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NOVC > SEC Filings for NOVC > Form 10-Q on 8-May-2014All Recent SEC Filings

Show all filings for NOVATION COMPANIES, INC.

Form 10-Q for NOVATION COMPANIES, INC.


8-May-2014

Quarterly Report


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. 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. Actual results and operations for any future period may vary materially from those discussed herein. Some important factors that could cause actual results to differ materially from those anticipated include: our ability to manage our business; variability in the home mortgage or refinancing market that affects the demand for real estate appraisal services; changes in the regulatory environments within which our subsidiaries operate; our ability to develop new relationships and maintain existing relationships with both customers and business partners; decreases in cash flows from our mortgage securities; our ability to remain in compliance with the agreements governing our indebtedness; the outcome of litigation actions pending against us or other legal contingencies; our compliance with applicable local, state and federal laws and regulations; compliance with new accounting pronouncements; the impact of general economic conditions; and the risks that are from time to time included in our filings with the Securities and Exchange Commission ("SEC"), including the Company's most recent Annual Report on Form 10-K and this report on Form 10-Q. Other factors not presently identified may also cause actual results to differ. This report on Form 10-Q speaks only as of its date and we expressly disclaim any duty to update the information herein except as required by applicable law.

Executive Overview
The following Management's Discussion and Analysis of Financial Condition and Operating Results ("MD&A")
should be read in conjunction with the preceding unaudited condensed consolidated financial statements of Novation Companies, Inc. and its subsidiaries (the "Company" or "Novation" or "we" or "us") and the notes thereto as well as the Company's Annual Report on Form 10-K for the year ended December 31, 2013. MD&A includes the following sections:

• Corporate Overview, Background and Strategy - a brief overview of our business, current strategy, and significant recent events.

• Critical Accounting Policies - an update, since December 31, 2013, of our discussion of accounting policies that impact our financial statements and involve a high degree of judgment or complexity. This section also includes the impact of new accounting standards.

• Consolidated Results of Operations - an analysis of our results of operations for the three months ended March 31, 2014 and 2013 as presented in our unaudited Condensed Consolidated Financial Statements.

• Segment Results of Operations - an analysis of our results of operations for the three months ended March 31, 2014 and 2013 as presented in our unaudited Condensed Consolidated Financial Statements for our reporting segments.

• Liquidity and Capital Resources - an analysis of our cash flows and financial commitments.

Corporate Overview, Background and Strategy Our Business
Novation Companies, Inc. (the "Company" or "Novation" or "we" or "us") is a Maryland corporation formed on September 13, 1996.

StreetLinks, LLC (StreetLinks) is a national residential appraisal and real estate valuation management company which we acquired in 2008. We owned 91% of StreetLinks as of March 31, 2014. Subsequent to quarter end, the Company and the non-controlling members of StreetLinks entered into a Purchase and Sale Agreement with Assurant Services, LLC, a subsidiary of Assurant, Inc. ("Assurant"), pursuant to which Assurant purchased 100% of the outstanding membership units of StreetLinks. This transaction closed on April 16, 2014. At the time of the transaction, the Company owned 88% of StreetLinks. See Note 3 to the condensed consolidated financial statements for additional information regarding this transaction and the reduction in the Company's ownership interest.

Advent Financial Services, LLC (Advent) is a provider of financial settlement services for income tax preparation businesses and prepaid debit card and related services to customers of these tax preparation businesses. We acquired Advent in 2009. We own 100% of Advent.

CorvisaCloud, LLC (CorvisaCloud) is a developer and seller of proprietary cloud-based contact center software and private branch exchange (PBX) systems. In addition, CorvisaCloud provides implementation consulting services for clients of a leading


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customer relationship management (CRM) software. We acquired CorvisaCloud in 2012. It was originally named IVR Central LLC and we rebranded the business to CorvisaCloud in 2013. We own 100% of CorvisaCloud.

In each of these businesses we invested at the early stage of the company's life with the goal of growing each business to its maximum potential. When we acquire businesses, our goal is to own indefinitely. However, we may consider the sale of a business or businesses if we believe we can invest the proceeds from a sale elsewhere at a better risk adjusted long term return for shareholders. This may include investing capital in a business we already own or investing in an unrelated business not yet identified.

What follows is a discussion of each business separately. Note 13 to the condensed consolidated financial statements set forth in Item 1 of this report, which is incorporated by reference, includes information about the operating results and financial position of the segments to which these businesses relate.

STREETLINKS, LLC

StreetLinks is a leading national provider of residential appraisal management services, appraisal management technology, and automated valuation products. StreetLinks offers three primary products:

• Lender Plus, the core appraisal management service, for which StreetLinks manages the full appraisal process for lenders;

• Lender X, software that facilitates lenders managing their own appraisal process; and

• StreetLinks QX, an automated appraisal risk management product.

StreetLinks' goal with each of these products is to offer the industry's leading quality solution delivered with best-in-class service.

LenderPlus is designed for mortgage lenders of all sizes who want to outsource the management of their appraisal process. Upon receiving an appraisal order from a lender, StreetLinks will order that appraisal through its national appraiser vendor network, quality control that appraisal when it is received from the appraiser, and upon completion of a quality appraisal, deliver it to the lender. To increase the LenderPlus business StreetLinks focuses on increasing the number of customers who utilize LenderPlus and increasing its market share with each current customer.

LenderX is designed for mortgage lenders who want to manage their own appraisal process and need the technology necessary to do so efficiently. To grow the LenderX business StreetLinks focuses on increasing the number of customers who utilize LenderX. StreetLinks believes that over time a certain percentage of customers who initially elect to use the LenderX product may move to its LenderPlus product. LenderX also acts as a gateway for StreetLinks to deliver its automated valuation products to lenders, which today consists of StreetLinks QX.

StreetLinks QX is designed to assist underwriters in evaluating the quality of an appraisal. StreetLinks offers the product with every LenderPlus appraisal it delivers as well as to lenders to evaluate appraisals from competing appraisal management companies. To grow the QX business StreetLinks focuses on growing the number of customers who use the product as well as selling those customers on the value of running QX on 100% of their appraisals. We believe QX is the best automated appraisal risk management product in the industry today.

ADVENT FINANCIAL SERVICES, LLC

Advent provides financial settlement services for professional tax preparers nationwide. Certain customers of professional tax preparers who receive a tax refund may not have a bank account in which to deposit their refund and/or may prefer to pay for the cost of the tax preparation work once the refund is received rather than pay an upfront fee at the time the return is prepared. These customers can choose to have the tax refund processed through Advent for a fee. When Advent receives the refund, it collects its settlement fee, pays the tax preparer their fee and remits the remaining proceeds to the customer in the manner they choose. While being a convenience and value add service for the customer, this also serves as an important receivables management and reconciliation platform for the tax preparer.

The taxpayer has the choice of receiving their refund in the form of a check, direct deposit to an existing bank account, or loaded onto Advent's prepaid debit card, branded the Get It Card. The Get It Card provides access to tailored banking and payment services 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. If the customer chooses the Get It Card, Advent earns additional revenue from card usage.

Advent establishes a relationship with its professional tax preparer customers through direct call center sales, e-mail campaigns, attendance at trade shows and a small field sales force. In order for the tax preparers to process returns through Advent during


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the tax season, Advent has to integrate with the tax software that each tax preparer uses. Today Advent is integrated with seven of the top ten tax software providers. When the tax return is prepared, taxpayer information is collected and transmitted to Advent through the tax software's electronic filing platform. For serving as this gateway between Advent and the tax preparer, the tax software provider receives a portion of the economics of the transaction fees between Advent and the tax preparer.

CORVISACLOUD, LLC

CorvisaCloud is a provider of cloud-based, proprietary communication software under the brand CorvisaOne™ and implementation consulting services for its own clients as well as clients of a leading customer relationship management (CRM) software provider.

CorvisaOne™ is a full contact center suite including both inbound and outbound contact center functionality as well as full private branch exchange (PBX) phone system functionality. Features of the communications software include interactive voice response, automated call distribution, campaign dialing, and a variety of other services, all of which are delivered to clients as part of a comprehensive, fully-hosted cloud solution. The software is fully integrated with the leading CRM provider and can be integrated with other third party software solutions via our advanced web service, JavaScript and platform integration solutions. CorvisaCloud's target customers are businesses of all sizes in all industries, anywhere in the world.

We acquired CorvisaCloud in October 2012 and set out to build a complete cloud-based contact center software solution. By joining the years of contact center operating experience possessed by Novation's leadership team with the technology team acquired through the CorvisaCloud acquisition, we believe we have built a best-in-class contact center software solution. In addition to the product offering, CorvisaCloud has built its product as part of a platform that enables its customers and others to develop their own tools to tie into CorvisaCloud's product offering.

In addition to the benefits associated with cloud-based technology solutions such as security, scalability, reliability, rapid deployment and low cost, additional business benefits to customers using CorvisaCloud's technology product/platform include:

Integrated Cloud PBX (phone system) within CorvisaCloud's contact center application. This integration enables executives and contact center employees to be on the same platform and eliminates the need for separate contact center and PBX vendors.

Platform in addition to CorvisaCloud's product. CorvisaCloud's platform provides a highly configurable platform that allows for the creation or editing of voice and SMS applications utilizing Summit, CorvisaCloud's Lua-based programming language. Applications built on the CorvisaOne™ platform are fully hosted on the CorvisaCloud network that provides, scalability, redundancy, backup, testing frameworks and other features required for enterprise-class applications. Existing applications or those developed by third-party developers can also easily be integrated through our open APIs. This makes it easy for developers to scale with their application and effectively support their product while eliminating the need to manage independent server and hosting environments.

Contact and Campaign Manager. CorvisaOne™ includes a highly scalable contact/lead management system allowing for dynamic management of millions of contact/lead records, including real-time assignment to dialing campaigns. This functionality eliminates the need to store and manage complex campaign logic in third-party systems or manual spreadsheets. In addition, CorvisaOne™ supports real-time synchronization with leading CRM systems to allow customers to work seamlessly within their CRM.

Redundant Instance-based Architecture. CorvisaCloud's highly scalable, instance-based architecture allows CorvisaOne™ to scale to support a worldwide presence while providing customer benefits such as read access to their client data, segmented client data and a highly redundant architecture.

Combined Telecom and Production Reporting. As business operators ourselves, we believe strongly in the importance of closely aligning telecommunications and production data to give greater visibility into overall business operations. The CorvisaOne™ product is tightly integrated with leading CRM systems to ensure accurate and comprehensive business reporting.

CorvisaCloud derives its revenue from software subscription fees for its product and from telecommunications minutes used. CorvisaCloud also derives revenue from professional service fees charged for enhanced implementation requirements of its contact center solution as well as CRM implementation services.

While CorvisaCloud is still in the initial phases of launching its product, our plan over time is to sell CorvisaCloud's product and services through its direct sales force which is comprised of telephone sales personnel located regionally. For larger opportunities CorvisaCloud will send its implementation teams on site in a consulting role to help onboard clients.


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CorvisaCloud's marketing strategy is to promote its brand and generate quality leads for its sales force. CorvisaCloud's primary marketing activities will consist of:

• Press and industry analyst relations for third-party validation of the CorvisaCloud offering and value proposition

• Attendance at user conferences and trade show events

• Search engine marketing and advertising to drive leads to the CorvisaCloud sales force

• Use of customer testimonials and referrals

• Leads from the CorvisaCloud CRM implementation practice

On April 23, 2014, the Company announced that it would be devoting up to $30 million of the proceeds from the StreetLinks sale to CorvisaCloud. The additional capital will be used to expand CorvisaCloud's sales, marketing and operational development efforts and, potentially, fund potential acquisitions. The funds will also be used to accelerate product development and customer acquisition of CorvisaCloud's CorvisaOne™ contact center software products and platform.

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 quarterly 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. Key performance measures for executive management are:

• generating income and long-term value for our shareholders, and

• 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 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."

Table 1 - Summary of Financial Highlights and Key Performance Metrics (dollars

in thousands; except per share amounts)
                                                                  For the Three Months Ended
                                                                           March 31,
                                                                    2014               2013
Net income available to common shareholders per diluted share $          0.01     $        0.01

                                                                             As of
                                                                  March 31,        December 31,
                                                                    2014               2013
Unrestricted cash and cash equivalents                        $        11,352     $       9,267

Significant Recent Events
Prior to 2013, the Company entered into a Membership Interest Purchase Agreement (the "Unit Purchase Agreement") with its Chief Operating Officer, Mr. Steve Haslam, pursuant to which Mr. Haslam sold 1,927 units in StreetLinks to the Company in exchange for a total purchase price of $6.1 million, payable in quarterly installments. At the time of the original transaction, Mr. Haslam's units represented approximately 5% of the outstanding StreetLinks membership units. On April 16, 2014, the Company and Mr. Haslam agreed to terminate the Unit Purchase Agreement. In full satisfaction of the Company's outstanding obligations under the Unit Purchase Agreement, which are discussed further in Note 9 to the condensed consolidated financial statements, the Company transferred back to Mr. Haslam 1,218 StreetLinks membership units (approximately 3% of StreetLinks), which represents the portion of the membership units attributable to the $3.9 million in unpaid installment payments and $0.2 million in interest remaining under the Unit Purchase Agreement. The termination of the Unit Purchase Agreement and simultaneous transfer of 1,218 StreetLinks membership units to Mr. Haslam reduced the Company's ownership interest from approximately 91% as of March 31, 2014 to approximately 88% as of April 16, 2014.

On April 16, 2014, the Company and non-controlling members of StreetLinks (the "Sellers) entered into a purchase and sale agreement with Assurant, pursuant to which Assurant purchased 100% of the outstanding membership units of StreetLinks in exchange for $60.0 million paid in cash at closing and up to $12.0 million in post-closing consideration contingent upon the total revenue of StreetLinks in fiscal years 2015 and 2016. The sale closed on April 16, 2014. The Company received approximately $53.9 million in cash proceeds at closing, of which $1.0 million was used to make certain earned bonus payments to three StreetLinks executives and approximately $1.4 million was used to pay transaction-related expenses.


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The post-closing consideration provides for a payment if (a) the total revenue of StreetLinks is $184 million or more for calendar year 2015, Assurant shall pay to the Sellers an aggregate of $12.0 million; but if not, then (b) if the total revenue of StreetLinks is greater than $167.5 million for the calendar year 2016, Buyer shall pay to Sellers up to an aggregate of $12.0 million, based on a linear scale where full payment of the $12.0 million would occur at total revenue of $184 million. The post-closing consideration will be reduced for certain earned bonus payments to three StreetLinks executives of $2.0 million if the maximum post-closing consideration is earned and otherwise prorated based on the same linear scale.

In connection with the sale, the Company and Assurant also entered into a transition services agreement, pursuant to which the Company will provide ongoing information technology, human resources management and accounting services to StreetLinks for a period of up to eighteen months. The Company will have no significant continuing involvement with StreetLinks beyond the transition services. The Company has also executed a Non-Competition, Non-Solicitation and Non-Disclosure Agreement with StreetLinks providing that Novation will be prohibited from competing in the real estate appraisal management or valuation services business for a period of four years.

Critical Accounting Policies
In our Annual Report on Form 10-K for the year ended December 31, 2013, 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. There have been no updates to the critical accounting policies contained in our Annual Report on Form 10-K for the year ended December 31, 2013.

Impact of Recently Issued Accounting Pronouncements In September 2013, the U.S. Department of the Treasury and the IRS released final regulations providing guidance on the application of IRC Section 263(a) to amounts paid to acquire, produce, or improve tangible property, as well as rules for materials and supplies ("Tangible Property Regulations"). While the final regulations are generally effective for taxable years beginning on or after January 1, 2014, taxpayers are permitted to early adopt provisions for years beginning on or after January 1, 2012. This guidance did not have a significant impact on the Company's financial statements.

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740):
Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force), which provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss (NOL) carryforward, a similar tax loss, or a tax credit carryforward exists. The FASB's objective in issuing this ASU is to eliminate diversity in practice resulting from a lack of guidance on this topic in current U.S. GAAP. This ASU applies to all entities with unrecognized tax benefits that also have tax loss or tax credit carryforwards in the same tax jurisdiction as of the reporting date and is effective for fiscal years beginning after December 15, 2013, and interim periods within those years. This guidance did not have a significant impact on the Company's financial statements.

Consolidated Results of Operations
Service Fee Income and Cost of Services
See discussion within the Segment Results of Operations section below.

Interest Income - Mortgage Securities
Interest income on the mortgage securities we own increased to approximately $1.8 million during the three months ended March 31, 2014 compared to $0.9 million during the three months ended March 31, 2013. This increase was due primarily to lower than anticipated losses on the underlying loan collateral, which led certain securities to begin cash-flowing during the current year period after extended periods of inactivity. Management does not expect this trend to continue on a long-term basis. Instead, the Company expects interest income and cash flow from these securities to decline as the principal on the underlying loan collateral is paid or written down or off.

Selling, General and Administrative
On a consolidated basis, selling, general and administrative expenses decreased slightly to $8.8 million for the three months ended March 31, 2014, compared to $8.9 million for the three months ended March 31, 2013. The decrease was driven primarily by declines in performance-based compensation costs, such as commissions and bonuses.

Other Income
Other income was not material during the three months ended March 31, 2014. During the three months ended March 31, 2013, other income totaled approximately $1.2 million, which was primarily attributable to the recovery of credit losses related to a note receivable due from ITS Financial, LLC ("ITS"). Prior to 2013, the Company, based on the existing facts and circumstances surrounding ITS, had recorded a full provision for credit losses of approximately $1.1 million related to this note. The note was paid in full during the first quarter of 2013.


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Interest Expense
Interest expense was materially consistent period over period, with the Company incurring approximately $0.8 million during the three months ended March 31, 2014 and 2013. See Note 9 to the condensed consolidated financial statements for additional information regarding the Company's borrowings.

Income Tax Expense
Income tax expense was not material during the three months ended March 31, 2014, as the Company's effective tax rate is anticipated to be close to 0% for 2014 due to the valuation allowance against the Company's deferred tax assets. During the three months ended March 31, 2013, the Company recorded income tax expense of $1.1 million based on the operating results of continuing operations, for an effective tax rate of 46.0%. See Note 12 to the condensed consolidated financial statements for further details regarding the Company's income tax provision and deferred tax assets.

Segment Results of Operations
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, and other expenses necessary to the production process.

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