OFS Capital Q3 2024 Earnings Report

OFS Capital EPS Results

• Actual EPS: $0.27
• Consensus EPS: $0.25
• Beat/Miss: Beat by +$0.02
• One Year Ago EPS: $0.40

OFS Capital Revenue Results

• Actual Revenue: $10.92 million
• Expected Revenue: $10.97 million
• Beat/Miss: Missed by -$50.00 thousand
• YoY Revenue Growth: N/A

OFS Capital Announcement Details

• Quarter: Q3 2024
• Date: 10/31/2024
• Time: After Market Closes
• Conference Call Date: Friday, November 1, 2024
• Conference Call Time: 10:00AM ET

OFS Capital (NASDAQ:OFS) (NASDAQ: OFS) is a business development company (BDC) that provides customized debt and equity financing solutions to U.S. middle-market companies. As an externally managed BDC, OFS Capital focuses on sponsoring capital structures that support growth initiatives, recapitalizations, acquisitions and other strategic transactions. The firm targets companies that demonstrate strong cash flow potential and scalable business models across a range of industries.

The company’s investment portfolio typically includes senior secured loans, unitranche facilities, mezzanine debt and equity co-investments. OFS Capital generally commits between $5 million and $35 million per transaction, partnering with management teams to help accelerate expansion, fund acquisitions and refinance existing debt. Key sectors of focus include business services, healthcare, specialty finance, manufacturing and consumer products.

Founded in 2007 under the name ORIX Financial Services and rebranded as OFS Capital in 2015, the firm is headquartered in New York City. OFS Capital’s investment activities are overseen by OFS Capital Management, LLC, an external adviser composed of seasoned professionals with deep experience in private credit and middle-market investing. The management team emphasizes disciplined underwriting, active portfolio monitoring and tailored capital solutions.

OFS Capital seeks to generate current income for its shareholders while pursuing long-term capital appreciation through diverse private credit and equity investments. The company’s flexible mandate and hands-on approach aim to deliver value to both its portfolio companies and investors by providing strategic financing alternatives uncommon in the traditional banking sector.

OFS Capital Q3 2024 Earnings Call Transcript

Key Takeaways

• Q3 net investment income rose 4.8% to $0.27 per share, driven by lower G&A and yields, while management targets further increases by rotating non‐interest equity into interest‐earning assets.
• Net asset value per share fell 1.9% to $11.29 due to markdowns in loan and structured finance positions, partially offset by equity valuation gains.
• The Fan Steel minority equity investment appreciated by $2.8 million to $73.7 million, reflecting improved fundamentals and offering potential monetization proceeds after generating 16x cost in distributions.
• The portfolio remains 100% senior secured with 1st and 2nd lien loans, and 72% of debt is unsecured, with all maturities in 2026 or later and locked‐in fixed rate debt at a 4.8% coupon.
• Management expects lower Fed rates may pressure net interest margins but benefit portfolio companies’ debt servicing, support M&A‐driven originations and fee income, and reduce recession risks.

Presentation

[Steve Altebrando, Head of Investor Relations at OFS Capital]

Good morning, everyone, and thank you for joining us. Also on the call today are Bilal Rashid, 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.

[Steve Altebrando, Head of Investor Relations at OFS Capital]

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.

[Bilal Rashid, Chairman and CEO at OFS Capital]

Thank you, Steve. Earlier this morning, we announced our Q3 earnings. Our net investment income increased by approximately 4.8% to $0.27 per share. Our net asset value per share decreased modestly by 1.9% to $11.29 per share. With respect to net investment income, while we had an improvement this quarter, we remain focused on increasing this metric longer term, primarily by rotating certain non-interest-earning equity positions into interest-earning assets. As we discussed on our last call, we continue to explore potential alternatives for our minority equity investment in Fansteel, our largest equity position. In the meantime, the fair value of the position continued to improve this quarter, appreciating by $2.8 million to $73.7 million at quarter end. The increase in value is primarily attributed to improved fundamental performance of the company.

[Bilal Rashid, Chairman and CEO at OFS Capital]

As a reminder, this is a position we invested in more than 10 years ago at a cost of only $200,000. To date, we have received $3.4 million in distributions for approximately 16 times our cost. Our net asset value per share decreased by 1.9% as a result of certain markdowns during the quarter in our loan and structured finance positions, which were offset by an increase in the value of our equity positions, notably Fansteel. Our non-accrual metrics, as a percentage of our total portfolio at fair value, were relatively stable compared to the prior quarter. We removed one loan, which had previously been on non-accrual status during the quarter, and we placed one loan on non-accrual this quarter, representing only 0.6% of the total portfolio at fair value. Overall, we believe the portfolio continues to be well-positioned for the current macroeconomic environment.

[Bilal Rashid, Chairman and CEO at OFS Capital]

As part of our long-standing investment discipline, we remain committed to avoiding highly cyclical industries. We believe that our loan portfolio remains well-diversified and defensively positioned. At quarter end, our largest sector exposures at fair value are in manufacturing and healthcare. Another key part of our investment discipline is investing higher in the capital structure, with 100% of our loan portfolio at fair value in first lien and second lien senior secured loans. In our view, our financing continues to benefit our company. At the end of the Q3, 100% of our outstanding debt matures in 2026 or later, and 72% of our outstanding debt is unsecured. Our non-recourse $150 million floating rate facility with BNP Paribas matures in June 2027. Our Banc of California floating rate corporate line of credit provides us additional liquidity and flexibility.

[Bilal Rashid, Chairman and CEO at OFS Capital]

As we have discussed before, in 2021, we locked in $180 million of fixed-rate unsecured debt bearing a weighted average coupon of 4.8%, which remains notably lower than current market pricing. Looking ahead, we believe the recent interest rate cut by the Federal Reserve and potential additional interest rate reductions in the near to medium term will put some pressure on our net interest margin. However, we also believe that lower interest rates should have a positive impact on the health of the loan portfolio, as it decreases the debt service burden on our borrowers. Additionally, we believe that lower rates reduce the risk of a recession, which would bode well for our portfolio. We expect M&A activity to pick up in the coming quarters, which could lead to higher originations and fee income and a potential positive impact on net investment income.

[Bilal Rashid, Chairman and CEO at OFS Capital]

As we navigate this market environment, we have confidence in the experience of our advisor, which manages approximately $3.9 billion 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.

[Jeffrey Cerny, CFO and Treasurer at OFS Capital]

Thanks, Bilal. Good morning, everyone. As Bilal mentioned, we posted net investment income of $0.27 per share for the Q3, which was up $0.01 per share from the Q2, primarily due to a decrease in G&A expenses, which more than offset the modest decline in investment income. Our current distribution rate represents a 16.1% annualized yield based on the market price of our common stock at quarter end. We also announced that our quarterly distribution will remain at $0.34 per share for the Q4. We are focused on improving net investment income so that it exceeds our distribution rate. As Bilal discussed, we are actively exploring potential alternatives to monetize certain non-interest-earning equity investments to increase our net investment income, primarily our minority equity stake in Fansteel. Our net asset value per share decreased by approximately 1.9% or $0.22 this quarter.

[Jeffrey Cerny, CFO and Treasurer at OFS Capital]

This decrease was primarily the result of certain markdowns during the quarter in our loan and structured finance positions, which were offset by an increase in the value of our equity positions, notably Fansteel, as Bilal described. Our one new non-accrual loan, J.P. Intermediate, was downgraded this quarter based on our internal credit rating scale. It represents 0.6% of the total portfolio at fair value. In addition, we removed one loan which had previously been on non-accrual status during the quarter. Our non-accrual metrics, as a percentage of our total portfolio at fair value, were relatively stable compared to the prior quarter. Overall, we believe the portfolio continues to be well-positioned for the current macroeconomic environment, and we believe the overall quality of the portfolio remains stable. 5.4% of our total investments at fair value were on non-accrual status at quarter end.

[Jeffrey Cerny, CFO and Treasurer at OFS Capital]

Turning to the income statement, total investment income was down approximately 2% to $10.9 million this quarter. This was primarily driven by one of our large loan positions being repaid at par, which impacted interest income as we redeployed the proceeds into a handful of new loan positions. Our regulatory asset coverage ratio stands at 161% at quarter end. Total expenses were down 5.3% during the period to $7.3 million, primarily due to a decrease in G&A expenses, as I mentioned earlier, most notably a reduction in administration fees. Turning to net investment income, it was up $0.01 to $0.27 per share for the Q3. We described our plans to increase net investment income, and it is also worth noting that at quarter end, all of our outstanding debt matures in 2026 or later, and approximately 72% of our outstanding debt was unsecured.

[Jeffrey Cerny, CFO and Treasurer at OFS Capital]

Turning to our investments, we believe the overall performance of our portfolio companies remained relatively stable compared to last quarter, despite this uncertain macroeconomic environment. We do believe that the recent interest rate reduction and the expected future reductions will benefit our borrowers overall. We are committed to being senior in the capital structure and selective in our underwriting. As M&A activity has remained subdued, we continue to work with our portfolio companies as they identify add-on opportunities for growth. As of September 30th, we had $8.5 million in commitments under various credit facilities to fund investments 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 September 30th.

[Jeffrey Cerny, CFO and Treasurer at OFS Capital]

Based on amortized cost as of quarter end, our investment portfolio was comprised of approximately 71% senior secured loans, 23% structured finance securities, and 6% equity securities. At the end of the quarter, we had investments in 69 unique issuers totaling $394.7 million on a fair value basis. The weighted average performing investment income yield on the interest-bearing portion of the portfolio improved slightly to 13.6%, which is up about 0.2% quarter over quarter. This includes all interest, prepayment fees, and amortization of deferred loan fees. With that, I'll turn the call back over to Bilal.

[Bilal Rashid, Chairman and CEO at OFS Capital]

Thank you, Jeff. In closing, we remain focused on increasing our net investment income in the coming quarters, specifically by exploring the sale of certain non-interest-earning equity positions and redeploying the proceeds into interest-earning assets. We continue to focus on capital preservation, and we remain confident in the overall quality and fundamentals of our portfolio. We believe our long-standing experience and investment discipline has served us well over the past 13 years. Since the beginning of 2011, the BDC has invested more than $2 billion, with a cumulative net realized loss of just 3.2%, while generating attractive risk-adjusted returns on our portfolio. We believe our business is especially equipped to navigate this market successfully due to the size, experience, and reputation of our advisor.

[Bilal Rashid, Chairman and CEO at OFS Capital]

With a $3.9 billion corporate credit platform affiliated with a $29 billion asset management group, our advisor has broad expertise, including long-standing banking and capital markets relationships. Our corporate credit platform has gone through multiple credit cycles over the last 25-plus years. Our advisor and affiliates are strongly aligned with the shareholders as they maintain an approximately 23% ownership in the company. With that, operator, please open up the call for questions.

[Operator]

We will now begin the question and answer session. To ask a question, you may press star, then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. And if you would like to withdraw a question, please press star, then two. At this time, we will pause just momentarily to assemble our roster. And this will conclude our question and answer session. It will also conclude today's conference call. Thank you all for attending today's presentation. You may now disconnect your lines.

Participants

Executives

• Bilal Rashid, Chairman and CEO
• Jeffrey Cerny, CFO and Treasurer
• Steve Altebrando, Head of Investor Relations