180 Degree Capital Corp (TURN) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Harris & Harris Group second quarter conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, [Bethany Prince], with Lippert/Heilshorn & Associates.

Thank you, operator. Thank you, everyone for joining us this morning for the Harris & Harris Group second quarter 2010 shareholders conference call. On this morning's call, Doug Jamison, Chairman and CEO; and Daniel Wolfe, President, Chief Operating Officer and Chief Financial Officer; as well as [Patty] Egan, Chief Accounting Officer will lead a discussion about the Company's business and its second quarter results. This conference call and webcast is being accompanied by a slide presentation. To access the presentation, please go to the Company's web site at www.HHVC.com. A link to the presentation can be found on the home page.

Before starting the call, I will read the Safe Harbor statement. The matters being discussed on today's conference call may contain statements of a forward-looking nature relating to future events. 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 in the forward-looking statements.

Please see the Company's annual report on Form 10-K for the year ended December 31, 2009 as well as subsequent SEC 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 risk 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 undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties. With that, I would now like to turn the call over to Doug. Doug?

Thank you. Good morning, everyone. This is Doug Jamison, and welcome to our second -- call reporting on our second quarter 2010. For those that are interested, we do have the slides available, and you can gain access to the slides through our website at www.HHVC.com.

I'd like to start by briefly providing some background on Harris & Harris Group. For those who are new participants on our shareholder call, Harris & Harris Group is a venture capital firm, that invests in companies that apply nanotechnology and microsystems to large high growth markets. We define venture capital investments as the money and resources made available to privately held start-up firms and privately held and publicly traded small businesses with exceptional growth potential. The venture capital investments where we focus, regardless of whether they are private or public, often have the following traits. The companies are in need of capital and guidance, knowledge of the innovative technologies in the markets these technologies are being developed for are both critical for the company's success. The companies often need help assembling high-quality management and resources necessary for success. And the companies can benefit from our ecosystem, our contacts, our relationships in order to execute on their business plan.

In our June letter to shareholders, and in our MD&A, we continue our transparency in communicating the enhanced flexibility we are bringing to our venture capital strategy. In addition to our private portfolio, we are currently focusing our efforts on identifying small capitalization public companies that will provide us with the opportunity to realize venture capital returns in a 12 to 24-month time frame. These companies provide more liquidity than our private portfolio. They present the opportunity to augment our early stage private venture returns with more predictable and frequent returns than in our private portfolio alone. Although, many of these companies may have market capitalizations under $50 million, we may find attractive investment opportunities in companies with market capitalizations greater than $50 million as well. Our approach to these public company investments is no different than our approach to private company investments. We view both of them as venture capital investments, and we will continue to focus our investments in companies commercializing products enabled by nanotechnology and microsystems.

Throughout our 15-minute presentation today, we'll be referencing our recently filed quarterly report on Form 10-Q and will refer to the page numbers. We'll begin by having Patty Egan, our Chief Accounting Officer, briefly provide the highlights of our June 30, 2010 financials. Then Daniel Wolfe, our President and CFO, will walk you through some of the additional slides, articulating some of our recent disclosures in our management discussion and analysis in our 2010 10-Q. We believe these disclosures help tell our story to shareholders more effectively. We'll then open it up to questions. We expect the call to last approximately 45 minutes. Patty, will you take us through the financials?

Yes. Thank you, Doug. At June 30, 2010, we had total assets of $141.5 million on our balance sheet. Included in our total assets is our venture capital portfolio, which was valued at $92 million as of the end of the second quarter. We also held $48.5 million in cash and US treasuries as of June 30. We have no debt. Our net assets of June 30 were approximately $139 million and our net asset value per share was $4.51. This was an increase from our net asset value per share of $4.42 at March 31, 2010, and an increase from our net asset value per share of $4.35 at December 31, 2009.

Turning to our income statement, through the first six months of 2010, we had investment income of approximately $208,000. This compares with $60,000 of investment income during the first six months of 2009. The increase in our investment income reflects an increase in bridge-note interest as well as an increase in interest on our US Government securities, resulting from an increase in our average holdings of the US Government securities, offset by a decrease of interest rates on those US Government securities.

Our total expenses were $4.3 million during the first six months of 2010 compared with approximately $4.2 million during the same period of 2009. These total expense figures include both cash and non-cash based operating expenses such as stock-based compensation. Our non-cash stock-based compensation expense was approximately $1.2 million for the first six months ended June 30, 2010 as compared with $1.4 million during the same period last year. We had slight increases to professional fees, board of director fees, custody fees and lease termination costs in the first half of 2010. While we had lower costs associated with salaries and stock-based compensation as well as lower administrative costs.

This yielded a net operating loss of $4.1 million for the six months ended June 30, 2010. We also had a net operating loss of $4.1 million for the first six months ended June 30, 2009. During the six months ended June 30, 2010, we realized $408,000 of losses on the disposal of investments. This compares to approximately $1.5 million in losses realized during the first six months of 2009. During the six months ended June 30, 2010, there was an $8.3 million change in the value of our investment portfolio. Of this $8.3 million increase, approximately $200,000 relates to investments that were disposed of during the first half of the year. The remaining $8.1 million represents a net increase in the value of the portfolio that was still on our balance sheet at (inaudible).

Thank you, Patty. Daniel, will you take over?

Absolutely. Thank you, Doug. Some of our continued efforts to provide meaningful transparency into our business are captured in our quarterly report filed on Form 10-Q in the management's discussion and analysis section. The change in the value of our venture capital portfolio was the dominant source of the increase in our net asset value per share to $4.51 as of June 30, 2010.

There are many inputs used by our valuation committee to value our privately-held portfolio companies each quarter. On page 55, we provide a table that discusses examples of some of the quantitative inputs that contribute to changes in the value of our privately held venture capital portfolios during the past four quarters. The price per share paid in new rounds of financing that occurred in the second quarter of 2010 and included third party independent investors were significant inputs that led to the majority of increases in the value of our portfolio companies. Increase in the nonperformance risk were significant inputs that led to the majority of the decreases in the values of our portfolio companies. We define nonperformance risk on page 56. We expect nonperformance risk to continue to be an important input in determining value, particularly as our portfolio companies encounter the risks associated with maturation of their businesses.

On page 51, we provide two charts detailing three levels of maturity for our portfolio companies. The first chart shows our most mature companies account for almost 50% -- 52% -- of the value of our venture capital portfolio. Many of these late stage companies started as early stage companies in our portfolio. Over 40% of our 31 portfolio companies are currently early stage companies. These companies provide us with a funnel of investments that could eventually graduate to mid-stage and late-stage companies. For example, during the second quarter of 2010, we transitioned one company, ABS Materials, from an early stage company to a mid-stage company.

The second chart delineates the value of our venture capital portfolio by voting ownership at each level of maturity. We believe it is important to note that we own between 5% and 25% of the voting interests in approximately half of our portfolio companies. These levels of ownership are standard within the venture capital industry. We also note that our voting membership in Solazyme will drop below 5% after June 30, 2010, with the final close of the company's Series D round of financing. We classified Solazyme as a late stage company.

On page 52, we mentioned steps being taken by three of our portfolio companies to pursue potential exit opportunities. These steps include the filing of a registration statement by NeoPhotonics and the hiring of bankers by two of our portfolio companies to pursue opportunities to sell those companies. A variety of factors, including general business conditions and the state of the capital markets, could lead any or all of these companies to terminate such efforts. As we stated in previous shareholder letters and on page 67 of our Form 10-Q for the period ended June 30, 2010, we continue to believe our current amount of cash and US treasuries will provide us with adequate liquidity to execute on our business strategy. Our operating runway without exits and without -- and with cash expenses of approximately $6 million per year could range from 3.2 to 4.8 years, based on the scenarios for capital allocation to new and follow-on investments shown in the displayed slide.

On page 56, we provide a list of our top-10 venture capital investments by value. These top ten investments represent 71% of the value of our venture capital portfolio. We believe the most recent round of financing, or the next round of financing for those needing to raise capital in the next 12 months, will allow at least eight of these 10 companies to reach positive cash flow, or to exit through an IPO or M&A transaction.

On page 57, we discuss our investment objectives. We continue to seek the point where our future growth is financed through reinvestment of capital gains from our venture capital investment. While secondary to our principal objective, we also seek opportunities to generate current income such as providing debt financing to our current and new portfolio companies. We believe the limited availability of debt to small companies creates an opportunity for us to secure favorable terms. This cash flow could be used to cover some of our cash-based expenses -- operating expenses -- during periods of time between the realization of capital gains on our venture capital investment.

Additionally, we recently announced that we were going to focus more resources on identifying and investing in publicly traded companies with market capitalizations below $50 million. The attributes of these companies are the same as those found in our current privately held portfolio companies, and directly leverage our skill set to venture capital investors. We have identified a number of potentially interesting venture capital and investment opportunities that operate in sectors such as energy efficiency or green technology, healthcare and electronics and semiconductors. These investment opportunities range in stage from relatively new companies with exciting platform technologies that are looking to assemble all of the components required to build a successful company, to restarting an existing company with new management and a new business plan, to generating positive cash flow and figuring out how to take an already mature business to the next level. I'll now turn the call back over to Doug.

Thank you, Daniel. We'd like to end by discussing our strategic reasons for reducing our presence in Palo Alto that we announced in late June, 2010. As a small venture capital fund, and as a micro-cap public company, we need to be nimble. We believe the investment opportunities will best utilize our skill sets over the coming years, [resulting] in smaller venture-backed investments at early stages of development, both private and public.

We [were a team one] Managing Director in Palo Alto, to work closely with our existing portfolio there. That Managing Director is well connected into the venture community in Silicon Valley, and has excellent access to high-quality deal flow. Additionally, we were lucky to have Lucio Lanza recently join our Board. He is also actively involved, and close to that same community, as for many years, he was a general partner at USVP, one of the largest venture capital firms in Silicon Valley. These changes to our Palo Alto office allow to us focus our resources where they are most needed and allow us to be more efficient as a firm.

In summary, as we continue through 2010, we see risks for the general economy and for the US specifically. However, we are excited by the direction of our venture capital portfolio and for the opportunities for investments that we are encountering. Our number one priority will be to look for opportunities to realize gains in our venture capital portfolio over the next year and a half. We will reinvest those gains back into Harris&Harris Group to grow the Company organically. We will continue to look for quality investments that fit the flexible strategy we laid out in our MD&A and shareholder letters. We believe this is important, as our continued growth will require a portfolio approach to investment. I'd like to now open it up to any questions that we may have.

Thank you. (Operator Instructions) And our first question comes from Ted Kundtz from Needham & Company.

Yes, good morning. Couple questions for you. Doug, could you address some of the specific companies that had some fair amount of movement and valuation over the quarter? I've got five of them here. I think Solazyme you covered reflecting that went up dramatically, reflecting the Series D round of financing that just took place?

Yes.

Okay. How about SiOnyx. That one went up significantly as well that doubled in value. What was the rationale behind that. Then you had three that declined. I wanted you to touch on that.

Certainly. So I'll take Solazyme to be clear on that. Solazyme had a Series D financing, and that Series-B financing was at a significantly higher price than the previous round of financing and then where we were holding it in our valuation. So you saw the increase as of June 30, 2010. SiOnyx is similar. SiOnyx just consummated a financing as well. Some of you probably saw the strategic announcement with Coherent coming into that deal as well but they consummated financing at a valuation higher than we were holding on our books previously as well.

Okay. How about the three that did go down a bit were Nextreme, BridgeLux and NeoPhotonics, and could you comment on those three as well?

Certainly. I'll start with NeoPhotonics. As most people know, NeoPhotonics has filed an S-1 to go public. NeoPhotonics is one of the companies we value based on comparables. And if you look at what happens in the market, so if the market goes up or specifically their comparables go up, you'll see the valuation of NeoPhotonics fluctuate from quarter to quarter. If you see the valuation of their comparables decrease, you'll also see us reflect that decrease. And you look at just the May/June time period in the market -- it was a tough time in that market. Some of the comparables decreased so we decreased it as well. We believe that's the right methodology for thinking about that investment. Of course, if it's successful going public it will trade -- become a market security at that point as well.

Okay.

I'll tackle BridgeLux and -- actually, I will tackle Molecular Imprints, which is another one you probably saw go down this quarter as well. Both are two of our more mature companies, both of them you've actually seen increase in the recent quarters as well. As we articulated in our 10-Qs, one of the tools in our tool box within FAS 157 for valuations are what we call nonperformance discount risk. As these companies get more mature, I think that the market's going to look to their growing revenue to also support the valuations they're at. Again, from quarter to quarter, we look at the growth, how they are performing according to their business plans -- and we have a tool, which allows us if we think the environment is going to get more difficult for economic growth or we think they have very aggressive growth plans, we sometimes take a look at that nonperformance risk to adjust them within the standards of FAS 157. Nextreme I would say is very similar.

Nothing -- let me just get it straight. There's no core change in your outlook for these companies other than I wasn't quite clear with the nonperformance risk was for those specific companies. The increase in the nonperformance risk. The growth outlook was a little more muted than it was before? You indicated that?

I think that is accurate. We don't go into those details because of the confidential nature. I will tell that you both Molecular Imprints and BridgeLux had record revenue growth in 2009, but I also say that both companies are really in the big growth periods of their development as companies. That's going to be based on revenue as well. So we're going to continue to look at whether we think those companies are growing fast enough to support the future outcomes of those companies.

Do you give any -- I know you do this annually -- the revenue of all the -- the group -- the companies you do own, combined revenue? Or do you do it quarterly?

We only do it annually just because for a lot of these companies it's still very lumpy. The only one, now you see NeoPhotonics, they updated their S-1. They had a record quarter in revenue -- I think they reported over $45 million in revenue, their best quarter ever. And they also reported, I think, $2.8 million in net income over the second quarter as well, which is also a record.

Okay.

So again, the point we always try to make on valuations is, and look, and NeoPhotonics went down in valuation because of comparables, right? So that in these early stage companies, there's also the movements in their valuations can be lumpy just like their growth or demise can be lumpy.

Right. Okay, good. Thank you. Finally what is your goal with this change in the strategy of moving towards investing in small microcap public companies. Do you have a target as to how much of your portfolio you'd like to see in that category?

Again, we don't have an actual target. We do have a goal of doing a few of those deals by year end. In most of these cases, in the end you're going to see us not buying these stocks in the open market although we may but you'll see us doing pipe transactions into the deals. Or potentially even buying out existing shareholders that want some liquidity as well. So again, once identified, we need to find the right opportunity to actually invest in them. What we've communicated and I think what's true especially when there's so little visibility liquidity is we look at this strategy as a way to get venture capital return, use our same skill set but in a shorter period of time of 12 to 24 months which we think that is important as we guide Harris & Harris Group over the next 10 or 15 years to have exits that we can look to, monetization events in a 12 to 24 month time frame in addition to the private portfolio, which is taking longer to mature.

Right. Okay. Thank you.

Thank you.

(Operator Instructions). It looks like our next question comes from the line of Robert Littel with JPMorgan.

Good morning, everybody. Quick question in terms -- as it relates to the venture community in general. How do you see this changing environment affecting the industry overall. There's some people that feel that the industry is in a lot of dislocation. You hear things about the concept of founders shares, which I think is a relatively new concept.

Would you care to comment on those issues as you see them evolving? Yes. Certainly. As I think we've communicated in our shareholder letters for probably the last year, we do view -- the venture capital community is certainly in disarray. I think that that really comes from two aspects. First of all, there have been very few exits over the last decade so they haven't been able to return capital to their LPs or recognize those gains. Secondly, I think, especially with the credit crisis, the world has found a new love with liquidity, or a new value for liquidity that that had forgotten previously. You've seen that across the board whether that be endowments or pension funds, which makes it difficult for LPs to want to fund private equity and venture capital firms when they have so little liquidity. I'll mention that's one of the benefits, we think, to Harris & Harris Group, which is you have a venture capital firm but you have the liquidity of a publicly traded stock.

So I think you're starting to see that -- the disarray in the venture community work itself out. I read recently, about six months ago, so we're still probably about 12 months of sorting through some of that disarray. What you're seeing happen from our perspective is you're seeing a bifurcation of the venture capital, and we think that's a good thing. The very large funds still have a lot of money, they have a lot of money to invest. They can write larger checks in some of the late-stage deals, and I think those returns ultimately will be good for them, for the valuations they're getting currently, and you're seeing some of the smaller investors, what I'll call the sub-$300 million -- even sub-$200 million fund size venture capital firms realize that perhaps the investments they should be looking at are smaller investments that need less money to get to cash flow positive, or to exit, but the returns there can be very good as well. Where the returns don't work is for companies that take multiple hundreds of millions of dollars of investments to get to only multiple hundreds of millions of dollars in exits. That's been one of the difficulties.

So one of the strategies we communicated at the beginning of this year was that we were really looking in our private investments at these companies that needed less capital to get to exit. ABS, in our portfolio, is a great example of that. The company for the last couple of months has actually been cash flow positive. The investment is six months old. It has a clear, quick path to revenue that appears to be climbing. We like that, because low valuation, if it's successful, it doesn't have to be a $400 million, $500 million market cap company to make us a very nice venture capital return.

So I think that this disarray is going to continue. We've seen it and we've discussed it in our own syndicates where syndicate members are falling out. You've seen it impact some of the valuation. The flip of that is if you have capital and if you've managed yourself conservatively it is a great time to be in the venture world. I think you see that in our most recent shareholder letter. It's a fantastic time to find great companies at low valuations that are fairly far along in their development process as well. So if you have the capital to deploy, we think it's a very nice environment currently.

Thank you, Doug.

Our next question comes from Adam Hinckley with GC Research.

Hi. Thanks for taking my question. Just wanted to ask about the potential savings and cash burn from scaled down efforts in Palo Alto, just talk about savings on salaries and rent and when you expect them to start kicking in?

So in Palo Alto, I think you'll see -- I'll give you one number, there will be some additional. If you look at it just from the human side of it, we'll probably save about $400,000 -- $450,000 a year from that -- over time, although, again, we'll continue to make some changes across the firm and do some things. We have the office in Palo Alto, we actually have a five-year lease on that office in Palo Alto that expires in 2013. We actually have some offices rented out in that office now. We'll continue to look out for that. And we may have an opportunity to rent out the whole office out as well. That will depend on the commercial real estate market in the beginning of 2011 when we look to do that.

The cost savings will be about $450,000 to $500,000 a year. As we continue to look forward I think in any environment but certainly in this environment, when you start to put your budgets together, you start to look at them and call nothing sacred, and take a look at what you can save. We'll continue to do that through the end of the year and the budget of next year. We think we're very well positioned going forward. We'll have three managing directors and a fourth member of the deal team. We think that that's probably the right size for our asset base currently as well.

Great. Then just in terms of the strategy of starting to invest in public equities or more so in the microcap companies, have you hired any managers that have expertise in micro-cap investing, or is it just the same team that's going to be responsible for that as well?

It'll be the same team here that'll be responsible for that. Most of us manage a microcap company ourselves right here at Harris & Harris Group so we're very familiar with that world and familiar with that ecosystem. Most of the companies we're looking at really look like venture capital companies. I'll give you a little more flavor to that. When we refined our strategies, one of the reasons we refined our strategy was because we had a decision point. We could have either gone out and hired traders here at Harris&Harris Group, and gone that route, or we could have really stuck with where we thought we had competitive advantages. We chose to stick where we thought we had competitive advantages within the ecosystem we worked. There's a lot of great hedge funds out there.

There's a lot of trading groups out there. We like to be in nanotechnology, because we're a leader. We think if you're going to do something, be a leader in that space. The same thought guided our principles here. The deals we're looking at tend to be a little bit smaller. They're going to be a little different than the pipe transactions you see, we're going to see a lot of capital go into them, like venture capital deals, but in this environment, those opportunities exist.

To add a little more flavor to what Daniel was saying earlier, one of the companies we're looking at, first of all, over 60% of the company is still owned by the venture capitalists. A company we knew very well, even when it was private. Whereas a company of this size would normally raise money in $3 million or $4 million increments in pipes overtime, which creates a tremendous financing risk from pipe transactions to pipe transaction. This company is going to probably raise a significant amount of money, take the financing risk out of it altogether. Normally that wouldn't occur but because the VCs own enough of the company, they're willing to take that dilution. That, we think, is a wonderful opportunity as they begin to launch their platform onto the marketplace. To me that doesn't look any different than a private company. It's public.

We're going to bet on the fundamentals. If we're wrong on the fundamentals, we'll lose money. If we're right on the fundamentals, we think there's excellent growth opportunity in a company that's already public. At a second company we're looking at, again, there is the shareholder basis is fairly tight. We know the major owners of the stock. In this case, the company doesn't even need money and we're looking to potentially work with the existing shareholders to buy some of those positions in what we think is an exciting company and exciting space.

So we are going to utilize the same skill sets that we have. We have done one thing -- we always use advisors and consultants. We surrounded ourselves with experts in -- call it the microcap and nanocap space from founders of some of the large firms and pipe firms that did these deals that are helping us with our diligence and helping us ask the questions we'll need as we go into public companies.

Thank you.

(Operator Instructions) And I'm showing no further questions in the queue. I'd like to turn it over to our speakers for any wrap-up.

This is Doug. Thank you very much. Thank everyone that participated today. I'll just close -- in preparation for this call, I went back through some of our shareholder letters for this year. In a very uncertain world and certainly in a volatile world, we've seen that just in the first six months, seven months of this year, it's important to us that we have a consistent message.

It's also important to us as a firm that we are proactive rather than reactive. So I went back to these letters just to see if we have a consistent message, and I think the message is that I take away from what we've communicated are, one, we do believe we're prepared for an uncertain environment. Two, we believe we're in a position to succeed without the need for additional capital. Three, the environment does make it difficult to have clear visibility in the timing of our exits. At the same time, we are in a position where we need to monetize our investments immediately. So we're going to continue to be patient and we're going to continue to think about monetizing our investments at appropriate valuations.

Our next shareholder call will be in November after the filing of our Q3 2010 financials. Thank you very much for your time.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.