NOVATION COMPANIES, INC. The following is a discussion and analysis of our financial condition and
results of operations for the years ended
Corporate Overview Through our wholly-owned subsidiary HCS, acquired onJuly 27, 2017 , we provide outsourced health care staffing and related services in theState 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$13.0 million . Our common stock, par value$0.01 per share, is traded on OTC Pink under the symbol "NOVC".
See Part I, Item 1 of this Form 10-K for a discussion of our note refinancing, which occurred in the third quarter of 2017, and the note amendment, which occurred in the third quarter of 2019.
Financial Highlights and Key Performance Metrics. The following key performance
metrics (in thousands, except per share amounts) are derived from our
consolidated financial statements for the periods presented and should be read
in conjunction with the more detailed information therein and with the
disclosure included in this report under the heading "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
December 31,
2020 2019
Cash and cash equivalents $ 1,340 $ 2,032
Service fee income $ 51,354 $ 63,474
General and administrative expenses $ 7,503 $ 8,345
Net loss available to common shareholders, per basic share
(0.10 )
Consolidated Results of Operations
Year Ended
Service Fee Income and Cost of Services
HCS delivers outsourced full-time and part-time employees primarily to Community
Service Boards ("CSBs"), quasi state organizations that provide behavioral
health services at facilities across 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. The CSB market in Georgia is large and growing steadily, as the
demand for the services provided by the CSBs continues to grow. 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 consolidated statement of operations and comprehensive income
(loss) 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 CSB and outsourced to HCS. Customer
contracts typically establish a fixed markup on the pay rate for the associates;
therefore the cost of services will generally fluctuate consistently with fee
income. HCS offers a health and welfare benefit plan to its associates. The cost
of this benefit is passed through to CSB customers plus a small markup to cover
the cost of administration.
A significant CSB customer terminated its contract services with HCS as of
January 29, 2020 . In addition, due to the recent developments of COVID-19, and
the resulting reduction of programs and staff utilized by CSBs, the Company has
experienced an impact to service fee income and cost of services starting in the
second quarter of 2020 and continuing through the end of 2020.
General and Administrative Expenses
General and administrative expenses consist of salaries, office costs, legal and professional expenses and other customary costs of corporate administration. During 2020 and 2019,$5.5 and$6.2 million , respectively, of the total general and administrative expenses were incurred by HCS. Corporate-level general and administrative expenses during 2020 and 2019 were$2.0 million and$2.1 million , respectively. The future amount of corporate-level general and administrative expenses will depend largely on corporate activities and staffing needs based on the evolving business strategy. For HCS, the amount of these expenses will depend on business growth. Decreased marketing, advertising, and travel advertising expense along with reductions in corporate-level staffing are the primary reasons for the decrease in general and administrative expenses incurred by HCS. Goodwill Impairment Charge Management completed its annual goodwill impairment assessment as ofApril 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 consolidated balance sheets of$3.9 million , as compared to fair value adjustments totaling$4.3 million in 2019. A goodwill impairment charge in this amount was recorded during the second quarter of 2020. 8
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Table of Contents Interest Expense Interest expense decreased period over period, with the Company incurring$3.3 million in 2020 and$4.5 million in 2019. See "Liquidity and Capital Resources" below and Note 6 to the consolidated financial statements for a discussion of the Note Purchase Agreement and the 2017 Notes, which were amended onAugust 9, 2019 . The Amendment, among other things, significantly reduced the interest rate applicable fromJanuary 2019 through the third quarter of 2028. Income Tax Expense Because of the Company's significant net operating losses and full valuation allowance, income tax expense was not material for any period presented and is not expected to be material for the foreseeable future.
Liquidity and Capital Resources
During 2020, the Company had net loss of$9.2 million and generated negative operating cash flow of$0.7 million . As ofDecember 31, 2020 , the Company had an overall shareholders deficit of$81.1 million . As ofDecember 31, 2020 , the Company had an aggregate of$1.3 million in cash and cash equivalents and total liabilities of$93.3 million . Of the$1.3 million in cash,$0.3 million is held by the Company's subsidiary NMLLC. This cash is only available to pay general creditors and expenses of NMLLC. 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 6 to the 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 fromAugust 2019 throughMarch 2022 , leading to significant cash savings for the Company. This amendment to the Note Purchase Agreement and waiver of interest payments throughApril 2022 has significantly improved our forecasted cash position over the next year. In lateMarch 2020 , HCS started experiencing a reduction inGeorgia CSB customer needs related to 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 still concern at the Company about the ongoing effects of COVID-19 on our services for the foreseeable future. As ofDecember 31, 2020 , based on our operating losses and negative cash flow, substantial doubt exists related to the Company's ability to continue as a going concern.
Overview of Cash Flow for the Year Ended
The following table provides a summary of our operating, investing and financing cash flows as taken from our consolidated statements of cash flows for the years endedDecember 31, 2020 and 2019 (in thousands). For the Years Ended December 31, 2020 2019 Cash flows used in operating activities $ (677 ) $ (5,168 ) Cash flows (used in) provided by investing activities (15 ) (70 ) Cash flows used in financing activities - (1,979 ) Operating Activities The decrease in net cash flows used in operating activities to approximately$0.7 million during 2020 from cash used in operating activities of$5.2 million during 2019 was driven primarily by the Company's decrease in net loss, along with a decrease in and paydowns of accounts receivable. Another contributor is the reduction of interest payments in 2020 resulting from the amendment of the senior note agreements, effectiveAugust 9, 2019 .
Investing Activities
The decrease in the net cash flows used in investing activities is due to the 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 2020.
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Table of Contents Critical Accounting Estimates We prepare our consolidated financial statements in conformity with GAAP and, therefore, are required to make estimates regarding the values of our assets and liabilities and in recording income and expenses. These estimates are based, in part, on our judgment and assumptions regarding various economic conditions that we believe are reasonable based on facts and circumstances existing at the time of reporting. These estimates affect reported amounts of assets, liabilities and accumulated other comprehensive income at the date of the consolidated financial statements and the reported amounts of income, expenses and other comprehensive income during the periods presented. The following summarizes the components of our consolidated financial statements where understanding accounting policies is critical to understanding and evaluating our reported financial results, especially given the significant estimates used in applying the policies. The discussion is intended to demonstrate the significance of estimates to our consolidated financial statements and the related accounting policies. Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board and the Audit Committee has reviewed our disclosure.
Impairment of Indefinite-Lived Intangible Assets and Long-Lived Assets with Finite Lives
The values of indefinite-lived assets such as goodwill and trademarks are assessed annually to determine whether their carrying value exceeds their fair value. The Company performs its annual tests of goodwill and trademarks during the second quarter of each fiscal year. In addition, indefinite-lived assets are tested on an interim basis if an event occurs or circumstances change that would more likely than not reduce their fair value below carrying value and for long-lived purchased intangible assets this occurs whenever an event or circumstances indicate the carrying value of the asset may not be fully recoverable. If we determine the fair value of the asset is less than its carrying value, an impairment loss is recognized. Impairment losses, if any, are reflected in operating income or loss in the period incurred. Income Taxes In determining the amount of deferred tax assets to recognize in the consolidated financial statements, the Company evaluates the likelihood of realizing such benefits in future periods. The income tax guidance requires the recognition of a valuation allowance if it is more likely than not that all or some portion of the deferred tax asset will not be realized. Income tax guidance indicates the more likely than not threshold is a level of likelihood that is more than 50%. Under the income tax guidance, companies are required to identify and consider all available evidence, both positive and negative, in determining whether it is more likely than not that all or some portion of its deferred tax assets will not be realized. Positive evidence includes, but is not limited to the following: cumulative earnings in recent years, earnings expected in future years, excess appreciated asset value over the tax basis and positive industry trends. Negative evidence includes, but is not limited to the following: cumulative losses in recent years, losses expected in future years, a history of operating losses or tax credit carryforwards expiring, and adverse industry trends. The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is required to support a conclusion that a valuation allowance is not needed for all or some of the deferred tax assets. Cumulative losses in recent years are significant negative evidence that is difficult to overcome when determining the need for a valuation allowance. Similarly, cumulative earnings in recent years represent significant positive objective evidence. If the weight of the positive evidence is sufficient to support a conclusion that it is more likely than not that a deferred tax asset will be realized, a valuation allowance should not be recorded. The Company examines and weighs all available evidence (both positive and negative and both historical and forecasted) in the process of determining whether it is more likely than not that a deferred tax asset will be realized. The Company considers the relevance of historical and forecasted evidence when there has been a significant change in circumstances. Additionally, the Company evaluates the realization of its recorded deferred tax assets on an interim and annual basis. The Company does not record a full valuation allowance if the weight of the positive evidence exceeds the negative evidence and is sufficient to support a conclusion that it is more likely than not that its deferred tax asset will be realized. If a valuation allowance is necessary, the Company considers all sources of taxable income in determining the amount of valuation allowance to be recorded. Sources of taxable income identified in the income tax guidance include the following: 1) taxable income in prior carryback year, 2) future reversals of existing taxable temporary differences, 3) future taxable income exclusive of reversing temporary differences and carryforwards, and 4) tax planning strategies. The Company currently evaluates estimates of uncertainty in income taxes based upon a framework established in the income tax accounting guidance. The guidance prescribes a recognition threshold and measurement standard for the recognition and measurement of tax positions taken or expected to be taken in a tax return. In accordance with the guidance, the Company evaluates whether a tax position will more likely than not be sustained upon examination by the appropriate taxing authority. The Company measures the amount to recognize in its consolidated financial statements as the largest amount that is greater than 50% likely of being realized upon ultimate settlement. The recognition and measurement of tax benefits is often judgmental, and determinations regarding the tax benefit can change as additional developments occur relative to the issue.
Impact of Recently Issued Accounting Pronouncements
No new accounting standards were adopted in 2020.
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