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Novation Companies (NOVC)

Filed: 13 Aug 20, 10:36am
 

 

Table of Contents



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended June 30, 2020

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period From       to       

 

 


Commission File Number 001-13533

 

NOVATION COMPANIES, INC.

(Exact Name of Registrant as Specified in its Charter)

 

Maryland

(State or Other Jurisdiction of Incorporation or Organization)

74-2830661

(I.R.S. Employer Identification No.)

 

 

9229 Ward Parkway, Suite 340, Kansas City, MO

(Address of Principal Executive Office)

64114

(Zip Code)

    

Registrant's Telephone Number, Including Area Code: (816) 237-7000

 

 


Securities registered pursuant to Section 12(b) of the Act: None

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐Accelerated filer ☐ 
Non-accelerated filer ☐Smaller reporting company ☒Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☒ No ☐

 

The number of shares of the Registrant's Common Stock outstanding on August 10, 2020 was 114,655,893.

 



 

 

 
 

PART I. FINANCIAL INFORMATION

Item 1.     Financial Statements

 

NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

 

  

June 30, 2020 (unaudited)

  

December 31, 2019

 

Assets

        

Current assets:

        

Cash and cash equivalents

 $2,134  $2,032 

Accounts and unbilled receivables

  5,753   6,583 

Prepaid expenses

  449   647 

Other

  142   21 

Total current assets

  8,478   9,283 

Non-current assets:

        

Goodwill

     3,905 

Intangible assets, net

  5,186   5,784 

Property and equipment, net

  107   125 

Operating lease right-of-use asset

  251   316 

Other

  5   4 

Total non-current assets

  5,549   10,134 

Total assets

 $14,027  $19,417 
         

Liabilities and Shareholders' Deficit

        

Current liabilities:

        

Accounts payable and accrued expenses

 $652  $524 

Accrued compensation and benefits payable

  2,420   2,717 

Health and wellness program liability

  492   492 

Operating lease liability

  158   205 

Accrued claim settlements

  246   246 

Other

  270   36 

Total current liabilities

  4,238   4,220 
         

Non-current liabilities:

        

Long-term debt, net of debt premium

  88,446   86,824 

Accrued claim settlements

  184   307 

Operating lease liability

  104   125 

Total non-current liabilities

  88,734   87,256 

Total liabilities

  92,972   91,476 
         

Shareholders' deficit:

        

Common stock, $.01 par value per share, 780,000,000 shares authorized:

        

114,655,893 and 112,355,893 shares issued and outstanding as of June 30, 2020 and December 31, 2019, respectively

  1,146   1,123 

Additional paid-in capital

  746,170   746,112 

Accumulated deficit

  (826,261)  (819,294)

Total shareholders' deficit

  (78,945)  (72,059)

Total liabilities and shareholders' deficit

 $14,027  $19,417 

 

See notes to condensed consolidated financial statements.

 

 

 

 

NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(unaudited; in thousands, except share and per share amounts)

 

  

Six Months Ended June 30,

  

Three Months Ended June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Service fee income

 $26,366  $32,151  $12,332  $16,297 

Cost and expenses:

                

Cost of services

  23,788   28,615   11,228   14,518 

General and administrative expenses

  4,018   4,463   2,038   2,206 

Goodwill impairment charge

  3,905   2,600   3,905   2,600 

Operating loss

  (5,345)  (3,527)  (4,839)  (3,027)
                 

Other income

  25   4   12   23 

Interest expense

  (1,626)  (2,706)  (816)  (1,324)

Reorganization items, net

     (62)     (31)
                 

Loss before income taxes

  (6,946)  (6,291)  (5,643)  (4,359)

Income tax expense

  21   4   10   11 

Net loss

  (6,967)  (6,295)  (5,653)  (4,370)
                 

Other comprehensive income:

                

Unrealized gain on marketable securities

     1       

Total other comprehensive income

     1       

Total comprehensive loss

 $(6,967) $(6,294) $(5,653) $(4,370)
                 

Loss per share:

                

Basic

 $(0.06) $(0.07) $(0.05) $(0.05)

Diluted

 $(0.06) $(0.07) $(0.05) $(0.05)

Weighted average common shares outstanding:

                

Basic

  110,188,393   95,103,986   110,188,393   97,675,946 

Diluted

  110,188,393   95,103,986   110,188,393   97,675,946 

 

See notes to condensed consolidated financial statements.

 

 

 

 

NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT

(unaudited; in thousands)

 

  

Common Stock

 

Additional Paid-in Capital

 

Accumulated Deficit

 

Accumulated Other Comprehensive Income

 

Total Shareholders’ Deficit

Balance, December 31, 2019

 $1,123 $746,112 $(819,294) $ $(72,059)

Issuances of nonvested stock

 23 (23)   

Compensation recognized under stock compensation plans

  81   81

Net loss

   (6,967)  (6,967)

Balance, June 30, 2020

 $1,146 $746,170 $(826,261) $ $(78,945)
                     

Balance, March 31, 2020

 $1,146 $746,123 $(820,608) $ $(73,339)

Issuances of nonvested stock

     

Compensation recognized under stock compensation plans

  47   47

Net loss

   (5,653)  (5,653)

Balance, June 30, 2020

 $1,146 $746,170 $(826,261) $ $(78,945)

 

 

  

Common Stock

 

Additional Paid-in Capital

 

Accumulated Deficit

 

Accumulated Other Comprehensive Income (Loss)

 

Total Shareholders’ Deficit

Balance, December 31, 2018

 $991 $745,104 $(809,050) $(1) $(62,956)
Issuances and cancellations of nonvested stock 22 (22)      

Compensation recognized under stock compensation plans

  153   153

Net loss

   (6,295)  (6,295)

Adjustment to retained earnings for adoption of accounting standard

   (19)  (19)
Other comprehensive income    1 1

Balance, June 30, 2019

 $1,013 $745,235 $(815,364) $ $(69,116)
                     

Balance, March 31, 2019

 $1,016 $745,149 $(810,994) $ $(64,829)
Cancellations of nonvested stock (3) 3   

Compensation recognized under stock compensation plans

  83   83

Net loss

   (4,370)  (4,370)

Balance, June 30, 2019

 $1,013 $745,235 $(815,364) $ $(69,116)

 

See notes to condensed consolidated financial statements.

 

 

 

 

NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited; in thousands)

 

  

Six Months Ended June 30,

 
  

2020

  

2019

 

Cash flows from operating activities:

        

Net loss

 $(6,967) $(6,295)

Adjustments to reconcile net loss to net cash used in operating activities:

        

Amortization of intangible assets

  598   598 

Amortization of debt premium and prepaid interest into interest expense

  1,622    

Depreciation expense

  32   14 

Lease expense

  (3)  (9)

Gain on disposal of fixed assets

  (3)   

Goodwill impairment

  3,905   2,600 

Compensation recognized under stock compensation plans

  81   153 

Changes in operating assets and liabilities

        

Accounts and unbilled receivables

  830   (27)

Accounts payable and accrued expenses

  128   (152)

Accrued compensation and benefits payable

  (297)  799 

Accrued interest payable

     28 

Accrued claim settlements

  (123)  (336)

Other current assets and liabilities, net

  310   (43)

Other noncurrent assets and liabilities, net

     (327)

Net cash provided by (used in) operating activities

  113   (2,997)
         

Cash flows from investing activities:

        

Purchase of property and equipment

  (11)  (17)

Net cash used in investing activities

  (11)  (17)
         

Cash flows from financing activities:

        

Borrowings under revolving line of credit

     8,685 

Repayments of borrowings under revolving line of credit

     (10,633)

Paydowns of long-term debt

     (31)

Net cash used in financing activities

     (1,979)
         

Net increase (decrease) in cash and cash equivalents

  102   (4,993)

Cash and cash equivalents, beginning of period

  2,032   9,249 

Cash and cash equivalents, end of period

 $2,134  $4,256 
         

Supplemental disclosure of cash flow information:

        

Cash paid for interest

 $5  $2,693 

 

See notes to condensed consolidated financial statements.

 

 

 

NOVATION COMPANIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of and for the period ended June 30, 2020 (unaudited)

 

 

Note 1. Condensed Consolidated Financial Statement Presentation

 

Description of Operations Novation Companies, Inc. and its subsidiaries (the “Company,” “Novation,” “we,” or “us”), through Healthcare Staffing, Inc. ("HCS"), our wholly-owned subsidiary, provides outsourced health care staffing and related services in the State of Georgia. Our common stock, par value $0.01 per share, is traded on the OTC Pink marketplace of the OTC Markets Group, Inc. under the symbol “NOVC”.

 

Prior to the Company's acquisition of HCS in 2017, the Company originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage securities. During 2018, the Company sold all but 33 non-performing mortgage securities. The Company retains clean-up call rights associated with prior servicing activities, and has determined these clean-up call rights have no fair value as of June 30, 2020 and December 31, 2019.

 

Liquidity and Going Concern – During the six months ended June 30, 2020, the Company incurred a net loss of $7.0 million and generated positive operating cash flow of $0.1 million. As of June 30, 2020, the Company had an overall shareholders deficit of $78.9 million, an aggregate of $2.1 million in cash and cash equivalents and total liabilities of $93.0 million. Of the $2.1 million in cash, $0.5 million is held by the Company's subsidiary NovaStar Mortgage LLC ("NMLLC"). This cash is available only to pay general creditors and expenses of NMLLC.

 

From January 2019 through August 2019, the Company had a significant on-going obligation to pay interest under its senior notes agreement at LIBOR plus 3.5% per annum, payable quarterly in arrears until maturity on March 30, 2033, leading to a significant annual cash outflow. In addition, HCS has experienced lower than anticipated cash flows due to increased costs and changes in customers. These items have led to substantial doubt about the Company's ability to continue as a going concern.


Management continues to work toward expanding HCS’s customer base by increasing revenue from existing customers, looking at methods to reduce overall operating costs, both at HCS and the corporate level, and targeting new customers that have not previously been served by HCS. As disclosed in Note 5 to the condensed consolidated financial statements, the Company was successful in amending the senior note agreements to lower the interest rate and receive future credit for cash interest payments made in 2019 in exchange for the issuance of common stock and warrants. Based on the terms of the amendment, the Company is not required to make cash interest payments on the senior notes from August 2019 through March 2022, leading to significant cash savings for the Company. This amendment to the Note Purchase Agreement and waiver of interest payments through April 2022 has significantly improved our forecasted cash position over the next year.


In late March 2020, HCS started experiencing a reduction in Georgia Community Service Board ("CSB") customer needs related to the coronavirus (COVID-19).  This resulted in the layoff of approximately 8% of the Company’s employees. As HCS relies on providing healthcare staffing services to generate income, this has decreased our service fee income, and direct cost of services, accordingly. While the majority of these employees were rehired when customer demand returned, there have been some permanent loss of staffing opportunities based on changes to programs and services offered by CSBs. In addition, there is general concern about a resurgence of COVID-19 now that stay-at-home orders around the country continue to be lifted.

 

Our historical operating results and poor cash flow suggest substantial doubt exists related to the Company's ability to continue as a going concern. Furthermore, there is still significant uncertainty regarding the future impact that COVID-19 will have on our business. Based on these uncertainties, there is no guarantee the Company's cash position will cover current obligations. As a result, we have not been able to alleviate the substantial doubt about the Company's ability to continue as a going concern for at least one year after the date that these condensed consolidated financial statements are issued.

 

Condensed Consolidated Financial Statement Presentation – The Company’s condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of income and expense during the period. The Company uses estimates and judgments in assessing the recoverability of its long-lived assets, impairments, 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 these 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, and the amounts could be material.

 

The Company's condensed consolidated financial statements are unaudited. In the opinion of management, all necessary adjustments have been made, which were of a normal and recurring nature, for a fair presentation of the condensed consolidated financial statements. The Company's condensed consolidated financial statements should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations included herein and the consolidated financial statements of the Company and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2019 (the "2019 Form 10-K").

 

 

 

 

Note 2. Revenue; Accounts and Unbilled Receivables

 

Staffing services include the augmentation of customers' workforce with our contingent employees performing services under the customer's supervision, which provides our customers with a source of flexible labor at a competitive cost. Customer contracts are typically annual contracts but may be terminated upon 60 days' notice for any reason.

 

The Company recognizes revenue when control of the promised services is transferred to customers and for the amount that reflects the consideration we are entitled to receive in exchange for those services. Furthermore, revenue is recognized over time based on a fixed amount for each hour of staffing service provided as our customers benefit from our services and as we provide them.

 

Performance Obligations — A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company’s customer contracts have a single performance obligation to transfer the individual goods or services, and it is not separately identifiable from other promises in the contracts and is, therefore, not distinct. Performance obligations are satisfied at the point in time the HCS employees work on behalf of the customer. Contract costs include compensation, benefits and overhead when appropriate. Because of the nature of the contracts and the fact that revenue is earned at the time the employee works for the customer, no contract estimates are necessary.

 

Contract Balances — The timing of revenue recognition, billings and cash collections results in accounts receivable and unbilled receivables (the "contract assets"). The Company bills customers generally every other week based on the work performed during the two-week period ended the week prior to billing. Generally, billing occurs after revenue recognition, resulting in contract assets. The Company does not receive advances or deposits from its customers.

 

Disaggregation of Revenue — All revenue is generated from customers that provide healthcare services in Georgia. The following is a disaggregation of the Company’s revenue, unaudited, in thousands, into categories that best depict how the nature, amount, timing, and uncertainty of revenues and cash flows are affected by economic factors.

 

  

Six Months Ended June 30, 2020

 

Three Months Ended June 30, 2020

 

Six Months Ended June 30, 2019

 

Three Months Ended June 30, 2019

Type of Customer

                                

CSB

 $25,847 98.0% $12,079 98.0% $31,033 96.5% $15,778 96.8%

Other

 519 2.0% 253 2.0% 1,118 3.5% 519 3.2%

Total

 $26,366 100.0% $12,332 100.0% $32,151 100.0% $16,297 100.0%

 

Accounts and unbilled receivables are summarized as follows, in thousands:

 

  

June 30, 2020 (unaudited)

 

December 31, 2019

Accounts receivable

 $3,409 $4,083

Unbilled receivables (Contract Assets)

 2,349 2,500
Allowance for doubtful accounts (5) 

Total

 $5,753 $6,583

 

During the six months ended June 30, 202071% of service fee income was generated from four customers. For the six months ended June 30, 201952% of service fee income was generated from three customers. As of June 30, 2020 and June 30, 201968% of accounts receivables and unbilled receivables were due from four and five customers, respectively. At June 30, 2020 and June 30, 201997% and 96% of accounts receivables and unbilled receivables were due from 12 and 14 CSB customers, respectively.

 

 

Note 3. Goodwill and Intangible Assets

 

  

June 30, 2020 (unaudited)

 

December 31, 2019

  

Gross Carrying Amount

 

Accumulated Amortization

 

Net Carrying Amount

 

Gross Carrying Amount

 

Accumulated Amortization

 

Net Carrying Amount

Indefinite-lived assets (in thousands)

                        

Goodwill

 $ $ $ $3,905 $- $3,905

Tradenames

 1,147  1,147 1,147 - 1,147
  $1,147 $ $1,147 $5,052 $- $5,052
                         

Finite-lived assets (in thousands)

                        

Customer relationships

 $6,895 $2,873 $4,022 $6,895 $2,380 $4,515

Non-compete agreement

 627 610 17 627 505 122
  $7,522 $3,483 $4,039 $7,522 $2,885 $4,637

 

 

 

 

Amortization expense (unaudited, in thousands)

    

Six Months Ended June 30, 2020 and 2019

 $598

Estimated future amortization expense (unaudited, in thousands)

    

2020

 $510

2021

 985

2022

 985

2023

 985

Thereafter

 574

Total estimated amortization expense

 $4,039

 

  

June 30, 2020, (unaudited)

Goodwill activity (in thousands):

    

Beginning balance

 $3,905

Impairment charge

 (3,905)

Ending balance

 $0

 

Management completed its annual goodwill impairment assessment as of April 30, 2020.  Increased cost of services and administrative expenses at HCS and the loss of a significant customer during the first quarter of 2020 have resulted in declining cash flow for the business. In addition, COVID-19 concerns were attributable to a lay-off of staffed employees during the second quarter of 2020, as described in Note 1 to the condensed consolidated financial statements. Based on these factors, management determined that the carrying value of the HCS goodwill exceeded its fair value by the full amount recorded of $3.9 million. A goodwill impairment charge in this amount has been recorded for the quarter. Management assessed the other indefinite and definite lived intangible assets and determined no impairment was necessary.

 

 

Note 4. Leases

 

Our leases consist primarily of office space. Leases with an initial term of 12 months or less, and leases which are on a month-to-month basis, are not recorded on the condensed consolidated balance sheets. For these leases we recognize lease expense on a straight-line basis over the lease term. The Company does not have any finance leases.

 

Most leases include one or more options to renew, with renewal terms that can extend the lease term from one to three years or more. The exercise of lease renewal options is at our discretion. Our lease agreements do not contain any variable lease payments, residual value guarantees or restrictive covenants. The components of lease expense for the three and six months ended June 30, 2020 were immaterial.

 

As our leases do not provide an implicit interest rate, we use our incremental current borrowing rate in determining the present value of lease payments.

 

Maturities of lease liabilities were as follows (in thousands):

 

  

June 30, 2020 (unaudited)

Remaining 2020

 $116

2021

 128

2022

 32

Thereafter

 -

Total

 $276

Less interest

 14

Present value of lease liabilities

 $262

 

Other information related to the Company's operating leases was as follows (in thousands):

 

  

June 30, 2020 (unaudited)

 

Lease Term and Discount Rate

    

Weighted average remaining lease term (years)

  1.47 

Weighted average discount rate

  6.75%

 

 

 

 

Note 5. Borrowings

 

Note Refinancing and 2017 Notes — On August 9, 2019, the Company and Taberna Preferred Funding I, Ltd. (“Taberna I”), Taberna Preferred Funding II, Ltd. (“Taberna II”) and Kodiak CDO I, Ltd. (“Kodiak” and, together with Taberna I and Taberna II, the “Noteholders”) executed a First Amendment to Senior Secured Note Purchase Agreement (the “Amendment”) amending the terms of the Note Purchase Agreement (as defined below) and the 2017 Notes (as defined below) to, among other things, significantly reduce the interest rate applicable from January 2019 through the third quarter of 2028 and allow the Company to apply certain surplus interest payments against future quarterly interest payments. This amendment qualified as a troubled debt restructuring. As of June 30, 2020, the Company had $85.9 million in aggregate borrowings outstanding under three senior secured promissory notes (the “2017 Notes”). The unpaid principal amounts of the 2017 Notes bear interest at the following rates until the maturity date on March 30, 2033, with interest payable quarterly in arrears as follows: 1% per annum from April 1, 2019 through December 31, 2023; 2% per annum from January 1, 2024 through December 31, 2028; and 10% per annum from January 1, 2029 through the maturity date. Commencing with the delivery to the Noteholders of the financial statements for the fiscal year ended December 31, 2019, the Company is required to remit 50% of excess cash flow each year to the Noteholders to be applied as a principal reduction to the outstanding balance of the debt. The 2017 Notes generally rank senior in right of payment to any existing or future subordinated indebtedness of the Credit Parties (as defined below). The Company may at any time upon 30 days’ notice to the Noteholders redeem all or part of the 2017 Notes at a redemption price equal to 101% of the principal amount redeemed plus any accrued and unpaid interest thereon. The 2017 Notes were entered into on July 27, 2017 as a result of a refinancing of the Company’s then outstanding senior notes with the same aggregate principal amount through the execution of the Senior Secured Note Purchase Agreement, dated as of the same date (as amended, the “Note Purchase Agreement”), with NHI and HCS as guarantors (together with the Company, collectively, the “Credit Parties”).


On April 1, 2019 and on July 1, 2019, the Company made payments under the 2017 Notes totaling $2.6 million. The actual aggregate amounts due for those dates totaled $0.4 million. Under the terms of the Amendment, the Company is permitted to apply the payment surplus of $2.2 million against future quarterly interest payments. Therefore, the Company will not have another quarterly interest payment due until April 1, 2022. The Note Purchase Agreement contains customary affirmative and negative covenants, including but not limited to certain financial covenants. Under the terms of the Amendment, the financial covenants have been waived until the quarter ending December 31, 2021. The Note Purchase Agreement also contains customary events of default, including but not limited to payment defaults, cross defaults with certain other indebtedness, breaches of covenants and bankruptcy events. In the case of an event of default, the Noteholders may, among other remedies, accelerate the payment of all obligations under the Note Purchase Agreement and the 2017 Notes. The Credit Parties entered into a Pledge and Security Agreement, dated as of the same date, pursuant to which each of the Credit Parties granted a first priority lien generally covering all of its assets, other than accounts receivable and inventory, for the benefit of the Noteholders, to secure the obligations under the Note Purchase Agreement and the 2017 Notes.

 

Under the terms of the Amendment, the Company issued to the Noteholders 9,000,000 shares of common stock of the Company and ten-year warrants allowing the Noteholders to purchase up to 22,250,000 shares of the Company’s common stock at an exercise price of $0.01 per share. These warrants can be exercised at any time prior to expiration. At the time of the amendment, the outstanding principal balance of the notes were reduced by the fair value of the common stock and warrants issued by the Company, resulting in debt premium of $0.9 million, offset by accrued interest of $0.5 million. The Company will amortize the debt premium and prepaid interest over the amended term of the Note Purchase Agreement using the effective interest method.


The carrying value of the 2017 Notes is as follows (in thousands):

 

  

June 30, 2020 (unaudited)

  

December 31, 2019

 

Principal balance

 $85,938  $85,938 

Unamortized debt premium

  2,508   886 

Total, 2017 Notes

 $88,446  $86,824 

 

 

Note 6. Commitments and Contingencies

 

Contingencies — Prior to 2016, the Company originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage securities. 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 recent years. 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. Claims to repurchase loans or to indemnify under securitization documents 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 or made any such indemnification payments since 2010.

 

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 condensed consolidated 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. Any legal fees associated with these proceedings are expensed as incurred.

 

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 condensed 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 NovaStar Mortgage, Inc. ("NMI"), wholly-owned subsidiaries of the Company, and NMFC's 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, plaintiff filed an amended complaint. 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 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. 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 plaintiff's second amended complaint with prejudice and without leave to replead. Plaintiff filed an appeal in the United States Court of Appeals for the Second Circuit (the "Appellate Court"). 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 which had held that plaintiff lacked standing, even as a class representative, to sue on behalf of investors in securities in which plaintiff had not invested, and the appellate court remanded the case back to the lower court for further proceedings. On April 23, 2013 plaintiff filed its memorandum with the lower court seeking a reconsideration of the earlier dismissal of plaintiff's claims as to five offerings in which plaintiff was not invested, and on February 5, 2015, the lower court granted plaintiff's motion for reconsideration and vacated its earlier dismissal. On March 8, 2017, the affiliated defendants and all other parties executed an agreement to settle the action, with the contribution of the affiliated defendants to the settlement fund being paid by their insurance carriers. The court certified a settlement class and granted preliminary approval to the settlement on May 10, 2017.  One member of the settlement class objected to the settlement and sought a stay of the final settlement approval hearing on the ground that it did not receive notice of the settlement and had no opportunity to timely opt out of the class.  After the court rejected the motion for a stay, the objector filed an appeal and requested a stay of the district court proceedings pending disposition of the appeal. The court of appeals denied the temporary stay of the district court proceedings and on October 19, 2018 dismissed the appeal as moot.  Following the court of appeals’ denial of the objector’s petition for rehearing, the district court on March 7, 2019 held a fairness hearing.  On March 8, 2019, the district court issued a memorandum and order approving the settlement as fair, reasonable and adequate, and dismissing the action with prejudice.  Following entry of judgment, the objector filed a notice of appeal on March 26, 2019 and their opening brief was filed on June 28, 2019.  The defendants answered on September 27, 2019, and the objector replied on October 18, 2019.  Oral argument was held on February 19, 2020.  Assuming the settlement approval becomes final, which is expected, the Company will incur no loss. The Company believes that the affiliated defendants have meritorious defenses to the case and, if the settlement approval does not become final, 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 August 24, 2012, the plaintiff filed an amended complaint making essentially the same claims against NMFC. NMFC filed a motion to dismiss the amended complaint which was denied on September 12, 2013. The defendants claimed the case should be dismissed based upon a statute of limitations and sought an appeal of the court's denial of this defense. An interlocutory appeal of this issue was allowed, and on August 27, 2013, the United States Court of Appeals for the Tenth Circuit (the "Tenth Circuit") affirmed the lower court’s denial of defendants’ motion to dismiss the plaintiff’s claims as being time barred; the Tenth Circuit held that the Extender Statute, 12 U.S.C. §1787(b)(14) applied to plaintiff’s claims. On June 16, 2014, the United States Supreme Court (the "Supreme Court") granted a petition of NMFC and its co-defendants for certiorari, vacated the ruling of the Tenth Circuit, and remanded the case back to that court for further consideration in light of the Supreme Court’s decision in CTS Corp. v. Waldburger, 134 S. Ct. 2175 (2014). On August 19, 2014, the Tenth Circuit reaffirmed its prior decision, and on October 2, 2014, the defendants filed a petition for writ of certiorari with the Supreme Court, which was denied. On March 22, 2016, NMFC filed motions for summary judgment, and plaintiff filed a motion for partial summary judgment. Those motions remain pending. Given that plaintiff did not file a timely proof of claim in NMFC’s bankruptcy case, the Company believes it is likely that the case will be dismissed. The Company believes that NMFC has meritorious defenses to the case and expects it to defend the case vigorously in the event it proceeds.

 

On February 28, 2013, the Federal Housing Finance Agency, as conservator for the Federal Home Loan Mortgage Corporation (Freddie Mac) and purportedly on behalf of the Trustee of the NovaStar Mortgage Funding Trust, Series 2007-1 (the “Trust”), a securitization trust in which the Company retains a residual interest, filed a summons with notice in the Supreme Court of the State of New York, New York County against the Company and NMI. The notice provides that this is a breach of contract action with respect to certain, unspecified mortgage loans and defendants’ failure to repurchase such loans under the applicable agreements. Plaintiff alleges that defendants, from the closing date of the transaction that created the Trust, were aware of the breach of the representations and warranties made and failed to give notice of and cure such breaches, and due to the failure of defendants to cure any breach, notice to defendants would have been futile. The summons with notice was not served until June 28, 2013. By letter dated June 24, 2013, the Trustee of the Trust forwarded a notice from Freddie Mac alleging breaches of representations and warranties with respect to 43 loans, as more fully set forth in included documentation. The 43 loans had an aggregate, original principal balance of about $6.5 million. On August 19, 2013, Deutsche Bank National Trust Company, as Trustee, filed a complaint identifying alleged breaches of representations and warranties with respect to seven loans that were included in the earlier list of 43 loans. Plaintiff also generally alleged a trust-wide breach of representations and warranties by defendants with respect to loans sold and transferred to the trust. Plaintiff seeks specific performance of repurchase obligations; compensatory, consequential, recessionary and equitable damages for breach of contract; specific performance and damages for anticipatory breach of contract; indemnification (indemnification against NMI only) and damages for breach of the implied covenant of good faith and fair dealing. On October 9, 2013, the Company and NMI filed a motion to dismiss plaintiff’s complaint.

 

 

 

 

This motion to dismiss was withdrawn after plaintiff filed an amended complaint on January 28, 2014, and on March 4, 2014, the Company and NMI filed a motion to dismiss the amended complaint. By a Decision/Order dated November 30, 2017, the court granted in part and denied in part the motion to dismiss the amended complaint. The court dismissed all claims except for plaintiff’s claim for damages for breach of contract, to the extent that claim is based on the Company’s and NMI’s alleged failure to notify plaintiff of allegedly defective loans, and plaintiff’s claim for indemnification. The court denied the motion to dismiss these claims without prejudice to the Company’s and NMI’s right to file a new motion to dismiss in conformity with procedures to be established in coordinated proceedings before the court addressing similar claims against numerous defendants. Briefing of the indemnification issue was completed.

 

The parties have reached a settlement of this matter. On October 25, 2018, the bankruptcy court overseeing the Company's bankruptcy case entered an order approving the settlement, and on November 19, 2018, the New York State Court "so ordered" a Stipulation of Voluntary Discontinuance terminating the case. Pursuant to the terms of the settlement agreement, the required upfront payment of $0.3 million was made on March 1, 2019. The settlement also requires equal quarterly installments over a three year period, which total an additional $0.3 million. The Company recorded an expense in the second quarter of 2018 in the Reorganization Items, net expense line item of the income statement and the short and long-term liability totals in the applicable Accrued Settlement Claims lines per the condensed consolidated balance sheets.

 

DB Structured Products, Inc., Deutsche Bank AG, Deutsche Bank National Trust Company, Deutsche Bank Securities Inc., Greenwich Capital Derivatives, Inc., RBS Acceptance Inc., RBS Financial Products Inc., RBS Securities Inc., The Royal Bank of Scotland PLC, Wachovia Investment Holdings, LLC, Wells Fargo & Company, Wells Fargo Advisors, LLC, Wells Fargo Bank, N.A. and Wells Fargo Securities, LLC (collectively, the “Indemnity Claimants”) filed proofs of claim in the Company’s bankruptcy case asserting the right to be indemnified by the Company for, and/or to receive contribution from the company in respect of, certain liabilities incurred as a result of their roles in the issuance of residential mortgage-backed securities sponsored by the Company.  The Company filed an objection in the bankruptcy case seeking to disallow and expunge the Indemnity Claimants’ proofs of claim. The Indemnity Claimants’ claims were not discharged by the confirmation of the Company’s plan of reorganization, and the bankruptcy court has not ruled on the Company’s objection to those claims.

 

The parties have reached a settlement in this matter, which was approved by the court on November 29, 2018. This settlement includes an upfront payment of $0.5 million, which was paid on December 21, 2018.  In addition, the settlement provides for equal quarterly installments over a three year period, which total an additional $0.4 million. The Company recorded an expense during the second quarter of 2018 in the Reorganization Items, net expense line item of the income statement and the short and long-term liability totals in the applicable Accrued Settlement Claims lines per the condensed consolidated balance sheets.

 

 

Note 7. 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, for substantially the full term of the asset or liability.

  

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 table provides the estimated fair value of financial instruments and 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 carrying value approximates their fair value.

 

The estimated fair values of the Company's financial instruments are (in thousands):

 

  

June 30, 2020 (unaudited)

 

December 31, 2019

  

Carrying Value

 

Fair Value

 

Carrying Value

 

Fair Value

Financial liabilities:

                

2017 Notes (Level 3)

 $88,446 $17,239 $86,824 $21,289

 

The 2017 Notes in the table above are not measured at fair value in the condensed consolidated balance sheets but are required to be disclosed at fair value. The fair value of the 2017 Notes 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. The fair value is estimated by discounting future projected cash flows using a discount rate commensurate with the risks involved. The interest rate on the senior notes is three-month LIBOR plus 3.5% per annum until maturity in March 2033. The three-month LIBOR used in the analysis was projected using a forward interest rate curve.

 

 

 

 

Financial assets reported at fair value (Level 3) on a nonrecurring basis include the following (in thousands):

 

  

June 30, 2020 (unaudited)

  

Fair Value (Level 3)

 

Gains and (Losses)

Goodwill

 $- $(3,905)

 

See Note 3 for additional information regarding the Company's Goodwill and Intangible Assets.

 

 

Note 8. Income Taxes

 

Prior to 2018, the Company concluded that it was no longer more likely than not that it would realize a portion of its deferred tax assets. Therefore, as of June 30, 2020 and December 31, 2019, the Company maintained a full valuation allowance against its net deferred tax assets of $168.2 million and $166.5 million, respectively. The Company's determination of the realizable deferred tax assets requires the exercise of significant judgment, based in part on business plans and expectations about future outcomes. In the event 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. Because of the full valuation allowance, the Company's effective tax rate is expected to be near 0% and therefore the income tax expense is not material for any period presented.

 

As of June 30, 2020, the Company had a federal NOL of approximately $728.5 million, including $250.3 million in losses on mortgage securities that have not been recognized for income tax purposes. The federal NOL may be carried forward to offset future taxable income, subject to applicable provisions of the Internal Revenue Code (the "Code"). If not used, these NOLs will expire in years 2025 through 2037. Due to tax reform enacted in 2017, NOLs created after 2017 carry forward indefinitely. The 2019 tax return has not been filed as of the date of this report, however the estimated federal NOL that does not expire included in the total above is $93.9 million. States may vary in their treatment of post 2017 NOLs. The Company has state NOL carryforwards arising from both combined and separate filings from as early as 2004. The state NOL carryforwards may expire as early as 2024 and as late as 2037.

 

 

 

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

Statements in this report regarding Novation Companies, Inc. and its business that are not historical facts are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements are those that predict or describe future events, do not relate solely to historical matters and include statements regarding management's beliefs, estimates, projections, and assumptions with respect to, among other things, our future operations, business plans and strategies, as well as industry and market conditions, all of which are subject to change at any time without notice. Words such as “believe,” “expect,” “anticipate,” “promise,” “plan,” and other expressions or words of similar meanings, as well as future or conditional auxiliary verbs such as “would,” “should,” “could,” or “may” are generally intended to identify forward-looking statements. Risks, uncertainties, contingencies, and developments, including those discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report and those identified in “Risk Factors” in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019, (the "2019 Form 10-K"), could cause our future operating results to differ materially from those set forth in any forward-looking statement. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future results, events or developments.

 

Corporate Overview

 

Novation Companies, Inc. and its subsidiaries (the "Company," "Novation," "we," "us," or "our") through our wholly-owned subsidiary Healthcare Staffing, Inc. ("HCS") acquired on July 27, 2017, provides outsourced health care staffing and related services in the State of Georgia. We also previously owned a portfolio of mortgage securities which generated earnings to support on-going financial obligations through the end of 2018. The mortgage securities were sold during 2018 for a total of $13 million. Our common stock, par value $0.01 per share, is traded on the OTC Pink marketplace of the OTC Markets Group, Inc. under the symbol “NOVC”.  

 

Financial Highlights and Key Performance Metrics. The following key performance metrics (in thousands, except per share amounts) are derived from our condensed 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.”

 

  June 30, 2020 (unaudited) 

December 31, 2019

Cash and cash equivalents

 $2,134 $2,032

 

 

  

Six Months Ended June 30, (unaudited)

 

Three Months Ended June 30, (unaudited)

  

2020

 

2019

 

2020

 

2019

Service fee income

 $26,366 $32,151 $12,332 $16,297

Net loss available to common shareholders, per basic share

 $(0.06) $(0.07) $(0.05) $(0.05)

 

Critical Accounting Policies

In our 2019 Form 10-K, we disclose critical accounting policies that require management to use significant judgment or that require significant estimates. Management regularly reviews the selection and application of our critical accounting policies. See Note 1 to the condensed consolidated financial statements for a discussion of significant accounting policies.

 

Results of Operations for the Three and Six Month Period Ended June 30, 2020 as Compared to June 30, 2019

 

Service Fee Income and Cost of Services

HCS delivers outsourced full-time and part-time employees primarily to Community Service Boards (“CSBs”), quasi state organizations that provide behavioral health services at facilities across Georgia including mental health services, developmental disabilities programs and substance abuse treatments. The State of Georgia has a total of 25 CSBs. Each CSB has a number of facilities, including crisis centers, outpatient centers and 24-hour group homes that require a broad range of employees, such as registered nurses, social workers, house parents and supervisors. In addition to providing outsourced employees to CSBs, HCS also provides healthcare outsourcing and staffing services to hospitals, schools and a variety of privately owned businesses. The services and positions provided to non CSB clients are similar to the ones provided to CSB clients. The service fee income and costs of services in the condensed consolidated statement of operations and comprehensive loss for the three and six months ended June 30, 2020 are from the operations of HCS.

 

Future service fee income will be driven by the number of customers and the volume of associates employed by the CSBs and outsourced to HCS. Customer contracts typically establish a fixed markup on the pay rate for the associates, therefore cost of services will generally fluctuate consistently with fee income. HCS offers a health and welfare benefit plan to its associates. The cost of this benefit is passed through to customers plus a small markup to cover cost of administration.

 

HCS revenue for the three and six months ended June 30, 2020 was $12.3 and $26.4, respectively. This decrease in revenue compared to the three and six months ended June 30, 2019 of $16.3 and $32.2, respectively, is due to the loss of a significant customer during the first quarter of 2020, in addition to the reduction of revenue with other CSBs and retail customers during the first and second quarters of 2020. HCS cost of goods sold for the three and six months ended June 30, 2020 was $11.2 and $23.8, respectively. This decrease in cost of goods sold compared to the three and six months ended June 30, 2019 of $14.5 and $28.6, respectively, is also consistent with the decrease in revenue. 

 

 

 

 

In addition, due to the recent developments of COVID-19, the Company has experienced an impact to service fee income and cost of services starting in the second quarter of 2020. Please see Note 1 to the condensed consolidated financial statements for a discussion regarding this impact.

 

General and Administrative

General and administrative expenses consist of salaries, office costs, legal and professional expenses and other customary costs of corporate administration. For the three and six months ended June 30, 2020, $1.4 million and $3.0 million of the total general and administrative expenses were incurred by HCS, as compared to $1.6 million and $3.4 million for the three and six months ended June 30, 2019. Corporate-level general and administrative expenses for the three and six months ended June 30, 2020 were $0.6 million and $1.1 million, respectively, as compared to $0.6 million and $1.1 million for the three and six months ended June 30, 2019. The decrease in general and administrative expenses results from a reduction in staffing, professional fees and other costs of administration as the Company continues to focus on cost containment.

 

The future amount of corporate-level general and administrative expenses will depend largely on corporate activities, professional fees associated with those activities and staffing needs based on the evolving business strategy. For HCS, the amount of these expenses will depend on business growth.

 

Goodwill Impairment Charge

Management completed its annual goodwill impairment assessment as of April 30, 2020.  Increased cost of services and administrative expenses at HCS and the loss of a significant customer during the first quarter of 2020 have resulted in declining cash flow for the business. In addition, COVID-19 concerns were attributable to a lay-off of staffed employees during the second quarter of 2020. Based on these factors, management determined that the carrying value of the HCS goodwill exceeded its fair value by the full amount recorded on the condensed consolidated balance sheets of $3.9 million. A goodwill impairment charge in this amount has been recorded for the quarter.

 

Reorganization Items, Net

There were no reorganization and bankruptcy-related expenses for the six months ended June 30, 2020, and expenses for the six months ended June 30, 2019 were approximately $0.06 million. These costs have decreased as a result of the completion of the Company's reorganization of NMLLC.

 

Interest Expense

Interest expense decreased period over period, with the Company incurring $1.6 million and $2.7 million during the six months ended June 30, 2020 and 2019, respectively. See Note 5 to the condensed consolidated financial statements for a discussion of the Note Purchase Agreement and the 2017 Notes, which were amended on August 9, 2019. This Amendment, among other things, significantly reduced the interest rate applicable from January 2019 through the third quarter of 2028.

 

Income Tax Expense

Because of the Company's significant net operating losses and full valuation allowance, the income tax expense was not material for any period presented and is not expected to be material for the foreseeable future.

 

Liquidity and Capital Resources

 

Liquidity and Going Concern

See discussion of our liquidity and capital resources in Note 1 to the condensed consolidated financial statements.

 

Overview of Cash Flow for the six months ended June 30, 2020

The following table provides a summary of our operating, investing and financing cash flows as taken from our condensed consolidated statements of cash flows for the six months ended June 30, 2020 and 2019 (in thousands).

 

  

Six Months Ended June 30,

  

2020

 

2019

Cash flows provided by (used in) operating activities $113 $(2,997)

Cash flows used in investing activities

 (11) (17)

Cash flows used in financing activities

  (1,979)

 

Operating Activities – The increase in net cash flows provided by (used in) operating activities to approximately $0.1 million during the six months ended June 30, 2020 from cash used of $3.0 million during the six months ended June 30, 2019 was driven primarily by collections on accounts receivable, the goodwill impairment charge, and the amortization of the debt premium and prepaid interest into interest expense for the 2017 Notes.

 

Investing Activities – The decrease in net cash flows used in investing activities is due to a reduction in purchases of property and equipment.

 

Financing Activities – The decrease in cash used in financing activities is due to the payoff of HCS’s line of credit in 2019. The Company did not participate in any financing activities during the first and second quarters of 2020.

 

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Not applicable.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this report, our chief executive officer and our chief financial officer conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on their evaluation of our disclosure controls and procedures, our chief executive officer and chief financial officer, with the participation of the Company’s management, concluded that our disclosure controls and procedures were not effective as of June 30, 2020, to ensure that information required to be disclosed by the Company in the reports that we file or submit under the Exchange Act is (a) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (b) accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow for timely decisions regarding required disclosure.

 

Description of Material Weakness of Disclosure Controls

 

As discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations above and in Note 1 to the condensed consolidated financial statements, in July 2017, we acquired HCS, which now is our primary business activity. Prior to the HCS Acquisition, HCS was a privately-owned business with limited administrative and accounting resources, accounting software inappropriate for the size of the business and generally weak accounting processes, procedures and controls. Specifically, material weaknesses existed in HCS's processes, procedures and controls with respect to revenue, receivables, payment of payroll taxes and estimating various accrued expenses.

 

Remediation of Material Weakness

 

We are working to improve the processes, procedures and controls at HCS and remediate this material weakness. Since the HCS Acquisition in July 2017, we have implemented improvements in processes, procedures and controls and we will continue to do so. We are evaluating the accounting professionals at the Company and HCS and will determine if additional resources with relevant experience are needed. We will disclose in future periods the progress we have made in efforts to remediate this material weakness.

 

Changes in Internal Control Over Financial Reporting

 

As a result of the HCS acquisition and the generally weak controls at HCS discussed above, we determined that we have a material weakness in our internal control over financial reporting, as discussed in our 2019 Form 10-K. We are working to remediate this material weakness as discussed above.

 

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In designing and operating a control system, one must consider the potential benefits of controls relative to their costs and the reality of limited resources available to allocate to control activities, particularly in smaller companies. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any control will meet its objectives under all potential future conditions. Because of such inherent limitations in any control system, there can be no absolute assurance that control issues, misstatements, and/or fraud will be prevented or detected.

 

 

 

FORM 10-Q

 

PART II. OTHER INFORMATION

 

Item 1. 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.

 

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 NovaStar Mortgage, Inc. ("NMI"), wholly-owned subsidiaries of the Company, and NMFC's 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. 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 plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss plaintiff's claims, which the court granted on March 31, 2011, with leave to amend. 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 plaintiff's second amended complaint with prejudice and without leave to replead. Plaintiff filed an appeal. On March 1, 2013, the United States Court of Appeals for the Second Circuit (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 which had held that plaintiff lacked standing, even as a class representative, to sue on behalf of investors in securities in which plaintiff had not invested, and the appellate court remanded the case back to the lower court for further proceedings. On April 23, 2013 plaintiff filed its memorandum with the lower court seeking a reconsideration of the earlier dismissal of plaintiff's claims as to five offerings in which plaintiff was not invested, and on February 5, 2015 the lower court granted plaintiff's motion for reconsideration and vacated its earlier dismissal. On March 8, 2017, the affiliated defendants and all other parties executed an agreement to settle the action, with the contribution of the affiliated defendants to the settlement fund being paid by their insurance carriers. The court certified a settlement class and granted preliminary approval to the settlement on May 10, 2017. One member of the settlement class objected to the settlement and sought a stay of the final settlement approval hearing on the ground that it did not receive notice of the settlement and had no opportunity to timely opt out of the class.  After the court rejected the motion for a stay, the objector filed an appeal and requested a stay of the district court proceedings pending disposition of the appeal. The court of appeals denied the temporary stay of the district court proceedings and on October 19, 2018 dismissed the appeal as moot.  Following the court of appeals’ denial of the objector’s petition for rehearing, the district court on March 7, 2019 held a fairness hearing.  On March 8, 2019, the district court issued a memorandum and order approving the settlement as fair, reasonable and adequate, and dismissing the action with prejudice.  Following entry of judgment, the objector filed a notice of appeal on March 26, 2019 and their opening brief was filed on June 28, 2019.  The defendants answered on September 27, 2019, and the objector replied on October 18, 2019.  Oral argument was held on February 19, 2020.  Assuming the settlement approval becomes final, which is expected, the Company will incur no loss.  The Company believes that the Affiliated Defendants have meritorious defenses to the case and, if the settlement approval does not become final, 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 August 24, 2012, the plaintiff filed an amended complaint making essentially the same claims against NMFC. NMFC filed a motion to dismiss the amended complaint which was denied on September 12, 2013. The defendants claimed the case should be dismissed based upon a statute of limitations and sought an appeal of the court's denial of this defense. An interlocutory appeal of this issue was allowed, and on August 27, 2013, the United States Court of Appeals for the Tenth Circuit (the “Tenth Circuit”) affirmed the lower court’s denial of defendants’ motion to dismiss the plaintiff’s claims as being time barred; the Tenth Circuit held that the Extender Statute, 12 U.S.C. §1787(b)(14) applied to plaintiff’s claims. On June 16, 2014, the United States Supreme Court (the "Supreme Court") granted a petition of NMFC and its co-defendants for certiorari, vacated the ruling of the Tenth Circuit, and remanded the case back to that court for further consideration in light of the Supreme Court’s decision in CTS Corp. v. Waldburger, 134 S. Ct. 2175 (2014). On August 19, 2014, the Tenth Circuit reaffirmed its prior decision, and on October 2, 2014, the defendants filed a petition for writ of certiorari with the Supreme Court, which was denied. On March 22, 2016, NMFC filed motions for summary judgment, and plaintiff filed a motion for partial summary judgment. Those motions remain pending. Given that plaintiff did not file a timely proof of claim in NMFC’s bankruptcy case, the Company believes it is likely that the case will be dismissed. The Company believes that NMFC has meritorious defenses to the case and expects it to defend the case vigorously in the event it proceeds.

 

On February 28, 2013, the Federal Housing Finance Agency, as conservator for the Federal Home Loan Mortgage Corporation (Freddie Mac) and purportedly on behalf of the Trustee of the NovaStar Mortgage Funding Trust, Series 2007-1 (the “Trust”), a securitization trust in which the Company retains a residual interest, filed a summons with notice in the Supreme Court of the State of New York, New York County against the Company and NMI. The notice provides that this is a breach of contract action with respect to certain, unspecified mortgage loans and defendants' failure to repurchase such loans under the applicable agreements. Plaintiff alleges that defendants, from the closing date of the transaction that created the Trust, were aware of the breach of the representations and warranties made and failed to give notice of and cure such breaches, and due to the failure of defendants to cure any breach, notice to defendants would have been futile. The summons with notice was not served until June 28, 2013. By letter dated June 24, 2013, the Trustee of the Trust forwarded a notice from Freddie Mac alleging breaches of representations and warranties with respect to 43 loans, as more fully set forth in included documentation. The 43 loans had an aggregate, original principal balance of about $6.5 million. On August 19, 2013, Deutsche Bank National Trust Company, as Trustee, filed a complaint identifying alleged breaches of representations and warranties with respect to seven loans that were included in the earlier list of 43 loans. Plaintiff also generally alleged a trust-wide breach of representations and warranties by defendants with respect to loans sold and transferred to the trust. Plaintiff seeks specific performance of repurchase obligations; compensatory, consequential, recessionary and equitable damages for breach of contract; specific performance and damages for anticipatory breach of contract; indemnification (indemnification against NMI only) and damages for breach of the implied covenant of good faith and fair dealing. On October 9, 2013, the Company and NMI filed a motion to dismiss plaintiff’s complaint. This motion to dismiss was withdrawn after plaintiff filed an amended complaint on January 28, 2014, and on March 4, 2014, the Company and NMI filed a motion to dismiss the amended complaint. By a Decision/Order dated November 30, 2017, the court granted in part and denied in part the motion to dismiss the amended complaint. The court dismissed all claims except for plaintiff’s claim for damages for breach of contract, to the extent that claim is based on the Company’s and NMI’s alleged failure to notify plaintiff of allegedly defective loans, and plaintiff’s claim for indemnification. The court denied the motion to dismiss these claims without prejudice to the Company’s and NMI’s right to file a new motion to dismiss in conformity with procedures to be established in coordinated proceedings before the court addressing similar claims against numerous defendants. Briefing of the indemnification issue was completed.

 

 

 

The parties have reached a settlement of this matter.  On October 25, 2018, the bankruptcy court overseeing the Company's bankruptcy case entered an order approving the settlement, and on November 19, 2018, the New York State Court “so ordered” a Stipulation of Voluntary Discontinuance terminating the case.  Pursuant to the terms of the settlement agreement, the required upfront payment of $0.3 million was made on March 1, 2019.  The settlement also requires equal quarterly installments over a three years period, which total an additional $0.3 million. The Company has recorded an expense in the second quarter of 2018 in the Reorganization Items, net expense line item of the income statement and the short and long-term liability totals in the applicable Accrued Settlement Claims lines per the condensed consolidated balance sheets.

 

See the "Corporate Overview" section of the Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 2 to the condensed consolidated financial statements for a description of the Company’s Chapter 11 proceedings.

 

 

Item 1A. Risk Factors

 

There have been no material changes from the risk factors set forth in Part I. Item 1A. "Risk Factors" of the 2019 Form 10-K, except as set forth below. The risk factors set forth below supplement, and should be read together with, that section for disclosures regarding what we believe are the more significant risks and uncertainties related to our businesses.

 

Our operations and financial results have been negatively affected by the ongoing COVID-19 pandemic and could continue to be negatively impacted, perhaps materially, by the COVID-19 pandemic.

 

The COVID-19 pandemic has harmed our ability to staff employees, and has negatively impacted the Company’s revenue. As HCS relies on staffing healthcare professionals to generate income, the spread of COVID-19 has reduced our ability to provide these services based on customer driven lay-offs or reduction in hours of the staff provided by HCS.

 

While HCS employees provide services throughout the state of Georgia at multiple facilities, the Company’s operations are limited to this region. COVID-19 case numbers continue to rise in Georgia. If Georgia experiences a severe outbreak of COVID-19 resulting in a massive lockdown in the state, it could have a larger impact on the Company and its business than on companies which operate in multiple states. 

 

The COVID-19 pandemic, and any other outbreak or other public health crises, may also impact our ability to attract and retain employees or healthcare professionals due to illness, risk of illness, quarantines, or other factors. Some of our healthcare professionals have been exposed, diagnosed and or quarantined as a result of the virus. As such, there is a risk that our employees may not want, or be able to provide services, which could negatively impact our supply and ability to provide staffing services to our customers. In addition, HCS may be charged higher insurance premiums for workers compensation and other corporate insurance coverage as a result of this pandemic. HCS may also be subject to claims regarding the health and safety of our staffed healthcare associates and our colleagues.

 

As HCS generates most of its revenue from customers which are ultimately funded by the state of Georgia, the state could impose emergency measures related to state sponsored services. These measures could limit our customer activities or operating status, therefore, restricting HCS business options. 

 

The foregoing and other potential disruptions to our business as a result of the COVID-19 pandemic could materially adversely affect our business and operating results, financial condition, and cash flow. The extent of such impact will depend on future developments, including the duration and spread of COVID-19 in Georgia, which is highly uncertain and cannot be predicted at this time.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

 

Item 3. Defaults Upon Senior Securities

 

None.

 

 

Item 4. Mine Safety Disclosures

 

None

 

 

Item 5. Other Information

 

None

 

 

 

Item 6. Exhibits

 

Exhibit No.

 

Description of Document

   

31.1

 

Principal Executive Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

 

Principal Financial Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

 

Principal Executive Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Principal Financial Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101

 

The following financial information from Novation Companies, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, formatted in XBRL (Extensible Business Reporting Language) includes: (i) Condensed Consolidated Balance Sheets as of June 30, 2020 and December 31, 2019, (ii) Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended June 30, 2020 and 2019, (iii) Condensed Consolidated Statements of Shareholders' Deficit for the six months ended June 30, 2020 and 2019, (iv) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2020 and 2019, and (v) Notes to Condensed Consolidated Financial Statements.

 

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 
    

 

 

 

NOVATION COMPANIES, INC.

 

 

 

 

DATE:

August 13, 2020

 

/s/ David W. Pointer

 

 

 

David W. Pointer, Chief Executive Officer

 

 

 

(Principal Executive Officer)

 

 

 

 

DATE:

August 13, 2020

 

/s/ Carolyn K. Campbell

 

 

 

Carolyn K. Campbell, Chief Financial Officer

 

 

 

(Principal Financial Officer)

 

 

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