180 Degree Capital Corp.

Good morning, and welcome to 180 Degree Capital Corp's third quarter 2023 financial results update call. This is Daniel Wolfe, President and Portfolio Manager of 180 Degree Capital. Kevin Rendino, our Chief Executive Officer and Portfolio Manager, and I would like to welcome you to our call this morning. All participants are currently in a listen-only mode. Following our prepared remarks, we will open the line to questions. If you'd like to ask a question, please type star six on your phone or click the ask a question icon if you are participating via your computer. I would like to remind participants that this call is being recorded and that we will be referring to a slide deck that we have posted on our investor relations website at ir.180degreecapital.com under financial results. Please turn to our safe harbor statement on slide two. This presentation may contain statements of a forward-looking nature relating to future events. Statements contained in this presentation that are forward-looking statements are intended to be made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to inherent uncertainties in predicting future results and conditions. These statements reflect the company's current beliefs, and a number of important factors could cause actual results to differ materially from those expressed herein. Please see the company's filings with the Security and Exchange Commission for a more detailed discussion of the risks and uncertainties associated with the company's business that could affect the company's actual results. Except as otherwise required by federal securities laws, the 180-degree Capital Corp. undertakes no obligation to update or revive these forward-looking statements to reflect new events or uncertainties. I would now like to turn the call over to Kevin.

Thank you, Daniel, and good morning, everyone. I want to leave you with a few key thoughts this morning. Our business transformation is essentially complete. After this past quarter, 97% of our assets are now in public companies. While it took over six years to get to this point, it is over. For those that are keeping track, since I arrived and 180 came to be in 2017, we have generated nearly $3 per share, or specifically $2.77 in gains from our new strategy. We have had losses over the same period of time of $2.28 from the historic legacy positions of Harris & Harris. To be candid, this business probably wouldn't exist if we hadn't changed our stripes in 2017. And while the last seven quarters have been a challenge for our public holdings, the market, and specifically the microcap indices, we now have a liquid, easily transparent balance sheet to be able to understand our NAV is easy to calculate. Therefore, as we said from day one, the discount our stock trades at relative to our NAV should be far less than it was when our book was 80% privates. To that end, we announced a discount management program that Daniel will speak to later in this call. It's important that the reality of our discount mirror the thesis we had for it when we first started. To be clear, the most important thing we can do is invest in companies that rise in value so the absolute value of our NAV climbs. There is a reason our stock traded at close to $9 per share at the end of 2021. It was because we grew our NAV to over $10 per share from where it was when we started. And while the last seven quarters have been a challenge for our holdings and the microcap index in general, we believe this period has set us up to once again grow our NAV as we look beyond this incredibly volatile and bearish market. In fact, we're going to use the rest of this call to show you in illustration form why we believe this is the right time to be invested in microcaps, and as a result, turn. We're going to show you a series of charts and data that highlight just how undervalued we believe our investment universe is, and therefore how much upside we believe there actually is for the companies that we own. I think this is one of the better buying opportunities for what we do than at any time since I've been here. The rest of this call will offer the rationale for why I think that is the case. As for the topics that we normally discuss on these calls, I recommend reviewing our shareholder call slides that are posted on our investor relations website. I won't speak to every chart included in this presentation, but I'll speak to a bunch of them and encourage you to flip through the presentation and shareholder letter for a complete discussion. On slide four, this shows that the ratio of U.S. small-cap performance to large-cap performance is at the lowest level in almost a quarter of a century. And yet at the same time, this level of underperformance is nothing about the fundamentals of the businesses that comprise each index, given the fundamentals have actually held up better for many micro-cap companies than the index performance would suggest. On slide five, this argues that not only have the stocks of smaller companies underperformed, the relative price-to-earnings ratio are back to levels not seen since 2000 and 1978. What's interesting about 1978 was that was also a time of inflation, as has been the case in the last two years. The question for us is, has the CPI peaked, and are we at the end of the Fed tightening cycle? The answer that we have for both of those questions is yes and yes. I do know the CPI has gone from 9.1% to 3.7%, and perhaps like 1978, which was the bottom for small caps, this is the bottom for small caps today because the CPI has long past peak. You can review the CPI numbers this morning. They were a little softer than expected. Slide six shows that not only are small cap value and small cap core equities the cheapest segment of U.S. equities on a relative basis, It's also remarkable that these two categories are the only ones that are below their 20-year, 25-year average valuation. Every other index in this chart shows that those indices traded premiums to their 25-year averages, but small caps don't. Slide 7 shows that small caps trade not only at a discount to their large cap peers, but the discounts are incredibly high. For example, the performance cap is 41% on the trailing PE, 39% on price to book, and 30% on price to sales. This is neither normal nor justified based on the actual performance of the company's fundamentals. Slide 8 shows the historical returns of market indices. At least in 2008, when the economy actually did melt down, most indices were down about the same amount. Back in 2008, the S&P 500 index was down 37%. The NASDAQ composite index was down 40%. The Russell 2000 index was down 34%. And the Russell microcap index was down 40%. How is it that today the NASDAQ 100 can be up 37% while the Russell microcap index is down 10%? How can the S&P 500 be 3% from its all-time high when the Russell microcap index is down 38% and the Russell... microcap growth index is down 49% from the high. While we understand the bearish effect of today's world of higher interest rates, it has had a significantly greater effect on small caps relative to the 2008 economic environment where nearly $1 trillion of losses occurred from categories of loans and related securities issued in the United States secured primarily by residential real estate. 2008 was an economic Pearl Harbor, as Warren Buffett said, And 2023 is not the same economic calamity. The disparity of performance between the size of companies is the widest it has ever been and makes no sense to us. This is not 2008. Skipping ahead to slide 10, the above chart depicts bearish sentiment. Are there problems in the world? Yes, there clearly are a number of pressing issues. Higher interest rates, a war in Ukraine, now a war in the Middle East. inflationary pressures, there's many concerns. But bottoms in stock markets nearly always occur when bearishness is at its highest levels. And the opposite, of course, is true of tops in markets. We are near the high end of bearish sentiment as depicted in this chart. Skipping ahead to slide 13, this shows the historical PE ratios of the Russell 2000. It isn't only about relative valuations of one asset size to the next. The above chart from Royce Investment Partners shows that the actual PE for the Russell 2000 has gone down measurably over the last few years. Now, one would expect that higher interest rates would lead to lower PE multiples, but the multiples are now lower than the long-term growth rates, arguing for an inexpensive asset class. Additionally, given we believe that the Fed is likely near the end of its interest rate hiking cycle, it is possible that rates have hit or are close to hitting a peak, and therefore multiples should be close to or at a trough. Again, referring back to my prior comments, while one would expect multiples to be lower given interest rates are higher, why is it that the only indices, the small cap universe, has lower multiples while every other asset-sized company has higher multiples based on its 25-year average? That is completely incongruent. Slide 16 shows flows in different ETFs for 2023. Never underestimate the effect of flows of investor capital on the value of public market assets, especially equities. As you can see above, there was $5.1 billion of inflows into the iShares Core S&P 500 ETF and the Vanguard S&P 500 ETF, while at the same time there was a combined outflow of $1 billion from small cap funds. In the case of the Russell 2000 value ETF, the outflow has been a staggering 11.4% of the entire asset base. There is almost no question that the price dislocation that we have seen in the small cap universe is a direct result of indiscriminate selling by ETFs and other funds facing redemptions. Again, this trend is normal for equity market bottoms, not tops. Slide 17 shows U.S. indices' returns by size. And in this chart, you can see the effects of the outflows on specific performance of stocks based on size. Through September 30, 2023, there is a historically large 3,000 basis point disparity between small and large industries. I have yet to see that in all my career of investing. Slide 18, what is the most important explanatory power, sorry about that, over long-term returns for an index? We have long stated that the price you pay for the business you buy is a key factor in determining one's ultimate success in an investment. If you buy a good business at the wrong time, you may lose money. If you buy a less than good company at the right time, you may make money. The above chart was published by Bank of America and shows that while valuations tend to be a poor short-term timing indicator, they do matter for longer-term returns. Note that this chart represents the relationship between the relative PE for the Russell 2000 versus the Russell 1000 and subsequent rolling return differentials. Simply put, valuation has the highest explanation power over long-term returns. And we know today that small caps are historically attractive using that metric. And finally, on slide 20, the above chart above and commentary below is again attributed to Royce Investment Partners. I love any statistic which has a 100% success rate, and this one does. Small caps' historical return patterns show that below average return periods have been followed by those with above average return periods, with a much lower than average frequency of negative return periods. Specifically, the Russell 2000 had positive annualized three-year returns 100% of the time, that is, in all 86 periods, averaging an impressive 17.5%, following five-year periods of less than 5% annualized returns. At the same time, five-year returns had positive annual returns 100% of the time. That is, in all 81 periods, averaging 14.9%. So while the future may be different than the past, it's hard to ignore this trend given its accuracy to date. We can debate opinions, but we can't debate facts. Every chart depicted above shows historically low valuations and significant underperformance for small cap stocks. We are very comfortable with our view that our stocks have discounted a lot of bad news that quite simply has not occurred in 2023. Maybe the news will come next year and maybe they won't. Either way, we expect the management teams of the companies we own to adapt to whatever environment we are in, and we will use our collaborative and collegial activism, if need be, in an effort to unlock value for all our stakeholders. We are not naive enough to not be aware that there are bear cases for why small-cap companies will underperform for the next decade. I am sure there are myriads of investors who have charts that bolster their bearish thesis. I have often told you that the price you pay for the business you buy is the first and key factor in determining whether or not you will be ultimately successful in that particular investment. It would be an understatement at this point to say that we own many companies whose stock prices and valuations we believe materially understate the true values of those businesses. The starting point is price, and we believe the price is right for the potential for material upside in our portfolio. If you believe I'm right, you should own Turner Mute Portfolio. If you don't, then you shouldn't. I currently own 680,000 shares. And Daniel currently owns 229,000 shares. You can certainly expect that our ownership levels will continue to grow in the future through open market purchases. One day I hope to be able to reference this call at the bottom. As always, thank you for your support. I'll now turn the call over to Daniel.

Thank you, Kevin. Please turn to slide 22. While many of 180 Degrees' current portfolio companies have generally been swept up in the recent vicious market selling, particularly for microcap companies, we do not believe the businesses and the balance sheets of many of these holdings reflect the distress that their falling stock prices indicate. This slide provides examples of some recent announcements from our portfolio companies that clearly show, in our view, that these companies continue to execute on their business plans and we believe are set up well for value creation for their shareholders, including 180-degree capital. For example, Pot Valley announced a new shop development agreement for 36 shops and four re-franchise shops that brings its new contracted franchise shops to 150. It also announced record average unit volumes and continued growth in shop-level margins and gain in market share. Synchronos sold its non-core assets and now is a pure play cloud service company that is currently expected to generate material positive free cash flows and 25% EBITDA margins in 24. Arena Group signed a definitive agreement to merge with Bridge Media, a company owned by the founder and owner of Five Hour Energy, that will result in a combined company with 100 owned and affiliated stations and over-the-top partnerships across 46 states, on top of the assets that Arena brings to the combination. Intivac is in the final stages of certification for its new TRIO tool with its partner, Corning. Plantronics announced that it's beginning volume production of its smart meter product for grids for keys or email that is expected to drive 30% plus organic growth and material profitability in 2024. In summary, these are all positive news for each of these companies. While our performance has been challenged over the past seven quarters after five years of strong performance, the notes above are just a portion of the reasons we believe our portfolio is positioned well for the creation of value for shareholders in 2024 and beyond. We will use this period to ramp up our collegial and constructive activism. We are keenly aware that hope is not a strategy. Activism is. As Kevin noted earlier in this call, and we announced in the press release yesterday, 180's board has initiated the discount management program with an initial two measurement periods beginning January 1st of 24 to the end of 24. and January 1st of 25 to June 30th of 25. Should 180-degree capital as common stock trade an average daily discount to NAV of more than the current average trading discount of other equity closed-end funds, which is about 12% during either of these measurement periods, then 180 Degrees Board will consider all available options, including but not limited to significant expansion of our buyback program, where 180 repurchases stock through open market trades, cash distributions in the forms of dividends or returns of capital, depending on in-year gains, or a tender offer, where shareholders would be able to decide if they wanted to sell a portion of their holdings back to 180 at a price per share that is set by 180's board. To be clear, any decision regarding actions taken at the end of each measurement period as a result of this program remains with the 180 Capitals Board and has not been made today. We believe that the existence of the program and its associated measurement periods demonstrates the continued focus of both 180's board and management team on taking active steps to minimize any persistent discount in 180's share price. In the future, 180's board may or may not determine to extend the program beyond June of 25. During these measurement periods, as Kevin mentioned, we fully expect that management will continue to purchase turned stock in the open market. To be clear, and I'll reiterate what Kevin said, The most important thing we can do is find investments that materially increase values so that as a result, NAV increases from its current values. We believe that that will have the most impactful effect and positive effect on terms of stock price and returns for shareholders. Lastly, I would like to note that we included the size we normally present on these calls in an appendix at the end of the slide deck on our website. We're not going to discuss them on today's call, but we'd be happy to answer any questions on them any time. We would now like to open the line for questions. If you have a question, please press star six on your phone or click the ask a question icon if you are participating via computer. We'll give a second for the queue to fill with any questions that there are. Hi, Oliver, please go ahead. Oliver? OK, sorry, we'll move to our next question. Hi, Dennis, please go ahead. Dennis, if your line is on mute, you may have to turn it off of mute.