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
Over the recent past, Safeguard has provided 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 a significant equity interest. In many, but not all cases, we will also be 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.
In January 2018, Safeguard announced that we will not deploy any capital into new partner company opportunities and will focus on supporting our existing partner companies and maximizing monetization opportunities to enable returning value to shareholders. In that context, we have, are and will consider initiatives including, among others: the sale of individual partner companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize shareholder value. As a result of the debt repayment, we anticipate returning value to shareholders in the form of stock repurchases and/or dividends, based on prevailing market conditions and other factors.
Safeguard's existing group of partner companies consists principally of technology-driven businesses in healthcare, financial services and digital media that are capitalizing on the next wave of enabling technologies including business intelligence and predictive analytics. We strive to create long-term value for our shareholders by helping our partner companies to increase their market penetration, grow revenue and improve cash flow. Safeguard typically deploys up to $25 million in a company.
Results of Operations
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, generally, but not all cases, are actively involved influencing development, usually through board representation in addition to our equity ownership. During 2019 we ceased using the equity method of accounting for Hoopla Software, Inc. and T-REX Group, Inc. as a result of other new investors diluting our interest. We have retained our equity interests under the Other accounting method.
The following listing of our partner companies includes only entities which were considered partner companies as of
June 30, 2019
. Certain entities which may have been partner companies in previous periods are omitted if, as of
June 30, 2019
, they had been sold or are no longer considered a partner company as a result of a reduction in our ownership interest and value
ascribed to the entity.
|
|
|
|
|
|
|
|
|
|
Safeguard Primary Ownership as of June 30,
|
|
|
Partner Company
|
2019
|
|
2018
|
Accounting Method
|
|
Aktana, Inc.
|
18.8%
|
|
24.5%
|
Equity
|
|
Clutch Holdings, Inc.
|
41.2%
|
|
41.2%
|
Equity
|
|
Flashtalking
|
10.1%
|
|
10.3%
|
Other
|
|
InfoBionic, Inc.
|
25.4%
|
|
39.5%
|
Equity
|
|
Lumesis, Inc.
|
43.6%
|
|
43.8%
|
Equity
|
|
MediaMath, Inc.
|
13.4%
|
|
20.5%
|
Other
|
|
meQuilibrium
|
32.7%
|
|
36.2%
|
Equity
|
|
Moxe Health Corporation
|
32.4%
|
|
32.4%
|
Equity
|
|
NovaSom, Inc.
|
31.7%
|
|
31.7%
|
Equity
|
|
Prognos Health Inc.
|
28.7%
|
|
28.7%
|
Equity
|
|
QuanticMind, Inc.
|
24.2%
|
|
24.7%
|
Equity
|
|
Sonobi, Inc.
|
21.6%
|
|
21.6%
|
Equity
|
|
Syapse, Inc.
|
19.4%
|
|
20.0%
|
Equity
|
|
Trice Medical, Inc.
|
16.7%
|
|
24.8%
|
Equity
|
|
WebLinc, Inc.
|
38.5%
|
|
38.0%
|
Equity
|
|
Zipnosis, Inc.
|
37.7%
|
|
25.4%
|
Equity
|
Three months ended June 30, 2019 versus the three months ended June 30, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
|
2019
|
|
2018
|
|
Variance
|
|
|
(In thousands)
|
|
General and administrative expense
|
$
|
(2,603
|
)
|
|
$
|
(5,148
|
)
|
|
$
|
2,545
|
|
|
Other income (loss), net
|
3,118
|
|
|
(2,452
|
)
|
|
5,570
|
|
|
Interest income
|
763
|
|
|
666
|
|
|
97
|
|
|
Interest expense
|
(5,682
|
)
|
|
(3,422
|
)
|
|
(2,260
|
)
|
|
Equity income (loss), net
|
40,497
|
|
|
(14,540
|
)
|
|
55,037
|
|
|
|
$
|
36,093
|
|
|
$
|
(24,896
|
)
|
|
$
|
60,989
|
|
General and Administrative Expense.
General and administrative expense decreased
$2.5 million
million for the three months ended June 30, 2019 compared to the prior year period primarily due to the lower overall level of staffing, the absence of the $1.7 million severance charge for employees who were terminated in connection with our change in strategy in 2018, and $0.9 million of lower professional fees, primarily due to costs associated with activist shareholder matters in the prior year. The three months ended June 30, 2019 also includes an increase of $0.3 million for depreciation of our leasehold improvements as a result of our exit from our prior facility in June 2019.
Other Income (Loss)
. Other Income (loss) improved
$5.6 million
for the three months ended June 30, 2019 compared to the prior year period. Other income for three months ended June 30, 2019 included a $3.0 million of income related to the decrease in the fair value of the amended credit facility repayment feature liability as compared to a $2.5 million loss related to an increase in the same liability in the prior comparable period.
Interest Income.
Interest income increased $0.1 million for the three months ended June 30, 2019 compared to the prior year period was primarily attributable to higher investment income resulting from our marketable securities resulting from a higher daily average investment balances, partially offset by lower average notes receivable from our partner companies.
Interest Expense.
Interest expense increased $2.3 million for the three months ended June 30, 2019 compared to the prior year period primarily due to a $2.9 million make-whole interest payment related to the credit facility, net of the absence of any borrowings under the convertible debentures that were outstanding in 2018.
Equity Income (loss), net.
Equity income (loss), net increased
$55.0 million
for the three months ended June 30, 2019 compared to the prior year period. The components of equity income (loss), net for the three months ended June 30, 2019 and 2018 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
|
2019
|
|
2018
|
|
Variance
|
|
|
(In thousands)
|
|
Gains on sales of partner interests
|
$
|
50,441
|
|
|
$
|
4,153
|
|
|
$
|
46,288
|
|
|
Unrealized dilution gains on the decrease of our percentage ownership in partner companies
|
1,290
|
|
|
3,515
|
|
|
(2,225
|
)
|
|
Loss on impairment of partner companies
|
(2,965
|
)
|
|
(6,567
|
)
|
|
3,602
|
|
|
Share of loss of our equity method partner companies
|
(8,269
|
)
|
|
(15,641
|
)
|
|
7,372
|
|
|
|
$
|
40,497
|
|
|
$
|
(14,540
|
)
|
|
$
|
55,037
|
|
The gains on sale of partner interests for the three months ended June 30, 2019 is comprised of Transactis of $50.4 million. The gain on the sale of partner company interests for the three months ended June 30, 2018 is comprised of the sale of Cask Data.
The unrealized dilution gains for the three months ended June 30, 2019 was the result of meQuilibrium, T-Rex and Syapse, who each raised additional equity capital that diluted the Company's interest in those entities.
The loss on impairment of partner companies for the three months ended June 30, 2019 is comprised of NovaSom, Inc.'s August 2019 bankruptcy filing. For the three months ended June 30, 2018, the loss on impairment of partner companies is comprised of Apprenda, which ceased operations.
The change in our share of equity loss of our equity method partner companies for the three months ended June 30, 2019 compared to the prior year period was due to a decrease in the number of partner companies and a decrease in losses associated with the remaining partner companies.
Six months ended
June 30, 2019
versus the
six months ended
June 30, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30,
|
|
|
2019
|
|
2018
|
|
Variance
|
|
|
(In thousands)
|
|
General and administrative expense
|
$
|
(5,660
|
)
|
|
$
|
(10,738
|
)
|
|
$
|
5,078
|
|
|
Other income (loss), net
|
1,233
|
|
|
(3,887
|
)
|
|
5,120
|
|
|
Interest income
|
1,636
|
|
|
1,465
|
|
|
171
|
|
|
Interest expense
|
(8,217
|
)
|
|
(6,112
|
)
|
|
(2,105
|
)
|
|
Equity income (loss), net
|
68,764
|
|
|
(11,794
|
)
|
|
80,558
|
|
|
|
$
|
57,756
|
|
|
$
|
(31,066
|
)
|
|
$
|
88,822
|
|
General and Administrative Expense.
General and administrative expense decreased
$5.1 million
for the
six months ended June 30, 2019
compared to the prior year period primarily due to the lower overall level of staffing, the absence of the $2.8 million severance charge for employees who were terminated in connection with our change in strategy in 2018, and $1.9 million of lower professional fees, primarily due to costs associated with activist shareholder matters in the prior year. The six months ended June 30, 2019 also includes an increase of $0.7 million for depreciation of our leasehold improvements as a result of our exit from our prior facility in June 2019.
Other Income (Loss)
. Other Income (loss) improved $5.1 million for the
six months ended June 30, 2019
compared to the prior year period. Other income for the
six months ended June 30, 2019
included $1.0 million of income related to the decrease in the fair value of the amended credit facility repayment feature liability as compared to a $2.5 million loss related to an increase in the same liability in the prior comparable period. Other loss for the six months ended June 30, 2018 also reflected a $1.2 million decrease in the fair value of shares of Invitae Corporation common stock obtained in connection with the sale of Good Start Genetics in August 2017.
Interest Income.
Interest income increased $0.2 million for the
six months ended June 30, 2019
compared to the prior year period primarily attributable to higher investment income resulting from our marketable securities resulting from a higher daily average investment balances, which was partially offset by lower average notes receivable from our partner companies.
Interest Expense.
Interest expense increased $2.1 million for the
six months ended June 30, 2019
compared to the prior year period primarily due to a $2.9 million make-whole interest payment related to the credit facility, net of the absence of any borrowings under the convertible debentures in 2019 that were outstanding in 2018.
Equity Income (loss), net.
Equity income (loss), net increased $80.6 million for the
six months ended June 30, 2019
compared to the prior year period. The components of equity income (loss), net for the
six months ended June 30, 2019
and 2018 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30,
|
|
|
2019
|
|
2018
|
|
Variance
|
|
|
(In thousands)
|
|
Gains on sales of partner interests
|
$
|
85,573
|
|
|
$
|
18,176
|
|
|
$
|
67,397
|
|
|
Unrealized dilution gains on the decrease of our percentage ownership in partner companies
|
1,760
|
|
|
3,081
|
|
|
(1,321
|
)
|
|
Loss on impairment of partner companies
|
(2,965
|
)
|
|
(6,567
|
)
|
|
3,602
|
|
|
Share of loss of our equity method partner companies
|
(15,604
|
)
|
|
(26,484
|
)
|
|
10,880
|
|
|
|
$
|
68,764
|
|
|
$
|
(11,794
|
)
|
|
$
|
80,558
|
|
The gains on sales of partner interests for the six months ended June 30, 2019 is comprised primarily of Propeller of $34.9 million and Transactis of $50.4 million. The gains on sales of partner company interests for the six months ended June 30, 2018 is comprised of Spongecell's merger with Flashtalking, the repayment of the note from Nexxt (fka Beyond.com), and the sale of Cask Data.
The unrealized dilution gains for the six months ended June 30, 2019 was the result of meQuilibrium, Syapse, Trice, and T-Rex, who each raised additional equity capital that diluted the Company's interest in those entities.
The loss on impairment of partner companies for the six months ended June 30, 2019 is comprised of NovaSom, Inc., which was unable to service its debt obligations. For the six months ended June 30, 2018, the loss on impairment of partner companies is comprised of Apprenda, which ceased operations.
The change in our share of equity loss of our equity method partner companies for the
six months ended June 30, 2019
compared to the prior year period was due to a decrease in the number of partner companies and a net decrease in losses associated with the remaining partner companies.
Income Tax Benefit (Expense)
Income tax benefit (expense) was $0.0 million for the three and
six months ended June 30, 2019
and 2018. 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 income tax provision that would have been recognized in the
six months ended June 30, 2019
and 2018 was offset by changes in the valuation allowance.
Liquidity and Capital Resources
As of
June 30, 2019
, we had $72.9 million of cash and cash equivalents and $25.0 million of marketable securities and trading securities for a total of $97.9 million. As of
June 30, 2019
, we had
$44.5 million
of principal outstanding on our Credit Facility, which was repaid in full in July 2019.
In January 2018, Safeguard announced that, from that date forward, we will not deploy any capital into new partner company opportunities and will focus on supporting our existing partner companies and maximizing monetization opportunities to return value to shareholders. In that context, we have, are and will consider initiatives including, among others: the sale of individual partner companies, the sale of certain partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize shareholder value. As a result of the debt repayment, we anticipate returning value to shareholders in the form of stock repurchases and/or dividends, based on prevailing market conditions and other factors.
The Company was subject to a Credit Facility consisting of a term loan. Repayment terms under the Credit Facility included a make-whole interest provision equal to the interest that would have been payable had the principal amount subject to repayment been outstanding through the maturity date of the Credit Facility. If the aggregate amount of our qualified cash at any quarter end date exceeded $50.0 million, we were required to prepay outstanding principal amounts under the Credit Facility, plus any applicable interest and prepayment fees, in an amount equal to such excess. Based on this requirement, the Company made a principal payment of $24.0 million and a make-whole interest payment of $2.9 million on April 15, 2019 based on the Company's qualified cash at March 31, 2019. Further, the Company repaid the remaining obligation, including $49.5 million of principal, $4.1 million of make-whole interest and $0.9 million of accrued interest, in July 2019.
The Credit Facility required us to (i) maintain a liquidity threshold of at least
$20 million
of unrestricted cash; (ii) maintain a minimum aggregate appraised value of our ownership interests in our partner companies, plus unrestricted cash in excess of the liquidity threshold, of at least
$350 million
less the aggregate amount of all prepayments; (iii) limit deployments to only existing partner companies and such deployments may not exceed, when combined with deployments after January 1, 2018, to $40.0 million in the aggregate through the maturity date; and (iv) limit certain expenses (which excluded severance payments, interest expense, depreciation and stock-based compensation) incurred or paid to no more than $11.5 million in any twelve-month period after the date of the amendment (or such shorter period as has elapsed since the date of the amendment). Additionally, the Company was restricted from repurchasing shares of its outstanding common stock and/or issuing dividends until such time as the Credit Facility is repaid in full. As of June 30, 2019 and the date the loan was repaid, we were in compliance with all applicable covenants.
In 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. During the year ended December 31, 2018 and the six months ended June 30, 2019, we did not repurchase any shares under this authorization.
We are 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”). 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. In 2017, we were notified by the fund's manager that the fund was being dissolved and $1.0 million of our clawback liability was paid. The maximum additional clawback liability is $0.3 million which was reflected in Other long-term liabilities on the Consolidated Balance Sheet at
June 30, 2019
.
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. 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 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. The Company believes that its cash, cash equivalents and marketable securities at
June 30, 2019
will be sufficient to fund operations past one year from the issuance of these financial statements.
Analysis of Consolidated Cash Flows
Cash flow activity was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30,
|
|
|
2019
|
|
2018
|
|
Variance
|
|
|
(In thousands)
|
|
Net cash used in operating activities
|
$
|
(12,181
|
)
|
|
$
|
(13,613
|
)
|
|
$
|
1,432
|
|
|
Net cash provided by investing activities
|
101,652
|
|
|
20,984
|
|
|
80,668
|
|
|
Net cash used in financing activities
|
(24,204
|
)
|
|
(8,452
|
)
|
|
(15,752
|
)
|
|
|
$
|
65,267
|
|
|
$
|
(1,081
|
)
|
|
$
|
66,348
|
|
Net Cash Used In Operating Activities
Net cash used in operating activities decreased by $1.4 million for the
six months ended June 30, 2019
compared to the prior year period. The change was primarily the result of various non-cash adjustments to net income, including the $68.8 million of equity income, a $1.0 million gain from the increase in the fair value of the repayment feature derivative, depreciation, and the amortization of debt discount. Also, the Company made $6.6 million of cash interest payments for the six months ended June 30, 2019 as compared to $3.7 million of cash interest payments for the six months ended June 30, 2018.
Net Cash Provided by Investing Activities
Net cash provided by investing activities increased by $80.7 million for the
six months ended June 30, 2019
compared to the prior year period. The increase primarily related to $98.7 million in proceeds from the sale of Propeller and Transactis as compared to a $10.5 million repayment of an outstanding note from Nexxt, Inc. in the previous year. The Company also had $12.9 million of marketable securities mature in excess of purchases during the six months ended June 30, 2019 as compared to $3.8 million of marketable securities sales during the six months ended June 30, 2018.
Net Cash Used In Financing Activities
The Company made a principal payment of $24.0 million during the
six months ended June 30, 2019
. The primary financing activities during the six months ended June 30, 2018 were the repayment of the convertible debentures of $41.0 million, which were funded by the $35.0 million of proceeds from the Credit Facility.
Contractual Cash Obligations and Other Commercial Commitments
The following table summarizes our contractual obligations and other commercial commitments as of
June 30, 2019
, by period due or expiration of the commitment.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
Total
|
|
2019
(remainder)
|
|
2020 and
2021
|
|
2022 and
2023
|
|
After
2023
|
|
|
(In millions)
|
|
Contractual Cash Obligations:
|
|
|
|
|
|
|
|
|
|
|
Credit facility
|
44.5
|
|
|
44.5
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Interest payments on debt
|
5.0
|
|
|
5.0
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Operating leases (a)
|
4.3
|
|
|
0.4
|
|
|
1.3
|
|
|
1.2
|
|
|
1.4
|
|
|
Severance payments
|
0.4
|
|
|
0.3
|
|
|
0.1
|
|
|
—
|
|
|
—
|
|
|
Potential clawback liabilities (b)
|
0.3
|
|
|
—
|
|
|
0.3
|
|
|
—
|
|
|
—
|
|
|
Other long-term obligations (c)
|
1.9
|
|
|
0.8
|
|
|
1.1
|
|
|
—
|
|
|
—
|
|
|
Total Contractual Cash Obligations (d)
|
$
|
56.4
|
|
|
$
|
51.0
|
|
|
$
|
2.8
|
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$
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1.2
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$
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1.4
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(a)
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In 2015, we entered into an agreement for the lease of our former principal executive offices which expires in April 2026. In March 2019, we entered into a sublease for these offices which is expected to result in aggregate sublease receipts of $3.7 million through April 2026.
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(b)
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We are 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”). 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 were notified by the fund's manager that the fund is being dissolved and $1.0 million of our clawback liability was paid in the first quarter of 2017. The maximum clawback liability is $0.3 million which is reflected in Other long-term liabilities on the Consolidated Balance Sheets at
June 30, 2019
.
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(c)
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Reflects the estimated amount payable to a former Chairman and CEO under an ongoing agreement.
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(d)
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The maximum aggregate exposure under employment and severance agreements for remaining employees was approximately $4.0 million at June 30, 2019 (not reflected in the table above).
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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. In addition to our partner companies that are referenced in this section, we also hold relatively small 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. While these interests are relatively small on an individual basis, from time to time they may become material on an aggregate basis, especially as we continue to execute our strategy, and the risks described in this section may also apply to these other interests.
The intended monetization of our partner company interests and the return of value to shareholders are subject to factors beyond our control.
In January 2018, we announced that we will not deploy any capital into new partner companies. We will instead focus on supporting, and maximizing monetization opportunities for, our existing partner company interests to return value to shareholders. However, this strategic plan may require providing additional capital and operational support to such existing partner companies and we may not be able to sell our partner company interests during any specific time frame or otherwise on desirable terms, if at all, and there can be no assurance as to how long this process will take or the results that this process will yield. There can be no assurance as to whether we will realize the value of escrowed proceeds, holdbacks or other contingent consideration, if any, associated with the sale of partner company interests. Additionally, there can be no assurance that we will be able to satisfy our liabilities during this process. Further, the method, timing and amount of any return of value resulting from the monetization of existing partner companies will be at the discretion of our Board of Directors and will depend on market and business conditions and our overall liabilities, capital structure and liquidity position.
The continuing costs and burdens associated with being a public company will constitute a much larger percentage of our expenses and we may in the future delist our Common Stock with the New York Stock Exchange and seek to deregister our Common Stock with the SEC.
We will remain a public company and will continue to be subject to the listing standards of the New York Stock Exchange and SEC rules and regulations, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Sarbanes-Oxley Act of 2002. The costs and burdens of being a public company will be a significant and continually increasing portion of our expenses if we are able to monetize partner company interests. As part of such monetization efforts, we will likely in the future, once the majority of our partner company interests have been monetized, delist our Common Stock from the New York Stock Exchange and seek to deregister our Common Stock with the SEC. However, there can be no assurance as to the timing of such transactions, or whether such transactions will be completed at all, and we will continue to face the costs and burdens of being a public company until such time as our Common Stock is delisted with the New York Stock Exchange and deregistered with the SEC.
Our principal business strategy depends upon our ability to make good decisions regarding the deployment of capital into, and subsequent disposition of, existing partner company interests and, ultimately, the performance of our partner companies, which is uncertain.
If we make poor decisions regarding the deployment of capital into, and subsequent disposition of, existing partner companies, our business strategy will not succeed. 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:
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most of our partner companies have a history of operating losses and/or limited operating history;
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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;
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the inability to adapt to changing marketplaces;
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the inability to manage growth;
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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;
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the inability to protect their proprietary rights and/or infringing on the proprietary rights of others;
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that our partner companies could face legal liabilities from claims made against them based upon their operations, products or work;
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the impact of economic downturns on their operations, results and growth prospects;
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the inability to attract and retain qualified personnel;
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the existence of government regulations and legal uncertainties may place financial burdens on the businesses of our partner companies; and
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the inability to plan for and manage catastrophic events.
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These and other risks are discussed in detail under the caption “Risks Related to Our Partner Companies” below.
As we execute against our strategy, a significant amount of our deployed capital may be concentrated in partner companies operating in the same or similar industries, limiting our diversification.
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 do not provide us with 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 fund the capital needs of our existing partner companies. We also need cash to finance our corporate overhead and meet our existing funding commitments. As a result, we have substantial cash requirements. Our partner companies do not provide us with 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 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.
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. 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 intrinsic value. 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. On April 6, 2018, we publicly announced a series of management changes intended to streamline our organizational structure and reduce our operating costs. These aggressive cost-reduction initiatives better aligned our cost structure with the strategy we announced in January 2018. A loss of one or more of the remaining 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 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:
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the management of a partner company having economic or business interests or objectives that are different from ours; and
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the partner companies not taking our advice with respect to the financial or operating issues they may encounter.
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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 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, and results of operations 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 an innovative technology or device, including, without limitation, technologies or devices used in healthcare, financial services or digital media. Despite all of our efforts to understand the research and development underlying the innovation or creation of such technologies and devices 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:
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rapidly changing technology;
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evolving industry standards;
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frequent introduction of new products and services;
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shifting distribution channels;
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evolving government regulation;
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frequently changing intellectual property landscapes; and
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changing customer demands.
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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:
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improve, upgrade and expand their business infrastructures;
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scale up production operations;
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develop appropriate financial reporting controls;
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attract and retain qualified personnel; and
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maintain appropriate levels of liquidity.
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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, or decline 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 from third parties, either debt or equity, such capital may rank senior to, or dilute, 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. We may not be able to, or decline to, provide partner companies with sufficient capital resources to enable them to reach a cash-flow positive position or a sale of the company. 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, 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 from third parties, either debt or equity, such capital may be dilutive, making our interests less valuable or if such capital ranks senior to the capital we have deployed, such capital may entitle its holders to receive returns of capital before 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 current 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, data security 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, some of our partner companies are subject to federal, state and local financial securities and data security regulations, including, without limitation, the Health
Insurance Portability and Accountability Act of 1996, as amended, and the European General Data Protection Regulation, which impose varying degrees of additional obligations, costs and risks upon such partner companies, including the imposition of significant penalties in the event of any non-compliance. Further, 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, 2018, filed with the SEC on March 1, 2019.
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
June 30, 2019
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.