The following Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the consolidated
financial statements and the related notes thereto, which appear elsewhere
herein. Except for statements of historical facts, many of the matters discussed
in this Item 7 are considered "forward-looking" statements that reflect our
plans, estimates, and beliefs. Actual results could differ materially from those
discussed in the forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those discussed
below or elsewhere herein, including in Item 1A. Risk Factors, and under the
heading "Cautionary Statement Regarding Forward-Looking Statements."
Overview
We are a holding company owning and seeking to own subsidiaries engaged in a
variety of business operations. As of June 30, 2020, we had two existing
operating segments: (i) MCA operations, conducted primarily through our
subsidiary LMCS, and (ii) real estate operations, conducted through Recur and
its subsidiaries.
As of June 30, 2020, the Company holds an 80% interest in LMCS, with the
remaining 20% held by Old LuxeMark. Through LMCS, we manage a network of MCA
originators and syndicate participants who provide those originators with
capital by purchasing participation interests in or co-funding MCA transactions.
In addition, we provide loans to MCA originators, the proceeds of which are used
by the MCA originators to fund MCAs themselves. LMCS' daily operations are led
by the three principals of Old LuxeMark. CCUR provides operational, accounting,
and legal support to LMCS. On July 17, 2020, we entered into a series of
agreements with Old LuxeMark pursuant to which our interest in LMCS was reduced
from 80% to 51%. After the repayment of the outstanding balance of the Master
Promissory Note issued by LMCS to the Company, Old LuxeMark has the right to
purchase the remaining 51% equity interest in LMCS for nominal consideration. We
are reviewing our strategic options with respect to our continued participation
in the MCA industry.
25
Recur provides commercial loans to local, regional, and national builders,
developers, and commercial landowners and also acquires, owns, and manages a
portfolio of real property for development. Recur does not provide consumer
mortgages.
In addition to our MCA and real estate operating segments, we actively evaluate
acquisitions of additional businesses or operating assets, either as part of an
expansion of our current operating segments or establishment of a new operating
segment, in an effort to reinvest the proceeds of our calendar year 2017
business dispositions and maximize use of other assets such as our NOL
carryforwards. We may also seek additional capital and financing to support the
purchase of additional businesses and/or to provide additional working capital
to further develop our operating segments. We believe that these activities will
enable us to identify, acquire, and grow businesses and assets that will
maximize value for all our stockholders.
In support of the Company's goal of expanding its existing operations and
acquiring additional operating assets, we work with our external asset manager
to prudently invest the excess capital of the Company so that the capital of the
Company is preserved for future acquisitions, while also generating a return for
stockholders. Our external asset manager allocates the investment assets of the
Company while balancing the amount of liquid resources needed to continue to
expand and support our current operations. Our external asset manager has broad
investment authority to invest our excess capital resources in marketable debt
and equity securities and also assists in our acquisition strategy by
identifying potential acquisition targets.
Recent Events
The global outbreak of COVID-19 was declared a pandemic by the World Health
Organization and a national emergency by the U.S. government in March 2020 and
has negatively impacted the U.S. and global economy, disrupted global supply
chains, resulted in significant travel and transport restrictions, including
mandated closures and orders to "shelter-in-place," and created significant
disruption of the financial markets. The extent of the impact of the COVID-19
pandemic on our operational and financial performance will depend on future
developments, including the duration and spread of the pandemic and related
actions taken by the U.S. government, state and local government officials, and
international governments to prevent disease spread, all of which are uncertain
and cannot be predicted.
Our MCA segment experienced a decline in revenues during the last four months of
our fiscal year ended June 30, 2020, which management believes is predominantly
due to the economic uncertainties caused by the pandemic, and we anticipate our
MCA revenues will continue to be adversely affected while major parts of the
U.S. economy are restricted by mandatory business shut-downs and/or stay-at-home
orders, as well as other effects of the pandemic. We and our finance partners
decreased our volume of new funding arrangements while evaluating the effect of
the current economic uncertainties on the MCA business and its customers during
the third quarter of our fiscal year 2020. During the fourth quarter of our
fiscal year 2020, management concluded that it would not resume funding MCAs
with MCA originators and would focus our MCA segment exclusively on MCA
syndication fee income generated by our LMCS business unit. Our reduced
participation in MCA funding through originators reduces our syndication fee
income and revenue from direct funding of MCAs. We anticipate continued lower
funding of new MCAs and reduced collection volume on outstanding MCAs until the
economic situation caused by the pandemic stabilizes and a greater level of
economic activity returns. Additionally, while originators of MCAs modified
their underwriting criteria during the fourth quarter of our fiscal year ended
June 30, 2020 and focused new funding on businesses that have been deemed
"essential services" during the pandemic, it remains to be seen whether
essential businesses will pursue MCAs at levels sufficient to offset the
declines in MCA collections for the foregoing reasons.
On July 17, 2020, LMCS entered into a series of transactions resulting in its
recapitalization. The transactions included an amendment to the operating
agreement of LMCS that reduced our ownership from 80% to 51% of LMCS and the
grant by the Company to LMCS' non-controlling member of a right to purchase the
Company's remaining equity interests in LMCS upon the occurrence of certain
conditions, including, without limitation, the repayment of an intercompany note
from the Company to LMCS. The transaction also included (i) the waiver of LMCS'
obligations to pay contingent consideration to the non-controlling member,
(ii) the termination of certain warrants to purchase the Company's capital stock
held by certain affiliates of the non-controlling member, (iii) the assignment
of certain contractual rights of LMCS to the non-controlling member, and
(iv) the amendment of an intercompany note from the Company to LMCS. All
conditions required for the non-controlling member to have the right to
repurchase LMCS have been met as of the filing date of this report, with the
exception of the repayment of the intercompany note.
26
The economic impact of the ongoing pandemic on our LMCS business unit and the
decision not to provide additional resources to LMCS to fund MCAs through MCA
originators in the future triggered the requirement for an impairment test of
the goodwill and long-lived assets attributable to our LMCS business unit during
the fourth quarter of our fiscal year ended June 30, 2020. As a result of the
impairment tests, we concluded that the goodwill, definite-lived intangible
assets, and right-of-use lease assets attributable to our LMCS business unit
were impaired as of June 30, 2020, and we recorded a $1.4 million impairment
charge. Furthermore, these same impairment indicators, coupled with the
post-fiscal-year-end waiver of LMCS' obligations to pay contingent consideration
to its non-controlling member and termination of certain warrants to purchase
the Company's capital stock held by certain affiliates of the non-controlling
member, resulted in the full write off of our contingent consideration liability
payable to the non-controlling member, in the amount of $3.1 million during the
fiscal year ended June 30, 2020.
We believe that our real estate borrowers will continue to be able to service
their real estate loans by paying principal and interest as payments become due.
We continue to develop real estate for future sale. While we do not believe that
any of these projects warrant impairment charges or other reserves at this
point, we do expect that the economic impact of the pandemic will result in a
delay in the eventual sale of this real estate.
Through most of the fiscal year ended June 30, 2020, we continued to actively
evaluate and engage with potential acquisition target candidates; however, the
pandemic delayed our due diligence process by impeding our ability to
participate in in-person site visits and physical tours and complicated our
ability to place valuations on targets given the uncertainty in the global
markets. We expect this uncertainty to continue as the pandemic persists over
the next few months.
In August 2020, we established CCUR Aviation Finance, LLC, a wholly owned
subsidiary through which we operate our aviation funding business. Since
August 2018, we have periodically funded aviation deposit purchases for a fee,
and we expect this business to continue and grow. We have reported income from
this business within our MCA segment. During fiscal year 2020, we provided $17.5
million in funding for aviation deposits.
In April 2020, the Company's Board of Directors appointed existing director
Steven G. Singer as Chairman of the Board. In June 2020, Wayne Barr, Jr.
resigned from the Board and provided the Board of Directors with notice that he
will take an indefinite leave of absence from his position as CEO and President
of the Company while he serves as interim CEO of HC2 Holdings, Inc. during its
search for a permanent CEO. The Board approved the selection of Igor Volshteyn,
age 43, to serve as interim COO and President of the Company during the Leave
Period. From January 2019 to June 2020, Mr. Volshteyn served as Senior Vice
President of Business Development of the Company. Additionally, in June 2020,
the Board appointed Robert Pons to serve on the Board until the 2020 annual
meeting of stockholders of the Company (the "2020 Meeting"). The Board intends
to nominate Mr. Pons for election as an independent director of the Company and
recommend in favor of his election by stockholders at the 2020 Meeting. The
Board also appointed Mr. Pons as the Nominating Committee Chairman and as a
member of the Compensation, Audit, and Asset Management committees. Mr. Pons
will receive the non-employee director compensation designated for directors and
for the Nominating Committee Chairman as outlined in the Company's definitive
proxy statement on Schedule 14A filed with the SEC on September 9, 2019, as
adjusted by the Board of Directors from time to time.
Application of Critical Accounting Policies
The SEC defines "critical accounting policies" as those that require application
of management's most difficult, subjective, or complex judgments, often as a
result of the need to make estimates about the effect of matters that are
inherently uncertain and may change in subsequent periods.
The following is not intended to be a comprehensive list of all our accounting
policies. Our significant accounting policies are more fully described in Note 1
to the consolidated financial statements. In many cases, the accounting
treatment of a transaction is specifically dictated by accounting principles
generally accepted in the United States, with no need for management's judgment
in their application. There are also areas in which management's judgment in
selecting an available alternative would not produce a materially different
result.
27
We have identified the following as accounting policies critical to us:
Revenue Recognition for MCA Syndication Fee Income
We recognize revenue when our performance obligations with our customers have
been satisfied. Our performance obligation is to facilitate funding for MCA
originators through the LMCS syndication network. The performance obligation is
satisfied at a point in time when the syndicate participants provide MCA
originators with capital by purchasing participation interests in funded MCAs.
We determine the transaction price based on the fixed consideration in our
contractual agreements, which do not contain any variable consideration. As we
have identified only one distinct performance obligation, the transaction price
is allocated entirely to this service. In determining the transaction price, a
significant financing component does not exist, since the timing from when we
perform this service to when the syndicate participants fund the MCA is less
than one year, and we are not paid in advance for the performance of our
services.
Goodwill and Intangible Assets
Goodwill represents the excess of purchase price over the fair value of the net
assets of businesses acquired. We review goodwill at least annually for
impairment. In our evaluation of goodwill impairment, we perform a qualitative
assessment that requires management judgment and the use of estimates to
determine if it is more likely than not that the fair value of a reporting unit
is less than the reporting unit's carrying amount. An entity has an
unconditional option to bypass the qualitative assessment for any reporting unit
and proceed directly to performing the quantitative goodwill impairment test. An
entity may resume performing the qualitative assessment in any subsequent
period. We perform our annual impairment tests as of December 31 of each year,
unless circumstances indicate the need to accelerate the timing of the tests. We
completed our annual impairment test of goodwill as of December 31, 2019 and
concluded that there was no impairment.
Intangible assets include trade name, non-competition agreements, and syndicate
participant/originator relationships, are subject to amortization over their
respective useful lives, and are classified in definite-lived intangibles, net,
in the accompanying consolidated balance sheets. These intangibles are evaluated
for impairment whenever events or changes in circumstances indicate that the
carrying value of the assets may not be fully recoverable. If facts and
circumstances indicate that the carrying value might not be recoverable,
projected undiscounted net cash flows associated with the related assets or
groups of assets over their estimated remaining useful lives is compared against
their respective carrying amounts. If an asset is found to be impaired, the
impairment charge will be measured as the amount by which the carrying amount of
an asset exceeds its fair value.
Subsequent to completion of our annual goodwill impairment analysis, the
COVID-19 virus developed into a pandemic that significantly impacted the global
economy. Our MCA segment experienced a decline in revenues during the last
quarter of our fiscal year ended June 30, 2020, which management believes is
predominantly due to the economic uncertainties caused by the pandemic, and we
anticipate our MCA revenues will continue to be adversely affected while major
parts of the U.S. economy are restricted by mandatory business shut-downs and/or
stay-at-home orders, as well as other effects of the pandemic. We decreased our
volume of new funding arrangements while evaluating the effect of the current
economic uncertainties on the MCA business and its customers during the third
quarter of our fiscal year 2020. During the fourth quarter of our fiscal year
2020, management concluded that it would not resume funding MCAs with MCA
originators and would focus our MCA segment exclusively on MCA syndication fee
income generated by our LMCS business unit and funding aviation purchase
deposits for fees. Our reduced participation in MCA funding through originators
reduces our syndication fee income and revenue from direct funding of MCAs. We
anticipate continued lower funding of new MCAs and reduced collection volume on
outstanding MCAs until the economic situation caused by the pandemic stabilizes
and a greater level of economic activity returns.
The economic impact of the ongoing pandemic on the LMCS business and decision
not to provide additional resources to LMCS to fund MCAs through MCA originators
in the future triggered the requirement for a quantitative impairment test of
the goodwill and long-lived assets attributable to our LMCS business unit during
the fourth quarter of our fiscal year ended June 30, 2020. As a result of the
impairment tests, we concluded that the goodwill, definite-lived intangible
assets, and right-of-use lease assets attributable to our LMCS business unit
were impaired as of June 30, 2020. Please see Note 6 for further discussion.
28
Fair Value Measurements
Fair value is defined as the price that would be received from selling an asset
or paid to transfer a liability in an orderly fashion between market
participants at the measurement date. When determining the fair value
measurements for assets and liabilities required or permitted to be either
recorded or disclosed at fair value, we consider the most advantageous market in
which transactions would occur and we consider assumptions that market
participants would use when pricing the asset or liability.
Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and
Disclosures, requires certain disclosures regarding fair value and establishes a
fair value hierarchy for valuation inputs. The hierarchy prioritizes the inputs
into three levels based on the extent to which inputs used in measuring fair
value are observable in the market. Each fair value measurement is reported in
one of the three levels, which are determined by the lowest level input that is
significant to the fair value measurement in its entirety. The levels are:
· Level 1 Quoted prices (unadjusted) in active markets for identical assets or
liabilities;
· Level 2 Inputs other than quoted prices included within Level 1 that are either
directly or indirectly observable; and
· Level 3 Assets or liabilities for which fair value is based on valuation models
with significant unobservable pricing inputs and which include the use
of management estimates.
Our investment portfolio consists of money market funds, equity securities,
mortgage loans, and corporate debt. All highly liquid investments with an
original maturity of three months or less when purchased are considered to be
cash equivalents. All cash equivalents are carried at cost less any unamortized
premium or discount, which approximates fair value. All investments with
original maturities of more than three months are classified as
available-for-sale, trading, or held-to-maturity investments. Our marketable
securities, other than equity securities, are classified as available-for-sale,
and are reported at fair value, with unrealized gains and losses, net of tax,
reported in stockholders' equity as a component of accumulated other
comprehensive income or loss. Interest on securities is reported in the
accompanying consolidated statements of operations in interest income. Dividends
paid by securities are reported in the accompanying consolidated statements of
operations in other income. Realized gains or losses are reported in the
accompanying consolidated statements of operations in net realized gain on
investments.
We used Level 3 inputs to determine the fair value of our preferred stock
investments. The Company has elected the measurement alternative and will record
the investments at cost adjusted for observable price changes for an identical
or similar investment of the same issuer. Observable price changes and
impairment indicators will be assessed each reporting period.
We also used Level 3 inputs to determine the fair value of our contingent
consideration and common stock purchase warrants related to the LuxeMark
Acquisition. The Company used a Monte Carlo simulation technique to value the
performance-based contingent consideration and common stock purchase warrants.
This technique is a probabilistic model which relies on repeated random sampling
to obtain numerical results. As of June 30, 2020, we reduced the fair value of
contingent consideration related to the LuxeMark Acquisition, as management
decided to reduce funding of MCAs and the contingent consideration agreements
were terminated on July 17, 2020.
We provide fair value measurement disclosures of our available-for-sale
securities in accordance with one of the three levels of fair value measurement.
Commercial and Mortgage Loans and Loan Losses
We have potential exposure to transaction losses as a result of uncollectibility
of commercial mortgage and other loans. We base our reserve estimates on prior
charge-off history and currently available information that is indicative of a
transaction loss. We reflect additions to the reserve in current operating
results, while we make charges to the reserve when we incur losses. We reflect
recoveries in the reserve for transaction losses as collected.
We have the intent and ability to hold these loans to maturity or payoff, and as
such have classified these loans as held-for-investment. These loans are
reported on the balance sheet at the outstanding principal balance adjusted for
any charge-offs, allowance for loan losses, and deferred fees or costs. As of
June 30, 2020, we have not recorded any charge-offs, and believe that an
allowance for loan losses is not required.
29
Advances Receivable
In December 2018, we began purchasing participation interests in MCAs from third
parties whose principal activity is originating MCAs to small businesses. MCAs
are contracts formed through future receivables purchase and sale agreements,
which stipulate the purchase price, or the amount advanced, and the specified
amount, or the advance amount plus the factored receivable balance that will be
repaid, on the face of the contract. Generally, a specified amount will be
withdrawn from the merchant's bank account via daily or weekly automatic
transactions in order to pay down the merchant's advance. These are not consumer
loan contracts, nor are they installment loan contracts to businesses for
business use only. In addition, there is no monthly minimum payment, nor is
there a specific repayment schedule.
Allowance for MCA Credit Losses
The allowance for credit losses for MCAs is established at the time of funding
through a provision for losses charged to our consolidated statement of
operations based on an analysis of our charge-off history and historical
performance experienced by an industry peer group. Losses are charged against
the allowance when management believes that the future collection in full of
purchased receivables is unlikely. We review our MCA receivables on a regular
basis and charge off any MCA receivables for which the merchant has not made a
payment in 90 days or more. Subsequent recoveries, if any, are credited to the
provision for credit losses on advances. The establishment of appropriate
reserves is an inherently uncertain process, and ultimate losses may vary from
the current estimates. We regularly update our reserve estimates as new facts
become known and events occur that may affect the settlement or recovery of
losses. In addition, new facts and circumstances may adversely affect our MCA
portfolio, resulting in increased delinquencies and losses, and could require
additional provisions for credit losses, which could impact future periods.
Income Taxes
As part of the process of preparing our consolidated financial statements, we
are required to estimate income taxes in each of the jurisdictions in which we
operate. The provision for income taxes is determined using the asset and
liability approach for accounting for income taxes. A current liability is
recognized for the estimated taxes payable for the current fiscal year. Deferred
tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using the enacted tax
rates in effect for the fiscal year in which the timing differences are expected
to be recovered or settled. The effects on deferred tax assets and liabilities
of changes in tax rates or tax laws are recognized in the provision for income
taxes in the period that includes the enactment date.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount more likely than not to be realized. To the extent we
establish or change the valuation allowance in a period, the tax effect will
generally flow through the consolidated statement of operations.
The determination of our provision for income taxes requires significant
judgment, the use of estimates, and the interpretation and application of
complex tax laws. We are subject to income taxes in the United States and
several foreign jurisdictions. Significant judgment is required in determining
our worldwide provision for income taxes and recording the related tax assets
and liabilities. In the ordinary course of our business, there are transactions
and calculations for which the ultimate tax determination is uncertain. Despite
our belief that we have appropriate support for all the positions taken on our
tax returns, we acknowledge that certain positions may be successfully
challenged by the taxing authorities. Therefore, an accrual for uncertainty in
income taxes is provided for when necessary. If we have accruals for uncertainty
in income taxes, these accruals are reviewed quarterly and reversed upon being
sustained under audit, the expiration of the statute of limitations, new
information, or other determination by the taxing authorities. The provision for
income taxes includes the impact of changes in uncertainty in income taxes.
Although we believe our recorded tax assets and liabilities are reasonable, tax
laws and regulations are subject to interpretation and inherent uncertainty.
Therefore, our assessments can involve both a series of complex judgments about
future events and reliance on estimates and assumptions. Although we believe
these estimates and assumptions are reasonable, the final determination could be
materially different than that which is reflected in our provision for income
taxes and recorded tax assets and liabilities.
30
In assessing the realizability of deferred tax assets, we consider whether it is
more likely than not that some portion or all of our deferred tax assets will
not be realized. In determining whether or not a valuation allowance for
deferred tax assets is needed, we evaluate all available evidence, both positive
and negative, including: trends in operating income or losses, currently
available information about future tax years, future reversals of existing
taxable temporary differences, future taxable income exclusive of reversing
temporary differences and carryforwards, taxable income in prior carryback tax
years if carryback is permitted under the tax law, and tax planning strategies
that would accelerate taxable amounts to utilize expiring carryforwards, change
the character of taxable and deductible amounts from ordinary income or loss to
capital gain or loss, or switch from tax-exempt to taxable investments. The
ultimate realization of deferred tax assets is dependent upon the generation of
future taxable income during the periods in which those temporary differences
become deductible.
As of June 30, 2020, we have sufficient evidence of future income to conclude
that it is more likely than not that the Company will realize its entire U. S.
deferred tax inventory with the exception of the aforementioned NOLs and credits
expected to expire before usage. Therefore, we have recognized a valuation
allowance on the Company's U. S. NOLs and credits expected to expire before
usage, as well as on our German deferred tax assets. We reevaluate our
conclusions quarterly regarding the valuation allowance and will make
appropriate adjustments as necessary in the period in which significant changes
occur.
Defined-Benefit Pension Plan
We maintain defined-benefit pension plans (the "Pension Plans") for a number of
former employees of our German subsidiary ("participants"). In 1998, the Pension
Plans were closed to new employees and no existing employees are eligible to
participate, as all eligible participants are no longer employed by the Company.
The Pension Plans provide benefits to be paid to all participants at retirement
based primarily on years of service with the Company and compensation rates in
effect near retirement. Our policy is to fund benefits attributed to
participants' services to date. The determination of our Pension Plans' benefit
obligations and expenses is dependent on our selection of certain assumptions
used by actuaries in calculating such amounts. Those assumptions include, among
others, the weighted-average discount rate and the weighted-average expected
rate of return on plan assets. To the extent that these assumptions change, our
future benefit obligation and net periodic pension expense may be positively or
negatively impacted.
Results of Operations
MCA revenue includes fees from advances that we provide on future merchant
receivables, as well as fees earned for sourcing both syndication capital and
merchant leads for MCA originators. We generate revenue from interest on loans
by entering into commercial loan agreements to fund third party originators in
the MCA industry and real estate industry.
Selling, general, and administrative ("SG&A") expenses consist primarily of
salaries, benefits, commissions, rent, travel, administrative personnel costs,
information systems, insurance, accounting, legal services, board of director
fees and expenses, and other professional services.
Other interest income is earned on cash overnight sweep accounts and money
market deposits as well as investments in debt securities. Interest income also
includes accretion of discounts related to transactions in which we purchased
debt securities on the secondary markets at a discount. Such discounts are
amortized over the terms of each debt security to the commitment values that
will be due on each maturity date, as well as early repayment. Additionally, we
earn PIK interest from one of our debt securities whereby interest is paid in
the form of an increase in the commitment value due from the debt security
issuer on the maturity date.
31
Fiscal Year 2020 in Comparison to Fiscal Year 2019
Consolidated Revenues and Income. During the fiscal year ended June 30, 2020, we
generated $5.9 million of total revenue, compared to $3.5 million during the
fiscal year ended June 30, 2019. The increase was driven largely by our
increased participation in the MCA industry. Our net income for fiscal year 2020
increased to $13.0 million, compared to $0.6 million during fiscal year 2019.
This increase was attributable to a $6.0 million income tax benefit resulting
from the release of a substantial portion of the valuation allowance on our
deferred tax assets, our investments in certain debt and equity securities, and
an increase in our income before income tax driven by our MCA operations.
MCA Operations Segment Revenues. We generated $5.6 million of revenue from MCA
operations during the fiscal year ended June 30, 2020, compared to $2.6 million
during the fiscal year ended June 30, 2019. For the fiscal year ended June 30,
2020, we maintained a larger weighted-average outstanding balance of funded MCAs
compared to the prior year, and consequently earned higher MCA revenue during
the current period relative to the fiscal year ended June 30, 2019. Our
syndication fee revenue during the fiscal year ended June 30, 2020 benefited
from a full year of syndication activity, while in the prior fiscal year, we
only began generating syndication revenue after the LuxeMark Acquisition in
mid-February 2019. Additionally, as part of our MCA business, we originated term
loans to an MCA originator so that it may fund additional MCAs. These loans
generated $0.9 million of interest income during the fiscal year ended June 30,
2020. Our MCA operations revenues for the fiscal year are as follows:
Fiscal Year Ended
June 30,
2020 2019
(Amounts in thousands)
MCA revenue $ 3,240 $ 1,694
Syndication fee revenue 1,288 693
Fee income on MCA leads generation 154 93
MCA fees and other revenue 4,682 2,480
Interest on loans to MCA originators 887 117
Total MCA operations segment revenue $ 5,569 $ 2,597MCA revenue from interest on loans to MCA originators is categorized as MCA
operations revenue for purposes of segment reporting but reported within the
line item Interest on mortgage and commercial loans within our consolidated
statements of operations.
Revenues from each of the revenue sources within our MCA segment increased year
over year because, for our fiscal 2020, we reported 12 months of MCA revenues
from the LMCS business unit which we established in February of the prior fiscal
year upon the LuxeMark acquisition. However, with the onset of the COVID-19
pandemic during the third quarter of our fiscal year 2020, we experienced
declines of MCA revenues during the latter half of the fiscal year ended
June 30, 2020. This occurred as (i) fewer merchants are meeting MCA underwriting
criteria, which reduces our syndication fee income and ability to generate
revenue by funding MCAs, (ii) underwriters are less interested in purchasing
leads, and (iii) a portion of our merchants, in coordination with the
originators, have reduced or paused payments to better weather the current
economic downturn, which reduces our MCA revenues. Furthermore, we reduced our
volume of MCA funding during the third quarter of our fiscal 2020, primarily as
a result of our efforts to better evaluate the impact of the pandemic on MCA
assets before funding additional assets. We anticipate continued lower funding
and collection volSSSSume over the next few months and are uncertain as to the
long-term impact of the pandemic at this point. After the end of our fiscal
year, we entered into a series of agreements with Old LuxeMark pursuant to which
our interest in LMCS was reduced from 80% to 51%. After the repayment of the
outstanding balance of the Master Promissory Note issued by LMCS to the Company,
Old LuxeMark has the right to purchase the remaining 51% equity interest in LMCS
for nominal consideration. We are reviewing our strategic options with respect
to our continued participation in the MCA industry.
Real Estate Operations Segment Revenues. We generated $0.3 million of revenue
from real estate operations for the fiscal year ended June 30, 2020, as compared
to $0.9 million for the fiscal year ended June 30, 2019. The decrease in revenue
resulted from the decrease in interest on commercial mortgage loans due to
borrower payoffs outpacing originations.
32
SG&A Expenses. SG&A expenses were $7.7 million for the fiscal year ended
June 30, 2020, a $4.0 million, or 109.0%, increase from the fiscal year ended
June 30, 2019. This increase was due to the following:
· A $3.4 million increase in expenses for fees paid to the Asset Manager. During
the fourth quarter of our fiscal year 2020, the Company and the Asset Manager
entered into an Omnibus Amendment regarding the Management Agreement and SARs
Agreement (the "Amendment"), whereby all SARs issued to the asset manager may
be exercisable upon grant, rather than the previous condition requiring a
change in control of the business before exercise. This modification resulted
in approximately $2.8 million of expense recorded during the fourth quarter of
fiscal year 2020 for all previously issued SARs as well as SARs expected to be
issued in exchange for asset management services during the fourth quarter of
our fiscal year 2020. Additionally, as part of the Amendment, we paid $0.4
million in cash to the Asset Manager as a one-time fee calculated based upon
the number of SARs issued to the Asset Manager as of our February 24, 2020
dividend record date, multiplied by the $0.50 per share one-time dividend
declared February 2020 and paid in March 2020. The remaining $0.1 million of
this increase resulted from additional expense reimbursement fees paid by the
Company to the Asset Manager over the full 12 months of our fiscal year 2020,
compared to a partial year during which the asset management agreement was in
place during our fiscal year 2019.
· A $0.5 million increase in operating expenses and commissions attributable to
our MCA operations that we incurred during the full 12 months of our fiscal
year 2020, compared to only 4.5 months of our fiscal year 2019.
· A $0.4 million increase from corporate compensation attributable to salaries
from additional employees and financial performance bonuses earned during the
fiscal year ended June 30, 2020.
These increases to SG&A expense during our fiscal year 2020 were partially
offset by a decrease in acquisition-related costs, as the prior year included
$0.3 million of expenses related to the LuxeMark Acquisition.
Amortization of Purchased Intangibles. Our amortization of purchased intangibles
includes amortization over the respective useful lives of the trade name,
non-competition agreements, and investor/originator relationships attributable
to the LuxeMark Acquisition. Our intangible assets are evaluated for impairment
whenever events or changes in circumstances indicate that the carrying value of
the assets may not be fully recoverable. We acquired these intangibles as part
of the LuxeMark Acquisition on February 13, 2019.
Impairment of Goodwill and Long-Lived Assets and Change in Fair Value of
Contingent Consideration. During the fiscal year ended June 30, 2020, we
recorded a $1.7 million net gain from the change in fair value of contingent
consideration payable to Old LuxeMark, partially offset by impairment charges
attributable to the goodwill, purchased intangibles, and right-of-use lease
assets of our LMCS business unit, as further detailed below:
Fiscal Year Ended
June 30,
2020 2019
(Amounts in thousands)
Impairment charges:
Goodwill $ 780 $ -
Purchased intangibles 562 -
Leased asset 53 -
Impairment of goodwill and long-lived assets 1,395 -
(Gain) loss on adjustment to fair value of contingent
consideration
$ (3,090 ) $ 730
Impairment of goodwill and long-lived assets and fair
value adjustment to fair value of contingent
consideration, net $ (1,695 ) $ 730
33
The decrease in estimated contingent consideration liability associated with the
LuxeMark Acquisition resulted from (i) LMCS not meeting the minimum performance
levels to earn the calendar year 2019 earnout, and (ii) termination of the
earnout agreements on July 17, 2020. These same facts and circumstances resulted
in the impairment of the LMCS business unit's purchased intangibles, other
long-lived assets, and goodwill, which partially offset the gain from reducing
the fair value of the contingent consideration liability.
Provision for Credit Losses on Advances. During the fiscal year ended June 30,
2020, we recorded a $0.8 million provision for credit losses on MCAs, a $0.8
million, or 47.1%, decrease from the fiscal year ended June 30, 2019. The
year-over-year decrease in provision expense resulted from decreases in the
amounts of MCAs funded in the current year versus the prior year, and from our
shift away from originators with higher default rates to those with lower
default rates. Recent MCA funding activity decreased primarily as a result of
our efforts to better evaluate the impact of the pandemic on MCA assets before
funding additional assets. Included within the $0.8 million current year
provision for credit losses is $0.3 million of provision expense for existing
MCAs during the current period due to our anticipated impact of the pandemic on
merchant repayment activity.
Other Interest Income. Other interest income includes interest earned on
investments in debt securities and cash and money market balances. The
components of our interest income for the fiscal year ended June 30, 2020 and
2019 are as follows:
Fiscal Year Ended
June 30,
2020 2019
(Amounts in thousands)
Interest from cash deposits and debt securities $ 2,325 $ 1,873
Accretion of discounts on purchased debt securities 3,709 1,679
Payment-in-kind interest 970 864
Other interest income $ 7,004 $ 4,416
Other interest income for the fiscal year ended June 30, 2020 increased by $2.6
million, or 58.6%, compared to the fiscal year ended June 30, 2019, due to
higher yields on a higher weighted-average balance of investments in debt
securities and accretion of the discounts on these securities.
Realized Gain on Investments, Net. During the fiscal year ended June 30, 2020,
we sold investments in certain equity and debt securities for which we
recognized $2.3 million of net realized gains, as compared to $0.5 million of
realized gains on the sale of certain equity and debt securities during the
prior fiscal year.
Unrealized Loss on Equity Securities, Net. During the fiscal year ended June 30,
2020, we reported unrealized losses on equity securities, net, of $0.8 million,
compared to unrealized losses on equity securities, net, of $1.8 million during
the fiscal year ended June 30, 2019. Our unrealized gains and losses on equity
securities each year are a function of changes in the fair value of the equity
securities that we hold as of the current reporting period balance sheet date
relative to the preceding balance sheet date. Additionally, our unrealized
losses during the current year were primarily attributable to reversal of prior
year unrealized gains related to equity securities that we sold during the
current year for which we reported realized gains in the current period, while
the unrealized loss in the prior year is primarily attributable to declines in
the market values of securities.
(Benefit) Provision for Income Taxes. We reported $6.0 million of income tax
benefit for the fiscal year ended June 30, 2020. This income tax benefit
resulted from the release of a substantial portion of the valuation allowance on
our deferred tax assets during our fiscal year ended June 30, 2020. The release
of our valuation allowance was based on our cumulative taxable income over the
past three years and expectations of future taxable income. Should future
results vary from our expectations, we may release additional valuation
allowance or be required to provide additional valuation allowance reserves.
34
Liquidity and Capital Resources
We believe we have sufficient liquidity and capital resources to continue
funding our operations and sustain currently expected levels of capital
expenditures over the next 12 months. While we maintain significant amounts of
cash and cash equivalents and marketable securities which we may use to fund our
operations and make investments, the pandemic has had a significant impact on
credit and capital markets, which may adversely affect our ability to access
third-party debt or equity financing. Our future liquidity will be affected by,
among other things:
· our future access to capital;
· our exploration and evaluation of strategic alternatives and development of new
operating assets;
· our ability to collect on our commercial loans and advances receivable;
· the liquidity and fair value of our debt and equity securities;
· the longevity of the pandemic and severity of impact on our income and cash
flows;
· our ongoing operating expenses; and
· potential liquidation of the Company pursuant to an organized plan of
liquidation.
Uses and Sources of Cash
Cash Flows from Operating Activities
We generated $3.6 million and $1.8 million of cash from operating activities
during the fiscal years ended June 30, 2020 and 2019, respectively. Operating
cash generated during the fiscal year ended June 30, 2020 was primarily
attributable to net income, adjusted for non-cash items and realized gains on
investments, as well as favorable working capital changes, namely expense
incurred during the period for SARs that did not settle during the period.
Operating cash generated during the fiscal year ended June 30, 2019 was
primarily attributable to income from operations, adjusted for non-cash items
and profits on investments.
Cash Flows from Investing Activities
Fiscal Year Ending June 30, 2020
During the fiscal year ended June 30, 2020 we generated $4.0 million of cash,
net, from investing activities. Our net cash inflows were primarily driven by
liquidations of $5.3 million more in debt and equity securities than investments
in debt and equity securities during the fiscal year ended June 30, 2020. Our
collections of principal on mortgage and commercial loans outpaced new loan
funding amounts during the current fiscal year by $1.3 million. Our mortgage and
commercial loan borrowers are all current with their required payments as of
June 30, 2020. Our mortgage loans typically require interest-only payments until
maturity or payoff. Partially offsetting these investing cash inflows, we
experienced $2.3 million of net investing cash outflows from funding and
collecting MCAs and aviation deposits receivable, primarily due to increased
funding of aviation deposits during the latter half of the current fiscal year,
many of which are not expected to be collected until the first quarter of our
fiscal year 2021. Additionally, we invested an additional $0.3 million in a real
estate development project which we expect to monetize in the latter half of our
fiscal year 2021 or early fiscal year 2022.
Fiscal Year Ending June 30, 2019
During our fiscal year ended June 30, 2019 we used $26.8 million of cash, net,
for investing activities. We funded $8.3 million of commercial loans, $5.6
million of which were mortgage loans through our real estate operating
subsidiary, Recur. We received $5.8 million from principal payments during our
fiscal year 2019, as four loans were paid off during the period. We also funded
a $2.8 million loan to an MCA originator during the period.
35
In fiscal year 2019, we entered into an arrangement with certain MCA originators
to participate in funding MCA originations. We made initial advances of $8.0
million to one originator, who in turn advanced these funds to merchants as part
of a syndication. As merchant receivables have been collected, we have used the
collected funds to fund additional MCAs. Through June 30, 2019, we had funded
$18.1 million in MCAs (including the original $8.0 million) and collected $9.8
million of merchant receivables as repayment for these advances. Additionally,
we provided $4.8 million of cash advances to an aviation business to fund
deposits required for aircraft purchases for up to six months, in exchange for
paying us an upfront fee. We collected $2.0 million of these aviation advances
during our fiscal year 2019.
As part of our real estate operations, in fiscal year 2019 we acquired land in
the amount of $3.3 million for the purpose of development. The acquisition costs
include costs to acquire the land, including interest and other expenses that
have been capitalized as part of the purchase price. We continue to hold and
develop the land as of June 30, 2020.
In our fiscal year 2019, we acquired the assets of Old LuxeMark through our
subsidiary, LMCS, and retained an 80% interest in LMCS in exchange for an
initial payment of $1.2 million and the issuance of a 20% interest in LMCS to
Old LuxeMark. Additionally, the Purchase Agreement required the Company to pay
to Old LuxeMark four earnout payments of up to $1,000,000 each if fully earned
through the achievement of agreed-upon distributable net income ("DNI")
thresholds. The earnout payments are calculated based on DNI for each of the
calendar years ending on December 31, 2019, 2020, 2021, and 2022, and any such
payments earned would likely be paid in the third quarters of our fiscal years
2020, 2021, 2022, and 2023. As of July 17, 2020, both parties agreed to
terminate the contingent earnout consideration as part of a recapitalization of
LMCS.
Our remaining fiscal year 2019 investing activities consisted of $22.2 million
in purchases and $12.0 million in maturities or sales of debt and equity
securities for the purpose of funding our operating expenses as we continue to
evolve our real estate and MCA operating businesses and actively search for
additional operating businesses to acquire, as well as collection of the $1.45
million of proceeds from the sale of the Content Delivery business held in
escrow until January 2, 2019.
Cash Flows from Financing Activities
During the fiscal year ended June 30, 2020 we used $6.4 million of cash for
financing activities. During the fiscal year, we fully repaid the outstanding
balance of a $1.6 million term loan. We repaid the balance with existing cash
prior to maturity to reduce associated interest cost.
During our fiscal year 2020, the Company declared and paid a one-time dividend
of $0.50 per share, which resulted in $4.4 million of cash dividends paid during
the year. Another $0.1 million of dividends declared during the year relate to
restricted stock and will remain as dividends payable until the restricted stock
vests.
During our fiscal year 2020, the Company distributed $0.3 million of cash to the
non-controlling member of LMCS, representing the non-controlling member's 20%
interest in LMCS' DNI.
On March 5, 2018, we announced that our Board of Directors authorized the
repurchase of up to one million shares of the Company's common stock. In
January 2019, we completed the purchase of the authorized one million shares,
and the Board of Directors authorized the repurchase of an additional 500,000
shares of the Company's common stock under a new repurchase program that
replaces and supersedes the prior repurchase program. Purchases are made through
private transactions or open market purchases, which may be made pursuant to
trading plans subject to the restrictions and protections of Rule 10b5-1 and/or
Rule 10b-18 of the Exchange Act. We repurchased 16,821 shares of the Company's
common stock totaling $0.1 million during the fiscal year ended June 30, 2020,
as compared to 378,421 shares of the Company's common stock totaling $1.4
million during the fiscal year ended June 30, 2019. All repurchased stock was
retired. We may purchase up to 364,298 additional shares pursuant to our
previously announced repurchase plan.
Liquidity
We had working capital (which we define as current assets minus current
liabilities) of $51.0 million at June 30, 2020, compared to working capital of
$48.8 million at June 30, 2019. At June 30, 2020, we had no material commitments
for capital expenditures.
36
As of June 30, 2020, less than 0.1% of our cash was in foreign accounts, and
there is no expectation that any foreign cash would need to be transferred from
these foreign accounts to cover U.S. operations in the next 12 months. Based
upon our existing cash balances, equity securities, and available-for-sale
investments, historical cash usage, and anticipated operating cash flow in the
current fiscal year, we believe that existing U.S. cash balances will be
sufficient to meet our anticipated working capital requirements for at least the
next 12 months from the issuance date of this report.
Off-Balance Sheet Arrangements
We had no material off-balance sheet arrangements as of June 30, 2020.
Recent Accounting Guidance
Recently Issued and Adopted Accounting Guidance
In January 2016, the Financial Accounting Standards Board (the "FASB") issued
Accounting Standards Update ("ASU") No. 2016-01 ("ASU 2016-01"),Financial
Instruments-Overall: Recognition and Measurement of Financial Assets and
Financial Liabilities, as amended by ASU No. 2018-03, Financial
Instruments-Overall: Technical Corrections and Improvements, issued in
February 2018, on the recognition and measurement of financial instruments. The
new guidance is effective for fiscal years beginning after December 15, 2017,
including interim periods within those fiscal years. The new guidance changes
the current accounting guidance related to (i) the classification and
measurement of certain equity investments, (ii) the presentation of changes in
the fair value of financial liabilities measured under the fair value option
that are due to instrument-specific credit risk, and (iii) certain disclosures
associated with the fair value of financial instruments. Additionally, there is
no longer a requirement to assess equity securities for impairment since such
securities are now measured at fair value through net income. We utilized a
modified retrospective approach to adopt the new guidance effective July 1,
2018. The impact related to the change in accounting for equity securities for
our fiscal year ended June 30, 2018 was $0.3 million of net unrealized
investment gains, net of income tax, reclassified from AOCI to retained
earnings.
In February 2016, the FASB issued ASU No. 2016-02, Leases ("ASU 2016-02"), on
the recognition of lease assets and lease liabilities on the balance sheet. The
new guidance is effective for fiscal years beginning after December 15, 2018,
including interim periods within those fiscal years. The new guidance changes
the current accounting guidance related to the recognition of lease assets and
lease liabilities. We early adopted the new guidance effective June 30, 2019, as
further disclosed in Note 16 to these financial statements.
In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain
Tax Effects from Accumulated Other Comprehensive Income (Topic 220) ("ASU
2018-02"), which permits entities to reclassify the tax effects stranded in
accumulated other comprehensive income as a result of recent United States
federal tax reforms to retained earnings. The guidance also requires entities to
disclose their accounting policies with regards to the treatment of stranded tax
effects not related to the Tax Cuts and Jobs Act. It allows entities to elect
either a "security-by-security" approach or a "portfolio approach" to recognize
the stranded tax effects from a valuation allowance release. Under the
security-by-security approach, an entity will recognize the stranded tax effects
associated with individual securities as it disposes of each security. Under the
portfolio approach, an entity will recognize the stranded tax effects associated
with a portfolio of securities when it has disposed of all securities within
that portfolio. Entities can elect to apply the guidance retrospectively or in
the period of adoption. This guidance is effective for fiscal years beginning
after December 15, 2018 and interim periods therein, with early adoption
permitted. We adopted the new guidance effective July 1, 2019 with no material
impact on our consolidated financial statements or disclosures. We elected the
portfolio approach to recognize the stranded tax effects from our valuation
allowance release.
In March 2020, the FASB issued ASU No. 2020-03, Codification Improvements to
Financial Instruments ("ASU 2020-03"). ASU 2020-03 provides changes to clarify
or improve existing guidance. This guidance is effective upon issuance. We
adopted the new guidance effective March 31, 2020 with no impact on our
consolidated financial statements or disclosures.
37
Recent Accounting Guidance Not Yet Adopted
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic
820): Disclosure Framework - Changes to the Disclosure Requirements for Fair
Value Measurement ("ASU No. 2018-13"). ASU No. 2018-13 is part of the disclosure
framework project and eliminates certain disclosure requirements for fair value
measurements, requires entities to disclose new information, and modifies
existing disclosure requirements. The new guidance is effective for fiscal years
beginning after December 15, 2019, including interim periods within those fiscal
years. Early adoption is permitted. We are currently evaluating the impact this
change will have on our consolidated financial statements and disclosures.
In November 2019, the FASB issued ASU No. 2019-10, Financial Instruments -
Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases
(Topic 842): Effective Dates ("ASU 2019-10"). Among other things, ASU 2019-10
provides that ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments ("ASU 2016-13") will be
effective for Public Business Entities that are SEC filers, excluding smaller
reporting companies such as the Company, for fiscal years beginning after
December 15, 2019 and interim periods within those fiscal years. For all other
entities, including smaller reporting companies like the Company, ASU 2016-13
will be effective for fiscal years beginning after December 15, 2022, including
interim periods within those fiscal years. For all entities, early adoption will
continue to be permitted. We are currently evaluating the impact that ASU
2016-13 will have on our consolidated financial statements and disclosures.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740):
Simplifying the Accounting for Income Taxes ("ASU 2019-12"). ASU 2019-12
simplifies the accounting for income taxes by removing certain exceptions to the
general principles in Topic 740 and clarifying and amending existing guidance.
This guidance is effective for fiscal years, and interim periods within those
fiscal years, beginning after December 15, 2020, with early adoption permitted.
We are currently evaluating the impact that ASU 2019-12 will have on our
consolidated financial statements and disclosures.
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