Business Context and Reporting Period
Company: Rand Capital Corporation (RAND)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2017
Business Overview: Rand Capital is an internally managed Business Development Company (BDC) and Small Business Investment Company (SBIC) licensed by the U.S. Small Business Administration (SBA). The company invests in privately-held, early-stage, and emerging growth businesses, primarily through its subsidiary, Rand Capital SBIC, Inc. As of June 30, 2017, the company held 6,321,988 shares of common stock outstanding.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2017 | Six Months Ended June 30, 2016 |
|---|---|---|
| Total Investment Income | $677,776 | $414,637 |
| Total Operating Expenses | $1,123,572 | $2,428,752 |
| Net Investment Loss | $(273,885) | $(1,236,524) |
| Net Realized Gain on Investments | $0 | $8,366,972 |
| Net Change in Unrealized Depreciation | $(720,933) | $(7,546,060) |
| Net Decrease in Net Assets from Operations | $(994,818) | $(415,612) |
| Net Assets (End of Period) | $31,634,545 | $33,438,048 |
| Net Asset Value (NAV) per Share | $5.00 | $5.28 (approx. based on prior period) |
| Cash and Cash Equivalents | $6,590,994 | $14,376,673 (End of period 2016) |
| SBA Debentures (Gross) | $8,000,000 | $8,000,000 |
Material Changes vs. Prior Period
- Operating Expenses: Total operating expenses decreased by 53.7% to $1.12 million from $2.43 million in the prior year. This significant reduction was primarily driven by the absence of a $1.41 million profit-sharing bonus expense recorded in 2016 related to the sale of Gemcor II, LLC assets. Conversely, professional fees increased due to costs associated with forming a new SBIC fund.
- Investment Income: Total investment income increased by 63.5% to $677,776. Interest income from portfolio companies rose 74.0% due to new debt instruments originated in 2016 and 2017 (e.g., Genicon, eHealth).
- Realized Gains: The company reported no realized gains in the first half of 2017, compared to a $13.3 million realized gain in the same period of 2016, which was largely attributable to the sale of Gemcor II, LLC assets.
- Unrealized Depreciation: Net unrealized depreciation decreased significantly to $720,933 from $7.55 million in the prior year. The 2016 figure included a $11.4 million reclassification of Gemcor II, LLC to realized gain. In 2017, valuation decreases were noted for City Dining Cards (Loupe), Teleservices Solutions, SciAps, and Mercantile Adjustment Bureau, partially offset by increases in ACV Auctions and Athenex.
- Liquidity: Cash balances declined from $12.3 million at year-end 2016 to $6.6 million at June 30, 2017, reflecting new investments totaling $3.8 million and the funding of a new SBIC subsidiary.
Guidance, Outlook, and Risks
- New SBIC Fund: The company received SBA authorization to form a second SBIC subsidiary. In April 2017, Rand capitalized this new fund with $7.5 million of cash and expects to leverage an additional $15 million from the SBA, creating a $22.5 million fund. Investing has commenced under pre-licensing protocols.
- Portfolio Strategy: Management continues to focus on privately-held, early-stage businesses. The portfolio is heavily weighted toward Healthcare (41.1%), Software (23.8%), and Manufacturing (20.6%).
- Valuation Risks: Approximately 98% of the investment portfolio is classified as Level 3 assets (unobservable inputs), meaning valuations are determined by management based on financial performance, liquidation preferences, and recent financing rounds rather than active market prices.
- Debt Maturity: The company holds $8 million in SBA debentures maturing between 2022 and 2025. Management anticipates using cash on hand and proceeds from portfolio exits to meet future obligations.
- Share Repurchase: The company has an authorization to repurchase up to 1,000,000 shares (458,954 remaining as of June 30, 2017) at prices not exceeding NAV, though no shares were repurchased in the first half of 2017.
Investor Verification Checklist
- Profit Sharing Plan: Verify the calculation of the 12% profit-sharing obligation on net realized capital gains and confirm no accruals were made for the current period due to lack of realized gains.
- Level 3 Valuations: Review the specific unobservable inputs (e.g., EBITDA multiples, revenue multiples) used to value the $29.6 million in Level 3 assets, particularly for companies with recent valuation write-downs (Loupe, Teleservices, SciAps).
- New SBIC Licensing: Monitor the status of the SBA application for the second SBIC fund to confirm the expected $15 million leverage commitment.
- Cash Burn Rate: Assess the sustainability of the $6.6 million cash balance against operating expenses and new investment commitments, given the absence of realized gains in the current period.
- Non-Accrual Status: Review the status of loans on non-accrual status (G-TEC Natural Gas Systems, First Wave Products Group, and portion of Mercantile Adjustment Bureau) for potential future impairment.