Business Context and Reporting Period
Company: Rand Capital Corporation (Rand)
Reporting Period: Quarterly period ended September 30, 2014 (Form 10-Q)
Business Overview: Rand is a publicly traded, closed-end, diversified management company operating as a Business Development Company (BDC) under the Investment Company Act of 1940. It operates through a wholly-owned subsidiary, Rand Capital SBIC, Inc., which is licensed by the U.S. Small Business Administration (SBA). The company invests in debt and equity securities of small to medium-sized U.S. companies, with a portfolio heavily weighted toward manufacturing (58.8%) and software (17.5%).
Key Financial Metrics
| Metric | 9 Months Ended Sep 30, 2014 | 9 Months Ended Sep 30, 2013 |
|---|---|---|
| Total Investment Income | $1,758,855 | $2,012,826 |
| Total Expenses | $1,087,895 | $968,634 |
| Net Investment Gain | $578,879 | $686,752 |
| Net Realized Gain (Loss) | ($701,202) | $487,467 |
| Net Unrealized Appreciation (Increase) | $695,928 | ($1,340,504) |
| Net Increase in Net Assets from Operations | $573,605 | ($166,285) |
| Cash and Cash Equivalents | $4,647,673 | $3,946,504 |
| Total Assets | $37,773,720 | $39,750,370 |
| Net Assets (Stockholders' Equity) | $28,554,885 | $25,069,474 |
| Net Asset Value (NAV) per Share | $4.47 | $3.85 (End of 2013: $4.38) |
| SBA Debentures (Debt) | $7,000,000 | $7,000,000 |
Material Changes vs. Prior Period
- Investment Portfolio Growth: Total investments at fair value increased by 15.5% to $32.75 million, driven by new investments of $5.13 million. The portfolio now represents 115% of net assets, up from 101% in the prior year.
- Realized Losses: The company reported a net realized loss of $701,202 for the nine months ended September 30, 2014, compared to a gain of $487,467 in the prior year. This was primarily due to a $778,253 realized loss on the sale of EmergingMed.com, Inc. and a $476,334 adjustment to the Liazon Corporation escrow receivable, partially offset by a $160,634 gain on the sale of QuaDPharma, LLC.
- Unrealized Appreciation: Net unrealized appreciation increased by $695,928, a significant improvement from the $1.34 million decrease in the prior year. Key drivers included a $1.2 million revaluation of BinOptics Corporation and the reclassification of EmergingMed to a realized loss.
- Expense Increase: Total operating expenses rose 12.3% to $1.09 million. This increase was largely due to higher SBA interest expense ($65,930 increase) resulting from increased leverage, and a reversal of a bad debt recovery from the prior year. These were partially offset by a $45,635 reduction in profit sharing expenses.
- Liquidity: Cash balances decreased from $9.76 million at year-end 2013 to $4.65 million at September 30, 2014, reflecting active deployment of capital into new portfolio companies.
Guidance, Outlook, and Risks
- Outlook: Management anticipates that most future investments will be originated through the SBIC subsidiary. They expect current cash balances, combined with $1 million of available SBA leverage and portfolio income, to be sufficient to meet cash needs for the next twelve months.
- Stock Repurchase Program: The company extended its stock buyback program through October 23, 2015, authorizing the purchase of up to 1,000,000 shares at prices no greater than the current net asset value. During the quarter, 28,471 shares were repurchased at an average price of $3.09.
- Risks:
- Valuation Risk: 98% of the portfolio consists of Level 3 assets (unobservable inputs), meaning valuations are determined by management and may differ significantly from actual liquidation values.
- Concentration Risk: Five portfolio companies (Gemcor II, BinOptics, Rheonix, Microcision, and Carolina Skiff) represented 57% of the fair value of the investment portfolio.
- Market Fluctuations: Quarterly results may fluctuate due to the timing of realized/unrealized gains, portfolio company performance, and general economic conditions.
Investor Verification Checklist
- Valuation Methodology: Verify the assumptions used for Level 3 asset valuations, particularly for BinOptics (upward revaluation) and Mezmeriz (downward revaluation).
- Escrow Receivables: Monitor the collection of escrow amounts from QuaDPharma (expected Q4 2014) and Ultra-Scan (expected 2015), as these impact realized gains.
- Portfolio Concentration: Assess the financial health of the top five holdings, which comprise the majority of the portfolio's value.
- Debt Service: Confirm the company's ability to service $7 million in SBA debentures maturing between 2022 and 2024, given the reduction in cash reserves.
- Stock Buyback Execution: Track the execution of the extended stock repurchase program and its impact on shares outstanding and NAV per share.