NOVATION COMPANIES, INC. The following is a discussion and analysis of our financial condition and
results of operations for the years ended
Corporate Overview
Through our wholly-owned subsidiary HCS, acquired on
See Part I, Item 1 of this Form 10-K for a discussion of our emergence from bankruptcy and note refinancing, which both occurred in the third quarter of 2017, and the note amendment, which occurred in the third quarter of 2019.
Financial Highlights and Key Performance Metrics. The following key performance metrics (in thousands, except per share amounts) are derived from our consolidated financial statements for the periods presented and should be read in conjunction with the more detailed information therein and with the disclosure included in this report under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations."
December 31,
2019 2018
Cash and cash equivalents $ 2,032 $ 9,249
Service fee income $ 63,474 $ 55,126
General and administrative expenses $ 8,345 $ 8,089
Net income (loss) available to common
shareholders, per basic share $ (0.10 ) $ 0.07
Consolidated Results of Operations
Year Ended
Service Fee Income and Cost of Services
HCS delivers outsourced full-time and part-time employees primarily to Community
Service Boards ("CSBs"), quasi state organizations that provide behavioral
health services at facilities across
Future service fee income will be driven by the number of customers and the volume of associates employed by the CSB and outsourced to HCS. Customer contracts typically establish a fixed markup on the pay rate for the associates; therefore the cost of services will generally fluctuate consistently with fee income. HCS offers a health and welfare benefit plan to its associates. The cost of this benefit is passed through to customers plus a small markup to cover the cost of administration.
HCS acquired two significant customers that started in
General and Administrative Expenses
General and administrative expenses consist of salaries, office costs, legal and
professional expenses and other customary costs of corporate administration.
During 2019 and 2018,
Goodwill Impairment Charge
Management completed its annual goodwill impairment assessment as of
Interest Income -
All of our mortgage securities were sold in
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Impairment on
To the extent that the cost basis of mortgage securities exceeds the fair value
and the unrealized loss is considered to be other than temporary, an impairment
charge is recognized and the amount recorded in accumulated other comprehensive
income or loss is reclassified to earnings as a realized loss. The impairment
of
Other Income
Fluctuations in the income received from the Company's mortgage securities results from the timing of purchases/sales and amounts of dividends and interest paid. Subsequent to the HCS Acquisition, the Company had significantly less available funds to invest. In 2018, other income consisted primarily of the gains on sale of the Company's mortgage securities.
For the Years Ended December 31,
2019 2018
Interest income $ 1 $ 10
Gain (loss) on sales of investments (1 ) 12,881
Other income 39 401
Total $ 39 $ 13,292
Reorganization items, net
The Company incurred approximately
Interest Expense
Interest expense decreased period over period, with the Company incurring
Income Tax Expense
Because of the Company's significant net operating losses and full valuation allowance, income tax expense was not material for any period presented and is not expected to be material for the foreseeable future.
Liquidity and Capital Resources
During 2019, the Company had net loss of
From
After engaging major investment firms to evaluate the marketplace for its
mortgage securities, the Company executed trades to sell all of its mortgage
securities during 2018. These sales generated
Management continues to work toward expanding HCS's customer base by increasing revenue from existing customers and targeting new customers that have not previously been served by HCS.
As discussed, the Amendment to the Note Purchase Agreement and waiver of
interest payments through
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Overview of Cash Flow for the Year Ended
The following table provides a summary of our operating, investing and financing
cash flows as taken from our consolidated statements of cash flows for 2019 and
2018 (in thousands).
For the Years Ended December 31,
2019 2018
Cash flows used in operating activities $ (5,168 ) $ (5,056 )
Cash flows (used in) provided by investing activities (70 ) 13,031
Cash flows used in financing activities (1,979 ) (1,466 )
Operating Activities
The increase in net cash flows used in operating activities to approximately
Investing Activities
The decrease in the net cash flows provided by (used in) investing activities is mainly due to the sale of the Company's marketable securities in 2018, compared to no sales of securities in 2019.
Financing Activities
The increase in cash used in financing activities is mainly due to the payoff of HCS's line of credit in 2019 and additional fees associated with the payoff.
Critical Accounting Estimates
We prepare our consolidated financial statements in conformity with GAAP and, therefore, are required to make estimates regarding the values of our assets and liabilities and in recording income and expenses. These estimates are based, in part, on our judgment and assumptions regarding various economic conditions that we believe are reasonable based on facts and circumstances existing at the time of reporting. These estimates affect reported amounts of assets, liabilities and accumulated other comprehensive income at the date of the consolidated financial statements and the reported amounts of income, expenses and other comprehensive income during the periods presented. The following summarizes the components of our consolidated financial statements where understanding accounting policies is critical to understanding and evaluating our reported financial results, especially given the significant estimates used in applying the policies. The discussion is intended to demonstrate the significance of estimates to our consolidated financial statements and the related accounting policies. Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board and the Audit Committee has reviewed our disclosure.
Impairment of
The values of goodwill and trademarks are assessed annually to determine whether their carrying value exceeds their fair value. In addition, they are tested on an interim basis if an event occurs or circumstances change between annual tests that would more likely than not reduce their fair value below carrying value. If we determine the fair value of goodwill or trademarks is less than their carrying value, an impairment loss is recognized. Impairment losses, if any, are reflected in operating income or loss in the period incurred. The Company performs its annual tests of goodwill and trademarks during the second quarter of each fiscal year.
Impairment of Long-Lived Assets with Finite Lives
The value of purchased intangible assets is assessed for impairment whenever an event or change in circumstances indicates that the carrying value of the asset may not be fully recoverable. Recoverability is determined based on an estimate of undiscounted future cash flows resulting from the use of an asset and its eventual disposition. An impairment loss is measured by comparing the fair value of the asset to its carrying value. If we determine the fair value of an asset is less than the carrying value, an impairment loss is incurred. Impairment losses, if any, are reflected in operating income or loss in our consolidated statements of operations during the period incurred.
Income Taxes
In determining the amount of deferred tax assets to recognize in the consolidated financial statements, the Company evaluates the likelihood of realizing such benefits in future periods. The income tax guidance requires the recognition of a valuation allowance if it is more likely than not that all or some portion of the deferred tax asset will not be realized. Income tax guidance indicates the more likely than not threshold is a level of likelihood that is more than 50%.
Under the income tax guidance, companies are required to identify and consider all available evidence, both positive and negative, in determining whether it is more likely than not that all or some portion of its deferred tax assets will not be realized. Positive evidence includes, but is not limited to the following: cumulative earnings in recent years, earnings expected in future years, excess appreciated asset value over the tax basis and positive industry trends. Negative evidence includes, but is not limited to the following: cumulative losses in recent years, losses expected in future years, a history of operating losses or tax credit carryforwards expiring, and adverse industry trends.
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The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is required to support a conclusion that a valuation allowance is not needed for all or some of the deferred tax assets. Cumulative losses in recent years are significant negative evidence that is difficult to overcome when determining the need for a valuation allowance. Similarly, cumulative earnings in recent years represent significant positive objective evidence. If the weight of the positive evidence is sufficient to support a conclusion that it is more likely than not that a deferred tax asset will be realized, a valuation allowance should not be recorded.
The Company examines and weighs all available evidence (both positive and negative and both historical and forecasted) in the process of determining whether it is more likely than not that a deferred tax asset will be realized. The Company considers the relevance of historical and forecasted evidence when there has been a significant change in circumstances. Additionally, the Company evaluates the realization of its recorded deferred tax assets on an interim and annual basis. The Company does not record a full valuation allowance if the weight of the positive evidence exceeds the negative evidence and is sufficient to support a conclusion that it is more likely than not that its deferred tax asset will be realized.
If a valuation allowance is necessary, the Company considers all sources of taxable income in determining the amount of valuation allowance to be recorded. Sources of taxable income identified in the income tax guidance include the following: 1) taxable income in prior carryback year, 2) future reversals of existing taxable temporary differences, 3) future taxable income exclusive of reversing temporary differences and carryforwards, and 4) tax planning strategies.
The Company currently evaluates estimates of uncertainty in income taxes based upon a framework established in the income tax accounting guidance. The guidance prescribes a recognition threshold and measurement standard for the recognition and measurement of tax positions taken or expected to be taken in a tax return. In accordance with the guidance, the Company evaluates whether a tax position will more likely than not be sustained upon examination by the appropriate taxing authority. The Company measures the amount to recognize in its consolidated financial statements as the largest amount that is greater than 50% likely of being realized upon ultimate settlement. The recognition and measurement of tax benefits is often judgmental, and determinations regarding the tax benefit can change as additional developments occur relative to the issue.
Impact of Recently Issued Accounting Pronouncements
Information regarding the impact of recently issued accounting pronouncements is included in Note 3 to the consolidated financial statements.
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