Rand Capital Corporation (RAND) Q2 2021 Earnings Report, Transcript and Summary

Greetings. Welcome to the Rand Capital Corporation Second Quarter 2021 Financial Results 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]. Please note, this conference is being recorded. I'll now turn the conference over to your host, Deborah Pawlowski, Investor Relations for Rand Capital. You may begin.

Thank you, [Shamali], and good afternoon, everyone. We appreciate your interest in Rand Capital and for joining us today for our second quarter 2021 financial results conference call. Here with me today are Pete Grum, our Chief Executive Officer; and Dan Penberthy, our Executive Vice President and Chief Financial Officer. You should have a copy of the release that crossed the wire this morning as well as the slides that will accompany our conversation today. If not, they are available on our website at randcapital.com. If you are following along on the slide deck and would turn to Slide 2, I would like to point out some important information. As you are likely aware, we may make some forward-looking statements during this presentation and 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. You can find a summary of these risks and uncertainties and other factors 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 sec.gov. During today's call, we will also discuss some non-GAAP financial measures. We believe these will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results in accordance with GAAP. We have provided reconciliations of non-GAAP measures with comparable GAAP measures in the tables that accompany today’s release and in the slide. So with that, if you would turn to Slide 3, I will hand the discussion over to Pete to begin. Pete?

Thank you, Deb. Good afternoon, everyone. We continue to execute our strategy as we focus on evolving our portfolio from equity investments to income-producing investments, with goal of driving investment income and ultimately delivering higher cash distributions. For the quarter, our total investment income grew 20% to $811,000. Net asset value per share of $22.51 was up 7% and 26% from the sequential first quarter and year-end period, respectively. The sequential increase largely reflects unrealized appreciation of our investment in Open Exchange following their equity financing by a new nonstrategic outside investors. The change from year-end reflects the increase in fair value of our investments in ACV Auctions, which completed their IPO at the end of March. During the quarter, we sold our investment in GiveGab, a software company that we've owned since 2015. Our equity investment of $616,000 netted us a recognized gain of $1.8 million. This is consistent with our strategy of transforming our portfolio from equity into debt. During the quarter, we accrued $1.1 million in noncash expenses related to capital gains incentive fees, which were primarily a result of realized gains from the sale of GiveGab and the increase in unrealized appreciation mostly related to Open Exchange. The accrual will be adjusted on a quarterly basis. As a result, we reported a GAAP net investment loss of $0.31 per share. Absent this expense, adjusted net investment income was $0.10 per share. We announced and paid our regular quarterly dividend distribution of $0.10 per share during the second quarter. And at the end of July, we announced our third quarter dividend distribution also $0.10 per share. So far this year, we have declared $1.63 per share in dividends, including the $1.33 per share that was declared at the end of last year but is paid in 2021. If you turn to Slide 4, we can discuss the progress we have made regarding the evolution of our investment portfolio to support our strategy. The 14% increase in fair value shown here reflects the impact of Open Exchange, which now has a fair value of $5.6 million, an increase of $4.9 million during the year. The fair value of all of our investments increased by $7.5 million. At quarter end, our portfolio was comprised of approximately 55% equity investments, 36% in fixed-rate debt investments and 9% in dividend-paying publicly traded BDCs. During the quarter, we made $4.6 million in new and follow-on investments and received $2.4 million from the 1 exit we discussed and the other loan repayments. These transactions are highlighted on Slide 5. The largest investment during the quarter was for ITA Inc and totaled $3.9 million, $3.4 million consisted of 12% term notes and $500,000 was in equity. ITA manufactures a wide -- broad variety of window covering components and finished wood treatment, including wood, faux wood and fabric shades, shutters and blinds for residential and commercial applications. The follow-on investment was provided to Mattison Avenue Holdings, LLC, a high-end salon suite business that provides customized fully furnished salon and spa studio space for lease in prime locations for individual stylists, barbers, massage therapists, nail technicians and estheticians, these works as well as for either individualized services such as acupuncture. Our $667,000 follow-on investors consisted of a 14% promissory note. In total, we now have $1.8 million investment in Mattison at the end of the quarter. The charts on Slide 6 illustrate the diversity of our portfolio and the change in industry mix since 2020 year-end. With the investment we recently made, the impact of the investments at fair value changes, software and health care saw notable changes, while most of the other industries were within 1 point or so during that period. We like the diversity of our portfolio and believe it reduces our exposure to market risk. Slide 7 lists our top 5 portfolio companies at quarter end. There are 2 new companies on the list. Open Exchange, which saw a measurable increase in its fair value and ITA with the new investment. ACV's fair value came down about $1.7 million during the quarter, which followed the significant jump during the first quarter given their IPO. Their valuation on our portfolio represents 24% of net assets. Our ACV holdings consist of 147,645 Class A common stock and 442,935 of Class B common stock. The Class A shares are freely tradable, while the Class B are still restricted and non-tradeable through the September 20, 2021. We have discounted our valuation due to these current restrictions. As a reminder, any proceed for us above our 163,000 initial investment will be a capital gain and traded as such, as it relates to any dividend or distribution. With that, I'm going to turn it over to Dan to review our financials in greater depth.

Thanks, Pete, and good afternoon all. Slide 9 provides an overview of our financial summary and our operational highlights. Total investment income for the quarter was $811,000, a 20% increase over last year and does reflect the shift in our portfolio profile to more interest-yielding assets. In total, 23 portfolio companies generated income compared with 13 in the prior year period. This quarter's total investment income also benefited from approximately $137,000 of dividend income, which was up 45% over last year's second quarter. This was primarily comprised of dividends received from our BDC investment portfolio. Total expenses in the quarter were $1.6 million, up from $476,000 in last year's second quarter. The change was largely due to the addition of $1.1 million of accrued capital gains incentive fees during the quarter, which Pete has already discussed. This incentive fee accrual was a result of the sale of GiveGab and the unrealized appreciation on Open Exchange's portfolio value. As a reminder, a capital gains incentive fee accrual under GAAP is calculated using the cumulative aggregate realized capital gains and losses and the aggregate net change in unrealized capital appreciation and depreciation at the close of the period. Operating expenses in the quarter, of which a non-GAAP financial measure excludes the capital gains incentive fee accrual, increased $84,000 or 18%, mostly because of the increase in the base management fee payable to Rand's investment advisor resulting from the increased portfolio asset values. Net investment loss was $811,000 or $0.31 per share. Excluding the accrued capital gains incentive fees, adjusted net investment income per share was $0.10 compared with $0.08 per share in the prior year period. Even with the increase in expenses, net assets from operations increased $4.5 million or $1.74 per share. Slide 10 provides a waterfall graph for the change in NAV for the quarter. The increase was primarily due to the change in the fair value of Rand's investment in Open Exchange, which was reflected in the $3.5 million net change in unrealized depreciation on the portfolio investments. Also contributing to the NAV increase was a net realized gain on the sale of GiveGab, which Pete has discussed. We also paid out approximately $260,000 of cash dividends. Slide 11 highlights the strength of our balance sheet. We have approximately $16 million in liquidity for new investments. This does include $3 million of availability for borrowing under our SBIC debentures. The $10.8 million currently owed to the SBA matures over a long multiyear period. However, that begins next year in September when $3 million is due. As required to maintain our RIC status, we will continue to distribute at least 90% of our calendar year qualified income to our shareholders in the form of dividends. Our annualized dividend rate of $0.40 is based off our initial conservative estimates of our 2021 net investment income and is reviewed quarterly based on our actual year-to-date GAAP and estimated tax results. Later in the fourth quarter, we will then review all sources of GAAP and tax based income, including those from short- and long-term capital gains which may result in additional 2021 distributions over the previously distributed regular quarterly cash dividend estimates. The final determination and calculation of our tax-based distributable income for each year is finalized in September of the following year in conjunction with our corporate tax return filings. This is commonly referred to as a spillback dividend. Our current share repurchase program authorizes the purchase of up to $1.5 million in stock and expires next year in April of 2022. We did not repurchase any stock during the second quarter. As we look forward, with the support of our strong liquidity position, we believe we can continue to execute our strategy to grow our portfolio, drive investment income and support a growing dividend. That completes our prepared remarks. Operator, please open the lines for questions.

[Operator Instructions]. Our first question is from Sam Rebotsky with SER Asset Management.

The ACVA, which is currently valued at $23.62, what was the value on June 30 that we used?

It was -- well, we wrote it down $1.7 million, and some of that was due to changes in the market value and some of that was changes in the discounts that we used because of lack of salability at the time.

Sam, the Class A at June 30 was $24.85 and the Class B was $23.61.

So of the 1.60 million in capital gains that were -- we paid the $3.6 million. How much is that attributable to the ACVA?

Well, I don't think we've paid anything. We have accrued.

Accrued, right, Okay. What amount that we accrued would you say is attributable to the ACVA?

I can't do that out of my head, but I'll certainly get back to you.

Sam, I think you're maybe mixing up a couple of items here. The $1.6 million of the gains, those are primarily driven off GiveGab, so -- of the realized gains, I'm sorry. There is a capital gains incentive fee, which was $1.60 million, which was accrued during the quarter, most of that is attributable to unrealized appreciation on Open Exchange and also some offset by the depreciation actually in ACV during the quarter because if you remember, we had ACV valued at $26.79 at the end of the March 31 quarter, and that was adjusted downward based on the closing stock price at June 30 to the $24 numbers that Pete had mentioned.

Okay. And the $3.6 million?

That includes the net -- that is the total capital gains incentive fee if, in theory, the portfolio were to liquidate at its closing values at June 30 based on the realized gains and losses, unrealized activity.

Okay. Okay. So are we happy where -- do we have another ACVA in our portfolio?

Sure. Of course, we do, Sam. We have a...

Sam, that the portfolio is mark-to-market quarterly -- And those are the corporation's estimates of what the fair value is at that time period. We can't get out the crystal ball and tell you where things will end up, in September 30, 2021, much less where they're going to be 3 or 5 years down the road.

Okay. When the stock ran up 26, 27, what was that attributable to?

We were not responsible for that. We didn't have any news in there. It's happened periodically during my life here. You have a thinly traded stock and people start talking about it, but we don't have any idea. There is certainly -- we talk to NASDAQ surveillance. There was no information that we put into the market. So I don't know, Sam, and I didn't get any calls prior to that or after that.

Yes, yes, yes. Okay. I heard somebody attributed you to another -- be another Warren Buffett stock. But share has to wait. Did you hear those rumors?

No.

And our next question is from [Brett Davidson], who is a private investor.

And forget about whether you heard the rumors, are they true?

You mean that we're the next -- I'm the next Warren Buffett?

There you go. That's the important answer I want to hear. Is it true? I got a couple of questions. So I heard in the presentation and tried taking all into account as far as adjusting the dividend. And so it looks like yearly, it's going to be done after the close of the year. Any adjustment would be done later but subsequent year, how will that play into adjusting the quarterly dividend? Or are most of these adjustments going to be done on a onetime special, sometime later in the subsequent year?

I'll answer it as I thought I heard it. Quarterly dividend, we believe is designed on a conservative basis to match our net investment income of what we see in the future. And we forecast out and look at that. And the Board and the management company analyze that to make sure it's a sustainable dividend and the hope is that will grow over time. I'm going to turn it over to Dan to talk about the work that goes through because on the capital gains -- because that's also on a tax basis as most of this is -- so there can be some differences and differences in timing.

Yes. So at the beginning of the year, we project out what we think we're going to happen for the year based on our investment portfolio. Since we are in a debt portfolio, we do experience more debt repayment, which often happens unexpectedly, which does have a negative effect to deterioration of our income, obviously. And so we monitor that quarterly and we prepare an analysis and determine where we think the year will end up. And then so that is done each quarter. And then as we get to the fourth quarter, we'll then tighten those numbers down as we prepare an initial tax estimate based on our actual projected results for the full calendar year 2021. And as Pete mentioned, those will have 2 components. The first will be a capital gains component, which will be more kind of just a onetime type dividend annually because that's based on capital gains, net capital gains, offset by losses, obviously, that we may have had. And then we also look at operating income for the year, and we do an initial tax calculation with our third-party tax advisors trying to get as precise a tax model as you can on your income because we strive to make sure we distribute out at least 90% of our income on a -- during the calendar year or in the immediately January following the conclusion of the year and all that is attributable to 2021. Then what happens is when the final tax returns are done, hopefully, we've done our job well enough with our outside advisors, that there's minimal adjustment that's needed for 2021 on a tax basis based on our final tax return calculations. And that work will be done is being done currently with an expectation of our tax returns being filed typically in September. And that is what I referred to as that spill -- I want to make sure, I referred to spillback dividends. And we would think that would be a minor amount, but we don't know until we're to the conclusion of the tax returns and that would be included as a onetime adjustment to this upcoming quarter's tax numbers. This is now the first time through all these RIC calculation process on a tax basis. So some of this is still subject to change, but that is the fundamental thesis. Well, we look at it quarterly, we tighten it down in December for the calendar year and then we go back and proof our numbers in August and September to see if there's a plus or minus adjustment that needs to happen for tax purposes.

My particular interest is in how that's going to be paid. So capital gains, that's going to be a onetime thing. so say that the estimate for the income that was used to base that $0.10 quarterly dividend is wrong by a dime. So is that going to result in a onetime $0.10 dividend? Or is that going to be spread over the subsequent years quarterly.

You mean -- I believe that it has to be paid during the year. Also you lose your RIC status. So it would be paid and it's not spread over the next years.

Yes. I don't believe it will be spread. However, I will stress again that this is in consultation with our third-party RIC tax advisors. And so we need to take that into consideration. But I also believe it would be a onetime adjustment to the dividend. And the Board at its election can determine whether that be a cash stock or other form of distribution.

Well, I would think it would need to be a cash, wouldn't it, if it requires the distribution of the earnings?

You can you can do cash or you can do a combination of the cash and stock with some limitations.

There's minimum cash requirements that have to go out, but that is also to be discussed at the Board level on a quarterly and annual basis.

All right. So correct me if I'm wrong here. So then the dividend for the subsequent year will be set prior to that year, and it will result in up or down adjustment in the quarterly dividend. And then for the spillback and any capital gains, those would ordinarily result in onetime dividends.

Yes, it would be an adjustment to the third quarter dividend, most likely.

Okay. So it will be adjustment to 1 quarter's dividend then?

But we'll differentiate when we...

That's right.

Yes. We'll make it very clear. This is the regular quarterly dividend.

Here's our $0.10 plus whatever the adjustment is just a -- this is the $0.10 we just issued in July. Here's $0.10 plus the extra amount or we have to offset the number because the net real number for last year was make up, subtract if any. We don't know what the number is until the final tax calculations are occurred.

Yes. Understood. Next question I'm interested in. Is there any kind of exit strategy for ACV.

Yes, we -- and we highlight -- we look at that with our liquidity, upcoming needs where we think the price will go, kind of our own little algorithm that we have. But yes, we are not in the business of owning public shares. And I think over time, as we have historically done, we will exit.

So you said over time, that means this isn't like an all or none operation here?

Of course, you wouldn't want us to give you insight or information. Would you?

No, no, no. I'm just talking about the character of the transaction as I'm not looking for specifics or any timing.

Yes. So here's what our goal is to take equity investments like that, liquefy them, convert that cash into interest paying debentures or loans or a variety of other things so that we can increase -- our goal is to increase our ongoing dividend and part of that is changing equity into debt.

Yes. And so I mean from the all or none perspective, I mean, this isn't going to be -- we're going to decide, we're going to exit ACV and it's going to happen over the course of a day or a couple of days. This could be a period that runs from beginning of 1 year to the end of the next. Is that fair characterization?

I wouldn't -- I'm uncomfortable characterizing it either way. We own 500,000 shares. It's a $4 billion company. It will be based on our alternatives to put the money out, where we think the price is, compared to where we think it should be.

All right. Let me rephrase it. Is there a certain time period that this has to occur over? Is there an end date that this has to occur by?

No.

Okay. So this could conceivably take place over a period of time and not necessarily, once you decide to sell, it has to be completed within a week or whatever.

Right.

Okay. Are you aware of any other investments that are currently looking to take advantage of the atmosphere in the public equity markets? Is there anybody that you've got feedback from that's looking to maybe do an IPO? Or is something you guys wouldn't ordinarily be previewed to?

We wouldn't -- well, we wouldn't disclose it in the conference call.

Got it. And my last one is -- I'm looking -- is there -- can you give some clarity as to what the transaction was that precipitated the sale of the GiveGab position? Was it something that they did or you guys were just able to find a buyer for your investment?

Well, the company sold in totality, and that was our proportional -- so that's our proportion that we received. As you can imagine, COVID hits each company a little bit different. They were in the business of online fundraising and they have been having a nice trajectory of growing anyway. I'd say we're in a nice spot and -- at a number of opportunities and to provide liquidity and they picked this 1 until the whole company was sold.

Is that information available online? Or can you give some idea what that transaction involved? Was it private equity? Or...

It was acquired by -- it is all available online. If you just Google GiveGab and do a search, every action, acquirers, this is in April 15 from the nonprofit time, just Google as you're on the phone. Every exit, continued shopping, acquirers GiveGab. No transaction price was disclosed. But I'm sure if you're afloat, you can find out a lot.

Yes. Yes. I think I can probably figure that one out. So thanks so much. And I appreciate it, and that’s pretty much all I had. Thanks, guys.

Our next question is from Ross Haberman with RLH Investments.

I had just 2 follow-up questions about ACV. I got on a little late. If I understand right, you have about 353,000 of the B shares currently?

I'm going to tell you, not approximately I'm going to tell you exactly. We have 147,645 shares of the Class A and 442,935 of the Class B.

When can you register the B to sale?

I believe that the B sales will become freely tradable after September 20.

And if I understood it right, you marked the whole position of roughly, I don't know, $23.5 to $24 as of the end of the quarter. Is that correct? Or was this...

We marked using the last 3 trading days of the quarter. The Class A, we don't have any discount because it's freely tradable. The Class B, we have a 5% discount to reflect its lack of a -- to reflect the restrictions.

I see what you're saying. And all the -- and both those marks are total your $14 million carrying value at the end of the quarter.

Yes, sir.

Operator?

We have reached the end of the question-and-answer session. I'll now turn the call over to Pete Grum for closing remarks.

Thank you very much, and thank you for joining us today and for your interest in Rand Capital. We look forward to updating all of you on our third quarter 2021 results in November, and have a great day.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.`