OFS Capital Q4 2023 Earnings Report

OFS Capital EPS Results

• Actual EPS: $0.35
• Consensus EPS: $0.39
• Beat/Miss: Missed by -$0.04
• One Year Ago EPS: $0.35

OFS Capital Revenue Results

• Actual Revenue: $13.48 million
• Expected Revenue: $14.53 million
• Beat/Miss: Missed by -$1.05 million
• YoY Revenue Growth: N/A

OFS Capital Announcement Details

• Quarter: Q4 2023
• Date: 3/5/2024
• Time: Before Market Opens
• Conference Call Date: Tuesday, March 5, 2024
• Conference Call Time: 10:00AM ET

OFS Capital (NASDAQ:OFS) is a business development company specializing in direct and fund investments as well as add-on acquisitions. It provides flexible capital solutions primarily through debt capital and to a lesser extent, minority equity investments serving the needs of U.S.-based middle-market companies across a broad array of industries. It does not invest in operational turnarounds or start-up businesses. For direct, it specializes in debt and structured equity investments, recapitalizations and refinancing, management and leveraged buyouts, acquisition financings, ownership transition, shareholder liquidity events, growth capital, independent sponsor transactions, ESOPs, and minority investments in the lower middle market companies. It invests in the aerospace and defense, business services, consumer products and services, construction & building, durable goods, capital equipment, automotive, food and beverage, healthcare & pharmaceutical, specialty chemicals, transportation cargo and logistics, value added distribution, franchising, and industrial and niche manufacturing sectors. The firm invests in companies based in United States. It seeks to invest between $3 million and $35 million, revenues between $15 million and $300 million, annual EBITDA between $5 million and $50 million, and Enterprise value between $10 million and $500 million. The firm seeks to invest in companies with debt investment values between $5 million and $25 million. The fund uses senior secured, unitranche loans, first-lien, second lien, subordinated/ mezzanine loans, warrants, and preferred equity securities and common equity securities. It prefers to take a minority as well as majority stake in the investments made. It also co-invests with its partners for additional capital.

OFS Capital Q4 2023 Earnings Call Transcript

[Operator]

Good morning, and welcome to the OFS Capital Corporation 4th Quarter 2023 Earnings Conference Call. All participants will be in listen only mode. Please note, this event is being recorded. I would now like to turn the conference over to Steve Altobrando, Vice President of Capital Markets. Please go ahead.

[Speaker 1]

Good morning, everyone, and thank you for joining us. Also on the call today are Bilal Rahid, our Chairman and Chief Executive Officer and Jeff Cerny, the Company's Chief Financial Officer and Treasurer. Before we begin, please note that the statements made on this call and webcast may constitute forward looking statements as defined under applicable securities laws. Such statements reflect various assumptions, expectations and opinions by OFS Capital Management concerning anticipated results, are not guarantees of future performance and are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from such statements. The uncertainties and other factors are in some way beyond management's control, including the risk factors described from time to time in our filings with the SEC.

[Speaker 1]

Although we believe these assumptions are reasonable, any of those assumptions could prove inaccurate. And as a result, the forward looking statements based on those assumptions also could be incorrect. You should not place undue reliance on these forward looking statements. OFS Capital undertakes no duty to update any forward looking statements made herein, and all forward looking statements speak only as of the date of this call. With that, I'll turn the call over to Chairman and Chief Executive Officer, Bilal Rashid.

[Speaker 2]

Thank you, Steve. Earlier this morning, we announced our Q4 results. Our net investment income in the 4th quarter was $0.35 per share, which was below our net investment income of $0.40 per share in the 3rd quarter. As you may recall, in the Q3, we had some non recurring investment income, which was the primary driver of the drop in net investment income in the Q4. Even so, our net investment income remains above our distribution of $0.34 per share.

[Speaker 2]

We believe the overall performance of the companies in our portfolio remains solid. We had no new non accruals this quarter and we placed one investment back on accrual status. Additionally, we believe that we benefited from our balance sheet positioning with the majority of our debt being fixed rate and the vast majority of our loan portfolio being floating rate. Our net asset value declined in the 4th quarter to $12.09 per share from $12.74 per share at September 30, primarily due to unrealized depreciation in a couple of positions. Looking ahead to 2024, we continue to believe our portfolio is well positioned for the current macroeconomic environment.

[Speaker 2]

As part of our long standing investment discipline, we have historically avoided investing in highly cyclical industries. We believe that our well diversified portfolio is defensively positioned with our largest sector exposures in manufacturing, healthcare, business services and technology. 100% of our loan portfolio at fair value is senior secured. We believe that being at the top of the capital structure will continue to benefit us in this economic environment. In terms of new originations, we expect to see an increase in M and A activity later in the year as we get more clarity on interest rates.

[Speaker 2]

In the meantime, we remain active in supporting our existing portfolio companies. Our financing continues to benefit our company. At the end of the Q4, approximately 89% of our outstanding debt matures in 2026 or later, and 60% of our outstanding debt is unsecured. Our non recourse $150,000,000 senior loan facility with BNP Paribas matures in June 2027. Our corporate line of credit is flexible with no mark to market provisions.

[Speaker 2]

As we have discussed before, we locked in $180,000,000 of fixed rate unsecured debt in 2021 and that has a weighted average coupon of 4.8%, which is notably lower than current market pricing. Since the end of the Q4, we retired our remaining $31,900,000 of SBIC debt, which was due to mature in early 2025. Going into the new year, we anticipate that we will continue to benefit from the experience of our advisor, which manages approximately $4,000,000,000 across the loan and structured credit markets, has expertise in multiple asset classes and industries, and has a more than 25 year track record through multiple credit cycles. At this point, I'll turn the call over to Jeff Cerny, our Chief Financial Officer, to give you more details and color for the quarter.

[Speaker 3]

Thanks, Bilal. Good morning, everyone. As Bilal mentioned, we posted net investment income of $0.35 per share for the Q4, once again covering our $0.34 per share distribution declared during the quarter. Our current distribution rate represents an 11.6% annualized yield based on the price of our common stock at year end. We also announced that our quarterly distribution for the quarter remains at $0.34 per share.

[Speaker 3]

Our net asset value per share decreased by $0.65 to $12.09 As Bilal mentioned, this decline was primarily due to unrealized depreciation concentrated in a couple of positions. During the quarter, we had no new non accruals and one loan was placed back on accrual status following an amendment, which included an equity infusion from the private equity sponsor and an improvement in the loan's fair value. This loan had a fair value of $4,200,000 as of December 31. 2.9 percent of our total investments at fair value were on non accrual status at year end. Turning to the income statement, total investment income was down by approximately 8% to $13,500,000 This was partly due to a 50 basis point decline in our investment income yield, largely related to non recurring investment income realized in the 3rd quarter, as well as some prepayments in the 4th quarter.

[Speaker 3]

This resulted in a lower overall investment balance in the 4th quarter. We did not reinvest certain of the proceeds from repaid investments as we were preparing to redeem our remaining $31,900,000 of SBIC debentures, which were due to mature in early 2025. On March 1st, we completed this redemption. Total expenses of $8,800,000 were down approximately 5% during the period, primarily due to a decrease in interest expense related to the lower average outstanding debt balances during the quarter, as well as lower management incentive fees due to the declines in our investment portfolio and net investment income. As I mentioned, net investment income was $0.35 per share for the 4th quarter.

[Speaker 3]

Net investment income covered our $0.34 distribution for the 4th quarter and we believe that net investment income has benefited from our balance sheet positioning, given that 92% of our loan portfolio at fair value is floating rate, while 70% of our outstanding debt is fixed rate. It is also worth noting that at quarter end, 89% of our outstanding debt matures in 2026 or later and 60% of our outstanding debt was unsecured. Excluding the SBIC debt, our regulatory debt to equity ratio was approximately 1 point 6 7 times and our regulatory asset coverage ratio was 160%. Turning to our investments, the overall performance of our portfolio companies remains solid in this uncertain macroeconomic environment, despite weaknesses in a few of our investments. We are committed to being senior in the capital structure and selective in our underwriting.

[Speaker 3]

We remain cautious with regard to new originations and continued to see slow M and A activity during the Q4. As I mentioned, we saw some heavier prepayments in the Q4 and we're sitting on a much larger cash position at year end than is typical as we prepare interest. We continue to support our portfolio companies as they identify add on opportunities for growth and we also funded a few new middle market investments in the Q4. As of December 31st, we had $13,800,000 in commitments to fund investments under various credit facilities to our portfolio companies. The majority of our investments are in loans and 100% of our loan portfolio at fair value was senior secured as of December 31st.

[Speaker 3]

Based on amortized cost as of quarter end, our investment portfolio was comprised of approximately 69% senior secured loans, 1% subordinated debt, 24% structured finance securities and 6% equity securities. At the end of the quarter, we had investments in 76 unique issuers totaling approximately $420,000,000 on a fair value basis. For the quarter ended December 31st, the weighted average performing investment income yield on the interest bearing portion of the portfolio was down about 50 basis points to 14.1%. This includes all interest, prepayment fees, and amortization of deferred loan fees. The decline was largely due to certain non recurring income in our structured finance investments that occurred in the 3rd quarter, as well as some prepayments in the 4th quarter.

[Speaker 3]

With that, I'll turn the call back over to Bilal.

[Speaker 2]

Thank you, Jeff. In closing, we believe our portfolio remains in good shape with no new non accruals in the quarter and with one investment being placed back on accrual status. Our focus remains on capital preservation with 100% of our loan portfolio at fair value being senior secured, and we remain confident in the overall quality and fundamentals of our portfolio. We have relied on our long standing experience and investment discipline, which we believe has served us well. Since the beginning of 2011, the BDC has invested more than $1,900,000,000 with a cumulative net realized loss of just 2.5% over the past 13 years, while generating attractive risk adjusted returns on our portfolio.

[Speaker 2]

We believe our business is especially equipped to navigate this market successfully due to the size, experience and reputation of our advisor. With a $4,000,000,000 corporate credit platform affiliated with a more than $30,000,000,000 asset management group, our advisor has broad expertise, including longstanding banking and capital markets relationships. Our corporate credit platform has gone through multiple credit cycles over the past 25 plus years. Our advisor and affiliates are also strongly aligned with shareholders as they maintain an approximately 23% ownership stake in the BDC. With that, operator, please open up the call for questions.

[Operator]

We will now begin the question and answer Our first question is from Mitchell Penn with Oppenheimer. Please go ahead.

[Speaker 4]

Hi, guys. A couple of quick questions, just housekeeping. Your what percent of your loans are second liens?

[Speaker 5]

Hey, good morning, Mitchell. This is Jeff. Yes, good morning. About 19% of our loan portfolio is second liens and you'll notice we did start to break that out on our SOI, but happy to address that, but just for your

[Speaker 4]

Okay, great. And the affiliate PIK income, was there a catch up there for the quarter or because or is that it doesn't appear to be the run rate going forward, but I'm curious if there was some sort of adjustment?

[Speaker 5]

Yes. There was a pickup of a loan, as I mentioned, the loan that we put back on accrual status. We had an equity infusion and recognized some previously reserved past due interest in the form of PIK.

[Speaker 4]

Got it. Got it. And one last question. The audit opinion sort of talked about valuation. Do you guys I always thought you guys employ like a 3rd party valuation service that periodically looks at the portfolio.

[Speaker 4]

Is that correct?

[Speaker 5]

So for all of our Level 3 investments, we have them valued by a 3rd party, all of them, all the Level 3s every quarter.

[Speaker 4]

So it's not sweep. Got it. And anything else you guys have valued? Is that it where the market values it?

[Speaker 5]

That's right, if it's a level 2.

[Speaker 4]

Got it. Okay. That's all for me. Thanks so much.

[Speaker 5]

Thank you.

[Operator]

This concludes our question and answer session and the conference has also now concluded. Thank you for attending today's presentation. You may now disconnect.