OFS Capital Q2 2024 Earnings Report

OFS Capital EPS Results

• Actual EPS: $0.26
• Consensus EPS: $0.29
• Beat/Miss: Missed by -$0.03
• One Year Ago EPS: $0.38

OFS Capital Revenue Results

• Actual Revenue: $11.17 million
• Expected Revenue: $11.78 million
• Beat/Miss: Missed by -$610.00 thousand
• YoY Revenue Growth: N/A

OFS Capital Announcement Details

• Quarter: Q2 2024
• Date: 8/1/2024
• Time: After Market Closes
• Conference Call Date: Friday, August 2, 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 Q2 2024 Earnings Call Transcript

Key Takeaways

• Net asset value per share rose 3.9% to $11.51, driven in part by a $7.8 million fair-value gain on its long-held Fansteel equity stake.
• Net investment income declined to $0.26 per share from $0.42 due to Q1’s non-recurring dividends and ongoing deleveraging, while the Q3 distribution remains at $0.34.
• Balance sheet positioning benefits from 72% fixed-rate debt at a weighted average 4.8% coupon and a 92% floating-rate loan portfolio, with all maturities in 2026 or later.
• The company plans to monetize non-interest-earning equity positions—most notably Fansteel—to redeploy proceeds into higher-yielding, interest-bearing assets and boost income.
• Portfolio quality stays stable and defensive with 100% senior secured loans, no new non-accruals, a 4.6% non-accrual rate, and a 13.4% average yield.

Presentation

[Operator]

Good day, and welcome to the OFS Capital Corporation second quarter 2024 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Star, then One on your touchtone phone. To withdraw your question, please press Star, then Two. Please note this event is being recorded. I would now like to turn the conference over to Steve Altebrando for opening remarks. Please go ahead.

[Steve Altebrando, VP of Investor Relations at OFS Capital Corporation]

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, VP of Investor Relations at OFS Capital Corporation]

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, President, CEO and Chairman of the Board at OFS Capital Corporation]

Thank you, Steve. Earlier this morning, we announced our second quarter earnings. Our net asset value per share increased by 3.9% to $11.51, up $0.43 from the prior quarter. While the current interest rate environment remains uncertain, we believe that we continue to benefit from our balance sheet positioning, with 72% of our debt being fixed rate and 92% of our loan portfolio at fair value being floating rate. Our net investment income for the quarter decreased from $0.42 per share in the first quarter to $0.26 per share this quarter. As you recall, the net investment income from last quarter reflected certain non-recurring items, including significant non-recurring dividends from two of our equity investments. This quarter's net investment income primarily reflects the impact of our de-levered balance sheet, which Jeff will discuss in more detail.

[Bilal Rashid, President, CEO and Chairman of the Board at OFS Capital Corporation]

That being said, we are focused on increasing our net investment income, primarily by converting certain non-interest-earning equity positions into interest-earning assets, as we mentioned on our last call. In that regard, we are continuing to explore alternatives for our minority equity investment in Pfanstiehl, our largest equity position. The fair value of the position rebounded this quarter, appreciating by $7.8 million to $70.8 million at quarter end. The improvement in value is in part attributed to an upswing in fundamental performance following a recent trough. As a reminder, this is a position we invested in more than 10 years ago at a modest cost of only $200,000. To date, we have received approximately $3.4 million in distributions, or approximately 16 times our cost.

[Bilal Rashid, President, CEO and Chairman of the Board at OFS Capital Corporation]

Turning to our portfolio, we believe it is well positioned for the current macroeconomic environment. 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, healthcare, wholesale trade, and business services. Another key part of our investment discipline is investing higher in the capital structure, with approximately 100% of our loan portfolio at fair value in first lien and second lien senior secured loans. In terms of new originations, M&A activity remains subdued, though we anticipate an increase in activity later in the year as we get more clarity on interest rates. In the meantime, we remain active in supporting our existing portfolio companies. In our view, our financing continues to benefit our company.

[Bilal Rashid, President, CEO and Chairman of the Board at OFS Capital Corporation]

At the end of the second quarter, 100% of our outstanding debt matures in 2026 or later, and 72% of our outstanding debt is unsecured. Our non-recourse $150 million senior loan facility with BNP Paribas matures in June 2027. Our corporate line of credit is flexible, with no mark-to-market provisions. As we have discussed before, we locked in $180 million of fixed-rate unsecured debt in 2021, bearing a weighted average coupon of 4.8%, which is notably lower than current market pricing. As we navigate this market environment, we have confidence in the experience of our advisor, which manages approximately $4 billion across the known 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.

[Bilal Rashid, President, CEO and Chairman of the Board at OFS Capital Corporation]

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.

[Jeff Cerny, CFO and Treasurer at OFS Capital Corporation]

Thanks, Bilal. Good morning, everyone. As Bilal mentioned, we posted net investment income of $0.26 per share for the second quarter, which was down from the first quarter, primarily due to two factors. First, we received certain non-recurring dividends in the first quarter from a couple of equity investments, and second, we continued to delever our balance sheet, resulting in a smaller asset base. Our GAAP leverage ratio has decreased from 1.87 times at December thirty-first to 1.62 times at June thirtieth. Our current distribution rate represents a 15.3% annualized yield based on the price of our common stock at quarter end. We also announced that our quarterly distribution will remain at $0.34 per share for the third quarter. We are keenly focused on improving net investment income and once again exceeding our distribution rate.

[Jeff Cerny, CFO and Treasurer at OFS Capital Corporation]

As Bilal discussed, we are actively exploring alternatives to monetize some non-interest-bearing investments, specifically our minority equity stake in Pfanstiehl, to increase our net investment income. Our net asset value per share increased by approximately $0.43 this quarter. This increase was primarily due to unrealized appreciation in certain segments of our investment portfolio, most notably our minority equity position in Pfanstiehl Holdings and certain CLO equity positions. We had no new non-accruals this quarter, and we believe the overall quality of the portfolio remains stable. 4.6% of our total investments at fair value were on non-accrual status at quarter's end. Turning to the income statement, total investment income was down approximately $3.1 million to $11.2 million this quarter.

[Jeff Cerny, CFO and Treasurer at OFS Capital Corporation]

This was largely due to the factors I previously mentioned, including the non-recurring dividends of approximately $2.4 million received in the first quarter, as well as the smaller asset base driven by repayments as we delevered the balance sheet. Our regulatory asset coverage ratio stands at 162% at quarter end. Total expenses were down 10.5% during the period to $7.7 million, primarily due to a decrease in interest expense related to our lower average outstanding debt balances from delevering activities I just mentioned, as well as the resulting lower base management and incentive fees. As I mentioned, net investment income was $0.26 per share for the second quarter.

[Jeff Cerny, CFO and Treasurer at OFS Capital Corporation]

In addition to our intentions to increase net investment income, we believe that our balance sheet positioning was beneficial this quarter, given that 92% of our loan portfolio at fair value is floating rate, while approximately 72% of our outstanding debt is fixed rate. 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. Turning to our investments, we believe the overall performance of our portfolio companies remains relatively stable compared to last quarter, despite this uncertain macroeconomic environment. We are committed to being senior in the capital structure and selective in our underwriting. We remain cautious about new originations, and M&A activity remains slow. We continue to work with our portfolio companies as they identify add-on opportunities for growth.

[Jeff Cerny, CFO and Treasurer at OFS Capital Corporation]

As of June 30th, we had $8.9 million in commitments under various credit facilities to fund investments to our portfolio companies. The majority of our investments are in loans, and approximately 100% of our loan portfolio at fair value was senior secured as of June 30th. Based on amortized cost as of quarter end, our investment portfolio was comprised of approximately 69% senior secured loans, 1% subordinated debt, 23% structured finance securities, and 7% equity securities. At the end of the quarter, we had investments in 68 unique issuers, totaling $398.2 million on a fair value basis. The weighted average performing investment income yield on the interest-bearing portion of the portfolio improved slightly to 13.4%, which is up about 0.4% quarter-over-quarter.

[Jeff Cerny, CFO and Treasurer at OFS Capital Corporation]

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, President, CEO and Chairman of the Board at OFS Capital Corporation]

Thank you, Jeff. In closing, we believe our portfolio remains solid with no new non-accruals in the quarter. We are focused on increasing net investment income in the coming quarters, specifically by pursuing the sale of certain non-interest-earning equity positions and redeploying the proceeds into interest-earning assets. Our focus remains on capital preservation, with approximately 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 $1.9 billion with a cumulative net realized loss of just 2.7% over the past 13 years, while generating attractive risk-adjusted returns on our portfolio.

[Bilal Rashid, President, CEO and Chairman of the Board at OFS Capital Corporation]

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 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+ years. Our advisor and affiliates are also strongly aligned with shareholders as they maintain an approximately 23% ownership in the company. With that, operator, please open up the call for questions.

[Operator]

At this time, the conference has concluded. Thank you for attending today's presentation. You may now disconnect.

Participants

Executives

• Bilal Rashid, President, CEO and Chairman of the Board
• Jeff Cerny, CFO and Treasurer
• Steve Altebrando, VP of Investor Relations