Item 1. Business
Novation Companies, Inc. ("Novation" or "NCI" or the "Company") is a Maryland corporation formed on September 13, 1996. Prior to May 23, 2012, Novation was NovaStar Financial, Inc. The name was changed to reflect the Company's current business strategy of acquiring and operating technology-enabled service businesses.
In 2008, we acquired a majority interest in StreetLinks LLC (“StreetLinks”), a national residential appraisal and real estate valuation management company. As of December 31, 2012, we owned 91% of StreetLinks. StreetLinks has three primary products:
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Lender Plus, the core appraisal management service, for which StreetLinks manages the full appraisal process for lenders;
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Lender X, the technology solution that facilitates lenders managing their own appraisal process; and
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Appraisal QX, introduced in the fourth quarter of 2012, an automated appraisal risk management product.
In 2009, we purchased a majority interest in Advent Financial Services LLC (“Advent”). Advent provides financial settlement services for income tax preparation businesses. Advent also provides access to tailored banking accounts and related services via its prepaid debit card, which is designed to meet the needs of low and moderate-income level individuals. Advent is not a bank but acts as an intermediary for banking products on behalf of other banking institutions. As of December 31, 2012, we owned 78% of Advent.
The primary distribution channel for Advent is by way of settlement services to electronic income tax return originators. Advent provides a process for the originators to collect refunds and other payments from the Internal Revenue Service, distribute fees to various service providers and deliver the net refund/payment to individuals. Individuals may elect to have the net refund/payment deposited to an Advent-issued prepaid debit card. Individuals also have the option to have the net refund/payment paid by check or to an existing bank account. Regardless of the settlement method, Advent receives a fee from the originator for providing the settlement service.
If the refund/payment is deposited to the prepaid debit card offered by Advent, Advent earns fee income related to the usage of the prepaid card. Advent is working to increase its number of independent tax preparation customers and encourage individuals to reload their prepaid debit card after tax time.
In 2011, we acquired a majority interest in Build My Move, LLC (BMM), which subsequently changed its name to Mango Moving, LLC ("Mango"). As of December 31, 2012, we owned 61% of Mango. Mango is a third-party logistics provider within the household goods industry. Because of continued capital demands and difficulties generating positive cash flows or earnings, effective February 27, 2013 the Company and non-controlling owners agreed to dissolve Mango and abandon its operations.
In October of 2012, we acquired 85% of IVR Central, LLC, a call center technology company. Subsequent to the acquisition, the name was changed to Corvisa Cloud LLC. Primary products of Corvisa Cloud include interactive voice response, automated call distribution, call dialing and call recording using cloud technology. Corvisa Cloud also provides a full call center replacement offering, which allows for the elimination of legacy on-premise phone systems and includes integration to multiple leading
Customer Relation Management and cloud-based sales and operation management systems. The call center solution is fully web-based, hosted in the cloud and highly scalable.
Prior to 2011, we originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage securities. Although those activities have been discontinued, as a result of those activities, we acquired and continue to own mortgage securities that continue to be a source of our cash flow.
Our acquisitions are discussed in greater detail in Note 4 to the consolidated financial statements. During 2011, we completed exchanges of our preferred stock and our junior subordinated debentures to improve our liquidity position and financial condition and to provide stability. See Note 3 and Note 9 to the consolidated financial statements, respectively, for further details.
Personnel
As of December 31, 2012, we employed, directly or through subsidiaries, an aggregate of 705 full-time employees. None of our employees are represented by a union or covered by a collective bargaining agreement.
Available Information
Copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to these reports filed or furnished with the SEC are available free of charge through our Internet site (www.novationcompanies.com) as soon as reasonably practicable after filing with the SEC. References to our website do not incorporate by reference the information on such website into this Annual Report on Form 10-K and we disclaim any such incorporation by reference. Copies of our board committee charters, our board’s Corporate Governance Guidelines, Code of Conduct, and other corporate governance information are available at the Corporate Governance section of our Internet site (www.novationcompanies.com), or by contacting us directly. Our investor relations contact information follows.
Investor Relations
2114 Central Street
Suite 600
Kansas City, MO 64108
816.237.7424
Email: ir@novationcompanies.com
You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.
Item 1A.
Item 1A. Risk Factors
Risk Factors
You should carefully consider the risks described below in evaluating our business and before investing in our publicly-traded securities. Any of the risks we describe below or elsewhere in this report could negatively affect our results of operations, financial condition, liquidity and business prospects. The risks described below are not the only ones facing us. Our business is also subject to the risks that affect many other companies, such as competition, inflation, general economic conditions and geopolitical events.
Risks Related to our Business
Our ability to profitably manage, operate and grow operations is critical to our ability to pay our operating expenses and meet our other obligations and is subject to significant uncertainties and limitations. If we attempt to make any acquisitions, we will incur a variety of costs and may never realize the anticipated benefits.
Our ability to pay our operating expenses and meet our other obligations is dependent upon our ability to successfully operate and grow operations such that they generate positive cash flow. Our ability to start or acquire new businesses is significantly constrained by our limited liquidity and our likely inability to obtain debt financing or to issue equity securities as a result of our current financial condition, as well as other uncertainties and risks. There can be no assurances that we will be able to successfully operate and grow operations or establish or acquire new business operations.
If we pursue any new business opportunities, the process of establishing a new business or negotiating the acquisition and integrating an acquired business may result in operating difficulties and expenditures and may require significant management attention. Moreover, we may never realize the anticipated benefits of any new business or acquisition. We may not have, and may not be able to acquire or retain, personnel with experience in any new business we may establish or acquire. In addition,
future acquisitions could result in contingent liabilities and/or impairment or amortization expenses related to goodwill and other intangible assets, which could harm our results of operations, financial condition and business prospects.
We may not have access to financing on reasonable terms, or at all, that may be necessary for us to continue to operate or to acquire new businesses.
We do not currently have in place any agreements or commitments for short-term financing nor any agreements or commitments for additional long-term financing. In light of these factors and current market conditions, and our lack of significant unencumbered assets, we may not be able to secure additional financing for existing or new operations or for any acquisition.
Various legal proceedings could adversely affect our financial condition, our results of operations and liquidity.
In the course of our business, we are subject to various legal proceedings and claims. See Item 3. Legal Proceedings. In addition, we have become subject to various securities and derivative lawsuits, and we may continue to be subject to additional litigation, in some cases on the basis of novel legal theories. The resolution of these legal matters or other legal matters could result in a material adverse impact on our results of operations, liquidity and financial condition.
Differences in our actual experience compared to the assumptions that we use to determine the value of our residual mortgage securities and to estimate fair values could further adversely affect our financial position.
The actual experience will differ from the assumptions that we used to determine the fair value of these securities. Material differences may negatively impact our financial condition and results of operations.
The value of, and cash flows from, our mortgage securities will further decline as the underlying mortgage loan collateral declines.
There are many factors that affect the value of, and cash flows from, our mortgage securities, many of which are beyond our control. In general, the nature of mortgage securities is that as the underlying mortgage loan collateral is repaid or defaults, the value of, and cash flows from, our securities will decline.
Risks Related to Our Operating Subsidiaries
A decline in the number of home sales and the originations and refinancings of home loans would decrease appraisal order volume and adversely affect the revenues and profitability of StreetLinks.
StreetLinks, our residential appraisal management company, retains a portion of the fee for appraisal services collected from lenders and borrowers for an independent residential appraisal to cover its costs of managing the process of fulfilling the appraisal order. A decline in the number of home sales and the originations and refinancings of home loans would cause a decrease in the demand for appraisals. A decreased demand for appraisals would have an adverse effect on the revenues and profitability of StreetLinks. Generally, these decreases would be caused by factors beyond our control, such as increases in interest rates for residential mortgage loans. Such an increase in applicable interest rates may be caused by market forces, a change in government policy, or a change in policy by the Federal Reserve Bank, Fannie Mae or Freddie Mac.
StreetLinks may be unable to maintain its relationships with its existing lending customers and may be unable to add new lending customers which would decrease appraisal order volume and adversely affect the revenues and profitability of StreetLinks.
StreetLinks has increased its appraisal order volume by adding lending customers and intends to further develop its business through the addition of new lending customers. There is no assurance that StreetLinks will be able to maintain the relationships with its existing lending customers, including three customers that comprised approximately 31% of StreetLinks' service fee revenues during the years ended December 31, 2012, or add new lending customers which would decrease appraisal order volume and adversely affect the revenues and profitability of StreetLinks.
Government agencies and regulatory authorities may change or eliminate current restrictions and requirements for appraisals.
StreetLinks' appraisal order volume has increased, in part, as a result of increased restrictions and requirements for appraisals established by government agencies and regulatory authorities such as the Federal Housing Finance Agency and the United States Department of Housing and Urban Development that, among other things, require appraiser independence. Changes in, or elimination of, these restrictions and requirements could adversely affect the demand for StreetLinks' services and the viability of its business model.
Advent may be unable to develop systems and a network of business partners to successfully distribute its products and services.
The success of Advent in large part depends on its ability to develop systems and maintain its network of business partners for the distribution of its products and services. Advent's business depends on a limited number of business partners and the loss of any significant business partner may adversely affect the business. For example, Advent finances its operations through a
lending facility with one bank. If that bank ceased financing Advent's operations, then Advent would be unable to operate its business until alternative arrangements could be made. Moreover, part of Advent's method of distributing its products and services is to integrate its offerings with tax preparation software created by a limited number of third party developers. If any third party developers ceased integrating Advent's products and services into the tax preparation software, then Advent's ability to maintain its business would be impaired. To the extent Advent is unable to develop systems and maintain its network of business partners to successfully distribute Advent's products and services, it will have an adverse effect on Advent's business, financial condition and results of operations.
Advent's ability to distribute its financial products is, to some extent, dependent on the success of its business partners.
Advent distributes its financial products through business partners such as tax return preparation offices and is to some extent dependent on the success of these business partners. To the extent there is a decrease in the demand for the products or services of Advent's business partners, there may be a decrease in demand for Advent's products and services, which would have an adverse effect on Advent's business, financial condition and results of operations.
Changes in regulation of Advent's business may impact results.
Advent's facilitation of bank card and other financial products and services is done in a financial industry that has faced, and may continue to face, increased levels of regulatory scrutiny and rulemaking. New or revised regulations or enforcement perspectives may adversely affect Advent's ability to effectively design, distribute and facilitate its products and services, and may adversely affect Advent's sales channels (e.g., tax return preparation businesses) and funding sources.
Legal proceedings against our operating subsidiaries could adversely affect their business, financial condition and results of operations.
In the course of their business, our operating subsidiaries may become subject to legal proceedings and claims and could experience significant losses as a result of litigation defense and resolution costs that would have an adverse effect on their business, financial condition and results of operations.
Risks Related to Our Discontinued Operations
We may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, borrower fraud, or certain borrower defaults, which could further harm our liquidity.
When we sold mortgage loans, whether as whole loans or pursuant to a securitization, we made customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our whole loan sale agreements require us to repurchase or substitute mortgage loans in the event we breach any of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower, broker, or employee fraud. Likewise, we are required to repurchase or substitute mortgage loans if we breach a representation or warranty in connection with our securitizations. We have received various repurchase demands as performance of subprime mortgage loans has deteriorated. A majority of repurchase requests have been denied, otherwise a negotiated purchase price adjustment was agreed upon with the purchaser. Enforcement of repurchase obligations against us would further harm our liquidity.
Risks Related to our Capital Stock
There can be no assurance that our common stock will continue to be traded in an active market.
Our common stock is currently quoted by the OTC Markets' Group inter-dealer quotation service as an OTCQB security. Trading of securities on this quotation service is generally limited and is effected on a less regular basis than on exchanges, such as the NYSE, and accordingly investors who own or purchase our stock will find that the liquidity or transferability of the stock may be limited. Additionally, a shareholder may find it more difficult to dispose of, or obtain accurate quotations as to the market value of, our stock. If an active public trading market cannot be sustained, the trading price of our common stock could be adversely affected and the ability of an investor to transfer their shares of our common stock may be limited.
We are not likely to pay dividends to our common shareholders in the foreseeable future.
Payment of dividends is at the discretion of our board of directors. Under the restrictions of our senior notes, no dividends can be paid on our common stock.
The market price and trading volume of our common stock may be volatile, which could result in substantial losses for our shareholders.
The market price of our capital stock can be highly volatile and subject to wide fluctuations. In addition, the trading volume in our capital stock may fluctuate and cause significant price variations to occur. Investors may experience volatile returns and material losses. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our capital stock include:
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actual or perceived changes in our ability to continue as a going concern;
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actual or anticipated changes in the delinquency and default rates on mortgage loans, in general, and specifically on the loans we invest in through our mortgage securities;
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actual or anticipated changes in our earnings and cash flow;
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general market and economic conditions, including the operations and stock performance of other industry participants;
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the impact of new state or federal legislation or adverse court decisions;
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the activities of investors who engage in short sales of our common stock;
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actual or anticipated changes in financial estimates by securities analysts;
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sales, or the perception that sales could occur, of a substantial number of shares of our common stock by insiders;
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additions or departures of senior management and key personnel; and
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actions by institutional shareholders.
Our charter permits us to issue additional equity without shareholder approval, which could materially adversely affect our current shareholders.
Our charter permits our board of directors, without shareholder approval, to:
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authorize the issuance of additional shares of common stock without shareholder approval, including the issuance of shares of preferred stock that have preference rights over the common stock with respect to dividends, liquidation, voting and other matters or shares of common stock that have preference rights over our outstanding common stock with respect to voting;
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classify or reclassify any unissued shares of common stock or preferred stock and to set the preferences, rights and other terms of the classified or reclassified shares; and
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issue additional shares of common stock or preferred stock in exchange for outstanding securities, with the consent of the holders of those securities.
Other Risks Related to our Business
Our ability to use our net operating loss carryforwards and net unrealized built-in losses could be severely limited in the event of certain transfers of our voting securities.
We currently have recorded a significant deferred tax asset, before valuation allowance, almost all of which relates to certain net operating loss carryforwards and net unrealized built-in-losses. While we believe that it is more likely than not that we will be able to utilize at least a portion of such losses in the future, the net operating loss carryforwards and net unrealized built-in losses could provide significant future tax savings to us if we are able to fully utilize such losses. However, our ability to use these tax benefits may be impacted, restricted or eliminated due to a future “ownership change” within the meaning of Section 382 of the Code. An ownership change could occur that would severely limit our ability to use the tax benefits associated with the net operating loss carryforwards and net unrealized built-in losses, which may result in higher taxable income for us (and a significantly higher tax cost as compared to the situation where these tax benefits are preserved).
Covenant restrictions under our indebtedness may limit our ability to operate our business.
The indentures governing the senior notes we issued on March 22, 2011 (the “Senior Notes”) contain, among other things, covenants that may restrict our and our subsidiaries' ability to finance future operations, capital needs or to engage in other business activities. Without the prior consent of the holders of our Senior Notes, the terms of our Senior Notes and the related indentures restrict, among other things, our ability and the ability of our subsidiaries to:
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incur indebtedness;
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create certain liens;
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make payments from our subsidiaries to us;
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make payments to our shareholders;
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acquire our outstanding shares, or the shares of our subsidiaries;
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make payments on debt securities pari passu or junior to the Senior Notes; and
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merge, consolidate, transfer and/or sell substantially all of our assets.
There can be no assurance that we will be able to receive the consent of the persons holding the Senior Notes should we have a need to take one of the restricted actions, which such limitation may hinder our ability to operate or grow our business in the future.
The interest rate on our Senior Notes will increase.
The Senior Notes accrue interest at a rate of 1% until the earlier of (a) the completion of an equity offering that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5%. The aggregate principal amount of the Senior Notes is $85.9 million. The three-month LIBOR rate is at a historically low level and may increase in the future. Without accounting for increases in LIBOR, the increase in the applicable
interest rate on the Senior Notes from 1% to 3.5% will negatively affect our business, financial condition and results of operations.
Some provisions of our charter, bylaws, Maryland law and our current Rights Plan may deter takeover attempts, which may limit the opportunity of our shareholders to sell their common stock at favorable prices.
Certain provisions of our charter, bylaws, Maryland law, and our current Rights Plan could discourage, delay or prevent transactions that involve an actual or threatened change in control, and may make it more difficult for a third party to acquire us, even if doing so may be beneficial to our shareholders. For example, our board of directors is divided into three classes with three year staggered terms of office. This makes it more difficult for a third party to gain control of our board because a majority of directors cannot be elected at a single meeting. Further, under our charter, generally a director may only be removed for cause and only by the affirmative vote of the holders of at least a majority of all classes of shares entitled to vote in the election for directors together as a single class. Our bylaws make it difficult for any person other than management to introduce business at a duly called meeting requiring such other person to follow certain advance notice procedures. Maryland law provides protection for Maryland corporations against unsolicited takeover situations. Finally, we have a Rights Plan to protect our net operating loss carryforwards by preventing any shareholder from becoming a 5% shareholder, which may constitute a change in control of the Company.
Changes in accounting standards, subjective assumptions and estimates used by management related to complex accounting matters could have an adverse effect on results of operations.
Generally accepted accounting principles in the United States and related accounting pronouncements, implementation guidance and interpretations with regard to a wide range of matters, such as stock-based compensation, asset impairment, valuation reserves, income taxes and fair value accounting, are highly complex and involve many subjective assumptions, estimates and judgments by management. Changes in these rules or their interpretations or changes in underlying assumptions, estimates or judgments by management could significantly change our reported results.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and other rules and regulations promulgated thereunder could cause additional operating and compliance costs in addition to other uncertainties.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into federal law. The Dodd-Frank Act has had and will continue to have a broad impact on the financial services industry, including significant regulatory and compliance changes. Regulatory agencies will implement new regulations in the future that will establish the parameters of the new regulatory framework and provide a clearer understanding of the legislation's effect on our business. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies, the full extent of the impact the Dodd-Frank Act will have on our operations is unclear. Nonetheless, while it is difficult to predict at this time what specific impact the Dodd-Frank Act and certain yet-to-be implemented rules and regulations will have on us, we expect that at a minimum our operating and compliance costs will increase.
The Health Care and Education Reconciliation Act of 2010 and proposed amendments thereto could cause our compensation costs to increase, adversely affecting our results and cash flows.
The Health Care and Education Reconciliation Act of 2010 and proposed amendments thereto contain provisions that could materially impact the future healthcare costs of the Company. The legislation will continue to become effective through a phased approach that will not conclude until 2018, thus the ultimate impact of the new legislation remains uncertain, it is possible that these changes could significantly increase our compensation costs which would adversely affect our results and cash flows.
Loss of key members of our management could disrupt our business.
We are heavily dependent upon certain key personnel and the loss of service of any of these senior executives could adversely affect our business. Our success depends on the Company's ability to retain these key executives. The loss of any of these senior executives could have a material adverse effect on our business financial condition and results of operation. We may not be able to retain our existing senior management, fill new positions or vacancies created by expansion or turnover or attract additional qualified senior management personnel.
System interruptions or other technology failures could impair the Company's operations.
We rely on our computer systems and service providers to consistently provide efficient and reliable service. System interruptions or other system intrusions, which may not be within the Company's control, may impair the Company's delivery of its products and services, resulting in a loss of customers and a corresponding loss in revenue.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The executive and administrative offices for the Company are located in Kansas City, Missouri, and consist of approximately 12,142 square feet of leased office space. As of December 31, 2012, the Company leases approximately 195,000 total square feet of office space throughout the United States. The majority of this office space is located in Indianapolis, Indiana and Tampa, Florida and houses the operations of our Appraisal Management segment. We also maintain smaller offices in other U.S. locations under leases that expire at varying times from 2013 to 2019.
Item 3.
Item 3. Legal Proceedings
The Company is a party to various legal proceedings. Except as set forth below, these proceedings are of an ordinary and routine nature.
Although it is not possible to predict the outcome of any legal proceeding, in the opinion of management, other than the active proceedings described in detail below, proceedings and actions against the Company should not, individually, or in the aggregate, have a material effect on the Company's financial condition, operations and liquidity. Furthermore, due to the uncertainty of any potential loss as a result of pending litigation and due to the Company's belief that an adverse ruling is not probable, the Company has not accrued a loss contingency related to the following matters in its consolidated financial statements. However, a material outcome in one or more of the active proceedings described below could have a material impact on the results of operations in a particular quarter or fiscal year.
On May 21, 2008, a purported class action case was filed in the Supreme Court of the State of New York, New York County, by the New Jersey Carpenters' Health Fund, on behalf of itself and all others similarly situated. Defendants in the case included NovaStar Mortgage Funding Corporation (“NMFC”) and its individual directors, several securitization trusts sponsored by the Company ("affiliated defendants") and several unaffiliated investment banks and credit rating agencies. The case was removed to the United States District Court for the Southern District of New York. On June 16, 2009, the plaintiff filed an amended complaint. The plaintiff seeks monetary damages, alleging that the defendants violated sections 11, 12 and 15 of the Securities Act of 1933, as amended, by making allegedly false statements regarding mortgage loans that served as collateral for securities purchased by the plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss the plaintiff's claims, which the court granted on March 31, 2011, with leave to amend. The plaintiff filed a second amended complaint on May 16, 2011, and the Company again filed a motion to dismiss. On March 29, 2012, the court dismissed the plaintiff's second amended complaint with prejudice and without leave to replead. The plaintiff filed an appeal. On March 1, 2013, the appellate court reversed the judgment of the lower court, which had dismissed the case. Also, the appellate court vacated the judgment of the lower court holding that the plaintiff lacked standing, even as a class representative, on securities in which plaintiff had not invested and remanded the case back to the lower court for further proceedings. Given the early stage of the litigation, the Company cannot provide an estimate of the range of any loss. The Company believes that the affiliated defendants have meritorious defenses to the case and expects them to defend the case vigorously.
On June 20, 2011, the National Credit Union Administration Board, as liquidating agent of U.S. Central Federal Credit Union, filed an action against NMFC and numerous other defendants in the United States District Court for the District of Kansas, claiming that the defendants issued or underwrote residential mortgage-backed securities pursuant to allegedly false or misleading registration statements, prospectuses, and/or prospectus supplements. On October 12, 2011, the complaint was served on NMFC. On December 20, 2011, NMFC filed a motion to dismiss the plaintiff's complaint and to strike certain paragraphs of the complaint. On July 25, 2012, the court granted the motion in part and denied the motion in part. The plaintiff was granted leave to amend the complaint. On August 24, 2012, the plaintiff filed an amended complaint making essentially the same claims against NMFC. On October 29, 2012, NMFC filed a motion to dismiss the amended complaint, which motion remains pending. This litigation is in an early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that NMFC has meritorious defenses to the case and expects it to defend the case vigorously.
On May 30, 2012, Woori Bank filed an action against NovaStar ABS CDO I, Inc. and NovaStar ABS CDO I, Ltd. (collectively, “NCDO”) and certain other unrelated entities in the United States District Court for the Southern District of New York, claiming common law fraud, negligent misrepresentation and unjust enrichment based on allegations that defendants knew that NCDO securities purchased by the plaintiff involved more risk than their ratings suggested. The plaintiff dismissed, without prejudice, NovaStar ABS CDO I, Ltd., and on August 20, 2012, the plaintiff filed an amended complaint against NovaStar ABS CDO I, Inc. and other, unrelated entities. The amended complaint alleged the same claims against NovaStar ABS CDO I, Inc. On September 12, 2012, NovaStar ABS CDO I, Inc. filed a motion to dismiss the amended complaint. On December 27, 2012, the court dismissed the claims against all defendants without granting the plaintiff leave to amend its complaint. However, the court gave the plaintiff the opportunity, until March 1, 2013, to write a letter to the court explaining how it would amend to correct the noted deficiencies in its complaint if granted leave. In response, the plaintiff, on January 23, 2013, filed a motion for leave to file an amended complaint and to alter, amend or vacate the judgment of dismissal.
Item 4.
Item 4. Mine Safety Disclosures
None.
Part II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is currently quoted by the OTC Markets’ Group inter-dealer quotation service as an OTCQB security under the symbol “NOVC”. The following table sets forth the high and low bid prices as reported by this quotation service, for the periods indicated, and the cash dividends paid or payable per share of common stock.
As of February 22, 2013, we had approximately 812 shareholders of record of our common stock, including holders who are nominees for an undetermined number of beneficial owners based upon a review of the securities position listing provided by our transfer agent.
Dividend distributions will be made at the discretion of the Board of Directors and will depend on earnings, financial condition, cost of equity, investment opportunities and other factors as the Board of Directors may deem relevant. The indentures governing the Company's Senior Notes contain certain restrictive covenants which prohibit the Company and its subsidiaries, from among other things, making any cash dividend or distribution. We do not expect to declare any stock dividend distributions in the near future.
Company Purchases of Equity Securities (dollars in thousands)
(A)
A current report on Form 8-K was filed on October 2, 2000 announcing that the Board of Directors authorized the Company to repurchase its common shares, bringing the total authorization to $9.0 million. The Company has repurchased $8.0 million to date, leaving approximately $1.0 million of shares that may yet be purchased under the plan.
Item 6.
Item 6. Selected Financial Data
As a smaller reporting company, we are not required to provide the information required by this Item.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this report.
Executive Overview
The following Management's Discussion and Analysis of Financial Condition and Operating Results (“MD&A”)
should be read in conjunction with the consolidated financial statements of Novation Companies, Inc. and its subsidiaries (the “Company,” ”Novation,” “NCI,” “we” or “us”) and the notes thereto as contained in Item 8 of this report. MD&A includes the following sections:
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Corporate Overview, Background and Strategy - a brief overview of our business, current strategy, and significant recent events.
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Consolidated Results of Operations - an analysis of our results of operations for the years ended December 31, 2012 and 2011 as presented in our Consolidated Financial Statements.
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Segment Results of Operations - an analysis of our results of operations for the years ended December 31, 2012 and 2011 as presented in our Consolidated Financial Statements for our reporting segments.
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Liquidity and Capital Resources - an analysis of our cash flows and financial commitments.
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Critical Accounting Estimates - a discussion of our critical accounting estimates, which involve a high degree of judgment or complexity. This section also includes the impact of new accounting standards.
Corporate Overview, Background and Strategy
Our Business
We are a Maryland corporation formed on September 13, 1996. Effective May 23, 2012, we changed our name from NovaStar Financial, Inc. to Novation Companies, Inc. to reflect the Company's current business strategy of acquiring and operating technology-enabled service businesses.
We own 91% of StreetLinks LLC (“StreetLinks”), a national residential appraisal and real estate valuation management company. StreetLinks has three primary products:
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Lender Plus, the core appraisal management service, for which StreetLinks manages the full appraisal process for lenders;
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Lender X, the technology solution that facilitates lenders managing their own appraisal process; and
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Appraisal QX, introduced in the fourth quarter of 2012, an automated appraisal risk management product.
StreetLinks is working to increase its customer base, capture a larger percentage of current customers' business and bring new, innovative products to market.
We own 78% of Advent Financial Services LLC (“Advent”). Advent provides financial settlement services for income tax preparation businesses and access to tailored banking accounts and related services via its prepaid debit card, which is designed to meet the needs of low and moderate-income level individuals. Advent is not a bank but acts as an intermediary for banking products on behalf of other banking institutions.
The primary distribution channel for Advent is by way of settlement services to electronic income tax return originators. Advent provides a process for the originators to collect refunds and other payments from the Internal Revenue Service, distribute fees to various service providers and deliver the net refund/payment to individuals. Individuals may elect to have the net refund/payment deposited to an Advent-issued prepaid debit card. Individuals also have the option to have the net refund/payment paid by check or deposited to/withdrawn from an existing bank account. Regardless of the settlement method, Advent receives a fee from the originator for providing the settlement service.
If the refund/payment is deposited to the prepaid debit card offered by Advent, Advent earns fee income related to the usage of the prepaid card. Advent is working to increase its number of independent tax preparation customers and encourage individuals to reload their prepaid debit card after tax time, as the reload and subsequent usage of the prepaid card generates additional fee income for Advent.
We own 61% of Mango Moving, LLC. Mango is an “asset-light” third-party logistics provider within the household goods industry.
In October of 2012, we acquired 85% of IVR Central, LLC, a call center technology company. Subsequent to the acquisition, the name was changed to Corvisa Cloud LLC. Primary products of Corvisa Cloud include interactive voice response, automated call distribution, call dialing and call recording using cloud technology. Corvisa Cloud also provides a full call center replacement offering, which allows for the elimination of legacy on-premise phone systems and includes integration to multiple leading
Customer Relation Management and cloud-based sales and operation management systems. The call center solution is fully web-based, hosted in the cloud and highly scalable.
Prior to 2011, we originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage securities. As a result of those activities, we acquired and continue to own mortgage securities that continue to be a source of our cash flow.
Our Strategy
Management is focused on building its operating subsidiaries with a focus on long term value creation. Given the early-stage nature of many of these businesses, they may not contribute to earnings for some time, but we believe they represent solid investments with the opportunity for future earnings and equity value creation that will benefit shareholders.
The key performance measures for executive management are:
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generating income and long-term value for our shareholders, and
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maintaining and/or generating adequate liquidity to sustain us and allow us to take advantage of acquisition opportunities.
The following key performance metrics 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.”
Table 1 - Summary of Financial Highlights and Key Performance Metrics (dollars in thousands; except per share amounts)
Significant Recent Events
During 2011, the Company acquired a majority interest in Build My Move, LLC and immediately renamed and rebranded the
company as Mango Moving LLC. Under the original concept, Mango would contract to complete residential moves for individuals
and hire non-household goods movers to execute the moves. During the fourth quarter of 2012, the Company, due in large part
to Mango's continued operating losses, concluded that the original concept was not effective and began to retool the business to
build a network of independent, full-service movers to fulfill moves. As part of this effort, the Company replaced some members of Mango's management team. The Company also moved Mango's operations from Overland Park, Kansas to Tampa, Florida in order to take advantage of the Company's shared operation facilities.
The combination of the preceding factors triggered the Company to revise its financial projections for Mango during the fourth
quarter of 2012. As a result, after completing its annual impairment test, the Company concluded that the carrying amount of the goodwill assigned to the Company's Logistics reporting unit exceeded its implied fair value. Therefore, the Company recorded an impairment loss of $2.2 million during the fourth quarter of 2012. See Note 8 to the consolidated financial statements for additional information.
Because of continued capital demands and difficulties generating positive cash flows or earnings, effective February 27, 2013, the Company committed to a plan to abandon the operations of Mango, which comprises the Company's entire Logistics segment.
Consolidated Results of Operations
Year ended December 31, 2012 as Compared to the Year Ended December 31, 2011
Service Fee Income and Cost of Services
See discussion within the Segment Results of Operations section below.
Interest Income - Mortgage Securities
The interest on the mortgage securities we own has decreased when comparing 2012 to 2011 as the cash flow on the securities have decreased mainly due to poor performance of the underlying collateral. Management expects that the interest income and cash flow from these securities will continue to decline as the underlying loan collateral is written down or off.
Selling, General and Administrative
Selling, general and administrative expenses have increased to $32.2 million for 2012 from $21.5 million for 2011. This increase was driven by the acquisition of Mango, which was acquired in the fourth quarter of 2011. Because of the timing of the acquisition, only one quarter of operations were included in the consolidated operating results for 2011. The increase was also due to growth across all operating segments along with the Corporate segment and the increased workforce and infrastructure to help support the existing and expected increase in operations.
Interest Expense
Interest expense has increased to $3.1 million for 2012 from $2.5 million for 2011. The increase is due to the accretion of the debt discount to the higher principal balance of the Senior Notes as a result of the Debt Exchange transactions executed at the end of the first quarter of 2011. See Note 9 to the consolidated financial statements for further details.
Income Tax Benefit
During 2012, the Company released $63.1 million of its valuation allowance against its deferred tax assets. This was due largely to the Company attaining 36 months of cumulative earnings and other positive factors as discussed in more detail in Note 15.
Segment Results of Operations
Year ended December 31, 2012 as Compared to the Year Ended December 31, 2011
Appraisal Management
We manage the process of residential home appraisals for our customers, generally residential mortgage lenders. We earn fees when our service is completed and the appraisal is delivered to our customer. We also provide transaction-based technology services for mortgage lenders to manage their own appraisal process and other valuation services, such as automated appraisal risk management products. Fee revenue is directly related to the number of completed orders or transactions and product mix. Cost of services includes the direct cost of the appraisal or other service, when applicable, which is paid to an independent party, and the internal costs directly associated with completing the appraisal order. The internal costs include compensation and benefits, office administration, depreciation of equipment used in the production process, and other expenses necessary to the production process.
Following is an analysis of the results of operations from the Appraisal Management segment.
Table 2 - Appraisal Management Segment Operations (dollars in thousands, except unit and per unit amounts)
Service Fee Income
The large increase in service fee income in the Appraisal Management segment is directly related to the increase in completed orders and transactions. The substantial increase in order volume is mainly due to our sales efforts, which led to increases in the number of mortgage lender customers, along with gaining additional order volume from existing customers.
Cost of Services
As a percentage of service fee income, direct costs of services have increased steadily when comparing 2012 to 2011. This is due to regulatory changes requiring that the fees we pay to appraisers are "customary and reasonable". Management continues to evaluate its methods for assigning appraisals in order to lower the cost of the appraisal, while maintaining compliance with regulatory guidelines. The indirect cost of services have remained reasonably consistent as a percentage of revenues. Changes in the fee income and cost of service per unit, and therefore net margin, from period to period may be impacted by the mix of the appraisal products completed, as margins for other valuation and transaction-based services are significantly different from full service appraisal management services.
Selling, General and Administrative
Selling, general and administrative expenses are higher when comparing 2012 to 2011. However, as a percentage of service fee income, these expenses are lower as many of these costs have not increased proportionate to production. A significant portion of these amounts are related to compensation and benefits for administrative and sales employees which have increased but at a slightly slower rate than revenue.
Financial Intermediary
We earn fees for providing financial settlement services for income tax preparation businesses and consumers. Settlement services are facilitated through arrangements we have made with other independent financial service providers, including our bank partners and data exchange managers. Settlement services consist mainly of collecting income tax refunds on behalf of our customers, distributing fees to independent service providers and delivering the refund, net of fees, to the individual taxpayer. As the majority of our business is directly related to income tax refunds, a significant portion of the financial intermediary's operations occur during the first quarter of each year.
Although we are not a bank, we provide access to tailored banking accounts and related services via our prepaid debit card designed to meet the needs of low and moderate-income level individuals. We earn additional service fee income based on the customers' account activity. In the analysis below, we have included all accounts opened (titled banking accounts enrolled), regardless of whether the account was used and generated fees. Cost of Services includes the direct cost related to providing services, which includes fees to third-party vendors performing services on our behalf. Additionally, internal costs directly associated with completing our services are included in Cost of Services. The internal costs include compensation and benefits of employees, office administration, depreciation of equipment used in the production process, and other expenses necessary to complete services performed.
Following is an analysis of the results of operations from the Financial Intermediary segment.
Table 3 - Financial Intermediary Segment Operations (dollars in thousands, except unit and per unit amounts)
(A)
Advent processes both federal and state income tax refunds. However, many taxpayers have no state refund and others may have more than one state tax refund. For this analysis, the number of state refunds have not been included. The number of federal income tax refunds generally represents the number of individual taxpayers using Advent services.
(B)
Includes all accounts opened regardless of whether the account was used and/or generated fees.
Service Fee Income
The large increase in service fee income in the Financial Intermediary segment is due to a significant increase in the number of settlements and enrollments, which was driven by continued sales and marketing efforts coupled with our current strategy to increase transaction volume through a reduction in our settlement and other service fee rates.
Cost of Services
The increase in cost of services for 2012 when compared to 2011 is due to the increased transaction volume over the same period. The increase in cost of services as a percentage of service fee income is due primarily to the Financial Intermediary segment's current strategy. While this strategy has driven additional service fee income dollars and volume, this strategy has also reduced margins during 2012. In addition, this segment had higher operational costs than we expect to incur in the long term, as we continue to grow this business and supporting functions.
Selling, General and Administrative
Selling, general and administrative expenses were higher during 2012 when compared to 2011. The Financial Intermediary segment incurred additional costs to administer the settlement programs, including compensation and related expenses for non-production staff and fees for professional services. As a percentage of service fee income, however, these expenses are lower as many of these costs have not increased proportionate to production.
Guarantee Fees and Interest Expense
During the first quarter of 2012, NCI charged a guaranty fee of approximately $1.0 million to the Financial Intermediary segment for NCI's guarantee of Advent's performance under its contract with its settlement services banking partner. Interest was also charged on amounts borrowed from NCI.
Logistics
Prior to discontinuing the logistics segment effective February 27, 2013, we provided interstate residential moving services by serving as the sales and marketing partner to independent household goods movers nationwide. Service fee income is directly related to the number of completed moves. Cost of services includes the direct costs of a move (such as loading, transportation, and unloading services), which are paid to independent parties, and the internal costs directly associated with completing a move. The internal costs include compensation and benefits, office administration, depreciation of equipment used in the production process, and other expenses necessary to complete the production process.
As discussed in Note 13 to the consolidated financial statements, prior period comparatives have not been included for the Logistics segment for 2011. This is due to the fact the the operating results for this segment were not material to the financial statements as a whole due to the fact that this segment was acquired in the fourth quarter of 2011. As such, the following discussion regarding the results of operations of this segment will focus primarily on the activity within this segment for 2012.
Table 4 - Logistics Segment Operations (dollars in thousands, except unit and per unit amounts)
Service Fee Income
Service fee income in the Logistics segment is directly related to the number of moves completed by Mango. Completed moves are tracked by three verticals; labor-only, direct-to-consumer, and transportation-only and other. Labor-only consists of labor services referred through third parties that offer portable moving and self-storage solutions to consumers. Direct-to-consumer moves are full-service moves that are offered directly to consumers. Leads for these types of moves are generally obtained through Internet sources. Transportation-only and other moves consist of services provided to third parties' customers when they cannot fulfill the transportation with their own transportation fleet. This vertical also includes corporate relocation services provided to employees and clients of our corporate partners.
Cost of Services
Generally, fluctuations in direct cost of services in the Logistics segment are directly correlated to the number of moves completed by Mango. Changes in the fee income and cost of service per unit, and therefore, the net margin, from period to period may be impacted by the mix of the completed moving and storage solutions. As this segment is still in the early stages of development, Management continues to identify and explore opportunities to scale the business and improve the efficiency of operations with the intent to generate positive margins in future periods.
Selling, General and Administrative
As the Logistics segment is still in the early stages of development, selling, general and administrative expenses are significantly higher as a percentage of service fee income than we would anticipate going forward. As we continue to grow and develop this business, we anticipate this percentage will decline, as many of these costs do not increase proportionate to production.
Other Income (Expense), Net
The Company's annual impairment test indicated that the carrying amount of the goodwill assigned to the Logistics reporting unit exceeded its implied fair value. As such, the Company recorded an impairment loss of $2.2 million during the fourth quarter of 2012. See Note 8 to the consolidated financial statements for additional information.
Liquidity and Capital Resources
As of December 31, 2012, we had approximately $16.4 million in unrestricted cash and cash equivalents and $2.2 million of restricted cash, $1.1 million of which is included in the other assets line item. The bank that provides financial settlement services for Advent requires cash collateral in an account and its release is subject to contractual requirements. During the first and second quarters of 2012, the balance in this account increased from December 31, 2011 due to the high volume of transactions that Advent processed, however, approximately $4.7 million was released from restriction during the third quarter of 2012.
Service fee income was a substantial source of our cash flows during 2012. We have had significant growth during 2012 as compared to the same period in 2011, and are currently projecting an increase in service fee income over the course of the next year as we continue to increase our customer base, although we cannot assure the same rate of growth that we have experienced will continue in future periods. Our current projections indicate that sufficient cash and cash flows are and will be available to meet payment needs. However, our mortgage securities cash flows are volatile and uncertain, and the amounts we receive could vary materially from our projections though we believe that the increased cash flows from operations will offset any reduction in our mortgage securities cash flows. As discussed under the heading “Item 3. Legal Proceedings” of Part I of this report, we are the subject of various legal proceedings, the outcomes of which are uncertain. We may also face demands in the future that are unknown to us today related to our legacy lending and servicing operations. However, management believes that its current operations and its cash availability are sufficient for the Company to discharge its liabilities and meet its commitments in the normal course of business.
The indentures governing the Senior Notes (the “Indentures”) contain restrictive covenants (the “Negative Covenants”) subject to exceptions in the Indentures, including written consent of the holders of the Senior Notes. The Negative Covenants prohibit NCI and its subsidiaries, from among other things, incurring debt, permitting any lien upon any of its property or assets, making any cash dividend or distribution or liquidation payment, acquiring our shares or equity in our subsidiaries, making payment on our debt securities that rank pari passu or junior to the Senior Notes, or disposing of any equity interest in our subsidiaries or all or substantially all of the assets of our subsidiaries. The Senior Notes accrue interest at a rate of 1.0% until the earlier of (a) the completion of an equity offering by NCI or our subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”). Interest on the Senior Notes is paid on a quarterly basis and no principal payments are due until the Senior Notes mature on March 30, 2033. The Negative Covenants remain in effect until both of the following conditions are met: 1) the Senior Notes begin accruing interest at the Full Rate, and 2) the Company satisfies certain financial covenants (the “Financial Covenants”). Satisfaction of the Financial Covenants requires the Company to demonstrate on a consolidated basis that (1) its Tangible Net Worth is equal to or greater than $40 million, and (2) either (a) the Interest Coverage Ratio is equal to or greater than 1.35x, or (b) the Leverage Ratio is not greater than 95%. As the Senior Notes were not accruing interest at the Full Rate, the Negative Covenants, as defined above, were still in effect as of December 31, 2012 and December 31, 2011. As such, the Company was under no obligation to comply with the Financial Covenants during these periods.
Overview of Cash Flow for the Year Ended December 31, 2012
The following table provides a summary of our operating, investing and financing cash flows as taken from our consolidated statements of cash flows for 2012 and 2011.
Table 5 - Summary of Operating, Investing and Financing Cash Flows (dollars in thousands)
Operating Activities
Cash provided by operating activities increased during 2012 over 2011. This was directly related to the cash flows from operating activities of our Appraisal Management segment offset slightly by the cash used in operating activities of our Financial Intermediary and Logistics segments.
Investing Activities
During 2012, the Company had a large decrease in proceeds from paydowns and maturities of securities as compared to the same period last year mainly due to poor performance of the underlying collateral. However, as discussed in Note 6 to the consolidated financial statements, the Company received a large note receivable payment of $1.5 million during 2012. During 2012, we also purchased a larger amount of property and equipment as compared to 2011 to support growth in the operating businesses.
Financing Activities
As discussed in Note 4 to consolidated financial statements, during 2012, the Company acquired an additional equity interest in StreetLinks for an initial payment of $0.5 million and a note payable of $5.6 million. During 2012, the Company paid approximately $1.0 million under the note payable to related party. In addition, the Company distributed approximately $0.4 million to the noncontrolling members of StreetLinks, and paid approximately $0.3 million to redeem the membership units of a noncontrolling member of Mango. These outflows were offset by the receipt of approximately $1.3 million in capital contributions from noncontrolling interests of Mango. During the same period in 2011, the Company paid approximately $3.0 million to holders of preferred stock as part of the Recapitalization.
Contractual Obligations
We have entered into certain long-term debt and lease agreements which obligate us to make future payments to satisfy the related contractual obligations. The following table summarizes our contractual obligations as of December 31, 2012.
Table 6 - Contractual Obligations (dollars in thousands)
(A)
In computing the future obligations relating to the Senior Notes, interest payments are calculated using an interest rate of 1.0% per annum until January 2016 and an effective rate of 3.58% thereafter. The Senior Notes are assumed to mature in March 2033. The Senior Notes, including the actual interest rates, are described in detail in Note 9 to our consolidated financial statements.
(B)
In computing the future obligations related to contingent payments and other acquisition-related obligations, interest payments are calculated using the stated interest rate of 4.0% per annum. These obligations are described in detail in Note 4 and Note 10 to our consolidated financial statements.
The estimated liability associated with uncertain tax positions of $1.2 million, which is included in the other liabilities line item of the noncurrent liabilities section of the consolidated balance sheet as of December 31, 2012, are not included in the table above as the timing of payment cannot be reasonably or reliably estimated.
Critical Accounting Estimates
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“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 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 of Directors and the Audit Committee has reviewed our disclosure.
Mortgage Securities
Our mortgage securities represent beneficial interests we retained in securitization transactions. The residual securities include interest-only mortgage securities, prepayment penalty bonds and over-collateralization bonds.
The residual securities we retained in securitization transactions structured as sales primarily consist of the right to receive the future cash flows from a pool of securitized mortgage loans which include:
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The interest spread between the coupon net of servicing fees on the underlying loans, the cost of financing, mortgage insurance, payments or receipts on or from derivative contracts and bond administrative costs;
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Prepayment penalties received from borrowers who pay off their loans early in their life; and
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Overcollateralization which is designed to protect the primary bondholder from credit loss on the underlying loans.
We believe the accounting estimates related to the valuation of our residual securities and establishing the rate of income recognition are “critical accounting estimates” because they can materially affect net income and shareholders’ equity and require us to forecast interest rates, mortgage principal payments, prepayments and loan default assumptions which are highly uncertain and require a large degree of judgment. The rate used to discount the projected cash flows is also critical in the valuation of our residual securities. We use internal, historical collateral performance data and published forward yield curves when modeling future expected cash flows and establishing the rate of income recognized on mortgage securities. We believe the value of our residual securities is appropriate, but can provide no assurance that future changes in interest rates, prepayment and loss experience or changes in the market discount rate will not require write-downs of the residual assets.
At each reporting date, the fair value of the residual securities is estimated based on the present value of future expected cash flows to be received. Management’s best estimate of key assumptions, including credit losses, prepayment speeds, expected call dates, market discount rates and forward yield curves commensurate with the risks involved, are used in estimating future cash flows. See Note 12 to the consolidated financial statements for the current fair value of our residual securities.
Notes Receivable and Allowance for Doubtful Accounts
The Company determines the required allowance for doubtful accounts using information such as the status of the note, borrower’s financial condition, economic trends and conditions, past payment history and information provided from legal counsel if the note is in litigation.
Goodwill
Goodwill is tested for impairment at least annually and impairments are charged to results of operations only in periods in which the recorded carrying value of reporting unit is more than its estimated fair value. Goodwill is tested for impairment using a two-step process that begins with an estimation of fair value. The first step compares the estimated fair value of a reporting unit with its carrying amount, including goodwill. If the estimated fair value exceeds its carrying amount, goodwill is not considered impaired. However, if the carrying amount exceeds its estimated fair value, a second step is performed that compares the implied fair value to the carrying amount of goodwill. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. Due to the factors detailed in Note 8, the impairment test in 2012 indicated that the carrying amount of the goodwill assigned to the Company's Logistics reporting unit exceeded its implied fair value. As such, the Company recorded an impairment loss of $2.2 million during 2012. No impairment was incurred in 2011.
Income Taxes
In determining the amount of deferred tax assets to recognize in the financial statements, the Company evaluates the likelihood of realizing such benefits in future periods. The income taxes 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 taxes guidance indicates the more likely than not threshold is a level of likelihood that is more than 50%.
Under the income taxes 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.
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. Accordingly, the more negative evidence that exists requires more positive evidence to counter, thus making it more difficult 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 relevancy 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 the weighted positive evidence is not sufficient to support a conclusion that it is more likely than not that all or some of the Company's deferred tax assets will be realized, the Company considers all alternative sources of taxable income identified in determining the amount of valuation allowance to be recorded. Alternative sources of taxable income identified in the income taxes 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 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
In September 2011, the FASB issued Accounting Standards Update ("ASU") 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which amends previous guidance to allow companies the option of performing a qualitative assessment before completing step one of the impairment test, calculating the fair value of the reporting unit. If the Company determines on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not greater than the carrying amount, the two-step impairment test would not be required. The amendments are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The guidance was in effect for the Company beginning with the annual goodwill impairment tests completed in the fourth quarter of 2012 and did not have a material impact on the Company's consolidated financial statements.
In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, which amends the guidance in ASC 350-30 on testing indefinite-lived intangible assets, other than goodwill, for impairment. The FASB issued the ASU in response to feedback on ASU 2011-08, which amended the goodwill impairment testing requirements by allowing an entity to perform a qualitative impairment assessment before proceeding to the two-step impairment test. Similarly, under ASU 2012-02, an entity testing an indefinite-lived intangible asset for impairment has the option of performing a qualitative assessment before calculating the fair value of the asset. Although ASU 2012-02 revises the examples of events and circumstances that an entity should consider in interim periods, it does not revise the requirements to test (1) indefinite-lived intangible assets annually for impairment and (2) between annual tests if there is a change in events or circumstances. This guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, and is not expected to have a material impact on the Company's consolidated financial statements.
In August 2012, the FASB issued ASU 2012-03, Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22 (SEC Update), which amends a number of SEC sections in the FASB Accounting Standards Codification as a result of (1) the issuance of SAB 114, (2) the issuance of SEC
Final Rule 33-9250, and (3) corrections related to ASU 2010-22. This guidance was effective upon issuance, and did not have a significant impact on the Company's financial statements.
In October 2012, the FASB issued ASU 2012-04, Technical Corrections and Improvements, which makes certain technical corrections (i.e., relatively minor corrections and clarifications) and “conforming fair value amendments” to the FASB Accounting Standards Codification (the “Codification”). The amendments affect various Codification topics and apply to all reporting entities within the scope of those topics. This guidance was effective upon issuance (except for amendments that are subject to transition guidance, which will be effective for fiscal periods beginning after December 15, 2012), and did not have a significant impact on the Company's financial statements.
In January 2013, the FASB issued ASU 2013-1, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which clarifies which instruments and transactions are subject to the offsetting disclosure requirements established by ASU 2011-11. The new ASU addresses preparer concerns that the scope of the disclosure requirements under ASU 2011-11 was overly broad and imposed unintended costs that were not commensurate with estimated benefits to financial statement users. This guidance is effective for fiscal years beginning on or after January 1, 2013, and will not have a significant impact on the Company's financial statements.
In February 2013, the FASB issued ASU 2013-2, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which adds new disclosure requirements for items reclassified out of accumulated other comprehensive income (AOCI). This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012, and is not expected to have a significant impact on the Company's financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
As a smaller reporting company, we are not required to provide the information required by this Item.
Item 8.
Item 8. Financial Statements and Supplementary Data
NOVATION COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share and per share amounts)
See notes to consolidated financial statements.
NOVATION COMPANIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share and per share amounts)
See notes to consolidated financial statements.
NOVATION COMPANIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands)
See notes to consolidated financial statements.
NOVATION COMPANIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT
(dollars in thousands, except share amounts)
NOVATION COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Supplemental Disclosure of Cash Flow Information
(dollars in thousands)
NOVATION COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation, Business Plan and Liquidity
Description of Operations - Effective May 23, 2012, NovaStar Financial, Inc. changed its name to Novation Companies, Inc. (“NCI” or the “Company”) to reflect the Company's current business strategy of acquiring and operating technology-enabled service businesses.
The Company owns 91% of StreetLinks LLC (“StreetLinks”), a national residential appraisal and mortgage real estate valuation management services company. The Company owned 88% of StreetLinks as of December 31, 2011. See Note 4 to the consolidated financial statements for additional details related to the change in ownership percentage. The majority of StreetLinks' business is generated from managing the process of fulfilling an appraisal order and performing a quality control review of all appraisals. StreetLinks also provides other real estate valuation management services, such as field reviews, value validation, and automated appraisal risk management. StreetLinks charges a fee for these services which is collected from lenders and borrowers.
The Company owns 78% of Advent Financial Services LLC (“Advent”). Advent, along with its distribution partners, provides financial settlement services, mainly for income tax preparation businesses, and also provides access to tailored banking accounts and related services via its prepaid debit card designed to meet the needs of low and moderate-income level individuals. Advent is not a bank, but it acts as an intermediary for banking products on behalf of other banking institutions.
The primary distribution channel for Advent is by way of settlement services to electronic income tax return originators. Advent provides a process for the originators to collect refunds from the Internal Revenue Service, distribute fees to various service providers and deliver the net refund to individuals. Individuals may elect to have the net refund dollars deposited into Advent's prepaid debit card. Individuals also have the option to have the net refund dollars paid by check or to an existing bank account. Regardless of the settlement method, Advent receives a fee from the originator for providing the settlement service. If the refund is deposited to the prepaid debit card offered by Advent, Advent earns additional fee income.
The Company owns 61% of Mango Moving, LLC ("Mango"), a third-party logistics provider within the household goods industry. The Company owned 51% of Mango as of December 31, 2011. The increase in ownership interest was due primarily to the redemption of the membership units of a noncontrolling member during the fourth quarter of 2012. Effective February 27, 2013 the Company and non-controlling owners agreed to dissolve Mango and abandon its operations.
On October 2, 2012, pursuant to a Membership Interest Purchase Agreement between the Company and IVR Central, LLC ("IVR"), the Company acquired 85% of the membership interests in IVR in exchange for a purchase price of $0.8 million and the issuance of 200,000 stock options, 75,000 of which vested immediately and were included in the consideration transferred for the purposes of the purchase price allocation. Due to certain operational and financial vesting conditions, the remaining 125,000 options were deemed to be attributable to post-combination service and, thus, will be recognized as compensation cost over the applicable service periods. The impact of this acquisition was not material to the consolidated Company. See Note 4 to the consolidated financial statements for additional information.
Subsequent to the acquisition, IVR changed its named to Corvisa Cloud LLC ("Cloud"). Cloud is a technology company in the call center communications industry, whose primary products include interactive voice response, automated call distribution, call dialing and call recording using cloud technology.
Effective January 1, 2012, the Company adopted the provisions of Accounting Standards Update ("ASU") 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, with retrospective application as reflected in the consolidated statements of comprehensive income included herein. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.
During 2011, the Company completed the exchange of all outstanding shares of its preferred stock for an aggregate of 80,985,600 shares of newly-issued common stock and $3.0 million in cash (the "Recapitalization"). See Note 3 to the consolidated financial statements for additional details.
During 2011, the Company completed an exchange of its junior subordinated debentures for senior debentures (the "Debt Exchange"). See Note 9 to the consolidated financial statements for further details.
Prior to significant changes in our business during 2008, the Company originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage-backed securities. The Company retained, through its mortgage securities investment portfolio, interests in the nonconforming loans it originated and purchased, and through its servicing platform, serviced all of the loans in which it retained interests. The Company discontinued its mortgage lending operations and sold its mortgage servicing rights which subsequently resulted in the closing of our servicing operations. The Company continues to hold the nonconforming residential mortgage securities.
Financial Statement Presentation - The Company’s consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the period. The Company uses estimates and judgments in establishing the fair value of its mortgage securities, notes receivable, goodwill, and accounting for income taxes, including the determination of the timing of the establishment or release of the valuation allowance related to the deferred tax asset balances and reserves for uncertain tax positions. While the condensed consolidated financial statements and footnotes reflect the best estimates and judgments of management at the time, actual results could differ significantly from those estimates.
The consolidated financial statements of the Company include the accounts of all wholly-owned and majority-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
Note 2. Summary of Significant Accounting and Reporting Policies
Cash and Cash Equivalents and Restricted Cash. Cash equivalents consist of liquid investments with an original maturity of three months or less. Amounts due from banks and credit card companies of $0.3 million and $0.5 million for the settlement of credit card transactions are included in cash and cash equivalents as of December 31, 2012 and 2011, respectively, as they are generally collected within three business days. Cash equivalents are stated at cost, which approximates fair value. Restricted cash includes funds the Company is required to post as cash collateral or transfer to escrow accounts and its release is subject to contractual requirements and time restrictions. The cash may not be released to the Company without the consent of the counterparties, which is generally at their discretion. The cash could also be subject to the indemnification of losses incurred by the counterparties. Restricted cash is included in the restricted cash line item of the consolidated balance sheets, while noncurrent restricted cash of $1.1 million is included in the other assets line item of the consolidated balance sheets as of both December 31, 2012 and 2011.
The Company maintains cash balances at several major financial institutions in the United States. Accounts at each institution are secured by the Federal Deposit Insurance Corporation up to $250,000 through December 31, 2013. At December 31, 2012 and 2011, 83% and 73%, respectively, of the Company’s cash and cash equivalents, including restricted cash, were with one institution. The uninsured balances of the Company’s unrestricted cash and cash equivalents and restricted cash aggregated $16.1 million and $11.8 million as of December 31, 2012 and 2011, respectively.
Revenue Recognition. Service fee revenues consist primarily of fees for real estate valuation management services provided by StreetLinks, financial settlement services provided by Advent and logistics fees for moving services provided by Mango. Service fee revenues are recognized in the period in which the service provided to and accepted by the customer. Deferred revenue is recorded when payments are received in advance of performing our service obligations and is recognized in accordance with the above criteria. When the Company is the principal in its transactions with customers, service fee revenues are recorded on a gross basis. Otherwise, service fee revenues are recorded on a net basis.
Cost of Services. Cost of Services includes the direct costs to provide services to customers, which are payments to independent parties, and the internal costs directly associated with completing customer orders. Internal costs include other expenses necessary to the production process, such as compensation and benefits of employees, occupancy costs and depreciation of equipment.
Earnings Per Share (“EPS”). Basic EPS excludes dilution and is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is calculated assuming all options, nonvested shares and performance based awards on the Company's common stock have been exercised, unless the exercise would be antidilutive.
Earnings per share is calculated under the treasury method. For 2011, this calculation included the Series D Preferred Stock assumed to be converted to 1,875,000 shares of Common Stock that shared in distributions with common shareholders on a 1:1 basis through the date of the Recapitalization. See Note 14 to the consolidated financial statements for additional details on earnings per share calculation.
Notes Receivable and Allowance for Doubtful Accounts. Notes receivable are considered delinquent, based on current information and events, if it is probable that we will be unable to collect all amounts due that are contractually obligated. The Company determines the required allowance for doubtful accounts using information such as the borrower’s financial condition and economic trends and conditions. See additional details in Note 6 to the consolidated financial statements.
Service Fee Receivable and Allowance for Doubtful Accounts. The majority of the Company's service fee receivables relate to the Company's Appraisal Management segment. Generally, these service fees are invoiced weekly and due within 10 days of receipt of the invoice. The Company maintains an allowance for doubtful accounts at an amount estimated to cover potential
uncollectible losses. Management analyzes receivables and historical bad debts, current economic trends and conditions, and the length of time receivables are past due in order to establish the allowance for doubtful accounts. The past due or delinquency status of a receivable is based on the contractual payment terms of the receivable, which are generally due within ten to fifteen days for customers that the Company extends credit. All other amounts are due and collected at the time the service is rendered. Reserves for individual accounts are recorded when the Company becomes aware of specific customer circumstances, such as bankruptcy filings, deterioration in the customer’s operating results or financial position, or potential unfavorable outcomes from disputes with customers. The Company charges off uncollectible service fees receivable when repayment of contractually-obligated amounts is not deemed to be probable.
Mortgage Securities - Available-for-Sale. Mortgage securities - available-for-sale represent beneficial interests the Company retains in securitization transactions which consist of residual interests (the “residual securities”). Mortgage securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. 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 specific identification method was used in computing realized gains or losses.
As previously described, mortgage securities-available-for-sale represent retained beneficial interests in certain components of the cash flows of the underlying mortgage loans to securitization trusts. As payments are received on the residual securities, the payments are applied to the cost basis of the related mortgage securities. Each period, the accretable yield for each mortgage security is evaluated and, to the extent there has been a change in the estimated cash flows, it is adjusted and applied prospectively. The accretable yield is recorded as interest income with a corresponding increase to the carrying basis of the mortgage security.
The Company estimates the fair value of its residual securities retained based on the present value of future expected cash flows to be received. Management’s best estimate of key assumptions, including credit losses, prepayment speeds, market discount rates and forward yield curves commensurate with the risks involved, are used in estimating future cash flows.
Mortgage Securities - Trading. Mortgage securities - trading consist of mortgage securities purchased by the Company as well as retained by the Company in its securitization transactions. Trading securities are recorded at fair value with gains and losses, realized and unrealized, included in earnings. The Company uses the specific identification method in computing realized gains or losses.
The Company estimates fair value for the subordinated securities based on quoted market prices obtained from brokers which are compared to internal discounted cash flows.
Goodwill. Goodwill represents cost in excess of fair values assigned to the underlying net assets of acquired businesses. Goodwill is tested for impairment at least annually as of November 30, or when events or circumstances suggest that an impairment may exist. Goodwill is tested for impairment using a two-step process that begins with an estimation of fair value. The first step compares the estimated fair value of the reporting unit to its carrying amount, including goodwill. If the estimated fair value exceeds its carrying amount, goodwill is not considered impaired. However, if the carrying amount exceeds its estimated fair value, a second step is performed, comparing the implied fair value to the carrying amount of goodwill. An impairment loss is recorded in the consolidated statement of operations to the extent that the carrying amount of goodwill exceeds its implied fair value. Due to the factors detailed in Note 8, the impairment test in 2012 indicated that the carrying amount of the goodwill assigned to the Company's Logistics reporting unit exceeded its implied fair value. As such, the Company recorded an impairment loss of $2.2 million during 2012. No impairment was incurred in 2011.
Income Taxes. The Company had a gross deferred tax asset of $284.0 million and $286.4 million as of December 31, 2012 and 2011, respectively. In determining the amount of deferred tax assets to recognize in the financial statements, the Company evaluates the likelihood of realizing such benefits in future periods. The income taxes 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 taxes guidance indicates the more likely than not threshold is a level of likelihood that is more than 50%.
Under the income taxes 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.
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. Accordingly, the more negative evidence that exists requires more positive evidence to counter, thus making it more difficult 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 relevancy 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 the weighted positive evidence is not sufficient to support a conclusion that it is more likely than not that all or some of the Company's deferred tax assets will be realized, the Company considers all alternative sources of taxable income identified in determining the amount of valuation allowance to be recorded. Alternative sources of taxable income identified in the income taxes 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 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.
New Accounting Pronouncements
In September 2011, the FASB issued ASU 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which amends previous guidance to allow companies the option of performing a qualitative assessment before completing step one of the impairment test, calculating the fair value of the reporting unit. If the Company determines on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not greater than the carrying amount, the two-step impairment test would not be required. The amendments are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The guidance was in effect for the Company beginning with the annual goodwill impairment tests completed in the fourth quarter of 2012 and did not have a material impact on the Company's consolidated financial statements.
In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, which amends the guidance in ASC 350-30 on testing indefinite-lived intangible assets, other than goodwill, for impairment. The FASB issued the ASU in response to feedback on ASU 2011-08, which amended the goodwill impairment testing requirements by allowing an entity to perform a qualitative impairment assessment before proceeding to the two-step impairment test. Similarly, under ASU 2012-02, an entity testing an indefinite-lived intangible asset for impairment has the option of performing a qualitative assessment before calculating the fair value of the asset. Although ASU 2012-02 revises the examples of events and circumstances that an entity should consider in interim periods, it does not revise the requirements to test (1) indefinite-lived intangible assets annually for impairment and (2) between annual tests if there is a change in events or circumstances. This guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, and is not expected to have a material impact on the Company's consolidated financial statements.
In August 2012, the FASB issued ASU 2012-03, Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22 (SEC Update), which amends a number of SEC sections in the FASB Accounting Standards Codification as a result of (1) the issuance of SAB 114, (2) the issuance of SEC Final Rule 33-9250, and (3) corrections related to ASU 2010-22. This guidance was effective upon issuance, and did not have a significant impact on the Company's financial statements.
In October 2012, the FASB issued ASU 2012-04, Technical Corrections and Improvements, which makes certain technical corrections (i.e., relatively minor corrections and clarifications) and “conforming fair value amendments” to the FASB Accounting Standards Codification (the “Codification”). The amendments affect various Codification topics and apply to all reporting entities within the scope of those topics. This guidance was effective upon issuance (except for amendments that are subject to transition guidance, which will be effective for fiscal periods beginning after December 15, 2012), and did not have a significant impact on the Company's financial statements.
In January 2013, the FASB issued ASU 2013-1, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which clarifies which instruments and transactions are subject to the offsetting disclosure requirements established by ASU 2011-11. The new ASU addresses preparer concerns that the scope of the disclosure requirements under ASU 2011-11 was overly broad and imposed unintended costs that were not commensurate with estimated benefits to financial
statement users. This guidance is effective for fiscal years beginning on or after January 1, 2013, and will not have a significant impact on the Company's financial statements.
In February 2013, the FASB issued ASU 2013-2, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which adds new disclosure requirements for items reclassified out of accumulated other comprehensive income (AOCI). This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012, and is not expected to have a significant impact on the Company's financial statements.
Note 3. Recapitalization of Preferred Stock.
Series D Exchange. On June 23, 2011, the Company completed the exchange of all outstanding shares of the Company's Series D Preferred Stock for an aggregate of 37,162,000 shares of newly-issued Common Stock and $1.4 million in cash (the "Series D Exchange"). Completion of this exchange eliminated the Series D Preferred Stock and the Company's obligations with respect to outstanding and future preferred dividends and the preferred liquidating preference related to the Series D Preferred Stock. As of June 23, 2011, there were accrued and unpaid dividends of approximately $34.5 million on the Series D Preferred Stock and the aggregate liquidating preference was $52.5 million.
The shares of Common Stock issued in the exchange were issued pursuant to an exemption from registration under Regulation D of the Securities Act of 1933, as amended, and therefore are "restricted securities." The Company entered into a registration rights agreement with the holders of Series D Preferred Stock (the "Series D Holders") which obligates the Company to register the Common Stock when the restrictions are lifted. Under the terms of the Series D Exchange, the Series D Holders are generally not permitted to sell or transfer the Common Stock for three years from issuance. However, the restriction may be lifted earlier if an ownership change occurs which results in the loss of the Company's existing net operating loss carryforwards ("NOLs") or if the board of directors determines that the Company's NOLs will not be realized in whole or in part.
Series C Offer. On June 27, 2011, the Company completed the exchange offer for all the outstanding shares of the 8.9% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (the "Series C Preferred Stock"), for an aggregate of 43,823,600 shares of Common Stock and $1.6 million of cash. Completion of the transaction eliminated the Series C Preferred Stock and the Company's obligations with respect to outstanding and future preferred dividends and the preferred liquidating preference related to the Series C Preferred Stock. Immediately before the exchange, as of June 27, 2011, there were accrued and unpaid dividends of approximately $24.8 million on the Series C Preferred Stock and the aggregate liquidating preference was $74.8 million.
Note 4. Business Combinations and Consolidation
On October 2, 2012, pursuant to a Membership Interest Purchase Agreement between the Company and IVR Central, LLC ("IVR"), the Company acquired 85% of the membership interests in IVR in exchange for a purchase price of $0.8 million and the issuance of 200,000 stock options, 75,000 of which vested immediately and were included in the consideration transferred for the purposes of the purchase price allocation. Due to certain operational and financial vesting conditions, the remaining 125,000 options were deemed to be attributable to post-combination service and, thus, will be recognized as compensation cost over the applicable service periods. IVR is a technology company in the call center communications industry, whose primary products include interactive voice response, automated call distribution, call dialing and call recording using cloud technology. The impact of this acquisition was not material to the Company's consolidated results of operations and consolidated balance sheet. Subsequent to the acquisition, IVR changed its name to Corvisa Cloud LLC ("Cloud").
On March 8, 2012, Steve Haslam, the Chief Executive Officer of StreetLinks, was appointed the Chief Operating Officer of the Company. As part of the transition of Mr. Haslam to his new position with the Company, and pursuant to the exercise of his rights under his employment agreement with StreetLinks, he sold all of his 1,927 membership units of StreetLinks to the Company pursuant to a Membership Interest Purchase Agreement, dated March 8, 2012, by and between Mr. Haslam and the Company (the “Unit Purchase Agreement”). At the time of the transaction, the 1,927 membership units of StreetLinks represented approximately 5% of the outstanding StreetLinks membership units. The total purchase price under the Unit Purchase Agreement was $6.1 million, of which $1.5 million was paid during 2012. The remainder of this obligation is payable as follows: $0.3 million on the last day of each quarter hereafter until March 8, 2016, on which date the unpaid principal balance of $1.6 million is to be paid, plus interest on the unpaid balance at the rate of 4.0% per annum, compounded quarterly. The additional equity interest acquired as a result of this transaction was offset slightly by the issuance of additional StreetLinks membership units to certain StreetLinks employees during the second quarter of 2012. The issuance of these membership units reduced the Company's equity interest in StreetLinks from approximately 93% to approximately 91%.
On November 10, 2011, StreetLinks acquired the remaining 49% noncontrolling owner interests in Corvisa, LLC ("Corvisa") and now owns 100% of Corvisa. In exchange for the minority owner interests, StreetLinks paid $0.5 million in cash at the time of exchange with an additional $0.5 million payable no later than one year from the exchange date and is also obligated to make $1.2 million in payments to the former minority owners on or before June 30, 2014 if revenues from the Corvisa technology products exceed certain thresholds. The Company recorded a liability of $0.9 million for the estimated contingent consideration
under the terms of the acquisition. As of December 31, 2012, the short-term portion of $0.5 million is recorded in the accrued expenses line item of the consolidated balance sheet, while the long-term portion of $0.4 million is recorded in the noncurrent liabilities line item. As of December 31, 2011, the entire amount was recorded in the noncurrent liabilities. The effects of this transaction were recorded through shareholders' equity (deficit) in accordance with the relative consolidation guidance.
On October 17, 2011, pursuant to the terms of a Unit Purchase Agreement between the Company and Build My Move, LLC ("BMM"), the Company acquired 51% of the fully diluted membership interests in BMM. The Company purchased Class C units of BMM, having preferred distribution, liquidation and management rights, in exchange for a purchase price of $1.7 million and, upon the occurrence of certain conditions related to BMM's financial condition and its contractual obligations, the Company has the obligation to make additional capital contributions to BMM up to $0.7 million. The additional capital contribution includes a contingent consideration obligation of up to $0.3 million, which could be payable to a former employee upon compliance with the separation agreement. BMM changed its name to Mango on October 21, 2011.
The purchase price for the Cloud and Mango acquisitions have been allocated based on the assessment of the fair value of the assets acquired and liabilities assumed, determined based on the Company’s internal operational assessments and other analyses, which are Level 3 measurements. Pro forma disclosure requirements have not been included as they are not considered material. The Company’s financial statements include the operating results of both Cloud and Mango from the dates of the respective acquisitions. Revenues and earnings since the respective acquisition dates are not considered material to the Company's financial results. All legal and other related acquisition costs were expensed as incurred and recorded in the selling, general and administrative expense line item of the consolidated statements of operations, and were not material.
A summary of the aggregate amounts of the assets acquired and liabilities assumed and the aggregate consideration paid for Cloud during 2012 and Mango during 2011 follows (dollars in thousands):
Note 5. Mortgage Securities
As of December 31, 2012 and December 31, 2011, mortgage securities consisted entirely of the Company's investment in the residual securities issued by securitization trusts sponsored by the Company and classified as available-for-sale. Residual securities consist of interest-only, prepayment penalty and overcollateralization bonds. See Note 12 to the consolidated financial statements for details on the Company's fair value methodology.
The following table presents certain information on the Company's portfolio of mortgage securities - available-for-sale as of December 31, 2012 and December 31, 2011 (dollars in thousands):
(A)
The average yield is calculated from the cost basis of the mortgage securities and does not give effect to changes in fair value that are reflected as a component of shareholders' equity (deficit).
There were no other-than-temporary impairments relating to mortgage securities - available-for-sale for the years ended December 31, 2012 and 2011. Maturities of mortgage securities owned by the Company depend on repayment characteristics and experience of the underlying financial instruments.
The following table relates to the securitizations where the Company retained an interest in the assets issued by the securitization trust, a variable interest entity or VIE (dollars in thousands):
(A)
Size/Principal Outstanding reflects the estimated principal of the underlying assets held by the VIE.
(B)
Assets on balance sheet are securities issued by the entity and are recorded in the mortgage securities line item of the consolidated balance sheets.
(C)
The maximum exposure to loss includes the assets held by the Company. The maximum exposure to loss assumes a total loss on the referenced assets held by the VIE.
Note 6. Notes Receivable and Allowance for Doubtful Accounts
The Company has made loans to independent entities that have used the proceeds to finance current and on-going operations. Notes receivable are considered impaired, based on current information and events, if it is probable that the Company will be unable to collect all amounts due that are contractually obligated. The Company determines the required allowance for doubtful accounts using information such as the borrower's financial condition and economic trends and conditions. Recognition of income is suspended and the loan is placed on non-accrual status when management determines that collection of future income is not probable. Accrual is resumed, and previously suspended income is recognized, when the loan becomes contractually current and/or collection doubts are removed. Cash receipts on impaired loans are recorded against the receivable and then to any unrecognized income.
The Company charges off uncollectible notes receivable when repayment of contractually-obligated amounts is not deemed to be probable. There were no amounts charged off during 2012, and a $0.5 million charge off, which had previously been reserved, during 2011.
Due to the low number of notes receivable, the Company evaluates each note individually for collectability rather than analyzing by class or credit quality indicator. As a result of this review, the Company established a provision for credit losses of $1.1 million for 2012 related to the note receivable due from ITS Financial, LLC (“ITS”), an entity with which it was previously in litigation. During 2011, the Company agreed to settle the litigation. Pursuant to the original settlement agreement, the Company received approximately $1.3 million of the amount due under the note at the time of settlement. A modification to the original settlement agreement was reached in February 2012, whereby the Company received $1.5 million at the time of the modification, and the remaining note balance of approximately $1.1 million plus an additional $0.1 million in February 2013. In a complaint dated March 28, 2012, the United States Department of Justice ("DOJ") filed lawsuits against ITS and some of its franchisees. The actions claim that ITS was committing tax fraud against the United States Government and extracting excessive fees from the taxpaying customers. The action seeks to shut down the franchises accused of committing fraud and the entire ITS organization. Due to these lawsuits, the Company established a full allowance of $1.1 million against the note during 2012. For 2011, this review resulted in recoveries of credit losses of $0.5 million.
The remaining $0.6 million and $0.7 million of notes receivable outstanding as of December 31, 2012 and December 31, 2011, respectively, was current.
Activity in the allowance for credit losses on notes receivable is as follows for 2012 and 2011 (dollars in thousands):
Note 7. Property and Equipment, Net
All of the Company's property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets. The estimated useful lives of the assets are leasehold improvements, lesser of 5 years or remaining lease term, furniture and fixtures, 5 years, office and computer equipment, 3 to 5 years, and software, 3 years.
Maintenance and repairs are charged to expense. Major renewals and improvements are capitalized. Gains and losses on dispositions are credited or charged to earnings as incurred. Depreciation and amortization expense relating to property and equipment was $3.3 million and $2.0 million for the years ended December 31, 2012 and 2011, respectively.
The following table shows the Company's property and equipment, net as of December 31, 2012 and December 31, 2011 (dollars in thousands):
Note 8. Goodwill
Goodwill totaled $3.2 million and $5.3 million as of December 31, 2012 and 2011, respectively. During 2011, the Company acquired a majority interest in Build My Move, LLC and immediately renamed and rebranded the company as Mango Moving LLC. As part of the purchase price allocation for this acquisition, the Company allocated $2.2 million of goodwill to Mango. See Note 4 to the consolidated financial statements for further details regarding the acquisition. In addition to the goodwill allocated to the Mango reporting unit, the Goodwill balance as of 2011 includes approximately $3.2 million of goodwill assigned to the Appraisal Management reporting unit. As of December 31, 2012, the entire goodwill balance represents the goodwill assigned to the Appraisal Management reporting unit.
During the fourth quarter of 2012, the Company, due in large part to Mango's continued operating losses, concluded that the original concept was not effective and began to retool the business to build a network of independent, full-service movers to fulfill moves. As part of this effort, the Company replaced certain members of Mango's management team. The Company also moved Mango's operations from Overland Park, Kansas to Tampa, Florida in order to take advantage of the Company's shared operating facilities.
The combination of the preceding factors triggered the Company to revise its financial projections for Mango during the fourth quarter of 2012. These revisions, when utilized in the Company's annual impairment analysis, resulted in a $2.2 million impairment loss for the Logistics reporting unit during 2012. This impairment loss is included in the other income (expense) line of the Company's consolidated statement of operations.
As discussed in Note 17, effective February 27, 2013, the Company committed to a plan to abandon the operations of the Company's Logistics segment.
Including the 2012 impairment loss of $2.2 million, the Company's accumulated goodwill impairment through December 31, 2012, was $5.7 million. Of this amount, $0.5 million relates to the Appraisal Management reporting unit, $1.2 million relates to the Financial Intermediary reporting unit, and $2.2 million relates to the Logistics reporting unit. The remaining $1.9 million of accumulated impairment relates to Company's legacy business.
Goodwill activity is as follows for 2012 and 2011 (dollars in thousands):
For tax purposes, goodwill is included in the Company's basis in its investments in StreetLinks and Mango as they are limited liability companies. Therefore, it will be non-deductible for tax purposes as long as the Company holds its investments.
Note 9. Borrowings
Senior Notes - In an effort to improve the Company's liquidity position, on March 22, 2011, the Company entered into agreements that canceled the then existing $78.1 million aggregate principal amount of junior subordinated notes (the “Junior Subordinated Notes”). The Junior Subordinated Notes were replaced by unsecured senior notes pursuant to three indentures (collectively, the “Senior Notes”). The aggregate principal amount of the Senior Debentures is $85.9 million. The Senior Notes accrue interest at a rate of 1.0% until the earlier of (a) the completion of an equity offering by the Company or its subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”). Interest on the Senior Notes is paid on a quarterly basis and no principal payments are due until the Senior Notes mature on March 30, 2033.
For accounting purposes the Debt Exchange transactions were considered a modification of a debt instrument as opposed to an extinguishment and new debt. Therefore, the principal amount of the debt will be accreted up to the new principal balance of $85.9 million using the effective interest method from the balance of $81.7 million and $79.7 million as of December 31, 2012 and December 31, 2011, respectively.
The indentures governing the Senior Notes (the “Indentures”) contain certain restrictive covenants (the “Negative Covenants”) subject to certain exceptions in the Indentures, including written consent of the holders of the Senior Notes. The Negative Covenants prohibit the Company and its subsidiaries, from among other things, incurring debt, permitting any lien upon any of its property or assets, making any cash dividend or distribution or liquidation payment, acquiring shares of the Company or its subsidiaries, making payment on debt securities of the Company that rank pari passu or junior to the Senior Notes, or disposing of any equity interest in its subsidiaries or all or substantially all of the assets of its subsidiaries. The Negative Covenants remain in effect until both of the following conditions are met: 1) the Senior Notes begin accruing interest at the Full Rate, and 2) the Company satisfies certain financial covenants (the “Financial Covenants”). Satisfaction of the Financial Covenants requires the Company to demonstrate on a consolidated basis that (1) its Tangible Net Worth is equal to or greater than $40 million, and (2) either (a) the Interest Coverage Ratio is equal to or greater than 1.35x, or (b) the Leverage Ratio is not greater than 95%. As the Senior Notes were not accruing interest at the Full Rate, the Negative Covenants, as defined above, were still in effect as of December 31, 2012 and December 31, 2011. As such, the Company was under no obligation to comply with the Financial Covenants during these periods.
The Company was in compliance with all Negative Covenants as of December 31, 2012 and December 31, 2011.
Note Payable to Related Party - As discussed in Note 4 to the consolidated financial statements, Steve Haslam sold all of his membership units of StreetLinks to the Company, approximately 5% of the outstanding membership units, on March 8, 2012. The total purchase price was $6.1 million, of which $1.5 million was paid during 2012. The remainder of this obligation is payable as follows: $0.3 million on the last day of each quarter hereafter until March 8, 2016, on which date the unpaid principal balance of $1.6 million is to be paid, plus interest on the unpaid balance at the rate of 4.0% per annum, compounded quarterly. During 2012, the Company incurred approximately $0.2 million of interest expense related to this obligation. The Company's obligation is secured by the StreetLinks' interest purchased.
Note 10. Commitments and Contingencies
Commitments - The Company leases office space under various operating lease agreements. Rent expense for 2012 and 2011 aggregated $2.1 million and $1.2 million, respectively. At December 31, 2012, future minimum lease commitments under those leases for the next five years are as follows (dollars in thousands):
The Company has sublease agreements for office space formerly occupied by the Company and received approximately $0.2 million and $0.4 million during the years ended December 31, 2012 and 2011, respectively.
Contingencies - As discussed in Note 4 to the consolidated financial statements, the Company is obligated to make payments in the future to the former minority owners of Corvisa of up to $1.2 million if revenue targets are achieved. The Company has recorded a liability of $0.9 million, based on management’s estimate of the earnings targets being achieved. As of December 31, 2012, $0.5 million is recorded in the accrued expenses line item of the consolidated balance sheet, while $0.4 million is recorded in the noncurrent liabilities line item. The full amount of the liability is included in the other liabilities line item of the consolidated balance sheets as of December 31, 2011.
The Company also has a contingent obligation related to a separation agreement with a former Mango employee of up to $0.3 million. During October 2012, the Company paid approximately $0.1 million pursuant to this separation agreement, leaving approximately $0.2 million of contingent obligation as of December 31, 2012, all of which is included in other current liabilities in the consolidated balance sheets. There was a liability for this contingent obligation of $0.2 million in the other current liabilities and $0.1 million in the other liabilities line items in the consolidated balance sheets as of December 31, 2011.
The Company has received indemnification and loan repurchase demands with respect to alleged violations of representations and warranties (“defects”) and with respect to other alleged misrepresentations and contractual commitments made in loan sale and securitization agreements. These demands have been received substantially beginning in 2006 and have continued into 2013. Prior to the Company ceasing the origination of loans in its mortgage lending business, it sold loans to securitization trusts and other third parties and agreed to repurchase loans with material defects and to otherwise indemnify parties to these transactions. Beginning in 1997 and ending in 2007, affiliates of the Company sold loans to securitization trusts and third parties with the potential of such obligations. The aggregate original principal balance of these loans was $43.1 billion at the time of sale or securitization. The remaining principal balance of these loans is not available as these loans are serviced by third parties and may have been refinanced, sold or liquidated. During 2011 and 2012, the Company has received claims to repurchase loans with original principal balances of approximately $24.6 million. These claims have not been acknowledged as valid by the Company. In some cases, claims were made against affiliates of the Company that have ceased operations and have no or limited assets. The Company has not repurchased any loans in 2011 or 2012 or made any payments in response to indemnification requests.
Historically, repurchases of loans or indemnification of losses where a loan defect has been alleged have been insignificant and any future losses for alleged loan defects have not been deemed to be probable or reasonably estimable; therefore, the Company has recorded no reserves related to these claims. The Company does not use internal groupings for purposes of determining the status of these loans. The Company is unable to develop an estimate of the maximum potential amount of future payments related to repurchase demands because the Company does not have access to information relating to loans sold and securitized and the number or amount of claims deemed probable of assertion is not known nor is it reasonably estimated. Further, the validity of claims received remains questionable. Also, considering that the Company completed its last sale or securitization of loans during 2007, the Company believes that it will be difficult for a claimant to successfully validate any additional repurchase demands. Management does not expect that the potential impact of claims will be material to the Company's financial statements.
Pending Litigation.
The Company is a party to various legal proceedings. Except as set forth below, these proceedings are of an ordinary and routine nature.
Although it is not possible to predict the outcome of any legal proceeding, in the opinion of management, other than the active proceedings described in detail below, proceedings and actions against the Company should not, individually, or in the aggregate, have a material effect on the Company's financial condition, operations and liquidity. Furthermore, due to the uncertainty of any potential loss as a result of pending litigation and due to the Company's belief that an adverse ruling is not probable, the Company has not accrued a loss contingency related to the following matters in its consolidated financial statements. However, a material outcome in one or more of the active proceedings described below could have a material impact on the results of operations in a particular quarter or fiscal year.
On May 21, 2008, a purported class action case was filed in the Supreme Court of the State of New York, New York County, by the New Jersey Carpenters' Health Fund, on behalf of itself and all others similarly situated. Defendants in the case included NovaStar Mortgage Funding Corporation (“NMFC”) and its individual directors, several securitization trusts sponsored by the Company ("affiliated defendants") and several unaffiliated investment banks and credit rating agencies. The case was removed to the United States District Court for the Southern District of New York. On June 16, 2009, the plaintiff filed an amended complaint. The plaintiff seeks monetary damages, alleging that the defendants violated sections 11, 12 and 15 of the Securities Act of 1933, as amended, by making allegedly false statements regarding mortgage loans that served as collateral for securities purchased by the plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss the plaintiff's claims, which the court granted on March 31, 2011, with leave to amend. The plaintiff filed a second amended complaint on May 16, 2011, and the Company again filed a motion to dismiss. On March 29, 2012, the court dismissed the plaintiff's second amended complaint with prejudice and without leave to replead. The plaintiff filed an appeal. On March 1, 2013, the appellate court reversed the judgment of the lower court, which had dismissed the case. Also, the appellate court vacated the judgment of the lower court holding that the plaintiff lacked standing, even as a class representative, on securities in which plaintiff had not invested and remanded the case back to the lower court for further proceedings. Given the early stage of the litigation, the Company cannot provide an estimate of the range of any loss. The Company believes that the affiliated defendants have meritorious defenses to the case and expects them to defend the case vigorously.
On June 20, 2011, the National Credit Union Administration Board, as liquidating agent of U.S. Central Federal Credit Union, filed an action against NMFC and numerous other defendants in the United States District Court for the District of Kansas, claiming that the defendants issued or underwrote residential mortgage-backed securities pursuant to allegedly false or misleading registration statements, prospectuses, and/or prospectus supplements. On October 12, 2011, the complaint was served on NMFC. On December 20, 2011, NMFC filed a motion to dismiss the plaintiff's complaint and to strike certain paragraphs of the complaint. On July 25, 2012, the court granted the motion in part and denied the motion in part. The plaintiff was granted leave to amend the complaint. On August 24, 2012, the plaintiff filed an amended complaint making essentially the same claims against NMFC. On October 29, 2012, NMFC filed a motion to dismiss the amended complaint, which motion remains pending. This litigation is in an early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that NMFC has meritorious defenses to the case and expects it to defend the case vigorously.
On May 30, 2012, Woori Bank filed an action against NovaStar ABS CDO I, Inc. and NovaStar ABS CDO I, Ltd. (collectively, “NCDO”) and certain other unrelated entities in the United States District Court for the Southern District of New York, claiming common law fraud, negligent misrepresentation and unjust enrichment based on allegations that defendants knew that NCDO securities purchased by the plaintiff involved more risk than their ratings suggested. The plaintiff dismissed, without prejudice, NovaStar ABS CDO I, Ltd., and on August 20, 2012, the plaintiff filed an amended complaint against NovaStar ABS CDO I, Inc. and other, unrelated entities. The amended complaint alleged the same claims against NovaStar ABS CDO I, Inc. On September 12, 2012, NovaStar ABS CDO I, Inc. filed a motion to dismiss the amended complaint. On December 27, 2012, the court dismissed the claims against all defendants without granting the plaintiff leave to amend its complaint. However, the court gave the plaintiff the opportunity, until March 1, 2013, to write a letter to the court explaining how it would amend to correct the noted deficiencies in its complaint if granted leave. In response, the plaintiff, on January 23, 2013, filed a motion for leave to file an amended complaint and to alter, amend or vacate the judgment of dismissal.
Note 11. Shareholders’ Deficit
During the second quarter of 2011, we completed the exchange of all outstanding shares of our preferred stock for an aggregate of 80,985,600 shares of newly-issued common stock and $3.0 million in cash. Completion of this exchange eliminated our obligations with respect to outstanding and future preferred dividends and the preferred liquidating preference related to the preferred stock. At the time of the exchange, there were accrued and unpaid dividends of approximately $59.3 million on the preferred stock and the aggregate liquidating preference was $127.3 million. See Note 3 to the consolidated financial statements for further details.
The Company’s Board of Directors has approved the repurchase of up to $9.0 million of the Company’s common stock. No shares were repurchased during December 31, 2012 and December 31, 2011. The Company has repurchased $8.0 million prior to 2009, leaving approximately $1.0 million of shares that may yet be purchased under the repurchase plan. Under Maryland
law, shares repurchased under the repurchase plan are to be returned to the Company’s authorized but unissued shares of common stock. Common stock purchased under the repurchase plan is charged against additional paid-in capital.
Noncontrolling Interests - During 2012, the Company received approximately $1.3 million in capital contributions from the noncontrolling members of Mango. These contributions were made pursuant to calls for additional capital. Members are not required to make contributions. If they do, their portion of the contribution is made based on their current ownership interest. No additional membership interests are issued as a result of these transactions as long as all members choose to contribute. If a member fails to contribute, the noncontributing member's ownership interest is effectively diluted through the issuance of additional membership interests to contributing members. The Company distributed approximately $0.4 million of excess capital, as determined in accordance with the StreetLinks operating agreement, to the noncontrolling members of StreetLinks during 2012. Each member's share of the distribution is determined based on their ownership interest at the time of the distribution. The Company also recognized approximately $0.1 million of additional noncontrolling interests as part of the acquisition of Corvisa Cloud in the fourth quarter of 2012. See Note 4 for additional information regarding this acquisition. The remaining noncontrolling interest activity for 2012 was not material.
Note 12. Fair Value Accounting
Fair Value Measurements
The Company's valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These two types of inputs create the following fair value hierarchy:
•Level 1 - Valuations based on quoted prices in active markets for identical assets and liabilities.
•Level 2 - Valuations based on observable inputs in active markets for similar assets and liabilities, other than Level 1 prices, such as quoted interest or currency exchange rates.
•Level 3 - Valuations based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies based on internal cash flow forecasts.
The following tables present for each of the fair value hierarchy levels, the Company's assets and liabilities which are measured at fair value on a recurring basis as of December 31, 2012 and December 31, 2011 (dollars in thousands):
(A)
The contingent consideration represents the estimated fair value of the additional potential amounts payable in connection with our acquisitions of Mango and Corvisa, $0.2 million and $0.9 million, respectively.
(A)
The contingent consideration represents the estimated fair value of the additional potential amounts payable in connection with our acquisitions of Mango and Corvisa, $0.3 million and $0.9 million, respectively.
Valuation Methods and Processes
The Company estimates the fair value of all items subject to fair value accounting using present value techniques and generally does not have the option to choose other valuation techniques for these items. There have been no significant changes to the Company's financial statements as a result from changes to the Company's valuation techniques as of December 31, 2012 compared to December 31, 2011.
An independent entity has been engaged to prepare projected future cash flows of the Company's mortgage securities for each reporting period (quarterly) used by management to estimate fair value. The Company's internal finance and accounting staff reviews and monitors the work of the independent entity, including analysis of the assumptions used, retrospective review and preparing an overall conclusion of the value and process. All other fair value analysis, consisting of simple cash flow estimates and discounting techniques, is conducted internally by the Company's internal financial staff. The Company's fair value process is conducted under the supervision of the Chief Financial Officer.
Mortgage securities - available-for-sale. Mortgage securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. 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 specific identification method is used in computing realized gains or losses. The Company uses the discount rate methodology for determining the fair value of its residual securities. The fair value of the residual securities is estimated based on the present value of future expected cash flows to be received. Management's best estimate of key assumptions, including credit losses, prepayment speeds, forward yield curves and discount rates commensurate with the risks involved, are used in estimating future cash flows.
Mortgage securities - trading. Trading securities are recorded at fair value with gains and losses, realized and unrealized, included in earnings. The Company uses the specific identification method in computing realized gains or losses. The Company estimates fair value based on the present value of expected future cash flows using management's best estimates of credit losses, prepayment rates, forward yield curves, and discount rates, commensurate with the risks involved. Due to the unobservable inputs used by the Company in determining the expected future cash flows, the Company determined its valuation methodology for residual securities would qualify as Level 3.
Contingent consideration. The fair value of the Mango contingent consideration was estimated using a probability analysis of compliance with the separation agreement and a discount rate was applied to the projected earn-out payments that approximated the weighted average cost of capital. The key input was management's estimation of probability that the employee will comply with the agreement. The Company estimated the fair value of the Corvisa contingent consideration using projected revenue over the earn-out period, and applied a discount rate commensurate with the risks involved to the projected earn-out payments. The key inputs for the projected revenue analysis were the number of units completed and the average amount of revenue per unit.
The following table presents certain quantitative information about the significant unobservable inputs used in the fair value measurement for items measured at fair value on a recurring basis using significant unobservable inputs (Level 3).
The Company's mortgage securities - available-for-sale, as discussed in Note 5 to the consolidated financial statements, are measured at fair value. These securities are valued at each reporting date using significant unobservable inputs (Level 3) by discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The Company has no other assets measured at fair value.
The significant unobservable inputs used in the fair value measurement of mortgage securities - available-for-sale are prepayment rates and the weighted average life for the underlying mortgage loan collateral. Using a faster (higher) estimated prepayment rate would decrease the value of the securities. The Company uses a weighted average life of 2 years from the reporting date for the expected future estimated cash flows. The future cash flows are highly-dependent upon the performance of the underlying collateral of mortgage loans and the nonperformance risk of the collateral is the key reason the Company utilizes such a short weighted average life in its calculation. Assuming a shorter weighted average life would decrease the estimated value of the mortgage securities. Alternatively, assuming a longer weighted average life would increase the estimated value of the mortgage securities.
The Company has a liability recorded at fair value that is the estimated additional potential earn-out opportunity payable in connection with its acquisition of Corvisa. The payment is contingent on future revenue generated from the original Corvisa technology platform. The obligation is valued at each reporting date using significant unobservable inputs (Level 3). The Company estimated the fair value using projected revenue over the earn-out period, and applied a discount rate commensurate with the risks involved to the projected earn-out payments. The Company has no other liabilities measured at fair value.
The significant unobservable input used in the fair value measurement of the contingent consideration liability is the growth of the forecasted revenue to be generated from the original Corvisa technology platform and the discount rate used in the present value calculation. The Company generally assumes that the forecasted revenue required in order for the earnings targets to be achieved will be realized. Assuming that the required revenue will not be realized would decrease the estimated fair value of the contingent consideration liability. Assuming a higher discount rate would decrease the estimated fair value of the contingent consideration liability, whereas assuming a lower discount rate would increase the estimated fair value of the contingent consideration liability.
The following tables provide a reconciliation of the beginning and ending balances for the Company's mortgage securities - available-for-sale which are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for 2012 and 2011 (dollars in thousands):
(A)
Cash received on mortgage securities with no cost basis was $3.7 million and $7.6 million for the years ended December 31, 2012 and 2011, respectively.
There was no activity during 2012 for the Company's mortgage securities - trading as they were determined to have no value as of December 31, 2011. The following table provides a reconciliation of the beginning and ending balances for the Company's mortgage securities - trading which are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for 2011 (dollars in thousands):
The following table provides a reconciliation of the beginning and ending balances for the Company's contingent consideration liability which is measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2012 and 2011 (dollars in thousands):
(A) As part of the Corvisa noncontrolling interest acquisition, the previous contingent consideration payable of $0.3 million was canceled, the new contingent consideration payable amount was estimated at $0.9 million.
The following table provides a summary of the impact to earnings for 2012 and 2011 from the Company's assets and liabilities which are measured at fair value on a recurring and nonrecurring basis (dollars in thousands):
(A)
The contingent consideration represents the estimated fair value of the additional potential earn-out opportunity payable in connection with the acquisition of Corvisa that is contingent and based upon certain future earnings targets.
(B)
The Company did not have any impairments relating to mortgage securities - available-for-sale for 2012 and 2011.
The following disclosure of the estimated fair value of financial instruments presents amounts that have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimation methodologies could have a material impact on the estimated fair value amounts. The fair value of short-term financial assets
and liabilities, such as service fees receivable, notes receivable, and accounts payable and accrued expenses are not included in the following table as their fair value approximates their carrying value.
The estimated fair values of the Company's financial instruments are as follows as of December 31, 2012 and December 31, 2011 (dollars in thousands):
For the items in the table above not measured at fair value in the statement of financial position but for which the fair value is disclosed, the fair value has been estimated using Level 3 methodologies, based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow calculations based on internal cash flow forecasts. No assets or liabilities have been transferred between levels during any period presented.
Restricted cash - The fair value of restricted cash was estimated by discounting estimated future release of the cash from restriction.
Senior notes - The fair value is estimated by discounting future projected cash flows using a discount rate commensurate with the risks involved. The value of the Senior Notes was calculated assuming that the Company would be required to pay interest at a rate of 1.0% per annum until January 2016, at which time the Company would be required to start paying the Full Rate of three-month LIBOR plus 3.5% until maturity in March 2033. The three-month LIBOR used in the analysis was projected using a forward interest rate curve.
Note payable to related party - The fair value of the note payable to related party is estimated by discounting future projected principal and interest payment cash flows using a discount rate commensurate with the risks involved. As of December 31, 2012, the future projected interest payments were calculated assuming the stated rate of 4.0% per annum until maturity in March 2016.
Note 13. Segment Reporting
During 2012, the Company changed its segment reporting structure by including Logistics as a separate operating unit. Historically, this segment has been aggregated with the Corporate operating segment based on the insignificant results of its operations. Due to recent and expected growth of the Logistics segment, management deems it appropriate to segregate this segment. Prior period comparatives have not been updated to reflect this change in segmentation as the operating results for this subsidiary for 2011 were not material to the financial statements as a whole due to the fact that this segment was acquired in the fourth quarter of 2011.
The Company reviews, manages and operates its business in four segments: Corporate, Appraisal Management, Financial Intermediary, and Logistics. Corporate operating results include mortgage securities retained from securitizations, corporate general and administrative expenses, and the operating results of Cloud, as these results were not significant during 2012. Appraisal Management operations include the service fee income and related expenses from the Company's majority-owned subsidiary, StreetLinks. The Financial Intermediary segment consists of the financial settlement service fee income and related expenses from a majority-owned subsidiary of the Company, Advent. The Logistics segment represents service fee income and related expenses from the Company's majority-owned subsidiary, Mango. Management evaluates segment performance based on income before income taxes, which is prior to the allocation of losses attributable to the noncontrolling interests.
The following is a summary of the operating results of the Company's segments for 2012 and 2011 and a summary of their financial positions as of December 31, 2012 and December 31, 2011 (dollars in thousands):
(A)
Amounts are included in the cost of services and selling, general and administrative expense line items of the consolidated statements of operations.
(B)
Appraisal Management segment includes goodwill of $3.2 million resulting from the acquisition of StreetLinks.
The intersegment service fee income consists of a guaranty fee of approximately $1.0 million paid by the Financial Intermediary segment to the Corporate segment for Corporate's guarantee of the Financial Intermediary segment's performance under its contract with its banking partner. It also includes fees charged by the Corporate segment to the Appraisal Management, Financial Intermediary, and Logistics segments for operational support provided by the Corporate segment's employees. The intersegment interest income and interest expense consists of interest charged by the Corporate segment to the Appraisal Management, Financial Intermediary, and Logistics segments for borrowings. Outside of interest, no such fees were charged to the Appraisal Management, Financial Intermediary and Logistics segments during 2011.
(A)
Amounts are included in the cost of services and selling, general and administrative expense line items of the consolidated statements of operations.
(B)
Corporate segment includes goodwill of $2.2 million resulting from the acquisition of Mango, which was subsequently impaired during 2012.
(C)
Appraisal Management segment includes goodwill of $3.2 million resulting from the acquisition of StreetLinks.
Revenues from one customer of the Appraisal Management segment, approximately $17.1 million, were in excess of 10% of total consolidated revenues for 2011. While three customers of the Appraisal Management segment comprised approximately 31% of the Appraisal Management revenue for 2012, none of these customers, individually, exceeded 10% of total consolidated revenues for 2012.
Note 14. Earnings Per Share
Earnings per share was calculated using the treasury method for all periods presented. For 2011, this calculation included the Company's 9.0% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 per share (the "Series D Preferred Stock"), which was assumed to be converted to 1,875,000 shares of common stock that shared in distributions with common shareholders on a 1:1 basis through the date of the Recapitalization.
The computations of basic and diluted earnings per share for 2012 and 2011 (dollars in thousands, except share and per share amounts) are as follows:
(A)
The net effect of the preferred stock exchange includes amounts attributable to the Series C Offer and the Series D Exchange and was calculated in accordance with applicable Earnings per Share guidance. The Series C Offer amount is calculated as the difference between (1) the fair value of the consideration transferred to the holders of the Series C Preferred Stock and (2) the carrying amount of the Series C Preferred Stock. The Series D Exchange amount consists of the excess of (1) the fair value of all securities and other consideration transferred by the Company to the Series D Holders over (2) the fair value of securities issuable pursuant to the original conversion terms.
The following weighted-average stock options to purchase shares of Common Stock were outstanding during each period presented, but were not included in the computation of diluted earnings (loss) per share because the number of shares assumed to be repurchased, as calculated was greater than the number of shares to be obtained upon exercise, therefore, the effect would be antidilutive (in thousands, except exercise prices):
During 2012, the Company granted 6.9 million options to purchase shares of Common Stock at a weighted average exercise price of $0.77. Including the 0.2 million options issued in conjunction with the acquisition of Corvisa Cloud, the Company granted 7.1 million options during 2012. The weighted average impact of 6.1 million shares are included in the table above for 2012.
Of the 7.1 million total options granted, 5.3 million relate to a non-discretionary anti-dilution provision adjustment to preserve the benefits and potential benefits of grants issued prior to the Recapitalization. These options maintained the original exercise prices and vesting terms of the respective initial grants.
During 2011, the Company granted 0.4 million options to purchase shares of Common stock at a weighted average exercise price of $0.51, of which the weighted average outstanding amount is included in the table above for 2011.
The Company had approximately 0.8 million and 0.9 million nonvested shares outstanding as of December 31, 2012 and December 31, 2011, respectively. These shares have original cliff vesting schedules ranging between five and ten years. Of these, the weighted average impact of approximately 0.6 million and 0.7 million nonvested shares were not included in the calculation of earnings per share for 2012 and 2011, respectively, because they were anti-dilutive.
Note 15. Income Taxes
The components of income tax benefit for the years ended December 31, 2012 and 2011 were as follows (dollars in thousands):
The Company recorded a receivable for the overpayment of previously paid income taxes of $2.3 million during 2011 which is reflected in the amounts above. A substantial portion of the receivable was collected during 2012.
A reconciliation of the expected federal income tax expense using the federal statutory tax rate of 35% to the Company’s actual income tax benefit and resulting effective tax rate for the years ended December 31, 2012 and 2011 were as follows (dollars in thousands):
Significant components of the Company’s deferred tax assets and liabilities at December 31, 2012 and 2011 were as follows (dollars in thousands):
During 2012, the Company determined that it is more likely than not that it will realize a portion of its deferred tax assets. This determination was based on the Company's evaluation of the available evidence, both positive and negative, such as historical levels of income and future forecasts of taxable income, among other items. The Company's evaluation of the available evidence was significantly influenced by the fact that the Company is currently in a positive cumulative earnings position for the three year period ended December 31, 2012. The Company, therefore, released a portion of its valuation allowance and recognized a net deferred tax asset of approximately $63.1 million on its balance sheet as of December 31, 2012. The Company recorded an income tax benefit of $63.1 million for 2012 for the portion of the change in valuation allowance arising from expected realization of deferred tax assets in future years.
The current and noncurrent component of the deferred tax balance is reported separately on the financial statements and is based on the financial statement classification of the related asset or liability giving rise to the temporary difference. During fourth quarter we have evaluated some of our mortgage securities that have previously been written off for book purposes and believe changes in the economic environment, the lack of an active market to sell these securities, and the continued lack of cash flows from these securities warrants reclassification of these as noncurrent assets, thus resulting in a reclassification of approximately $25.9 million of current deferred tax assets to noncurrent.
Our estimates require the exercise of significant judgment. The Company based its estimate of realizable deferred tax assets in part on business plans and expectations about future outcomes. In the event that the actual results differ from these estimates in future periods, the Company may need to adjust the valuation allowance, which could materially impact our financial position and results of operations. The Company will continue to assess the need for a valuation allowance in future periods. The Company maintained a valuation allowance of $219.7 million for deferred tax assets as of December 31, 2012 compared to a valuation allowance of $284.5 million as of December 31, 2011.
As of December 31, 2012, the Company had a federal net operating loss of approximately $398.2 million. The federal net operating loss may be carried forward to offset future taxable income, subject to applicable provisions of the Internal Revenue Code (the "Code"). If not used, this net operating loss will expire in years 2025 through 2032. The Company has state net operating loss carryovers arising from both combined and separate filings from as early as 2004. The state net operating loss carryovers may expire as early as 2013 and as late as 2032.
The activity in the accrued liability for unrecognized tax benefits for the years ended December 31, 2012 and 2011 was as follows (dollars in thousands):
As of December 31, 2012 and 2011, the total gross amount of unrecognized tax benefits was $1.1 million and $1.5 million, respectively, which also represents the total amount of unrecognized tax benefits that would impact the effective tax rate. The Company anticipates a reduction of unrecognized tax benefits in the amount of $0.4 million due the lapse of statute of limitations in the next twelve months. The Company does not expect any other significant change in the liability for unrecognized tax benefits in the next twelve months.
It is the Company’s policy to recognize interest and penalties related to income tax matters in income tax expense. The benefit for interest and penalties recorded in income tax expense was $0.2 million for 2011. This benefit was not significant for 2012. There were accrued interest and penalties of $0.1 million as of December 31, 2012 and 2011.
The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state and local jurisdictions. Tax years 2007 to 2012 remain open to examination for U.S. federal income tax. Tax years 2007 to 2012 remain open for major state tax jurisdictions.
Note 16. Employee Benefit Plans
Eligible employees may save for retirement through pretax contributions in defined contribution plans offered by the Company. Employees of the Company may contribute up to the statutory limit. The Company may elect to match a certain percentage of participants’ contributions. No matching contributions were made to the plans for the years ended December 31, 2012 and 2011. The Company may also elect to make a discretionary contribution, which is allocated to participants based on each participant’s compensation. There were no discretionary contributions made to the plans during the years ended December 31, 2012 and 2011.
The Company maintains a stock compensation plan. The aggregate value and expense associated with the grants under the plan is not material to the Company's consolidated statements.
Note 17. Subsequent Events
Effective February 27, 2013, Management committed to a plan to abandon the operations of the Company's Logistics segment. The Company is still in the process of evaluating the potential exit costs associated with this plan and cannot make an estimate regarding a possible range of those costs.
REPORT OF INDEPENDENT OF REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
Novation Companies, Inc.
We have audited the accompanying consolidated balance sheet of Novation Companies Inc., a Maryland corporation, and subsidiaries (the “Company”) as of December 31, 2012, and the related consolidated statements of income, comprehensive income, changes in shareholders' deficit, and cash flows for the year ended December 31, 2012. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Novation Companies Inc. and subsidiaries as of December 31, 2012, and the results of their operations and their cash flows for the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Kansas City, Missouri
March 1, 2013
REPORT OF INDEPENDENT OF REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Novation Companies, Inc.
Kansas City, Missouri
We have audited the accompanying consolidated balance sheet of Novation Companies, Inc. (formerly NovaStar Financial, Inc.) and subsidiaries (the "Company") as of December 31, 2011, and the related consolidated statements of operations, comprehensive income, stockholders' deficit, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such 2011 consolidated financial statements present fairly, in all material respects, the financial position of Novation Companies, Inc. and subsidiaries as of December 31, 2011, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the accompanying 2011 financial statements have been retrospectively adjusted for changes in the presentation of comprehensive income.
/s/ DELOITTE & TOUCHE LLP
Kansas City, Missouri
March 15, 2012 (March 1, 2013 related to the change in presentation of comprehensive income as described in Note 1)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
As previously disclosed in the Form 8-K filed July 5, 2012, on June 28, 2012, the Company, as approved by the Audit Committee of the Board of Directors (the “Audit Committee”), dismissed Deloitte & Touche LLP (“Deloitte”) as the Company's principal independent registered public accounting firm and approved the engagement of Grant Thornton LLP (“Accounting Firm”) as the Company's independent registered public accounting firm for the year ending December 31, 2012.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The Company maintains a system of disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the federal securities laws, including this report, is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed under the federal securities laws is accumulated and communicated to the Company’s management on a timely basis to allow decisions regarding required disclosure. The Company’s principal executive officer and principal financial officer evaluated the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(d)) as of the end of the period covered by this report and concluded that the Company’s controls and procedures were effective.
Internal Control over Financial Reporting
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934. This internal control system has been designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of the Company’s published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management of the Company has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012. To make this assessment, management used the criteria for effective internal control over financial reporting described in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management has excluded from the scope of its assessment of internal control over financial reporting the operations and related assets of Corvisa Cloud, which the Company acquired on October 2, 2012. As of and for the year ended December 31, 2012, the amounts subject to the internal control over financial reporting arising from this acquisition represented 0.7% of our consolidated total assets, 0.0% of our consolidated total revenue, and (0.8%) of our consolidated net income. Based on that evaluation and its assessment, management concluded that the Company’s internal control over financial reporting is effective as of December 31, 2012.
Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over financial reporting during the three months ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Item 9B.
Item 9B. Other Information
None.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information with respect to Items 401, 405 and 407(d)(4) and (d)(5) of Regulation S-K is incorporated by reference to the information included in our Proxy Statement for the 2013 Annual Meeting of Shareholders.
Item 11.
Item 11. Executive Compensation
Information with respect to Items 402 and 407(e)(4) and (e)(5) of Regulation S-K is incorporated by reference to the information included in our Proxy Statement for the 2013 Annual Meeting of Shareholders.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information with respect to Items 403 of Regulation S-K is incorporated by reference to the information included in our Proxy Statement for the 2013 Annual Meeting of Shareholders.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information with respect to Item 404 and 407(a) of Regulation S-K is incorporated by reference to the information included in our Proxy Statement for the 2013 Annual Meeting of Shareholders.
Item 14.
Item 14. Principal Accountant Fees and Services
Information with respect to Item 9(e) of Schedule 14A is incorporated by reference to the information included in our Proxy Statement for the 2013 Annual Meeting of Shareholders.
Part IV
Item 15.
Item 15. Exhibits and Financial Statements Schedules
Financial Statements and Schedules
(1)
The financial statements as set forth under Item 8 of this report on Form 10-K are included herein.
(2)
The required financial statement schedules are omitted because the information is disclosed elsewhere herein.
Exhibit Listing
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.
NOVATION COMPANIES, INC.
(Registrant)
DATE:
March 1, 2013
/s/ W. LANCE ANDERSON
W. Lance Anderson, Chairman of the Board
of Directors and Chief 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 and dates indicated.