Business Context and Reporting Period
Company: Rand Capital Corporation (RAND)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2016
Business Overview: Rand Capital is an internally managed, closed-end, diversified management investment company operating as a Business Development Company (BDC). It invests primarily in small and medium-sized U.S. companies through its wholly-owned subsidiary, Rand Capital SBIC, Inc., which is licensed by the U.S. Small Business Administration (SBA). The company focuses on long-term capital appreciation through a mix of equity, loan, and debenture investments.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2016 | Six Months Ended June 30, 2015 |
|---|---|---|
| Total Investment Income | $414,637 | $1,360,271 |
| Total Operating Expenses | $2,428,752 | $825,277 |
| Net Investment (Loss) Income | ($1,236,524) | $361,007 |
| Net Realized Gain on Investments | $8,366,972 | $173,183 |
| Net Change in Unrealized Appreciation/Depreciation | ($7,546,060) | ($211,546) |
| Net (Decrease) Increase in Net Assets from Operations | ($415,612) | $322,644 |
| Cash and Cash Equivalents | $14,376,673 | $6,520,170 |
| Total Assets | $44,573,181 | $44,562,060 |
| Total Liabilities | $11,135,133 | $10,708,400 |
| Net Assets (Stockholders' Equity) | $33,438,048 | $33,853,660 |
| Net Asset Value (NAV) per Share | $5.28 | $5.35 |
| SBA Debentures (Gross) | $8,000,000 | $8,000,000 |
Material Changes vs. Prior Period
- Portfolio Valuation Shift: Total investments at fair value decreased by 24.9% to $27.7 million from $36.8 million. This was primarily driven by the sale of assets by portfolio company Gemcor II, LLC in March 2016, which resulted in a significant reclassification from unrealized to realized gains.
- Realized Gains: Net realized gains surged to $8.4 million (after tax) compared to $173,000 in the prior year. This was due to a $13.2 million pre-tax realized gain from the Gemcor II, LLC asset sale and a $168,000 gain from an earn-out provision related to a prior sale.
- Unrealized Depreciation: The company recorded a net decrease in unrealized appreciation of $7.5 million. This includes a $11.4 million reclassification of Gemcor II, LLC to realized gains, offset by valuation decreases in Knoa Software ($422,800) and Statisfy, Inc. ($325,000), and an increase in Athenex, Inc. ($69,444).
- Operating Expenses: Expenses increased by 194.3% to $2.4 million. The primary driver was a $1.41 million accrual for profit sharing and bonuses payable to executive officers, triggered by the realized gains from the Gemcor sale. Professional fees also increased by 62% due to strategic planning costs.
- Liquidity: Cash on hand increased significantly to $14.4 million (43% of net assets) from $5.8 million (17% of net assets) at year-end 2015, largely due to proceeds from the Gemcor asset sale.
Guidance, Outlook, and Risks
- Outlook: Management expresses confidence in the ability to grow the portfolio, citing $14.4 million in available cash for new investments. They anticipate participating in financing well-run U.S. businesses given the low cost of capital and strong consumer spending.
- Strategy: The company plans to continue investing with other investors to manage risk and leverage its infrastructure as the portfolio expands. They intend to reinvest in existing portfolio companies demonstrating growth potential.
- Risks:
- 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: Five portfolio companies (Rheonix, Outmatch, Genicon, Social Flow, and SciAps) represented 41% of the fair value of the investment portfolio as of June 30, 2016.
- Regulatory Risk: As a BDC and SBIC, the company is subject to complex regulatory requirements, including SBA oversight and potential automatic events of default.
- Unusual Items: The $1.41 million profit sharing accrual is a non-cash expense for the period but represents a significant liability payable to executives. The company ceased accruing interest on loans to First Wave Products Group, Intrinsiq Materials, and a portion of Mercantile Adjustment Bureau due to collection doubts.
Investor Verification Checklist
- Profit Sharing Liability: Verify the timing and cash impact of the $1.41 million profit sharing and bonus payable accrued in Q2 2016.
- Gemcor II, LLC Escrow: Confirm the status of the $1.41 million escrow receivable remaining from the Gemcor asset sale and the timeline for its release.
- Valuation Methodology: Review the specific unobservable inputs (e.g., EBITDA multiples, revenue multiples) used to value Level 3 assets, particularly for Knoa Software and Statisfy, which saw valuation decreases.
- Interest Accruals: Monitor the status of non-accrual loans (First Wave, Intrinsiq, Mercantile) to assess potential future write-offs or recoveries.
- Cash Deployment: Track the deployment of the $14.4 million cash balance to ensure it generates sufficient yield to cover operating expenses in the absence of the one-time Gemcor dividend.