Rand Capital Corporation — Q1 2023 Form 10-Q Summary
Business context and reporting period
Rand Capital Corporation is an externally managed, closed-end, diversified business development company that invests primarily in debt and equity securities of lower middle-market companies. The filing covers the three months ended March 31, 2023, with comparative results for the three months ended March 31, 2022. Rand is externally managed by Rand Capital Management, LLC and has elected regulated investment company tax treatment.
Key financial metrics
| Metric | Q1 2023 | Q1 2022 or prior period |
|---|---|---|
| Total investment income | $1.85 million | $1.12 million |
| Net investment income | $714,916 | $772,003 |
| Realized gain/(loss) on investments | $53,388 | $(851,471) |
| Unrealized appreciation/(depreciation) | $1.40 million | $(331,069) |
| Net increase/(decrease) in net assets from operations | $2.17 million, or $0.84 per share | $(410,537), or $(0.16) per share |
| Net assets at period end | $59.38 million | $59.95 million at March 31, 2022 |
| NAV per share | $23.00 | $22.36 at December 31, 2022 |
| Cash at period end | $1.84 million | $1.37 million at December 31, 2022 |
| Investments at fair value | $68.19 million | $61.50 million at December 31, 2022 |
| Investments at cost | $61.00 million | $55.72 million at December 31, 2022 |
| Debt outstanding | $7.95 million | $2.55 million at December 31, 2022 |
Total investment income increased 64.6% year over year, driven by higher interest income, dividend income and fee income. Net investment income declined 7.4% because expenses increased 203.4% to $1.05 million, primarily from the capital gains incentive fee accrual and interest expense.
Cash flow from operating activities was $(4.41) million, compared with $150,071 provided by operating activities in Q1 2022. Rand invested $5.57 million in portfolio companies and received $268,329 from investment sales and $300,000 from loan repayments. Financing activities provided $4.88 million, including $5.40 million of credit-facility borrowings, partly offset by the $516,204 cash dividend.
The company declared and paid a quarterly dividend of $0.20 per share during the quarter. On April 26, 2023, the Board declared a $0.25 per-share dividend payable on or about June 14, 2023.
Material changes versus the prior comparable period
- Investment income increased by $726,750, or 64.6%, including a 42.2% increase in interest from portfolio companies and a 174.4% increase in dividend and other investment income.
- Net investment income decreased by $57,087 despite higher investment income, primarily because of increased capital gains incentive fee accruals and $158,400 of interest expense on the credit facility.
- Rand recorded $1.40 million of net unrealized appreciation, compared with $331,069 of net unrealized depreciation in Q1 2022. The Q1 2023 increase was primarily attributable to a $1.52 million appreciation in ACV Auctions.
- Realized investment results improved from an $851,471 loss to a $53,388 gain. The 2023 gain included $58,329 of additional proceeds from Microcision, partly offset by a $4,941 loss on a SocialFlow escrow receivable.
- Portfolio investments at fair value increased 10.9% from December 31, 2022, while net assets increased 2.9%. New investments included $3.0 million in Pressure Pro, $2.32 million in BMP Food Service Supply and $250,000 in Tilson.
- Total liabilities increased 95.0% to $11.23 million, principally because credit-facility borrowings increased by $5.40 million.
Guidance, outlook, commentary, risks and unusual items
Management expects to fund investment activity through operating cash flows, sales of publicly traded liquid investments and borrowings under the $25 million senior secured revolving credit facility. Management also expects to continue exiting investments, although the timing of liquidity events for privately held investments is difficult to project. No formal earnings guidance was provided.
The credit facility matures June 27, 2027, bears interest at a variable rate, and carried an 8.05% rate at March 31, 2023. The borrowing base produced $17.05 million of unused line capacity at quarter end. The facility requires, among other conditions, tangible net worth of at least $50 million, an asset coverage ratio of at least 3:1 and a trailing twelve-month interest coverage ratio of at least 2.5:1. Management stated that Rand was in compliance with these covenants at March 31, 2023.
Portfolio valuation remains a significant risk: 89% of investments were Level 3 assets valued using significant unobservable inputs, and 89% of the investment portfolio fair value represented restricted securities. Fair values may differ materially from amounts ultimately realized. The five largest portfolio exposures represented approximately 47% of total investment fair value, led by Tilson at 15%, Seybert’s at 9%, SciAps at 8%, ITA at 8% and DSD at 7%.
Other risks include concentration in private lower middle-market companies, credit and default risk, interest-rate risk on variable-rate debt, limited liquidity of restricted investments, dependence on portfolio company performance, and potential conflicts arising from external management and affiliate co-investments.
GAAP required a $2.46 million capital gains incentive fee accrual at March 31, 2023 based on net portfolio appreciation, although no corresponding capital gains fee was currently payable under the investment management agreement. The accrual could change with subsequent realized gains, losses or unrealized depreciation.
On April 19, 2023, the Board approved a share repurchase plan of up to $1.5 million at prices no greater than NAV, expiring April 19, 2024. No shares were repurchased during the quarter. Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether ACV Auctions’ valuation gains and other unrealized appreciation persist or reverse.
- The sustainability and cash collectability of interest, dividend and PIK income, particularly from concentrated private investments.
- Credit-facility borrowing-base availability, variable interest expense and continued compliance with all financial covenants.
- The timing and recoverability of portfolio company repayments, exits and realizations, including investments with near-term maturities or modified payment terms.
- The potential future cash impact of the $2.46 million GAAP capital gains incentive fee accrual.
- Whether the $0.25 per-share subsequent dividend is supported by taxable income and recurring cash generation.
- The effect of the high proportion of restricted and Level 3 investments on NAV and liquidity.