NOVATION COMPANIES, INC. - Quarter Report: 2014 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



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

For the Quarterly Period Ended March 31, 2014



o	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.)



2114 Central Street, Suite 600, Kansas City, MO (Address of Principal Executive Office)		64108 (Zip Code)

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

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 x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes x No o

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



Large accelerated filer	Accelerated filer	Non-accelerated filer	Smaller reporting company
o	o	o	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

The number of shares of the Registrant's Common Stock outstanding on May 2, 2014 was 91,479,519.

NOVATION COMPANIES, INC.

FORM 10-Q

For the Quarterly Period Ended March 31, 2014

TABLE OF CONTENTS



PART I	Financial Information

Item 1.	Financial Statements (Unaudited)	1
	Condensed Consolidated Balance Sheets	1
	Condensed Consolidated Statements of Operations	2
	Condensed Consolidated Statements of Comprehensive Income	3
	Condensed Consolidated Statements of Shareholders’ Equity (Deficit)	4
	Condensed Consolidated Statements of Cash Flows	5
	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31

Item 4.	Controls and Procedures	31

PART II	Other Information	32

Item 1.	Legal Proceedings	32

Item 1A.	Risk Factors	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33

Item 3.	Defaults Upon Senior Securities	33

Item 4.	Mine Safety Disclosures	33

Item 5.	Other Information	33

Item 6.	Exhibits	34

	Signatures	35

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

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



	March 31, 2014			December 31, 2013
Assets
Current Assets
Cash and cash equivalents	$	11,352		$	9,267
Service fee receivable, net of allowance of $300 and $191, respectively	7,398			5,274
Restricted cash	1,035			1,035
Mortgage securities	3,466			3,728
Other current assets	3,381			3,333
Total current assets	26,632			22,637
Non-Current Assets
Property and equipment, net of accumulated depreciation	4,779			4,925
Goodwill	3,170			3,170
Deferred income tax asset, net	1,024			1,101
Other assets	2,188			2,209
Total non-current assets	11,161			11,405
Total assets	$	37,793		$	34,042

Liabilities and Shareholders' Equity (Deficit)
Liabilities:
Current Liabilities
Accounts payable	$	3,446		$	3,453
Accrued expenses	8,860			6,406
Deferred revenue	958			731
Note payable to related party	1,500			1,250
Deferred income tax liability, net	1,024			1,101
Other current liabilities	424			424
Total current liabilities	16,212			13,365
Non-Current Liabilities
Senior notes	84,406			83,867
Note payable to related party	2,363			2,613
Other liabilities	2,374			2,417
Total non-current liabilities	89,143			88,897
Total liabilities	105,355			102,262

Commitments and contingencies (Note 10)

Shareholders' equity (deficit):
Capital stock, $0.01 par value per share, 120,000,000 shares authorized:
Common stock, 91,479,519 shares issued and outstanding	915			915
Additional paid-in capital	739,595			739,468
Accumulated deficit	(811,012		)	(811,742		)
Accumulated other comprehensive income	2,876			3,103
Total Novation Companies, Inc. shareholders' deficit	(67,626		)	(68,256		)
Noncontrolling interests	64			36
Total shareholders' deficit	(67,562		)	(68,220		)
Total liabilities and shareholders' deficit	$	37,793		$	34,042

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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



	For the Three Months Ended March 31,
	2014			2013
Income and Revenues:
Service fee income	$	31,555		$	47,862
Interest income – mortgage securities	1,786			917
Total	33,341			48,779

Costs and Expenses:
Cost of services	23,015			37,855
Selling, general and administrative expense	8,812			8,868
Total	31,827			46,723

Other income	76			1,215
Interest expense	(799		)	(788		)

Income before income taxes	791			2,483
Income tax expense, continuing operations	28			1,138
Net income from continuing operations	763			1,345
Loss from discontinued operations, net of income taxes	—			(690		)
Net income	763			655
Less: Net income (loss) attributable to noncontrolling interests	33			(101		)
Net income attributable to Novation	$	730		$	756
Earnings Per Share attributable to Novation:
Basic	$	0.01		$	0.01
Diluted	$	0.01		$	0.01
Weighted average basic shares outstanding	90,866,933			90,716,933
Weighted average diluted shares outstanding	90,866,933			91,119,949

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited; dollars in thousands)



	For the Three Months Ended March 31,
	2014			2013
Net income	$	763		$	655
Other comprehensive income:
Change in unrealized gain on mortgage securities – available-for-sale (Note 11)	(227		)	(619		)
Total comprehensive income	536			36
Comprehensive income attributable to noncontrolling interests:
Less: Net income (loss) attributable to noncontrolling interests	33			(101		)
Total comprehensive income attributable to Novation	$	503		$	137

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

(unaudited; dollars in thousands)



	Total NCI Shareholders’ Equity (Deficit)
	Common Stock		Additional Paid-in Capital		Accumulated Deficit			Accumulated Other Comprehensive Income			Noncontrolling Interests			Total Shareholders’ Equity (Deficit)
Balance, December 31, 2013	$	915	$	739,468	$	(811,742	)	$	3,103		$	36		$	(68,220	)
Compensation recognized under stock compensation plans	—		127		—			—			—			127
Distributions to noncontrolling interests	—		—		—			—			(5		)	(5		)
Net income	—		—		730			—			33			763
Other comprehensive loss	—		—		—			(227		)	—			(227		)
Balance, March 31, 2014	$	915	$	739,595	$	(811,012	)	$	2,876		$	64		$	(67,562	)



	Total NCI Shareholders’ Equity (Deficit)
	Common Stock		Additional Paid-in Capital		Accumulated Deficit			Accumulated Other Comprehensive Income			Noncontrolling Interests			Total Shareholders’ Equity (Deficit)
Balance, December 31, 2012	$	915	$	740,171	$	(744,213	)	$	3,301		$	(2,198	)	$	(2,024	)
Compensation recognized under stock compensation plans	—		110		—			—			—			110
Contributions from noncontrolling interests	—		—		—			—			39			39
Distributions to noncontrolling interests	—		—		—			—			(195		)	(195		)
Net income (loss)	—		—		756			—			(101		)	655
Other comprehensive loss	—		—		—			(619		)	—			(619		)
Balance, March 31, 2013	$	915	$	740,281	$	(743,457	)	$	2,682		$	(2,455	)	$	(2,034	)

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited; dollars in thousands)



	For the Three Months Ended March 31,
	2014			2013
Cash flows from operating activities:
Net income	$	763		$	655
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion of mortgage securities	(193		)	(280		)
Provision for (recovery of) bad debt, net	135			(951		)
Amortization of deferred debt issuance costs and senior debentures discount	539			520
Fair value adjustments	—			(79		)
Loss on disposal of fixed assets	5			8
Compensation recognized under stock compensation plans	127			110
Depreciation expense	584			1,170
Deferred taxes	—			585
Changes in:
Service fee receivable	(2,258		)	578
Restricted cash	—			65
Other current assets and liabilities, net	(52		)	(76		)
Other noncurrent assets and liabilities, net	47			38
Deferred revenue	227			(306		)
Accounts payable and accrued expenses	2,447			4,134
Net cash provided by operating activities	2,371			6,171

Cash flows from investing activities:
Proceeds from paydowns of mortgage securities	228			272
Proceeds from paydowns of notes receivable	—			996
Issuance of notes receivable	—			(190		)
Purchases of property and equipment	(393		)	(1,009		)
Net cash (used in) provided by investing activities	(165		)	69

Cash flows from financing activities:
Contributions from noncontrolling interests	—			39
Distributions to noncontrolling interests	(5		)	(195		)
Principal payments under capital leases	(116		)	(63		)
Paydowns of note payable to related party	—			(250		)
Net cash used in financing activities	(121		)	(469		)
Net increase in cash and cash equivalents	2,085			5,771
Cash and cash equivalents, beginning of period	9,267			16,362
Cash and cash equivalents, end of period	$	11,352		$	22,133

Continued

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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

(unaudited; dollars in thousands)



	For the Three Months Ended March 31,
	2014		2013
Cash paid for interest	$	263	$	267
Cash received from income taxes, net	9		15
Cash received on mortgage securities – available-for-sale with no cost basis	1,593		637
Non-cash investing and financing activities:
Assets acquired under capital lease	50		428

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of and for the period ended March 31, 2014 (Unaudited)

Note 1. Financial Statement Presentation

Description of Operations – Novation Companies, Inc. (the “Company” or ”Novation" or “we” or “us”) acquires and operates technology-enabled service businesses, with a focus on building and developing these businesses to create long-term value.

As of March 31, 2014, the Company owned 91% of StreetLinks LLC (“StreetLinks”), a national residential appraisal and mortgage real estate valuation management services company. 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 agreed to purchase 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.

The majority of StreetLinks' business is generated from managing the process of fulfilling an appraisal order and performing a quality control review of all appraisals. StreetLinks also provides other real estate valuation management services, such as field reviews, value validation, and automated appraisal risk management. StreetLinks charges a fee for these services which is collected from lenders and borrowers.

The Company owns 100% of Advent Financial Services LLC (“Advent”). 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. The customer 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.

The Company owns 100% of CorvisaCloud, LLC ("CorvisaCloud"). CorvisaCloud provides cloud-based communication software under the CorvisaOne™ brand and implementation consulting services for its own clients as well as clients of a leading customer relationship management (CRM) software provider.

Effective February 27, 2013 the Company and non-controlling owners agreed to dissolve Mango Moving, LLC ("Mango"), a third-party logistics provider within the household goods industry, and abandon its operations. As discussed in Note 4, the operations of Mango have been classified as discontinued operations for all periods presented.

Prior to 2008, the Company originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage securities. As a result of those activities, we acquired mortgage securities that continue to be a source of our earnings and cash flow.

Financial Statement Presentation – The Company’s consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the period. The Company uses estimates and judgments in establishing the fair value of its mortgage securities, goodwill, and accounting for income taxes, including the determination of the timing of the establishment or release of the valuation allowance related to the deferred tax asset balances and reserves for uncertain tax positions. While the condensed consolidated financial statements and footnotes reflect the best estimates and judgments of management at the time, actual results could differ significantly from those estimates.

Cash equivalents consist of liquid investments with an original maturity of three months or less. Amounts due from banks and credit card companies of $0.2 million for the settlement of credit card transactions are included in cash and cash equivalents as of both March 31, 2014 and December 31, 2013, as they are generally collected within three business days. Cash equivalents are stated at cost, which approximates fair value.

The condensed consolidated financial statements of the Company include the accounts of all wholly-owned and majority-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

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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 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 fiscal year ended December 31, 2013.

Note 2. New 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.

Note 3. Subsequent 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.

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.

Included in selling, general and administrative expenses in the Company’s condensed consolidated statements of operations for three months ended March 31, 2014 were $0.1 million in costs related to the transaction.

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Note 4. Discontinued Operations

Because of continued capital demands and difficulties generating positive cash flows or earnings, effective February 27, 2013, the Company committed to a plan to abandon the operations of Mango, which comprised the Company's entire Logistics segment. The run-off operations of Mango ceased during the first quarter of 2013, and the Company will not have any significant continuing involvement in Mango.

The results of operations for the Company's Logistics segment and any related eliminations have been classified as discontinued operations for all periods presented and are summarized below. There was no activity for this segment for the three months ended March 31, 2014.



	For the Three Months Ended March 31,
	2013
Service fee income	$	372

Cost of services	815
Selling, general and administrative expense	747

Net loss from discontinued operations before income taxes	(1,190		)
Income tax benefit	(500		)
Net loss from discontinued operations, net of income taxes	$	(690	)

The Company recorded a loss from discontinued operations, net of income taxes of $0.7 million for the three months ended March 31, 2013. This amount includes one-time employee termination benefits of $0.1 million and depreciation expense of $0.4 million, which largely represents the revision of depreciation estimates to reflect the use of the Logistics segment's fixed assets over their shortened useful lives through the date of abandonment.

There were no remaining assets and liabilities for the Company's Logistics segment as of March 31, 2014 and December 31, 2013.

Note 5. Business Combinations and Consolidation

During the fourth quarter of 2013, the Company, through a series of transactions with the minority owners of CorvisaCloud, acquired an additional 15% ownership stake in CorvisaCloud for a total purchase price of approximately $0.6 million. These transactions increased the Company's ownership interest in CorvisaCloud to 100% as of December 31, 2013.

Prior to 2013, Advent entered into a revolving note and revolving credit agreement with the Company whereby the noncontrolling members of Advent pledged their membership interests as security for Advent's obligations under the agreements. As a result of Advent's default under the agreements, during the second quarter of 2013 the Company foreclosed on the membership interests of the noncontrolling members in full satisfaction of Advent's outstanding intercompany debt obligations. At the time of foreclosure, Advent's noncontrolling members held approximately 22% of the outstanding membership interests. Therefore, the foreclosure raised the Company's ownership interest in Advent to 100% as of December 31, 2013. In accordance with the relevant accounting guidance, this debt extinguishment was treated as an equity transaction, reducing both additional paid in capital and Advent's noncontrolling interest deficit by approximately $1.9 million on a consolidated basis with no corresponding gain or loss recognized in the condensed consolidated statement of operations.

Note 6. Mortgage Securities

As of March 31, 2014 and December 31, 2013, mortgage securities consisted entirely of the Company's investment in the residual securities issued by securitization trusts sponsored by the Company and classified as available-for-sale. Residual securities consist of interest-only, prepayment penalty and overcollateralization bonds. See Note 11 to the condensed consolidated financial statements for details on the Company's fair value methodology.

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The following table presents certain information on the Company's portfolio of mortgage securities – available-for-sale as of March 31, 2014 and December 31, 2013 (dollars in thousands):



	Cost Basis		Unrealized Gain		Estimated Fair Value		Average Yield (A)
March 31, 2014	$	590	$	2,876	$	3,466	122.0	%
December 31, 2013	625		3,103		3,728		116.3


(A)	The average yield is calculated from the cost basis of the mortgage securities and does not give effect to changes in fair value that are reflected as a component of shareholders' equity (deficit).

There were no other-than-temporary impairments relating to mortgage securities – available-for-sale for the three months ended March 31, 2014 and 2013. Maturities of mortgage securities owned by the Company depend on repayment characteristics and experience of the underlying financial instruments.

The following table relates to the securitizations where the Company retained an interest in the assets issued by the securitization trust, a variable interest entity or VIE (dollars in thousands):



	Size/Principal Outstanding (A)		Assets on Balance Sheet (B)		Liabilities on Balance Sheet		Maximum Exposure to Loss(C)		Year to Date Loss on Sale		Year to Date Cash Flows (D)
March 31, 2014	$	4,701,370	$	3,466	$	—	$	3,466	$	—	$	1,821
December 31, 2013	4,811,987		3,728		—		3,728		—		909


(A)	Size/principal outstanding reflects the estimated principal of the underlying assets held by the VIE.


(B)	Assets on balance sheet are securities issued by the entity and are recorded in the mortgage securities line item of the condensed consolidated balance sheets.


(C)	The maximum exposure to loss includes the assets held by the Company and assumes a total loss on the referenced assets held by the VIE.


(D)	Year to date cash flows are for the three months ended March 31, 2014 and 2013, respectively.

Note 7. Property and Equipment, Net

All of the Company's property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets. The estimated useful lives of the Company's property and equipment are the lesser of 5 years or remaining lease term for leasehold improvements, 5 years for furniture and fixtures, 3 to 5 years for office and computer equipment, and 3 years for software.

Maintenance and repairs are charged to expense. Major renewals and improvements are capitalized. Gains and losses on dispositions are credited or charged to earnings as incurred. Depreciation and amortization expense relating to property and equipment was $0.6 million and $1.2 million for the three months ended March 31, 2014 and 2013, respectively.

The following table shows the Company's property and equipment, net as of March 31, 2014 and December 31, 2013 (dollars in thousands):



	March 31, 2014			December 31, 2013
Furniture, fixtures and office equipment	$	1,168		$	1,187
Hardware and computer equipment	4,026			3,924
Software	7,624			7,373
Leasehold improvements	1,236			1,238
Total Cost	14,054			13,722
Less: Accumulated depreciation and amortization	(9,275		)	(8,797		)
Property and equipment, net	$	4,779		$	4,925

The hardware and computer equipment amount above includes gross assets under capital leases of $1.3 million as of both March 31, 2014 and December 31, 2013. Accumulated depreciation and amortization relating to these assets totaled approximately $0.7 million and $0.5 million as of March 31, 2014 and December 31, 2013, respectively.

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Note 8. Goodwill

As of both March 31, 2014 and December 31, 2013, goodwill totaled $3.2 million, the entire amount of which represents the goodwill assigned to the Appraisal Management reporting unit. There was no goodwill activity for the three months ended March 31, 2014 and 2013.

Goodwill is tested for impairment at least annually as of November 30, or when events or circumstances suggest that an impairment may exist. In September 2011, the FASB approved changes to the goodwill impairment guidance, which amended the previous guidance to allow Companies the option of performing a qualitative assessment before completing step one of the two-step impairment test. If, on the basis of the qualitative factors, the Company determines that it is more likely than not that the fair value of the reporting unit is greater than its carrying amount, the two-step impairment test is not required. If, however, the Company determines that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the Company is required to test goodwill for impairment using the two-step impairment test.

The two-step impairment test begins with an estimation of fair value. The first step compares the estimated fair value of the reporting unit to its carrying amount, including goodwill. If the estimated fair value exceeds its carrying amount, goodwill is not considered impaired. However, if the carrying amount of the reporting unit exceeds its estimated fair value, a second step is performed, comparing the implied fair value to the carrying amount of goodwill. An impairment loss is recorded in the consolidated statement of operations to the extent that the carrying amount of goodwill exceeds its implied fair value.

For tax purposes, goodwill is included in the Company's basis in its investment in StreetLinks as StreetLinks is a limited liability company. Therefore, it will be non-deductible for tax purposes as long as the Company holds its investment.

Note 9. Borrowings

Senior Notes – The Company has outstanding unsecured senior notes pursuant to three indentures (collectively, the “Senior Notes”) with an aggregate principal balance of $85.9 million. The Senior Notes were created through an exchange of the Company's previously outstanding junior subordinated notes that occurred prior to 2012. This exchange was considered a modification of a debt instrument for accounting purposes, therefore the Company uses the effective interest method to accrete from the existing balances of $84.4 million and $83.9 million as of March 31, 2014 and December 31, 2013, respectively to the aggregate principal balance of $85.9 million.

The Senior Notes accrue interest at a rate of 1.0% until the earlier of (a) the completion of an equity offering by the Company or its subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”). Interest on the Senior Notes is paid on a quarterly basis and no principal payments are due until maturity on March 30, 2033.

The indentures governing the Senior Notes (the “Indentures”) contain certain restrictive covenants (the “Negative Covenants”) subject to certain exceptions in the Indentures, including written consent of the holders of the Senior Notes. The Negative Covenants prohibit the Company and its subsidiaries, from among other things, incurring debt, permitting any lien upon any of its property or assets, making any cash dividend or distribution or liquidation payment, acquiring shares of the Company or its subsidiaries, making payment on debt securities of the Company that rank pari passu or junior to the Senior Notes, or disposing of any equity interest in its subsidiaries or all or substantially all of the assets of its subsidiaries. The Negative Covenants remain in effect until both of the following conditions are met: 1) the Senior Notes begin accruing interest at the Full Rate, and 2) the Company satisfies certain financial covenants (the “Financial Covenants”). Satisfaction of the Financial Covenants requires the Company to demonstrate on a consolidated basis that (1) its Tangible Net Worth is equal to or greater than $40 million, and (2) either (a) the Interest Coverage Ratio is equal to or greater than 1.35x, or (b) the Leverage Ratio is not greater than 95%. As the Senior Notes were not accruing interest at the Full Rate, the Negative Covenants, as defined above, were still in effect as of March 31, 2014 and December 31, 2013. Compliance with the Financial Covenants is required only when the Company seeks to take action prohibited by the Negative Covenants that has not been approved by the holders of the Senior Notes.

As discussed in Note 3, the Company and the non-controlling members of StreetLinks entered into a purchase and sale agreement with Assurant, pursuant to which Assurant purchased 100% of the outstanding membership units of StreetLinks. The sale of a subsidiary is not prohibited by the Negative Covenants, provided that the sale is at fair market value and the proceeds are reinvested in the Company. As such, the Company was in compliance with all Negative Covenants as of March 31, 2014 and December 31, 2013, and therefore the Company was under no obligation to comply with the Financial Covenants during these periods.

Note Payable to Related Party – Prior to 2013, the Company entered into a Membership Interest Purchase Agreement (the "Unit Purchase Agreement") with its Chief Operating Officer, Mr. Steve Haslam, whereby Mr. Haslam sold 1,927 units in StreetLinks to the Company in exchange for $6.1 million. Through March 31, 2014, the Company has made approximately $2.2 million of principal payments under the Unit Purchase Agreement. The remainder of this obligation is payable as follows: $0.3 million on the last day of each quarter until March 8, 2016, on which date the unpaid principal balance of $1.6 million is to be

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paid, plus interest on the unpaid balance at the rate of 4.0% per annum, compounded quarterly. The Company's obligation is secured by the proportional StreetLinks' interest purchased.

As of March 31, 2014, the Company had not made the principal payments due December 31, 2013 and March 31, 2014, and therefore the associated payments totaling $0.5 million are included as a current liability in the note payable to related party line item as of March 31, 2014.

As detailed in Note 3, subsequent to quarter end, the Company and Mr. Haslam agreed to terminate the Unit Purchase Agreement. In full satisfaction of the Company's outstanding obligation under the Unit Purchase Agreement, the Company transferred back to Mr. Haslam 1,218 StreetLinks membership units, 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.

Capital Leases – The Company leases hardware and computer equipment under capital leases. These capital leases are payable in 36 monthly installments and mature between August 2014 and March 2017. Current maturities of obligations under capital leases were approximately $0.4 million as of both March 31, 2014 and December 31, 2013. Noncurrent maturities of obligations under capital leases were approximately $0.3 million and $0.4 million, as of March 31, 2014 and December 31, 2013, respectively. Due to the immaterial nature of these obligations with regard to the Company's financial statements as a whole, current maturities and noncurrent maturities of capital leases are included in the other current liabilities and other liabilities line items, respectively, in the Company's condensed consolidated balance sheets.

Note 10. Commitments and Contingencies

Contingencies – The Company has received indemnification and loan repurchase demands with respect to alleged violations of representations and warranties (“defects”) made in loan sale and securitization agreements. These demands have been received substantially beginning in 2006 and have continued into 2014. 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 a loan due to missing documentation or breaches of representations or warranties made in sale documents that materially adversely affected the value of the loan. Beginning in 1997 and ending in 2007, affiliates of the Company sold loans to securitization trusts and third parties with the potential of such repurchase 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. Between 2011 and 2014, the Company received claims to repurchase loans with original principal balances of approximately $31.2 million. These claims have not been acknowledged as valid by the Company. In some cases, claims were made against affiliates of the Company that have ceased operations and have no or limited assets. The Company has not repurchased any loans between 2011 and 2014.

Historically, repurchases of loans or indemnification of losses where a loan defect has been alleged have been insignificant and any future losses for alleged loan defects have not been deemed to be probable or reasonably estimable; therefore, the Company has recorded no reserves related to these claims. The Company does not use internal groupings for purposes of determining the status of these loans. The Company is unable to develop an estimate of the maximum potential amount of future payments related to repurchase demands because the Company does not have access to information relating to loans sold and securitized and the number or amount of claims deemed probable of assertion is not known nor is it reasonably estimated. Further, the validity of claims received remains questionable. Also, considering that the Company completed its last sale or securitization of loans during 2007, the Company believes that it will be difficult for a claimant to successfully validate any additional repurchase demands. Management does not expect that the potential impact of claims will be material to the Company's financial statements.

Pending Litigation – The Company is a party to various legal proceedings. Except as set forth below, these proceedings are of an ordinary and routine nature.

Although it is not possible to predict the outcome of any legal proceeding, in the opinion of management, other than the active proceedings described in detail below, proceedings and actions against the Company should not, individually, or in the aggregate, have a material effect on the Company's financial condition, operations and liquidity. Furthermore, due to the uncertainty of any potential loss as a result of pending litigation and due to the Company's belief that an adverse ruling is not probable, the Company has not accrued a loss contingency related to the following matters in its consolidated financial statements. However, a material outcome in one or more of the active proceedings described below could have a material impact on the results of operations in a particular quarter or fiscal year.

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sections 11, 12 and 15 of the Securities Act of 1933, as amended, by making allegedly false statements regarding mortgage loans that served as collateral for securities purchased by the plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss the plaintiff's claims, which the court granted on March 31, 2011, with leave to amend. The plaintiff filed a second amended complaint on May 16, 2011, and the Company again filed a motion to dismiss. On March 29, 2012, the court dismissed the plaintiff's second amended complaint with prejudice and without leave to replead. The plaintiff filed an appeal. On March 1, 2013, the appellate court reversed the judgment of the lower court, which had dismissed the case. Also, the appellate court vacated the judgment of the lower court which had held that the 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 the 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. Given the early stage of the litigation, the Company cannot provide an estimate of the range of any loss. The Company believes that the affiliated defendants have meritorious defenses to the case and expects them to defend the case vigorously.

On June 20, 2011, the National Credit Union Administration Board, as liquidating agent of U.S. Central Federal Credit Union, filed an action against NMFC and numerous other defendants in the United States District Court for the District of Kansas, claiming that the defendants issued or underwrote residential mortgage-backed securities pursuant to allegedly false or misleading registration statements, prospectuses, and/or prospectus supplements. On October 12, 2011, the complaint was served on NMFC. On December 20, 2011, NMFC filed a motion to dismiss the plaintiff's complaint and to strike certain paragraphs of the complaint. On July 25, 2012, the court granted the motion in part and denied the motion in part. The plaintiff was granted leave to amend the complaint. On August 24, 2012, the plaintiff filed an amended complaint making essentially the same claims against NMFC. On October 29, 2012, NMFC filed a motion to dismiss the amended complaint. The defendants had claimed that 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 oral argument on the appeal occurred May 8, 2013. On August 27, 2013, the Tenth Circuit affirmed the lower court’s denial of defendants’ motion to dismiss the plaintiff’s claims as being time barred; the appellate court held that the Extender Statute, 12 U.S.C. §1787(b)(14) applied to plaintiff’s claims. On September 12, 2013, the lower court denied NMFC’s motion to dismiss the amended complaint against NMFC. This litigation is in an early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that NMFC has meritorious defenses to the case and expects it to defend the case vigorously.

On February 28, 2013 the Federal Housing Finance Agency, as conservator for the Federal Home Loan Mortgage Corporation (Freddie Mac) and 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, County of New York against Novation Companies, Inc. and NovaStar Mortgage, Inc. ("NMI"), a wholly-owned subsidiary of the Company. The notice provides that this is a breach of contract action with respect to certain, unspecified mortgage loans and defendant's failure to repurchase such loans under the applicable agreements. Plaintiff alleges that defendants, from the closing date of the transaction that created the Trust that mortgage loans that were sold to the Trust, were aware of the breach of the representations and warranties made and failed to notice 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; and indemnification (indemnification against NMI only). 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. This litigation is in an early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that it has meritorious defenses to the case and expects to defend the case vigorously.

Note 11. 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.

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•Level 3 – Valuations based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies based on internal cash flow forecasts.

The following tables present for each of the fair value hierarchy levels, the Company's assets which are measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013 (dollars in thousands):



			Fair Value Measurements at Reporting Date Using
Description	Fair Value at March 31, 2014		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Mortgage securities – available-for-sale	$	3,466	$	—	$	—	$	3,466



			Fair Value Measurements at Reporting Date Using
Description	Fair Value at December 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Mortgage securities – available-for-sale	$	3,728	$	—	$	—	$	3,728

Valuation Methods and Processes

The Company estimates the fair value of all items subject to fair value accounting using present value techniques and generally does not have the option to choose other valuation techniques for these items. There have been no significant changes to the Company's financial statements as a result from changes to the Company's valuation techniques during the three months ended March 31, 2014.

An independent entity has been engaged to prepare projected future cash flows of the Company's mortgage securities for each reporting period (quarterly) used by management to estimate fair value. The Company's internal finance and accounting staff reviews and monitors the work of the independent entity, including analysis of the assumptions used, retrospective review and preparing an overall conclusion of the value and process. All other fair value analysis, consisting of simple cash flow estimates and discounting techniques, is conducted internally by the Company's internal financial staff. The Company's fair value process is conducted under the supervision of the Chief Financial Officer.

Mortgage securities – available-for-sale – Mortgage securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. To the extent that the cost basis of mortgage securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. The specific identification method is used in computing realized gains or losses. The Company uses the discount rate methodology for determining the fair value of its residual securities. The fair value of the residual securities is estimated based on the present value of future expected cash flows to be received. Management's best estimate of key assumptions, including credit losses, prepayment speeds, forward yield curves and discount rates commensurate with the risks involved, are used in estimating future cash flows.

The following table presents certain quantitative information about the significant unobservable inputs used in the fair value measurement for items measured at fair value on a recurring basis using significant unobservable inputs (Level 3):




Description	Valuation Techniques	Significant Unobservable Inputs	Range
Assets:
Mortgage securities – available-for-sale	Present value analysis	Prepayment rates	3.4% – 13.5%
		Weighted average life (years)	2.0 – 2.0

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As discussed in Note 6 to the condensed consolidated financial statements, the Company's mortgage securities – available-for-sale, are measured at fair value. These securities are valued at each reporting date using significant unobservable inputs (Level 3) by discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The Company has no other assets measured at fair value.

The significant unobservable inputs used in the fair value measurement of mortgage securities – available-for-sale are prepayment rates and the weighted average life for the underlying mortgage loan collateral. Using a faster (higher) estimated prepayment rate would decrease the value of the securities. The Company uses a weighted average life of 2 years from the reporting date for the expected future estimated cash flows. The future cash flows are highly-dependent upon the performance of the underlying collateral of mortgage loans. The nonperformance risk associated with the collateral is the key reason the Company utilizes such a short weighted average life in its calculation. Assuming a shorter weighted average life would decrease the estimated value of the mortgage securities. Alternatively, assuming a longer weighted average life would increase the estimated value of the mortgage securities.

The following table provides a reconciliation of the beginning and ending balances for the Company's mortgage securities – available-for-sale, which are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2014 and 2013 (dollars in thousands):



	For the Three Months Ended March 31,
	2014			2013
Balance, beginning of period	$	3,728		$	3,906
Increases (decreases) to mortgage securities – available-for-sale:
Accretion of income (A)	193			280
Proceeds from paydowns of securities (A)	(228		)	(272		)
Mark-to-market value adjustment	(227		)	(619		)
Net decrease to mortgage securities – available-for-sale	(262		)	(611		)
Balance, end of period	$	3,466		$	3,295


(A)	Cash received on mortgage securities with no cost basis was $1.6 million and $0.6 million for the three months ended March 31, 2014 and 2013, respectively.

In conjunction with the acquisition of Corvisa, LLC in 2011, the Company is obligated to make up to $1.2 million in future contingent consideration payments to the former minority owners of Corvisa if revenues generated by the original Corvisa technology platform exceed agreed-upon revenue thresholds over the earn-out period, which ends June 30, 2014. Based on management's estimates of future revenues and actual revenues generated to date, the Company believes the likelihood of future payment to be remote. As such, the condensed consolidated balance sheets as of both March 31, 2014 and December 31, 2013 include no accrual for loss related to this obligation and therefore no reconciliation of the beginning and ending balances for the three months ended March 31, 2014 is included herein. The following table provides a reconciliation of the beginning and ending balances for the Company's contingent consideration liability, which was measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2013 (dollars in thousands):



	For the Three Months Ended March 31,
	2013
Balance, beginning of period	$	1,099
Fair value adjustment	(79		)
Balance, end of period	$	1,020

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The following table provides a summary of the impact to earnings for the three months ended March 31, 2014 and 2013 from adjustments to those Company's assets and liabilities measured at fair value on a recurring and nonrecurring basis (dollars in thousands):



		Fair Value Adjustments
		For the Three Months Ended March 31,
Asset or Liability Measured at Fair Value	Fair Value Measurement Frequency	2014		2013			Statement of Operations Line Item Impacted
Contingent consideration (A)	Recurring	—		(79		)	Other income
Total fair value gains (B)		$	—	$	(79	)

(A)

The contingent consideration represents the estimated fair value of the additional potential earn-out opportunity payable in connection with the acquisition of Corvisa that is contingent and based upon certain future earnings targets. As the likelihood of future payment is deemed to be remote, the condensed consolidated balance sheets as of both March 31, 2014 and December 31, 2013 include no accrual for loss related to this obligation.


(B)	The Company did not have any impairments relating to mortgage securities – available-for-sale or the three months ended March 31, 2014 and 2013.

The following disclosure of the estimated fair value of financial instruments presents amounts that have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimation methodologies could have a material impact on the estimated fair value amounts. The fair value of short-term financial assets and liabilities, such as service fees receivable, notes receivable, and accounts payable and accrued expenses are not included in the following table as their fair value approximates their carrying value.

The estimated fair values of the Company's financial instruments are as follows as of March 31, 2014 and December 31, 2013 (dollars in thousands):



	As of March 31, 2014				As of December 31, 2013
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:
Restricted cash	$	2,567	$	1,752	$	2,566	$	1,667
Mortgage securities – available-for-sale	3,466		3,466		3,728		3,728
Financial liabilities:
Senior notes	$	84,406	$	12,815	$	83,867	$	13,119
Note payable to related party	3,863		3,007		3,863		2,880

For the items in the table above not measured at fair value in the statement of financial position but for which the fair value is disclosed, the fair value has been estimated using Level 3 methodologies, based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow calculations based on internal cash flow forecasts. No assets or liabilities have been transferred between levels during any period presented.

Restricted cash – The fair value of restricted cash was estimated by discounting estimated future release of the cash from restriction.

Senior notes – The fair value is estimated by discounting future projected cash flows using a discount rate commensurate with the risks involved. The value of the Senior Notes was calculated assuming that the Company would be required to pay interest at a rate of 1.0% per annum until January 2016, at which time the Company would be required to start paying the Full Rate of three-month LIBOR plus 3.5% until maturity in March 2033. The three-month LIBOR used in the analysis was projected using a forward interest rate curve.

Note payable to related party – The fair value of the note payable to related party is estimated by discounting future projected principal and interest payment cash flows using a discount rate commensurate with the risks involved. As of March 31, 2014, the future projected interest payments were calculated assuming the stated rate of 4.0% per annum until maturity in March 2016.

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Note 12. Income Taxes

Income tax expense from continuing operations was approximately $1.1 million for the three months ended March 31, 2013 for an effective tax rate of 46.0%. Income tax expense from continuing operations was not material for 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, which is discussed further below.

During 2013, the Company determined that it was no longer more likely than not that it will recognize a portion of its deferred tax assets. Therefore, as of both March 31, 2014 and December 31, 2013, the Company maintained a full valuation allowance against its deferred tax assets of $282.8 million and $283.0 million, respectively. The Company's determination of the extent to which its deferred tax assets will be realized 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.

As of March 31, 2014 and December 31, 2013, the total gross amount of unrecognized tax benefits was $0.8 million and $0.7 million, respectively. These amounts also represent the total amount of unrecognized tax benefits that would impact the effective tax rate in the respective periods. The Company anticipates an additional reduction of the unrecognized tax benefits in the amount of $0.6 million due to the lapse of statute of limitations in the next twelve months.

Note 13. Segment Reporting

During the fourth quarter of 2013, the Company changed its segment reporting structure by including Cloud Software as a Service ("Cloud SaaS") as a separate operating unit. Historically, this segment has been aggregated with the Corporate operating segment based on the immaterial nature of its operations. Prior period comparatives have not been updated to reflect this change in segmentation as the operating results for this subsidiary were not material to the financial statements as a whole for the three months ended March 31, 2013.

The Company reviews, manages and operates its business in four segments: Corporate, Appraisal Management, Financial Intermediary, and Cloud SaaS. Corporate operating results include mortgage securities retained from securitizations, corporate general and administrative expenses, and, for 2013 only, the operating results of CorvisaCloud, as these results were not significant during the three months ended March 31, 2013. Appraisal Management operations include the service fee income and related expenses from the Company's majority-owned subsidiary, StreetLinks. The Financial Intermediary segment consists of the financial settlement service fee income and related expenses from a wholly-owned subsidiary of the Company, Advent. The Cloud SaaS segment represents service fee income and related expenses from the Company's wholly-owned subsidiary, CorvisaCloud. Management evaluates segment performance based on income before income taxes, which is prior to the allocation of losses attributable to the noncontrolling interests.

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The following is a summary of the operating results of the Company's segments for the three months ended March 31, 2014 and 2013 and a summary of their financial positions as of March 31, 2014 and December 31, 2013 (dollars in thousands):



	Corporate			Appraisal Management		Financial Intermediary		Cloud SaaS			Eliminations			Discontinued Operations (C)		Total
For the Three Months Ended March 31, 2014
Service fee income	$	2,690		$	23,884	$	6,881	$	852		$	(2,752	)	$	—	$	31,555
Interest income	1,797			—		—		—			(11		)	—		1,786
Interest expense	795			6		—		9			(11		)	—		799
Depreciation and amortization expense (A)	253			188		44		99			—			—		584
(Loss) income from continuing operations before income tax expense	(813		)	379		2,604		(1,379		)	—			—		791
Additions to long-lived assets (D)	132			27		38		246			—			—		443

As of March 31, 2014
Total assets (B)	$	24,759		$	13,211	$	5,539	$	2,268		$	(7,984	)	$	—	$	37,793


(A)	Amounts related to continuing operations are included in the cost of services and selling, general and administrative expense line items of the condensed consolidated statements of operations, while amounts related to discontinued operations are included in the (loss) income from discontinued operations, net of income taxes.


(B)	Appraisal Management segment includes goodwill of $3.2 million resulting from the acquisition of StreetLinks.


(C)	See Note 4 for additional information regarding the financial position and operating results of discontinued operations.


(D)	Amount includes assets acquired under capital leases.



	Corporate			Appraisal Management		Financial Intermediary		Eliminations			Discontinued Operations (C)		Total
For the Three Months Ended March 31, 2013
Service fee income	$	2,202		$	41,145	$	6,620	$	(2,105	)	$	—	$	47,862
Interest income	1,179			—		—		(262		)	—		917
Interest expense	784			10		256		(262		)	—		788
Depreciation and amortization expense (A)	183			534		59		—			394		1,170
(Loss) income from continuing operations before income tax benefit	(1,101		)	2,528		1,285		(229		)	—		2,483
Additions to long-lived assets	853			40		78		—			38		1,009

As of December 31, 2013
Total assets (B)(D)	$	25,535		$	13,034	$	3,983	$	(8,510	)	$	—	$	34,042


(A)	Amounts related to continuing operations are included in the cost of services and selling, general and administrative expense line items of the condensed consolidated statements of operations, while amounts related to discontinued operations are included in the (loss) income from discontinued operations, net of income taxes.


(B)	Appraisal Management segment includes goodwill of $3.2 million resulting from the acquisition of StreetLinks.


(C)	See Note 4 for additional information regarding the financial position and operating results of discontinued operations.


(D)	Corporate segment includes Cloud SaaS assets of $1.9 million as of December 31, 2013.

The intersegment service fee income for the three months ended March 31, 2014 includes fees charged by the Corporate segment to the Appraisal Management, Financial Intermediary, and Cloud SaaS segments for operational support provided by the Corporate segment's employees. The intersegment interest income and interest expense consists of interest charged by the Corporate segment to the Appraisal Management, Financial Intermediary, and Cloud SaaS segments for borrowings. For the three months ended March 31, 2013, intersegment service fee income and interest amounts also include fees charged to the Logistics segment.

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Note 14. Earnings per Share

Basic earnings per share is computed by dividing net earnings available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share include the effect of conversions of stock options and nonvested shares. The computations of basic and diluted earnings per share for the three months ended March 31, 2014 and 2013 (dollars in thousands, except share and per share amounts) are as follows:



	For the Three Months Ended March 31,
	2014		2013
Numerator:
Net income from continuing operations	$	763	$	1,345
Loss from discontinued operations	—		(690		)
Net income	763		655
Less net income (loss) attributable to noncontrolling interests	33		(101		)
Net income available to common shareholders	$	730	$	756

Denominator:
Weighted average common shares outstanding – basic	90,866,933		90,716,933

Weighted average common shares outstanding – dilutive:
Weighted average common shares outstanding – basic	90,866,933		90,716,933
Stock options	—		157,195
Nonvested shares	—		245,821
Weighted average common shares outstanding – dilutive	90,866,933		91,119,949

Basic earnings per share:
Net income from continuing operations	$	0.01	$	0.02
Loss from discontinued operations	—		(0.01		)
Net income	0.01		0.01
Less net income (loss) attributable to noncontrolling interests	—		—
Net income available to common shareholders	$	0.01	$	0.01

Diluted earnings per share:
Net income from continuing operations	$	0.01	$	0.02
Loss from discontinued operations	—		(0.01		)
Net income	0.01		0.01
Less net income (loss) attributable to noncontrolling interests	—		—
Net income available to common shareholders	$	0.01	$	0.01

The following weighted-average options to purchase shares of Common Stock were outstanding during each period presented, but were not included in the computation of diluted earnings per share because the calculated number of shares assumed to be repurchased was greater than the number of shares to be obtained upon exercise, therefore, the effect would be antidilutive (in thousands, except exercise prices):



	For the Three Months Ended March 31,
	2014		2013
Number of stock options	8,492		7,987
Weighted average exercise price of stock options	$	0.68	$	0.70

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During the three months ended March 31, 2013, the Company granted 0.6 million options to purchase shares of Common Stock at a weighted average exercise price of $0.53. The weighted average impact of 0.1 million is included in the table above for the three months ended March 31, 2013. There were no options granted during the three months ended March 31, 2014.

The Company had approximately 0.6 million and 0.8 million nonvested shares outstanding as of March 31, 2014 and March 31, 2013, respectively, which have original cliff vesting schedules ranging between five and ten years. Of these, the weighted average impact of approximately 0.6 million and 0.5 million nonvested shares were not included in the calculation of earnings per share for the three months ended March 31, 2014 and 2013, respectively, because they were anti-dilutive.

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

Significant Recent Events

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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

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.

Following is an analysis of the results of operations from the Appraisal Management segment.

Table 2 – Appraisal Management Segment Operations (dollars in thousands, except unit amounts)



	For the Three Months Ended March 31,
	2014				2013
	Total		%		Total			%
Service fee income:
Full service appraisal management	$	22,994	96.3	%	$	40,402		98.2	%
Other valuation services and transactions	364		1.5		380			0.9
Automated examination and valuation services	526		2.2		363			0.9
Total service fee income	23,884		100.0		41,145			100.0

Cost of services	20,638		86.4		35,404			86.0
Selling, general and administrative expense and other	2,882		12.1		3,134			7.6
Total expenses	23,520		98.5		38,538			93.7

Other income (expense), net	15		0.1		(79		)	(0.2	)

Net income before income taxes	$	379	1.6	%	$	2,528		6.1	%

Completed orders:
Full service appraisal management	56,905				99,994
Other valuation services and transactions	22,742				22,974
Automated examination and valuation services	39,778				25,542

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Service Fee Income

Service fee income in the Appraisal Management segment decreased to $23.9 million during the three months ended March 31, 2014 from $41.1 million during the three months ended March 31, 2013. The decrease in service fee income for the full service appraisal management product line for the three months ended March 31, 2014 was directly attributable to the decline in completed order volume period over period. Completed order volume was impacted by higher mortgage rates during the three months ended March 31, 2014 when compared to the three months ended March 31, 2013.

Cost of Services

Cost of services totaled $20.6 million for the three months ended March 31, 2014 compared to $35.4 million for the same period in 2013. This decrease was attributable to declines in direct costs to appraisers as the completed order volume has declined. Further, as order volume declines, the Company reduces related production costs, primarily compensation-related costs.

Selling, General and Administrative

Selling, general and administrative expenses decreased slightly to $2.9 million from $3.1 million for the three months ended March 31, 2014 and 2013, respectively. This decrease is due primarily to declines in performance-based compensation costs, such as commissions and bonuses.

Other Income (Expense)

Other income (expense) was not material for the three months ended March 31, 2014. For the three months ended March 31, 2013, other income (expense) is comprised entirely of the fair value adjustment for the Corvisa contingent consideration obligation. For additional information regarding this obligation and the related fair value adjustment, see Note 11 to the condensed consolidated financial statements.

Financial Intermediary

We earn fees for providing financial settlement services for income tax preparation businesses and consumers. Settlement services are facilitated through arrangements we have made with other independent financial service providers, including our bank partners and data exchange managers. Settlement services consist mainly of collecting income tax refunds on behalf of our customers, distributing fees to independent service providers and delivering the refund, net of fees, to the individual taxpayer. As the majority of our business is directly related to income tax refunds, a significant portion of the financial intermediary's operations occur during the first quarter of each year.

Although we are not a bank, we provide access to tailored banking accounts and related services via our prepaid debit card designed to meet the needs of low and moderate-income level individuals. We earn additional service fee income based on the customers' account activity. Cost of Services includes the direct cost related to providing services, which includes fees to third-party vendors performing services on our behalf. Additionally, internal costs directly associated with completing our services are included in Cost of Services. The internal costs include compensation and benefits of employees, office administration, depreciation of equipment used in the production process, and other expenses necessary to complete services performed.

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Following is an analysis of the results of operations from the Financial Intermediary segment.

Table 3 – Financial Intermediary Segment Operations (dollars in thousands, except unit amounts)



	For the Three Months Ended March 31,
	2014				2013
	Total		%		Total			%
Service fee income:
Settlement	$	5,863	85.2	%	$	5,609		84.7	%
Bank account distribution	1,018		14.8		1,011			15.3
Total service fee income	6,881		100.0		6,620			100.0

Cost of services	3,036		44.1		3,685			55.7
Selling, general and administrative expense	1,259		18.3		1,373			20.7
Total expenses	4,295		62.4		5,058			76.4

Other income (expense), net	18		0.2		(21		)	(0.3	)
Interest expense - NCI	—		—		(256		)	(3.9	)

Net income before income taxes	$	2,604	37.8	%	$	1,285		19.4	%

Settlements of federal income tax refunds (A)	343,594				382,767
Bank accounts enrolled (B)	54,549				63,509


(A)	Advent processes both federal and state income tax refunds. However, many taxpayers have no state refund and others may have more than one state tax refund. For this analysis, the number of state refunds have not been included. The number of federal income tax refunds generally represents the number of individual taxpayers using Advent services.


(B)	Includes all accounts opened regardless of whether the account was used and/or generated fees.

Service Fee Income

Service fee income in the Financial Intermediary segment increased from $6.6 million for the three months ended March 31, 2013 to $6.9 million for the three months ended March 31, 2014 despite a decrease in settlement volume over the same period. This was driven primarily by a decline in the per unit impact of rebates and other incentives offered by the Company, which are netted against service fee income in accordance with the applicable accounting guidance. The decline in the per unit impact is simply a function of favorable changes in these programs period over period.

Cost of Services

Costs of services decreased to $3.0 million from $3.7 million for the three months ended March 31, 2014 and 2013, respectively. This decrease was due primarily to declines in settlement volume coupled with more favorable pricing terms with our third party service providers when compared to the three months ended March 31, 2013.

Selling, General and Administrative

Selling, general and administrative expenses primarily include costs to administer settlement programs, including compensation and related expenses for non-production staff, professional service fees, and IT support costs. For the three months ended March 31, 2014, selling, general and administrative expenses decreased slightly to $1.3 million from $1.4 million for the three months ended March 31, 2013. This decrease was driven primarily by a decline in professional services fees period over period.

Interest Expense

The decline in interest expense period over period is due to the forgiveness of Advent's intercompany debt obligations during the second quarter of 2013 in exchange for the remaining noncontrolling ownership interests. See Note 5 to the condensed consolidated financial statements for additional discussion regarding this transaction.

Cloud SaaS

We earn call center technology fees through software licenses, inbound and outbound minute usage, ancillary fees, and implementation services. Once implemented, clients pay a software as a service (SaaS) fee for a contact center seat license or PBX license, as well as a per minute fee for inbound and outbound minutes used. Minute fees can also be generated from the

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use of our interactive voice response software. Cost of Services represents both the direct and other costs of providing these services, including but not limited to software development, fees to third party telecommunications carriers, compensation-related expenses, and other expenses necessary to complete services performed.

We earn professional service fees for providing CRM implementation, support and administrative services to our clients. Cost of Services includes the direct costs of providing these services, which consist primarily of compensation-related expenses.

Following is an analysis of the results of operations from the Cloud SaaS segment.

Table 4 – Cloud SaaS Segment Operations (dollars in thousands, except unit amounts)



	For the Three Months Ended March 31,
	2014
	Total			%
Service fee income:
Professional services	$	572		67.1	%
Call center technology	280			32.9	%
Total service fee income	852			100.0

Cost of services	1,130			132.6
Selling, general and administrative expense	1,092			128.2
Total expenses	2,222			260.8

Other expense, net	(9		)	(1.1	)

Net loss before income taxes	$	(1,379	)	(161.9	)%

Service Fee Income

Service fee income in the Cloud SaaS segment totaled $0.9 million during the three months ended March 31, 2014. Service fee income was comprised primarily of professional service fees related to implementations of third party CRM software. In addition to being a significant source of revenue for CorvisaCloud during the current quarter and for the foreseeable future, these implementation services are expected to serve as a lead source for CorvisaCloud's CorvisaOne™ product, which was launched during the fourth quarter of 2013.

Cost of Services

Cost of services totaled $1.1 million for the three months ended March 31, 2014. This amount consists of the direct costs of providing professional and other services, in addition to other compensation-related expenses, depreciation, software licenses, and IT support costs. As this segment is still in the early stages of development, Management continues to identify and explore opportunities to scale the business and improve the efficiency of operations with the intent to generate positive margins.

Selling, General and Administrative

Selling, general and administrative expenses for the three months ended March 31, 2014 totaled $1.1 million. This amount is comprised primarily of compensation-related expenses and IT support costs, as the Company continues to develop, maintain and expand its IT infrastructure and support staff to accommodate the anticipated growth of this segment. As this segment is still in the early stages of development, selling, general and administrative expenses are significantly higher as a percentage of service fee income than we would anticipate going forward. As we continue to grow and develop this business, we anticipate this percentage will decline, as many of these costs should not increase proportionate to production.

Liquidity and Capital Resources

As of March 31, 2014, we had approximately $11.4 million in unrestricted cash and cash equivalents and $2.6 million of restricted cash, $1.0 million of which is included in the restricted cash line item of the condensed consolidated balance sheets and $1.6 million is included in the other noncurrent assets line item.

Our current projections indicate that sufficient cash and cash flows are and will be available to meet payment needs. However, our mortgage securities cash flows are volatile and uncertain, and the amounts we receive could vary materially from our

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projections though we believe that the increased cash flows from operations will offset any reduction in our mortgage securities cash flows. As discussed under the heading “Item 1. Legal Proceedings” of Part II of this report, we are the subject of various legal proceedings, the outcomes of which are uncertain. We may also face demands in the future that are unknown to us today related to our legacy lending and servicing operations. Management believes that its current operations and its cash availability are sufficient for the Company to discharge its liabilities and meet its commitments in the normal course of business.

The indentures governing the Senior Notes (the “Indentures”) contain restrictive covenants (the “Negative Covenants”) subject to exceptions in the Indentures, including written consent of the holders of the Senior Notes. The Negative Covenants prohibit NCI and its subsidiaries, from among other things, incurring debt, permitting any lien upon any of its property or assets, making any cash dividend or distribution or liquidation payment, acquiring our shares or equity in our subsidiaries, making payment on our debt securities that rank pari passu or junior to the Senior Notes, or disposing of any equity interest in our subsidiaries or all or substantially all of the assets of our subsidiaries. The Senior Notes accrue interest at a rate of 1.0% until the earlier of (a) the completion of an equity offering by NCI or our subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”). Interest on the Senior Notes is paid on a quarterly basis and no principal payments are due until maturity on March 30, 2033. The Negative Covenants remain in effect until both of the following conditions are met: 1) the Senior Notes begin accruing interest at the Full Rate, and 2) the Company satisfies certain financial covenants (the “Financial Covenants”). Satisfaction of the Financial Covenants requires the Company to demonstrate on a consolidated basis that (1) its Tangible Net Worth is equal to or greater than $40 million, and (2) either (a) the Interest Coverage Ratio is equal to or greater than 1.35x, or (b) the Leverage Ratio is not greater than 95%. As the Senior Notes were not accruing interest at the Full Rate, the Negative Covenants, as defined above, were still in effect as of March 31, 2014 and December 31, 2013. Compliance with the Financial Covenants is required only when the Company seeks to take action prohibited by the Negative Covenants that has not been approved by the holders of the Senior Notes.

There have been no significant changes to the Company's contractual obligations as presented in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Overview of Cash Flow for the Three Months Ended March 31, 2014

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 three months ended March 31, 2014 and 2013.

Table 5 – Summary of Operating, Investing and Financing Cash Flows (dollars in thousands)



	For the Three Months Ended March 31,
	2014			2013
Consolidated Statements of Cash Flows:
Cash provided by operating activities	$	2,371		$	6,171
Cash flows (used in) provided by investing activities	(165		)	69
Cash flows used in financing activities	(121		)	(469		)

Operating Activities

Cash provided by operating activities decreased to $2.4 million during the three months ended March 31, 2014 from $6.2 million over the same period in 2013. This decline is driven almost entirely by the operations of the Appraisal Management segment. More specifically, this decline is driven by the volume of customer/provider receipts/payments when comparing the three months ended March 31, 2014 to the three months ended March 31, 2013, which can be attributed to trends in completed order volume during these periods.

Investing Activities

The decrease in the net cash flows provided by investing activities is due primarily to declines in the cash received from paydowns of notes receivable, offset by declines in the cash outflows related to purchases of property and equipment and issuances of notes receivable.

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Financing Activities

The decrease in the net cash flows used in financing activities when comparing the three months ended March 31, 2014 and 2013 is due to a decrease in the distributions of excess capital, as determined in accordance with the StreetLinks operating agreement, to noncontrolling members of StreetLinks. The reduction in distributions of excess capital is simply a function of the decline in StreetLinks' earnings year over year. Further contributing to the decrease in cash flow is the payment activity on the note payable to related party.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As a smaller reporting company, we are not required to provide the information required by this Item.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company maintains a system of disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the federal securities laws, including this report, is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Company's principal executive officer and principal financial officer evaluated the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(d)) as of the end of the period covered by this report and concluded that the Company's controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There were no changes in our internal controls over financial reporting during the three months ended March 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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.

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”), a wholly-owned subsidiary of the Company, and its individual directors, several securitization trusts sponsored by the Company ("affiliated defendants") and several unaffiliated investment banks and credit rating agencies. The case was removed to the United States District Court for the Southern District of New York. On June 16, 2009, the plaintiff filed an amended complaint. The plaintiff seeks monetary damages, alleging that the defendants violated sections 11, 12 and 15 of the Securities Act of 1933, as amended, by making allegedly false statements regarding mortgage loans that served as collateral for securities purchased by the plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss the plaintiff's claims, which the court granted on March 31, 2011, with leave to amend. The plaintiff filed a second amended complaint on May 16, 2011, and the Company again filed a motion to dismiss. On March 29, 2012, the court dismissed the plaintiff's second amended complaint with prejudice and without leave to replead. The plaintiff filed an appeal. On March 1, 2013, the appellate court reversed the judgment of the lower court, which had dismissed the case. Also, the appellate court vacated the judgment of the lower court which had held that the 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 the 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. Given the early stage of the litigation, the Company cannot provide an estimate of the range of any loss. The Company believes that the affiliated defendants have meritorious defenses to the case and expects them to defend the case vigorously.

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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; and indemnification (indemnification against NMI only). On October 9, 2013, 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 Company and NMI filed a motion to dismiss the amended complaint. This litigation is in an early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that it has meritorious defenses to the case and expects to defend the case vigorously.

Item 1A. Risk Factors

Risk Factors

There have been no material changes to the risk factors previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2013.

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

(dollars in thousands, except per share amounts)



	Issuer Purchases of Equity Securities
	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (A)
January 1, 2014 - January 31, 2014	—	—	—	$	1,020
February 1, 2014 - February 28, 2014	—	—	—	$	1,020
March 1, 2014 - March 31, 2014	—	—	—	$	1,020


(A)	A current report on Form 8-K was filed on October 2, 2000 announcing that the Board of Directors authorized the Company to repurchase its common shares, bringing the total authorization to $9 million. The Company has repurchased $8.0 million to date, leaving approximately $1.0 million of shares that may yet be purchased under the plan.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

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Item 6. Exhibits

Exhibit Listing



Exhibit No.		Description of Document
31.1		Chief 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		Chief 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 March 31, 2014, formatted in XBRL (Extensible Business Reporting Language) includes: (i) Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013, (ii) Consolidated Statements of Operations for the three months ended March 31, 2014 and 2013, (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2014 and 2013, (iv) Consolidated Statements of Shareholders' Equity for the three months ended March 31, 2014 and 2013, (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013, and (vi) the Notes to Consolidated Financial Statements.

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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:	May 8, 2014	/s/ W. Lance Anderson
		W. Lance Anderson, Chairman of the Board of Directors and Chief Executive Officer
		(Principal Executive Officer)

DATE:	May 8, 2014	/s/ Rodney E. Schwatken
		Rodney E. Schwatken, Chief Financial Officer
		(Principal Financial Officer)

DATE:	May 8, 2014	/s/ Brett A. Monger
		Brett A. Monger, Vice President and Chief Accounting Officer
		(Principal Accounting Officer)