Rand Capital Corporation (RAND) Q4 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to Rand Capital Corporation Fourth Quarter and Full Year 2018 Conference Call. 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 introduce your host Deborah Pawlowski, Investor Relations for Rand. Please go ahead.

Thank you, Kevin, and good afternoon, everyone. We certainly appreciate your time today for Rand’s fourth quarter 2018 financial results conference call. On the line with me 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 discussion today are also posted on the website. If you look at the slide deck and turn to Slide 2, we will review our Safe Harbor statement. As you are 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 either on our website or at sec.gov. Before I turn it over to Pete, let me point out that we are restricted in what we can discuss in regard to the proposed strategic investment by East Asset Management into Rand that we announced on Friday, January 25. We anticipate that the preliminary proxy will be filed within the next week or so with the SEC. Until it is filed, we're not really in a position to provide any more details. As a result we would, we will not be taking any questions relating to the transaction on today's call. So to avoid any confrontation regarding this, I ask you to please limit your questions today to Rand performance and current business. With that, let me turn it over to Pete who is going to summarize the highlights for the quarter and the year as well as feature some of our portfolio of companies, and then Dan will follow with more details regarding the financial. Pete?

Thanks, Dan. Good afternoon everyone. Happy to have this opportunity to update you on Rand’s fourth quarter and reflect on the 2018 full year. We’ll start on Slide 3, we can summarize some of the highlights of the fourth quarter. As previously announced it’s a very long process pending over the past two years, in December we announced that we have successfully secured an additional $6 million leverage commitment from the United States Small Business Administration. This demonstrates the SBA’s confidence in Rand and the important role we serve in the funding cycle of young businesses in underserved markets. We have a healthy pipeline of deserving opportunities and have already begun putting some of the capital to work. During the quarter we invested $1.1 million consisting almost all of loan instruments. I'll review these details of those investments with you on the next slide. At the end of the quarter, our net asset value or as we call it NAV increased to $4.99 per share up from $4.84 at the end of September. This increase was driven by net appreciation and certain portfolio investments. Dan during this discussion will provide further details on them. We are pleased to see our investment income up considerably again this quarter growing 76% above last year's fourth quarter. A benefit from a couple of items that don't necessarily recur each quarter including a $60,000 one-time distribution from one portfolio and an increase of $95,000 in the year-end distribution from another which also provide quarterly dividends. Excluding those fourth quarter items, the investment income was up 39% benefiting from our strategy to include more loan and debt instruments in our portfolio. Regarding the balance between investment income and expenses. We finished the quarter close to break even, which is our goal. Subsequent to the end of the quarter on January 25, we announced that East Asset Management or EAM plans to make a $25 million strategic investment in Rand subject to shareholder approval. This will be in return for approximately 8.3 million shares of Rand common stock at a purchase price of $3 per share. On closing the investment will provide additional capital for new investments to facilitate our growth and importantly our investment strategy is expected to support an ongoing and ultimately growing cash dividend. We believe that EAMs investment in Rand is a testament to the company we have created as well as their commitment to Buffalo in Western New York. This proposed strategic investment combined with additional leverage available from the SBA provides us greater liquidity to expand our portfolio, enable a step change in our rate of growth and scale. Let’s all turn to Slide 4, our investing activity was somewhat light in 2018 as we focused on securing the additional SBA capital. And also worked on the potential of the EAM investment. For the year we invested 2.5 million and these investments went into one new portfolio company and eight existing portfolio companies. To recap two investments in the first quarter, one each in the second and third quarter and we finished off the year with five investments in the fourth quarter. I’ll provide you some details of our fourth quarter investments. First we invested in a additional 50,000 in Empire Genomics in the form of promissory note. The second event we invested in Tilson Technology Management for $100,000 in the form of a subordinated promissory note and Series D preferred shares. The third investment in the quarter was $250,000 in the form of a convertible promissory note to another one of our existing portfolio companies Genicon. Our largest investment in the quarter was a $600,000 and a new portfolio company named Tech 2000, Inc. This is one of our feature portfolio companies that I will discuss in more detail later on. Finally, our last investment of the year was in BeetNPath also known under the Grainful brand with the convertible secured note of $122,628. To remind you, our focus over the last couple of years has been the investment vehicles that build the investment income which has been evident in our investment income, results over the past several quarters. In addition to that we realize nonrecurring loan restructuring income interest income in the third quarter and nonrecurring distributions during the fourth quarter as I mentioned a few minutes ago. Excluding those nonrecurring items, our investment income was up 18% over 2017. Dan will cover the financial results later in the discussion. On Slide 5, as I do each quarter, I want to take the opportunity to feature some of the companies within our portfolio and give you more insight into them. I'll start with Tech 2000, the most recent addition to our portfolio. Based near Washington DC Tech 2000, is a Cisco Training Partner that offers information technology training courses and certifications. As I mentioned a moment ago, we recently invested $600,000 during our fourth quarter as part of a broader financing. They work with Fortune 500 companies to develop and deliver a solution for the last 25 years. Tech 2000 currently offers 225 IT training courses with a satisfaction rating of nearly perfect at 4.83 out of 5. They believe they're on the forefront of providing next generation learning and training solutions. Our recent investment at Tech 2000 is expected to support their expansion plans and allow them to leverage ongoing industry advance. We categorize them in our expansion revenue stage, which includes companies with revenues between $5 million and $20 million. If you turn to Slide 6, this is a company I'd like to talk about headquartered in New York City, which has known. They are a leading provider of user management software. They deliver solutions that generate unique insights for the optimization of the end user experience and improved efficiency for enterprise applications including SAP, Oracle, and other. SAP resells Knoa’s solution under the name SAP User Experience Management by Knoa. Companies patent the software, provide CIOs, the business executives the actionable metrics needed to ensure that organizations and end users realize a full valuation of their software investment. As evidence of their market penetration and advancement of cloud technology, in 2018 Knoa’s cloud revenue accelerated by more than 250% and it's total number of cloud customers doubled. Additionally, they closed on their largest cloud deal in their history in 2018. Knoa has found that implementation process for complex system such as SAP can be a very difficult process for companies and with Knoa's help they can ensure more seamless implementation process and realize the full benefits of the enterprise system. Knoa believes that this dedication to customers, is facilitating since its cloud. 2018 ended our investment in Knoa, they valued at approximately 1.2 million. We can now turn to Slide 7. The next company I'd like to discuss is Microcision, which is based in Pennsauken township New Jersey near Philadelphia. Included in our expansion revenues phase category Microcision is a leading manufacturer of medical device, implants and instrumentation. Applications include Small Bone Orthopedics, spine infusion, dental implants, neurology, maxillofacial, hand, wrist, foot, and ankle, and many others. From product development through production Microcision capabilities including complex turning, drilling, cross-drilling, threading and milling of small parts made from all medical grade metals and plastics. Company has invested millions of dollars in state-of-the-art, CNC technology training, information of tracking system, allowing them to produce the most complex configurations in the most cost effective manner. The recent financial results let us increase the fair value of our investment by $610,000 in the fourth quarter. At December 31, 2018 Rand’s investment in Microcision was valued to approximately $2.5 million. Move on to Slide 8, this shows the logos of all the companies in our portfolio categorized by revenue stage. You've seen this before with startups on the left, initial revenue expansion, moving on to high traction on the right. The newest investment in our portfolio, Tech 2000, which I spoke to you for a few minutes ago within the expansion category. Regarding the other two companies that we just feature. You can also see that Knoa and Microcision are within the expansion stage. As I mentioned before, as companies progress to the right they may start to develop exit plans from our portfolio. It's impossible to predict how quickly or slowly such transactions progress as they are all dependent on market conditions. If you look at Slide 9 is the same company logos, but they are categorized based on how long the company has been in our portfolio. Tech 2000 is the only addition to our portfolio in the past year. The average age of a company on our portfolio is just over five and a half years and our normal investment period is approximately five years. As you can see, the majority of the companies sit at or above the five-year time horizon. Today, 17 of our companies are there. If you turn to Slide 10, you can see how diverse our portfolio is. The breakdown by industry category doesn't change drastically over time. Consistent with our strategy, we are and have been a diversified Company. We invest in almost all industries, with the exception of real estate, retail, and financial services. The year-over-year comparison as of December 31, show a drastic increase within software industries driven by the addition of Tech 2000. Decreases in healthcare and consumer products were primarily due to our write-downs of Empire Genomics and SOMS Technologies. On Slide 11, we dissect our portfolio into capital characteristics, with debt and equity being the two main choices. Our strategy has always been for capital appreciation to grow our net asset value. Accordingly, our portfolio is more heavily weighted towards equity as opposed to debt. However, we adjust our investment objective depending on the mix of cash flow stream within our portfolio. As this slide illustrates, since 2016 we have trended to more debt. We're focused on building investment income to generate cash flow to cover our expenses. As a matter of fact during 2018, there approximately 60% of our investments were in debt related instruments. Consequently, at the end of the year, nearly 60% of our investments were in equity and about 40% were in debt, virtually unchanged since 2017. Looking forward, anticipating the proposed EAM investment in Rand. We anticipate a heavier focus on debt-related investments to support an ongoing dividend. Everyone, if you can turn to Slide 12, this is a snapshot of the five top investments in our portfolio based on the value at the end of December. Our portfolio is valued at nearly $34.7 million and includes 30 active companies. The value of our top five investments consistently compromises about half of our portfolio and as you can see, they’re weighted towards healthcare. Our largest portfolio company is still Genicon, which is valued at $4.4 million based in Orlando, Florida. They design, produce and distribute patented surgical instrumentation. We've been an investor in them since 2015. eHealth is our second largest investment in our portfolio valued at $3.5 million, based in Rochester, New York, they provide a proprietary electronic platform to aggregate patient clinical networks and images to support medical referrals. Our initial investment in eHealth was in 2016. There are two new investments in our top five. One is our third largest investment ACV Auctions. They’re an exciting and growing Buffalo based software company that provides a mobile platform for automobile, auction operation, title management, floor plan purchasing, arbitration and logistics. They are revolutionizing dealer-to-dealer car sale by automating the process by replacing expensive and inefficient physical auction. Founded less than four years ago, ACV now has 500 employees. 2018 they expanded from 30 to 80 markets. They estimate more than 10,000 cars are now being sold per month on their platform. We began investing in 2016 and increased the fair value of our investment in them in the fourth quarter. The 2.5 million of appreciation to 2.8 million at December 31, was based on valuation defined by third-party investors during ACV recent $93 million Series C funding round. Fourth is Tilson headquartered in Portland, Maine. They construct and manage cellular fiber optic and wireless information system. We've been investing in them since 2015. 2018 at the end they have 17 nationwide offices spread across 36 states. And their total employment almost doubled since 2018 to 490 team members. 2019 they resolved, they hire an additional 250 great people and double their business building America's information and construct infrastructure. Our investment in Tilson was valued at $2.6 million at the end of 2018. The second new company in the list is our fifth largest investment, Microcision which we've discussed in detail earlier. We began investing them in 2018 and their recent financial performance led us to increase the fair value of our investment to $2.5 million as of year-end. Now I’d like to turn it over to Dan Penberthy, our EVP and CFO to cover the financial results.

Thanks Pete and good afternoon everyone. If you could please turn to Slide 14, I’ll start with the net asset value per share or NAV. As Pete mentioned, we finished the year with net asset value at $4.99 per share. As you see on the chart, NAV increased $0.15 per share over the trailing quarter. This increase is attributable primarily to net increase in the valuations of certain of our portfolio investments, driven by the appreciation recorded for ACV Auctions and Microcision and partially offset by depreciation recorded on other investments within our portfolio. Please turn to Slide 15. Here, we summarize our operating performance for the fourth quarters of 2018 and 2017, and also the comparable full year periods. Investment income increased significantly to $668,000 in the fourth quarter. This is a 76% increase over the prior year's quarter. Incremental investment income drove a 35% increase and nonrecurring distributions drove a 41% increase. As we previously mentioned, we have been investing in more income-producing instruments over the past few years, and that has driven increased investment income. On a year-to-date basis, investment income was up $652,000, or 45% to $2.1 million. In addition to the fourth quarter nonrecurring distributions, we had nonrecurring loan restructuring income in the third quarter. To give you a sense for the increase in our investment income driven by our investment strategy. Excluding those nonrecurring items, investment income grew by 18% in 2018 over 2017, our fourth quarter expenses of $684,000 or 53% above the same quarter of last year, but our full year expenses are up only 9%. Excluding bonus fourth quarter expenses were up $123,000 and full year expenses were up $70,000. The increase was driven by higher professional fees, primarily due to the pending strategic investments by East. Net investment loss before income taxes refers to the difference between our investment income and our expenses. This is before changes in the valuations of our investment. Our goal is to reach break-even level at that line. We are significantly closer to reaching that goal in 2018 with a net loss of $15,000 in the fourth quarter and a net loss of $87,000 for the full year. Below that line, the net realized and unrealized gains or losses on investments drove the $0.15 increase in NAV in the fourth quarter and the overall $0.06 decline for the year. Please turn to Slide 16, our balance sheet continues to be strong. On a per share basis, we have $0.64 of cash at the end of the year. This includes $0.44 per share, which resides at the corporate or parent level and $0.20 per share in our SBIC, which is available for investing. Our portfolio investments are valued at $5.48 per share at the end of the year. Our portfolio growth has benefited from and has been partially funded by the SBA leverage, which as of the end of the year, we have a $0.38 per share which we owe to the SBA. We also have $0.25 per share rather of other assets net of liabilities. This all adds up to our net asset value or NAV per share of $4.99. With that, I think it's time to open up the line for questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] My first question today is coming from MJ Bartlett [ph] from IIU. Your line is now live.

Hello gentlemen, thanks for taking my call. Congratulations on bringing the NAV up to just under $5 a share. Am I right in understanding that that is generally what you would call the orderly liquidation value of the portfolio today?

That's not really a defined term that we use. I think our term is a fair value and that's a GAAP term.

So you'd say that the portfolio and net of all that is $5 a share or $4.99 a share?

Correct.

So given that I'm struggling to understand why you would contemplate a change of control transaction at $2 discount to that value when change of control transaction is normally happen at a premium and that $2 discount will be highly dilutive to all of your shareholders?

As we talked about earlier, that'll all be described in the proxy, which should be out shortly. And then once that's out, I'd be happy to talk to you.

Okay. But I'm not asking for any new information, this is the information that's already been released by the company, your idea is to issue shares at $3 a share, which by your own accounting is it $2 per share discount to the current NAV or?

MJ, this is Deborah Pawlowski here. So in the proxy statement, what you're going to find is all of the discussions regarding the board's decision on the price per share. And it will go through exactly the answer to your question. That's why until the proxy is filed, we're kind of restricted as to what we can talk to.

Yes. I think that's rationalization, we all know what the rules are around in S-1 and you're more than in a position to answer my question now but clearly you don't want to. So I'll relinquish the line to somebody else.

Thank you.

Thank you. [Operator Instructions] Our next question is coming from Sam Rebotsky from S.E.R. Asset Management. Your line is now live.

Yes, hi. Good quarter, Pete and Dan. To the previous gentleman's question, my understanding the $1.50 dividend, there will be a $1.50 dividend and I assume that dividend is prior to the new investment of $3. I think that was described previously. Am I incorrect on that, Pete?

Sam, I think you're right on weighting and reading the proxy.

Okay. Okay. That was my understanding because if the new investors were putting in $3, they're not getting a buck and a half back. That's just my understanding. Do we have a date for the annual – the meeting to vote on the proxy or we don't have that yet?

We don't have that and until the SEC reviews and gives us feedback…

Okay. The ACV Auctions, we have 1% and so they raised $93 million, is that values that company at $288 million. Is that a fair assumption?

I think it's higher than that.

Okay. Okay. The increase in this valuation only came about because of the $93 million raise.

Yes, they’ve had previous money raise, primarily with insiders and that is not – we don't look at that as a basis to increase our value. This was and I think you can get it on the web, you can Google it. This is primarily on new investors.

Okay. Do we have any other investments where the insiders have been putting money in and the possibility there is raises going to be needed or might happen that's similar to this ACV transaction?

Yeah, we do, Sam, as you and I have talked there the two or three, not a handful than the insiders and it is very common. The insiders will continue to fund it and we do not reflect to write up when they do it at a higher valuation.

Okay. Well this was because this is basically of all the transactions this covered all, whatever write-downs there were and towards that $0.15 increase, which is very good. Alright and the proxy will be filed in a week, or two weeks, or something, that's what we expect to file.

Yes, I think that’s a good answer.

Okay. Alright, looking forward to receiving it.

Thanks Sam.

Thank you. [Operator Instructions] Our next question is coming from Brett Reiss from Janney Montgomery Scott. Your line is now live.

Yes, hi Pete. Hi Dan.

Hi Brett.

The $6 million you're getting from the SBIC, what is the cost of that capital? And then can you use that to make equity or debt investment? And how much leverage are you able to employ with that?

So what happens is our borrowings along with all the other SBAs get full and it gets priced in the agency market. This is a 10-year interest on the instrument and against price in general, also 10-year treasury. I would guess it would be in the mid three, you say maybe you’re closer to four all in. And we can use it for any of our portfolio investments. And it's not really technically done on a deal-by-deal basis. It's done on a portfolio basis. So I guess the answer is yes, you can use this for debt or equity. We're mindful though that we have enough interest income to pay for expenses.

Right. Any restrictions on the leverage?

Not sure what you mean by leverage.

Well, if you’re borrowing $6 million, can you only make $6 million in investments or can you make $12 million in investments?

If you’re borrowing $6 million, you really only have $6 million to deploy.

Okay. And the SBIC that's the same as the SBA?

Yes, we use them phenomenally.

Okay. Alright, thank you.

Thank you. We reached end of our question-and-answer session. Let's turn the floor back over to management for any further or closing comments.

Thank you for your time and attention this afternoon. Hope you can see a lot of excitement going on with Rand and a lot of underlying value in our portfolio. We're really excited about our investment by EAM and we believe this will take us to a new level for the benefit of all stakeholders. Look forward to updating you as we progress with that process and have a great evening.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time. And have a wonderful day.