Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Note Concerning Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements that are based on current expectations, estimates, forecasts and projections about Safeguard Scientifics, Inc. (“Safeguard” or “we”), the industries in which we operate and other matters, as well as management's beliefs and assumptions and other statements regarding matters that are not historical facts. These statements include, in particular, statements about our plans, strategies and prospects. For example, when we use words such as “projects,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “should,” “would,” “could,” “will,” “opportunity,” “potential” or “may,” variations of such words or other words that convey uncertainty of future events or outcomes, we are making forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Our forward-looking statements are subject to risks and uncertainties. Factors that could cause actual results to differ materially, include, among others, our ability to make good decisions about the deployment of capital, the fact that our partner companies may vary from period to period, our substantial capital requirements and absence of liquidity from our partner company holdings, fluctuations in the market prices of our publicly traded partner company holdings, competition, our inability to obtain maximum value for our partner company holdings, our ability to attract and retain qualified employees, our ability to execute our strategy, market valuations in sectors in which our partner companies operate, our inability to control our partner companies, our need to manage our assets to avoid registration under the Investment Company Act of 1940, and risks associated with our partner companies and their performance, including the fact that most of our partner companies have a limited history and a history of operating losses, face intense competition and may never be profitable, the effect of economic conditions in the business sectors in which Safeguard's partner companies operate, compliance with government regulation and legal liabilities, all of which are discussed in Item 1A. “Risk Factors” in Safeguard's Annual Report on Form 10-K and updated, as applicable, in “Factors that May Affect Future Results” and Item 1A. “Risk Factors” below. Many of these factors are beyond our ability to predict or control. In addition, as a result of these and other factors, our past financial performance should not be relied on as an indication of future performance. All forward-looking statements attributable to us, or to persons acting on our behalf, are expressly qualified in their entirety by this cautionary statement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this report might not occur.
Business Overview
Safeguard’s charter is to be a nationally recognized leader with respect to entrepreneurship and innovation. Our vision is to provide capital and relevant expertise to fuel the growth of technology-driven businesses in healthcare, financial services and digital media. Throughout this document, we use the term “partner company” to generally refer to those companies in which we have an equity interest and in which we are actively involved, influencing development through board representation and management support, in addition to the influence we exert through our equity ownership. From time to time, in addition to these partner companies, we also hold relatively small equity interests in other enterprises where we do not exert significant influence and do not participate in management activities. In some cases, these interests relate to former partner companies and in some cases they relate to entities which may later become partner companies.
Safeguard targets technology-driven businesses in healthcare, financial services and digital media. Safeguard targets companies that are capitalizing on the next wave of enabling technologies with a particular focus at present on the Internet of Everything, enhanced security and artificial intelligence, which includes predictive analytics and machine learning. We strive to create long-term value for our shareholders by helping our partner companies increase their market penetration, grow revenue and improve cash flow. Safeguard focuses principally on companies with initial capital requirements between $5 million and $15 million, and follow-on financing needs of between $5 million and $10 million, with a total anticipated deployment of up to $25 million from Safeguard. We will occasionally provide certain early-stage financing in amounts generally up to $1 million to promising young companies with the goal to provide more capital once certain development milestones are achieved.
Results of Operations
Previously, we presented our operating results in two reportable segments - Healthcare and Technology. Recently, we shifted our focus to providing capital to technology companies within the fields of healthcare, financial services and digital media. Beginning in the third quarter of 2016, we have determined we operate as one operating segment based upon the similar nature of our technology-driven partner companies, the functional alignment of the organizational structure, and the reports that are regularly reviewed by the chief operating decision maker for the purpose of assessing performance and allocating resources.
There is intense competition in the markets in which our partner companies operate. Additionally, the markets in which these companies operate are characterized by rapidly changing technology, evolving industry standards, frequent introduction of new products and services, shifting distribution channels, evolving government regulation, frequently changing intellectual property landscapes and changing customer demands. Their future success depends on each company’s ability to execute its business plan and to adapt to its respective rapidly changing market.
As previously stated, throughout this document, we use the term “partner company” to generally refer to those companies in which we have an economic interest and in which we are actively involved influencing development, usually through board representation in addition to our equity ownership.
The following listing of our partner companies only includes entities which were considered partner companies as of
September 30, 2016
. Certain entities which may have been partner companies in previous periods are omitted if, as of
September 30, 2016
, they had been sold or are no longer considered a partner company.
|
|
|
|
|
|
|
Safeguard Primary Ownership as of September 30,
|
|
Partner Company
|
2016
|
|
2015
|
Accounting Method
|
AdvantEdge Healthcare Solutions, Inc.
|
40.1%
|
|
40.1%
|
Equity
|
Aktana, Inc.
|
23.4%
|
|
NA
|
Equity
|
Apprenda, Inc.
|
29.5%
|
|
29.5%
|
Equity
|
Aventura, Inc.
|
19.9%
|
|
19.9%
|
Equity
|
Beyond.com, Inc.
|
38.2%
|
|
38.2%
|
Equity
|
Cask Data, Inc.
|
31.3%
|
|
NA
|
Equity
|
CloudMine, Inc.
|
30.1%
|
|
30.1%
|
Equity
|
Clutch Holdings, Inc.
|
45.0%
|
|
39.3%
|
Equity
|
Full Measure Education, Inc.
|
36.0%
|
|
25.4%
|
Equity
|
Good Start Genetics, Inc.
|
29.6%
|
|
29.8%
|
Equity
|
Hoopla Software, Inc.
|
25.5%
|
|
25.6%
|
Equity
|
InfoBionic, Inc.
|
40.5%
|
|
38.5%
|
Equity
|
Lumesis, Inc.
|
44.1%
|
|
44.7%
|
Equity
|
MediaMath, Inc.
|
20.5%
|
|
20.6%
|
Equity
|
Medivo, Inc.
|
35.3%
|
|
34.5%
|
Equity
|
meQuilibrium
|
31.5%
|
|
31.5%
|
Equity
|
Moxe Health Corporation
|
32.6%
|
|
NA
|
Equity
|
NovaSom, Inc.
|
31.7%
|
|
31.7%
|
Equity
|
Pneuron Corporation
|
35.4%
|
|
35.4%
|
Equity
|
Propeller Health, Inc.
|
24.4%
|
|
24.6%
|
Equity
|
QuanticMind, Inc.
|
23.5%
|
|
24.5%
|
Equity
|
Sonobi, Inc.
|
21.6%
|
|
22.6%
|
Equity
|
Spongecell, Inc.
|
23.0%
|
|
23.0%
|
Equity
|
Syapse, Inc.
|
25.8%
|
|
24.4%
|
Equity
|
Transactis, Inc.
|
24.2%
|
|
24.5%
|
Equity
|
Trice Medical, Inc.
|
27.7%
|
|
27.7%
|
Equity
|
WebLinc, Inc.
|
38.0%
|
|
29.2%
|
Equity
|
Zipnosis, Inc.
|
26.2%
|
|
NA
|
Equity
|
Three months ended
September 30, 2016
versus the three months ended
September 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
2016
|
|
2015
|
|
Variance
|
|
(In thousands)
|
General and administrative expense
|
$
|
(4,687
|
)
|
|
$
|
(3,962
|
)
|
|
$
|
(725
|
)
|
Other income (loss), net
|
(2,405
|
)
|
|
704
|
|
|
(3,109
|
)
|
Interest income
|
513
|
|
|
398
|
|
|
115
|
|
Interest expense
|
(1,161
|
)
|
|
(1,133
|
)
|
|
(28
|
)
|
Equity loss
|
(16,345
|
)
|
|
(7,635
|
)
|
|
(8,710
|
)
|
|
$
|
(24,085
|
)
|
|
$
|
(11,628
|
)
|
|
$
|
(12,457
|
)
|
General and Administrative Expense.
Our general and administrative expenses consist primarily of employee compensation, insurance, travel-related costs, depreciation, office rent and professional services such as consulting, legal, and accounting. General and administrative expense also includes stock-based compensation expense which consists primarily of expense related to grants of stock options, restricted stock and deferred stock units to our employees and directors. General and administrative expense increased $0.7 million for the three months ended September 30, 2016, compared to the prior year period due to an increase of $0.5 million in stock-based compensation, including a $0.3 million increase in expense related to performance-based awards and a $0.1 million increase in expense related to restricted stock awards and deferred stock units, and an increase of $0.2 million in employee costs.
Other Income (Loss), Net
. Other income (loss), net decreased $3.1 million for the
three months ended September 30, 2016
compared to the prior year period. Other income (loss), net for the three months ended September 30, 2016 reflected a $2.4 million impairment related to our Penn Mezzanine debt and equity participations. Other income (loss), net for the three months ended September 30, 2015 included a $0.9 million gain on the release of proceeds from escrow associated with the February 2014 sale of Crescendo Bioscience which was partially offset by an impairment charge of $0.2 million related to our interest in a legacy private equity fund.
Interest Income.
Interest income includes all interest earned on available cash and marketable security balances as well as interest earned on notes receivable from our partner companies. Interest income remained relatively consistent compared to the prior year period.
Interest Expense.
Interest expense is primarily related to our convertible senior debentures. Interest expense remained relatively consistent compared to the prior year period.
Equity Loss.
Equity loss fluctuates with the number of partner companies accounted for under the equity method, our voting ownership percentage in these partner companies and the net results of operations of these partner companies. We recognize our share of losses to the extent we have cost basis in the partner company or outstanding commitments or guarantees. Certain amounts recorded to reflect our share of the income or losses of our partner companies accounted for under the equity method are based on estimates and on unaudited results of operations of those partner companies and may require adjustments in the future when audits of these entities are made final. We report our share of the results of our equity method partner companies on a one quarter lag basis.
Equity loss increased $8.7 million for the three months ended September 30, 2016 compared to the prior year period. The components of equity loss for the three months ended September 30, 2016 and 2015 were as follows:
|
|
|
|
|
Three months ended September 30, 2016:
|
|
Loss on impairment of Aventura in September 2016
|
$
|
(1,000
|
)
|
Gain on proceeds received upon expiration of first escrow period related to sale of Quantia in July 2015
|
600
|
|
Gain on additional proceeds received on the sale of Putney in April 2016
|
430
|
|
Unrealized dilution gain on the decrease of our ownership percentage in partner companies
|
365
|
|
Share of loss of our equity method partner companies
|
(16,740
|
)
|
|
$
|
(16,345
|
)
|
|
|
|
|
|
Three months ended September 30, 2015:
|
|
Gain on performance milestone proceeds related to sale of Thingworx in December 2013
|
$
|
3,264
|
|
Gain on proceeds received upon expiration of escrow period related to sale of Alverix in January 2014
|
1,741
|
|
Unrealized dilution loss on the decrease of our percentage ownership in partner companies
|
(492
|
)
|
Share of loss of our equity method partner companies
|
(12,148
|
)
|
|
$
|
(7,635
|
)
|
The change in our share of equity loss of our equity method partner companies for the three months ended September 30, 2016 compared to the prior year period was due to an increase in losses associated with our partner companies.
Nine months ended
September 30, 2016
versus the nine months ended
September 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September 30,
|
|
2016
|
|
2015
|
|
Variance
|
|
(In thousands)
|
General and administrative expense
|
$
|
(14,764
|
)
|
|
$
|
(13,596
|
)
|
|
$
|
(1,168
|
)
|
Other income (loss), net
|
(1,746
|
)
|
|
301
|
|
|
(2,047
|
)
|
Interest income
|
1,460
|
|
|
1,487
|
|
|
(27
|
)
|
Interest expense
|
(3,465
|
)
|
|
(3,383
|
)
|
|
(82
|
)
|
Equity income (loss)
|
17,954
|
|
|
(30,062
|
)
|
|
48,016
|
|
|
$
|
(561
|
)
|
|
$
|
(45,253
|
)
|
|
$
|
44,692
|
|
General and Administrative Expense.
General and administrative expense increased $1.2 million for the nine months ended September 30, 2016, compared to the prior year period primarily due to an increase of $0.7 million in stock-based compensation including a $0.8 million increase in expense related to performance-based awards which was partially offset by a $0.1 million decrease in expense related to service-based awards. Depreciation expense also increased $0.2 million for the nine months ended September 30, 2016 compared to the prior year period due to an increase in assets placed into service related to our corporate relocation in October 2015.
Other Income (Loss), Net
. Other income (loss), net decreased $2.0 million for the nine months ended September 30, 2016 compared to the prior year period. Other income (loss), net for the nine months ended September 30, 2016 primarily reflected a $2.4 million impairment related to our Penn Mezzanine debt and equity participations partially offset by a gain of $0.4 million on the sale of Bridgevine in June 2016. Other income (loss), net for the nine months ended September 30, 2015 primarily reflected a $2.9 million gain on the release of proceeds from escrow associated with the February 2014 sale of Crescendo Bioscience which was partially offset by an impairment charge of $2.4 million related to Dabo Health and an impairment charge of $0.3 million related to our interest in a legacy private equity fund.
Interest Income.
Interest income remained relatively consistent compared to the prior year period.
Interest Expense.
Interest expense remained relatively consistent compared to the prior year period.
Equity Income (Loss).
Equity income (loss) increased $48.0 million for the nine months ended September 30, 2016 compared to the prior year period. The components of equity income (loss) for the nine months ended September 30, 2016 and 2015 were as follows:
|
|
|
|
|
Nine months ended September 30, 2016:
|
|
Gain on sale of Putney in April 2016
|
$
|
55,638
|
|
Gain on performance milestone proceeds related to sale of Thingworx in December 2013
|
3,264
|
|
Unrealized dilution gain on the decrease of our ownership percentage in partner companies
|
1,414
|
|
Gain on proceeds received upon expiration of escrow period related to sale of DriveFactor in April 2015
|
1,100
|
|
Gain on proceeds received upon expiration of first escrow period related to sale of Quantia in July 2015
|
600
|
|
Loss on impairment of Aventura in September 2016
|
(1,000
|
)
|
Loss on impairment of AppFirst in June 2016
|
(1,731
|
)
|
Share of loss of our equity method partner companies
|
(41,331
|
)
|
|
$
|
17,954
|
|
|
|
|
|
|
Nine months ended September 30, 2015:
|
|
Gain on sale of DriveFactor in April 2015
|
$
|
6,095
|
|
Gain on performance milestone proceeds related to sale of Thingworx in December 2013
|
3,264
|
|
Gain on proceeds received upon expiration of escrow period related to sale of Alverix in January 2014
|
1,741
|
|
Unrealized dilution loss on the decrease of our percentage ownership in partner companies
|
(492
|
)
|
Loss on impairment of Quantia
|
(2,920
|
)
|
Loss on impairment of InfoBionic
|
(3,162
|
)
|
Share of loss of our equity method partner companies
|
(34,588
|
)
|
|
$
|
(30,062
|
)
|
The change in our share of equity loss of our equity method partner companies for the nine months ended September 30, 2016 compared to the prior year period was due to an increase in losses associated with our partner companies.
Income Tax Benefit (Expense)
Income tax benefit (expense) was $0.0 million for the three and nine months ended September 30, 2016 and 2015. We have recorded a valuation allowance to reduce our net deferred tax asset to an amount that is more likely than not to be realized in future years. Accordingly, the benefit of the net operating loss that would have been recognized in the three and nine months ended September 30, 2016 and 2015 was offset by changes in the valuation allowance.
Liquidity and Capital Resources
We fund our operations with cash on hand as well as proceeds from sales of and distributions from partner companies, private equity funds and marketable securities. In prior periods, we have also used sales of our equity and the issuance of debt as sources of liquidity and may do so in the future. Our ability to generate liquidity from sales of partner companies, sales of marketable securities and from equity and debt issuances has been adversely affected from time to time by adverse circumstances in the U.S. capital markets and other factors.
As of
September 30, 2016
, we had $52.5 million of cash and cash equivalents and $24.1 million of marketable securities for a total of $76.6 million.
In April 2016, Putney, Inc. was acquired by Dechra Pharmaceuticals Plc. We received cash proceeds of $58.2 million in initial cash proceeds in connection with the transaction, excluding $0.4 million which was released from escrow in July 2016 and $0.6 million which will be held in escrow until April 2017.
In July 2015, Quantia was acquired by Physicians Interactive. We received $7.8 million in initial cash proceeds in connection with the transaction. In July 2016, we received an additional $0.6 million which was released from escrow.
In June 2016, we sold our ownership interests in Bridgevine, Inc. and received cash proceeds of $5.0 million in connection with the transaction.
In June 2016, AppFirst shutdown its operations and sold its assets resulting in proceeds to us of $0.9 million.
In April 2015, DriveFactor was acquired by CCC Information Services Inc. We received $9.1 million in initial cash proceeds in connection with the transaction. In April 2016, we received an additional $1.1 million which was released from escrow.
In December 2013, ThingWorx was acquired by PTC Inc. We received $36.4 million in initial cash proceeds in connection with the transaction. In July 2015, we received $3.3 million associated with the achievement of the initial performance milestones related to the sale. In January 2016, we received $4.1 million in connection with the expiration of the escrow period related to the sale. In April 2016, we received $3.3 million associated with the achievement of the final performance milestones related to the sale.
In July 2015, the Company's Board of Directors authorized us, from time to time and depending on market conditions, to repurchase up to $25.0 million of the Company's outstanding common stock. We repurchased 0.4 million shares at an aggregate cost of $5.4 million during the nine months ended September 30, 2016.
We have outstanding $55.0 million in face amount of our 5.25% convertible senior debentures due 2018 (the "2018 Debentures"). Interest on the 2018 Debentures is payable semi-annually. At the debentures holders’ option, the 2018 Debentures are convertible into our common stock prior to November 15, 2017 subject to certain conditions, and at any time after November 15, 2017. The conversion rate of the 2018 Debentures is 55.17 shares of common stock per $1,000 principal
amount of debentures, equivalent to a conversion price of approximately $18.13 per share of common stock. The closing price per share of our common stock at
September 30, 2016
was $12.96. The 2018 Debentures holders have the right to require us to repurchase the 2018 Debentures if we undergo a fundamental change as defined in the debenture agreement, including the sale of all or substantially all of our common stock or assets, liquidation, or dissolution; a change in control; the delisting of our common stock from the New York Stock Exchange or the NASDAQ Global Market (or any of their respective successors); or a substantial change in the composition of our board of directors as defined in the agreement. On or after November 15, 2016, we may redeem for cash some or all of the debentures, subject to certain conditions. Upon any redemption of the 2018 Debentures, we will pay a redemption price of 100% of their principal amount, plus accrued and unpaid interest. Upon the conversion of the 2018 Debentures we have the right to settle the conversion in stock, cash or a combination thereof.
We are party to a loan agreement with a commercial bank which provides us with a revolving credit facility in the maximum aggregate amount of $25.0 million in the form of borrowings, guarantees and issuances of letters of credit, subject to a $20.0 million sublimit. Actual availability under the credit facility is based on the amount of cash maintained at the bank as well as the value of our public and private partner company interests. This credit facility bears interest at the prime rate for outstanding borrowings, subject to an increase in certain circumstances. Other than for limited exceptions, we are required to maintain all of our depository and operating accounts at the bank. The credit facility, as amended December 29, 2015, matures on December 19, 2016. We intend to renew or replace the existing credit facility prior to the maturity date. Under the credit facility, we provided a $6.3 million letter of credit expiring on March 19, 2019 to the landlord of CompuCom Systems, Inc.’s Dallas headquarters which was required in connection with our sale of CompuCom Systems in 2004. Availability under our revolving credit facility at
September 30, 2016
was $18.7 million.
Under certain circumstances, we may be required to return a portion or all the distributions we received as a general partner of a private equity fund for further distribution to such fund’s limited partners (“clawback”). The maximum clawback we could be required to return related to our general partner interest is $1.3 million, of which $1.0 million was reflected in Accrued expenses and other current liabilities and $0.3 million was reflected in Other long-term liabilities on the Consolidated Balance Sheet at
September 30, 2016
. Our ownership in the fund is 19%. The clawback liability is joint and several, such that we may be required to fund the clawback for other general partners should they default. We believe our potential liability due to the possibility of default by other general partners is remote.
The transactions we enter into in pursuit of our strategy could increase or decrease our liquidity at any point in time. As we seek to acquire interests in new partner companies, provide additional funding to existing partner companies, or commit capital to other initiatives, we may be required to expend our cash or incur debt, which will decrease our liquidity. Conversely, as we dispose of our interests in partner companies from time to time, we may receive proceeds from such sales, which could increase our liquidity. From time to time, we are engaged in discussions concerning acquisitions and dispositions which, if consummated, could impact our liquidity, perhaps significantly.
For the reasons we have presented above, we believe our cash and cash equivalents at
September 30, 2016
, availability under our revolving credit facility and other internal sources of cash flow will be sufficient to fund our cash requirements for at least the next 12 months, including interest payments, commitments to our existing partner companies and funds, possible additional funding of existing partner companies and our general corporate requirements. Our acquisition of new partner company interests is always contingent upon our availability of cash to fund such deployments, and our timing of monetization events directly affects our availability of cash.
Analysis of Consolidated Cash Flows
Cash flow activity was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September 30,
|
|
2016
|
|
2015
|
|
Variance
|
|
(In thousands)
|
Net cash used in operating activities
|
$
|
(14,114
|
)
|
|
$
|
(14,086
|
)
|
|
$
|
(28
|
)
|
Net cash provided by (used in) investing activities
|
39,593
|
|
|
(33,031
|
)
|
|
72,624
|
|
Net cash used in financing activities
|
(5,821
|
)
|
|
(1,072
|
)
|
|
(4,749
|
)
|
|
$
|
19,658
|
|
|
$
|
(48,189
|
)
|
|
$
|
67,847
|
|
Net Cash Used In Operating Activities
Net cash used in operating activities for the nine months ended September 30, 2016 remained relatively consistent compared to the prior year period.
Net Cash Provided by (Used In) Investing Activities
Net cash provided by (used in) investing activities increased by $72.6 million for the nine months ended
September 30, 2016
compared to the prior year period. The increase primarily related to a $48.8 million increase in proceeds from the sales of and distributions from companies. Cash proceeds from the sale of and distributions from companies was $73.9 million for the nine months ended September 30, 2016 which related to the sale of our interests in Putney and Bridgevine, proceeds received from AppFirst from the sale of its assets, cash received from escrow associated with the sale of our interests in DriveFactor, Thingworx, and Quantia and cash received associated with the achievement of performance milestones related to the sale of our interest in Thingworx. Cash proceeds from the sale of and distributions from companies was $25.0 million for the nine months ended September 30, 2015 which related to the sale of our interests in DriveFactor and Quantia, cash received from escrow associated with the sale of our interest in Crescendo Bioscience and Alverix, and cash received associated with the achievement of performance milestones related to the sale of our interest in Thingworx. The increase in cash provided by investing activities also related to a $17.3 million decrease in acquisitions of ownership interests in companies, and a $12.5 million increase in cash proceeds from the net change in marketable securities, partially offset by a net increase of $6.4 million in advances and loans to companies.
Net Cash Used In Financing Activities
Net cash used in financing activities increased by $4.7 million for the nine months ended
September 30, 2016
compared to the prior year period. The increase related to an increase of $3.6 million in repurchases of our common stock, a $0.7 million decrease in proceeds received from the exercise of stock options and in increase of $0.4 million in tax withholdings related to share-based payment awards.
Contractual Cash Obligations and Other Commercial Commitments
There have been no material changes to the contractual cash obligations and other commercial commitments we previously disclosed under Item 7 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the SEC on March 4, 2016.
Factors That May Affect Future Results
You should carefully consider the information set forth below. The following risk factors describe situations in which our business, financial condition and/or results of operations could be materially harmed, and the value of our securities may be adversely affected. You should also refer to other information included or incorporated by reference in this report.
Our principal business depends upon our ability to make good decisions regarding the deployment of capital into new or existing partner companies and, ultimately, the performance of our partner companies, which is uncertain.
If we make poor decisions regarding the deployment of capital into new or existing partner companies, our business model will not succeed. Our success as a company ultimately depends on our ability to choose the right partner companies. If our partner companies do not succeed, the value of our assets could be significantly reduced and require substantial impairments or write-offs and our results of operations and the price of our common stock would be adversely affected. The risks relating to our partner companies include:
|
|
•
|
most of our partner companies have a history of operating losses and/or limited operating history;
|
|
|
•
|
the intense competition affecting the products and services our partner companies offer could adversely affect their businesses, financial condition, results of operations and prospects for growth;
|
|
|
•
|
the inability to adapt to changing marketplaces;
|
|
|
•
|
the inability to manage growth;
|
|
|
•
|
the need for additional capital to fund their operations, which we may not be able to fund or which may not be available from third parties on acceptable terms, if at all;
|
|
|
•
|
the inability to protect their proprietary rights and/or infringing on the proprietary rights of others;
|
|
|
•
|
that our partner companies could face legal liabilities from claims made against them based upon their operations, products or work;
|
|
|
•
|
the impact of economic downturns on their operations, results and growth prospects;
|
|
|
•
|
the inability to attract and retain qualified personnel;
|
|
|
•
|
the existence of government regulations and legal uncertainties may place financial burdens on the businesses of our partner companies; and
|
|
|
•
|
the inability to plan for and manage catastrophic events.
|
These and other risks are discussed in detail under the caption “Risks Related to Our Partner Companies” below.
Our partner companies (and the nature of our interests in them) could vary widely from period to period.
As part of our strategy, we continually assess the value to our shareholders of our interests in our partner companies. We also regularly evaluate alternative uses for our capital resources. As a result, depending on market conditions, growth prospects and other key factors, we may at any time:
|
|
•
|
change the individual and/or types of partner companies on which we focus;
|
|
|
•
|
sell some or all of our interests in any of our partner companies; or
|
|
|
•
|
otherwise change the nature of our interests in our partner companies.
|
Therefore, the nature of our holdings could vary significantly from period to period.
Our consolidated financial results also may vary significantly based upon which, if any, of our partner companies are included in our Consolidated Financial Statements.
A significant amount of our deployed capital may be concentrated in partner companies operating in the same or similar industries, limiting the diversification of our capital deployments.
We do not have fixed guidelines for diversification of capital deployments, and our capital deployments could be concentrated in several partner companies that operate in the same or similar industries. This may cause us to be more susceptible to any single economic, regulatory or other occurrence affecting those particular industries than we would otherwise be if our partner companies operated in more diversified industries.
Our business model does not rely upon, or plan for, the receipt of operating cash flows from our partner companies. Our partner companies generally provide us with no cash flow from their operations. We rely on cash on hand, liquidity events and our ability to generate cash from capital raising activities to finance our operations.
We need capital to develop new partner company relationships and to fund the capital needs of our existing partner companies. We also need cash to service and repay our outstanding debt, finance our corporate overhead and meet our existing funding commitments. As a result, we have substantial cash requirements. Our partner companies generally provide us with no cash flow from their operations. To the extent our partner companies generate any cash from operations, they generally retain the funds to develop their own businesses. As a result, we must rely on cash on hand, partner company liquidity events and new capital raising activities to meet our cash needs. If we are unable to find ways of monetizing our holdings or raising additional capital on attractive terms, we may face liquidity issues that will require us to curtail our new business efforts, constrain our ability to execute our business strategy and limit our ability to provide financial support to our existing partner companies.
Fluctuations in the price of the common stock of our publicly traded holdings may affect the price of our common stock.
From time to time, we may hold equity interests in companies that are publicly traded. Fluctuations in the market prices of the common stock of publicly traded holdings may affect the price of our common stock. Historically, the market prices of our publicly traded holdings have been highly volatile and subject to fluctuations unrelated or disproportionate to operating performance.
Intense competition from other capital providers for interests in companies could adversely affect our ability to deploy capital and result in higher valuations of partner company interests which could result in lower gains or possibly losses on our partner companies.
We face intense competition from other capital providers as we acquire and develop interests in our partner companies. Some of our competitors have more experience identifying, acquiring and selling companies and have greater financial and management resources, brand name recognition or industry contacts than we have. Competition from other capital providers could adversely affect our ability to deploy capital. In addition, despite making most of our acquisitions at a stage when our partner companies are not publicly traded, we may still pay higher prices for those equity interests because of higher valuations of similar public companies and competition from other acquirers and capital providers, which could result in lower gains or possibly losses.
We may be unable to obtain maximum value for our holdings or to sell our holdings on a timely basis.
We hold significant positions in our partner companies. Consequently, if we were to divest all or part of our holdings in a partner company, we may have to sell our interests at a relative discount to a price which may be received by a seller of a smaller portion. For partner companies with publicly traded stock, we may be unable to sell our holdings at then-quoted market prices. The trading volume and public float in the common stock of a publicly traded partner company may be small relative to our holdings. As a result, any significant open-market divestiture by us of our holdings in such a partner company, if possible at
all, would likely have a material adverse effect on the market price of its common stock and on our proceeds from such a divestiture. Additionally, we may not be able to take our partner companies public as a means of monetizing our position or creating shareholder value.
Registration and other requirements under applicable securities laws and contractual restrictions also may adversely affect our ability to dispose of our partner company holdings on a timely basis.
Our success is dependent on our senior management.
Our success is dependent on our senior management team’s ability to execute our strategy. A loss of one or more of the members of our senior management team without adequate replacement could have a material adverse effect on us.
Our business strategy may not be successful if valuations in the market sectors in which our partner companies participate decline.
Our strategy involves creating value for our shareholders by helping our partner companies build value and, if appropriate, accessing the public and private capital markets. Therefore, our success is dependent on the value of our partner companies as determined by the public and private capital markets. Many factors, including reduced market interest, may cause the market value of our partner companies to decline. If valuations in the market sectors in which our partner companies participate decline, their access to the public and private capital markets on terms acceptable to them may be limited.
Our partner companies could make business decisions that are not in our best interests or with which we do not agree, which could impair the value of our holdings.
Although we may seek a controlling or influential equity interest and participation in the management of our partner companies, we may not be able to control the significant business decisions of our partner companies. We may have shared control or no control over some of our partner companies. In addition, although we currently own a significant, influential interest in some of our partner companies, we do not maintain a controlling interest in any of our partner companies. Acquisitions of interests in partner companies in which we share or have no control, and the dilution of our interests in or loss of control of partner companies, will involve additional risks that could cause the performance of our interests and our operating results to suffer, including:
|
|
•
|
the management of a partner company having economic or business interests or objectives that are different from ours; and
|
|
|
•
|
the partner companies not taking our advice with respect to the financial or operating issues they may encounter.
|
Our inability to control our partner companies also could prevent us from assisting them, financially or otherwise, or could prevent us from liquidating our interests in them at a time or at a price that is favorable to us. Additionally, our partner companies may not act in ways that are consistent with our business strategy. These factors could hamper our ability to maximize returns on our interests and cause us to incur losses on our interests in these partner companies.
We may have to buy, sell or retain assets when we would otherwise not wish to do so in order to avoid registration under the Investment Company Act.
The Investment Company Act of 1940 regulates companies which are engaged primarily in the business of investing, reinvesting, owning, holding or trading in securities. Under the Investment Company Act, a company may be deemed to be an investment company if it owns investment securities with a value exceeding 40% of the value of its total assets (excluding government securities and cash items) on an unconsolidated basis, unless an exemption or safe harbor applies. We refer to this test as the “40% Test.” Securities issued by companies other than consolidated partner companies are generally considered “investment securities” for purposes of the Investment Company Act, unless other circumstances exist which actively involve the company holding such interests in the management of the underlying company. We are a company that partners with growth-stage companies to build value; we are not engaged primarily in the business of investing, reinvesting or trading in securities. We are in compliance with the 40% Test. Consequently, we do not believe that we are an investment company under the Investment Company Act.
We monitor our compliance with the 40% Test and seek to conduct our business activities to comply with this test. It is not feasible for us to be regulated as an investment company because the Investment Company Act rules are inconsistent with our strategy of actively helping our partner companies in their efforts to build value. In order to continue to comply with the 40% Test, we may need to take various actions which we would otherwise not pursue. For example, we may need to retain a controlling interest in a partner company that we no longer consider strategic, we may not be able to acquire an interest in a company unless we are able to obtain a controlling ownership interest in the company, or we may be limited in the manner or timing in which we sell our interests in a partner company. Our ownership levels also may be affected if our partner companies
are acquired by third parties or if our partner companies issue stock which dilutes our ownership interest. The actions we may need to take to address these issues while maintaining compliance with the 40% Test could adversely affect our ability to create and realize value at our partner companies.
Economic disruptions and downturns may have negative repercussions for us.
Events in the United States and international capital markets, debt markets and economies may negatively impact our stock price and our ability to pursue certain tactical and strategic initiatives, such as accessing additional public or private equity or debt financing for us or for our partner companies and selling our interests in partner companies on terms acceptable to us and in time frames consistent with our expectations.
We cannot provide assurance that material weaknesses in our internal control over financial reporting will not be identified in the future.
We cannot assure you that material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in a material weakness, or could result in material misstatements in our Consolidated Financial Statements. These misstatements could result in a restatement of our Consolidated Financial Statements, cause us to fail to meet our reporting obligations and/or cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.
Risks Related to Our Partner Companies
Most of our partner companies have a history of operating losses and/or limited operating history and may never be profitable.
Most of our partner companies have a history of operating losses and/or limited operating history, have significant historical losses and may never be profitable. Many have incurred substantial costs to develop and market their products, have incurred net losses and cannot fund their cash needs from operations. We expect that the operating expenses of certain of our partner companies will increase substantially in the foreseeable future as they continue to develop products and services, increase sales and marketing efforts, and expand operations.
Our partner companies face intense competition, which could adversely affect their business, financial condition, results of operations and prospects for growth.
There is intense competition in the technology marketplaces, and we expect competition to intensify in the future. Our business, financial condition, results of operations and prospects for growth will be materially adversely affected if our partner companies are not able to compete successfully. Many of the present and potential competitors may have greater financial, technical, marketing and other resources than those of our partner companies. This may place our partner companies at a disadvantage in responding to the offerings of their competitors, technological changes or changes in client requirements. Also, our partner companies may be at a competitive disadvantage because many of their competitors have greater name recognition, more extensive client bases and a broader range of product offerings. In addition, our partner companies may compete against one another.
The success or failure of many of our partner companies is dependent upon the ultimate effectiveness of newly-created technologies, medical devices, financial services, healthcare diagnostics, etc.
Our partner companies’ business strategies are often highly dependent upon the successful launch and commercialization of innovative technologies, medical device, healthcare diagnostic, or similar technology. Despite all of our efforts to understand the research and development underlying the innovation or creation of such technologies before we deploy capital into a partner company, sometimes the performance of the technology or device does not match our expectations or those of our partner company. In those situations, it is likely that we will incur a partial or total loss of the capital which we deployed in such partner company.
Our partner companies may fail if they do not adapt to changing marketplaces.
If our partner companies fail to adapt to changes in technology and customer and supplier demands, they may not become or remain profitable. There is no assurance that the products and services of our partner companies will achieve or maintain market penetration or commercial success, or that the businesses of our partner companies will be successful.
The technology marketplaces are characterized by:
|
|
•
|
rapidly changing technology;
|
|
|
•
|
evolving industry standards;
|
|
|
•
|
frequent introduction of new products and services;
|
|
|
•
|
shifting distribution channels;
|
|
|
•
|
evolving government regulation;
|
|
|
•
|
frequently changing intellectual property landscapes; and
|
|
|
•
|
changing customer demands.
|
Our future success will depend on our partner companies’ ability to adapt to these evolving marketplaces. They may not be able to adequately or economically adapt their products and services, develop new products and services or establish and maintain effective distribution channels for their products and services. If our partner companies are unable to offer competitive products and services or maintain effective distribution channels, they will sell fewer products and services and forego potential revenue, possibly causing them to lose money. In addition, we and our partner companies may not be able to respond to the marketplace changes in an economically efficient manner, and our partner companies may become or remain unprofitable.
Our partner companies may grow rapidly and may be unable to manage their growth.
We expect some of our partner companies to grow rapidly. Rapid growth often places considerable operational, managerial and financial strain on a business. To successfully manage rapid growth, our partner companies must, among other things:
|
|
•
|
improve, upgrade and expand their business infrastructures;
|
|
|
•
|
scale up production operations;
|
|
|
•
|
develop appropriate financial reporting controls;
|
|
|
•
|
attract and retain qualified personnel; and
|
|
|
•
|
maintain appropriate levels of liquidity.
|
If our partner companies are unable to manage their growth successfully, their ability to respond effectively to competition and to achieve or maintain profitability will be adversely affected.
Based on our business model, some or all of our partner companies will need to raise additional capital to fund their operations at any given time. We may not be able to fund some or all of such amounts and such amounts may not be available from third parties on acceptable terms, if at all. Further, if our partner companies do raise additional capital, either debt or equity, such capital may rank senior to our interests in such companies.
We cannot be certain that our partner companies will be able to obtain additional financing on favorable terms when needed, if at all. Because our resources and our ability to raise capital are not unlimited, we may not be able to provide partner companies with sufficient capital resources to enable them to reach a cash-flow positive position or a sale of the company, even if we wish to do so. General economic disruptions and downturns may also negatively affect the ability of some of our partner companies to fund their operations from other stockholders and capital sources. We also may fail to accurately project the capital needs of partner companies. If partner companies need capital but are not able to raise capital from us or other outside sources, then they may need to cease or scale back operations. In such event, our interest in any such partner company will become less valuable. If our partner companies raise additional capital, either debt or equity, that ranks senior to the capital we have deployed, such capital may entitle its holders to receive returns of capital before the dates on which we are entitled to receive any return of our deployed capital. Also, in the event of any insolvency, liquidation, dissolution, reorganization or bankruptcy of a partner company, holders of such partner company’s instruments that rank senior to our deployed capital will typically be entitled to receive payment in full before we receive any return of our deployed capital. After returning such senior capital, such partner company may not have any remaining assets to use for returning capital to us, causing us to lose some or all of our deployed capital in such partner company.
Economic disruptions and downturns may negatively affect our partner companies’ plans and their results of operations.
Many of our partner companies are largely dependent upon outside sources of capital to fund their operations. Disruptions in the availability of capital from such sources will negatively affect the ability of such partner companies to pursue their business models and will force such companies to revise their growth and development plans accordingly. Any such changes will, in turn, negatively affect our ability to realize the value of our capital deployments in such partner companies.
In addition, downturns in the economy as well as possible governmental responses to such downturns and/or to specific situations in the economy could affect the business prospects of certain of our partner companies, including, but not limited to, in the following ways: weaknesses in the financial services industries; reduced business and/or consumer spending; and/or systemic changes in the ways the healthcare system operates in the United States.
Some of our partner companies may be unable to protect their proprietary rights and may infringe on the proprietary rights of others.
Our partner companies assert various forms of intellectual property protection. Intellectual property may constitute an important part of partner company assets and competitive strengths. Federal law, most typically copyright, patent, trademark and trade secret laws, generally protects intellectual property rights. Although we expect that our partner companies will take reasonable efforts to protect the rights to their intellectual property, third parties may develop similar intellectual property independently. Moreover, the complexity of international trade secret, copyright, trademark and patent law, coupled with the limited resources of our partner companies and the demands of quick delivery of products and services to market, create a risk that partner company efforts to prevent misappropriation of their technology will prove inadequate.
Some of our partner companies also license intellectual property from third parties and it is possible that they could become subject to infringement actions based upon their use of the intellectual property licensed from those third parties. Our partner companies generally obtain representations as to the origin and ownership of such licensed intellectual property. However, this may not adequately protect them. Any claims against our partner companies’ proprietary rights, with or without merit, could subject the companies to costly litigation and divert their technical and management personnel from other business concerns. If our partner companies incur costly litigation and their personnel are not effectively deployed, the expenses and losses incurred by our partner companies will increase and their profits, if any, will decrease.
Third parties have and may assert infringement or other intellectual property claims against our partner companies based on their patents or other intellectual property claims. Even though we believe our partner companies’ products do not infringe any third party’s patents, they may have to pay substantial damages, possibly including treble damages, if it is ultimately determined that they do. They may have to obtain a license to sell their products if it is determined that their products infringe on another person’s intellectual property. Our partner companies might be prohibited from selling their products before they obtain a license, which, if available at all, may require them to pay substantial royalties. Even if infringement claims against our partner companies are without merit, defending these types of lawsuits takes significant time, is expensive and may divert management attention from other business concerns.
Certain of our partner companies could face legal liabilities from claims made against their operations, products or work.
Because manufacture and sale of certain partner company products entail an inherent risk of product liability, certain partner companies maintain product liability insurance. Although none of our current partner companies have experienced any material losses in this regard, there can be no assurance that they will be able to maintain or acquire adequate product liability insurance in the future and any product liability claim could have a material adverse effect on a partner company’s financial stability, revenues and results of operations. In addition, many of the engagements of our partner companies involve projects that are critical to the operation of their clients’ businesses. If our partner companies fail to meet their contractual obligations, they could be subject to legal liability, which could adversely affect their business, operating results and financial condition. Partner company contracts typically include provisions designed to limit their exposure to legal claims relating to their services and products. However, these provisions may not protect our partner companies or may not be enforceable. Also, some of our partner companies depend on their relationships with their clients and their reputation for high-quality services and integrity to retain and attract clients. As a result, claims made against our partner companies’ work may damage their reputation, which in turn could impact their ability to compete for new work and negatively impact their revenue and profitability.
Our partner companies’ success depends on their ability to attract and retain qualified personnel.
Our partner companies depend upon their ability to attract and retain senior management and key personnel, including trained technical and marketing personnel. Our partner companies also will need to continue to hire additional personnel as they expand. Although our partner companies have not been the subject of a work stoppage, any future work stoppage could have a material adverse effect on their respective operations. A shortage in the availability of the requisite qualified personnel or work stoppage would limit the ability of our partner companies to grow, to increase sales of their existing products and services, and to launch new products and services.
Government regulations and legal uncertainties may place financial burdens on the businesses of our partner companies.
Failure to comply with applicable requirements of the FDA or comparable regulation in foreign countries can result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution. Manufacturers of pharmaceuticals and medical diagnostic devices and operators of laboratory facilities are subject to strict federal and state regulation regarding validation and the quality of manufacturing and laboratory facilities. Failure to comply with these quality regulation systems requirements could result in civil or criminal penalties or enforcement proceedings, including the recall of a product or a “cease distribution” order. The enactment of any additional laws or regulations that affect healthcare insurance policy and
reimbursement (including Medicare reimbursement) could negatively affect some of our partner companies. If Medicare or private payers change the rates at which our partner companies or their customers are reimbursed by insurance providers for their products, such changes could adversely impact our partner companies.
Some of our partner companies may be subject to significant environmental, health and safety regulation.
Some of our partner companies may be subject to licensing and regulation under federal, state and local laws and regulations relating to the protection of the environment and human health and safety, including laws and regulations relating to the handling, transportation and disposal of medical specimens, infectious and hazardous waste and radioactive materials, as well as to the safety and health of manufacturing and laboratory employees. In addition, the federal Occupational Safety and Health Administration has established extensive requirements relating to workplace safety. Compliance with such regulations could increase operating costs at certain of our partner companies, and the failure to comply could negatively affect the operations and results of some of our partner companies.
Catastrophic events may disrupt our partner companies’ businesses.
Some of our partner companies are highly automated businesses and rely on their network infrastructure, various software applications and many internal technology systems and data networks for their customer support, development, sales and marketing and accounting and finance functions. Further, some of our partner companies provide services to their customers from data center facilities in multiple locations. Some of these data centers are operated by third parties, and the partner companies have limited control over those facilities. A disruption or failure of these systems or data centers in the event of a natural disaster, telecommunications failure, power outage, cyber-attack, war, terrorist attack or other catastrophic event could cause system interruptions, reputational harm, delays in product development, breaches of data security and loss of critical data. Such an event could also prevent the partner companies from fulfilling customer orders or maintaining certain service level requirements, particularly in respect of their SaaS offerings. While certain of our partner companies have developed certain disaster recovery plans and maintain backup systems to reduce the potentially adverse effect of such events, a catastrophic event that resulted in the destruction or disruption of any of their data centers or their critical business or information technology systems could severely affect their ability to conduct normal business operations and, as a result, their business, operating results and financial condition could be adversely affected.
We cannot provide assurance that our partner companies’ disaster recovery plans will address all of the issues they may encounter in the event of a disaster or other unanticipated issue, and their business interruption insurance may not adequately compensate them for losses that may occur from any of the foregoing. In the event that a natural disaster, terrorist attack or other catastrophic event were to destroy any part of their facilities or interrupt their operations for any extended period of time, or if harsh weather or health conditions prevent them from delivering products in a timely manner, their business, financial condition and operating results could be adversely affected.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes to the information we previously disclosed under Item 7A of Part II of our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the SEC on March 4, 2016.
Item 4.
Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of
September 30, 2016
are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure. A controls system cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
(b) Change in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.