180 Degree Capital - Q1 2024

Transcript

Daniel Wolfe (President and Portfolio Manager)

Good morning and welcome to 180 Degree Capital Corp's First Quarter 2024 Financial Results Update Call. This is Daniel Wolfe, President and Portfolio Manager of 180 Degree Capital. Kevin Rendino, our Chief Executive Officer and Portfolio Manager, and I would like to welcome you to our call this morning. All participants are currently in a listen-only mode. Following our prepared remarks, we will open the line to questions. If you would like to ask a question, please type star six on your phone or click the Ask a Question icon if you are participating via your computer. I would like to remind participants that this call is being recorded and that we will be referring to a slide deck that we have posted on our Investor Relations website at ir.180degreecapital.com under Financial Results.

Please turn to our Safe Harbor Statement on slide 2. 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 1985. 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 financial filings with the Securities and Exchange Commission for a more detailed discussion of the risks and uncertainties associated with the company's business that could affect the company's actual results, except as otherwise required by federal securities laws.

180 Degree Capital Corp undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties. I would now like to turn the call over to Kevin.

Kevin Rendino (CEO and Portfolio Manager)

Thanks, Daniel. Good morning, everyone. In Q1, we navigated what has been an endless, continued, rough environment for our asset class by posting a 3% increase in our NAV against the backdrop of having our cash and public securities rise 5.4% in the quarter. It was a tale of two halves with a strong start to the year turning into a late quarter rout for the Microcap Index. As a risk-off environment took hold near the end of the quarter as investors came to grips with a view that rates would be higher for longer as employment numbers stayed strong, inflation levels leveled off above the Fed's 2% target. We'll have more on that later.

Our largest increases in value came from Potbelly, which continued to post strong results, and Synchronoss, which announced the sale of its messaging and digital assets to become a pure-play cloud business. On the negative side, Lantronix sold off after providing guidance for a reduction in revenues. Arena, which continued to shoot itself in the foot by getting into a disagreement with ABG over its Sports Illustrated agreement, and Comscore, which provided a soft revenue forecast. More on these in full depth in just a minute. We did receive a $1.3 million payment from the acquisition of our private portfolio company, TARA. As you know, we've broadly completed our transformation away from being a closed-end fund focused on VC investments to our current strategy of investing in public companies.

On slide 3, we'll review our holdings. Potbelly increased by about $2.5 million or $0.25 per share this quarter. It pre-announced another strong quarter with 6.4% growth in same-store sales, an average weekly sales that exceeded estimates driven primarily by traffic growth. Potbelly also noted 192 new shop commitments as part of a pre-announcement that was expanded to 202 when Potbelly reported its full results in March of 2024. The company provided long-term growth targets that supported its belief that the growth trends from 2024 will continue into the future. Synchronoss increased from $6.21-$8.35 in the quarter. In February, Synchronoss reported that it completed its post-divestiture cost removals that resulted in an annual savings of approximately $15 million.

In the same release, it noted that it expected to report revenue and adjusted EBITDA for Q4 2024 that met or exceeded the upper end of its original guidance. The stock doubled after this announcement to a high of nearly $14 a share before retreating through the remainder of the quarter on what was no new information. Quantum increased in the quarter as well from $0.35-$0.59. Even though Quantum remained delayed in filing its financial statements due to the ongoing review of revenue recognition as raised by its auditor, Grant Thornton, the company was able to provide updates on its balance sheet and noted that it was taking steps to optimize its working capital and to reduce debt. The company also announced a number of new products with artificial intelligence features. D-Wave increased in the quarter from $0.88-$2.04.

The company announced the availability of new quantum computing resources and partnerships to drive quantum computing adoption. The increase in the stock price also allowed it to regain compliance with the NYSE listing standards and the ability to tap its equity line of credit for additional capital to fund operations. Lantronix declined in the quarter, and it decreased from $586-$356. The reported results for Q2 2024, which ended December 31st, met expectations. However, delays in one of its compute programs, coupled with weakness in its distribution sales channels, led to a lowering of full-year guidance. While this reduction was expected to lead to weakness in the stock, the new CEO indicated his need to review every aspect of the company and would not back the opportunity funnel communicated on calls prior to his tenure.

His tone and word selection made Lantronix appear as a turnaround rather than a strong business, and this approach placed extreme pressure on the stock that continued throughout the remainder of the quarter. We viewed this as a faux pas in communications. Arena Group defaulted on its contractual payments to ABG related to its Sports Illustrated license, which resulted in ABG giving Arena notice that it was canceling the license. Subsequent to the end of Q1 2024, ABG signed a new agreement to run SI with Minute Media. Arena was also served with lawsuits from ABG and former management, who they fired.

In Q2 2024, representatives from Arena held a conference call during which they reiterated the expectation of driving to a close of the transaction between Arena and Bridge Media, albeit without providing financial estimates on what the go-forward business looks like without Sports Illustrated in terms of financial performance. The stock is down 27% this quarter. Comscore declined 7.8% in the quarter. The company missed top-line estimates and exceeded EBITDA targets for Q4 2023. Comscore then provided guidance to 2024 that indicated expected revenue growth but not the ability to maintain or exceed 15% EBITDA margins for the year. The company was also unable to reach a conclusion on the outstanding negotiations with Charter to resolve data licensing issues and with the preferred stockholders to resolve outstanding capital structure issues.

180 nominated Matt McLaughlin as a board nominee at the 2024 annual meeting and planned to run a competitive proxy until Comscore decided to include Matt on its proxy and expand the board to accommodate his election. As a result, we withdrew our proxy. Turning our attention to the environment on slide 5, it's been a painful period for microcap stocks, which started to roll over in November of 2022 during the Russian war with Ukraine and on the eve of a Fed funds rate hiking cycle, which pushed Fed funds to its current 5% from zero.

While there's a generation of investors who have never seen higher rates and, as a result, think we are in a permanent risk-off environment, what you can see from our chart on slide 5, what is more normal for the market in its history is having the Fed Funds Rate at its current level, not the free money level we have seen the market crashed in 2008. As shown above in this chart, the average Fed Funds Rate for the entirety of the last 60 years is exactly 4.9% or today's Fed Funds Rate. If one excluded the last 14 years, the average Fed Funds Rate is actually 6.3%.

My point in showing you this chart is there has been plenty of bull markets during periods where the Fed funds is exactly where it is today, and 5% rates do not portend an end of the world scenario that is depicted in the valuations for so many of our companies in our asset class, especially ones that aren't named NVIDIA. Despite the endless chatter about the recession, employment levels remain healthy, and many of the parts of the economy are showing resilience. The Russell Microcap, despite this, is still down 30% from its highs despite many companies performing relatively well. For the record, our view has been that rates will be higher for longer and the resiliency of the economy will leave the Fed thinking they don't have to cut rates, and that's not a bad thing.

I'd rather have today's market than an economy imploding where the Fed actually does have to lower rates. For those that assume because rates are higher the economy is going to collapse, let's turn to slide 6, and this chart tells an entirely different picture. Over the past 60 years, there have been 31 years or half the time in which the Fed Funds Rate was 4.9% or greater. The dark blue bars in the chart above show that the economy grew in 26 out of those 31 instances or 84%. As are perhaps more interesting, is that in the years where the Fed Funds Rate was greater than 4.9%, the economy grew an average of 3.3%. In the years where the Fed Funds Rate was less than 4.9%, the economy grew less than when it was over 4.9% or 2.9%.

Finally, on slide 7, we show you a historic look at the Fed funds rate versus the growth of the Russell 2000 Index. The Russell 2000 Index was down 14 out of the last 45 years. In 8 of those 14 years, the Fed funds rate was less than 5%, while in 6 years, the Fed funds rate was 4% or higher, was 4.9% or higher. The number of times the Russell 2000 Index was up in each interest rate environment is approximately equal with 15 years of increases when the Fed funds rate was greater than 4.9% and 16 times when it was less than 4.9%. The point of all of this is not to suggest that there aren't concerns to be worried about.

Today's PPI report shows that interest rates may be higher for longer, but the pendulum has constantly slanted too far to the pessimistic side, which has resulted in a complete movement away from the kinds of companies that we invest in. Of course, that is the opportunity for us, although I must say the exhaustion level couldn't be higher waiting for some normalcy to return to our holdings. When it does, and we believe it will, we have enormous upside in our portfolio. But we aren't just waiting, as Daniel will explain regarding our activist approach we have taken with many of our names. We are getting currently active, and I'll let Daniel take you through some of that right now. Daniel?

Daniel Wolfe (President and Portfolio Manager)

Thank you, Kevin. Please turn to slides 9 through 11. Last quarter, we provided a slide that listed potential catalysts to each of our holdings that we believe, along with our constructive activism, could lead to material value appreciation in 2024 and beyond should these events occur. These slides provide an update on the status of each of our holdings through this call. I won't run through all of them, but I'll take the opportunity to discuss a few of them. Synchronous, as Kevin mentioned, reported a strong first quarter of 2024 and reiterated guidance also for the calendar year 2024.

This is the first full quarter of the company reporting as a newly cloud-only business, and it is clear from the results that the transformation made a material difference in the financial profile of the company that should be the basis for material cash flows in future quarters and years going forward. Comscore nominated our candidate, Matt McLaughlin, for election at its upcoming shareholder meeting. We couldn't be more excited for what we believe Matt can bring to Comscore in terms of experience and improved corporate governance. Potbelly continues to sign up new franchisees to fuel its future growth off a successful turnaround of its operations and company-owned stores. IBAC resolved its payment dispute with Seagate, and the hard-disk drive business is on a cyclical upswing with HAMR seen as the enabling technology for future growth.

IBAC is also in qualification for its Trio tool at a leading glass coating company in Asia as it refines its go-to-market strategy for this new product. Lantronix reported securing an additional purchase order from its SmartGrid customer, Gridspertise, which is important to show that the product has the potential to help drive growth into fiscal 2025 and beyond. Ascent resolved the issues with its tubular plant in Bristol and is now back at 100% operating capacity. Ascent also secured a new large order in its chemicals business as it continues to reshape its operations under its new CEO and CFO. On the negative side, as Kevin mentioned, Arena lost its Sports Illustrated license, and it remains unclear whether the company will need to pay its sizable termination payment.

Arena now needs to complete the merger with Bridge Media and provide investors with clarity around its operating model and its ability to run profitably on the combined assets of the two companies, as it noted on the call it held earlier in the second quarter. Please turn to slides 12 through 14. We often say that we believe 180 Degree Capital is a unique investment vehicle for those investors that are interested to have exposure to a concentrated portfolio of microcapitalization stocks with both active management and activism. We thought it might be useful to provide some data to back up our beliefs, and we believe these slides do so.

TURN's portfolio holdings of 10-15 companies is drastically lower than the median number of holdings of our Lipper Peer Group, comprised of open-ended funds and closed-end funds that invest in micro and small capitalization stocks. We also focus on companies with market capitalizations that are substantially below the median market capitalization of the holdings of these funds. While other funds hold certain of our portfolio companies, the overlap in terms of percent of the total positions held by each fund tops out at just north of 4%. Also, we believe, as important, none of the listed funds include activism as part of their investment strategy and approach. Since our inception, we have also delivered gross total returns that are in the top decile of this peer group.

While past performance is not a guarantee of future returns, we believe our differentiated approach has delivered outsized returns in the past, is well-suited to potentially do so also in the future for investors who are interested in our unique investment vehicle. Please turn to slides 15 and 16. As previously disclosed, in a press release on November 13th, 2023, 180 Degree Capital's board of directors set two measurement periods of January 1st, 2024, to December 31st, 2024, and January 1st, 2025, to June 30th, 2025, in which it will evaluate the average discount between TURN's estimated daily NAV and its closing stock price pursuant to the Discount Management Program.

Should TURN's common stock trade at an average daily discount to NAV of more than 12% during either of these measurement periods, 180 Degree Capital's board will consider all available options at the end of each measurement period, including but not limited to a significant expansion of 180 Degree Capital's current stock buyback program of up to $5 million, cash distributions reflecting a return of capital to shareholders, or a tender offer. We reported on May 1st, 2024, that the average discount between Turn's estimated net asset value per share and its daily stock closing price during April of 2024 and year-to-date through the end of April were approximately 14% and 20%, respectively. This discount was approximately 16% on April 30th of 2024. We will continue to provide updates on the discount monthly throughout the measurement periods.

To be clear, the most important thing we can do is to find investments that materially increase in value so that, as a result, NAV increases from its current levels. We believe that we will have the most we believe that will have the most impactful and positive effect on Turn's stock price and returns for shareholders. We would now like to open up the line for questions. If you have a question, please type star six on your phone or click Ask a Question if you're participating via your computer. We'll now wait to see if there's any questions.

Kevin Rendino (CEO and Portfolio Manager)

While you're waiting, I mentioned November 2022 was the peak for the Russell Microcap, but it's November of 2021. So this is going on the third year of what has been significant underperformance relative to the large-cap stocks. And the second point I'd like to make while we're waiting for questions, we didn't announce that discount program for the sake of announcing the discount program. We do things intentionally, as all of you know, and it is our hope that if this continues in terms of our stock price trading at a significant discount to its NAV, that we will take advantage of that or at least allow our shareholders to participate in a monetization effect closer to NAV than where the stock currently trades at today.

Daniel Wolfe (President and Portfolio Manager)

I am not seeing any questions in the queue.

Kevin Rendino (CEO and Portfolio Manager)

Okay. With that said, we will look forward to reviewing Q2 with you sometime in, I assume, August, and we wish all of you a good start to your summer. Thanks.

Daniel Wolfe (President and Portfolio Manager)

Thank you, everyone. You can now disconnect.

Operator (participant)

Goodbye.