OFS Capital Corporation 4.95% Notes due 2028 (OFSSH) Q3 2020 Earnings Report, Transcript and Summary

Good morning, and welcome to the OFS Capital Corporation Third Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Steve Altebrando. Please go ahead.

Good morning, everyone, and thank you for joining us. Also on the call today is Bilal Rashid, Chairman and Chief Executive Officer of OFS Capital; and Jeff Cerny, the company’s Chief Financial Officer and Treasurer. Please note that we issued a press release this morning announcing our third quarter results. This press release was subsequently filed on Form 8-K with the SEC. Both documents can be obtained under the Investor Relations section of our website at ofscapital.com. Before we begin, please note that 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’s 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. 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 our Chairman and Chief Executive Officer, Bilal Rashid.

Thank you, Steve. Good morning and welcome. We appreciate you joining us today to discuss our third quarter performance and hope that you and your families continue to be safe and healthy. As with last quarter, we are pleased that our portfolio companies have continued to perform above our expectations, especially given the ongoing impact of the COVID-19 pandemic. This morning, we increased our distribution to $0.18 per share, a 6% increase from the prior quarter. We believe this reflects our confidence in the long-term outlook of the business and the increase in our earnings, while also preserving our strong liquidity and healthy balance sheet. Our NAV per share increased approximately 11% over the prior quarter to $11.18 in the third quarter. We had no new loans on non-accrual in the third quarter, out of a portfolio of 74 investments. Several of our portfolio companies have identified growth opportunities, both organically and through acquisitions. We have been supporting these companies as they pursue these opportunities and expect to continue to do so going forward. We are also encouraged by our increased pipeline activity. Even with this new activity and encouraging signals from our existing portfolio companies, we remain cautious, amid this continued period of uncertainty. As we entered the pandemic, our portfolio was already defensively positioned in terms of both seniority in the capital structure and industry selection. As a percentage of fair value, approximately 91% of our loan portfolio was senior secured at the end of the third quarter compared to 79% two years ago. Over this time period, we increased our focus on noncyclical sectors with minimal direct exposure to oil and gas and metals and mining. Turning to net investment income. We generated $0.20 per share for the third quarter, an increase over last quarter and above our quarterly distribution. Jeff will provide more details on net investment income later in the call. After significantly reducing our origination activities during the second quarter, due to the COVID 19 pandemic and the corresponding slow down in M&A activity, we are cautiously increasing our origination activity. With regard to our balance sheet, we have been using our capital to support our portfolio companies and invest opportunistically. Continue to do so as the broader economic picture becomes more clear. We believe, our flexible financing improves our ability to withstand market dislocation. As of September 30, over 88% of our debt had stated maturities in 2024 or later. Our long-term unsecured debt makes up a majority of our debt outstanding as of September 30. Our senior loan facility matures in 2024 and is nonrecourse to the BDC. And our corporate line of credit is flexible as well with no mark-to-market provisions. We expect that this will provide us with operational flexibility in the current environment. This quarter, we closed a $25 million unsecured bond, which provides us with additional flexible capital, allowing us to pursue new investments and pay down shorter maturity debt. As we look ahead to closing out what has been a remarkably uncertain year, we believe that OFS Capital continues to benefit from the expertise and scale of its advisor. With more than $2.2 billion in assets under management, the BDC advisor has experienced investing across the known and structured credit markets, which we believe gives us the ability to identify relative value credit opportunities across multiple markets. The BDC advisor has a team of investment professionals with extensive experience in credit underwriting and restructuring across industry verticals. Since 1994, our advisors credit platform has successfully navigated multiple credit cycles. As you know, the advisor owns 22% of the outstanding shares of the BDC. In our view, this key alignment of interests is always important, but in this environment we believe even more critical. You can be assured that we are working very hard every day to protect our investments and drive the business forward for the benefit of all of our shareholders. At this point, I’ll turn the call over to Jeff Cerny, our Chief Financial Officer to give you more color and details for the quarter.

Thanks, Bilal. Good morning, everyone. As Bilal just discussed, we are encouraged by the performance of our portfolio companies and optimistic about the increase in pipeline activity. We believe both our key data points in our future financial success and were considerations in our decision to increase the distribution. However, we remain cautious during this period of uncertainty. Turning to our financial results. Starting with our balance sheet, we had approximately $18.3 million of cash at the end of the quarter. $5.1 million of that cash was in our SBIC. Our debt to equity ratio at the end of the quarter, excluding our SBIC debt improved to approximately 1.4x from 1.5x in the prior quarter. As you may recall, the SBIC leverage does not count towards the regulatory test. Our net asset value per share at the end of the quarter was $11.18, up $1.08 from the prior quarter. This 11% increase was primarily driven by higher fair value marks on our investments. As Bilal mentioned, we had no new nonaccruals this quarter and several of our portfolio companies have identified opportunities for growth. We currently have 4.1% of the portfolio on nonaccrual fair value. Turning to the income statement. Total investment income for the quarter was approximately $10.5 million, a decrease of $500,000 from the second quarter. This decrease was primarily due to a reduction in pre-payment fees as we had some larger payoffs last quarter. Total expenses of $7.8 million were down approximately $600,000, primarily due to lower interest expense from smaller debt balances this quarter. Resulting net investment income per share was $0.20 for the quarter. As Bilal discussed, we declared a distribution of $0.18 earlier this morning, a 6% increase in the quarterly distribution rate. We believe this higher distribution is warranted based on our increased earnings and our confidence in the long-term outlook of the business. As always, we remained focused on preserving our strong liquidity and healthy balance sheet. Turning to the portfolio, we continue to actively work with our portfolio companies to help them get through the challenges associated with COVID-19. We are working through liquidity solutions and other actions that we expect will enable us to maximize the value in our investments. We are pleased that our portfolio companies have continued to perform, several of identified acquisition opportunities, and we are prepared to support them in their growth initiatives. In this period of uncertainty, we believe that our selective investment process and focus on capital preservation has positively impacted how our portfolio is performing and how it will perform in the future. As far as investments, at the end of the quarter, we had investments in 74 portfolio companies totaling approximately $456.3 million on a fair value basis, 91% of the fair value of our investments were in senior secured loans. 89% of our loan investments were floating rate loans. We had LIBOR floors on approximately 88% of our floating rate loan portfolio with an average LIBOR floor of 1.16%. The 1.16% LIBOR floor is a strong contributor in this environment, as it compares to the three-month LIBOR of just 23 basis points at September 30. As a percentage of costs, our investments were approximately 74% senior secured loans, 12% subordinated debt, 7% structured finance notes and 7% equity of which 56% of our equity was in preferred equity securities. Our portfolio remains diversified with an average investment in each portfolio company of approximately $6.3 million or 1.4% of the portfolio’s total fair value. The overall weighted average yield to cost on our performing debt and structured finance note investments remained constant quarter-over-quarter at approximately 10.1%. With that, I’ll turn the call back over to Bilal.

Thank you, Jeff. In closing, we are pleased with the 11% increase in our net asset value per share and that we had no new non-accruals in the loan portfolio. Additionally, we are happy to announce an increase in our distribution in the fourth quarter. We believe that our solid liquidity position will help us in this current economic environment, as we seek to take advantage of potential new investment opportunities and support our existing portfolio companies. Since last quarter, we have made both new investments, as well as add-ons to existing companies that are pursuing growth opportunities, including acquisitions and we continue to evaluate these types of opportunities. We remain focused on strengthening our balance sheet. We continue to proactively manage our portfolio and help our borrowers to navigate this uncertain economic environment. Since the beginning of 2011, OFS has invested approximately $1.4 billion with a cumulative net realized loss of principle of only $14 million or just 1%, while generating attractive yields on our portfolio. We have been steadily increasing our allocation to senior secured loans and our loan portfolio consists primarily of such loans. We have also been increasing our exposure to larger borrowers. Our financing is primarily long-term. As of September 30, 88% of our debt matures in 2024 and beyond. We believe that this gives us operational flexibility in the current market environment. Lastly, we benefit from the experience of our adviser, which manages a $2.2 billion corporate credit platform. Our adviser is part of an asset management group with over $30 billion in assets with broad resources, including longstanding banking relationships. Our advisor has gone through multiple credit cycles over the past 25 years, and we believe it has a strong alignment of interest with all shareholders with a 22% interest in the BDC. We also believe that we have a strong team of investment professionals with industry expertise and restructuring experience to help us through this period. Finally, I want to acknowledge the continued dedication and hard work of our employees. OFS continues to work diligently, to adapt to this evolving situation, especially by supporting our portfolio companies, employees, and other stakeholders. With that, operator, please open up the call for questions.

Thank you. [Operator Instructions] There are no questions in the queue. I’m sorry. Our first question comes from David [indiscernible]. Please go ahead.

Congratulations on your results guys. Just a quick question, perhaps just a thought instead of increasing the dividend, just buy back shares at this point, has Board thought about that as an alternative, given where the share price is relative to the NAV?

Hi, David. Good to speak with you. And so yes, we definitely, as you know, the Board has instituted a share buyback program that is in place. And so the Board is very much evaluating that share buyback program. And so I think we will continue to closely monitor the situation and where clearly evaluate that on a constant basis. But your point is well taken.

Great. Thank you.

[Operator Instructions] There are no more questions in the queue. This concludes our question-and-answer session. I’d like to turn the conference back over to Bilal Rashid for any closing remarks.

Thank you all for joining our call today. And we look forward to speaking with everyone again, next quarter. Operator, you may now end the call. Thank you.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.