the three and nine months
ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- -----------------
Sept 30, 1999 Sept 30, 1998 Sept 30, 1999 Sept 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Direct finance receivables $16,560 $ 34,267 $ 60,863 $ 94,199
Sales finance receivables 108,548 107,739 376,100 283,839
------- -------- -------- --------
$125,108 $142,006 $436,963 $378,038
======== ======== ======== ========
</TABLE>
The decline in originations of direct finance receivables for the three-month
and nine-month periods ended September 30, 1999 compared to the same periods one
year ago is attributable to the aforementioned sale of 39 direct loan offices
and greater emphasis on purchasing sales finance contracts versus direct
lending.
Purchases of sales finance receivables for the three month period ended
September 30, 1999 showed a slight increase over the same period a year ago.
Originations at this level are lower than the trend experienced in the first six
months of 1999 and are attributable to the closing and sale of the branches
referenced above during the second and third quarters. The Company also decided
to stop originating and purchasing installment contracts in Texas and Oklahoma
since the Company believes that these market areas do not have sufficient profit
potential at the present time. The offices in Texas and Oklahoma have remained
open and the Company may re-evaluate future originations of retail sales finance
receivables in these markets.
23
<PAGE>
The Company anticipates the trend on lower originations to continue through the
fourth quarter as the impact of the closed and sold branches becomes
neutralized. The Company installed software at one CPO location during the third
quarter that will allow the CPOs to become more efficient in processing
transactions and managing dealer relationships. The Company will be deploying
this software at other CPO locations over the next three quarters. The Company
will continue to place a greater emphasis on purchasing sales finance contracts
versus direct lending.
Allowance and Provision for Finance Credit Losses
MFN originates direct consumer loans and acquires individual retail sales
finance contracts from third party dealers. The Company maintains an allowance
for finance credit losses that are expected to be incurred on receivables that
have demonstrated a risk of loss based upon delinquency or bankruptcy status.
The sales finance contracts are generally acquired at a discount from the
principal amount. This discount is normally referred to as a non-refundable
dealer reserve. The amount of the discount is based upon the credit risk of the
borrower, the note rate of the contract and competitive factors. The dealer
reserve is available to absorb credit losses over the life of the pool of
receivables. The dealer reserve is not used to offset provision for finance
credit losses immediately, but rather is amortized over the life of the pool to
offset future losses. Management believes this method provides for an
appropriate matching of finance charge income and provision for finance credit
losses.
Each period, the provision for finance credit losses in the income statement
results from the combination of (a) an estimate by management of loan losses
that occurred during the current period and (b) the ongoing adjustment of prior
estimated losses. As the specific borrower and amount of a loan loss is
confirmed by gathering additional information, taking collateral in full or
partial settlement of the loan, bankruptcy of the borrower, etc., the loan is
charged off, reducing the allowance for finance credit losses. If, subsequent to
a charge off, the Company is able to collect additional amounts from the
borrower or obtain control of collateral worth more than earlier estimated, a
recovery is recorded. This recovery reduces the current period charge off
amounts.
In 1996, the Company 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 charge-offs) into separately
identified pools based upon the period the loans were acquired. MFN defines a
pool as loans acquired within a given month.
Reserve requirements for sales finance and direct receivables are calculated
based on the estimated losses inherent in each category of delinquency (i.e. not
delinquent, 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
24
<PAGE>
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 interim periods noted (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
Sept 30, 1999 Sept 30, 1998 Sept 30, 1999 Sept 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 48,707 $ 78,815 $ 53,485 $ 102,204
Reserves recaptured in conjunction
with sale of finance receivables (3,694) 0 (3,694) 0
Provision charged to expense 9,232 11,467 27,515 39,691
Finance receivables charged-off, net
of recoveries (12,087) (23,193) (35,148) (74,806)
-------- -------- -------- ---------
Balance at end of period $ 42,158 $ 67,089 $ 42,158 $ 67,089
======== ======== ======== =========
Allowance as a percentage of sales and direct finance
receivables, net of unearned income, outstanding at end of period 7.79% 9.95%
======== =========
</TABLE>
The amount of the provision for credit losses decreased in the third quarter of
1999 compared to one year ago due to the decrease in the size of the receivable
portfolio and an improvement in the relative delinquency of the remaining
portfolio. The overall reduction of the reserve as a percentage of the
receivable portfolio occurred primarily in the second half of 1998 as
delinquencies declined and the expected losses inherent in the portfolio
improved. The improvement has continued into the current calendar year through
September 30, 1999.
Nonrefundable Dealer Reserves
MFN acquires a majority of its sales finance contracts from dealers at a
discount. MFN negotiates the amount of the discounts 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 interim
periods ended September 30 (dollars in thousands):
25
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
Sept 30, Sept 30, Sept 30, Sept 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Balance at beginning of period $ 37,863 $ 38,848 $ 36,820 $ 52,731
Reserves recaptured in conjunction with
sale of receivables 95 0 495 0
Discounts acquired on new volume 6,339 6,136 22,258 17,509
Losses absorbed, net of recoveries (8,196) (8,423) (23,072) (33,679)
-------- -------- -------- --------
Balance at end of period $ 36,501 $ 36,561 $ 36,501 $ 36,561
======== ======== ======== ========
Reserves as a percentage of gross sales
finance receivables 5.77% 5.17%
======== ========
Discounts acquired as a percentage of
sales finance receivables originated 5.84% 5.70% 5.92% 6.17%
======== ======== ======== ========
</TABLE>
The increase in the discounts acquired in 1999 compared to the same period last
year is due to increased volume of contracts purchased.
Debt
The primary source for funding the Company's finance receivables comes from the
issuance of debt. As a result of the Plan of Reorganization, the Company
cancelled all of its senior debt in exchange for Senior Secured Notes, New
Common Stock and Excess Cash. The Company also cancelled its subordinated debt
in exchange for Senior Subordinated Notes. At September 30, 1999 the Company had
total debt of $403.7 million, a decline of $52.9 million from June 30, 1999 due
to early retirement of debt. See Notes 2, 8 and 11 to the Condensed Consolidated
Financial Statements.
The following table presents the Company's debt instruments and the stated
interest rates on the debt at the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
Balance Rate Balance Rate
<S> <C> <C> <C> <C>
Senior debt:
Commercial paper and short-term loans $ - - $339,340 5.7%
Senior secured debt 381,242 10.0% 335,905 7.0%
Senior subordinated debt 22,500 11.0% 22,500 10.3%
-------- ---- -------- ----
Total $403,742 10.0% $697,745 6.5%
======== ==== ======== ====
</TABLE>
26
<PAGE>
The Senior Secured Debt is comprised of both fixed and variable rate notes. Due
to the purchase of an interest rate cap, the all-inclusive cost on this debt is
10.0% to the Company and is combined in this table.
Stockholders' Equity
As of March 31, 1999, the Company adopted Fresh Start Reporting in accordance
with SOP 90-7. Fresh Start Reporting resulted in material changes to the
Condensed Consolidated Balance Sheet.
The reorganization value of $85.0 million (the approximate fair value) was based
on the consideration of many factors and various valuation methods, including
discounted cash flows, selected publicly traded company market multiples and
other applicable ratios and valuation techniques believed by the Company and its
financial advisors to be representative of the Company's business and industry.
As a result of the Plan of Reorganization and the requirements of Fresh Start
Reporting, stockholders' equity at March 31, 1999 was established at the
Company's reorganization value of $85.0 million. See notes 2 and 3 of the
Condensed Consolidated Financial Statements.
At September 30, 1999, total stockholders' equity stood at $101.6 million and
represented 16.74% of total assets.
RESULTS OF OPERATIONS
The results of operations shown in the accompanying Financial Statements are for
both the Reorganized Company and the Predecessor Company. MFN adopted Fresh
Start Reporting in accordance with SOP 90-7 effective March 31, 1999. To
facilitate a meaningful comparison of the Company's quarterly and year-to-date
operating performance in fiscal years 1999 and 1998, the following discussion of
consolidated financial information may be presented on a traditional comparative
basis for all periods. Consequently, the current year's information presented
below on a year-to-date basis is not in accordance with accounting requirements
for companies upon emergence from bankruptcy which calls for separate reporting
for the reorganized company and the predecessor company.
Net Income
For the three months ended September 30, 1999 the Company had net income of
$13.1 million, including an extraordinary gain on early retirement of debt of
$2.51 million, less income taxes of $0.99 million.
27
<PAGE>
Interest Income and Interest Expense
The largest single component of net income is net interest income which is the
difference between interest earned on finance receivables and interest paid on
borrowings. For the three months ended September 30, 1999 the Company's net
interest income was $24.4 million compared to $40.4 million for the same period
one year ago.
The net interest margin is the ratio of net interest income before provision for
finance credit losses divided by average interest earning assets. The net
interest margin was 14.38% in the third quarter of 1999 compared with 13.28% in
the third quarter of 1998. The increase is primarily attributable to a 107 basis
point improvement on the yield on finance receivables compared to the same
period one year ago.
The following table summarizes the amount of the net interest margin for the
three month periods ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended September 30, 1999 September 30, 1998
- ------------------ ------------------ ------------------
Annualized Annualized
Average Interest Rate Average Interest Rate
Out- Income/ Earned Out- Income/ Earned
standing Expense and Paid standing Expense and Paid
-------- ------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest earning assets $671,753 $35,180 20.78% $830,836 $43,153 20.61%
Interest bearing liabilities 430,204 10,825 10.06% 623,239 15,339 9.84%
-------- ------- -------- -------- ------- --------
Net interest income $241,549 $24,355 10.72% $207,597 $27,814 10.77%
======== ======= ======== ======== ======= ========
Net interest margin as a
percentage of average interest
earning assets (annualized) 14.38% 13.28%
======== ========
</TABLE>
During the three-month period ended September 30, 1998, the Predecessor Company
did not incur interest expense during the bankruptcy proceedings. For
comparative analysis purposes, prior management computed an estimate of the
amount of interest expense that would have been incurred had the bankruptcy case
not been filed. The above table reflects this estimate of $12.6 million.
Other Income
In addition to finance charges and interest, the Company has other 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.
During the three-month and nine-month periods ended September 30, 1999, other
income increased $6.6 million or 252.2% and $6.4 million or 72.9%, respectively,
versus the same periods one year ago. During the third quarter of 1999, the
Company realized a $7.1 million gain on the sale of finance receivables and
certain assets. See Note 12 to the Company's Condensed Consolidated Financial
Statements. Other income generated by the credit card portfolio decreased $0.7
million and $2.0 million during these respective periods. The sale of the
portfolio was finalized on March 2, 1999 and no credit card related revenue or
expense was recorded in 1999. Excluding the impact of the gain on sale of
finance receivables and credit card related
28
<PAGE>
revenue, other income during the three-month and nine-month periods ended
September 30, 1999 increased 15.3% and 19.7%, respectively, versus the same
periods one year ago primarily attributable to improved claim experience on the
sale of self-insured insurance products. The following table summarizes the
amounts earned from these products for the periods ended September 30 (dollars
in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
Sept 30, Sept 30, Sept 30, Sept 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Fees, insurance commissions and premiums $ 1,875 $ 1,513 $ 6,434 $ 5,467
Credit card related revenue and other 333 1,118 1,659 3,295
Gain on sale of finance receivables 7,058 0 7,058 0
------- -------- -------- -------
Total $ 9,266 $ 2,631 $ 15,151 $ 8,762
======= ======== ======== =======
Other income as a % of average assets
(annualized) 5.95% 1.32% 2.86% 1.35%
======= ======== ======== =======
</TABLE>
Other Expenses
In addition to interest expense and the provision for finance credit losses, the
Company incurs other operating expenses in the conduct of its business.
During the three-month and nine-month periods ended September 30, 1999, other
operating expenses decreased $8.5 million or 39.4% and $12.2 million or 19.6%,
respectively, versus the same periods one year ago. Credit card related expenses
declined $1.7 million and $4.7 million, respectively, as a result of the
aforementioned portfolio sale. Salary and benefits decreased $0.9 million and
$1.7 million, respectively, attributable to staff reductions. Equipment expense
declined $0.4 million and $1.0 million, respectively, primarily attributable to
a decline in depreciation.
During the three-month period ended June 30, 1999, the Company implemented a
plan to close a total of 46 branches. The Company recorded a provision against
earnings in the amount of $1.9 million to cover estimated severance, relocation
costs and lease termination costs. This cost is included in other operating
expenses and is summarized below (dollars in thousands):
<TABLE>
<CAPTION>
Amounts charged to Amounts to
expense in the six Amounts be utilized
month period ended Utilized in subsequent to
Sept 30, 1999 1999 Sept 30, 1999
------------- ----------- -------------
<S> <C> <C> <C>
Lease buyouts and other expenses $ 998 $ 217 $ 781
Employee severance and retention 952 333 619
------- ------- -------
$ 1,950 $ 550 $ 1,400
======= ======= =======
</TABLE>
29
<PAGE>
Annual operating expense savings of approximately $3.0 million are anticipated
as a result of this announcement.
The excess of revalued net assets over stockholders' investment totaling $49.4
million recorded on March 23, 1999 as a result of Fresh Start Reporting is being
amortized over a 60 month period resulting in a $2.5 million reduction in total
other operating expense for the three-month period ended September 30, 1999 and
a $4.9 million reduction in total other operating expense for the nine-month
period ended September 30, 1999.
The nine-month period ended September 30, 1998 included a reduction of other
operating expense of approximately $2.0 million related to the termination
agreement with a former chief executive officer.
The following table summarizes the components of other expenses for the interim
periods ended September 30 (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- --------------------------
Sept 30, Sept 30, Sept 30, Sept 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Salaries and employees benefits.................... $ 10,774 $ 11,720 $ 35,339 $ 37,069
Other operating expenses........................... 2,320 9,905 14,493 24,932
-------- -------- -------- --------
Total.............................................. $ 13,094 $ 21,625 $ 49,832 $ 62,001
======== ======== ======== ========
Other expense as a percentage of average
assets (annualized) 8.41% 10.83% 9.40% 9.58%
===== ====== ===== =====
</TABLE>
During 1997 and 1998, the Company closed a number of branches and implemented a
plan to close approximately 110 branches and to reduce branch personnel by
approximately 260 employees. The Company recorded a provision in 1997 for
restructuring in the amount of $3.7 million of which $3.5 million has been
utilized through September 30, 1999. The $0.2 million difference was credited to
expense during the third quarter as all anticipated charges have been paid.
These charges and their utilization are summarized in the following table
(dollars in thousands):
<TABLE>
<CAPTION>
Net Amounts to
Amounts Adjustments be Utilized
Amounts Utilized Amounts through Sept Subsequent
Charged 1997 and Utilized 30, 1999 to Sept 30,
In 1997 1998 In 1999 (Exp)/Income 1999
------- ---- ------- ------------ ----
<S> <C> <C> <C> <C> <C>
Asset and leasehold write-offs $ 1,200 $ 1,279 $ 0 $ (79) $ -
Lease buyouts and other expenses 1,025 900 318 (193) -
Employee severance and retention 1,500 652 104 744 -
------- -------- -------- ----------- -----------
$ 3,725 $ 2,831 $ 422 $ 472 $ -
======= ======== ======== =========== ===========
</TABLE>
30
<PAGE>
The Company records restructuring charges against operations and provides a
reserve based on the best information available at the time the commitment is
made to undertake the restructuring action. The reserves are considered utilized
when specific restructuring criteria are met, indicating the planned
restructuring action has occurred. Work-force-related reserves are considered
utilized at payment for termination or acceptance of other contractual
arrangements.
The reserve for lease buyouts is utilized when the remaining lease obligations
are settled or the space has been vacated and made available for sublease. It is
the Company's policy to continue to charge depreciation, rental, and other
operating costs relating to excess space to ongoing operations while they remain
in business use. Salaries and benefits are charged to operations while the
employee is actively employed.
Reserves for asset and leasehold improvement write-offs are utilized at the date
of disposal or the final date of the lease.
Reorganization Items
In accordance with SOP 90-7, expenses resulting from the Plan of Reorganization
should be reported separately as reorganization items in the Condensed
Consolidated Statement of Income. These expenses were incurred by the
Predecessor Company and are summarized below (dollars in thousands):
<TABLE>
<CAPTION>
Predecessor Company
Three Months Three Months Nine Months
Ended Ended Ended
March 31, 1999 Sept 30, 1998 Sept 30, 1998
-------------- ------------- -------------
<S> <C> <C> <C>
Forbearance fee $ 0 $ 0 $ 14,480
Other including professional fees 36,717 1,731 10,340
-------- ------ --------
$ 36,717 $1,731 $ 24,820
======== ====== ========
</TABLE>
Income Taxes
The provision for income taxes recorded for the three month period ended
September 30, 1999 was calculated using a 39.5% tax rate on earnings before
income taxes adjusted for (1) the amortization of the excess of revalued net
assets over stockholders' investment, which is a permanent difference between
book and tax income, and (2) an unrealized benefit related to the first quarter
of 1999 book loss (before extraordinary credit). The unrealized benefit of the
first quarter of 1999 book loss (before extraordinary credit) was believed to be
limited. The Company believes that any current year book loss will be utilized
against the deferred taxes associated with the first quarter gain on
cancellation of debt or future taxable income.
The Company recorded a full valuation allowance related to the tax benefit for
the loss recorded during the first nine months of 1998. At that time, the
Company was unable to carryback the losses to prior periods of taxable income.
31
<PAGE>
CREDIT LOSSES AND DELINQUENCIES
The credit loss and delinquency information below are for both the Reorganized
Company and the Predecessor Company.
Credit Losses
Finance receivable accounts which are contractually delinquent 120 days and 90
days on a recency basis are charged off monthly before they become 150 days
contractually 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 (dollars in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
Sept 30, Sept 30, Sept 30, Sept 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Loss provision charged to income $ 9,232 $11,467 $27,515 $39,691
Net charge-offs against allowance 12,087 23,193 35,148 74,806
Net charge offs against nonrefundable dealer reserves 8,196 8,423 23,072 33,679
Allowance for finance credit losses at end of period 42,158 67,089
Dealer reserves at end of period 36,501 36,561
Net charge offs annualized against allowance
to average total finance receivables 8.38% 12.15% 7.80% 11.96%
Net charge offs annualized against nonrefundable
dealer reserves to average total finance receivables 5.68% 4.41% 5.12% 5.38%
Allowance for finance credit losses to total gross
finance receivables at end of period 6.21% 6.11%
Dealer reserves to gross sales finance receivables
at end of period 5.77% 5.17%
</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):
32
<PAGE>
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
---- ----
<S> <C> <C>
Delinquent gross receivables $9,212 $19,938
Bankrupt accounts 15,817 23,607
Repossessed assets, net 2,928 3,836
------- -------
Total $27,957 $47,381
======= =======
Delinquent gross receivables and bankrupt
accounts to gross finance receivables 3.69% 5.49%
Delinquent gross receivables, bankrupt
accounts and repossessed assets to gross
finance receivables plus repossessed asset 4.10% 5.95%
</TABLE>
Repossession of collateral generally occurs when debtors are 60 to 90 days late
on payments. Repossession activities have been consolidated within the Company
and many of the activities have been outsourced to another party, which handles
the pickup of collateral and delivery to auction. Automobiles are generally sold
within 60 days at auction.
While delinquency and repossession numbers show improvement at September 30,
1999 compared to prior periods, the impact of closing or exiting 46 branch
locations during the second quarter may impact negatively on the trend which has
been experienced over the past several quarters.
LIQUIDITY AND FINANCIAL RESOURCES
The Company has sufficient cash flow from cash collections on finance
receivables to meet the current funding requirements of new originations and
purchases of finance receivables. In addition, at September 30, 1999 the Company
had $105.5 million in cash and short-term investments, which can be used to fund
future growth of finance receivables and other corporate activities.
The Company has $381.2 million of funding through March 23, 2001 in the form of
Senior Secured Notes and an additional $22.5 million of funding through March
23, 2002 in the form of Senior Subordinated Notes. See Notes 2 and 8 to the
Condensed Consolidated Financial Statements.
33
<PAGE>
CONTINGENCIES AND LEGAL MATTERS
On July 15, 1998, the Company filed a voluntary petition (the "Voluntary Case")
in the United States Bankruptcy Court (the "Court") for the Northern District of
Illinois for relief under chapter 11 of title 11 of the United States Code. The
Company's Second Amended Plan of Reorganization (the "Plan") was confirmed by
order of the Court on March 10, 1999. The effective date of the Plan was March
23, 1999.
Prior to the filing of the Voluntary Case, the Company had been named as a
defendant in a variety of lawsuits ("Securities Fraud Claims") generally arising
from the Company's announcement on January 29, 1997 that it would restate its
earnings for certain prior periods as a result of the discovery of accounting
irregularities. The Plan provided that the Company transfer to a certain trust
established under the Plan (the "Liquidating Trust"), (i) $5 million in cash,
(ii) the Company's claims against the Company's previous auditors and (iii)
$250,000 in cash for fees and costs to be incurred in connection with the
Liquidating Trust. The Plan also provided for holders of Securities Fraud Claims
to receive a share of the beneficial interests in the Liquidating Trust in
complete settlement, satisfaction and discharge of their claims.
The Securities and Exchange Commission is investigating the events giving rise
to the accounting irregularities. Those events are also under investigation by
the United States Attorney for the Northern District of Illinois and the Federal
Bureau of Investigation. The Company is cooperating fully in these
investigations.
In the normal course of its business, MFN and its subsidiaries are named as
defendants in legal proceedings. A number of such actions, including cases which
have been brought as putative class actions, are pending in the various states
in which subsidiaries of MFN conducts business. It is the policy of MFN and its
subsidiaries to vigorously defend litigation, however, MFN 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 MFN, 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, 1998, for more information regarding the litigation arising from
the overstatement of earnings and the restatement of previously issued financial
statements.
34
<PAGE>
The Company recognizes the expense for litigation when the incurrence of loss is
probable and the amount of such loss is estimable. Because of the uncertainty
that surrounds the above described litigation, no accrual has been made for the
majority of these lawsuits. An accrual was recorded at March 31, 1999 in the
amount of $250,000 for costs and expenses of certain officers, agents and
employees who were no longer employed by the Company as of the first day
immediately following March 23, 1999, in connection with their participation in
a government investigation. As of September 30, 1999, the remaining amount of
this accrual to utilize is $241,000.
YEAR 2000 COMPLIANCE
The Company has undertaken a review of its exposure to computer malfunctions
relating to the year 2000 ("Y2K"). The Y2K issue exists because many computer
systems and applications currently use two digit date fields to designate a
year. As the century date change occurs, date sensitive systems may recognize
the year 2000 as 1900 or not at all. This inability to recognize or properly
treat the Y2K issue may cause systems to process critical financial and
operational information incorrectly.
The Company has several systems that it considers critical to operations
including the branch loan system, the operating systems, and the financial
accounting systems. In addition, MFN has other less significant systems in use
by the human resources and legal departments. MFN has evaluated all of these
systems to determine the specific risks related to the Y2K and has implemented
changes to all of these systems to address risks. As a result of these efforts,
all of the Company's systems are currently Y2K compliant. MFN also utilizes
computer software maintained by external vendors and has received written
assurances from these vendors that Y2K compliant upgrades are installed and
operational.
To date, the costs associated with becoming Y2K compliant have been minimal
(i.e., less than $50,000). These costs have been expensed as incurred, while the
costs of new software is capitalized and amortized over the software's useful
life.
RECENT ACCOUNTING PRONOUNCEMENTS
During 1998, the FASB issued SFAS 133 and 134, "Accounting for Derivative
Instruments and Hedging Activities" and "Accounting for Mortgage-Backed
Derivative Securities Retained After the Securitization of Mortgage Loans Held
for Sale by a Mortgage Banking Enterprise", effective for fiscal years beginning
after June 15, 1999 and December 15, 1998, respectively. During the second
quarter of 1999, the FASB voted to delay for one year the effective date of
SFAS133 until June 15, 2000. Management does not expect these statements to have
a material impact on either the financial position, results for operations or
financial statement disclosures of the Company.
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
None.
35
<PAGE>
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings - See "Item 2 - Management's Discussion and Analysis
of Financial Condition and Results of Operations - Contingencies and
Legal Matters" which is incorporated herein by reference.
Item 2. Changes in Securities - None.
Item 3. Defaults Upon Senior Securities - None.
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - See Exhibit Index following the signature page
(b) Reports on Form 8-K - The Company did not file any Current
Reports on Form 8-K during the quarter ended September 30, 1999
36
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MFN FINANCIAL CORPORATION
(Registrant)
Date: November 12, 1999 /s/ Edward G. Harshfield
------------------------
Edward G. Harshfield
Chairman and
Chief Executive Officer
Date: November 12, 1999 /s/ Jeffrey B. Weeden
---------------------
Jeffrey B. Weeden
President and
Chief Operating Officer
Date: November 12, 1999 /s/ Mark D. Whitham
-------------------
Mark D. Whitham
Principal Accounting Officer
37
<PAGE>
INDEX OF EXHIBITS
Exhibit No. Description
---------- -----------
11. Computation of Net Income Per Share
27. Financial Data Schedule
38
<PAGE>
MFN FINANCIAL CORPORATION
EXHIBIT 11
COMPUTATION OF NET INCOME PER SHARE
PERIOD ENDED SEPTEMBER 30, 1999
Basic earnings per share is computed based upon the weighted average number of
shares of the Company's common stock outstanding during the period. Diluted
earnings per share is computed based upon the weighted average number of shares
of common stock outstanding and the dilutive common stock equivalents during the
period. Common stock equivalents include options granted to executive officers
and directors and warrants outstanding convertible into shares of common stock
of the Company using the treasury stock method.
<TABLE>
<CAPTION>
(Dollars in thousands, except per share amounts) Three Months Ended Six Months Ended
September 30, 1999 September 30, 1999
------------------ ------------------
<S> <C> <C>
BASIC
Net income $ 13,128 $ 16,627
Average common shares outstanding 10,000,000 10,000,000
Earnings before extraordinary credit $ 1.16 $ 1.51
Extraordinary gain from early retirement of debt 0.15 0.15
------------ -----------
Net income per common share $ 1.31 $ 1.66
============ ===========
DILUTED
Net income $ 13,128 $ 16,627
Average common shares and equivalents outstanding 10,054,269 10,087,248
Earnings before extraordinary credit $ 1.16 $ 1.50
Extraordinary gain from early retirement of debt 0.15 0.15
------------ -----------
Net income per common share $ 1.31 $ 1.65
============ ===========
</TABLE>
Due to the Company's emergence from the Voluntary Case and the implementation of
Fresh Start Reporting, the presentation of earnings per share for the
Predecessor Company is not meaningful in the accompanying financial statements.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 105,453
<SECURITIES> 0
<RECEIVABLES> 541,369
<ALLOWANCES> (78,659)
<INVENTORY> 0
<CURRENT-ASSETS> 37,346
<PP&E> 1,691
<DEPRECIATION> (46)
<TOTAL-ASSETS> 607,154
<CURRENT-LIABILITIES> 101,785
<BONDS> 403,742
0
0
<COMMON> 100
<OTHER-SE> 101,527
<TOTAL-LIABILITY-AND-EQUITY> 607,154
<SALES> 0
<TOTAL-REVENUES> 44,446
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 13,094
<LOSS-PROVISION> 9,232
<INTEREST-EXPENSE> 10,825
<INCOME-PRETAX> 11,295
<INCOME-TAX> (313)
<INCOME-CONTINUING> 11,608
<DISCONTINUED> 0
<EXTRAORDINARY> 1,520
<CHANGES> 0
<NET-INCOME> 13,128
<EPS-BASIC> $1.31
<EPS-DILUTED> $1.31
</TABLE>
