<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
------------------------------------------------------------------------
Date of Report: March 31, 1999
First Merchants Acceptance Corporation
-----------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 0-24686 36-3759045
---------- --------------- -----------------
(State of incorporation (Commission (IRS Employer of
or other jurisdiction) File Number) Identification No.)
303 W. Erie, Suite 410, Chicago, Illinois 60610
-----------------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(312) 397-3100
---------------
(Registrants telephone number)
<PAGE> 2
FIRST MERCHANTS ACCEPTANCE CORPORATION
(REORGANIZED)
CONSOLIDATED STATEMENT OF DEFICIENCY IN NET ASSETS AVAILABLE IN LIQUIDATION
(LIQUIDATION BASIS)
<TABLE>
<CAPTION>
Dollars and amounts in thousands As of December 31,
-----------------------
1998 1997
---- ----
<S> <C> <C>
ASSETS
Cash $ 184 $ 284
Finance receivables, net of allowance
for credit losses of $6,438 and $12,289, respectively 26,777 68,106
Residuals in finance receivables sold 6,405 16,440
Investments held in trust 29,149 20,550
Due from trusts --- 2,279
Income tax refunds receivable 3,020 12,170
Repossessed collateral 402 1,288
Property and equipment, held for sale --- 625
UDC Warrants 116 ---
Other assets --- 434
-------- --------
Total assets 66,053 122,176
-------- --------
LIABILITIES
Debtor-in-possession financing 11,678 10,318
Secured borrowings under working capital line of credit --- 554
Notes payable - securitized pools 20,403 60,291
Obligation due under secured claim recovery amount 4,928 9,410
Obligations due under Excess Collections Split Agreement
and Modified UDC Fee 7,082 9,553
Accounts payable - pre petition --- 1,046
Accounts payable and accrued expenses - post petition 678 3,935
New debt of reorganized company 44,000 44,000
-------- --------
Total liabilities 88,769 139,107
-------- --------
Deficiency in net assets available in liquidation $(22,716) $(16,931)
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 3
FIRST MERCHANTS ACCEPTANCE CORPORATION
(REORGANIZED)
CONSOLIDATED STATEMENT OF CHANGES IN DEFICIENCY IN NET ASSETS
AVAILABLE IN LIQUIDATION
(LIQUIDATION BASIS)
Dollars in thousands
<TABLE>
<S> <C>
Stockholders' Deficit
at December 31, 1997 (date liquidation basis of
accounting was adopted) $(46,114)
Effect of adoption of liquidation basis of
accounting, debt discharged upon confirmation
of the Plan of Reorganization 29,183
--------
Deficiency in net assets available in liquidation
at December 31, 1997 (16,931)
Changes in components in net deficiency in net, assets in liquidation
for the year ended December 31, 1998
Interest income - finance receivable 10,934
Other portfolio income 2,083
Servicing fees 3,413
Interest expense (4,236)
Employee compensation and related costs (2,991)
Other operating expenses (12,003)
Changes in estimates (see Note 15) (2,985)
--------
Net change in deficiency in net assets in liquidation (5,785)
--------
Deficiency in net assets available in liquidation at
December 31, 1998 $(22,716)
========
Changes in components increase (decrease) of the net deficiency
in liquidation for the year ended December 31, 1998
Cash $ (100)
Finance receivables, net (39,520)
Residuals in finance receivables sold, net (2,415)
Investments held in trusts 8,599
Due from trusts (2,279)
Income tax refund receivable (9,150)
Repossessed collateral (886)
Other assets (434)
Secured borrowings and DIP Facility, net (806)
Notes payable - securitized pools 39,888
Accounts payable - pre-petition 1,046
Accounts payable and accrued expenses post-petition 3,257
Net change in assets or liabilities due to change
in estimates (see Note 15) (2,985)
--------
Net change in deficiency in net assets in liquidation $ (5,785)
========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 4
FIRST MERCHANTS ACCEPTANCE CORPORATION
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF OPERATIONS
(GOING CONCERN BASIS)
FOR THE YEAR ENDED DECEMBER 31, 1997
Dollars and amounts in thousands except per share data
<TABLE>
<S> <C>
Revenues
Interest income - finance receivables $ 37,098
Other portfolio income 1,395
Loss on sale of finance receivables (6,892)
Servicing fees 14,311
--------
Total revenues 45,912
--------
Expenses
Interest expense 20,920
Provision for credit losses 11,451
Operating expenses:
Employee compensation and related costs 24,110
Other operating expenses 20,167
--------
Total expenses 76,648
--------
(Loss) before reorganization expenses (30,736)
Reorganization expenses 31,603
--------
Net (loss) $(62,339)
========
Basic (loss)per share $ (9.67)
Diluted (loss) per share (9.67)
Weighted average number of common shares 6,448
</TABLE>
Effective December 31, 1997, the Company changed to the liquidation basis of
accounting as explained in Note 2. Therefore, this presentation format is no
longer applicable. The effect of adopting the liquidation basis of accounting is
reported in the consolidated statement of changes in deficiency in net assets
available in liquidation.
See accompanying notes to consolidated financial statements.
<PAGE> 5
FIRST MERCHANTS ACCEPTANCE CORPORATION
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(GOING CONCERN BASIS)
FOR THE YEAR ENDED DECEMBER 31, 1997 Dollars and amounts in thousands except per
share data
<TABLE>
<CAPTION>
Additional
Common Paid-in Treasury Retained Equity
Stock Capital Stock (Deficit) (Deficit)
<S> <C> <C> <C> <C> <C>
Balance December 31, 1996 $ 65 $75,040 $ -- $ (57,050) $ 18,055
Purchase of 134 shares of common stock -- -- (1,830) -- (1,830)
Net loss -- -- -- (62,339) (62,339)
------- ------- ------- ---------- ---------
Balance December 31, 1997 $ 65 $75,040 $(1,830) $ (119,389) $ (46,114)
======= ======= ======= ========== =========
</TABLE>
Effective December 31, 1997, the Company changed to the liquidation basis of
accounting as explained in Note 2. Therefore, this presentation format is no
longer applicable. The effect of adopting the liquidation basis of accounting is
reported in the consolidated statement of changes in deficiency in net assets
available in liquidation.
See accompanying notes to consolidated financial statements.
<PAGE> 6
FIRST MERCHANTS ACCEPTANCE CORPORATION
(DEBTOR-IN POSSESSION)
CONSOLIDATED STATEMENT OF CASH FLOWS
(GOING CONCERN BASIS)
FOR THE YEAR ENDED DECEMBER 31, 1997
Dollars in thousands
<TABLE>
<S> <C>
Cash Flows From Operating Activities
Net (loss) $(62,339)
Adjustments to reconcile net (loss) to net
cash provided by operating activities:
Provision for credit losses 11,452
Loss on sale of finance receivables 6,892
Depreciation 2,183
Amortization of debt issuance costs 347
Amortization of securitization discount 19
(Increase) decrease in:
Accrued interest income and deferred revenue 3,237
Due from trusts (1,241)
Other assets 2,062
Income taxes receivable (1,354)
Increase (decrease) in:
Accounts payable and accrued expenses (11,161)
Obligation due under secured claim recovery
amount 9,410
Reorganization items:
Obligation due under Excess Collections Split
Agreement and Modified UDC Fee obligation 9,553
Impairment of property and equipment 8,907
Provision for rejected executory contracts
and real property leases 3,798
Employee retention program 3,131
Professional fees and other 3,076
Write-off of pre-petition debt issuance costs 2,018
Loss on sale of finance receivables 1,120
Purchases of finance receivables held for sale (224,933)
Proceeds from sales of finance receivables
held for sale 279,182
--------
Net cash flows provided by operating activities 45,359
--------
Cash Flows From Investing Activities
Principal payments on finance receivables, net 67,552
Increase in investments held in trust, net (1,299)
Residuals in finance receivables sold, net (9,572)
Purchases of property and equipment (6,058)
Proceeds from sales of property and equipment 1,013
--------
Net cash flows provided by investing activities 51,636
--------
</TABLE>
<PAGE> 7
FIRST MERCHANTS ACCEPTANCE CORPORATION
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF CASH FLOWS - CONTINUED
(GOING CONCERN BASIS)
FOR THE YEAR ENDED DECEMBER 31, 1997
Dollars in thousands
<TABLE>
<S> <C>
Cash Flows From Financing Activities
Purchase of treasury stock (1,830)
Repayment of notes payable - securitized pools (73,437)
Increase in debtor-in-process financing, net 10,318
Increase in secured borrowings under
working capital line of credit, net 554
Net borrowings (payments) under
senior revolving credit facility (33,300)
--------
Net cash flows (used in) financing activities (97,695)
--------
Net (decrease) in cash (700)
Cash balance beginning of year 984
--------
Cash balance end of year $ 284
========
</TABLE>
Effective December 31, 1997, the Company changed to the liquidation basis of
accounting as explained in Note 2. Therefore, this presentation format is no
longer applicable. The effect of adopting the liquidation basis of accounting is
reported in the consolidated statement of changes in deficiency in net assets
available in liquidation.
See accompanying notes to consolidated financial statements.
<PAGE> 8
FIRST MERCHANTS ACCEPTANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- BANKRUPTCY PROCEEDINGS
First Merchants Acceptance Corporation (the "Company") was a specialty consumer
finance company engaged in financing the purchase of automobiles through the
acquisition of dealer-originated retail installment contracts ("finance
contracts") collateralized by the underlying automobiles.
The Company's acquisition of finance contracts was principally funded by a
senior revolving credit facility (the "Senior Revolving Credit Facility") with a
nine-member bank group (the "Bank Group") and by a series of securitization
transactions (the "Securitized Pools"). The Senior Revolving Credit Facility was
secured by certain finance contracts (the "Owned Contracts") pledged to the Bank
Group. The securitization transactions were secured by certain finance contracts
pledged to the securitization trusts. In 1995 and 1996, the Company issued
subordinated debt (the "1995 Notes" and "1996 Notes") which were unsecured
obligations.
In 1996, the Company experienced substantial delinquencies and losses with
respect to its portfolio of finance contracts. Certain members of the Company's
senior management made unauthorized entries in the Company's accounting records
in an effort to conceal delinquencies and credit losses and their corresponding
effects on the Company's financial statements. Because of the accounting
irregularities, the Company was out of compliance with certain representations
and covenants under its financing arrangements and securitization agreements.
Although all payments due under such financing arrangements had been made on a
timely basis, an event of default existed with respect to the Senior Revolving
Credit Facility which by its terms, expired on June 30, 1997. The Company and
the Bank Group attempted to negotiate various workout and forbearance agreements
but, as of the maturity date of the Senior Revolving Credit Facility, no
agreement was reached. In early July 1997, the Bank Group refused to honor the
Company's checks. On July 11, 1997, the Company filed a voluntary petition (the
"Chapter 11 Petition") for reorganization under Chapter 11 of the United States
Bankruptcy Code (the "Chapter 11 Proceeding") in the District of Delaware (the
"Bankruptcy Court").
After filing the Chapter 11 Petition, the Company managed its business as a
"debtor-in-possession" subject to the supervision and control of the Bankruptcy
Court. As the Company's assets were pledged to secure obligations to its
lenders, the Company, as the servicer of the Owned Contracts and Securitized
Pools, was required to remit all cash collections received on the loan pools to
its lenders or to the securitization trusts. Because of a lack of available
funding, the Company had discontinued its purchases of finance contracts and
implemented a number of cost saving measures including the closure of its
origination branch offices and the reduction of its workforce.
First Merchants Residential Credit Corporation ("FMRCC"), a subsidiary of the
Company established for the purpose of originating home mortgage loans, filed a
Chapter 11 Petition on September 9, 1997. Its primary
<PAGE> 9
assets were sold at auction on September 22, 1997 resulting in a loss of
approximately $385,000.
DIP FACILITY
At the commencement of the Company's Chapter 11 Proceeding, the Ugly Duckling
Corporation ("UDC") agreed to provide up to $10 million of "debtor-in-
possession" financing (the "DIP Facility"). Borrowings under the DIP Facility
originally were to mature on February 28, 1998 and accrue interest at the rate
of 12% per annum. The DIP Facility was secured by super priority administrative
expense claims and liens, subject to existing liens, on all of the Company's
assets then existing or thereafter acquired. The DIP Facility was subsequently
amended (i) to provide for additional advances to pay administrative and
post-plan confirmation operating expenses of the Company, provided that total
advances under the DIP Facility could not exceed $21.5 million, (ii) to provide
for payment of certain fees of the lender, (iii) to reduce the interest rate on
borrowings outstanding under the DIP Facility to a non-default rate of 10% per
annum from and after the Effective Date of the confirmed Chapter 11 Plan; and
(iv) to extend the maturity date of the DIP Facility to December 31, 2000.
The first $10 million of tax refunds is to be used to pay down the DIP Facility
and permanently reduce the availability under the DIP Facility. (As of December
31, 1998, $9.2 million of tax refunds has been used to pay down the DIP
Facility). The DIP Facility will also be paid down from the Company's retained
rights in the excess cash flow (the "B Pieces") which are included as
investments held in trust, residuals in finance receivables sold and finance
receivables on the financial statements after the securitization debt and
related obligations are paid, and after payment of the Secured Claim Recovery
Amount (defined below). Payments made from other sources will not permanently
reduce the amount of the DIP Facility.
The increase in the DIP Facility to $21.5 million was agreed to in exchange for
an agreement by the parties involved to assign to UDC for collection the
receivables in the Securitized Pools that were charged off prior to February 28,
1998. Pursuant to such agreement, UDC was entitled to retain 27.5% out of every
dollar collected on the charged off receivables. The remaining 72.5% out of
every dollar collected was accumulated in an interest bearing escrow account
("Charge-off Receivable Funds").
When the aggregate of the spread accounts in the Securitized Pools reached a
certain coverage point, all monies in the Charge-off Receivable Funds were
released from the escrow account in July 1998. The total amount released was
approximately $1,124,000 and was computed based on one percent of the face
amount of all receivables in the Securitized Pools charged off prior to or on
November 30, 1997 and two percent of the face amount of all receivables in the
Securitized Pools charged off from December 1, 1997 to and including February
28, 1998. The monies were released back to the applicable pool and will be
available for distribution in accordance with the Excess Collection Split
(defined below) and applicable spread account agreement. Any additional
collections with respect to charged off receivables relating to a Securitized
Pool that has reached the coverage point is to be retained by UDC. The
$1,124,000 released was recorded as recoveries in each applicable pool.
<PAGE> 10
Receivable Funds escrow account in settlement of the Purchase Price
and was recorded as recoveries in each applicable securitized pool.
SALE OF OWNED CONTRACTS
The Senior Revolving Credit Facility was originally secured by (i) the Owned
Contracts, (ii) all personal property of the Company, (iii) accounts receivable
including tax refunds, contract rights and other intangibles; and (iv) the
common stock of First Merchants Auto Receivables Corporation (collectively, the
"Collateral").
During the bankruptcy proceedings, UDC purchased 78% of the debt outstanding
under the Company's Senior Revolving Credit Facility. The debt was purchased
from seven members of the Company's original nine-member bank group for
approximately $69 million, which represented a discount of 10% of the
outstanding principal amount of such debt.
In December 1997, UDC purchased the remaining 22% of the debt outstanding under
the Company's Senior Revolving Credit Facility.
On December 15, 1997, the agent (the "Agent") for the holders of the Senior
Revolving Credit Facility, credit bid the entire amount of the Owned Contracts
(collectively, the "Credit Bid Purchase Price"), and the Bankruptcy Court
approved the proposed purchase subject to the execution by the Company of
appropriate transfer documents.
On December 18, 1997, the Company executed the necessary transfer documents
assigning the Owned Contracts to the Agent (the "Transfer"), and the Agent then
sold the Owned Contracts to a third party purchaser (the "Contract Purchaser").
Concurrently with the Transfer, the Agent released the lien of the Bank Group on
the Collateral, allowing the Company to retain all assets constituting any part
of the Collateral other than the Owned Contracts (the "Retained Assets"),
including but not limited to uncollected state and federal income tax refunds
for 1996 and prior years (the "Tax Refunds"), certain receivables and related
vehicles pledged to a working capital loan (the "Working Capital Collateral"),
and Company furniture, fixtures, equipment, general intangibles, and causes of
action.
In consideration for the Bank Group's release of its liens on the Retained
Assets, the Company subsequently (a) guaranteed on a nonrecourse basis full and
timely payment to the Agent and UDC of any shortfall between (i) the Credit Bid
Purchase Price of the Owned Contracts plus interest thereon at the rate of 11%
per annum from December 15, 1997, plus an additional charge for servicing the
Owned Contracts (the "Owned Contracts Servicing Fee"), and (ii) collections and
proceeds of the Owned Contracts (collectively, the "Secured Claim Recovery
Amount"), and (b) granted a lien on the stock of First Merchants Auto
Receivables Corporation ("FMARC") and First Merchants Auto Receivables
Corporation II ("FMARC II") to secure that guarantee. In the event that the
Owned Contracts are not being serviced by UDC, (or an affiliate or assignee) (an
"Owned Loan Servicing Change"), the Secured Claim Recovery Amount will be
limited to $10 million. For the year ended December 31, 1997, the Company
recorded a loss on disposition on the Owned Contracts of $1.1 million which
included the establishment of a liability for the Secured Claim Recovery Amount
of approximately $9.4 million. For the year ended December 31, 1998, the Secured
Claim Recovery Amount has been adjusted to approximately $4.9 million,
<PAGE> 11
primarily due to changes in the projected charge-offs and cash flows. Any
recovery on the Owned Contracts in excess of the Secured Claim Recovery Amount
will be shared with UDC on the same basis as the Excess Collections Split
(defined below).
The Company entered into a Servicing Agreement dated December 18, 1997 (the
"Owned Contracts Servicing Agreement") between UDC and the Contract Purchaser,
pursuant to which the Owned Contracts would be serviced by UDC in the event that
the Company ceased to service the Owned Contracts. UDC began servicing the Owned
Contracts on April 1, 1998. As of April 1, 1998, the Company also entered into
amendments with UDC and other parties thereto, to the existing Pooling and
Servicing Agreements and Sale and Servicing Agreements that currently govern
servicing of the receivables in the Securitized Pool of the Company, which
amendments provide for UDC to service such Securitized Pool. UDC began servicing
these receivables on April 1, 1998. Under these agreements, UDC will receive a
servicing fee of the greater of (i) 3.25% per annum of the aggregate outstanding
principal balance of receivables portfolio or (ii) $15 per receivable per month,
plus, in either case, reimbursement of certain costs and expenses. For the year
ended December 31, 1998, UDC has been paid approximately $10.0 million in
servicing fees for the servicing of the Securitized Pools.
The Company will pay UDC on a nonrecourse basis a fee of $450,000 payable prior
to any payments pursuant to the Excess Collections Split (defined below) solely
from collections of the B Pieces and secured by a pledge of the stock of FMARC
and FMARC II, subordinate only to the DIP Facility, the Secured Claim Recovery
Amount and prior pledges of the FMARC II stock (the "Modified UDC Fee").
CHAPTER 11 PLAN
The Company, UDC and the Official Committee of Unsecured Creditors (the
"Committee") developed a consensual Chapter 11 plan (the "Plan") which was filed
with the Bankruptcy Court on December 12, 1997. Various amendments were made to
the Plan and on March 16, 1998 the Bankruptcy Court entered an order confirming
the Plan, which became effective on March 31, 1998. Under the terms of the Plan,
UDC acquired the Company's property and equipment related to the Company's loan
servicing operations and replaced the Company as the servicer of the Owned
Contracts and Securitization Contracts.
Under the Plan, the reorganized Company is overseeing the liquidation, sale
and/or collection of all remaining assets of the reorganized Company and is
overseeing the disbursements to claimants contemplated by the Plan. All cash
received by the reorganized Company (from B Piece collections and other sources)
will be disbursed to the various classes of claimants set forth in the Plan as
described in the Company's Disclosure Statement. After payment in full of the
Secured Claim Recovery Amount, the DIP Facility, the Modified UDC Fee, and
certain other amounts, any further distributions from the B Pieces will be
shared between the Company on the basis of 82 1/2% for the benefit of the
Company, for distribution to its claimants in accordance with the Plan, and 17
1/2% for the benefit of UDC (the "Excess Collections Split").
In the event that an Owned Loan Servicing Change occurs, the Excess Collections
Split will change to 85% for the benefit of the Company and 15% to UDC with
respect to the B Pieces and, subject to certain
<PAGE> 12
adjustments, 100% for the benefit of the Company and 0% to UDC with respect to
the Owned Contracts. UDC will not be entitled to receive any share of the Excess
Collections Split relating to a Securitized Pool for any period during which it
is not acting as servicer for such securitization. At December 31, 1997, the
Company recorded obligations due under the Excess Collections Split and Modified
UDC Fee of approximately $9.5 million. As of December 31, 1998, management has
adjusted its estimate to $7.1 million, primarily due to changes in estimated
charge-offs and projected cash flows. The reorganized Company is expected to
conclude its responsibilities and dissolve as a corporation on or before March
31, 2003.
As a result of the Plan, the reorganized Company issued $44 million of debt (the
"New Debt"), with interest to be accrued at a quarterly compounded rate of 5.47%
per annum, which has been allocated among the Company's subordinated debt
holders plus all other unsecured and trade creditors, in satisfaction of their
allowed claims. The Company will rely upon its portion of the collections on the
B Pieces for liquidity to meet Plan obligations. The Company estimates the
future cash flows associated with the B pieces, however, there can be no
assurance that such projections will ultimately be realized, and any failure to
realize the projected level of collections will affect future distributions to
allowed claimants. Based on estimated cash flow projections, the Company
believes there will not be sufficient funds to pay the full amount of the
principal of the New Debt and any interest which might accrue. As of December
31, 1998, management projects that future net cash flows available to repay
principal of the New Debt will be approximately $29.2 million which includes
management's estimate of future operating expenses of approximately $4.1
million. Due to this shortfall, no interest has been accrued since issuance of
the notes. If interest had been accrued, the amount would be approximately $1.8
million.
The existing common stock of the Company was canceled and common shares of the
reorganized Company (the "New Equity") are being allocated among the Company's
subordinated debt holders plus all other unsecured and trade creditors as
provided in the Plan. Warrants to purchase 325,000 shares of common stock in UDC
were issued to the reorganized Company as consideration for the property and
equipment acquired by UDC. The Company's pre-confirmation common shareholders
and members of the class action (see Note 11) who shall be deemed to hold three
million pre-confirmation shares as set forth in section 11 of the confirmation
order, may receive any benefit of 32,500 of these warrants. They do not have any
other rights under the Plan. The remaining UDC warrants are being retained by
the Company for the benefit of the subordinated debt holders and all other
unsecured and trade creditors. (See Note 9).
The UDC warrants issued upon the Plan confirmation were valued at $625,000 and
property and equipment was treated as sold. As of December 31, 1998, the value
of the warrants was adjusted to approximately $116,000 based on the
Black-Scholes model.
<PAGE> 13
ADDITIONAL MATTERS
At its option, UDC may distribute up to 5,000,000 shares of Common Stock of UDC
(the "Stock Option Shares") to the Company or directly to the unsecured
creditors of the Company, in lieu of the Company's right to receive all or a
portion of distributions under the Excess Collections Split in cash (the "Stock
Option"). If UDC decides to exercise this one time Stock Option, UDC must give
the Company at least 15 days advance written notice (the "Option Notice") of the
date on which UDC will exercise the Stock Option (the "Exercise Date") and the
number of Stock Option Shares that UDC will issue on the Exercise Date.
On the Exercise Date, the aggregate value of the distribution shall be
determined by multiplying the Stock Option Shares by 98% of the average of the
closing prices for the previous 10 trading days of UDC Common Stock (the "Stock
Option Value"). After issuance and delivery of the Stock Option Shares, UDC will
be entitled to receive the Company's share of cash distributions under the
Excess Collections Split from and after the Exercise Date until UDC has received
distributions equal to the Stock Option Value. This would be in addition to
UDC's right to receive its share under the Excess Collections Split. Once UDC
has received cash distributions equal to the Stock Option Value, the Company
will retain the remaining portion of its share of cash distributions under the
Excess Collections Split, if any, in excess of the Stock Option Value. UDC will
not be entitled to exercise the Stock Option unless (i) the value of its Common
Stock on the Exercise Date and the closing price for its Common Stock on each
day during the previous ten trading days shall be at least $8.00 per share, (ii)
UDC shall have caused the Stock Option Shares to be registered under the
Securities Act of 1933; and (iii) UDC shall not have purchased any of its Common
Stock or announced any stock repurchase programs from and after the delivery of
the Option Notice through the Exercise Date. UDC has registered the Stock Option
Shares under the Securities Act of 1933, and will be required to maintain such
registration in order to meet the above condition.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company filed for protection under Chapter 11 of the United States
Bankruptcy Code in the District of Delaware on July 11, 1997 and operated as a
debtor-in-possession under Chapter 11, subject to the supervision of the
Bankruptcy Court, during the remainder of 1997.
Under Chapter 11, pre-petition claims against a debtor are stayed while the
debtor remains in Chapter 11. In connection with these claims, the Bankruptcy
Court established a process for filing proof of claims. Under the Bankruptcy
Code, all claims were stayed against the Company during the Bankruptcy Case. As
of March 31, 1999, all claims have been processed (other than one reserve for
indemnity claims which is still pending) either having been paid or having been
issued New Debt.
While operating during the Chapter 11 Proceedings, the Company was stayed from
paying interest except on certain debts as authorized by the Bankruptcy Court.
During the time the Company was operating under the Bankruptcy Proceedings, it
only reported interest expense to the extent that such interest was paid at the
direction of the Bankruptcy Court. The amount of interest which was not accrued
as a result of the Chapter 11 Proceeding amounted to $3,050,000 for the year
ended December 31, 1997 and $848,000 for the three months ended March 31, 1998,
the date of the Plan confirmation.
<PAGE> 14
On December 12, 1997, the Company, UDC and the Committee signed an agreement to
support the proposed Plan. Based upon this agreement, which committed the
Company and the other significant parties to the Plan, the liquidation of the
Company appeared imminent. Accordingly, the Company changed its basis of
accounting, effective December 31, 1997, from a going concern basis to a
liquidation basis in accordance with generally accepted accounting principles.
Consequently, at December 31, 1997 and thereafter, assets are presented at net
realizable values and liabilities are presented at their estimated settlement
amounts.
The Plan became effective on March 31, 1998, before the issuance of the December
31, 1997 consolidated financial statements. This subsequent event allowed for
the adjustment of the liabilities subject to compromise at December 31, 1997 to
the amounts confirmed by the Bankruptcy Court as follows (in thousands):
<TABLE>
<CAPTION>
Before Confirmed
Confirmation Amount
<S> <C> <C>
Accounts payable - pre-petition $ 7,617 $ 1,046
Interest payable 487 -
Subordinated reset notes, net 66,125 -
New debt of reorganized company -- 44,000
------- -------
Total $74,229 $45,046
======= =======
</TABLE>
The discharge of debt of approximately $29.2 million is included in the
consolidated statement of changes in deficiency in net assets available in
liquidation at December 31, 1997, as the effect of adopting the liquidation
basis of accounting. After confirmation, accounts payable - pre-petition
consists of certain contract and lease cure costs and convenience class payments
under the Plan (see Note 14).
BANKRUPTCY REMOTE ENTITIES
First Merchants Auto Receivables Corporation (FMARC) and First Merchants Auto
Receivables Corporation II (FMARC II) (collectively referred to as
"Securitization Subsidiaries"), are the Company's wholly owned special purpose
"bankruptcy remote entities." The Company's 1995-A and 1996-A securitizations
were accounted for as financing transactions. Their assets, included in Net
Finance Receivables, Residuals in Finance Receivables Sold, Investments Held in
Trust, and Repossessed Collateral, in the amount of approximately $61.9 million
and $104.1 million, at December 31, 1998 and 1997, respectively, as well as the
assets of FMARC and FMARC II, would not be available to satisfy claims of
creditors of the Company on a consolidated basis, until the related
securitization obligations, and notes payable-securitized pools are paid in
full.
USE OF ESTIMATES IN PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities as of
the date of the consolidated financial statements, as well as the reported
amounts of income and expenses during the reported periods. Actual results could
differ from those estimates. Significant estimates include the determination of
the allowance for credit losses,
<PAGE> 15
the determination of the obligations due under the Secured Claim Recovery
Amount, obligations due under the Excess Collections Split, the computation of
the gain/loss on sale of finance receivables, the valuation or impairment of
residuals in finance receivables sold, and the UDC warrants. The valuation of
the deficiency in net assets available in liquidation is based upon management's
best estimates of their value at the time of the valuation. Such values could
differ substantially from amounts ultimately realized in the future as the
Company performs under its Plan.
CONSOLIDATION
The consolidated financial statements include accounts of the Company and its
wholly owned subsidiaries. All significant intercompany accounts have been
eliminated in consolidation.
REVENUE RECOGNITION
Finance receivables consist of both precomputed and simple interest finance
contracts, which require payment of a fixed monthly amount over a specific term.
For precomputed finance receivables, the difference between the total amount of
contractual payments and the principal amount financed represents unearned
finance charges. Unearned finance charges are amortized and recorded as interest
income using the interest method over the terms and at the interest rates stated
in the underlying finance contracts.
Simple interest loan contracts are written at the principal amount advanced to
the borrower and bear interest computed on the unpaid balance. When an account
becomes 61 or more days past due, income recognition is suspended until the
contractual aging is restored to a current status.
Servicing income is recognized when earned, servicing costs are charged to
expense as incurred. The Company discontinued servicing operations April 1,
1998.
Other operating income, which includes customer late charges and extension fees,
is recognized when collected.
FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES
Finance receivables that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their outstanding
unpaid principal balances reduced by an allowance for credit losses.
Under the going concern basis of accounting, the allowance for credit losses is
maintained by direct charges to operations and under the liquidation basis of
accounting is maintained by charges to Changes in Deficiency in Net Assets in
Liquidation in amounts that are intended to provide adequate reserves on the
Company's finance receivables portfolio to absorb potential credit losses.
Management uses a static pool methodology to evaluate the adequacy of the
allowance for credit losses, as well as its credit loss experience and
delinquency trends on a pool by pool basis.
<PAGE> 16
RESIDUALS IN FINANCE RECEIVABLES SOLD AND GAIN ON SALE OF LOANS
In 1996, the Company initiated a securitization program under which it sold
(securitized), on a nonrecourse basis, finance receivables to third parties
which used the finance receivables to create asset backed securities ("A
certificates") which were remitted to the Company in consideration for the sale.
The Company then sold senior certificates to third party investors and, in some
cases, retained subordinated certificates ("B certificates"). In consideration
of such sale, the Company received cash proceeds from the sale of certificates
collateralizing the finance receivables and the right to future cash flows under
the subordinated certificates (residuals in finance receivables sold, or
residual) arising from those receivables, to the extent not required to make
payments on the A certificates sold to a third party or to pay associated costs.
Residuals in finance receivables (interest-only strip) resulted from the sale of
finance receivables on which the Company retained servicing rights and the
excess cash flows on the A certificates, including any excess cash flows on the
B certificates. The interest-only strip residual was determined by computing the
difference between the weighted average yield of the finance receivables sold
and the yield to the certificate purchasers, adjusted for the servicing fee
based on the agreements between the Company and the investor and further
adjusted for anticipated prepayments, repossessions, liquidations, and
charge-offs.
Gains or losses were determined based upon the difference between the sales
proceeds for the portion of finance receivables sold and the Company's recorded
investment in the finance receivables sold. The Company allocated the recorded
investment in the finance receivables between the portion retained based on the
relative fair values on the date of sale.
Under the going concern basis of accounting, to the extent that actual cash
flows on a securitization were below original estimates and differed materially
from the original securitization assumptions, and in the opinion of management
if those differences appear to be other than temporary in nature, the Company's
residual was adjusted, with corresponding charges against income in the period
in which the adjustment was made.
Under the liquidation basis of reporting, the Company will periodically review
its assumptions used in estimating future cash flows and adjust the carrying
value of residuals in finance receivables sold to net realizable value, with the
amount of the adjustment recorded in the change in deficiency in net assets
available in liquidation for the period the change in estimate is determined.
Such evaluations are performed in aggregate for all securitizations due to the
securitizations being cross collateralized.
REPOSSESSED COLLATERAL
The Company commences repossession procedures against the underlying collateral
when it determines the collection efforts are likely to be unsuccessful.
Repossession generally occurs before a borrower misses more than three
consecutive monthly payments. When collateral is
<PAGE> 17
repossessed for finance receivables owned or finance receivables held in
bankruptcy remote entities, the net amount due under the finance receivable is
reduced to the estimated fair value of the collateral, less the cost of
disposition, and the reduction is recorded as a charge-off. Charge-offs related
to repossessions for finance receivables serviced but not owned or held in
bankruptcy remote entities, are recorded when the Company disposes of the
repossessed collateral.
PROPERTY AND EQUIPMENT
Property and equipment was stated at original cost less accumulated depreciation
and amortization. Depreciation and amortization was computed on the
straight-line method over the estimated useful lives of the related assets,
generally ranging from 2 to 7 years. The Company capitalized all direct external
costs associated with the development of software for internal use. During 1997,
as a result of the bankruptcy proceedings and the absence of available
financing, the Company determined that an impairment of the carrying value of
these assets was necessary. At December 31, 1997, property and equipment are
stated at net realizable amounts based upon the value of the UDC warrants that
the Company received at March 31, 1998 in exchange for its property and
equipment.
INCOME TAXES
The Company recognized deferred tax assets and liabilities based on differences
between the consolidated financial statements and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. The effect of a change in tax rates on
deferred tax assets and liabilities was recognized in the period in which the
enactment is effective. Valuation allowances are established to reduce deferred
tax to the amount expected to be realized.
STOCK BASED COMPENSATION
Compensation costs associated with the Company's stock option and employee stock
purchase plans were recognized based upon the intrinsic value of such benefits.
Under the intrinsic value-based method, compensation cost was the excess, if
any, of the quoted market price of the stock at grant date or other measurement
date over the amount an employee must pay to acquire the stock.
INCOME (LOSS) PER SHARE
In 1997, the Company adopted SFAS No. 128, "Earnings per Share," which replaced
the calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Under the liquidation basis of accounting, no income
(loss) per share amounts are presented.
NOTE 3 --NET FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES
Net finance receivable balances consisted of the following at December 31, 1998
and 1997 (in thousands):
<PAGE> 18
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Precomputed interest receivables, net 26,177 $64,641
Simple interest receivables 7,038 15,754
------ -------
Total finance receivables 33,215 $80,395
Allowance for credit losses (6,438) (12,289)
------ -------
Net finance receivables 26,777 $68,106
====== =======
</TABLE>
Activity in the allowance for credit losses consisted of the following for the
years ended December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Balance, beginning of year $ 12,289 $ 63,281
Provision or increase for credit losses 1,809 11,452
Charge-offs, net ( 7,660) (36,587)
Allowance relating to loans sold -- (25,857)
-------- --------
Balance, end of year $ 6,438 $ 12,289
======== ========
</TABLE>
Net charge-offs consisted of the following for the years ended December 31, 1998
and 1997 (in thousands):
<TABLE>
<S> <C> <C>
Charge-offs - allowance for credit losses $ 9,829 $ 43,318
Recoveries - allowance for credit losses ( 2,169) (6,731)
-------- --------
Total net charge-offs $ 7,660 $ 36,587
======== ========
</TABLE>
Precomputed interest receivables are shown net of unearned finance charges of
$4,422,000 and $16,518,000 at December 31, 1998 and 1997, respectively.
Finance contracts generally have original terms of 18 to 60 months. The primary
concentration of credit risk relates to lending to borrowers who cannot obtain
traditional financing and the borrowers' ability to honor their contracts may be
dependent upon the economic condition for a particular geographic region. The
borrowers under the finance contracts are not concentrated in any specific
geographic region.
Net finance receivables are either owned by the Company or are held in
bankruptcy remote subsidiaries. Finance receivables held in bankruptcy remote
subsidiaries result from several securitization transactions accounted for as
financing transactions for which actual title to the assets have been
transferred to FMARC and FMARC II. These finance receivables are restricted to
provide credit enhancement as required under the terms of the Company's sales
and securitizations of finance receivables. In two of the securitization
transactions, finance receivables along with a cash deposit, were pledged as
additional collateral as part of the spread account. As of December 31, 1998 and
1997, these excess spread account finance receivables are included in net
finance receivables held in bankruptcy remote subsidiaries and totaled
$5,886,000 and $10,706,000, respectively. Net finance receivables owned and held
in bankruptcy remote subsidiaries consisted of the following at December 31,
1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Finance receivables - owned $ 1,030 $ 2,487
Allowance for credit losses (417) (1,379)
------- -------
Net finance receivables, owned 613 1,108
------- -------
Finance receivables - held in bankruptcy
remote subsidiaries 32,185 77,908
Allowance for credit losses (6,021) (10,910)
------- -------
Net finance receivables, held in bankruptcy
remote subsidiaries 26,164 66,998
------- -------
Net finance receivables $26,777 $68,106
======= =======
</TABLE>
In 1996 and 1997 the Company completed several securitization transactions which
resulted in the sale of finance receivables. As of December 31, 1998 and 1997,
the outstanding balance of net finance receivables sold were $217.9 million and
$463.4 million, respectively.
<PAGE> 19
The finance receivables held in bankruptcy remote subsidiaries and finance
receivables sold in securitizations (excluding the securitization completed in
June of 1997) (collectively, "Serviced") were serviced through March 31, 1998 by
the Company and thereafter by UDC. They have been included for purposes of
delinquency and servicing disclosures which follow.
Finance receivables managed (owned or serviced) consisted of the following at
December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Total owned, net $ 1,030 $ 2,487
Total serviced, net 267,458 480,898
-------- --------
Total managed, net $268,488 $483,385
======== ========
</TABLE>
Delinquencies experienced by the Company in its managed finance receivables
portfolio consisted of the following at December 31, 1998 and 1997 (in
thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Net amount outstanding (managed) $268,488 $483,385
======== ========
Delinquencies
31-60 days 16,678 36,413
61+ days 14,360 18,242
-------- --------
Total $ 31,038 $ 54,655
======== ========
Total delinquencies as a percentage
Of net finance receivables, managed 11.6% 11.3%
</TABLE>
FMAC has also been named as a defendant in certain suits alleging wrongful
repossession of vehicles. FMAC has raised various defenses, including belated
defenses arising from its Bankruptcy Case and expects any exposure in connection
with such suits to be minimal.
NOTE 4 -- RESIDUALS IN FINANCE RECEIVABLES SOLD AND INVESTMENTS HELD IN TRUST
<PAGE> 20
RESIDUALS IN FINANCE RECEIVABLES SOLD
During 1997, the Company sold $199.1 million of loans in three securitizations.
The cash proceeds from the securitizations were $179.6 million, with a pretax
loss of $6.5 million. The value of the residuals in finance receivables sold is
included in computing the gain or loss on sale. The residuals represents the
present value of the Company's interest in anticipated future cash flows of the
underlying portfolio. The following are the key economic assumptions used in
measuring the residual in finance receivables sold at the date of the
securitization. There were no securitizations completed in 1998.
<TABLE>
<CAPTION>
1997
---------------------------
Quarter completed Q1 Q2
-------- --------
<S> <C> <C>
Prepayment rate (annual) 10% 10%
Expected lifetime credit losses (in thousands) $20,222 $ 11,302
Residual cash flows discounted at (annual) 16% 16%
</TABLE>
Residuals in finance receivables sold consisted of the following at December 31,
1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Interest-only strips $ -- $ 196
Retained asset-backed securities (B certificates) 6,405 16,244
-------- --------
Total residuals in finance receivables sold $ 6,405 $ 16,440
======== ========
</TABLE>
The residuals in finance receivables sold were calculated at December 31, 1998
and 1997 (in thousands) as follows:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Estimated future net cash flows before estimated
credit losses $ 37,520 $ 73,884
Allowance for estimated credit losses (29,815) (53,734)
-------- --------
Estimated future net cash flows 7,705 20,150
Discount to present value (1,300) (3,710)
-------- --------
Total residuals in finance receivables sold $ 6,405 $ 16,440
======== ========
</TABLE>
Activity in the residuals in finance receivables sold consisted of the following
for the years ended December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Balance, beginning of year $ 16,440 $ 6,868
Additions -- 13,689
Principal payments received on B Certificates
transferred to Investments Held in Trust (2,635) (4,117)
</TABLE>
<PAGE> 21
<TABLE>
<S> <C> <C>
Impairment of B Certificates (7,400) --
-------- --------
Balance, end of year $ 6,405 $ 16,440
======== ========
</TABLE>
The value of the residuals in finance receivables sold is determined using the
key economic assumptions as of December 31, 1998 and 1997 indicated below:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Prepayment rate (annual) 16% 10%
Residual cash flows discount rate (annual) 16% 16%
</TABLE>
The following are the static pool losses (lifetime losses), which are calculated
by summing the actual and projected cash losses for all pools of assets
securitized (in thousands):
<TABLE>
<CAPTION>
Loans Securitized In
------------------------------------------
Static Pool Losses as of: 1995 1996 1997
------------------------------------------
<S> <C> <C> <C>
December 31, 1998 $13,378 $87,668 $57,018
December 31, 1997 12,285 83,691 55,474
</TABLE>
INVESTMENTS HELD IN TRUST
In connection with its securitization transactions, the Company has been
required to provide a credit enhancement to the investors. The Company made
initial cash deposits ranging from 1.0% to 3.8% of the initial underlying
finance receivables principal balance, of cash into an account held by the
trustee (spread account) and pledged this cash to the trust to which the finance
receivables were sold. Additional deposits are made from the residual cash flow
(through the trustee) to the spread account as necessary to attain and maintain
the spread account at a specified percentage, ranging from a minimum of 1.5% to
a maximum of 6.25%, of the underlying finance receivables principal balance.
In the event that the cash flows generated by the finance receivables sold to
the trust are insufficient to pay obligations of the trust, including principal
or interest due to certificate holders or expenses of the trust, the trustee
will draw funds from the spread account as necessary to pay the obligations of
the trust.
The spread account must be maintained at a specified percentage of the principal
balances of the finance receivables held by the trust, which can be increased in
the event delinquencies or losses exceed specified levels. During the fourth
quarter of 1996, the delinquency and net loss performance triggers were exceeded
on various securitized pools which increased the required spread amounts to 11%
of the underlying finance receivables principal balance. If the spread account
exceeds the specified percentage, the trustee will release the excess cash to
the Company from the pledged spread account. Except for releases in this manner,
the cash in the spread account is restricted from use by the Company.
<PAGE> 22
A financial guaranty insurance company (Insurer) has provided a financial
guaranty insurance policy for the benefit of investors in each series of
asset-backed securities issued by the trusts or special purpose financial
subsidiaries of the Company. Certain agreements with the Insurer provide that if
delinquency, default and net loss ratios in the pools of finance receivables
supporting the asset-backed securities exceed certain amounts, the specified
level of enhancement would be increased and in certain instances the Company (or
at December 31, 1998, UDC) could be removed as servicer of the finance
receivables.
Because the Company was not in compliance with certain provisions of its
securitization agreements, certain of the required spread account balances were
either uncapped or set at the discretion of the Insurer. As part of the Plan,
the Insurer agreed to amend the required spread account amounts. The modified
spread account agreements provide for distributions of cash held in the spread
accounts to the Company to the extent that the aggregate cash in the spread
accounts plus the remaining unpaid principal balance on all contracts on which
obligors are current or less than 30 days past due (the "Aggregate Collateral"),
exceeds 150% of all obligations due on the Insurer-backed indebtedness. The
agreement also requires that at all times the Aggregate Collateral must exceed
the Insurer-backed indebtedness by $15 million. As of December 31, 1998, the
spread accounts for all securitizations total approximately $38.9 million.
At December 31, 1998 and 1997, investments held in trust consist of principal
and interest payments on Class B certificates not released to the Company and
principal and interest collections on finance receivables pledged as additional
collateral on certain securitizations.
NOTE 5 -- PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of December 31, 1997 (in
thousands):
<TABLE>
<CAPTION>
1997
<S> <C>
Computer equipment and capitalized software costs $ 10,305
Furniture and other equipment 1,365
Leasehold improvements 245
--------
Total cost 11,915
Accumulated depreciation, amortization and impairment (11,290)
--------
Total $ 625
========
</TABLE>
Depreciation, amortization and impairment of property and equipment was
$2,183,000 for 1997. See Note 1 which describes the impairment of property and
equipment.
On March 31, 1998, in accordance with the Plan, the property and equipment was
sold to UDC. Therefore, as of December 31, 1998 the Company no longer owns any
property and equipment.
NOTE 6 - SECURED BORROWINGS
<PAGE> 23
On June 9, 1997, the Company received approximately $1.7 million under a Working
Capital Line of Credit. Borrowings under the Working Capital Line of Credit are
secured by certain finance receivables and repossessed collateral of the Company
and a second lien on the stock of FMARC II. The Working Capital Line of Credit
bore interest at the one month LIBOR rate plus 2.0% (with a default margin of
5.0% over the one month LIBOR rate). In addition, the lender received a portion
of the proceeds from the sale of repossessed collateral to the extent such
monies exceed the related secured borrowing. As of December 31, 1998, the
Working Capital Line of Credit has been paid in full and the Company is
currently receiving cash distributions. The DIP Facility and its terms are
described in Note 1.
Interest rate and borrowing information for Secured borrowings for the years
ended December 31, 1998 and 1997 were as follows (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Borrowings
Year-end balances $ 11,678 $ 10,872
Weighted average contractual interest rate 10.00% 10.03%
Interest expense $ 1,363 $ 9,449
Highest month - end borrowings 15,905 103,549
Average outstanding borrowings 11,482 87,069
Weighted average interest rates:
Contractual 11.01% 9.99%
Effective 11.87% 10.78%
</TABLE>
NOTE 7 -- NOTES PAYABLE-SECURITIZED POOLS
On May 21, 1996, the Company completed a $125.9 million debt financing
consisting of automobile receivable-backed notes, Series 1996-A. Of these notes,
$85.0 million have a floating interest rate of 0.17% over the one-month LIBOR
rate and the remaining $40.9 million have a fixed interest rate of 6.70%. The
Series 1996-A notes were issued by First Merchants Auto Trust 1996-A ("1996-A
Trust"), a trust formed specifically for purposes of the securitization
structure. As the Company retained all of the ownership interests in the 1996-A
Trust, the sale of the 1996-A notes is treated as a financing and the notes are
included in the Company's consolidated financial statements. The balance of the
notes outstanding as of December 31, 1998 was approximately $15.0 million.
On November 17, 1995, the Company completed a $75.1 million debt financing
consisting of 6.20% automobile receivable-backed notes, Series 1995-A. The
Series 1995-A notes were issued by FMARC, a wholly owned special purpose
subsidiary of the Company. The balance of the notes outstanding at December 31,
1998 was approximately $5.4 million.
Principal and interest on the notes are payable monthly from collections and
recoveries on the pools of finance receivables. Interest expense was $2,873,000
for 1998. Interest expense including amortization of debt issuance costs was
$7,462,000 for 1997.
<PAGE> 24
NOTE 8 - NEW DEBT AND SUBORDINATED DEBT
On November 1, 1996, the Company issued $51.8 million of the 1996 Notes in an
underwritten public offering. Interest on the 1996 Notes was payable quarterly
at an interest rate of 9.50%, until December 15, 2001. The interest rate was to
reset at the Company's option on December 15, 2001 to a rate, and for a term of
one, two, three or five years, determined by the Company and was to reset
thereafter, at the Company's option, upon the date of expiration of each such
new interest period prior to maturity on December 15, 2006. Holders of the 1996
Notes had the option to redeem all or any portion of the notes on December 15,
2001 or any subsequent interest reset date. Proceeds from the issuance of the
1996 Notes were used to repay borrowings under the Senior Revolving Credit
Facility. Interest expense was $2,735,000 including amortization of underwriting
discount and issuance costs in 1997. The indentures relating to the 1996 Notes
required the Company to maintain specified financial ratios and to comply with
other covenants.
On February 14, 1995, the Company received $13,530,000 from the sale of
$14,375,000 of the 1995 Notes, in an underwritten public offering, including
$1,875,000 from the exercise of the underwriters' over-allotment option and
after deducting the underwriting discount and offering expenses. The proceeds
were used to repay borrowings under the Senior Revolving Credit Facility.
Interest on the 1995 Notes was payable quarterly, at an interest rate of 11% per
annum until March 15, 2000. The interest rate was to reset, at the Company's
option, on March 15, 2000 to a rate and for a term of one, two, three, or five
years determined by the Company and was to reset thereafter, at the Company's
option, upon the date of expiration of each such new interest period prior to
maturity on March 15, 2005. Holders of the notes had the option to redeem all or
any portion of the notes on March 15, 2000 or any subsequent interest reset
date. Interest expense was $1,060,000, including amortization of underwriting
discount and issuance costs in 1997. The indentures relating to the 1995 Notes
required the Company to maintain specified financial ratios and to comply with
other covenants.
Because of the accounting irregularities announced in April 1997, the Company
was in technical default, subject to certain cure periods, of certain covenants
pertaining to the 1995 Notes and the 1996 Notes. All quarterly interest payments
were made through June 15, 1997. On June 30, 1997, the Company received a Notice
of Default from the Trustee of the 1995 Notes and the 1996 Notes. On July 14,
1997, the Trustee was notified by the Company that it had filed a Chapter 11
Petition which constituted an Event of Default under the respective Indentures.
As part of the Plan, the Company issued the New Debt to the subordinated debt
holders plus other trade and unsecured creditors, in the amount of $44 million
with interest stated at 5.47% compounded quarterly from and after the Effective
Date. The New Debt shall mature on February 28, 2003. Based on estimated cash
flow projections, the Company believes there will not be sufficient funds to pay
the full amount of the principal of the New Debt and any interest. As of
December 31, 1998, management projects that future net cash flows available to
pay principal of the New Debt will be approximately $29.2 million which includes
management's estimate of future operating expenses of approximately $4.1
million. The estimated cash flows, however, do not include any potential
proceeds which might arise from causes of action which the Company is pursuing.
If interest had been accrued for 1998, the amount would have been approximately
$1,830,000. The New Debt of the Company is allocated as follows:
<PAGE> 25
New debt allocation by principal amount (in thousands):
<TABLE>
<CAPTION>
Original
Issue
<S> <C> <C>
Subordinated debt issued May 1995 $ 8,118
Subordinated debt issued November 1996 32,096
Trade and other unsecured creditors 3,786
-------
$44,000
=======
</TABLE>
NOTE 9 -- STOCKHOLDERS' EQUITY AND COMMON STOCK WARRANTS
GENERAL
According to the terms of the Plan, the Company's Common Stock was canceled and
New Equity in the reorganized Company was issued to subordinated debt holders
and unsecured and trade creditors as specified in Note 8. Dividends to the
holders of the New Equity in the reorganized Company, if any, will occur only
after repayment of the New Debt.
On April 1, 1998, UDC issued to the Company warrants to purchase 325,000 shares
of UDC's Common Stock at any time through April 1, 2001 at a price of $20.00 per
share (the "Warrants"), subject to a call feature by UDC if the closing market
price of UDC's Common Stock equals or exceeds $28.50 per share for a period of
10 consecutive trading days. The Company's pre-confirmation common shareholders
and members of the class action (see Note 1) will receive the benefit of 32,500
of these warrants and the remaining UDC warrants will be retained by the Company
for the benefit of the New Debt holders. UDC also contributed to the Company all
of its pre-confirmation shares of the Company's Common Stock in exchange for the
assets constituting the servicing platform.
Upon confirmation, the value of the warrants was $625,000. As of December 31,
1998, based on a Black-Scholes valuation, the UDC warrants were adjusted to
$116,000. The fair value of each warrant is estimated at year-end using the
Black-Scholes option-pricing model, with the following assumptions for 1998 and
1997, respectively: divided rate of 0.0% for all years; risk-free interest rates
of 4.5% and 5.5%; expected lives of 821 and 1,095 days; and price volatility of
70% and 56%.
STOCK OPTION ACTIVITY
The Company had adopted various equity based incentive plans that authorized the
Company to award stock options and other stock related benefits to directors,
officers and employees. The awards had various terms and conditions with respect
to their exercise. The bankruptcy proceeding during 1997 made all the awards
under these plans worthless. All stock options not exercised were canceled.
Stock option activity under these plans was as follows:
<PAGE> 26
<TABLE>
<CAPTION>
1997
---------------------------
Weighted Weighted
Average Average
Number Option
of Shares Price
<S> <C> <C>
Options outstanding, beginning of
year 692,960 $ 14.11
Granted 292,050 14.37
Exercised or repurchased (10,000) .04
Canceled
Options effectively canceled
due to bankruptcy (975,010) --
Options outstanding, end of year --
</TABLE>
The Company's stock was delisted from the NASDAQ Stock Markets National Market
on June 30, 1997 and the options were effectively canceled due to bankruptcy.
Therefore, disclosures for 1997 including pro forma income (loss) and per share
amounts specified by SFAS 123, "Accounting for Stock-Based Compensation," are
not presented.
NOTE 10 -- EMPLOYEE BENEFIT PLANS
The Company sponsored a discretionary contribution savings plan (the "401(k)
Plan") covering substantially all employees, under Internal Revenue Code Section
401(k). Employees could elect to make a salary reduction contribution in any
percentage permitted by the 401(k) Plan administrator up to a maximum of 15% of
their compensation or up to the maximum amount permitted by tax law per calendar
year. All participants were fully vested in their account balances and were able
to direct the investment of their savings into several investment options. In
July 1995, the Company began to match a portion of each participant's
contribution. Company contributions vested over six years from the contribution
date. Contribution expense was $172,000 in 1997. Effective March 15, 1998 the
Company discontinued 401(k) Plan withholdings, and effective June 30, 1998, the
401(k) Plan was terminated.
NOTE 11 - LITIGATION
The Company and certain of its directors and former officers have been party to
several litigations in federal court alleging that the Company published false
consolidated financial statements and other misleading information in connection
with the Irregularities in violation of securities laws. This litigation has
been consolidated into a single class action amended complaint in the United
States District Court for the Northern District of Illinois. The complaint in
the consolidated class action alleges various purported causes of action under
various securities and other laws on behalf of persons who purchased
subordinated reset notes and/or common stock of the Company between September
23, 1994 and April 16, 1997, which class encompasses nearly all of the existing
noteholders and some of the existing shareholders. The complaint names as
defendants three former officers of the Company who were terminated in April
1997 for cause by the former board of directors of the Company, as well as the
Company's former outside auditors and former members of the Company's audit
committee. The Company and the class entered into a joint prosecution agreement
which allows the Company to participate in any recovery or settlement received
(net of the contingency fee paid to class counsel). The joint
<PAGE> 27
prosecution agreement provides certain directors and officers the benefits of a
covenant not to attach their personal assets. None of the three officers
terminated for cause, the former outside auditors nor the providers of directors
and officer liability insurance were released. The Company is in the process of
documenting a settlement of claims against its director and officer liability
insurers and has filed a complaint alleging causes of action against its former
auditor.
FMAC has also been named as a defendant in certain suits alleging wrongful
repossession of vehicles. FMAC has raised various defenses, including belated
defenses arising from its Bankruptcy Case and expects any exposure in
connection with such suits to be minimal.
NOTE 12 -- INCOME TAXES
There was no income tax provision for the year ended December 31, 1998 and 1997.
The income tax provision for 1998 computation below is based on the Net Change
in the deficiency in net assets available in liquidation for 1998.
The income tax provision differs from the provision computed at the Federal
statutory tax rate as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C> <C> <C>
Income tax at federal statutory
rate $(1,966) 34.0% $(11,275) 34.0%
State income tax, net of federal
tax benefit (231) 4.0% (1,326) 4.0%
Valuation for deferred tax asset 2,197 (38.0%) 12,601 (38.0%)
------- ------ -------- ------
Total income tax provision (benefit) $ -- 0% $ -- 0%
======= ====== ======== ======
</TABLE>
Temporary differences, which represent the difference between the amounts
reported in the consolidated financial statements and the tax bases of assets
and liabilities, result in deferred income taxes.
<PAGE> 28
The Company's deferred income taxes consisted of the following at December 31,
1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Deferred tax assets:
Accrued reorganization charges 4,559 8,955
Net operating loss carry forward 31,466 30,527
Allowance for credit losses 45 3,364
Accrued compensation and other 207 341
Property and equipment -- 2,367
-------- --------
Total deferred tax assets 36,277 45,554
-------- --------
Deferred tax liabilities:
Gain on discharge of debt -- (11,212)
Accumulated depreciation -- (262)
-------- --------
Total deferred tax liabilities -- (11,474)
-------- --------
Net potential deferred tax asset 36,277 34,080
Valuation allowance (36,277) (34,080)
-------- --------
Net deferred tax asset liability $ -- $ --
======== ========
</TABLE>
As of December 31, 1998, the Company had a net operating loss carry forward of
approximately $82,491,000. As a result of the confirmed Plan at March 31, 1998,
the Company's net operating loss carry forwards was reduced by approximately
$29,200,000 due to the cancellation of indebtedness of the Company upon its
emergence from bankruptcy. In addition, the net operating loss carry forwards
have been reduced by approximately $3,059,000 due to the application of Section
382 of the Internal Revenue Code for interest expense previously deducted
relating to the portion of the debt forgiven. The Plan has been structured so
that the Company would be able to utilize any net operating loss carry overs
remaining after the reduction for debt forgiveness.
However, if an "ownership change" as defined under Internal Revenue Code Section
382 with respect to the reorganized Company occurs within the two-year period
following the consummation of the Plan, any net operating losses and other
pre-ownership change losses remaining after the "ownership change" will be
eliminated. This result would cause the reorganized Company to owe federal
income tax in excess of the amount otherwise payable absent such an "ownership
change" and would severely limit the utilization of the net operating loss
carryovers in the post reorganized period. The Plan prohibits the transfer of
the Common Stock for a two-year period following the consummation of the Plan,
although no ruling from the Internal Revenue Service will be sought to confirm
that the Company had not undergone or will not undergo an "ownership change."
The income tax refunds receivable consists of both federal and state refunds for
prior taxes paid. The federal tax refunds are pending completion of an IRS Audit
and approval by the Joint Tax Committee of Congress. The amounts presented on
the balance sheet represent management's estimate of net realizable value.
<PAGE> 29
The deferred income taxes as of December 31, 1997, have been adjusted to reflect
the results of the preliminary Internal Revenue Service audit findings.
NOTE 13 -- COMMITMENTS
The Company leased its former corporate office and service centers under
noncancelable operating lease agreements with initial terms ranging from three
to five years. These leases generally required the Company to reimburse the
landlord for certain common area expenses, such as real estate taxes, utilities
and maintenance; such expenses are included in rent expense. Charges to expense
with respect to all operating leases totaled $174,000 and $1,371,000 in 1998 and
1997, respectively. These leases were rejected or assigned to UDC in connection
with the bankruptcy case.
NOTE 14 - REORGANIZATION EXPENSES
As a result of the Chapter 11 Proceeding and the development and execution of
the Plan, the Company incurred the following reorganization costs which are
included in the 1997 statement of operations (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Obligation due under Excess Collections Split
Agreement and Modified UDC Fee obligation (See Note 1) $ 9,553
Impairment of property and equipment 8,907
Provision for rejected executory contracts
and real property leases 3,798
Employee retention program 3,131
Professional fees 3,076
Write-off of pre-petition debt issuance costs 2,018
Loss on sale of finance receivables 1,120
-------
Total reorganization expenses $31,603
=======
</TABLE>
In accordance with the Bankruptcy Code, the Company rejected certain
pre-petition executory contracts and real property leases. Such lease rejections
give rise to a right of a proof of claim for pre-petition rejection or other
damages pursuant to the Bankruptcy Code and are included in provision for
rejected executory contracts. These claims were included as part of the
creditors for which the Company issued $44 million of debt in satisfaction of
their allowed claims.
EMPLOYEE RETENTION PROGRAM
The Company obtained the Bankruptcy Court's approval to offer various bonuses to
retain key personnel in its collection centers, headquarters and loan
origination centers.
<PAGE> 30
NOTE 15 -- CHANGE IN ESTIMATES
The value of certain assets and liabilities are based on estimates of future
cash flows and other assumptions by management, and therefore, will change as
actual cash flows occur and estimates change. Differences between actual cash
flows and estimated cash flows and changes in assumptions can significantly
affect these values. The following indicates the change in 1998 in the estimated
value of certain assets and estimated obligations of certain liabilities from
December 31, 1997 to December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
Change in
Value
(Increase) Decrease
-------------------
<S> <C>
Writedown of Residuals in Finance Receivables Sold (7,620)
Increase in provision for credit losses (1,809)
Decrease of obligations due under Secured Claim Recovery Amount 4,482
Decrease of obligations due under Excess Collection Split
Agreement & Modified UDC Fee 2,471
Writedown of UDC Warrants (509)
-------
Net decrease in assets and liabilities due
to changes in estimates (2,985)
=======
</TABLE>
NOTE 16 - RELATED PARTY TRANSACTIONS
UDC has been a party to the Company's Plan and previously owned common stock of
the Company. Under the terms of the Plan, UDC contributed to the Company all of
its shares of the Company's common stock and issued warrants of UDC to the
Company for distribution in accordance with the Plan.
Since early 1996, ReeseMcMahon, L.L.C. ("ReeseMcMahon") has provided financial
reporting and consulting services to the Company. In April 1998, Teresa McMahon
and Sandra Reese, principals of ReeseMcMahon, were named President and Secretary
of the Company, respectively. ReeseMcMahon is expected to provide ongoing
financial reporting and consulting services to the Company. ReeseMcMahon was
paid approximately $546,000 in consulting services for 1998 and at December 31,
1998 approximately $77,000 was due them and is included in Accounts Payable and
Accrued Expenses Post-petition.
NOTE 17 -- SUBSEQUENT EVENTS
The Company was notified on January 11, 1999 by UDC of an occurrence of default
under certain provisions relating to the DIP facility. The Company had received
various tax refunds and "B" Piece distributions, some of which had not been
remitted to UDC at the time of the notice.
<PAGE> 31
Various extensions of the time to cure have been granted by UDC with the latest
one being an open extension of time which is subject to a ten (10) day "call" by
UDC. UDC has also made various advances from time to time to allow FMAC to pay
post-confirmation operating expenses, while reserving UDC's rights as to the
asserted default. FMAC has sent UDC monies received from the 1997 tax refunds
and certain other monies and asserts that it has now fully cured the default.
Currently, UDC and FMAC have agreed to terms in principal related to the default
and UDC has agreed to provide the Company with additional borrowing capacity.
The general terms agreed to are that the Company will pay a fee of $100,000 to
UDC for the alleged default interest, late fees, and attorney fees, which is
less than the approximately $500,000 originally sought by UDC for such items.
UDC will provide a line of credit to the Company for $2.0 million. The line of
credit will be secured by the Company's interest in the 82.5% distribution of
the excess B Pieces. The Company will be able to borrow the $2.0 million in two
tranches of $1.0 million each. The first tranche will have a fee of $150,000 and
the second tranche will have a fee of $40,000. Interest on the line is to be at
10% per annum.
<PAGE> 32
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned hereunto duly authorized.
FIRST MERCHANTS ACCEPTANCE CORPORATION
/s/ Teresa McMahon
--------------------------------------
Teresa McMahon
Dated: March 31, 1999 President
<PAGE> 1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS EXHIBIT 23.1
TO THE BOARD OF DIRECTORS
FIRST MERCHANTS ACCEPTANCE CORPORATION
We have audited the accompanying consolidated statement of deficiency in net
assets available in liquidation of First Merchants Acceptance Corporation as of
December 31, 1998 and 1997, and the related consolidated statement of changes in
deficiency in net assets available for liquidation. In addition, we have audited
the related consolidated statements of operations, stockholders' equity
(deficit) and cash flows for the year ended December 31, 1997. These
consolidated financial statements are the responsibility of Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based upon our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As described in Note 1 to the consolidated financial statements, the United
States Bankruptcy Court confirmed a Chapter 11 Plan ("Plan"), which became
effective on March 31, 1998, which required the Company to liquidate over the
next five years. As a result, the Company has changed its basis of accounting as
of December 31, 1997 from the going concern basis to a liquidation basis.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the deficiency in net assets available in
liquidation of First Merchants Acceptance Corporation as of December 31, 1998
and 1997, and changes in net assets available in liquidation for the year ended
December 31, 1998, and the results of its operations and its cash flows for the
year ended December 31, 1997, in conformity with generally accepted accounting
principles on the basis of accounting described in the preceding paragraph.
/s/ McGladrey & Pullen, LLP
Schaumburg, Illinois
March 31, 1999
