Rand Capital Corporation (RAND) Q2 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to Rand Capital Corporation Second Quarter 2018 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the conference over to your host Deborah Pawlowski, Investor Relations. Thank you. Please go ahead.

Thanks Rob, and good afternoon, everyone. We certainly appreciate your time today and your interest in Rand Capital. Joining me on the call 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 this morning in the new release. If you don't have that release and the slide that will also accompany today’s discussion they can be found on our website at www.randcapital.com. So, if you’re looking at that slide deck, and turn to Slide 2, I’ll review our Safe Harbor statement. As you are likely aware, we may make some forward-looking statements during this presentation, as well as, 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 the Securities and Exchange Commission. So, you can find these documents either on our website or at sec.gov. So with that, let me turn it over to Pete to begin his discussion. Pete?

Good afternoon, everyone. We’re happy to happy have this opportunity to update you on Rand’s second quarter. I’m going to start with Slide 3. At the end of the quarter, our net asset value or as we call it the NAV was $4.87 per share, down from $4.97 at the end of Q1 2018. From an operating standpoint, our net investment income nearly covered all of our expenses, only short by $0.01 a share. Most of the decline in the NAV was due to unrealized losses we recorded on certain investments, which amounted to $0.09 per share base [ph]. This was from our normal quarterly review we’ve performed based on the operating performances of certain companies. During the first quarter, we invested $775,000 on one of our existing portfolio company KnowledgeVision. These debt instruments will be used to support KnowledgeVision progression of its smart media technology. Our initial investment in KnowledgeVision was back in 2013. Since then they have increased their registered user base ten-fold. As you know, if you’ve been listening in the past couple of years, we have been focused on building our investment income. That resulted in an 18% increase with investment income over the prior year quarter and a 15% increase over the first half of the year. Dan, when he goes through the financial results later in the discussion can highlight that. Finally, I’m pleased that we finally received word from the SBA that our application for $6 million of additional leverage has been verbally approached by the SBA Credit Committee. This has been a long process and we looked forward to finalizing the process. If you now turn to Slide 4, as I do each quarter, I want to take the opportunity to feature some of the companies within our portfolio, as a way to give you more insight to them. Since we invested in them this quarter I’ll start with KnowledgeVision, based in Lincoln, Mass near Boston. KnowledgeVision Systems is a leader in providing smart media creation and hosting technology. For the 300,000 people around the globe, utilize their Knovio video platform, representing more than 2,000 companies. They utilize this platform to create, post, share, organize, collaborate around and measure online media content. Recently, the company won its second [indiscernible] for its video technology. They also recently launched a ground-breaking live multimedia webcasting product called Knovio Live. The next company I’d like to talk is a Centivo, which is headquartered in New York City. The startup and they provide access to high quality healthcare for employers and employees at a sustainable cost benefit to both. Centivo targets the lower healthcare costs trend by providing a solution whereby employers no longer have to apologize for raising the cost and cutting their benefits. Centivo serves as a health plan or a third party administrator for employers and they partner closely with local health plans to enhance our offering. Because of that they are able to provide this type of quality healthcare at a sustainable cost for their business model, which enhances healthcare purchasing and deliver. First, they act as an innovative primary care center network focusing on outcomes. Secondly, they have a dynamic benefit design that rewards members for high value care and adherence. Lastly, they have a state-of-the-art digital technology platform and concierge service support that enables optimal care and exceptional experience. They recently raised $34 million of Series A finding, which we invest in $200,000 and converted 100,000 convertible note during the first quarter. They intend to use this capital to help build their technology and infrastructure, develop local partnerships and support market launch of their solution. Next is Rheonix, which we’ve talked about before, which is based in Ithaca, New York. They are developer of fully automatic, sample to answer molecular testing solutions for used in a variety of innovative application in different industries. They recently announced two innovative products to use on their Encompass Optimum workstation. First, they expanded their Beer SpoilerAlert assay, which detects organisms that may cause spoilage to beer. The innovation resulted in Rheonix becoming the provider of the simplest and most comprehensive Beer Spoiler test in the market. Secondly, they launched their Listeria PatternAlert assay, a breakthrough message for rapidly identify molecular pattern for Listeria strains. This allows the food industry to take rapid action to reduce the possibility of contamination or recall. In addition to these two developments coming to market, they’ve initiated clinical study to gain FDA clearance of its Encompass MDx workstation, and a company Rheonix STI triplex assay for the simultaneous detection of three sexually transmitted infections. So, they are really developing some of the most interesting and broad testing solution. We can now go to Slide 5; it shows a logo of all of our companies in our portfolio categorized by revenue stage. You’ve seen this before with startups on the left, initial revenue, expansion, and then what we call high traction on the right. Regarding the three companies we can feature, you can see Centivo is placed as a category and KnowledgeVision and Rheonix are both in their initial revenue stage. As I mentioned before, as companies progresses arise, they may start to develop extra plans from our portfolio. It's virtually impossible to predict how quickly or slowly these transaction takes as they are all dependent on market conditions. We added Slide 6 for your edification in the last corner. We believe this is an interesting perspective on our portfolio companies. One based on our investment period. As Centivo, last year and we haven't added any new companies to our portfolio since then. The average age of a companies currently in our portfolio is just under five years and our normally investment period is slightly over five years. As you can see the majority of our companies fit or added to five year time horizon. Today 18 companies are there. If we can now turn to Slide 7, it shows a diversity of our portfolio and a breakdown by industry category and this typically doesn't change over time. Consistent with our strategy, we are and/or have been a diversified company. We invest in almost all industries, with the exception to real estate, retail and financial services. Year-over-year comparisons as of June 30, show slight increase in the professional services and software industries and a slight decrease in healthcare. You can now turn to Slide 8. If we dissect our portfolio into capital characteristics with debt and equity have been doing in two major choices, our strategy has always been on capital appreciation to grow our net asset value. Accordingly, our portfolio is more heavily weighted towards equity, as opposed to debt instruments. However, as we just start, investment objectives depending on the mix of cash flow streams within our portfolio. As the slide illustrates in 2015, we have trended to more debt. We focus on building investment income to generate cash flow to cover our expenses. Consequently at the end of this quarter, June 30, nearly 60% of our investments were in equity and about 40% were in debt, unchanged from the end of 2017. We now go to Slide 9, the snapshot of our top five investments in our portfolio based on value at the end of June. Our portfolio was valued at over $32 million and it closed 30 active companies. The value of our top five investments consistently compromises about half of our portfolio. And as you could see they’re weighted towards healthcare. That's either, unchanged from the last quarter, I won't go into this detail again, but I'll give you a quick summary. Our top investment is with GENICON based in Orlando, Florida, they design and produce and distributed patented surgical instrumentation. We've been investing with them since 2015. Second is eHealth, based in Rochester, New York, they have a proprietary electronic platform that aggregates patient clinical record and images to support medical referrals. We've been investing with them since 2016. Rheonix follows, which I described a few minutes ago. We’ve been partnering with them since 2009. Fourth is Tilson, out of Portland, Maine. They construct, deploy and manage cellular fiber optics and wireless information systems. We’ve been investing in them since 2015. Last is OutMatch, they are in the business of helping companies be more productive and providing tools to facilitate hiring the right people for the right job. Based in Dallas, Texas, we’ve started investing in them in 2010. Now 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 11, I'll start with the net asset value per share or NAV. As Pete mentioned, we finished the quarter with net asset value at $4.87 per share. As you can see on the chart, NAV declined $0.10 per share over the trailing quarter. This decrease is attributable primarily to two factors. First, our valuation policy has us review the fair value of our investments each quarter. This sometimes results in unrealized appreciation or depreciation in fair value. This is based on the operating performance trends of the particular portfolio companies. During the quarter, we recognized unrealized depreciation in fair value amounting to about $0.09 per share. The second factor pertains to the fact that our expenses modestly exceeded our investment income this quarter. This impact was about $0.01 per share. Please turn to Slide 12. Here, I’ve summarized our operating performance for the second quarters of 2018 and 2017 and also the first half of both periods. I'll take you through the key line items that are noted here on the scheduled. As we’ve previously mentioned, we have been investing in more income producing instruments over the past few years. This has increased our investment income. You can see the results. Our second quarter investment income of $413,000 is up 18% over last year. On a year-to-date basis investment income is up $98,000 or 14%. Our second quarter expenses of $474,000 are 22% below the same quarter of the prior year. The decrease in expenses was due to lower professional services, partially offset by bad debt expense. For the year, expenses are down $62,000 or 6%. As I mentioned in the last slide, we have recorded unrealized losses on certain investments in accordance with our valuation policy. This included Empire Genomics and SOMS net of an unrealized gain we recorded on GiveGab. The net impact was about $117,000 more in the 2018 second quarter than the same period of last year and $220,000 more in the first half of 2018 than the first half of the prior year. There were no portfolio exits this quarter. To summarize, the 2018 second quarter resulted in a decrease in net assets from operations of $0.10 per share, which was the equivalent decrease in the 2017 second quarter. Now please turn to Slide 13. Our balance sheet continues to remain strong. On a per share basis, we have $0.75 of cash at the end of the quarter. This includes $0.43 per share, which resides at the corporate or parent level and $0.32 per share in our SBIC, which is available for investing. Our portfolio investments are valued at $5.11 per share at the end of the quarter. Our portfolio growth has benefited from and has been personally funded by our past SBA leverage for which we have $1.27 per share due to the SBA as of the end of the quarter. We also have $0.28 per share of other assets, net of liabilities. This all adds up to our net asset value or NAV per share of $4.87. With that, I'll turn it back to Pete.

Thanks, Dan. If you could turn to Slide 15, when we reemphasized our cash along capital priority, our first and foremost priority is to execute on our business plans, which calls for investments to deliver both high returns, as well as, cash for reinvestment. As we consider our various alternatives, we're also focused on structuring our investments to deliver sufficient cash flow to cover our ongoing operating and financing expenses. Now we hope to be able to put an additional $6 million of leverage from the SBA to put to work. Finally, we may also consider returning capital to shareholders on an opportunistic basis when cash flow dictates and on good timing. Before we open our lines for questions, I want to say I hope you can see, lot of excitement going with brand and a lot of underlying value in our portfolio of companies. We as a management team are working hard to take to the next level by driving our growth strategy. With that, we’ll open it up for question.

[Operator Instructions] Our first question comes from Thomas Burns, a Private Investor. Please proceed with your question.

Yes, I'd like to ask, Pete, in light of the fact over the last five years, the way I look at the 10-K, the two top officers have taken out millions of dollars in compensation between bonuses and salaries and the shareholders who actually own the company hadn’t received anything. In fact, be share price today, I don't know if you’ve looked at it, $2.38 which is just about half of what you’re reporting your net asset to be. Given the market is in my opinion shown a big no confidence in management. Have you considered either liquidating the company or doing a large stock buyback to finally give long suffering shareholders some relief other than just earning enough interest income, which you seem to be holding to cover expenses?

Let me take that in pieces, I think it was two years ago at our Annual Meeting, you can stay online or I’d be happy to send it to you and discuss it. We looked at everything from liquidating the company, to going dark, to merging the company with another thing, to becoming a traditional BDC and the alternatives needed to make those happen, cash needed to make those happen. And at the time, the thing that we could control was to continue to grow the company, using the SBA as our partner. It was our analysis and the board’s analysis at the time, liquidating the company did not make any sense. The board continues to look at alternatives. We have had discussions throughout the years with other ways to run the company; have not found that we could execute as a board. But we will continue to look for any other alternatives at the time we can control growing the company through the SBA. If you’re following, and you sound like you do follow the industry, you’ll see that all of the BDCs and specifically, the smaller ones, the stock price has not been a good place to be. I'm sure because you’ve read our Ks and Qs over the time, you also know that both Dan and I have taken those bonuses you’ve referred to and used them to buy substantial parts of our net worth are in the stock of the company, so we’re very aware of what’s happened to the price of the stock.

Can I have a follow-up?

Yeah, yeah, absolutely.

Okay, I appreciate that. Well, I appreciate that answer, but I still don't understand quite honestly, I am familiar with the whole industry and the fact that many of the BDCs still at discounts and they’re more normally in the 15% to 20% range, not 50%. To me, it seems like it’s a bit gift that the market seems to be given management, it's like a no brainer in other words, if I’m making decision, if I had $1 million to invest, and I can either invest it and loan it to somebody at 8% with maybe some warrants or I can buy my own stock back at $0.50 on the $1, I still don't understand management’s reticence, other than it would mean that the company would temporarily decrease in value and the management fee seems to be based upon the size of the company. So, I respect, and obviously, I'd like to hear your answer that one of the reasons that the company seems to be growing by the small business administration is to generate more fee income, rather than really generating returns to shareholders and maximizing shareholder value. Just my thought.

I appreciate your thoughts. We have to take it on offline if you like. There are no really management fees as you referred to it. Or maybe I misunderstood what you’re implying with that. There are no management fees.

Okay, so management would get paid the same whether the company was half the size or double the size?

Exactly. Yes.

Okay.

In our business, we are, what is referred to as internally managed, most of the other BDCs are what's called externally managed and they do have a fee that is based on the size of the company.

Okay. Thank you very much for your answer.

Thank you.

[Operator Instructions] Our next question is from Brett Reiss with Janney Montgomery. Please proceed with your question.

Yeah, hi and if this was asked and answered, I apologize because I’ve had a hop off briefly. Pete, you mentioned in your prepared remarks that you're going to be open to opportunistically sharing capital with shareholders. Can you give us a little bit more color and what you have in mind? And what milestones or triggers would we have to see, to see some of that stuff happen?

If you mean by that, buying back shares, we have done that opportunistically in the past to the point of about 0.5 million shares over the years. And we have done that in situations where we have cash flow from operations, exceeding expenses and I think the board would use that as a trigger again.

Okay, now I’d say about two years ago, you had monetized one of your major investments and there was a huge, as a percentage of the net worth of the company that came in and at that time you did not dividend out or do something with shareholders. What prevented you at that time and if something like that happens in the future, would that be different going forward?

The transaction you are talking about, I believe with GEMCORE [ph] which we didn’t monetize and really didn't change NAV because it went from a realized to an unrealized. And we did not pay a dividend and I frankly, struggle with whether dividend makes any sense because it’s not beneficial to us on tax basis. And frankly, the problem that we have is always we're too small to shrink the company is something that the board has not – has decided not to do and I’m not sure when they would do it. But we do hear from you and we hear from some other people that they would like a dividend because of our structure and kind of an atypical BDC we are taxpaying vehicle. And so paying out a dividend that has no tax advantage and frankly, we end up with a smaller company with the same fixed costs. So, the board when we’ve discussed it and we do discuss at every meaning has not adopted that strategy.

Right, right. You have a new large, deep pocketed, sophisticated shareholder. What do you think brings them to the table? What are they seeing here that the market is not seeing?

You can call them and ask them yourself and we have met with them and as we will meet with all shareholders and talk to them and talk through the portfolio. Show them the information that’s publicly available and what we view them and we’ll see; where it goes from them. We have a very nice and cordial relationship with them and ongoing and I think I would rather have them explain what they saw in the company rather than, me put words into their mouth.

Well, I hope if I call them, they'll take my call.

Okay, it wouldn't surprise me, if they say that they weren't on this call because they have been in previous ones.

Right, right. All right. Thank you. Enjoy the rest of the summer.

Thank you, Brett.

Our next question is from Norman Kadezja, a Private Investor. Please proceed with your question.

Hi, Pete and Dan. We’ve received verbal okays from the SBA credit, when will the cash actually arise or do we have a guess?

Well, the way and they're under a new process and it’s not a process we have gone through. What I believe will happen within the next couple of weeks, we will receive a letter to that effect. And what I believe happens and has happened historically you then pay a fee to in essence reserve that $6 million and then you take it down over time as you have deals that match up with it. So, it's not a one shot deal. There is a reserve part, I believe, you pay 1% upfront and then you take it down over time to fund deals.

Congratulations. Looking at your portfolio of companies; GENICON, eHealth and OutMatch are three of your larger holdings. Will any of those three companies move into the high traction stage net share if you had to guess?

Dan is more involved, but I believe he held probably as the highest revenues, but I’ll let Dan answer that if he heard it, able to do it off the cuff, Dan.

Yeah, I guess, I'm not prepared to answer that given confidentiality issues, but each one of those companies are beginning to make deeper penetrations into their respective fields of expertise, their business segments. And certainly, we remain optimistic that their revenue trends will continue. So, yeah, I think that those companies have as high a potential as any of the other ones in our portfolios to continue their growth trajectories, that's a generic enough and safe enough answer.

Okay. One other remark, I think it was Bill Nixon [ph], whether it was the last call or a couple of calls before, talked about penny stocks and stocks trading at $5 a share. And, I guess, until it really affects me, I didn't pay enough attention because this week I got a letter from Merrill Lynch saying that they have a new policy on low priced over-the-counter stocks, specifically stocks trading below $5 a share. And in most cases they will not allow customers or clients to purchase stocks that are in that $5 or below category. And I know UBS actually put in that same type of rule, I’m not sure exactly it’s the same within the last month or two. So I’d like the companies to be aware that the brokerage community, looks like it's toughening up on over-the-counter stocks, especially those trading over $5 a share, which prevents me from using my knowledge account to buy anymore Rand of these [ph], one of the low prices. So, something you might once again, not be aware of. Thank you so much.

Thank you. We actually did follow-up with Bill after the last call, and from the work we did, we then talk with Bill we weren’t -- Rand was not covered; A, because it was trading on NASDAQ over-the-counter, but we will stay aware. That maybe just the Merrill Lynch, but there is definitely a trend either through indexing and a variety of other things that is not helpful for smaller cap stock.

Ladies and gentlemen, we’ve reached the end of the question-and-answer session. At this time, I'd like to turn the call back to Pete Grum for closing comments.

Thank you. As I’ve said before, and I talked to some of you in between calls, we’re always willing to learn about your concerns and any things we can enlighten you to what we're doing up here and feel free to call in between and we look forward to talking to you another quarter.

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.