Rand Capital Corporation (RAND) Q3 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the Rand Capital Corporation Third Quarter 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference in being recorded. I'll now turn the conference over to your host Deborah Pawlowski, Investor Relations for Rand Capital. Thank you, please begin.

Thank you, operator, and good afternoon, everyone. We certainly appreciate your time today for Rand's third quarter 2017 financial results conference call. On the line with me today are Pete Grum, our Chief Executive Officer; and Dan Penberthy, our Executive Vice President and Chief Financial Officer. Pete and Dan will be reviewing the results that were published in the press release distributed this morning. If you don't have that release, it is available on our website at www.randcapital.com. The slides that will accompany our discussions today are also posted on the website. So, if you would look at the slide deck, and turn to Slide 2, we will discuss our Safe Harbor Statement. As you're likely aware, we may make some forward-looking statements during this presentation and also during the question-and-answer session. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ from where we are today. These risks and uncertainties and other factors are provided in the earnings release as well as in other documents filed by the company with Securities and Exchange Commission. These documents can be found on our website, or at www.sec.gov. So, with that, let me first turn it over to Pete who is going to summarize the quarter results and then Dan will go into greater detail regarding the financials.

Good afternoon, everyone. We're happy to have this opportunity to tell you what's been going on with Rand. For those of who you are following along, I'm going to start on Slide 3 which highlights our third quarter. At the end of the current quarter, net asset value or NAV stood at $5.1 per share, a slight increase from the end of last quarter. And Dan will go over all the financial results later in his discussion. This quarter's investment included $100,000 convertible unsecured note funded from our new small business investment company or SBIC fund, under the Small Business Administration pre-licensing the approval protocol. I'll pitch on the status of our relationship with the SBA in a moment. The investor within our company called Centivo which is development phased tech enabled the house pollution company, they're really interesting idea that helps self-insured employers and their employees save money and have a better experience. To do this, they are developing technology and administration services, but they intended to provide the self-insured companies. That in the last quarter and over the last year, we've filed our application through SAB is our SBIC with a small business administration. We're also to receive approval for $15 million of debenture leverage later this year. As previously noted, this will be in addition to the current $8 million of debentures that we currently have with the SBA. We intend to use these funds to further our growth strategy. Also want to note that board recently extended approval of our share repurchase program through October 26, 2018. We have approximately 460,000 shares available for repurchase under the program. This is really dependent on the delivery of excess cash at our corporate level, funds that are within our SBIC are not available for the share repurchase. We can all now turn to Slide 4. We're going to take this opportunity to feature some of the companies within our portfolio to give you an insight into them. We plan to do this on some of our portfolio companies receive each quarter to give you a better sense of what's going on with our portfolio. Let's start with one of our new investment which is PostProcess. This Buffalo based company has a unique product offering and a fast-growing market and that's 3D printing. They've developed efficient and comprehensive solutions for the prices as are required after the instrument or the device has been printed on the product. They include software, hardware and proprietary chemistry. They recently announced a new program, it's the rows only two in one machine that accomplishes two of the automated processes in onetime. It finished as the surface of the 3D printed product and removes the structural supports that are required in the 3D printing process. Last year, PostProcess had three employees and they've now grown to 26. They have big growth plans to support this rapidly expanding market. We first invented them last year with a convertible note valued at 300,000. Next is Kim CabatIthaca, New York, they provide a user friendly of secure social platform that connects dollars of volunteers and nonprofit organization. A significant driver their growth is what they call giving days which are designated days organized by nonprofit encourage donation all single day. 2017 is proven to be a break-out year for this company. They were 8,000 nonprofits registered to raise money on the platform. The revenue on transaction volume is up considerably. Revenues on pace to grow more than 600% in 2017 and transaction volume is expected to be a more than 900% this year. We started investing with a GiveGab team in 2013 and currently have approximately 7% ownership stake value of $424,000. The third company in our portfolio that I'm going to talk about is Knoa, a New York City company and they provide solutions to optimize and create efficiencies for the end users of highly integrated enterprise resource planning or ERP system such as SAP. Earlier, they launched a new version of their SAP user experience management application that provide support for the SAP platforms, SuccessFactors and HCM Suite. Knoa's user experience is reduces the cost and risk of system conversion projects by providing visibility into user behavior and effective use of SAP software. They also provide user analytics for a broader range of operating environments, including mobile devices, browser configurations and business applications. We first invest in Knoa in 2012, currently on about approximately 7% and average by our equity value of just under 500,000. Slide 5 is an interesting way to look at our portfolio and that's where we segmented by revenue stage. We have characterized all the companies within our portfolio based on their current revenue level from startup way to last to expansion then to what we call high traction on the right. Since last quarter few other ways were in the startup of stage have moved into the initial revenue stage. They have been ACV Auction, OnCore and GiveGab that I just spoke to you about. Our new investment this quarter Centivo is in the start of category as it's PostProcess that I just featured. Finally, the third company that I featured for you is Knoa we just categorized an expansion phase with revenue between $5 million and $20 million. As I mentioned previously, our company has progressed to the right, they made start to develop exit plants from our portfolio company. Fortunately, impossible to predict how quickly or slowly these transactions take and they're all dependent on the market transaction. Then we turn to Slide 6. If you have followed us, you know how diverse our portfolio and the breakdown by industry category doesn't change dramatically over time. Consistent with our strategy we are a diversified company, we invest in almost all industries with the exception of real estate, retail and financial services. Everyone gets a chance to turn to Slide 7. We have dissected our portfolio in the capital characteristics, debt or equity is the two basic choices. Our strategy has always focused on capital appreciation to grow our net asset value. Accordingly, our portfolio has been more heavily weighted towards equity as opposed to debt instrument. However, we may adjust our near-term investment objective depending on the mix of the cash flow stream within our portfolio. Over the past year or so, our mix has been on focus on building the best on income so that we develop a cash flow balance to cover our expenses. Given the investments we've made over that time, we are pleased to report that we are nearing operating cash breakeven. I give everyone chance to turn to Slide 8. This is a snapshot of our top five investments in our portfolio based on the market value as of September 30. And this top five is relatively unchanged from last quarter. Our portfolio is valued at $31 million at the end of September and includes 30 active companies. The value of our investment in the top five comprised about half of our portfolio value. And as you can see here, they're weighted towards healthcare and software industries. Given their significance on our portfolio, I once again summarize them for you. Our top investment is a GENICON net value to $4 million. This firm is based on Orlando, Florida and they design, produce and distribute patented surgical instrumentation. We invented them beginning of 2015. The second large investments on our portfolio is eHealth and its value to $3.5 million. Based on Rochester in New York they provide a proprietary electronic platform to aggregate patient clinical records and images to support medical referrals. Our initial investment into eHealth is in 2016. And Rheonix follows closely behind with our investment of $2.9 million. This Ithaca, New York company develops fully automated molecular assays for use in research labs for both medical as well as food and beverage applications. We started investing with this team in 2009. Four is Outmatch, with our investments valued at 2.1 million. They are in the business that helping companies be more productive, providing tools to facilitate hiring people who are the right match for the job. Based on Dallas, Texas, Outmatch provides workplace analytics driven from candidate assessments which have been proven to predict employee's performance. We've started investing them in 2010. Rounding up the top five is SocialFlow with our investment at 2.1 million. SocialFlow handles online, customize advertising for electronic publishers, including Facebook, Twitter and LinkedIn. They also provide data driven solutions for social media marketing campaign. Many major publishers including and also give National Geographic, Time Inc., Conde Nast and Bloomberg utilize their products. We started investing them in 2013. Now that, I'd like to turn it over to Dan Penberthy, our Executive Vice President and Chief Financial Officer to cover the financial results.

Thanks Pete, and good afternoon, everyone. If you could please turn to Slide 10 and I'll start with net asset value per share or NAV. As Pete mentioned, we did finish the quarter with a net asset value at $5.01 per share. As you can see NAV increased a penny per share over the trailing quarter as our investment income has been growing and we are nearing operating cash breakeven. Additionally, during the third quarter of 2017, we recorded favorable market value appreciation which I'll discuss in more detail on the next slide. The reduction in NAV since the December 2015 peak is the natural progression as the companies is our portfolio both succeed and struggle in their respective markets. The end of 2015 was the timing of our last exit which was Gemcor. We realized a sizable gain on that exit which helps us monetize our unrealized appreciation and help drive net asset value. Gemcor was also a strong cash flow provider for us. And since then we have been focused on rebuilding our portfolio to include more cash flow generating assets. These investments are helping us to more fully cover our expenses on a quarterly basis overtime. Additionally, exits do result in Rand realizing in investments full potential, but we do know from experience that we can't crush exits nor predict their timing. Please turn to Slide 11. Here I've summarized our operating performance for the third quarter of 2017 and 2016, as well as the comparable year-to-date period. As we've previously mentioned, in the near-term, we've been investing in more financial instruments which increase our interest income and you can see the results. Our third quarter investment income of $397,000 is up 26% over last year and our year-to-date investment income of $1.75 million is up 47%. Additionally, Q3 expenses of $439,000 are 10% below last year. Year-to-date total expenses were 46% lower than last year. Last year's expenses included Gemcor exit related transaction expense, certain taxes and incentive compensation costs. Regarding the realized and unrealized changes in our investments, these are in accordance with our valuation policies. We recorded $83,000 net of tax unrealized gain on our investment in Athenex this quarter. As we reported last quarter, Athenex did go public in June of this year, but our shares had been restricted from trading and we are valued at a discount. The market value of these shares increased during the third quarter, and this result in an unrealized depreciation that we reported. Our shares are now valued at a 10% discount due to the restrictions as of September 30. However, these restrictions have - since then listed during the fourth quarter and we do intent to liquate our position during this fourth quarter of 2017. Last year third quarter included some unrealized losses amounting to $457,000 net of tax. These reflect fluctuation in portfolio company operating condition. Looking at this year's year-to-date net unrealized loss on investment up $638,000, we identified that we had recorded some unrealized losses during the first half year, also due to portfolio value fluctuations. The 2016 year-to-date realized and unrealized gain on investments of $364,000 was primarily driven by finalization of our accounting for the Gemcor exit. These factors impacted our bottom line comparability. The 2017 third quarter results in a net increase, net asset from operations, while the 2016 third quarter in both year-to-date reflected a decrease. The respective per share amount are also shown here. Please turn to Slide 12. Our balance sheet continued to remain strong. On a per share basis, we have $1.1 of cash, $4.86 of portfolio investment at the end of September. Our portfolio growth has benefited from and has been personally funded by our past SBA leverage for which we have $1.27 per share remaining due to the SBA as of the end of the third quarter. We also have $0.41 per share of other net asset and liabilities. This all adds up to our net asset value or NAV per share of $5.1. With that I'll turn it back to Pete.

Thanks, Dan. In closing I am hoping that you can see that there's a lot of excitement going on with Rand and its portfolio of companies. We as a management team are working hard to take the company to the next level by driving our growth strategy. We hope to soon have this additional SBA capital to put to work and we have a wide variety of opportunities in our pipeline So, with that let me open up the line for any questions.

Thank you. Now, we'll be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Sam Rebotsky with SER Asset Management. Please go ahead.

Yeah. Good afternoon, Pete and Dan.

Hi, Sam. How are you?

Good, good. So, let me - do we expect to have any exit during the end of the current year besides be authentic?

We can't predict those with any degree of regularity. We have some that are talking with investment bankers. We do intend to liquidate our position in Athenex. And I guess without going into insider information that's where I'll leave it.

Okay. And now you've indicated that before the end of this quarter you expect to get the loan, is that like a 100% that is going - that's happening?

No, let me make sure that I'm clear. What we are trying to get is a commitment that would allow to borrow [Technical Difficulty] people from the SBA, we met with them couple of weeks ago Dan and I at a trade show and the guy who is running it went to great link, they describe how busy they were so the SBA is a big part of the recovery of Puerto Rico and then places they got hit by hurricane. But we've been in that process for some time and I think we kept by the end of the year I will know and answer one way or the other, but we would think hopefully in the next month or so, we will get a positive answer and that's what we put all our effort into. That's big part of our growth strategy.

Okay, okay. Now as far is your portfolio you spoke of the positives there, what about the stocks that you have losses on, for example, what your expectation City Dining Cards, the Teleservices that to you've written down to zero, are there any expectations of realizing any kind of value add of some of these investments or what is your expectation?

As the time and according with the valuation policy, our expected value is zero at that time and that's reflected in all of our valuation. There is some possibility that they may come back but at this point we're not predicting any of them.

Do you work with them to try to find a buyer or to find a way if there is a value to sort of do something with some of these investments?

We do, and we are in contact with them and without that going into specific, our companies that are still working and in robust high paid setters or Teleservices is a fairly large company. We just believe now is the time that where we are in the capital structure. That at this point if there was a liquidation we receive any time. Now that can't change over time as companies grow or not grow and we continue evaluate them every quarter. But at this point, our expected proceeds are if that zero, it's zero.

Okay. One final question right now. With the stock trading at a 40% discount to your stated valuation even though the other things are written down and with a $1 cash. It would appear the market is not giving you sufficient respect and possibly even though you may find a need for cash, it may be a very good investment to buy your own shares with the authorization that you have? What do you think of that?

I've been able to buy shares back dependent on cash and where we have our cash and cash that is in subsidiary, it is only for SBA fee investment and those tend to be private companies that are allowed. The cash that we have of the parent bank for you are to buy shares back. At this point, we have limited cash available for share repurchase. Conceptually, I agree with you 100% and academically I agree with you 100%. At this point, I would tell you from my perspective, we don't have excess cash to buy shares back. We can get the company to where do have excess cash, its first on our list.

Okay. Then what I would suggest try to in other words hold back on some investments, try to create cash at the subsidiary as long as the stock trades at this level to use some of this cash to buy some shares in the open market that way you could achieve that and improve. And give basically a dividend to shareholders with the 40% discount. That would be my judgment at this point.

I want to make sure I am clear the money that is in the subsidiary is not available to purchase shares back. It's only at the parent.

What do you need in other words you have no money at the parent, what do you need to get money at the parent if you could get a $1 million at the parent, you then could buy some shares. What do you need to get money at the parent?

We can take money from the subsidiary when we have enough some positive network and it's an SBA regulation and protocol that we follow. I understand what you're saying, and I understand that buying shares back and I wish we had cash at the parent do that. But at this point, we don't.

Okay. All right good luck.

Thank you, Sam. We always appreciate your support.

Okay. Thank you.

Thank you. [Operator Instructions] Our next question comes from the line of Bill McClain with Circle and Advisors [ph]. Please proceed.

Hey gentlemen, how you doing?

Hi Bill.

Good. There is a parent company have the ability given how low borrowing costs are now to borrow money and repurchase shares?

It maybe I have to go on to the regulation about BDC leverage amount, but I don't think it accounts the SBA. Leverage it as part of thing. We have now looked at that and we have just spent time trying to figure out who would borrow, who would lend those money.

Let's say given I don't know how much FNX would be free to use as collateral and so forth. But it just seems to me with the success you've had investing greatly exceeds today's cost of money and it might be in the shareholders' best interest to borrow money if you could to repurchase shares, I had roughly 40% discount to their net asset value. So, I would just suggest to take a look at that.

Okay. Taking notes right now. For your information there's very few assets that are at the parent level. And the once that are in the subsidiary are assets that with SBA as a first lien on that.

Great. Well I need a little bit you could find it might make some sense I mean if I was trade at a 10% or 15% discount like most let's say closed end funds or your peers which they are only a few that would be one thing by trading at this size of discount, I think extraordinary opportunities should be addressed with extraordinary action. I guess it's a best way to put it. Anyway, just a thought through something listen you guys are smart capital allocators, they are smart investors and you know a lot of smart folks maybe somebody is out there to help with that understand the transaction.

Okay. Thank you.

Sure

Our next question comes from the line of Sam Rebotsky with SER Asset Management. Please proceed.

Just as long as those lines to the extent that these appendix is sold, and it becomes cash does is that automatically go to the SBA?

Yeah, that's an asset of the - of our first SBA fee funds and that's for it, if there is only we have a gas pipeline and few other smaller investments that are at a parent and those were done 12, 14 years ago. But as FNX is owned by SBA B1.

So, the 7.8 million is balanced to the SBA, in other words you have to get it down since zero to be able to use the money. I'm trying to understand, what percentage of your assets have to hold up to against that liability?

Well, they are all owned by the SBIC. Now we have the ability to upstream cash under certain circumstances where as we have enough of positive network and there is some roles that are part of the SBA regulation that dictate that. Our SBIC II was created because we thought jump forum, we took cash out SBIC I up to the parent and then back down to fund the SBIC II. But the ability to money out, is created by having positive investing results exits.

So, I'm trying to understand what dollar amount has to be held decide - the one you've drawn out from the Gemcor for the next one. That's also going to be - you're not going to have flexibility on this money to buy any stock, when you didn't buy stock before you had flexibility, or I don't understand?

And I wish that there was a very clear answer, but we had money at a parent that had come from various things. When we do have an ability to take money out of parent we tend to do that, and it is not just one formula, but it primarily we have cash proceeds from a cash flow exit, we can look at taking those out of the subsidiary into the parents.

Well I would think you also you want to work with the SBIC and try to figure out and carve some money out for this, a limited amount and I think you have plenty of coverage with all your assets and with the stocks selling it at the discount, it would be helpful. And I think the objectivity of these stock traded higher, you have more flexibility in raising more funds. So, it defeats the purpose you're in essence of bank without any abilities. And anyhow that's my thought at this point relative that utilization of your cash. Hope you could work it out. Thank you.

Thank you. We have no further question in queue at this time. I would like to hand the floor back over to management for closing remarks.

Thank you. We enjoyed talking with you today and talking about this quarter. For those of you feel free to call us between quarters at any time but we look forward to talking to you next quarter.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.