180 Degree Capital Corp.
Q3 2013 Earnings Call Transcript

Published: 13 Nov 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Harris & Harris Group Third Quarter 2013 Shareholder Update Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Patty Egan, CFO. Please go ahead.

[Patricia N. Egan:]

Good morning, everyone. I'll begin by reading the Safe Harbor statement. This presentation may contain statements of a forward-looking nature relating to future events. Statements contained in this presentation that are forward-looking statements are intended to be made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. These statements reflect the company's current beliefs, and a number of important factors could cause actual results to differ materially from those expressed herein. Please see the company's annual report on Form 10-K as well as subsequent filings filed with the Securities and Exchange Commission for a more detailed discussion of the risks and uncertainties associated with the company's business, including, but not limited to, the risks and uncertainties associated with venture capital investing and other significant factors that could affect the company's actual results. Except as otherwise required by federal securities laws, Harris & Harris Group, Inc. undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties. I'll now turn the call over to our CEO, Doug Jackson (sic) [Jamison].

[Douglas W. Jamison:]

Thank you. Good morning. This is Doug Jamison. Welcome to our call reporting on the third quarter of 2013. Daniel Wolfe, our President, and I will begin by walking you through some slides that focus on our path forward. Patty Egan, our Chief Accounting Officer, will then provide a brief summary of our September 30, 2013 financials. Patty will be referencing our recently filed quarterly report on Form 10-Q. We will then answer any questions, and we expect the call to last approximately 45 minutes. Realize, invest, partner, return; in a Letter to Shareholders released on September 30, 2013, we described each part of our strategy. In the second quarter Letter to Shareholders, we described "realize" and our increasing ownership in our portfolio companies over the past 5 to 7 years. In a Letter to Shareholders on October 8, 2013, we described "invest" and our focus on BIOLOGY+. All 3 letters can be accessed on our website at www.hhvc.com under Investor Relations. In a letter to be released later this week, we will discuss "return". "Return" refers to returning shareholder value. If we execute on our plan over the next 5 years, we believe we have the potential to grow net asset value per share, or NAV, significantly for our shareholders. This morning, we are going to walk you through some of this 4-part strategy. In future quarters, we are going to move to updating you on each of these sections, so you can measure our progress against our plan for the next set of years. Harris & Harris Group builds transformative companies from disruptive science. One frequent misperception from some shareholders is that we are passive investors following other VC firms. We are not. We build these companies. We are often the first institutional investor. We license technologies. We build initial management teams. We develop business plans. We recruit other VC firms and we recruit strategic partners. We are skilled at identifying new technology trends ahead of the general market, accessing high-quality science and intellectual property, assembling founding teams of entrepreneurs, building management teams and executing on early-stage business opportunities. This is what we have done in companies like SiOnyx, Xradia, Solazyme, Ultora, Enumeral, Senova , ABS, PWA, HzO, EchoPixel and AgBiome. Our time as management is spent building these companies. It's what differentiates us from many other VC firms, and certainly, the new crop of equity BDC firms. Our strategy over the next 5 years has 4 parts

[Daniel B. Wolfe:]

Thank you, Doug. Harris & Harris Group will build transformative companies from disruptive science. Our investments will have 2 characteristics

[Douglas W. Jamison:]

Thank you, Daniel. So finally, let's turn to return. We believe that over the next few years, as we continue to execute on the plan presented today, that we will generate meaningful returns for our shareholders. We are focused on increasing value to shareholders. And in addition to growing net asset value per share, we believe we will have the opportunity to reduce the number of shares outstanding and to provide deemed dividends as well as cash dividends, as we execute on this plan. In summary, we think now is the time to invest in Harris & Harris Group. We now have significant stakes in companies, bringing transformative products to market, and that value is not yet reflected in our portfolio. Our interdisciplinary team is well-positioned to execute on our investment strategy in BIOLOGY+, which is where biology intersects with other scientific disciplines to enable life science breakthroughs and we have the resources we need to execute. Patty, I'm going to turn it over to you to talk to the financials.

[Patricia N. Egan:]

Thank you, Doug. At September 30, 2013, we had total assets of approximately $133.1 million on our balance sheet. Included in our total assets is our venture capital portfolio, which was valued at $94.4 million versus its cost basis of $109.5 million at September 30, 2013. Therefore, at September 30, our venture capital portfolio was in a depreciated state of $15.1 million. We also held $36.3 million in cash and receivables from the sale of the U.S. Treasuries, and had no debt outstanding as of September 30. At September 30, our primary and secondary liquidity was $44.8 million. This includes the proceeds of $12.8 million from the sale of Xradia that were received during the third quarter. Our net assets at September 30, 2013, were approximately $130.2 million, and our net asset value per share was $4.18. This is an increase from our net asset value per share of $4.13 at December 31, 2012. Turning to our income statement. For the 9 months ended September 30, 2013, we had investment income of approximately $510,000. This compares with approximately $529,000 in investment income in the same period during 2012. Our total expenses were approximately $6.3 million for the 9 months ended September 30, 2013, compared with approximately $7.2 million during the same period in 2012. These total expense figures include both cash and noncash-based operating expenses, such as stock-based compensation. Stock-based compensation expense has no impact to our NAV. Our total cash base and accrued operating expenses for the 9 months ended September 30, 2013, were approximately $5.4 million as compared with $4.7 million during the comparable period in 2012. This yielded a net operating loss of $5.8 million through September 30, which is a decrease compared to our net operating loss of $6.8 million for the 9 months ended September 30, 2012. I'll now turn the call back over to Doug.

[Douglas W. Jamison:]

Great. Thank you, Patty. So before opening it to questions, I just want to focus on one other area; this is our investor outreach goals. As you can see, and as the letters demonstrate, I think, Harris & Harris Group has a very good strategy for realizing returns over the coming years, certainly, for investing its capital in what we think is an exciting area at the intersection of biology with these other disciplines and what we call BIOLOGY+. We are now -- we have been reaching out to investors. We continue to reach out to investors. We really have over the next set of years, really, 2 big goals. One, we want to increase our institutional ownership at Harris & Harris Group. We're looking for very long-term, nontraditional institutions that invest in micro-cap stocks. These are institutions that have a similar timeline to us where they would invest over a period of 5 to 15 years and look for that growth, very different from many of the hedge funds that invest in much shorter periods outgoing. We don't think this will be a quick process. We think this will be a process whereby we meet with them, they understand our plan, they watch our execution against that plan, and over time, we build their confidence and they invest in Harris & Harris Group; but again, where their goals and their timelines are similar to our goals and timelines, as institutions. Secondly, we're always looking to increase analyst coverage, bringing in smart individuals that can tell the story of Harris & Harris Group, present it to other investors, and we continue to work on that, interesting them in that overlap with BIOLOGY+. So it's an ongoing process that we are focused on and continue to focus on in the future. So with that, I'd like to open it up to any questions that shareholders may have.

[Operator:]

[Operator Instructions] And our first question comes from Ed Woo from Ascendiant Capital.

[Edward M. Woo:]

I had a question on what your view is on what your view is on the overall market for these, I guess, emerging growth BIOLOGY+ companies. Have you seen any change in valuations or any difficulties in being able to find these new investment opportunities?

[Douglas W. Jamison:]

Ed, this is Doug Jamison. I think, let me talk about those on a couple of levels in front. From an early-stage perspective, there are a dearth of venture capital firms out there investing in this area currently. So I think there are plenty of deals. There are few investors, but again, as you know, we syndicate deals. So there needs to be a combination of both deals and investors to be able to put these together. There are still some great firms, and I think there will be, in the coming years, more firms moving into early-stage venture capital again, right? It's a cycle of sort of nadirs and pinnacles. We've hit the nadir. I think people, looking into the future, will be getting back into this field. I think that will benefit us by being active currently. So there is certainly no dearth of deal flow. It's sometimes difficult to put syndicates together because there are just so few investors left looking at these type of deals. And again, if you take a longer-term perspective, that will flip, right? That's where the opportunity will be. The investors will come right back into it. The valuations will move up. And then it'll become problematic to invest at that period of time, but it'll become a very good time to exit and realize value, right? So that's the one part of it. From a BIOLOGY+ standpoint, I think that the market is probably -- the public market's at probably at one of the more robust points it's been recently, right? The biotech sector, certainly the therapeutic sector, but I'd even say some of the molecular diagnostic companies are receiving very good valuations in the public market. So where we would realize value, they are receiving that currently as investors have gone looking for risk. I have no idea how long that will last in the public markets. But certainly, over the past 6 to 12 months, and even continuing through this current time, we're seeing that value. So I think there is always 2 ends of the market, and we're seeing that. The difference of what we do oftentimes is, is we build these BIOLOGY+ platform companies. And so the outcome of those is not necessarily therapeutic. It's not necessarily diagnostics. Sometimes, like in the case of Metabolon, we can build a very nice service business. We can build a company that stands on its own that has control over its own future, and it can use its own cash flow to fund things like the developments of its diagnostics. And when we do that well, we have a very nice intersection where we can build a high-quality company and make a very good investment return. So again, if I look back historically, when we do that well, Xradia was a good example of that, we had a very nice return. Solazyme was a very good example, we had a very nice return. On the flip side, in a company like Innovalight or NeoPhotonics, we actually built a very good company, but it wasn't a very good investment return to us or our shareholders. And so we actually think we're in a very unique period of time in BIOLOGY+, now, to be investing very inexpensively, getting the ownership and control we need of these companies and yet have a more robust market on the back end that we think will continue and will develop over different cycles to be able to sell those companies or IPO those companies at increased valuations from where we stand. Does that answer your question?

[Edward M. Woo:]

Yes, great.

[Operator:]

[Operator Instructions] And our next question comes from Sam Rebotsky from SER Asset Management.

[Sam Rebotsky:]

As far as PWA, I guess, your carrying value as of September 30 was $898,000 versus investment of 16 -- $1,648,000, and the acquisition that was taken out of bankruptcy, I think, was about an $8 million investment. I don't have the number in front of me. And you said you expect to own 10% to 15%. Did you -- which means that you may put $1 million to $2 million -- what did you put into this? And did you not want to own more than 15% in this venture?

[Douglas W. Jamison:]

So good question. Your math is accurate in looking at that, as far as what we invested into it. I'll answer the last question first, which is opportunity to invest more. We're happy with the ownership we have in the company. We actually stepped up our ownership in doing this. We didn't really have much of an opportunity to pick up anything more. There is another very large investor beside us, Energy Ventures, who is probably the top firm in the world for doing these type of venture investments, and they were very interested in maintaining and increasing their pro rata as well. So we picked up a level we felt comfortable with. I don't think there was much of an opportunity to pick up more than that. But this is the type of company where we're really looking to do that, so to take shareholders back a step, right? I mean, the first thing you all have seen is that we wrote down the valuation of PWA over the last year, right, so we wrote down the value of PWA. And actually, for the same invested dollars, we were able to pick up more ownership in the company. Then we did this transaction where we bought -- again, it'll vary. We didn't buy all of the assets of PWA, so we won't buy all of the revenue -- I'm sorry, of ProSep, so we won't have bought all of the revenue of ProSep. Some of that business is being shut down. But where we bought $30 million to $40 million in revenue from ProSep for $3 million in equity and $6 million in debt, which is a public number, so a very good transaction. And we did that with invested capital at that lower valuation. So now we believe that PWA is going to be a company in 2014 that, potentially, if they execute on their business, could do north of $30 million in revenue; will have introduced Osorb to the market, which is another revenue stream for them; and the company will be sitting at the same low valuation we did this previously, which we think has a great opportunity to yield us a much higher investment return in the future. We believe that, with this transaction of working capital we have, there'll probably be one more round of capital that goes into PWA. It will probably be expanded to bring other investors into it, but that will be it. And then it'll be probably -- when we look at this transaction our thought process would be, we probably sped up the time to commercialization 2 to 3 years, which means we sped up the time to exit for us 2 to 3 years, which is also a metric of our return function.

[Sam Rebotsky:]

Okay, that makes sense. And as far as you indicated you have a new partner where your potential to borrow money and, possibly, they may come into deals with you. Formerly, you had this Russian relationship that you had hoped to do something and you spent about 2 years and nothing came of it. Could you indicate whether you will be getting this new relationship that you have the potential to borrow, do you expect a deal with them soon? What's your thought process when something may happen and that would -- and how would this benefit you? Other than coming into your deal, how would you earn something, et cetera?

[Douglas W. Jamison:]

So first of all, I would think of them very separately, right. So the relationship we have with ORIX and the credit facility is not really -- I would not consider it part of our partner strategy. Although one of the reasons we did the credit facility with ORIX is because they are both equity investors and venture debt providers in portfolio companies, and they could be investors in our portfolio company, and they clearly have an interest in some of what our portfolio companies are doing, and have actually, even since the time of the relationship, looked at some of them. So we think there are synergies, but very different from our partnership strategy. ORIX is a classic credit facility. What we did was -- it's a credit facility unlike the banks will give you now. The banks don't give us credit. They take our cash and they give us cash. And we just store our cash with them, and they give us a little cash, which is not a credit facility or a loan by any measure. It's backed up 100% by your own cash asset. This is a classic credit facility. It allows us to borrow over a period of time, multiple times from this facility. It allows us to bolster our balance sheet. It allows us to be aggressive when we want to be aggressive in some of our best firms in doing this, while preserving cash on our balance sheet, if we so choose to use it. So I think of it as a defensive posture. I think of it as a way to -- you're always hoping for the best, but planning for the worst. To date, we have not drawn anything from that credit facility, so we have no debt outstanding. But again, in the future, it provides us the opportunity to do things where we think we could increase our invested return. One of the problems we've always talked about at Harris & Harris Group is that we get in these companies earlier, but as companies like Solazyme went and raised large rounds of capital -- or to your earlier question, PWA, why didn't we invest more; it's because we haven't had the balance sheet to really be able to, sometimes, keep up our investment or be aggressive in these larger later rounds. And so this is a vehicle that potentially, if we so choose to use it for that purpose, allows us to be able to take advantage where we might not feel so comfortable doing that with purely the cash on our balance sheet, and without the visibility that we often don't have to exact timelines for our exits. So very different from our partnering strategy. I hope that's clear.

[Sam Rebotsky:]

Okay. Now, one additional question as far as an exit strategy or -- are there any of your companies that expect to file an IPO in the next year or other type of transactions that you may make a minor profit or a more significant profit? What kind of capital events that you might have -- that might happen within the next year from now going forward?

[Douglas W. Jamison:]

I'll start that and I'll hand it over to Daniel. First of all, I mean, you have to realize that -- 2 things

[Daniel B. Wolfe:]

Yes. So on Page 63 of our Q, in the Management's Discussion and Analysis section, there is a statement in there that talks about how our companies are often in the process of pursuing potential sales and IPOs. We consider these to be ordinary course of business. And we really only highlight ones where they become tangible through events such as the receipt of letters of intent to acquire a company or drafting of registration documents. We do highlight 2 companies below that paragraph where we talk about Ancora that sold a substantial portion of its assets, including the use of its corporate name to CordenPharma International of the U.S. And then also, we talk about the fact that another one of our portfolio companies and a potential acquirer began drafting definitive documents for potential acquisition. We currently estimate that the second transaction could close during the fourth quarter of 2013 or the first quarter of 2014. However, there can be no assurance that this company will be able to consummate such transaction within this time or, if at all, and we're not at liberty to be able to discuss any financial details of the transaction as well.

[Douglas W. Jamison:]

Yes, so just to set expectations on that, I don't think, when looking at those -- Sam, these are not -- so what we said publicly, these are not the companies that one would expect to be transformative return potentials for Harris & Harris Group. But again, we always try to state what is happening with some of those companies. And clearly, they are transactions that will bring back cash to Harris & Harris Group, and potentially, returns as well. Again, I would -- I highlight, and have been highlighting in our "realize" section that companies like D-Wave, Metabolon, SiOnyx, Adesto, HzO, PWA, some companies are coming into that as they continue to grow as well. But as an investor in Harris & Harris Group, those are the companies I would be watching very closely, as they mature looking to do -- see what they're going to do for excess as that becomes publicly available. Because those are the type of companies we have the ownership and where their businesses are really progressing, where there is a potential for -- to investment return and that can drive NAV for the future of Harris & Harris Group.

[Operator:]

And I'm not showing any further questions at this time. I would now like to turn the call back to Doug Jamison for any further remarks.

[Douglas W. Jamison:]

Great. Thank you very much for everybody that listened in today. We very much appreciate your support of Harris & Harris Group. We believe that the steps we are taking, some of the steps we outlined today, are the steps needed to make this company successful for shareholders. Again, thank you for your support. And we look forward to talking to you throughout the quarter. Bye.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.