Business Context and Reporting Period
Company: Rand Capital Corporation (RAND)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2016
Business Overview: Rand Capital is an internally managed, closed-end, diversified management investment company operating as a Business Development Company (BDC). The majority of its investments are made through its wholly-owned subsidiary, Rand Capital SBIC, Inc., a Small Business Investment Company (SBIC) licensed by the U.S. Small Business Administration (SBA). The company invests in and lends to small and medium-sized companies, primarily in the United States.
Key Financial Metrics
| Metric | 9 Months Ended Sep 30, 2016 | 9 Months Ended Sep 30, 2015 |
|---|---|---|
| Total Investment Income | $730,523 | $2,078,550 |
| Total Operating Expenses | $2,915,300 | $1,221,995 |
| Net Investment (Loss) Income | ($1,351,252) | $594,270 |
| Net Realized Gain on Investments | $9,252,610 | $173,183 |
| Net Unrealized Depreciation | ($8,888,270) | ($158,312) |
| Net (Decrease) Increase in Net Assets from Operations | ($986,912) | $609,141 |
| Cash and Cash Equivalents (End of Period) | $11,708,164 | $4,763,631 |
| Total Assets | $43,293,415 | $44,562,060 |
| Total Liabilities | $10,448,281 | $10,708,400 |
| Net Assets (Stockholders' Equity) | $32,845,134 | $32,962,582 |
| Net Asset Value (NAV) per Share | $5.20 | $5.35 |
Debt: The company holds $8,000,000 in SBA-guaranteed debentures (net of issuance costs: $7,820,923). The weighted average interest rate is 3.54%, with maturities ranging from 2022 to 2025.
Material Changes vs. Prior Period
- Portfolio Composition: Total investments at fair value decreased by 25.1% to $27.6 million from $36.8 million. This decline is primarily due to the sale of assets by portfolio company Gemcor II, LLC in March 2016, which removed a significant portion of the portfolio.
- Liquidity: Cash on hand increased significantly to $11.7 million (36% of net assets) from $5.8 million (17% of net assets) at year-end 2015, driven by proceeds from the Gemcor asset sale.
- Investment Income: Total investment income dropped 64.9% to $730,523. Dividend and other investment income fell 89.7% to $152,818, largely due to the cessation of distributions from Gemcor following its asset sale.
- Operating Expenses: Expenses surged 138.6% to $2.9 million. This increase was driven by a $1.41 million accrual for profit sharing and bonuses related to the realized gain from the Gemcor sale, as well as an 87% increase in professional fees related to strategic planning.
- Valuation Adjustments: The company recorded a net unrealized depreciation of $14.1 million before taxes. This includes a $12.8 million reclassification of Gemcor to realized gain, and write-downs on investments in Statisfy, Inc. ($650,000), Teleservices Solutions Holdings, LLC ($595,340), and Knoa Software, Inc. ($422,800).
Guidance, Outlook, and Risks
Outlook: Management expects to utilize the approximately $12 million in cash on hand to pursue new investment opportunities and reinvest in existing portfolio companies. The company anticipates that low capital costs and strong business spending will create opportunities for growth. Management intends to continue managing risk by co-investing with other investors where possible.
Profit Sharing: A significant portion of the operating expense increase was due to the accrual of $1,411,659 under the company's Profit Sharing Plan, triggered by the realized capital gains from the Gemcor sale. This amount is payable to executive officers.
Risks and Contingencies:
- Valuation Risk: 100% of the investment portfolio consists of Level 3 assets (restricted securities with no active market). Valuations are determined in good faith by management and may differ significantly from actual liquidation values.
- Concentration Risk: As of September 30, 2016, five portfolio companies (Rheonix, Genicon, Outmatch, SocialFlow, and SciAps) represented 11%, 10%, 8%, 8%, and 7% of the portfolio's fair value, respectively.
- Escrow Receivables: Approximately $1.07 million of proceeds from the Gemcor sale remains in escrow, scheduled for release in 2017, subject to potential claims.
Investor Verification Checklist
- Profit Sharing Accrual: Verify the calculation and timing of the $1.41 million profit sharing expense and its impact on future cash outflows.
- Escrow Release: Monitor the status of the $1.07 million Gemcor escrow receivable scheduled for release in 2017.
- Portfolio Valuations: Review the specific valuation methodologies and unobservable inputs (Level 3) used for the write-downs in Statisfy, Teleservices, and Knoa Software.
- Deployment of Cash: Track the rate at which the $11.7 million cash balance is deployed into new investments to generate yield.
- Interest Accruals: Confirm the status of interest accruals on First Wave Products Group and Mercantile Adjustment Bureau, where accruals were previously ceased.