180 Degree Capital Corp (TURN) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Harris & Harris Group shareholder update 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, Patty Egan, Chief Accounting Officer.

Good morning. I'll begin by reading the Safe Harbor Statement before turning the call over to Doug Jamison, our CEO. 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 10K, 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.

Doug?

Thank you, Patty. Good morning. This is Doug Jamison, and welcome to our call reporting on year-end 2011. Harris & Harris Group is an early stage active investor in transformative nanotechnology companies. It's been a busy couple weeks at Harris & Harris Group, and before I begin today, I would like to recommend that anyone who is not at our Meet the Portfolio Day or has not listened to the webcast of the presentations, please take time to do so. You will learn much more about the potential of nanotechnology, and the potential of our portfolio by hearing about the progress of these subset of 10 companies than you will learn on a 45-minute call with us. It was a great event. We had over 100 participants, and some real, live demonstrations, first of an LED bulb built from gallium nitride on silicon electronics, and also of electronics working under water.

Additionally, please take a look at our new website, and the added functionality it provides to shareholders. Please go to Facebook and quote, LIKE US, end-quote, to see more about our portfolio companies. Look at the videos we have posted, which do a tremendous job explaining the technologies and the markets of many of our portfolio companies.

We had four priority objectives for 2011. The first was to position the portfolio for liquidity events. The second was to maintain a pipeline of investment opportunities for the future growth of the Company. The third was to increase our investment income primarily through increasing our venture debt business. The fourth was to end the year with an enhanced combination of primary and secondary liquidity. We believe we accomplished these goals in 2011.

We had five liquidity events in 2011. We've discussed four of these previously; I just want to focus on the sale of Crystal IS to Asahi Kasei, which was consummated on December 28, providing our fifth liquidity event for 2011. We continue to hold all of our shares of both IPOs in 2011, those of NeoPhotonics and Solazyme as of today. In 2011, our portfolio companies increased their revenue in aggregate to $424 million as of December 31, 2011. That's up from $380 million as of December 31, 2010. In 2011, our late stage companies, NeoPhotonics, Solazyme, Bridgelux, Metabolon and Xradia, all had record years of revenue. Of our private companies, Bridgelux increased its revenue by 90%, Metabolon increased its revenue by 32%, and Xradia increased its revenue by 31%.

We made four new investments in 2011. These new investments include PWA, or Produced Water Absorbents, Champions Oncology, Senova Systems, and HzO. We announced our first new initial investment in 2012 in OpGen on March 7, 2012. We generated income to offset expenses, partially reflecting our increasing involvement in venture debt. Additionally in the fourth quarter of 2011 and into 2012, we had the opportunity to sell covered call option on our positions in publicly traded portfolio companies. These transactions contributed positively to our cash flows, yielding approximately $580,000 in cash to Harris & Harris Group. Primary and secondary liquidity increased to $65 million as of December 31, 2011, up from $42 million as of December 31, 2010.

As we begin to look forward, I believe TINY is uniquely positioned as a leader, as this transformational technology continues its progression. We have established a unique ecosystem around commercializing nanotechnology. We believe this unique ecosystem will be difficult to replicate for those entering now, and we believe it will provide us and our shareholders with a competitive advantage over the coming decades.

Looking forward, currently we believe that more than 75% of our mid-stage and late-stage companies could be in a position to complete transactions that create liquidity events for our investments in those companies between 2012 and 2014. These efforts will remain ongoing. There could be no assurance that these companies will actually get to liquidity events or consummate transaction, but as we begin to look forward, we see potential, again, for over 75% of these mid-stage and late-stage companies to be in a position to complete transactions.

Looking forward, our high level objective is to increase assets under management, to provide us the capability to invest $10 million to $15 million per investment instead of the $5 million to $7 million currently. We believe this is the most effective means to influence growth in net asset value per share over the long-term.

Patty Egan, our Chief Accounting Officer, will continue this call with a brief summary of our December 31, 2011 financials. Patty will be referencing our recently filed annual report on Form 10K. After Patty, Daniel Wolfe, our President and CFO, will provide more detail on our venture capital portfolio, and on our strategy and directions moving forward. We will then open it up to questions.

Patty, will you continue?

Thank you, Doug. At December 31, 2011, we had total assets of $150 million on our balance sheet. Included in our total assets is our venture capital portfolio, which was valued at $113 million versus its cost basis of $103.3 million as of December 31, 2011. Therefore, our venture capital portfolio was in an appreciated state of $9.7 million at year-end. We also held $35.3 million in cash and restricted cash as of December 31. We had debt outstanding of $1.5 million at December 31.

Our net assets at December 31 were approximately $145.7 million, and our net asset value per share was $4.70. This was a decrease compared to our net asset value per share of $4.76 at December 31, 2010. For the year-ended December 31, 2011, we had investment income of approximately $703,000. This compares with approximately $446,000 in investment income in 2010.

Our total expenses were approximately $9 million during 2011, compared with approximately $8 million during 2010. These total expense figures include both cash- and non-cash-based operating expenses such as stock-based compensation. Our total cash-based and accrued operating expenses for the year-ended December 31, 2011 were approximately $6.3 million, as compared with $5.7 million for the year-ended December 31, 2010. This yielded a net operating loss of $8.3 million through December 31, 2011, which is an increase compared to our net operating loss of $7.6 million for the year-ended December 31, 2010.

Our investment pace picked up during 2011 from a slower rate of investment in 2009 and 2010 to levels more similar to that of 2007 and 2008. We invested $17.7 million in new and follow-on investments in equity-focused portfolio companies. Our average dollar invested in new portfolio companies increased substantially from under $120,000 to $1.3 million. This increase in the size of our initial investments in our new portfolio companies is reflective of our desire to own more of the companies that we invest in, which we believe could yield larger gains on our successful investments. The average size and number of our follow-on investments remain consistent with levels of the prior year.

We continue to believe that we have the financial resources to execute on our business. We ended the fourth quarter of 2011 with more cash and secondary liquidity than as of the end of the fourth quarter of 2010. With the recent advance of Solazyme stock price, our secondary liquidity as of the close of the markets yesterday was approximately $40.3 million, up from $31.5 million as of December 31, 2011, or approximately $0.28 per share. This amount will fluctuate over time as Solazyme stock price has been volatile in the public markets.

We also have the potential to receive up to $9.5 million in milestone payments from the sale of BioVex, which we currently value at $3.4 million. We do not currently expect any milestone payments before 2013. We also have up to $2.2 million in escrow payments from the sales of BioVex, Crystal IS, and Innovalight, which we value at approximately $1.1 million. We are expecting to receive our portion of the upfront payment from the sale of BioVex held in escrow of approximately $950,000 shortly.

The lock-up restrictions on us and our shares of publicly traded portfolio companies expired in August 2011 for NeoPhotonics, and November of 2011 for Solazyme. These restrictions prevent the sale of those shares, options against those shares, or other transactions associated with those shares until the expiration of the lock-up period. With the expiration of these restrictions, we began selling call options covered by a portion of our holdings in each company.

We believe this strategy of selling covered call options on our publicly traded portfolio companies provides at least three benefits. First, we receive a payment of premium in cash at the time of the sale of the call option. If the option expires out of the money, we retain the premium as a gain on our investment. If the option is exercised, it enables the monetization of the stock held by us in an orderly transaction that yields known returns. That said, it also sets an upper limit for the proceeds we would receive in such sale. We plan to enter into such contracts at a price per share and in a timeframe that we would be willing to sell those shares. While we may repurchase call options when advantageous to us, we commonly do not sell call options with the expectation that we will be able to repurchase them at a future date. Third, the sale of call options may help generate interest and liquidity in the stock of our publicly traded portfolio companies, which we believe may be beneficial to our future potential returns on these investments.

I'll now hand the call back over to Doug.

Thank you, Daniel. Harris & Harris Group is an early stage active investor in transformative nanotechnology companies. For the last decade, we assembled a team that has a unique ability to identify and diligence the network of discoveries that come from understanding science at the nano scale. This understanding continues to place us at the center of these discoveries impacting some of the most important sectors and industries of the economy, and we believe the progress of our portfolio evidences this impact. We believe we have completed the first decade of nanotechnology commercialization, and that the following two decades will be where nanotechnology diffuses through multiple sectors of our economy, transforming the industries it impacts.

With that, I'd like to open it up to questions.

(Operator Instructions) Sam Rebotsky, SER Asset Management.

Investor Day seemed to be very positive, creates some more interest in Harris & Harris. The first question I want to ask is about your practice of writing options, call options against Solazyme and NeoPhotonics. What your upper limit is and what your plan is? You have written against 500,000 shares of Solazyme and a smaller amount of NeoPhotonics. So, why don't you talk about your plan. Is there an upper price you would lose the stock?

Certainly, Sam. So, thank you and great question. Again, we are trying to be as transparent as we can in this process, so you are correct. To date, we have sold covered call options on up to 500,000 shares. We own 2.3 million shares of Solazyme. What we continue to say publicly is that we believe Solazyme, the markets, they are approaching, are potentially very, very large. This company could be not a $900 million market capitalization company but a multi-billion dollar market capitalization company, if it can execute on its strategy over the coming years. Their strategy will play out over the coming years into 2013, into 2014, into 2015.

We are believers in that and that's why we will not write covered calls on the vast portion of our holdings in Solazyme. Because as a venture capital investor, it's not often that a company like Solazyme comes along that could really change, not just an industry but can also be very impactful to us as a venture capital firm. So we would like to hold those shares believing that Solazyme's value could be much greater in the future. All of that hinges on their ability to execute, so we continually watch to make sure we believe Solazyme can execute in the future, that management can execute in the future and any sign that we believe was different from that, we may change our strategy.

We also balance the long-term nature of these investments with our own needs at Harris & Harris Group. We are an early stage venture capital firm. We have cash needs to continue investing in other promising companies in the portfolio and to continually look for new companies because, again, the nanotechnology field is exciting.

So the idea of the covered calls for us, it allows us -- and oftentimes stocks that are not truly liquid stocks to be able to potentially sell some shares at a price we would be willing to sell. To one, increase the cash on our balance sheet so that we can continue to run our business as well. So, our balance is really a balance between looking at what capital needs do we have to make follow-on and new investments in areas where we would like to make follow-on and new investments. Also maximizing the value of a company like Solazyme which for the entire time it's been in our portfolio has executed beautifully

So just to put that more tangible, I think one shouldn't look for much more than 500,000 shares in covered calls to be out there. You may see us begin to ladder, maybe with another 100,000 or 200,000 shares over a 12-month period. But I don't think you should be looking for us to put much more than that at risk in covered calls because we want to be able to play what we think will be the growth of Solazyme over the next couple years.

Okay, that's good. I have an idea of where you're going. I wanted to ask a question about the item in the income statement under expenses, salary benefits and stock based compensation, which is $5.972 million. I know you mentioned that there are 10 employees and 4 management employees. When you further look through the 10K, I see there's cash compensation of a $1.894 million and they talk of compensation stock unrecognized, $2,034,561. I'd like to have a better understanding what's in this $5.972 million and whether the 10 employees includes the 4 Management employees? What this total income is, et cetera -- I mean, expenses is and relative to the number of employees you have.

Certainly, so I'll just say that the 10 employees are the full 10 employees of Harris & Harris Group. There are certainly weeks like the past couple weeks where I wish we had an additional 4 employees from the Management team making that up but we run this Company with just the 10 employees. Daniel and Patty, will you address that?

Sure. Included in the salaries, benefits and stock based compensation line item, the $5 million or so that you're referencing, it includes both cash and non-cash items. The non-cash stock based compensation of $1.8 million that you referenced, that's the amount that is in the current income statement, included in that $5 million or so. The other $2.3 million of unrecognized compensation cost is the remaining compensation cost for stock options to be recognized over the vesting periods of the remaining outstanding grants. So, that $2.3 million is not currently in the income statement but will be recognized through the income statement over future periods.

Okay, with the loss relative to the expenses, instead of the operating loss for this period, I have a further question on how you take advantage of all the companies you're investing in and get some benefit. I don't know of you receive any income from any of the investors that you bring to your private investors investments, but it would appear to me based on the money that you're spending in the expenses even though you only have 10 employees, is there some plan -- I know you've been working to get additional money to manage. What is your time frame to get additional funds? Is there any way that when you bring investors into some of your various private investments to get additional income for this opportunity to cover the expenses you're incurring? Because these are substantial numbers and relative to 10 employees, this is a rather substantial cost.

Yes, so I'll address that. I think first of all, to address one of your questions, venture capital is still a fairly pure investment class, so no, we do not get fees. We don't get finders fees to bring other investors into the deals we invest in. It's not like what has happened in private equity where the moment you step in, you take fees out of the Company, you put debt in, you charge for managerial experience and you're constantly taking cash out of the Company.

These are early stage companies. These are companies poised for growth and so we rarely, we don't pay finders fees to groups. We don't pay finders fees to others VCs we co-invest with nor do we charge them, nor do we take money out of the portfolio companies themselves. So again, it's relatively pure from that perspective.

To your second question of what do we plan to do? In my mind, the future of Harris & Harris Group is fairly clear. It's a future that's going to play out over 12 to 24 months just if you look at what needs to be done. But the future of TINY is to one, yes, offset some of the expenses. We've never done that historically. We first started taking steps last year as we move the venture debt. The covered calls give us an opportunity to bring in some income as well or some cash. But we need to offset the expenses of TINY. I think that the ways to do that are we've talked about venture debt and we've talked about third party capital that would bring in some fees as well.

The other future of Harris & Harris Group is to be able to do $10 million to $15 million per deal. There are expenses of running a public Company. If you look at our expenses at Harris & Harris Group compared to other BDCs, they are similar and compare well. When you look at our expenses compared to venture capital and you look at the assets under management entirely, and you look at what they bill back to the LPs -- even running a public vehicle, we compare fairly well.

Again, we provide an added capability which is both transparency and liquidity. So again, just in summary, we do look to offset the expenses. I think the time frame to that to be honest with you is an 18 to 24 month-plus time frame before you can really offset them but we are going to be working towards that. Shareholders should expect to see that over the coming years.

Okay, I'm just about finished and I'll give somebody else a chance. But along the same question, have you thought about asking any of these private companies for warrants, which are non-cash, for your services. So, that if you are successful and you're putting excess time and you're spending a large amount of money in salaries to participate, that at least you could get something additional for this time because you're involved in the long period of time. So, warrants are some other thing which are non-cash for your time, do you get that? Is there an ability to get that?

So we get maybe two things. One, we often get warrants in deals, we get warrants from some of the deals we do for some of the bridge notes we do as well. I would not say that we seek warrants for our services but we do have warrants in many of the deals that we have and on the consolidated schedule of investments you can see the companies where we do have warrants.

I'll also make a note, there is a difference in venture debt. In venture debt, without being cynical, I'd say it's a less pure business. So that we actually -- when we do venture debt deals we often take a fee up front. We sometimes may take a fee on the back end and we do get warrants. So, in addition to the interest we get, we get warrants for the upside. So, the venture debt business does have some more fees and upside than I led you to believe to begin with. So again as we continue to do that, we believe that is a nice way to offset those.

Jerry Tweddell, Tweddell Goldberg.

Along the same line, it seems like it's an awful long time ago you made the announcement of the tentative agreement with RUSNANO -- I think it is, and there's been no update. Should we assume that's dead, or are you still working on it or trying to combine it with somebody else?

We're not combining it with somebody else. We are -- so it continues to move forward. There's not much we're allowed to say at this point in time on it. All I will say is twofold. One, there are multiple initiatives we're moving forward on. At the end of the day with RUSNANO, I think the question will be, is it strategically in our best interest because a good portion of that money will have to be used in Russia. Is it the best use of our time and to maximize value for our shareholders, but that work continues forward.

Sam Rebotsky, SER Asset Management.

One other thing relative to your investments. I found it very rewarding to watch the companies' presenting. You indicated in the 10-K that there are several companies that you expect to either do an IPO, et cetera. As far as my understanding, it was that Metabolon mentioned that and also Bridgelux mentioned that. I don't recall whether there was a third one. Could you talk some more of the time frame of some more of what your abilities for some of these companies to go public -- or you also mentioned of a potential acquisition. To whatever you could talk about these things in the time frames relative to those type of events.

So I'll certainly try. Again, there's not a lot we can say. We try to be as transparent as we can but of course, we're not allowed to speak on most of these things. So let me address a couple items to that. First of all historically, we have said something similar. Again, not all of those transactions occur. There are letters of interest and sometimes inquiries that we don't pursue because we don't believe we get the right value. There are others that are not pursued because the companies just cannot come to an agreement. But having said that historically, we talked about that historically and then had five liquidity events in 2011, so we do take what we say seriously.

I think as you look forward just to put it in a time frame, whereas 2011 was front end loaded, we knew what was happening towards the end of 2010. I think as you look at 2012, and into 2013, it's back end loaded. There are as you heard -- and Sam, I love it because I like it coming from you and not from me, but there are certainly companies that are looking for what their next step is and that next step we believe will provide liquidity for Harris & Harris Group.

I think most of the time frame for those events I would call our second half 2012 and into 2013 events with what we know today. But they can be surprises. Crystal IS, we knew some certain time frames there. There was some things written into agreement that drew action but in all honesty it was a bit of surprise that Asahi Kasei decided to purchase them in late December of last year. There's other companies that we talk about when we talk about liquidity events where we have control of their future or they have control of their future meaning they generate revenue. Some of them are cash flow positive. Those, we want to be able to maximize our value, not sell something early at the wrong price because we want to get to a liquidity event.

So the numbers that you see in the K, they will change over time but I think they give a good indication that one should not expect five liquidity events in 2011 and nothing else for the next couple years. That there are things in motion and that we expect to see more liquidity events. Again as we look actually through 2014, we think a lot of these companies are getting the maturity point where they will either -- many of them will seek acquisition opportunities. But as you see, some of them will certainly seek IPO opportunities if the market is receptive to small IPOs.

Okay, now as far as your cash on hand, could you address the cash that you had on hand and the need to set up a line of credit and actually borrow $1.5 million against the line of credit. What is your thinking for that situation with the amount of cash you have on hand?

Daniel, do you want to address the credit line and what we use it for and what we don't use it for?

Absolutely. Hi, Sam. So the credit line was established to borrow against for our venture debt investments solely, which we now have defined return on investment periods and are generating cash flow to be able to pay the interest on that line of credit during that process of time. We do not use it for borrowing against for any equity focused investments or where we do not have defined periods of return on our investment.

Just to add to that, there have not been a lot of things that have been in our favor over the last few years. We used to get a decent yield on Treasury yields which would offset some of our expenses. Yields on Treasury have been horrible. The venture debt, the line of credit and what we're able to do has been beneficial so we can borrow at a very, very low rate. We can put that again only into venture debt. We can lend at a very nice rate to these early stage companies that don't really have access to credit otherwise. We can get warrants in them and get a pretty nice IRR return on that venture debt business.

So we have decided to do that but again we want to be very clear. We do not use debt for our equity venture capital investments and the reason we don't do that is because the timing is unpredictable for return or for when you wanted to exit and we're big believers in matching maturities. We invest in the riskiest asset class available, early stage venture capital and we try to run Harris & Harris Group very conservatively. There you go Sam.

Thank you. Now, one other thing on the Solazyme. Solazyme seems to be one of your most successful investments to date and you've been in there a long, long time. Is your time horizon -- is the Solazyme what you're expecting to invest currently as the time horizon to when you initiate an investment at this point in time. Since Doug, you and Dan are involved and Charlie Harris is no longer involved. He had done significant things for the Company, you're running the ship, the question really is your time horizon different? Is it shorter? Is it the same? What is your time horizon from initially making the investments to getting your profits out of it?

Great question. Something we haven't really actually -- we used to address a lot, we haven't addressed recently. Our time horizon, we used to state and we still talk about as five to seven years, from first dollar in to getting to exit. I'd say to realized gain, not just to liquidity. If you look historically, that number was actually less than that in historical performance of Harris & Harris Group, it was three to four years. It's actually moved up dramatically over the last decade. I would actually say that for some companies, it's going to push 10 years.

The initial investment in Solazyme was made in 2004. So it's not pushing 10 years yet. So that time frame has pushed out. One, because as Charlie said before he passed away, he said when I look at your portfolio now looking at it in 2010 -- back a decade ago, the majority of these companies would already be public. But the public markets -- the structure of the public markets have changed. So it takes a little bit more mature Company to get out there. Therefore, it takes a little bit more investment in it.

So, the beauty of Harris & Harris Group is we have permanent capital. So, what we try to be very disciplined at is, whenever we make a new investment or a follow-on investment, we look and we say -- with what we know, would we do this investment new today? If the answer is yes, we would do it. Regardless if it's four years into the lifetime of the company or eight or nine years into the lifetime of the company. Sometimes it's those later investments that can yield very, very good returns. That said, everything we've said around our new portfolio, when we look at these companies. We are trying to do companies that require less capital invested, that can grow revenues sooner, that can control their future sooner. So, that we can stay in that, what I'll call five to seven year time horizon from first dollar out to realized gain.

One of the reasons is because most of the venture capital firms we invest with do not have permanent capital, so they have a 10 year lifetime. If they fall apart or they don't have money to invest, that can hinder the deal. The second is, if you're just looking at IRR and returns to remain competitive in investment class, we need to find ways to get that money, get it to work. At least get to an exit or get to a point where the Company controls its future before 10 years and I think you'll see that when you look at the next class of companies like Enumeral, like ABS, like PWA. They're going to look a lot more like Metabolon, that has a very nice revenue stream, a very nice margin business. It fully controls its future, it has a great growth future ahead of it, but it has an interesting opportunity in the market and liquidity in the nearer term as well.

Okay, that sounds good. Now just getting back to the income statement, under the item, professional fees, $1.156 million. Could you indicate how much this relates to the investments you make and how much relates to Harris & Harris as proportionate?

So I don't think we break that out. If I understood the question correctly. If you're looking at cash, how much relates to follow-on investment --

No, no, I'm looking at the expense item, professional fees, $1.156 million. These are the lawyers, these are to accountants, et cetera. To what extent is this charge for any of the companies you invest -- in other words, to analyze legal advice, accounting advice, and to what extent is it relating to running the expenses of Harris & Harris? You could specifically say if you're looking at ABC, XYZ and you're hiring a lawyer, do you capitalize that as part of your investment or do you expense it as professional fees? If you do --

We expense everything. We expense the due diligence, so our cost basis actually in an investment is lower than the real cost investment to make that investment because we expense everything. Patty or Daniel, maybe you can just, I think the easiest way to do that is -- again it's all in the 10K. But the vast majority of professional fees are accounting fees. So the auditing fees and the fees that round our accounting, and the other is legal fees. A lot of that is just regulation that's gone up tremendously over the last decade beginning certainly with Sarbanes-Oxley and accounting fees and legal fees have gone up as well. I will note when you compare our accounting audit fees to the other BDCs again on a per share basis, we are actually low, but maybe Daniel or Patty can just address some of that specifically.

I think you've got it, Doug. There's not much more to add.

At this time I'd like to turn it over to our speakers for any closing remarks.

Okay. Thank you very much. Again, it was a busy week for -- a busy couple weeks for Harris & Harris Group. I would again recommend that if you did not get a chance to see the webcast or Meet the Portfolio Day if you were not there, I think the speakers -- the 10 companies did a great job presenting. I think it gives you a good indication of how their businesses are going, what the growth opportunities are, and how they're thinking of the future as well. I think you saw some of that alluded to today as well. As always we appreciate your support. We thank you for being shareholders of Harris & Harris Group and look forward to speaking with you. Whenever you have questions, certainly give us a call. Thank you very much.