Rand Capital Corporation 10-Q Summary
Business Context and Reporting Period
Rand Capital Corporation is an externally managed, non-diversified business development company and regulated investment company focused on higher-yielding debt and related equity investments in lower middle-market companies. This Form 10-Q covers the quarter and nine months ended September 30, 2023, and was filed November 6, 2023. East owned approximately 64% of outstanding common stock at period-end.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Total investment income | $1.74 million, up 12.0% | $5.41 million, up 34.1% |
| Net investment income | $0.80 million, down 20.9% | $2.01 million, down 37.3% |
| Net realized gain/(loss) | $(2.80) million | $0.73 million after tax |
| Net unrealized appreciation | $2.60 million | $2.70 million after tax |
| Net increase in net assets from operations | $0.60 million, or $0.23 per share | $5.44 million, or $2.11 per share |
- Net investment income represented approximately 45.9% of quarterly investment income and 37.1% of nine-month investment income, compared with approximately 65.0% and 79.3%, respectively, in the prior comparable periods.
- Interest from portfolio companies increased 39.6% in the quarter and 42.7% year to date, driven by new interest-bearing investments. Dividend and other investment income declined 63.4% in the quarter and 9.8% year to date.
- Total assets were $79.0 million at September 30, 2023, compared with $63.5 million at December 31, 2022. Investments at fair value were $74.7 million, up 21.4%, and net assets were $61.4 million, up 6.3%.
- Net asset value was $23.77 per share versus $22.36 at year-end 2022. The reported market price at September 30 was $13.17 per share. Nine-month total return was 4.13% based on market value and 9.42% based on NAV.
- Cash was $3.48 million, compared with $1.37 million at year-end 2022. Nine-month operating cash flow was $(7.28) million, principally reflecting $18.06 million of portfolio investments, while financing activities provided $9.39 million.
- The company declared quarterly dividends of $0.20 per share for the first quarter and $0.25 per share for each of the second and third quarters, totaling $0.70 per share through September 30.
Debt and Liquidity
- Borrowings under the senior secured revolving credit facility were $13.75 million, compared with $2.55 million at December 31, 2022. The facility has a $25 million principal limit and matures June 27, 2027.
- Unused borrowing capacity under the borrowing-base formula was $11.25 million at September 30, 2023. The applicable interest rate was 8.81%, and the nine-month weighted average rate was 8.68%.
- The debt/equity ratio was 22.41% at September 30, 2023, versus no debt reported for the comparable 2022 period. Management stated that the company complied with its tangible net worth, asset coverage, and interest coverage covenants.
- All portfolio assets are pledged as collateral. A 1% increase in the credit facility rate would reduce annualized net investment income by approximately $137,500 based on period-end borrowings.
Material Changes Versus Prior Comparable Period
- New investments totaled $18.06 million, including investments in Inter-National Electronic Alloys, All About People, First Coast Mulch, Pressure Pro, BMP Food Service Supply, ITA, and Tilson.
- Interest income grew substantially as the portfolio expanded, but higher interest expense, capital gains incentive fee expense, and administrative fees reduced net investment income. Nine-month expenses increased 323.0% to $3.16 million.
- The quarter included a $2.80 million realized loss on liquidation of Rheonix, offset by $2.60 million of unrealized appreciation, including a $2.80 million reversal of prior Rheonix unrealized depreciation.
- Year-to-date realized gains included a $2.54 million gain on DSD and a $1.72 million gain on ACV Auctions, partly offset by losses on Rheonix and Somerset.
- Portfolio cost increased 18.9% to $66.3 million, while net unrealized appreciation increased 45.5% to $8.4 million. Affiliate investments represented 83.3% of net assets, compared with 66.3% at year-end 2022.
Guidance, Outlook, Risks, and Unusual Items
- The filing provides no formal earnings or investment guidance. Management expects to fund future investments through operating cash flow, sales of liquid public investments, and additional credit facility borrowings, and expects to continue exiting investments; the timing of private investment realizations is difficult to project.
- Management believes Rand complied with RIC requirements as of September 30, 2023. Maintaining RIC status requires compliance with income, asset diversification, and distribution requirements.
- A $2.91 million capital gains incentive fee liability was accrued under GAAP based on net portfolio appreciation, although no capital gains fee was currently payable under the investment management agreement at September 30. The payable amount can change with subsequent realized and unrealized gains or losses.
- The company recorded a partial valuation allowance of approximately $129,000 against federal deferred tax assets and recognized $24,543 of federal excise tax expense year to date.
- Approximately 90% of investments were Level 3 assets valued using significant unobservable inputs, and approximately 90% of the portfolio’s fair value consisted of restricted securities. Actual realizable values may differ materially from recorded fair values.
- Portfolio concentration is significant: the five largest holdings represented approximately 42% of total investment fair value, with Tilson at 14%, Seybert’s at 8%, SciAps and BMP Food Service Supply at 7% each, and INEA at 6%.
- Other key risks include portfolio company credit and operating performance, rising borrowing costs, illiquidity of private investments, valuation uncertainty, concentration risk, and potential conflicts associated with co-investments with affiliates.
- The Board approved a $1.5 million share repurchase authorization through April 19, 2024; no shares were repurchased during the quarter or nine-month period.
Important Facts for Investors to Verify
- Whether the higher portfolio interest income can offset rising variable-rate borrowing costs and materially higher operating expenses.
- The collectability and refinancing prospects of investments with near-term maturities, including Filterworks, SciAps, Mattison Avenue, and other portfolio companies.
- The reasonableness of Level 3 valuations, particularly the largest holdings and investments with significant equity appreciation.
- The sustainability and tax characterization of the $0.25-per-share quarterly dividend rate relative to recurring net investment income and realized gains.
- Future changes in the GAAP capital gains incentive fee accrual and the amount ultimately payable to the investment adviser.
- Compliance with the credit facility’s borrowing-base and financial covenants as borrowings and portfolio values change.