-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, M9uG1pDM/KNW93drEvBG88tiPfsiPfc+SOOj2gSV6xnifUgYx7meB5vwdSVNo5kK 12QsGNCL+0qrQQAb2QhHdw== 0000892569-98-000804.txt : 19980327 0000892569-98-000804.hdr.sgml : 19980327 ACCESSION NUMBER: 0000892569-98-000804 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980326 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: AVCO FINANCIAL SERVICES INC CENTRAL INDEX KEY: 0000008795 STANDARD INDUSTRIAL CLASSIFICATION: PERSONAL CREDIT INSTITUTIONS [6141] IRS NUMBER: 132530491 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-06119 FILM NUMBER: 98573622 BUSINESS ADDRESS: STREET 1: 600 ANTON BLVD STREET 2: PO BOX 5011 CITY: COSTA MESA STATE: CA ZIP: 92628 BUSINESS PHONE: 7144457860 MAIL ADDRESS: STREET 1: 600 ANTON BLVD STREET 2: PO BOX 5011 CITY: COSTA MESA STATE: CA ZIP: 92628 FORMER COMPANY: FORMER CONFORMED NAME: AVCO DELTA CORP DATE OF NAME CHANGE: 19720526 FORMER COMPANY: FORMER CONFORMED NAME: SEABOARD FINANCE CO DATE OF NAME CHANGE: 19700722 10-K 1 FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1997 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION J(1)(A) AND (B) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.) COMMISSION FILE NO. 0-6119 AVCO FINANCIAL SERVICES, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 13-2530491 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 600 ANTON BLVD., P.O. BOX 5011, COSTA MESA, CALIFORNIA 92628-5011 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 714-435-1200 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE 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 requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Not applicable. Aggregate market value of common stock: Not applicable. At December 31, 1997, the Registrant had 500,000 shares of common stock ($1 par value per share) outstanding, all of which are owned by Textron Inc. ================================================================================ 2 PART I ITEM 1. BUSINESS GENERAL Avco Financial Services, Inc., which was organized under the laws of Delaware on July 17, 1964, is the successor to the finance businesses of Seaboard Finance Company, originally established in 1927, and Delta Acceptance Corporation Limited, originally established in 1954. Unless the context otherwise requires, the term "Registrant" or "AFS" herein refers to Avco Financial Services, Inc. and its consolidated subsidiaries. All of the Registrant's outstanding common stock is owned by Textron Inc. The Registrant provides financial services to consumers and businesses worldwide. Consumer lending has been the focus of the Registrant's finance business; however, in 1996, the Registrant embarked on a strategy to expand its commercial financing in the international sector. Accordingly, the Registrant's finance receivables presented below have been segregated into two categories, consumer and commercial. For years prior to 1997, certain reclassifications have been made to be consistent with the 1997 presentation. The Registrant's consumer lending activities consist primarily of the following: (i) consumer loans which are unsecured or secured by personal property for relatively small amounts and short periods; (ii) real estate loans which are secured by real property for larger amounts and for considerably longer periods; and (iii) retail installment contracts, principally covering personal property. Its consumer loan business is conducted through a network of branch offices. At December 31, 1997, the Registrant operated 1,199 consumer finance offices located throughout the United States, the Commonwealth of Puerto Rico, the Virgin Islands, Australia, Canada, Hong Kong, India, Ireland, New Zealand, Spain, Sweden and the United Kingdom. The Registrant's commercial business focuses primarily on equipment leasing and inventory financing. During 1996 and 1997, the Registrant acquired or opened commercial financing operations in Australia, Canada, France, India, and the United Kingdom. Such operations added to its commercial lending business already being conducted in Australia and Hong Kong. The Registrant's commercial business portfolio grew to approximately $900 million at December 31, 1997, from approximately $300 million at December 31, 1996. Through various insurance subsidiaries, the Registrant also offers a variety of insurance products to its consumer loan customers and customers of independent financial institutions. Such products include credit life, credit disability and casualty insurance. For a summary of revenues, income before income taxes, and identifiable assets by industry segment, see Note 7 to the Consolidated Financial Statements of the Registrant. At December 31, 1997, the Registrant employed approximately 7,900 persons. 1 3 FINANCE OPERATIONS Finance Receivables Outstanding The Registrant's finance receivable portfolio consists of the following:
Year ended December 31, --------------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (Thousands of dollars) DOMESTIC: Consumer loans....................... $1,582,119 $1,794,932 $1,731,912 $1,669,686 $1,508,343 Real estate loans.................... 1,603,904 1,721,008 1,696,090 1,737,606 1,660,793 Retail installment contracts......... 736,808 630,117 605,623 650,882 394,239 ---------- ---------- ---------- ---------- ---------- Total consumer finance.......... 3,922,831 4,146,057 4,033,625 4,058,174 3,563,375 Commercial finance.............. -- -- 81,516 81,920 75,514 ---------- ---------- ---------- ---------- ---------- Total domestic............. 3,922,831 4,146,057 4,115,141 4,140,094 3,638,889 INTERNATIONAL: Consumer loans....................... 1,440,503 1,411,130 1,289,315 1,052,219 881,651 Real estate loans.................... 790,985 825,842 816,529 678,015 601,264 Retail installment contracts......... 684,870 579,213 530,207 456,400 347,759 ---------- ---------- ---------- ---------- ---------- Total consumer finance.......... 2,916,358 2,816,185 2,636,051 2,186,634 1,830,674 Commercial finance.............. 903,452 291,496 182,334 9,640 -- ---------- ---------- ---------- ---------- ---------- Total international........ 3,819,810 3,107,681 2,818,385 2,196,274 1,830,674 ---------- ---------- ---------- ---------- ---------- Total...................... $7,742,641 $7,253,738 $6,933,526 $6,336,368 $5,469,563 ========== ========== ========== ========== ==========
The following table presents the Registrant's outstanding finance receivables by country:
Total Consumer Commercial ------------------------ Finance Finance Dollars % of Total ---------- ---------- ---------- ---------- (Thousands of dollars) Australia........................... $ 737,018 $424,892 $1,161,910 15.0% Canada.............................. 1,104,929 88,215 1,193,144 15.4 France.............................. -- 105,398 105,398 1.4 Hong Kong........................... 230,679 143,893 374,572 4.9 India............................... 1,529 2,019 3,548 0.0 New Zealand......................... 55,167 -- 55,167 0.7 Spain............................... 40,870 -- 40,870 0.5 Sweden.............................. 33,767 -- 33,767 0.4 United Kingdom...................... 712,399 139,035 851,434 11.0 United States....................... 3,922,831 -- 3,922,831 50.7 ---------- -------- ---------- ----- Total.......................... $6,839,189 $903,452 $7,742,641 100.0% ========== ======== ========== =====
For a summary of revenues, income before income taxes and identifiable assets by geographic area, see Note 7 to the Consolidated Financial Statements of the Registrant. At December 31, 1997, finance receivables in the United States represented 51% of the Registrant's total finance receivables outstanding. At such date, receivables outstanding in no state exceeded 9% of the United States' portfolio, except California in which outstanding receivables represented 16% of the United States' portfolio and 8% of the consolidated portfolio. 2 4 Consumer Loans and Real Estate Loans The Registrant makes consumer loans to individuals primarily on the basis of the borrower's income while real estate loans consider both the borrower's income and the value of the real estate. The Registrant's real estate loans consist primarily of loans made to individuals which are secured by first or second mortgages on single family homes. Both consumer and real estate loans are limited to amounts which the borrower appears able to repay without hardship. In 1997, the Registrant received collateral on 53% of the dollar amount of consumer loans (including refinancings) made during the year. The realizable value of the household goods or other property on which liens are taken as security is in many cases less than the amount of the contract. For real estate loans, the amount of the loan is limited to a maximum of 85% of the unencumbered appraised market value. Of the aggregate of 873,151 consumer and real estate loans written during the year ended December 31, 1997, approximately 47% included advances to refinance outstanding balances. Subject to governmental restrictions, the Registrant makes loans secured by consumer goods for varying periods, with original contractual terms generally not exceeding 4 years. Loans secured by real estate generally do not exceed 15 years. During 1997, the weighted average maturity of real estate loans written was approximately 11 years. A summary of the Registrant's consumer and real estate loan accounts written (excluding both refinanced balances and receivables acquired from other finance companies) and outstanding was as follows:
Year ended December 31, --------------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (Thousands of dollars*) New funds advanced Consumer loans Funds advanced.................. $1,805,032 $1,868,293 $1,929,581 $1,736,634 $1,474,139 Average amount.................. $ 2,132 $ 2,304 $ 2,272 $ 2,014 $ 1,836 Real estate loans Funds advanced.................. $ 678,841 $ 635,323 $ 709,624 $ 727,139 $ 642,733 Average amount.................. $ 25,706 $ 21,982 $ 23,608 $ 23,714 $ 21,022 Receivables outstanding at end of period Consumer loans Net balance..................... $3,022,622 $3,206,062 $3,021,227 $2,721,905 $2,389,994 Average amount.................. $ 2,857 $ 2,909 $ 2,888 $ 2,725 $ 2,407 Real estate loans Net balance..................... $2,394,889 $2,546,850 $2,512,619 $2,415,621 $2,262,057 Average amount.................. $ 29,936 $ 29,615 $ 27,311 $ 27,450 $ 25,120
- ------------ * Except average amount. Retail Installment Contracts The Registrant's sales finance operations consist principally of the purchase, generally without recourse, of retail installment contracts from dealers in automobiles, furniture, television sets, household appliances and floor coverings. Retail installment operations provide a source of new customers for consumer loan business. In general, retail installment contracts carry a lower profit margin than consumer loans, and the volume of such business tends to be more volatile. The Registrant purchases retail installment contracts with original terms generally not exceeding three years. 3 5 The following table summarizes retail installment contracts purchased (excluding any contracts acquired from other finance companies) and outstanding:
Year ended December 31, ------------------------------------------------------------ 1997 1996 1995 ------------------ ------------------ ------------------ (Thousands of dollars*) Retail installment contracts purchased.......................... $ 1,643,996 $ 1,298,976 $ 1,310,373 Retail installment contracts outstanding at end of period: Net balance..................... $ 1,421,678 $ 1,209,330 $ 1,135,830 Average amount.................. $ 1,021 $ 1,017 $ 1,067 Year ended December 31, --------------------------------------- 1994 1993 ------------------ ------------------ Retail installment contracts purchased.......................... $ 1,319,291 $ 1,041,981 Retail installment contracts outstanding at end of period: Net balance..................... $ 1,107,282 $ 741,998 Average amount.................. $ 1,042 $ 859
- ------------ * Except average amount. Commercial Receivables At December 31, 1997, commercial receivables outstanding of $903.5 million consisted primarily of equipment finance lease receivables and inventory financing generated by the Registrant's international operations. The finance leases are generally written for periods not exceeding 7 years. Inventory financing receivables generally mature within one year. Finance leases are secured by the financed equipment and, in some instances, are personally guaranteed by the principals or include recourse arrangements with the originating vendor. Inventory financing receivables are secured by the inventory of the borrowing distributor or dealer and, in some programs, by recourse arrangements with the original manufacturer. Finance Yields The annual finance charge as a percent of average receivables outstanding (yield) was as follows:
Year ended December 31, ----------------------- 1997 1996 1995 ----- ----- ----- Consumer finance Domestic.......................................... 17.29% 17.76% 17.33% International..................................... 19.90% 20.41% 20.12% Total consumer finance......................... 18.36% 18.82% 18.40% Commercial finance Domestic.......................................... -- 16.27% 17.16% International..................................... 11.73% 11.40% 11.65% Total commercial finance....................... 11.73% 12.38% 13.31% Total.......................................... 17.77% 18.52% 18.20%
4 6 Finance Revenues Revenues from finance receivables are affected by the level of receivables outstanding, the interest rate environment, competitive pressures, and the product mix. The following table summarizes the changes in revenues due to both the level of receivables outstanding and finance receivable yields:
Year ended December 31, ------------------------ 1997 1996 ---------- ---------- (Thousands of dollars) Change due to: Growth in receivables Consumer finance Domestic........................................ $ 22,744 $(23,566) International................................... 29,918 22,028 -------- -------- Total consumer finance....................... 52,662 (1,538) Commercial finance Domestic........................................ -- (3,028) International................................... 48,338 5,856 -------- -------- Total commercial finance..................... 48,338 2,828 -------- -------- Total impact of growth....................... 101,000 1,290 Finance charge yield Consumer finance Domestic........................................ (18,355) 17,297 International................................... (8,587) 8,619 -------- -------- Total consumer finance....................... (26,942) 25,916 Commercial finance Domestic........................................ (10,365) (732) International................................... 797 775 -------- -------- Total commercial finance..................... (9,568) 43 -------- -------- Total impact of yield changes................ (36,510) 25,959 -------- -------- Total.................................................. $ 64,490 $ 27,249 ======== ========
Receivable growth in international operations is affected by fluctuations in foreign currency exchange rates. Increases (decreases) in receivable growth due to foreign currency translation for the years ended December 31, 1997 and 1996 were $(279.0) million and $130.1 million, respectively. Nonearning Assets Accrual of interest income is suspended for accounts which are contractually delinquent by more than three payments. Once an account is suspended, subsequent interest income is recognized when collected. Nonearning assets represent those finance receivables on which both the accrual of interest income has been suspended and for which no payment of principal or interest has been received for more than 30 days. Domestic and international nonearning assets totaled approximately $89.3 million and $47.5 million, respectively, at December 31, 1997 and $90.2 million and $50.5 million, respectively, at December 31, 1996. For 1997, the impact of nonearning assets on revenues was not material. Loss Experience Provisions for losses on receivables are charged to income in amounts sufficient to maintain the allowance at a level adequate to cover the losses of principal and interest in the existing receivable portfolio. The determination of an appropriate allowance for losses is based upon loss experience and payment history. 5 7 It is the Registrant's policy to write off accounts when they are deemed uncollectible, but in any event, all accounts for which an amount aggregating a full contractual payment has not been received for six consecutive months are written off. Foreclosed real estate loans are transferred out of finance receivables into other assets at the lower of fair value (less estimated costs to sell) or the outstanding loan balance. The difference between the amount transferred and the outstanding loan balance is written off. Subsequent gains and losses on the disposition of real estate owned are reflected in other operating expenses. At December 31, 1997 and 1996, real estate owned was $56.6 million and $48.0 million, respectively. The following table summarizes the amount of net credit losses, the percentage which these items bear to average finance receivables, and the allowance for losses as a percentage of finance receivables. See Note 2 to the Consolidated Financial Statements of the Registrant for an analysis of the allowance for losses for the five years ended December 31, 1997.
Year ended at December 31, -------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (Thousands of dollars) Net Credit Losses Consumer finance Real estate loans.............. $ 16,773 $ 20,577 $ 20,153 $ 19,303 $ 23,537 Other loans*................... 202,327 171,018 120,796 91,213 85,645 -------- -------- -------- -------- -------- Total consumer finance.... 219,100 191,595 140,949 110,516 109,182 Commercial finance................ 1,993 3,080 2,941 2,918 2,311 -------- -------- -------- -------- -------- Total..................... $221,093 $194,675 $143,890 $113,434 $111,493 ======== ======== ======== ======== ======== Net Credit Losses as a Percentage of Average Finance Receivables Consumer finance Real estate loans.............. 0.67% 0.82% 0.80% 0.84% 1.07% Other loans*................... 4.63% 4.21% 2.96% 2.75% 2.91% Total consumer finance.... 3.18% 2.91% 2.14% 1.97% 2.13% Commercial finance................ 0.30% 0.97% 1.08% 3.62% 3.29% Total..................... 2.93% 2.82% 2.10% 1.99% 2.14% Allowance for Losses to Finance Receivables Consumer finance.................. 3.25% 3.06% 2.84% 2.84% 2.83% Commercial finance................ 1.76% 1.79% 2.26% 3.42% 3.30%
- --------------- * Includes consumer loans and retail installment contracts. The following table presents for the five years ended December 31, 1997 loans on which one or more installments were more than 60 days delinquent on a contractual basis (expressed as a percentage of the related gross receivables outstanding):
Year ended at December 31, -------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- Consumer finance Real estate loans................. 1.70% 1.89% 1.76% 1.29% 1.45% Other loans*...................... 4.28% 3.96% 3.50% 2.84% 3.12% Total consumer finance.... 3.42% 3.25% 2.89% 2.28% 2.46% Commercial finance.................. 1.02% 0.79% 0.89% 1.97% 1.85% Total..................... 3.16% 3.20% 2.81% 2.27% 2.45%
- --------------- * Includes consumer loans and retail installment contracts. 6 8 Sources of Funds The Registrant's finance operations are financed from its common stock, additional paid-in capital, retained earnings, unsecured borrowings against bank lines of credit, unsecured commercial paper borrowings and unsecured medium- and long-term borrowings. The cost of borrowing, which is generally affected by changes in interest rates, represents a material expense of the Registrant. The Registrant's average annual cost of borrowed funds, for each fiscal year 1997 through 1995, grouped by major categories of borrowing, was as follows:
Year ended December 31, ----------------------- 1997 1996 1995 ----- ----- ----- Domestic debt Commercial paper and bank borrowings............. 5.65% 5.54% 6.08% Senior and senior subordinated notes*............ 6.51% 6.74% 6.89% Total domestic........................... 6.15% 6.28% 6.59% International debt Commercial paper and bank borrowings............. 6.14% 7.15% 8.26% Senior and senior subordinated notes*............ 7.41% 8.48% 8.81% Total international...................... 6.71% 7.80% 8.53% Total......................................... 6.39% 6.88% 7.32%
- --------------- * Includes savings deposits Since the maximum rates which the Registrant may charge on certain consumer loans are limited by law in many jurisdictions in the United States (see "Regulation"), any rise in prevailing interest rates adversely affects the profitability of the Registrant's finance operations. The Registrant's net interest margins were as follows:
Year ended December 31, --------------------------------------------------------------------------- 1997 1996 1995 ----------------------- ----------------------- ----------------------- Amount Percent(1) Amount Percent(1) Amount Percent(1) ---------- ---------- ---------- ---------- ---------- ---------- (Thousands of dollars) Interest, discount and service charges............................. $1,341,177 17.77% $1,276,687 18.52% $1,249,438 18.20% Interest and debt expense............. 434,055 5.75 426,260 6.18 455,379 6.64 ---------- ------ ---------- ------ ---------- ------ Net interest margin............... $ 907,122 12.02% $ 850,427 12.34% $ 794,059 11.56% ========== ====== ========== ====== ========== ======
- --------------- (1) Rates are expressed as a percent of average finance receivables outstanding for the indicated period. The interest expense on borrowings is affected by the level of debt outstanding, the interest rate environment, and the mix of types of borrowings. The changes in interest expense due to changes in the level of debt outstanding and the average cost of borrowing were as follows:
Year Ended December 31, ------------------------ 1997 1996 ---------- ---------- (Thousands of dollars) Change due to: Growth in debt Domestic.......................................... $ 6,215 $ (8,900) International..................................... 27,800 6,515 -------- -------- Total impact of growth....................... 34,015 (2,385) Borrowing rate Domestic.......................................... (5,521) (11,682) International..................................... (20,699) (15,052) -------- -------- Total impact of rate changes................. (26,220) (26,734) -------- -------- Total............................................. $ 7,795 $(29,119) ======== ========
7 9 INSURANCE OPERATIONS The Registrant is engaged in the credit life, credit disability and casualty insurance business in most states of the United States, Australia, Canada, and New Zealand. Where applicable laws permit, the Registrant makes available to customers credit life, credit disability and casualty insurance through the Registrant's consumer finance operations or independent companies. During 1997, approximately 70% of the credit life and credit disability insurance business and approximately 18% of the casualty insurance business was derived from the Registrant's finance customers. The remaining credit life, credit disability and casualty insurance business is written with customers on a direct basis or through independent agents. The casualty business consists primarily of insurance covering collateral protection, involuntary unemployment, personal property and automobile physical damage. The following table summarizes the results of the Registrant's insurance operations by major line of business:
Year ended December 31, --------------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (Thousands of dollars) Credit Life, Credit Disability and Other Premiums written.......................... $ 170,860 $ 151,048 $ 145,243 $ 151,370 $ 135,218 ========= ========= ========= ========= ========= Premiums earned........................... $ 151,255 $ 145,026 $ 139,105 $ 131,840 $ 127,458 Investment income......................... 33,488 38,258 35,594 20,239 19,793 Losses and adjustment expenses, less recoveries.............................. (63,723) (64,211) (61,782) (58,268) (59,306) Expenses.................................. (62,838) (61,218) (58,535) (55,019) (54,826) Income taxes.............................. (18,830) (19,007) (18,043) (11,567) (10,514) --------- --------- --------- --------- --------- Net income................................ $ 39,352 $ 38,848 $ 36,339 $ 27,225 $ 22,605 ========= ========= ========= ========= ========= Casualty Premiums written.......................... $ 264,136 $ 254,931 $ 240,723 $ 173,380 $ 158,645 ========= ========= ========= ========= ========= Premiums earned........................... $ 262,748 $ 253,615 $ 210,654 $ 155,538 $ 150,954 Investment income......................... 24,040 25,942 19,447 24,085 23,532 Losses and adjustment expenses, less recoveries.............................. (120,435) (119,846) (93,695) (69,417) (72,764) Expenses.................................. (121,100) (120,633) (107,870) (82,848) (82,894) Income taxes.............................. (15,307) (13,041) (9,275) (8,966) (5,004) --------- --------- --------- --------- --------- Net income................................ $ 29,946 $ 26,037 $ 19,261 $ 18,392 $ 13,824 ========= ========= ========= ========= ========= Total Operations Premiums written.......................... $ 434,996 $ 405,979 $ 385,966 $ 324,750 $ 293,863 ========= ========= ========= ========= ========= Premiums earned........................... $ 414,003 $ 398,641 $ 349,759 $ 287,378 $ 278,412 Investment income(1)...................... 57,528 64,200 55,041 44,324 43,325 Losses and adjustment expenses, less recoveries.............................. (184,158) (184,057) (155,477) (127,685) (132,070) Expenses.................................. (183,938) (181,851) (166,405) (137,867) (137,720) Income taxes.............................. (34,137) (32,048) (27,318) (20,533) (15,518) --------- --------- --------- --------- --------- Net income................................ $ 69,298 $ 64,885 $ 55,600 $ 45,617 $ 36,429 ========= ========= ========= ========= =========
- --------------- (1) Investment income includes capital gains of $5.2 million, $11.2 million, $3.2 million, $2.8 million and $4.3 million for the years 1997 through 1993, respectively. Included in the assets of the Registrant's insurance operations at December 31, 1997 were investments in securities carried at $825.5 million for which the aggregate cost was $805.4 million. At December 31, 1997, the Registrant carried a valuation adjustment for these investments totaling $13.1 million. This valuation adjustment represents the excess of aggregate estimated fair value over aggregate cost of its securities (net of applicable taxes). 8 10 The composition of invested assets of the Registrant's insurance operations at December 31, 1997 and 1996 and the returns on such investments for the years then ended were as follows:
1997 1996 ------------------- ------------------- Amount Percent Amount Percent -------- ------- -------- ------- (Thousands of dollars) Composition of Invested Assets Equities, at market Preferred.............................. $ 5,716 .7% $ 7,102 .9% Common................................. 13,371 1.6 17,842 2.1 Bonds available for sale, at estimated fair value(1).......................... 748,694 88.3 682,116 84.0 Commercial paper, at estimated fair value (approximates cost).................... 56,299 6.6 89,180 11.0 First mortgages on real estate, at cost... 1,423 .2 1,975 .2 -------- -------- Investments............................ 825,503 798,215 Other invested assets..................... 3,839 .5 3,507 .5 Cash...................................... 18,078 2.1 10,761 1.3 -------- ----- -------- ----- Total............................. $847,420 100% $812,483 100.0% ======== ===== ======== ===== Return on Invested Assets Investment income (before taxes)(2)....... $ 57,528 $ 64,200 Mean invested assets...................... $821,126 $765,653 Return on mean invested assets, before taxes.................................. 7.0% 8.4% Return on mean invested assets, after taxes.................................. 4.7% 5.7%
- --------------- (1) Substantially all of the Registrant's bond portfolio is in investment grade securities. (2) Includes capital gains and losses set forth in note (1) to the immediately preceding table. REGULATION The Registrant's loan business is regulated by laws which are in force in certain jurisdictions in which the Registrant operates and which, among other things, limit maximum charges for loans, the maximum amount and terms thereof. In jurisdictions within Australia, the United Kingdom and the United States, laws also require that each office conducting a consumer loan business be separately licensed. Such licenses have limited terms, but are renewable, and are subject to revocation for cause. Laws under which the Registrant operates also require disclosure to customers of the annual simple interest rate and other basic terms of most credit transactions and give customers a limited right to cancel certain loans and retail installment contracts without penalty. The Registrant is also subject to legislation addressing, among other things, issues of credit discrimination. In addition, in certain jurisdictions in which the Registrant operates, the retail installment business conducted by it is subject to regulations and legislation which, among other things, limit the rates which may be charged and require disclosure to customers of specific terms of the financing transactions. The insurance businesses are subject to licensing and detailed regulation by governmental authorities, and the rates charged on certain lines of insurance are subject to governmental limitation and change. Insurance regulations also include limitations on the amounts of dividends that can be paid by insurance companies. The laws of many jurisdictions in which the Registrant's insurance subsidiaries are admitted to do business require as a condition of admission that all insurance companies so admitted collectively guarantee to policyholders the benefits payable under policies issued by other insurance companies admitted in the particular jurisdictions up to statutory levels. The Registrant's insurance subsidiaries have not been required to date to make any significant payments pursuant to such guarantees. While the amount of any assessments 9 11 which may be made in the future cannot be predicted, the Registrant does not believe the total assessments, if any, will be material to its net income or financial condition. COMPETITION The consumer finance business is highly competitive. The Registrant's competitors include not only other companies operating under consumer loan laws, but also other types of lending institutions not so regulated and usually not limited in the size of their loans, such as companies which finance the sale of their own merchandise or the merchandise of others, industrial banks, the personal loan departments of commercial banks and credit unions. The most serious competition is offered by commercial banks and credit unions. The effective interest rates charged by these lenders are usually lower than the rates charged by the Registrant. The Registrant's insurance businesses, to the extent that they are not related to the Registrant's finance activities, compete with many other insurance companies offering similar products. ITEM 2. PROPERTIES Almost all of the offices of the Registrant are occupied under leases. Reference is made to Note 9 to the Consolidated Financial Statements of the Registrant for information concerning the Registrant's lease obligations. The Registrant does not own any substantial amount of physical property other than properties acquired by enforcing security interests and office furniture and fixtures. Of the 1,199 loan offices which the Registrant operated at December 31, 1997, 715 were located in the United States, the Virgin Islands and the Commonwealth of Puerto Rico, 215 in Canada, 141 in Australia and 98 in the United Kingdom. ITEM 3. LEGAL PROCEEDINGS Because the business of the Registrant involves the collection of numerous accounts, the validity of liens, accident and other damage or loss claims under many types of insurance, and compliance with state and federal consumer laws, the Registrant and its subsidiaries are plaintiffs and defendants in numerous legal proceedings, including individual and class action proceedings which seek compensatory, treble or punitive damages in substantial amounts. The outcome of specific legal proceedings could be unfavorable to the Registrant or any subsidiary. It is the opinion of the Registrant's management, based upon the advice of its counsel, that the aggregate liability from pending or threatened litigation will not have a material effect on the Registrant's net income or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Omitted in accordance with General Instruction J(2)(c). 10 12 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Textron Inc. owns all of the outstanding common stock of the Registrant. Dividends of $147.8 million and $94.9 million were declared and paid in 1997 and 1996, respectively. See Note 8 to the Consolidated Financial Statements of the Registrant regarding restrictions as to dividend availability. ITEM 6. SELECTED FINANCIAL DATA The following selected financial information has been derived from the Consolidated Financial Statements for the five years ended December 31, 1997 and is reported upon in the "Report of Independent Auditors" included on page 16. The information should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations", and the Consolidated Financial Statements and accompanying notes, included elsewhere in this report.
Year ended December 31, -------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (Thousands of dollars) REVENUES AND INCOME Revenues Financial Services and Related Insurance....................... $1,574,412 $1,499,488 $1,444,893 $1,214,918 $1,145,756 Nonrelated Insurance............... 278,853 260,582 219,094 173,316 178,308 ---------- ---------- ---------- ---------- ---------- Total Revenues............. $1,853,265 $1,760,070 $1,663,987 $1,388,234 $1,324,064 ========== ========== ========== ========== ========== Income Before Income Taxes Financial Services and Related Insurance....................... $ 281,821 $ 278,825 $ 271,299 $ 242,314 $ 217,789 Nonrelated Insurance............... 29,516 19,734 16,160 16,796 7,995 ---------- ---------- ---------- ---------- ---------- Total income before income taxes.................... 311,337 298,559 287,459 259,110 225,784 Income taxes......................... 115,221 111,552 108,056 96,781 83,755 ---------- ---------- ---------- ---------- ---------- Net Income........................... $ 196,116 $ 187,007 $ 179,403 $ 162,329 $ 142,029 ========== ========== ========== ========== ========== Ratio of Income to Fixed Charges(1)......................... 1.7 1.7 1.6 1.7 1.7 ========== ========== ========== ========== ========== FINANCIAL CONDITION Receivables Outstanding.............. $7,742,641 $7,253,738 $6,933,526 $6,336,368 $5,469,563 Investments.......................... 996,407 927,571 852,450 704,244 655,690 Consolidated Assets.................. 8,809,898 8,195,059 7,790,948 7,038,291 6,122,960 Debt (excludes savings deposits) Commercial paper and banks......... 3,174,190 2,766,994 2,413,601 2,430,291 1,959,063 Notes.............................. 3,735,522 3,630,889 3,746,652 3,168,178 2,851,399 Stockholder's Equity................. 1,210,515 1,152,686 1,028,230 893,744 827,511
- ------------ (1) See Note 1 to the Consolidated Financial Statements of the Registrant for computation of "Ratio of Income to Fixed Charges". 11 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 1997 VS. 1996 -- Revenues for 1997 were $1.853 billion compared to $1.760 billion for 1996, an increase of $93 million (5%). Income before income taxes for 1997 was $311 million compared to $299 million for 1996, an increase of $13 million (4%). These results reflect increases in both the Financial Services and Related Insurance segment and the Nonrelated Insurance segment of the Registrant's operations. Financial Services and Related Insurance REVENUES of this segment increased $75 million (5%) to $1.574 billion, due primarily to: (i) an increase in average finance receivables ($7.546 billion in 1997 vs. $6.892 billion in 1996) due primarily to acquisitions in 1997 of approximately $720 million of finance receivables, which consist of consumer receivables ($186 million) and commercial receivables ($534 million), partially offset by a decrease in receivable yields (17.77% in 1997 vs. 18.52% in 1996), reflecting both decreases in consumer finance yields and the impact of the increase in commercial receivables, which have lower yields; (ii) an increase in investment and other income due primarily to gains of $22 million on the sale of certain underperforming branches in 1997, compared to a $7 million gain on the sale of the U.S. small-ticket leasing operation in 1996, partially offset by a decrease of $3 million in capital gains. INCOME BEFORE INCOME TAXES of this segment increased $3 million (1%) to $282 million, due primarily to: (i) an increase in average finance receivables; (ii) an increase in investment and other income of $15 million due primarily to a $22 million gain on the sale of certain underperforming branches in 1997, compared to a $7 million gain on the sale of the U.S. small-ticket leasing operation in 1996, partially offset by a decrease of $3 million in capital gains; and (iii) a reduction in the cost of borrowed funds (6.39% in 1997 vs. 6.88% in 1996). Partially offsetting these increases were: (i) a decrease in receivable yields; (ii) an increase in the provision for credit losses due primarily to an increase in the ratio of net credit losses to average finance receivables (2.93% in 1997 vs. 2.82% in 1996); and (iii) higher operating expenses due primarily to international expansion and the start-up of centralized sales processing centers in the U.S. and Canada. The proliferation of credit cards continues to provide the consumer with an alternative source of funds, and as a result, the increase in consumer debt has continued to burden the consumer finance customer, resulting in higher delinquencies and charge-offs. This has been particularly true in the U.S. where charge-offs have increased and receivables outstanding have decreased. In order to make better use of its capital resources, the Registrant has undertaken a strategic review of its U.S. operations. This review, which will encompass underperforming branches, started in June 1997 and should be completed by year-end 1998. Each underperforming branch is being reviewed and when it is determined that a branch will not meet certain profitability standards, it will be sold. The Registrant does not anticipate these actions to result in any losses. Although the strategic review resulted in 47 branches being sold in 1997, the Registrant also opened 47 new branches in the U.S. while closing 38 branches as part of its normal operations. At December 31, 1997, the Registrant had 1,199 branches, of which 715 were in the U.S. Nonrelated Insurance REVENUES of this segment increased $18 million (7%) to $279 million, due primarily to an increase in premiums earned and a higher level of investment income, partially offset by lower capital gains. INCOME BEFORE INCOME TAXES of this segment increased $10 million (50%) to $29 million, due primarily to a decrease in insurance losses, commissions and other operating expenses in relation to premiums earned and a higher level of investment income, partially offset by lower capital gains. 12 14 1996 VS. 1995 -- Revenues for 1996 were $1.760 billion compared to $1.664 for 1995, an increase of $96 million (6%). Income before taxes for 1996 was $299 million compared to $287 million for 1995, an increase of $11 million (4%). These results reflect increases in both the Financial Services and Related Insurance segment as the Nonrelated Insurance segment of the Registrant's operations. Financial Services and Related Insurance REVENUES of this segment increased $55 million (4%) to $1.499 billion, due primarily to: (i) an increase in finance receivable yields (18.52% in 1996 vs. 18.20% in 1995), which had the effect of increasing revenues by approximately $25 million; (ii) an increase in premiums earned associated with an increase in premiums written; and (iii) an increase in investment and other income, attributable to an increase in capital gains resulting from a higher volume of sales in the bond investment portfolio and a gain on the sale of certain finance receivables. INCOME BEFORE INCOME TAXES of this segment increased $7 million (3%) to $279 million, due primarily to: (i) the increase in revenues and (ii) a decrease in the cost of borrowed funds (6.88% in 1996 vs. 7.32% in 1995). These factors were partially offset by an increase in the provision for credit losses attributable to an increase in the ratio of net credit losses to average finance receivables (2.82% in 1996 vs. 2.10% in 1995) and the strengthening of the allowance for credit losses (3.01% of finance receivables outstanding at December 31, 1996 vs. 2.82% at December 31, 1995). Nonrelated Insurance REVENUES of this segment increased $41 million (19%) to $261 million, due primarily to an increase in premiums earned associated with an increase in premiums written (resulting from growth in existing accounts as well as the addition of new accounts in the second half of 1995). INCOME BEFORE INCOME TAXES of this segment increased $4 million (22%) to $20 million, due primarily to: (i) an increase in investment income attributable to a higher level of investments outstanding and higher capital gains and (ii) a decrease in underwriting expenses in relation to earned premiums. These favorable factors were partially offset by higher losses in all lines of business. LIQUIDITY/CAPITAL RESOURCES The Registrant's business consists of its finance operations and insurance operations. The insurance operations have historically generated positive cash flows sufficient to preclude the need for borrowings. The Registrant utilizes a broad base of financial sources for its liquidity and capital requirements. Cash is provided from both operations and several different sources of borrowings, including unsecured borrowings under bank lines of credit, the issuance of commercial paper and sales of medium and long-term debt in the U.S. and foreign financial markets. For liquidity purposes, the Registrant has a policy of maintaining sufficient unused bank lines of credit to support its outstanding commercial paper. The commercial paper coverage ratio at December 31, 1997, was 107.4%. For further information regarding commercial paper and bank lines of credit, see Note 5 to the Consolidated Financial Statements of the Registrant. At December 31, 1997, $2.39 billion (31%) of the Registrant's finance receivables were represented by residential real estate loans, secured primarily by first and second mortgages on single family homes, which averaged $30 thousand in outstanding principal balance per loan. Such loans are geographically dispersed among many customers, and the loan amounts are limited to a maximum of 85% of the unencumbered appraised market value at the date of the loans, although most loans are made at significantly lower loan to value ratios. The Registrant believes that substantially all such loans remain fully secured. Foreclosed real estate loans are transferred out of finance receivables into other assets at the lower of fair value (less estimated costs to sell) or the outstanding loan balance. The carrying value of real estate owned is 13 15 periodically reevaluated and, where appropriate, adjustments are made to reflect subsequent decreases in fair value. At December 31, 1997, real estate classified in other assets aggregated $56.6 million. At December 31, 1997, the Registrant had an investment portfolio of $996.4 million, primarily represented by high quality, investment grade debt securities. Such portfolio included $194.6 million ($196.9 million market value) of mortgage-backed securities, including $54.8 million guaranteed by the U.S. Government or agencies thereof. The amount of net assets of the Registrant available for cash dividends and other payments to its parent, Textron Inc., is restricted by the terms of lending agreements and insurance statutory requirements. The Registrant paid dividends of $147.8 million, $94.9 million and $90.1 million to Textron Inc. in 1997, 1996 and 1995, respectively. See Note 8 to the Consolidated Financial Statements of the Registrant for restrictions on the declaration or payment of cash dividends. In late 1997, the Registrant changed its dividend policy so that its dividends will be paid based upon maintaining the Registrant's tangible leverage ratio at approximately 6.5:1. Under the previous policy, dividends could not exceed an amount equal to 50% of net earnings during each fiscal year. FINANCIAL RISK MANAGEMENT Interest Rate Risk: The Registrant is exposed to interest rate risk from its various interest sensitive assets and liabilities. As a result, the Registrant's financial results could be affected by changes in U.S. and foreign interest rates. As part of managing this risk, the Registrant enters into interest rate exchange agreements to convert certain variable-rate debt to long-term fixed-rate debt and vice versa. The overall objective of the Registrant's interest rate risk management is to reduce the risk that near-term earnings could be adversely affected by changes in interest rates while also reducing the overall cost of debt. By adjusting the underlying effective interest rate of certain debt instruments with these agreements, the Registrant is better able to match the effective maturity and interest rates of the debt to certain finance receivables to reduce the risk of the interest rate margins declining from increases in interest rates. The Registrant has interest sensitive assets and liabilities that are not perfectly matched. Management continuously monitors this situation to ensure that the net unmatched position is within acceptable limits. If the unmatched positions were to exceed the acceptable limits, then corrective action would be implemented. The difference between the variable-rate the Registrant received and the fixed-rate it paid on interest rate exchange agreements increased its reported interest expense by $18.2 million in 1997, $16.8 million in 1996 and $10.9 million in 1995. For a further discussion of interest rate exchange agreements, see Note 1 to the Consolidated Financial Statements of the Registrant. Foreign Exchange Risks: A portion of the Registrant's cash flows are denominated in foreign currencies. As a result, the Registrant is exposed to exchange rate market risks. The Registrant's financial results could be affected by changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Registrant operates. The Registrant's primary exposures are the Canadian dollar, Australian dollar, French franc, British pound and Hong Kong dollar. The Registrant funds non-U.S. dollar receivables with debt denominated in the same currency. However, the amount of the Registrant's non-U.S. dollar receivables generally exceeds the amount of debt denominated in that same currency. As such, the effect of changing exchange rates on foreign denominated assets and liabilities is reflected within the translation adjustment in stockholder's equity and is not part of income. Quantitative Risk Measures: The Registrant has used a value-at-risk model to quantify the market risk inherent in its financial instruments at year end. The value-at-risk model is intended to measure the maximum amount of fair value the Registrant's financial instruments could hypothetically lose over a given time period from adverse 14 16 movements in interest rates and foreign exchange rates at a 95% confidence level. The model uses the variance-covariance statistical modeling technique and only considers financial instruments (finance receivables, investments, debt, and interest rate swaps) but not all underlying exposures. The model only assumes adverse market conditions and most likely is not indicative of actual results. The estimated value-at-risk amounts representing the potential loss in value the Registrant's financial instruments could realize from adverse changes in interest rates and foreign exchange rates for a one day period are not material. YEAR 2000 ISSUE In early 1997, the Registrant performed a companywide assessment of its computer programs to identify the impact of the Year 2000 Issue on its operations. Some of these programs are critical to operations and could fail to properly process data unless they are modified. The Year 2000 Issue results from many computer programs using only two digits to identify the year in the date field. As a result of this assessment, the Registrant instituted a plan of corrective action. This project, which began in mid-1997, will be carried out both by existing personnel and outside contractors. The Registrant anticipates that all of the necessary internal program modifications will be completed by the end of 1998. During the latter part of 1998 and the first half of 1999, the Registrant will test its ability to communicate electronically with other entities, such as suppliers, independent data processing agencies, and customers. The costs of these efforts are recognized in income as incurred. The costs related to this project did not have a material impact on the Registrant's results of operations in 1997, and they are not anticipated to have a material impact in 1998 or 1999. The Registrant does not expect the Year 2000 Issue to materially affect its financial results, products, services, or competitive conditions in the year 2000 or thereafter. NEW ACCOUNTING PRONOUNCEMENTS In 1997, the Statement of Financial Accounting Standards No. 131 "Disclosures about Segments of an Enterprise and Related Information" was issued. This Statement establishes new standards for reporting information about operating segments. This Statement is effective for periods beginning after December 15, 1997. The Registrant is evaluating the impact of this Statement on future segment reporting. * * * * * Forward-looking Information: Certain statements in this Form 10-K, and other oral and written statements made by the Registrant from time to time, are forward-looking statements, including those that discuss strategies, goals, outlook, projected revenues, income, returns and other financial measures, and other non-historical statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those contained in the statements, including the following: (i) continued market demand for the types of financial services offered by the Registrant; (ii) increased contractual delinquencies or credit losses; (iii) ability of the Registrant to utilize a broad base of financial sources for liquidity and capital requirements; (iv) changes in laws or regulations governing the Registrant's finance operations or insurance operations; (v) increased competition; and (vi) changes in worldwide economic and political conditions and the associated impact on interest and foreign exchange rates and consumer bankruptcies and delinquencies. The statement on Year 2000 Issue that appears above is subject to the Registrant's ability to complete the corrective action without unexpected complications and the ability of its suppliers, and customers to successfully modify their own programs. The quantification of the interest-rate and foreign exchange-rate value-at-risk amounts above are also forward-looking statements, but should not be considered projections of future events or losses, since the analysis model only assumes adverse conditions. In addition, the words "believe," "expect," "anticipate," "intend," "aim," "will" and similar words identify forward-looking statements in this Form 10-K. 15 17 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT AUDITORS The Board of Directors Avco Financial Services, Inc. We have audited the accompanying consolidated balance sheet of Avco Financial Services, Inc. as of December 31, 1997 and 1996 and the related consolidated statements of income, cash flows and changes in stockholder's equity for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedules listed in the accompanying index to financial statements at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Avco Financial Services, Inc. at December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. We have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet at December 31, 1995, 1994 and 1993, and the related consolidated statements of income, cash flows, and changes in stockholder's equity for the years ended December 31, 1994 and 1993 (none of which are presented separately herein), and we expressed unqualified opinions on those consolidated financial statements. In our opinion, the information set forth in the selected financial data for each of the five years in the period ended December 31, 1997, appearing on page 11, is fairly stated in all material respects in relation to the consolidated financial statements from which it has been derived. ERNST & YOUNG LLP Orange County, California January 27, 1998 16 18 AVCO FINANCIAL SERVICES, INC. CONSOLIDATED BALANCE SHEET
December 31, ------------------------ 1997 1996 ---------- ---------- (Thousands of dollars) ASSETS Finance receivables -- net.................................. $7,233,561 $6,762,507 Investments................................................. 996,407 927,571 Property and equipment...................................... 89,982 80,646 Insurance policy acquisition costs.......................... 60,863 60,480 Goodwill.................................................... 78,406 27,086 Cash........................................................ 44,958 15,562 Other....................................................... 305,721 321,207 ---------- ---------- TOTAL ASSETS...................................... $8,809,898 $8,195,059 ========== ========== LIABILITIES AND STOCKHOLDER'S EQUITY Debt........................................................ $6,915,782 $6,403,348 Accounts payable and accrued liabilities.................... 347,796 303,713 Insurance reserves and claims Unearned insurance premiums............................... 215,968 215,768 Losses and adjustment expenses............................ 64,879 66,758 Income taxes................................................ 54,958 52,786 ---------- ---------- Total liabilities................................. 7,599,383 7,042,373 ---------- ---------- Stockholder's equity Common stock ($1 par value, 500,000 shares authorized; 500,000 shares outstanding)............................ 500 500 Additional paid-in capital................................ 257,453 137,588 Retained earnings......................................... 1,089,859 1,041,543 Securities valuation adjustment........................... 13,056 65,061 Currency translation adjustment........................... (150,353) (92,006) ---------- ---------- Total stockholder's equity........................ 1,210,515 1,152,686 ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY........ $8,809,898 $8,195,059 ========== ==========
See accompanying notes to consolidated financial statements. 17 19 AVCO FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENT OF INCOME
Year ended December 31, ------------------------------------ 1997 1996 1995 ---------- ---------- ---------- (Thousands of dollars) REVENUES Interest, discount and service charges.................. $1,341,177 $1,276,687 $1,249,438 Credit life, credit disability and casualty insurance premiums............................................. 414,003 398,641 349,759 Investment and other income (including net realized investment gains).................................... 98,085 84,742 64,790 ---------- ---------- ---------- Total revenues.................................. 1,853,265 1,760,070 1,663,987 EXPENSES Interest and debt expense Interest on notes.................................... 226,117 240,687 261,223 Amortization of debt expense......................... 6,782 4,731 4,740 Interest on commercial paper, bank loans and other indebtedness....................................... 201,156 180,842 189,416 ---------- ---------- ---------- Total........................................... 434,055 426,260 455,379 Salaries, wages, and other employee benefits............ 323,888 307,224 293,273 Provision for losses on collection of finance receivables.......................................... 233,182 203,410 149,143 Credit life, credit disability and casualty insurance losses and adjustment expenses, less recoveries...... 184,158 184,057 155,477 Amortization of insurance policy acquisition costs...... 95,129 90,808 79,168 Other operating expenses................................ 271,516 249,752 244,088 ---------- ---------- ---------- Total expenses.................................. 1,541,928 1,461,511 1,376,528 ---------- ---------- ---------- Income before income taxes................................ 311,337 298,559 287,459 Income taxes.............................................. 115,221 111,552 108,056 ---------- ---------- ---------- NET INCOME................................................ $ 196,116 $ 187,007 $ 179,403 ========== ========== ========== Ratio of income to fixed charges.......................... 1.7 1.7 1.6 === === ===
See accompanying notes to consolidated financial statements. 18 20 AVCO FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS
Year ended December 31, --------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (Thousands of dollars) CASH FLOWS FROM OPERATING ACTIVITIES Net income............................................ $ 196,116 $ 187,007 $ 179,403 Adjustments to reconcile net income to net cash provided by operating activities: Provision for losses on collection of finance receivables...................................... 233,182 203,410 149,143 Depreciation....................................... 20,464 19,301 19,249 Gain on sales of investments....................... (5,217) (11,218) (3,167) Increase in insurance policy acquisition costs..... (559) (5,872) (11,720) Increase in unearned insurance premiums and reserves for insurance losses and adjustment expenses......................................... 13,389 27,125 68,365 Increase (decrease) in accounts payable and accrued liabilities...................................... (20,850) 13,822 4,881 Increase (decrease) in income taxes................ 15,594 (2,012) (14,540) Other - net........................................ (1,926) (17,173) (20,370) ----------- ----------- ----------- Net cash provided by operating activities..... 450,193 414,390 371,244 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Finance receivables originated or purchased........... (5,682,214) (4,610,664) (4,272,148) Finance receivables repaid or sold.................... 5,244,630 4,222,535 3,957,343 Purchases of investments available for sale........... (288,434) (288,544) (179,210) Proceeds from sales of investments available for sale............................................... 151,183 198,562 65,513 Proceeds from maturities and calls of investments available for sale................................. 90,210 49,669 54,935 Capital expenditures.................................. (38,109) (31,249) (22,108) Cash used in acquisitions............................. (85,160) -- (39,808) ----------- ----------- ----------- Net cash used by investing activities......... (607,894) (459,691) (435,483) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Increase (decrease) in short-term debt................ 66,581 282,940 (307,542) Proceeds from issuance of notes....................... 917,736 839,294 1,376,393 Principal payments on notes........................... (690,243) (992,045) (911,255) Increase in savings deposits.......................... 823 120 380 Dividends paid........................................ (147,800) (94,900) (90,100) Capital Contribution.................................. 40,000 -- -- ----------- ----------- ----------- Net cash provided by financing activities..... 187,097 35,409 67,876 ----------- ----------- ----------- Net increase (decrease) in cash......................... 29,396 (9,892) 3,637 Cash at beginning of year............................... 15,562 25,454 21,817 ----------- ----------- ----------- Cash at end of year..................................... $ 44,958 $ 15,562 $ 25,454 =========== =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Interest.............................................. $ 442,087 $ 433,607 $ 461,587 Income taxes.......................................... $ 109,967 $ 111,193 $ 122,310
See accompanying notes to consolidated financial statements. 19 21 AVCO FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY
Additional Securities Currency Common paid-in Retained valuation translation stock capital earnings adjustment adjustment Total ------ ---------- ---------- -------------- ----------- ---------- (Thousands of dollars) Balance at December 31, 1994...... $500 $137,588 $ 860,133 $ 8,278 $(112,755) $ 893,744 Net income...................... 179,403 179,403 Cash dividends declared ($180.20 per common share)... (90,100) (90,100) Change in valuation adjustment................... 48,031 48,031 Change in translation adjustment................... (2,848) (2,848) ---- -------- ---------- -------- --------- ---------- Balance at December 31, 1995...... 500 137,588 949,436 56,309 (115,603) 1,028,230 Net income...................... 187,007 187,007 Cash dividends declared ($189.80 per common share)............ (94,900) (94,900) Change in valuation adjustment................... 8,752 8,752 Change in translation adjustment................... 23,597 23,597 ---- -------- ---------- -------- --------- ---------- Balance at December 31, 1996...... 500 137,588 1,041,543 65,061 (92,006) 1,152,686 Net income...................... 196,116 196,116 Cash dividends declared ($295.60 per common share)............ (147,800) (147,800) Capital contribution............ 40,000 40,000 Exchange of Textron, Inc. shares....................... 79,865 (79,865) Change in valuation adjustment................... 27,860 27,860 Change in translation adjustment................... (58,347) (58,347) ---- -------- ---------- -------- --------- ---------- Balance at December 31, 1997...... $500 $257,453 $1,089,859 $ 13,056 $(150,353) $1,210,515 ==== ======== ========== ======== ========= ==========
See accompanying notes to consolidated financial statements. 20 22 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION Avco Financial Services, Inc. is a wholly-owned subsidiary of Textron Inc. The consolidated financial statements include the accounts of Avco Financial Services, Inc. and its subsidiaries (AFS). All significant intercompany transactions are eliminated. Certain reclassifications have been made to prior year amounts to conform with current year presentation. USE OF ESTIMATES 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 those statements and accompanying notes. Actual results may differ from such estimates. FINANCE RECEIVABLES Revenue and Acquisition Cost Recognition For finance receivables, interest income is recognized in revenues using the interest method so as to produce a constant rate of return over the terms of the receivables. Accrual of interest income is suspended for accounts which are contractually delinquent by more than three payments. Once an account is suspended, subsequent interest income is recognized when collected. Fees received and direct loan origination costs are deferred and recognized in income over the contractual lives of the respective loans. Unamortized amounts are recognized in income when loans are sold or paid in full. Credit Losses Provisions for losses on receivables are charged to income in amounts sufficient to maintain the allowance at a level considered adequate to cover the losses of principal and interest in the existing receivable portfolio. The determination of an appropriate allowance for losses is based upon loss experience and payment history. Finance receivables are written off when they are deemed uncollectible, but in any event, all accounts for which an amount aggregating a full contractual payment has not been received for six consecutive months are written off. Foreclosed real estate loans are transferred out of finance receivables into other assets at the lower of fair value (less estimated costs to sell) or the outstanding loan balance. The difference between the amount transferred and the outstanding loan balance is written off. The carrying value of real estate owned is periodically reevaluated and, where appropriate, adjustments are made to reflect subsequent decreases in fair value. Subsequent gains and losses on the disposition of real estate owned are reflected in other operating expenses. INSURANCE OPERATIONS Recognition of Revenues and Expenses Unearned insurance premiums are deferred and subsequently recognized in revenues over the lives of the policies (a) on the interest method for decreasing term credit life insurance coverage and on the pro rata method for level term credit life coverage, (b) in relation to anticipated claims for credit disability insurance and (c) on the pro rata method for casualty insurance. Deferred Policy Acquisition Costs Costs, which vary with, and are primarily related to, the production of new business, have been deferred to the extent such costs are deemed recoverable from future profits. Such costs primarily include commissions and premium taxes. These costs are amortized in proportion to premiums over the estimated lives of the 21 23 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) policies. Anticipated investment income is considered in determining if a premium deficiency relating to short-term contracts exists. Insurance Reserves and Claims Insurance reserves and claims represent the estimated ultimate cost of settling claims incurred as of the balance sheet date. The reserves for casualty losses are based upon estimates for losses and loss adjustment expenses reported prior to the close of the accounting period and estimates of incurred but not reported losses and adjustment expenses based upon past experience and adjusted for current conditions, net of reinsurance recoverable and salvage and subrogation. The reserves for credit life and credit disability losses represent estimates of those claims due and unpaid, in the course of settlement, and incurred but not reported, computed using historical liquidation patterns adjusted for changes in portfolio composition, net of reinsurance recoverable. Due to the short-term nature of AFS' loss development and the effect of reinsurance agreements, casualty insurance losses and adjustment expenses in 1997, 1996 and 1995 relating to insured events occurring prior to each of those years, is immaterial. Reinsurance Prepaid reinsurance premiums and amounts recoverable from reinsurers are estimated and recognized in a manner consistent with the reinsured policy. See Note 6 for further information about reinsurance. INVESTMENTS AFS' securities portfolio is classified as available for sale and reported at estimated fair value, with the exception of the investment in Textron Inc. Series D Cumulative Preferred Stock. Unrealized gains and losses, net of applicable income taxes, are reported as a separate component of stockholder's equity. In 1990, AFS purchased $25.0 million of Textron Inc. common stock on the open market. In December 1997, Textron Inc. and AFS, pursuant to an exchange agreement, exchanged the shares of common stock held by AFS for 1,522 shares of Textron Inc. Series D Cumulative Preferred Stock bearing an annual dividend yield of 5.92%. Prior to the exchange, the common shares were carried as an investment at fair market value. As of the date of the exchange agreement, the market value of the common stock was $152,207,000. The preferred shares are not registered with the Securities and Exchange Commission. The preferred shares may be redeemed at the option of the issuer or the holder subsequent to December 31, 2017, in an amount equal to the per share price as of the date of the exchange ($100,000 per share), plus accrued but unpaid dividends. Accordingly, AFS carries, at cost, the preferred shares at the value established on the date of the exchange agreement. AFS reclassified the unrealized gain, net of taxes, recorded on the common shares at the date of the agreement (approximately $79,865,000) to additional paid-in capital. Net realized gains or losses resulting from sales or calls of investments and losses resulting from declines in fair values of investments that are other than temporary declines are included in revenues. The cost of securities sold was based primarily upon the specific identification method. See Note 3 for further information about investments. 22 24 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INTEREST RATE EXCHANGE AGREEMENTS Interest rate exchange agreements are used to help manage interest rate risk by converting certain variable-rate debt to fixed-rate debt and vice versa. Those agreements involve the exchange of fixed-rate interest for variable-rate amounts over the life of the agreement without the exchange of the notional amount. Interest rate exchange agreements are accounted for on the accrual basis with the differential to be paid or received recorded currently as an adjustment to interest expense. Some agreements that require the payment of fixed rate interest are designated against specific long-term variable-rate borrowings, while the balance is designated against existing short-term borrowings through maturity and their anticipated replacements. AFS continuously monitors variable-rate borrowings to maintain the level of borrowings above the notional amount of the designated agreements. If it is not probable variable-rate borrowings will continuously exceed the notional amount of the designated agreements, the excess is marked to market and the associated gain or loss recorded in income. Premiums paid to terminate these agreements are deferred and amortized to expense over the remaining term of the original life of the contract. If the underlying debt is then paid early, unamortized premiums are recognized as an adjustment to the gain or loss associated with the debt's extinguishment. GOODWILL AFS amortizes goodwill on the straight-line method, over periods not exceeding 25 years. AFS periodically reviews goodwill for impairment by comparing the carrying amount to the estimated future undiscounted cash flows of the businesses acquired. If this review indicates that goodwill is not recoverable, the carrying amount would be reduced to fair value. The increase in goodwill during 1997 was due to international acquisitions of commercial finance businesses. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS See Note 11 for information about AFS' accounting policies for postretirement benefits other than pensions. INCOME TAXES Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities based on enacted tax rates expected to be in effect when such amounts are expected to be realized or settled. See Note 4 for further information about income taxes. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair values presented in Note 13 are estimates of the fair values of the financial instruments at a specific point in time using available market information and appropriate valuation methodologies. These estimates are subjective in nature and involve uncertainties and significant judgment in the interpretation of current market data. Therefore, the fair values presented are not necessarily indicative of amounts AFS could realize or settle currently. AFS does not necessarily intend to dispose of or liquidate such instruments prior to maturity. FOREIGN OPERATIONS AFS' foreign entities' financial statements are measured in their functional currency. Balance sheet accounts at December 31, 1997 and 1996 have been translated at the closing rates on those dates. Income and 23 25 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) expense accounts have been translated at the average rates prevailing during the respective periods. Adjustments resulting from the translation of the financial statements of AFS' foreign operations are excluded from the determination of its consolidated income and are accumulated as a separate component of consolidated stockholder's equity until the entity is sold or substantially liquidated. Foreign exchange gains and losses included in consolidated income (which relate principally to transactions denominated in foreign currencies) in 1997, 1996 and 1995 were not material. RATIO OF INCOME TO FIXED CHARGES The ratio of income to fixed charges represents the number of times fixed charges (interest and debt expense [without adjustments for discounts or premiums resulting from the repurchase of debt securities] and one-third of all rent and related costs, considered to represent an appropriate interest factor, charged to income) are covered by income before income taxes and fixed charges. NOTE 2: FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES Contractual maturities of finance receivables outstanding at December 31, 1997 and total finance receivables outstanding at that date and at December 31, 1996 were as follows:
Contractual maturities Less Receivables outstanding ------------------------------------ finance ----------------------- 1998 1999 2000-2012 charges 1997(a) 1996 ---------- ---------- ---------- ---------- ---------- ---------- (Thousands of dollars) DOMESTIC: Consumer loans............ $ 979,194 $ 667,668 $ 663,442 $ 728,185 $1,582,119 $1,794,932 Real estate loans......... 313,251 311,701 2,845,707 1,866,755 1,603,904 1,721,008 Retail installment contracts................. 506,096 300,289 340,307 409,884 736,808 630,117 ---------- ---------- ---------- ---------- ---------- ---------- Total consumer finance.............. 1,798,541 1,279,658 3,849,456 3,004,824 3,922,831 4,146,057 INTERNATIONAL: Consumer loans............ 749,115 524,976 640,169 473,757 1,440,503 1,411,130 Real estate loans......... 285,526 176,023 664,058 334,622 790,985 825,842 Retail installment contracts............... 567,400 134,123 84,324 100,977 684,870 579,213 ---------- ---------- ---------- ---------- ---------- ---------- Total consumer finance.............. 1,602,041 835,122 1,388,551 909,356 2,916,358 2,816,185 Commercial finance...... 472,545 173,775 364,873 107,741 903,452 291,496 ---------- ---------- ---------- ---------- ---------- ---------- Total international.. 2,074,586 1,008,897 1,753,424 1,017,097 3,819,810 3,107,681 ---------- ---------- ---------- ---------- ---------- ---------- Total..................... $3,873,127 $2,288,555 $5,602,880 $4,021,921 7,742,641 7,253,738 ========== ========== ========== ========== Less allowance for credit losses............................................. (237,809) (218,416) Less finance-related insurance reserves and claims........................... (271,271) (272,815) ---------- ---------- Finance receivables -- net................................................... $7,233,561 $6,762,507 ========== ==========
- --------------- (a) As of December 31, 1997, total consumer and commercial finance receivables outstanding include loans bearing a variable rate of interest of approximately $736 million and $325 million, respectively. The maximum term over which consumer loans and retail installment contracts are written is 10 years, but approximately 90% of these loans are written with terms of 4 years or less. Real estate loans are written with a maximum term of 15 years. Consumer loans are unsecured or secured by personal property and are in relatively small amounts. Retail installment contracts are secured by personal property. Real estate loans are secured by real property and are limited to a maximum of 85% of the property's unencumbered appraised market value at the date of the loans. 24 26 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2: FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES (CONTINUED) Accounts are often repaid or refinanced prior to contractual maturity. Accordingly, the foregoing tabulation should not be regarded as a forecast of future cash collections. During 1997 and 1996, cash collections of receivables (excluding finance charges) were $4.9 billion and $4.2 billion, respectively. The ratio of cash collections to average finance receivables was approximately 65% and 61%, respectively. Nonearning assets represent those finance receivables on which both the accrual of interest income has been suspended and for which no payment of principal or interest has been received for more than 30 days. Nonearning assets totaled approximately $136.8 million at December 31, 1997 and $140.7 million at December 31, 1996. AFS has commitments to extend additional credit to customers under revolving secured and unsecured loan agreements. Interest rates charged are variable. The agreements provide for suspension or termination of the credit line for default and other factors adverse to the interests of AFS. At December 31, 1997, committed lines totaled approximately $846 million of which approximately $418 million remained unused. 25 27 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2: FINANCE RECEIVABLES AND ALLOWANCE FOR LOSSES (CONTINUED) Changes in the allowance for credit losses were as follows:
Year ended December 31, --------------------------------------------------------- 1997 1996 1995 1994(a) 1993(a) --------- --------- --------- --------- --------- (Thousands of dollars) Balance of the allowance for credit losses at beginning of year............................... $ 218,416 $ 195,413 $ 180,573 $ 155,015 $ 147,088 Deduct -- balances charged off: Gross charge offs: Domestic Real estate.................................. (15,135) (15,021) (14,773) (15,851) (17,647) Other loans.................................. (163,676) (136,490) (100,017) (79,087) (73,181) Commercial................................... -- (2,686) (3,354) (3,414) (2,849) --------- --------- --------- --------- --------- Total domestic............................. (178,811) (154,197) (118,144) (98,352) (93,677) International Real estate.................................. (6,509) (7,462) (7,166) (5,046) (7,478) Other loans.................................. (81,976) (66,771) (50,929) (38,488) (36,949) Commercial................................... (5,998) (1,725) (565) -- -- --------- --------- --------- --------- --------- Total international........................ (94,483) (75,958) (58,660) (43,534) (44,427) --------- --------- --------- --------- --------- Total................................... (273,294) (230,155) (176,804) (141,886) (138,104) Recoveries: Domestic Real estate.................................. 2,301 623 847 830 800 Other loans.................................. 28,520 18,720 17,782 16,489 14,870 Commercial................................... -- 759 744 496 538 --------- --------- --------- --------- --------- Total domestic............................. 30,821 20,102 19,373 17,815 16,208 International Real estate.................................. 2,570 1,283 939 764 788 Other loans.................................. 14,805 13,523 12,368 9,873 9,615 Commercial................................... 4,005 572 234 -- -- --------- --------- --------- --------- --------- Total international........................ 21,380 15,378 13,541 10,637 10,403 --------- --------- --------- --------- --------- Total................................... 52,201 35,480 32,914 28,452 26,611 Add -- charged to income.......................... 233,182 203,410 149,143 136,101 120,694 Other............................................. 7,304 14,268 9,587 2,891 (1,274) --------- --------- --------- --------- --------- Balance of the allowance for credit losses at end of year......................................... $ 237,809 $ 218,416 $ 195,413 $ 180,573 $ 155,015 ========= ========= ========= ========= ========= Balance of the allowance for credit losses at the end of each year applicable to: Domestic Real estate.................................. $ 16,039 $ 25,815 $ 25,441 $ 26,064 $ 24,912 Other loans.................................. 129,003 117,009 98,346 99,234 83,481 Commercial................................... -- -- 2,649 3,031 2,492 --------- --------- --------- --------- --------- Total domestic............................. 145,042 142,824 126,436 128,329 110,885 International Real estate.................................. 5,694 9,213 8,850 7,953 7,136 Other loans.................................. 71,200 61,161 56,810 44,195 36,994 Commercial................................... 15,873 5,218 3,317 96 -- --------- --------- --------- --------- --------- Total international........................ 92,767 75,592 68,977 52,244 44,130 --------- --------- --------- --------- --------- Total................................... $ 237,809 $ 218,416 $ 195,413 $ 180,573 $ 155,015 ========= ========= ========= ========= =========
- ------------ (a) The above data for the two years ended 1994 is not reported upon herein by independent auditors. 26 28 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3: INVESTMENTS
1997 1996 -------- -------- (Thousands of dollars) Debt securities: Commercial paper, at estimated fair value (approximates cost).................................................. $ 56,299 $ 89,180 Bonds available for sale at estimated fair value (cost: $748,612,000 in 1997 and $686,140,000 in 1996).................................................. 767,392 697,844 -------- -------- Total.................................................. 823,691 787,024 Preferred stock, at cost.................................... 152,207 -- Marketable equity securities, at market..................... 19,086 138,572 First mortgages on real estate, at cost..................... 1,423 1,975 -------- -------- Total............................................. $996,407 $927,571 ======== ========
The amortized cost and estimated fair value of debt securities and equity securities at December 31, 1997 and 1996 were as follows:
December 31, 1997 ----------------------------------------------- Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value --------- ---------- ---------- --------- (Thousands of dollars) U.S. Treasury securities and obligations of other U.S. Government agencies and authorities................. $ 77,971 $ 2,189 $ 51 $ 80,109 Obligations of states, municipalities and political subdivisions........................................ 57,823 4,146 621 61,348 Obligations of foreign governments and agencies....... 103,566 4,339 67 107,838 Public utility securities............................. 40,485 519 129 40,875 Mortgage-backed securities............................ 194,621 2,342 84 196,879 Corporate securities.................................. 330,444 7,026 828 336,642 Equity securities..................................... 169,977 1,363 47 171,293 -------- -------- ------ -------- Debt and equity securities available for sale.... $974,887 $ 21,924 $1,827 $994,984 ======== ======== ====== ========
December 31, 1996 ----------------------------------------------- Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value --------- ---------- ---------- --------- (Thousands of dollars) U.S. Treasury securities and obligations of other U.S. Government agencies and authorities................. $ 56,007 $ 1,547 $ 161 $ 57,393 Obligations of states, municipalities and political subdivisions........................................ 74,849 4,038 697 78,190 Obligations of foreign governments and agencies....... 96,336 4,573 90 100,819 Public utility securities............................. 53,289 730 434 53,585 Mortgage-backed securities............................ 179,484 829 583 179,730 Corporate securities.................................. 315,355 4,106 2,154 317,307 Equity securities..................................... 47,816 90,777 21 138,572 -------- -------- ------ -------- Debt and equity securities available for sale.... $823,136 $106,600 $4,140 $925,596 ======== ======== ====== ========
27 29 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3: INVESTMENTS (CONTINUED) The amortized cost and estimated fair value of debt securities at December 31, 1997, by contractual maturity, are presented below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Estimated Amortized fair cost value --------- --------- (Thousands of dollars) Due in 1998............................................ $141,686 $143,700 Due 1999 to 2002....................................... 254,363 258,852 Due 2003 to 2007....................................... 136,957 143,065 Due after 2007......................................... 77,283 81,195 Mortgage-backed securities............................. 194,621 196,879 -------- -------- $804,910 $823,691 ======== ========
Gross realized gains and (losses) on sales of securities were (in millions), $5.1 and $(.1) in 1997, $9.8 and ($.4) in 1996, and $6.7 and ($3.5) in 1995. NOTE 4: INCOME TAXES AFS' provision for income tax is based upon including all eligible U.S. subsidiaries in the consolidated U.S. federal income tax return filed by its parent, Textron Inc. Such provision does not differ materially from the amount which AFS would have provided if it and its eligible subsidiaries were filing their own consolidated federal income tax return, except that AFS would not have been able to utilize approximately $4 million of foreign tax credit benefits in 1997. The provision for income tax also includes amounts for AFS' foreign subsidiaries which file their own separate income tax returns. AFS recognizes deferred income taxes for temporary differences between the financial reporting basis and income tax basis of assets and liabilities based on enacted tax rates expected to be in effect when amounts are likely to be realized or settled. For years beginning after March 31, 1997, the United Kingdom government decreased its corporate tax rate from 33% to 31%. In accordance with FAS 109, the change in the tax rate resulted in a revaluation of AFS' net deferred tax assets that were in existence at the beginning of 1997. The effect of this revaluation was not material. Deferred income taxes have not been provided for the undistributed earnings of foreign subsidiaries which aggregated approximately $481 million at the end of 1997. Management intends to reinvest those earnings for an indefinite period, except for distributions upon which incremental taxes would not be material. If such earnings were distributed, taxes (net of foreign tax credits) would have increased by approximately $31 million, principally due to foreign withholding taxes. At December 31, 1997, consolidated stockholder's equity included $17 million of U.S. life insurance subsidiary policyholders' surplus on which no income taxes have been provided. The amount of taxes which would become due if the surplus were distributed is approximately $6 million. Under present circumstances, it is not anticipated that any of these earnings will become taxable. 28 30 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4: INCOME TAXES (CONTINUED) Income taxes (benefit) are summarized as follows:
1997 1996 1995 --------------- --------------- --------------- (Thousands of dollars) Current Federal.......................................... $ 32,428 $ 49,950 $ 56,628 State............................................ 5,692 6,038 8,227 Foreign.......................................... 71,221 59,734 42,073 --------------- --------------- --------------- 109,341 115,722 106,928 Deferred Federal.......................................... 10,191 (4,792) (2,826) State............................................ 716 (276) (938) Foreign.......................................... (5,027) 898 4,892 --------------- --------------- --------------- 5,880 (4,170) 1,128 --------------- --------------- --------------- Total income tax provision............... $ 115,221 $ 111,552 $ 108,056 =============== =============== ===============
The following reconciles the federal statutory income tax rate to the effective income tax rate applicable to pretax income, as reflected in the consolidated statement of income:
1997 1996 1995 ------- ------- ------- U.S. federal statutory tax rate............................ 35.0% 35.0% 35.0% Increases (decreases) in taxes resulting from: Residual tax on foreign dividends........................ (0.7) .8 .1 Higher tax on foreign income............................. 0.9 1.0 1.2 State income taxes....................................... 1.3 1.3 1.6 Nontaxable investment income............................. (0.8) (0.9) (1.0) Other, net............................................... 1.3 .2 .7 ------- ------- ------- Effective income tax rate.................................. 37.0% 37.4% 37.6% ======= ======= =======
AFS' net deferred tax asset consisted of gross deferred tax assets and gross deferred tax liabilities of $127.0 million and $98.1 million, respectively, at December 31, 1997 and $120.9 million and $63.5 million, respectively, at December 31, 1996. The components of AFS' net deferred tax asset as of December 31, 1997 and 1996 were as follows:
1997 1996 -------- -------- (Thousands of Dollars) Allowance for credit losses................................. $ 56,676 $ 56,673 Liabilities for future policy benefits...................... 24,299 21,628 Unrealized gain on marketable equity securities............. (52,369) (36,717) Obligation for postretirement benefits other than pensions.................................................. 13,642 13,877 Depreciation................................................ (10,643) (8,703) Insurance policy acquisition costs.......................... (12,943) (484) Lease financing transactions................................ 3,450 789 Other -- principally timing of expense deductions........... 6,824 10,314 -------- -------- Total net deferred tax asset...................... $ 28,936 $ 57,377 ======== ========
29 31 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5: DEBT AND CREDIT FACILITIES At December 31, 1997 and 1996, consolidated debt consisted of the following:
1997 1996 ---------- ---------- (Thousands of dollars) Senior Commercial paper.......................................... $2,956,719 $2,651,627 Banks..................................................... 217,471 115,367 Savings deposits.......................................... 6,070 5,465 3.74% to 5.99% due 1997 to 2002(a)........................ 1,895,949 1,124,414 6.00% to 7.99% due 1997 to 2002(a)........................ 1,316,216 1,819,816 8.00% to 9.99% due 1997 to 2000(a)........................ 504,720 664,676 10.77% due 1998........................................... 18,137 20,983 ---------- ---------- Total senior debt................................. 6,915,282 6,402,348 ---------- ---------- Senior subordinated 10.28% due 1998........................................... 500 1,000 ---------- ---------- Total debt........................................ $6,915,782 $6,403,348 ========== ==========
- ------------ (a) Interest rates on certain notes are adjusted periodically. Bank borrowings are arranged under revolving lines of credit. These borrowings are either on a demand basis or provide for maturities ranging up to one year. Commercial paper is issued with maturities up to one year with interest at prevailing market rates. The weighted average interest rates on bank borrowings and commercial paper outstanding at December 31, 1997, 1996 and 1995, without giving effect to the costs of maintaining the lines of credit, were 6.8%, 6.5% and 7.5%, respectively, for bank borrowings (primarily consisting of borrowings in foreign operations) and 5.5%, 5.4% and 6.2%, respectively, for commercial paper. The weighted average interest rate on bank borrowings and commercial paper outstanding during the three years ended December 31, 1997 was 5.5%, 5.9% and 6.6%, respectively. The weighted average interest rate is determined primarily by reference to daily outstanding principal amounts and excludes the cost of maintaining the lines of credit. At December 31, 1997 and 1996, AFS had lines of credit with various banks amounting to $4.1 billion and $3.5 billion, respectively, of which the unused portion of these lines amounted to $3.2 billion and $2.9 billion, respectively. AFS generally pays fees in support of these lines. During the years ended December 31, 1997 and 1996, AFS issued the following notes:
1997 1996 -------- ---------- (Thousands of dollars) Senior notes due 1997 to 2000 (Australia)................... $ 56,152 $ 422,187 Senior notes due 1997 to 2000 (Canada)...................... 158,192 36,675 Senior notes due 1999 to 2000 (Hong Kong)................... -- 71,111 Senior notes due 1997 to 2002 (United Kingdom).............. 314,916 9,321 Senior notes due 1997 to 1999 (United States)............... 400,000 300,000 -------- ---------- Total............................................. $929,260 $ 839,294 ======== ==========
Under interest rate exchange agreements, AFS makes periodic fixed payments in exchange for periodic variable payments. AFS has entered into such agreements to mitigate its exposure to increases in interest rates on a portion of its variable rate debt. These agreements had weighted average remaining terms of less than 2 years and had the effect of fixing the rate of interest at 7.3% and 7.9% on $1.125 billion and $1.143 billion of 30 32 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5: DEBT AND CREDIT FACILITIES (CONTINUED) variable rate borrowing at December 31, 1997 and 1996, respectively. The spread between the variable rate AFS received and the fixed rate AFS paid increased the reported interest expense by $18.2 million in 1997, $16.8 million in 1996, and $10.9 million in 1995. Such spread had the effect of increasing AFS' cost of borrowing by .27% in 1997, .27% in 1996, and .18% in 1995. The following details AFS' "fixed-pay" interest rate exchange agreement activity for the years 1997 and 1996:
1997 1996 ---------- ---------- (Thousands of dollars) Beginning notional amount................................... $1,143,369 $1,063,118 Notional amount of new contracts............................ 489,511 412,407 Notional amount of terminated and expired contracts......... (507,489) (332,156) ---------- ---------- Ending notional amount...................................... $1,125,391 $1,143,369 ========== ==========
The notional amount of fixed-pay interest rate swap agreements at December 31, 1997 categorized by annual maturity, along with the related weighted average interest rates paid are as follows: $362.9 million (8.1%) in 1998; $458.3 million (7.0%) in 1999; $267.6 million (6.9%) in 2000; $10.4 million (6.7%) in 2001; and $26.0 million (6.9%) in 2002. In 1997, AFS entered into additional fixed-pay interest rate exchange agreements which become effective in 1998 and 1999. These agreements expire through 2001 and will fix the rate of interest at 6.7% on $74 million of variable rate borrowing. The agreements will mitigate AFS' exposure to increases in interest rates primarily by replacing maturing fixed-pay swap agreements and fixed-rate notes. In addition, AFS entered into variable-pay swap agreements which have the effect of varying the rate of fixed rate debt. These agreements serve to better match the rate of interest AFS incurred on its financing with the rate of interest earned on certain of its variable rate finance receivables. The effect of these agreements on AFS' average annual cost of funds was not material. At December 31, 1997, $100.4 million of such agreements were in effect and expire through 2000. AFS had minimal exposure to loss from nonperformance by the counterparties to its interest rate exchange agreements at the end of 1997, and does not anticipate nonperformance by counterparties in the periodic settlements of amounts due. AFS currently minimizes this potential for risk by entering into contracts exclusively with major, financially sound counterparties having no less than a long-term bond rating of "A," by continuously monitoring the counterparties' credit ratings, and by limiting exposure with any one financial institution. The credit risk generally is limited to the amount by which the counterparties' contractual obligations exceed AFS' obligations to the counterparty. The aggregate maturities, required prepayments, redemptions and sinking fund requirements with respect to the consolidated debt outstanding (excluding commercial paper, bank notes and savings deposits) at December 31, 1997, for the five years ending December 31, 2002, were (in millions): $1,198.1 in 1998; $829.6 in 1999; $1,223.0 in 2000; $200.0 in 2001; and $284.8 in 2002. The senior subordinated note is subordinate and junior in right of payment, in all respects, to all indebtedness of AFS for money borrowed. 31 33 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 6: REINSURANCE In the normal course of business, AFS seeks to reduce the loss that may arise through AFS' insurance subsidiaries from catastrophes or other events that may cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises, or reinsurers. While reinsurance contracts do not relieve AFS from its obligations to policyholders, AFS evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. Additionally, AFS holds collateral under certain reinsurance agreements in the form of letters of credit and trust accounts at December 31, 1997. Reinsurance receivables with a carrying value of $2.8 million and prepaid reinsurance premiums of $26.1 million relating to a quota share agreement were associated with a single reinsurer. This reinsurance agreement was cancelled effective May 1, 1997. AFS holds collateral under this reinsurance agreement in the form of a trust account totalling $43.3 million at December 31, 1997. Additionally, AFS holds collateral under certain other reinsurance agreements in the forms of letters of credit and trust accounts. Reinsurance receivables and prepaid reinsurance premiums were $4.7 million and $27.7 million respectively at December 31, 1997 and $7.2 million and $38.1 million respectively at December 31, 1996. The effect of reinsurance on premiums written, premiums earned and losses incurred for the three years ended December 31, 1997 were as follows:
1997 1996 1995 -------- -------- -------- (Thousands of Dollars) Premiums Written Direct........................................... $389,597 $387,343 $382,592 Assumed.......................................... 55,931 64,039 50,784 Ceded............................................ (10,532) (45,403) (47,410) -------- -------- -------- Total premiums written................... $434,996 $405,979 $385,966 ======== ======== ======== Premiums Earned Direct........................................... $386,476 $397,753 $330,902 Assumed.......................................... 48,511 60,693 44,195 Ceded............................................ (20,984) (59,805) (25,338) -------- -------- -------- Total premiums earned.................... $414,003 $398,641 $349,759 ======== ======== ======== Losses Incurred Direct........................................... $174,507 $170,855 $143,248 Assumed.......................................... 16,659 20,210 16,626 Ceded............................................ (7,008) (7,008) (4,397) -------- -------- -------- Total losses incurred.................... $184,158 $184,057 $155,477 ======== ======== ========
NOTE 7: OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA AFS is principally engaged in finance and insurance activities. AFS' finance operations consist primarily of consumer loans which are unsecured or secured by personal property and are in relatively small amounts and for relatively short periods; real estate loans which are secured by real property in larger amounts and for considerably longer periods; and retail installment contracts, principally covering personal property, and commercial lending, focusing primarily on equipment leasing and inventory financing. As of December 31, 1997, AFS operated 1,199 consumer finance offices located throughout the United States, the Commonwealth of Puerto Rico, the Virgin Islands, Australia, Canada, Hong Kong, India, Ireland, New Zealand, Spain, Sweden and the United Kingdom. AFS' insurance business consists primarily of the sale of credit life, credit 32 34 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7: OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA (CONTINUED) disability and casualty insurance offered by various subsidiaries, a significant part of which is directly related to AFS' finance activities. Industry Segment The following is a summary of revenues, income before income taxes and identifiable assets by industry segment:
Year ended December 31, ----------------------------------------------------------------- 1997 1996 1995 1994* 1993* --------- --------- --------- --------- --------- (Thousands of dollars) Revenues..................................... Financial Services and Related Insurance................................ $1,574,412 $1,499,488 $1,444,893 $1,214,918 $1,145,756 Nonrelated Insurance....................... 278,853 260,582 219,094 173,316 178,308 ---------- ---------- ---------- ---------- ---------- Total revenues...................... $1,853,265 $1,760,070 $1,663,987 $1,388,234 $1,324,064 ========== ========== ========== ========== ========== Income Before Income Taxes Financial Services and Related Insurance................................ $ 281,821 $ 278,825 $ 271,299 $ 242,314 $ 217,789 Nonrelated Insurance....................... 29,516 19,734 16,160 16,796 7,995 ---------- ---------- ---------- ---------- ---------- Total income before income taxes.... $ 311,337 $ 298,559 $ 287,459 $ 259,110 $ 225,784 ========== ========== ========== ========== ========== Identifiable Assets Financial Services and Related Insurance................................ $8,384,440 $7,802,766 $7,437,119 $6,582,978 $5,681,416 Nonrelated Insurance....................... 425,458 392,293 353,829 455,313 441,544 ---------- ---------- ---------- ---------- ---------- Total identifiable assets........... $8,809,898 $8,195,059 $7,790,948 $7,038,291 $6,122,960 ========== ========== ========== ========== ==========
- --------------- * The above data for the two years ended 1994 is not reported upon herein by independent auditors. 33 35 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7: OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA (CONTINUED) Geographic Area The following is a summary of revenues, income before income taxes and identifiable assets by geographic area:
Year ended December 31, -------------------------------------------------------------- 1997 1996 1995 1994* 1993* ---------- ---------- ---------- ---------- ---------- (Thousands of dollars) Revenues Australia.................................... $ 261,589 $ 258,899 $ 240,683 $ 148,264 $ 133,080 Canada....................................... 260,104 235,197 221,175 204,068 210,423 United Kingdom............................... 174,816 147,349 144,675 127,813 112,607 United States................................ 1,083,744 1,071,412 1,028,907 900,023 867,954 Other Countries**............................ 73,012 47,213 28,547 8,066 -- ---------- ---------- ---------- ---------- ---------- Total revenues........................ $1,853,265 $1,760,070 $1,663,987 $1,388,234 $1,324,064 ========== ========== ========== ========== ========== Income (Loss) Before Income Taxes Australia.................................... $ 63,351 $ 58,236 $ 53,801 $ 43,796 $ 34,542 Canada....................................... 57,527 55,853 48,236 47,029 42,503 United Kingdom............................... 39,184 31,044 22,737 21,572 14,819 United States................................ 137,629 144,354 158,592 147,274 133,920 Other Countries**............................ 13,646 9,072 4,093 (561) -- ---------- ---------- ---------- ---------- ---------- Total income before income taxes...... $ 311,337 $ 298,559 $ 287,459 $ 259,110 $ 225,784 ========== ========== ========== ========== ========== Identifiable Assets Australia.................................... $1,244,675 $1,130,930 $1,081,286 $ 646,958 $ 526,410 Canada....................................... 1,270,180 1,105,794 1,031,678 963,689 937,339 United Kingdom............................... 874,201 679,761 606,857 585,736 465,820 United States................................ 4,768,121 4,911,331 4,823,918 4,735,989 4,193,391 Other Countries**............................ 652,721 367,243 247,209 105,919 -- ---------- ---------- ---------- ---------- ---------- Total identifiable assets............. $8,809,898 $8,195,059 $7,790,948 $7,038,291 $6,122,960 ========== ========== ========== ========== ==========
- ------------ * The above data for the two years ended 1994 is not reported upon herein by independent auditors. ** Includes the operations of France, Hong Kong, India, New Zealand, Spain and Sweden. At December 31, 1997, finance receivables in the United States represented 51% of AFS' total finance receivables outstanding. At such date, receivables outstanding in no state exceeded 9% of the United States' portfolio, except California in which outstanding receivables represented 16% of the United States' portfolio and 8% of the consolidated portfolio. Capital expenditures and depreciation expense for each of the five years ended 1997 were not material to the operations of the industry segments. NOTE 8: CERTAIN PROVISIONS CONTAINED IN NOTES, LOAN AGREEMENTS AND CERTIFICATE OF INCORPORATION AND OTHER RESTRICTIONS The notes, loan agreements and certificate of incorporation of AFS contain restrictions on the declaration or payment of cash dividends and on redemptions, purchases or other acquisitions of stock. Under the most restrictive provision at December 31, 1997, approximately $373.3 million of retained earnings was available for dividends on common stock or for redemptions, purchases or other acquisitions of stock. The notes and loan 34 36 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 8: CERTAIN PROVISIONS CONTAINED IN NOTES, LOAN AGREEMENTS AND CERTIFICATE OF INCORPORATION AND OTHER RESTRICTIONS (CONTINUED) agreements also contain various restrictive provisions regarding debt, the creation of liens or guarantees and the making of investments. Maximum dividend limitations imposed by U.S. and foreign insurance regulatory agencies and minimum capital requirements of various U.S. and foreign regulatory agencies imposed on certain of AFS' finance operations restrict the amount of certain subsidiaries' net assets which can be transferred to AFS. Such restricted net assets totaled approximately $486 million at December 31, 1997. NOTE 9: LEASE COMMITMENTS AFS' headquarters and regional executive offices are occupied under noncancelable operating leases expiring on various dates through 2017. The loan office locations through which operations are conducted are occupied under noncancelable operating leases having terms generally not exceeding five years with renewal options for an additional five years. Rental expense for such leases and for leased equipment was approximately $51 million for each of the three years ended December 31, 1997. Future minimum rental commitments for all noncancelable operating leases in effect at December 31, 1997 approximate $37 million in 1998, $31 million in 1999, $26 million in 2000, $21 million in 2001, $17 million in 2002 and $68 million thereafter. NOTE 10: CONTINGENCIES There is pending or threatened litigation against AFS and its subsidiaries. Among these lawsuits and proceedings are individual and class action proceedings which seek compensatory, treble or punitive damages in substantial amounts. These suits and proceedings are being defended or contested on behalf of AFS. On the basis of information presently available, AFS believes that any such liability from pending or threatened litigation will not have a material effect on AFS' net income or financial condition. The laws of many states in which AFS' insurance subsidiaries are admitted to do business require as a condition of admission that all insurance companies so admitted collectively guarantee to policyholders the benefits payable under policies issued by other insurance companies admitted in the particular state up to statutory levels. AFS' insurance subsidiaries have not been required to date to make any significant payments pursuant to such guarantees. While the amount of any assessments which may be made in the future cannot be predicted, AFS does not believe the total assessments, if any, will be material to its net income or financial condition. NOTE 11: POSTRETIREMENT BENEFITS OTHER THAN PENSIONS AFS has retirement plans, principally non-contributory (defined contribution) which cover substantially all employees. Costs relating to these plans, which are generally funded as accrued, amounted to approximately $15 million, $17 million and $16 million for 1997, 1996 and 1995, respectively. AFS provides certain health care and life insurance benefits for its employees and for certain retired employees. Such benefits are administered by insurance companies or other carriers who determine premiums for insured plans and expected costs to be paid during the year under self-insured plans. In 1989, AFS began phasing out postretirement benefits for future retirees. AFS recognizes the cost of postretirement benefits using the accrual method of accounting over the employees' years of service. Such costs for 1997, 1996 and 1995 were not material. 35 37 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 11: POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (CONTINUED) AFS' postretirement benefit plans other than pensions currently are not funded. The following table sets forth the status of AFS' retiree health care and life insurance plans at December 31, 1997 and 1996:
1997 1996 ------- ------- (Thousands of dollars) Actuarial present value of benefits attributed to: Retirees.................................................. $16,778 $23,149 Fully eligible active plan participants................... 5,489 5,056 Other active plan participants............................ 377 777 ------- ------- Accumulated postretirement benefit obligation............... 22,644 28,982 Unrecognized net actuarial gains............................ 10,453 6,479 ------- ------- Postretirement benefit liability recognized on the consolidated balance sheet........................... $33,097 $35,461 ======= =======
An assumed discount rate of 7.25% for 1997, 7.5% for 1996 and 8.25% for 1995 was used to determine postretirement benefit costs other than pensions. An assumed discount rate of 7.25% and 7.5% was used to determine the status of AFS' plans at December 31, 1997 and December 31, 1996, respectively. The weighted average annual assumed rate of increase in the per capita cost of covered benefits (that is, health care cost trend rate) is 6.5% for retirees age 65 and over and 9.0% for retirees under age 65 in 1998, and both rates are assumed to decrease gradually to 5.5% until 2001 and 2003, respectively, and remain at that rate thereafter. Increasing these rates by one percentage point in each year would have increased the accumulated postretirement benefit obligation as of December 31, 1997 by $2.1 million and increased the aggregate of the service and interest cost components of postretirement benefit costs for 1997 by $100,000. NOTE 12: QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) Quarterly results of operations for the years ended December 31, 1997 and 1996 were as follows:
1997 1996 ----------------------------------------- ----------------------------------------- First Second Third Fourth First Second Third Fourth Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter -------- -------- -------- -------- -------- -------- -------- -------- (Thousands of dollars) Revenues....................... $446,089 $457,637 $464,303 $485,236 $432,249 $433,481 $442,088 $452,252 ======== ======== ======== ======== ======== ======== ======== ======== Income before income taxes..... $ 75,545 $ 76,075 $ 77,178 $ 82,539 $ 72,214 $ 75,372 $ 75,711 $ 75,262 Income taxes................... 28,217 28,067 28,101 30,836 27,005 28,486 28,233 27,828 -------- -------- -------- -------- -------- -------- -------- -------- Net income..................... $ 47,328 $ 48,008 $ 49,077 $ 51,703 $ 45,209 $ 46,886 $ 47,478 $ 47,434 ======== ======== ======== ======== ======== ======== ======== ========
NOTE 13: FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used in estimating the fair value of AFS' financial instruments. Investments The estimated fair values of investment securities were based on quoted market prices where available. If quoted market prices were not available, the estimated fair values were based on independent appraisals, prices from independent brokers or discounted cash flow analyses. Independent appraisals and discounted cash flow analyses, using interest rates currently being offered for similar loans to borrowers of similar credit quality, were generally used to estimate the fair value of certain privately placed investments. 36 38 AVCO FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 13: FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) Finance Receivables The estimated fair values of fixed rate consumer loans and real estate loans were estimated based on discounted cash flow analyses using interest rates currently being offered for similar loans to borrowers of similar credit quality. Estimated future cash flows were adjusted for AFS' estimates of prepayments, refinances, and loan losses based on internal historical data. The estimated fair value of all variable rate receivables and fixed rate retail installment contracts approximated the net carrying value of such receivables. The fair values of AFS' leasing receivables and finance-related insurance reserves and claims ($496.9 million and $271.2 million, net carrying value, respectively, at December 31, 1997 and $291.5 million and $272.8 million, respectively, at December 31, 1996) are not required to be disclosed under generally accepted accounting principles. Debt and Interest Rate Exchange Agreements The estimated fair value of fixed rate debt was determined by independent investment bankers. The fair values of variable rate debt and borrowings under or supported by credit facilities approximated their carrying values. The estimated fair values of interest rate exchange agreements were determined by independent investment bankers as the estimated amounts that AFS would be required to pay to a third party to assume AFS' obligations under the agreements. The carrying values and estimated fair values of AFS' financial instruments for which it is practicable to calculate a fair value are as follows:
December 31, 1997 December 31, 1996 ----------------------- ----------------------- Estimated Estimated Carrying Fair Carrying Fair Value Value Value Value ---------- ---------- ---------- ---------- (Thousands of dollars) ASSETS: Investments......................... $ 996,407 $ 996,407 $ 927,571 $ 927,571 ========== ========== ========== ========== Finance receivables................. $6,736,705 $6,695,524 $6,471,011 $6,451,011 ========== ========== ========== ========== LIABILITIES: Debt: Variable rate debt.................. $4,839,706 $4,839,706 $3,989,901 $3,989,901 Interest rate exchange agreements... -- 11,075 -- 18,811 Fixed rate debt..................... 2,076,076 2,094,906 2,413,447 2,443,804 ---------- ---------- ---------- ---------- Total debt................ $6,915,782 $6,945,687 $6,403,348 $6,452,516 ========== ========== ========== ==========
37 39 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Omitted in accordance with General Instruction J(2)(c). ITEM 11. EXECUTIVE COMPENSATION Omitted in accordance with General Instruction J(2)(c). ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Omitted in accordance with General Instruction J(2)(c). ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Omitted in accordance with General Instruction J(2)(c). 38 40 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
PAGE ---- (a)1. Index to Financial Statements Report of Independent Auditors.............................. 16 Consolidated Balance Sheet at December 31, 1997 and 1996.... 17 Consolidated Statement of Income for the three years ended December 31, 1997........................................... 18 Consolidated Statement of Cash Flows for the three years ended December 31, 1997........................................... 19 Consolidated Statement of Changes in Stockholder's Equity for the three years ended December 31, 1997......................... 20 Notes to Consolidated Financial Statements.................. 21 2. Index to Financial Statement Schedules I. Condensed Financial Information of the Registrant....... S-1 All other schedules are omitted since the required information is not present or not present in amounts sufficient to require the submission of the schedules, or because the information required is included in the consolidated financial statements or the notes thereto. (b) No reports on Form 8-K were filed during the quarter ended December 31, 1997. (c) Exhibits (4) Instruments with respect to issues of long-term debt have not been filed as exhibits to this Annual Report Form 10-K as the authorized principal amount of any one of such issues does not exceed 10% of the total assets of the Registrant and its consolidated subsidiaries. Registrant agrees to furnish to the Commission a copy of each such instrument upon request. *(12) Statement of Computation of Number of Times Fixed Charges Earned. (21) Omitted in accordance with General Instruction J(2)(b). *(23) Consent of Independent Auditors. *(24) Powers of Attorney. *(27) Financial Data Schedule.
- ------------ * Filed herewith. 39 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. AVCO FINANCIAL SERVICES, INC. Dated: March 25, 1998 By WARREN R. LYONS ------------------------------------------- Warren R. Lyons Chairman (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 27, 1998.
SIGNATURE TITLE --------- ----- *WARREN R. LYONS Chairman of the Board of Directors -------------------------------- (Principal Executive Officer) Warren R. Lyons *NEIL R. ATON Director -------------------------------- Neil R. Aton *RONALD BUKOW Executive Vice President and Director -------------------------------- (Principal Financial Officer) Ronald Bukow *LEWIS B. CAMPBELL Director -------------------------------- Lewis B. Campbell *STEPHEN J. DAVIS Vice Chairman of the Board of Directors -------------------------------- Stephen J. Davis *GARY L. FITE Executive Vice President, Controller and -------------------------------- Director Gary L. Fite (Principal Accounting Officer) *STEPHEN A. GILIOTTI Director -------------------------------- Stephen A. Giliotti *JAMES F. HARDYMON Director -------------------------------- James F. Hardymon *WAYNE W. JUCHATZ Director -------------------------------- Wayne W. Juchatz
40 42
SIGNATURE TITLE --------- ----- *STEPHEN L. KEY Director -------------------------------- Stephen L. Key *EUGENE R. SCHUTT, JR. Executive Vice President and Director -------------------------------- Eugene R. Schutt, Jr. *HERBERT F. SMITH Executive Vice President, Secretary and -------------------------------- Director Herbert F. Smith *JOHN C. SPENCE Director -------------------------------- John C. Spence *By HERBERT F. SMITH -------------------------------- (Herbert F. Smith, on behalf of himself and as attorney-in-fact for each of the other persons indicated above)
41 43 AVCO FINANCIAL SERVICES, INC. SCHEDULE I CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
December 31, ------------------------ 1997 1996 ---------- ---------- (Thousands of dollars) BALANCE SHEET ASSETS Demand notes receivable from Avco Financial Services Group subsidiaries.............................................. $3,717,619 $3,868,329 Investments in subsidiaries, at equity...................... 1,444,526 1,468,045 Other....................................................... 216,502 167,655 ---------- ---------- Total assets........................................... $5,378,647 $5,504,029 ========== ========== LIABILITIES AND STOCKHOLDER'S EQUITY Debt........................................................ $4,108,984 $4,295,970 Other....................................................... 59,148 55,373 ---------- ---------- Total liabilities...................................... 4,168,132 4,351,343 Stockholder's equity........................................ 1,210,515 1,152,686 ---------- ---------- Total liabilities and stockholder's equity............. $5,378,647 $5,504,029 ========== ==========
See accompanying note. S-1 44 AVCO FINANCIAL SERVICES, INC. SCHEDULE I CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (CONTINUED)
Year ended December 31, ----------------------------------- 1997 1996 1995 --------- --------- --------- (Thousands of dollars) STATEMENT OF INCOME Revenues (primarily interest from Avco Financial Services Group subsidiaries).......................... $ 268,218 $ 268,171 $ 295,315 Expenses (primarily interest expense)................... (266,062) (275,087) (305,314) --------- --------- --------- Earnings (loss) before items shown below................ 2,156 (6,916) (9,999) Income tax benefits (expense)........................... (813) 2,378 3,450 Equity in income of subsidiaries........................ 194,773 191,545 185,952 --------- --------- --------- Net income.............................................. $ 196,116 $ 187,007 $ 179,403 ========= ========= ========= STATEMENT OF CASH FLOWS CASH FLOWS FROM OPERATING ACTIVITIES Net income.............................................. $ 196,116 $ 187,007 $ 179,403 Adjustments to reconcile net income to net cash provided by (used in) operating activities..................... (7,738) (34,611) 3,854 --------- --------- --------- Net cash provided by operating activities.......... 188,378 152,396 183,257 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Decrease (increase) in demand notes receivable.......... 125,075 (35,004) 20,207 Increase in investments in subsidiaries................. (30,790) (12,607) (9,784) --------- --------- --------- Net cash provided by (used in) investing activities....................................... 94,285 (47,611) 10,423 --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Increase (decrease) in short-term debt.................. 27,002 295,055 (426,815) Proceeds from issuance of notes......................... 400,000 300,000 950,000 Principal payments on notes............................. (601,865) (604,940) (626,765) Capital contribution from parent........................ 40,000 -- -- Dividends paid.......................................... (147,800) (94,900) (90,100) --------- --------- --------- Used in financing activities....................... (282,663) (104,785) (193,680) --------- --------- --------- Net change in cash...................................... -- -- -- Cash at beginning of year............................... -- -- -- --------- --------- --------- Cash at end of year..................................... $ -- $ -- $ -- ========= ========= =========
NOTE TO CONDENSED FINANCIAL INFORMATION The parent company is the primary financing entity for the U.S. finance operations. See Note 1 to the Consolidated Financial Statements for significant accounting policies. The aggregate maturities, required prepayments, redemptions and sinking fund requirements with respect to the Registrant's debt outstanding (excluding commercial paper, bank notes and savings deposits) at December 31, 1997 for the five years ending December 31, 2002 were (in millions): $581.9 in 1998; $584.9 in 1999; $525.0 in 2000; $200.0 in 2001; and $200.0 in 2002. At December 31, 1997 and 1996, the parent company was guarantor for payment of all its foreign subsidiaries' commercial paper and bank line borrowings of $1.587 billion and $1.261 billion, respectively, and senior notes of $1.644 billion and $1.337 billion, respectively. The Registrant received cash dividends from its subsidiaries aggregating $168.0 million in 1997, $187.6 million in 1996, and $194.6 million in 1995. S-2 45 EXHIBIT INDEX (4) Instruments with respect to issues of long-term debt have not been filed as exhibits to this Annual Report Form 10-K as the authorized principal amount of any one of such issues does not exceed 10% of the total assets of the Registrant and its consolidated subsidiaries. Registrant agrees to furnish to the Commission a copy of each such instrument upon request. *(12) Statement of Computation of Number of Times Fixed Charges Earned (21) Omitted in accordance with General Instruction J(2)(b) *(23) Consent of Independent Auditors *(24) Powers of Attorney *(27) Financial Data Schedule
- --------------- * Filed herewith. S-3 EX-12 2 COMPUTATION OF NUMBER OF TIMES FIXED CHARGES EARNE 1 EXHIBIT 12 AVCO FINANCIAL SERVICES, INC. STATEMENT OF COMPUTATION OF NUMBER OF TIMES FIXED CHARGES EARNED
Year ended December 31, ------------------------------------------------ 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (Thousands of dollars) Income Income before income taxes................ $311,337 $298,559 $287,459 $259,110 $225,784 -------- -------- -------- -------- -------- Fixed charges to be added back to income-- Interest and debt expense.............. 434,055 426,260 455,379 334,084 324,211 Rentals (one-third of all rent and related costs charged to income)..... 14,961 15,015 14,905 13,942 14,378 -------- -------- -------- -------- -------- Total fixed charges............... 449,016 441,275 470,284 348,026 338,589 -------- -------- -------- -------- -------- Income before income taxes and fixed charges................................... $760,353 $739,834 $757,743 $607,136 $564,373 ======== ======== ======== ======== ======== Ratio Number of times fixed charges covered by income before income taxes and fixed charges................................ 1.7 1.7 1.6 1.7 1.7 === === === === ===
S-4 EX-23 3 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-3 No. 33-55953) of Avco Financial Services, Inc. and in the related Prospectus of our report dated January 27, 1998, with respect to the consolidated financial statements and schedules of Avco Financial Services, Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 1997. ERNST & YOUNG LLP Orange County, California March 25, 1998 S-5 EX-24 4 POWER OF ATTORNEY 1 EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that each of the undersigned, an officer or director, or both, of AVCO FINANCIAL SERVICES, INC., a Delaware corporation, does hereby constitute and appoint HERBERT F. SMITH or LAILA B. SOARES with full power of substitution to said attorney, as the true and lawful attorney and agent of the undersigned, to do any and all acts and things and to execute any and all instruments which said attorney and agent deems advisable, of AVCO FINANCIAL SERVICES, INC. to comply with the Securities Act of 1934, as amended, and any requirements of the Securities and Exchange Commission with respect thereto in connection with the filing under the Securities Act of 1934 of an Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 on Form 10-K for the 1997 year of AVCO FINANCIAL SERVICES, INC., as well as any and all amendments to said Report, including specifically, but without limitation of the authority hereby granted, the power and authority to sign his or her name as an officer or director, or both, of AVCO FINANCIAL SERVICES, INC., as indicated opposite his or her signature below, to said Report, and any such amendments, and each of the undersigned does fully ratify and confirm all that said attorney, or any of them, or the substitute of any of them, shall do or cause to be done by virtue hereof. IN WITNESS WHEREOF, each of the undersigned has subscribed these presents this 25th day of February, 1998.
SIGNATURE TITLE --------- ----- /s/ N. R. ATON Director - ----------------------------------------------------- N. R. Aton /s/ R. BUKOW Director - ----------------------------------------------------- R. Bukow /s/ L. B. CAMPBELL Director - ----------------------------------------------------- L. B. Campbell /s/ S. J. DAVIS Director - ----------------------------------------------------- S. J. Davis /s/ G. L. FITE Director - ----------------------------------------------------- G. L. Fite /s/ S. A. GILIOTTI Director - ----------------------------------------------------- S. A. Giliotti /s/ J. F. HARDYMON Director - ----------------------------------------------------- J. F. Hardymon /s/ W. W. JUCHATZ Director - ----------------------------------------------------- W. W. Juchatz /s/ S. L. KEY Director - ----------------------------------------------------- S. L. Key /s/ W. R. LYONS Director - ----------------------------------------------------- W. R. Lyons
2
SIGNATURE TITLE --------- ----- /s/ W. J. PEARSON Director - ----------------------------------------------------- W. J. Pearson /s/ E. R. SCHUTT, JR. Director - ----------------------------------------------------- E. R. Schutt, Jr. /s/ H. F. SMITH Director - ----------------------------------------------------- H. F. Smith /s/ J. C. SPENCE Director - ----------------------------------------------------- J. C. Spence
EX-27 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM AFS' CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1997 AND CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 44,958 0 7,742,641 237,809 0 0 89,982 0 8,809,898 0 3,741,592 0 0 500 1,210,015 8,809,898 0 1,853,265 0 279,287 595,404 233,182 434,055 311,337 115,221 196,116 0 0 0 196,116 0 0
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