OFS Capital Corporation (NASDAQ:OFS)
Q2 2014 Earnings Conference Call
August 8, 2014 11:00 AM ET
Mary Jensen – VP, IR
Bilal Rashid – Chairman and CEO
Jeffrey Cerny – CFO
Terry Ma – Barclays Capital
Patrick Buckley – UBS
Good morning and welcome to OFS Capital Second Quarter 2014 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.
I would now like to turn the conference over to Mary Jensen, Vice President of Investor Relations. Please go ahead.
Thank you. Good morning everyone and thank you for joining us. With me today is Bilal Rashid, Chief Executive Officer and Jeffrey Cerny, our Chief Financial Officer. Please note, our earnings announcement was released this morning and can be accessed via the Investor Relations section of our website at ofscapital.com. We plan on filing our Form 10-Q later this evening. Before we begin, please note that the statements made on this call and webcast may constitute forward-looking statements, within the meaning of the Securities Act of 1933 as amended.
Such statements reflect various assumptions by OFS Capital 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 ways beyond management’s control including the risk factors described from time-to-time in our filings with the Securities and Exchange Commission.
Although we believe these assumptions are reasonable, any of these assumptions could prove to be 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. All forward-looking statements speak only as of the date of this call. A replay of the call will be available until August 18, 2014 beginning approximately two hours after we conclude this morning. Alternatively, the webcast will be available for the next 30 days. To access either replays, please visit our website at ofscapital.com.
With that, I’ll turn the call over to our Chief Executive Officer, Bilal Rashid.
Thanks, Mary. Good morning and welcome. As you probably know, this is the first quarterly earnings call for Jeff Cerny and me, since we assumed the leadership of OFS Capital last month. We appreciate your support and look forward to strengthening our relationship with all stakeholders. We hope that these calls will provide you with meaningful insights into our company. On this call, I will explain my vision for the company’s growth and provide insights into how we are progressing in the third quarter. After that, I will turn the call over to Jeff, who will discuss the second quarter results.
To begin, I would like to reiterate that our focus for OFS Capital remains the same, which is to grow our earnings by prudently increasing the origination of assets in our SBIC fund. Over the past couple of quarters, we have added resources to bolster our origination activities and have successfully integrated the SBIC fund into our investment platform. Our efforts are beginning to pay off. And the OFS brand is increasingly being recognized by middle market borrowers, who are rewarding us with flexible capital solutions. Borrowers are completing transactions with us, because of their confidence in our ability to close.
During the second quarter, we made three new investments in the SBIC fund that totaled $20 million. This total was an improvement compared to the first quarter, yet still below our target of an average of 30 million per quarter. We have seen an increase in the number of deals that fit our underwriting criteria, as well as an increase on the number of deals that have progressed from our pipeline into our portfolio. Looking ahead, we have begun to see some encouraging interim results since the close of the second quarter. Thus far, in the third quarter, we have already closed approximately 26 million in new investments in the SBIC fund. Jeff will provide more details on these transactions shortly.
As we grow our portfolio, we continue to adhere to our longstanding underwriting standards and our careful portfolio construction. Today’s results were boosted by the decision of our external manager to reduce its fee by half for this calendar year. As the largest shareholder, the external manager continues to demonstrate that its interests are aligned, with the interest of all of our shareholders. As Jeff is about to explain, and I will have additional comments afterwards, real progress has been made. And there is a renewed sense of urgency, to execute on our business plan and I feel confident in our ability to do so.
With that, I turn the call over to our Chief Financial Officer, Jeff Cerny.
Thanks, Bilal. Before I discuss our earnings, I would like to mention that Bilal and I have worked together since 2008 as partners as the advisor and our relationship goes back several years before that. We share a common vision for the company as Bilal just described and we are confident that we will improve the performance of OFS. I have a credit background in longstanding relationships in the investment community that go back decades. As CFO, I expect to not only have leadership and value in traditional areas like financial reporting, treasury and strategic decisions, but also to make a significant contribution on the deal sourcing side of the business. Since I became more involved in the pipeline and deal flow earlier this year, I have taken an active role in meeting and talking to our investment side relationships to increase deal flow and make sure we maximize the outcome of our investment opportunities.
Turning to our second quarter results, our investment portfolio totaled $230.7 million on a fair value basis as of June 30, equating to 97.3% of costs. The portfolio was comprised of 57 companies, 45 in the senior loan fund and 12 in the SBIC fund. At quarter end, our investments were comprised of senior secured debt investments in 55 borrowers, with an aggregate fair value of up to $213.4 million, subordinated debt investments and two borrowers, with an aggregate fair value of $9.1 million and equity investments in eight of the SBIC funds 12 portfolio companies, which has an aggregate fair value of $8.2 million. At June 30, with 57 companies in our portfolio were diversified across 19 industries. Our largest portfolio company investment accounted for 5.1% of the aggregate fair value of our portfolio. Additionally, our five largest investments accounted for just under 18% of the portfolio’s total fair value at June 30th.
Our average portfolio company loan size was approximately $4.1 million at June 30th and the weighted average yield to fair value on our debt investments was 8.1%, including 6.9% on debt investments in our senior loan fund and 11.2% on debt investments in the SBIC fund. During the quarter, Tangible Software was omitted from the weighted average yield to fair value calculation, due to its non-accrual status in June. In addition, a number of our senior loan fund portfolio companies were reprised downward, which was a continuing trend from the first quarter. We are seeing a trend early in the third quarter indicating a potential decline in repricing events. However, the leverage loan market including the middle market still remains competitive. At the end of the second quarter, floating rate loans comprised 84% of our loan portfolio. All of our floating rate loans contain LIBOR floors.
We had two non-accruals at June 30th. Our debt investment in Strata Pathology which had a fair value of $700,000 compared to approximately $1 million at March 31, 2014, and has been our non-accruals since the first quarter of 2013. And Tangible Software that had a fair value of $6 million compared to approximately $6.4 million at March 31, 2014 and was placed on non-accrual status in June of this year. Tangible has made all of its cash interest payments to-date however we have reason to believe we may not be able to collect our full principal interest amounts related to this loan. We are actively monitoring this loan and are deploying all of the necessary resources to maximize its repayment.
Moving on to deal activity, during the second quarter, we closed three new debt investments in our SBIC fund, with an aggregate principal amount of $20 million. These investments were all floating rates senior secured debt investments. So far this quarter, we are pleased with the amount of traction we have gained. We have closed investments totaling approximately $26 million. The yields range from 9.75% to 14.5% on the debt investments with one small equity investment of $350,000.
Going forward, we continue to remain focused on meeting or exceeding our target of $30 million on average on the quarter on the SBIC fund. We derived approximately $4.7 million in total investment income from our portfolio in the second quarter of this year compared with $5 million in the first quarter of this year. The decline was largely due to prepayments and amortization in the senior loan fund which in some cases occurred prior to the funding of the new SBIC fund investments and spread compression.
Approximately $2.8 million of this quarter’s total investment income was derived from our senior loan fund and $1.9 million came from our SBIC fund. Expenses totaled $2.6 million for the three months ended June 30th compared with $3.6 million for the prior quarter. The reduction in expenses was largely driven by the investment advisors, voluntary reduction of its base management fee as previously discussed. Administrative expenses were also down due to the onetime bonus expenses paid in the first quarter and professional fees were down primarily due to the completion of the drop down and integration of the SBIC fund into OFS Capital. Net investment income for the second quarter was $2.1 million or $0.22 per share, compared to $1.4 million or $0.15 per share in the first quarter of 2014. During the second quarter, we recorded $1.5 million net unrealized loss on investments which was primarily driven by spread based fair value changes as well as unrealized losses in connection with the two non-accrual loans previously mentioned.
For the three months ended, June 30th, we had an increase in net assets of $6 million or $0.06 per share compared with $2.1 million or $0.21 per share for the three months ended March 31st. In July 2014, we amended our senior loan funds credit facility pursuant to what’s the calculation of the based with the adjusted and the minimum equity requirement was lowered, $50 million to $35 million resulting in an additional liquidity for OFS Capital. In addition, the maximum facility was reduced from the $135 million to $125 million, no financing costs were incurred in connection with this amendment.
Also, in July, OFS Capital funded the remaining $13.6 million of its $75 million commitment into the SBIC fund, which results in access to the full $150 million of SBA debentures subject to proper approval and customary procedures at the SBA. Upon final approval, the access to full $150 million on SBA debentures, we have capacity to make investments in the SBIC fund of approximately $128 million, which includes $112 million of incremental SBA debenture borrowing and approximately $16 million of cash and cash equivalents.
With that, I’ll turn the call back over to, Bilal.
Thank you, Jeff. To summarize, there has been an acceleration in the number of deals completed in our SBIC fund, both in the second quarter and thus far in the third quarter. Overall, OFS Capital is well positioned and we are working smarter and better at sourcing, evaluating, structuring and closing transactions. To be clear, there is work ahead to fully realize our full potential. However, I’m confident in our ability to grow our earnings by prudently increasing the origination of assets in our SBIC fund.
Operator, please open the call for questions.
Thank you. [Operator Instructions]. Our first question comes from Terry Ma with Barclays. Please go ahead.
Terry Ma – Barclays Capital
It seems like your originations have been picking up relative to the last couple of quarters. So can you may be just talk more specifically about what resources you have added to your sourcing capabilities, mainly more broadly about what you guys have made to your origination strategies since taken over?
I think we’ve been adding personnel some marketing and origination personnel to our roster. So that’s one of the changes that we have made. The other aspect to be increase in origination as I mentioned, in my prepared remarks, OFS name is getting recognized more and more in the market. So the number of deals that fit our investment criteria has been increasing over time. So, I think that had made the process of origination much more efficient for us.
I think the other change that we have made we have streamlined the process of evaluating, transactions since we’ve taken over. And so the proportion of transactions where we have signed term sheets to the closing of the transactions that proportion has increase over time as well. So we are working harder to on the marketing side, go from taking a loan from the pipeline to the closing we’ve added resources as I mentioned on the marketing side personnel resources. We also added technology resources on our side and also as the name is getting recognized in the market, the deals that we are reviewing that fit our criteria the number of those deals is actually increasing over time.
Terry Ma – Barclays Capital
Okay, got it. Can you may be give a little more color on may be the yield or returns on the SBIC assets that you’ve originated quarter to-date? And what’s that relative to your 11.2% in the book right now?
So I think Jeff can answer that question.
Yes. So the investments that cracked three new investments and two add-on investments, add-ons are relatively small to send three centers Malabar and two add-ons we have three investment range, add-ons. Then we have three investments and the yield range exceeds 11.2%. We’ve got a range from about 9.75% to 14.5% and there’s one asset that has 2.5% of that 14.5% is picked.
Terry Ma – Barclays Capital
Okay, got it. So I think most shareholders appreciate the reduction in the management fee. Has the board considered may be realigning the dividend at least temporarily until you guys can earn it?
As you’ve seen, we’ve been reducing the gap between our earnings and our dividend. Now most of that has come through the deduction in management fees. We believe that as we increase the origination activity in the SBIC, that gap will continue to narrow. And the earnings… We expect that earnings will catch up to the dividend that we are paying out. So we are, the board considers the pay out of the dividend every quarter and I think it would make that decision at the right time. So our next quarter but our strategy here really is to roll out earnings so we can meet our dividend as opposed to cutting our dividend at this time.
Terry Ma – Barclays Capital
Okay, got it. That’s it for me. Thanks.
Our next question comes from Patrick Buckley with UBS.
Patrick Buckley – UBS
Thank you, gentlemen. Congratulations on the quarter. I just wanted to see if you can follow up on the question about yields. Noticed that over the past two quarters yield has gone down by 20 basis points per quarter about 8.53 fourth quarter is down to 8.08 this quarter. Does it seem that it’s a bit much for that to be a function of turnover or lower yields on new investments? Could you shed some light on what’s happening?
There is slight compression, re-pricing amendments that we’ve experienced in our loans as I discussed. Also, the Tangible Software which we put our non-accrual in at the end of June was a minute from our calculation and that exceeded the way that average amounts so that reduced somewhat and some of the assets that were grew up in the second quarter is you’ll see yields were little bit below the average. So I think they are the primary three factors.
Patrick Buckley – UBS
And could you offer any expectations about what might happen, spread compression on new investment anything like that?
So far as I mentioned in the third quarter, we have actually seen very limited repricing amendments so we’re optimistic although I’ll caution that the market remains competitive especially in some of the selective larger deals. And the deals that we have booked quarter to date of approximately $26 million only $5.5 million were actually below and the other 20 plus million was in excess of the weighted average in the SBIC funds. So I would think at least the assets that we booked quarter to date I would say exceed that weighted average.
Patrick Buckley – UBS
Thank you. That’s been very helpful. We wish the management team best of luck going forward.
I appreciate it.
[Operator Instructions]. I’m showing no further questions. This concludes our question-and-answer session. I’d now like to turn the conference back over to Bilal Rashid for any closing remarks.
Thank you all for joining us along today and for your questions. We look forward to speaking with everyone again on our next call. Operator you may now end the call. Thank you.
The conference has now concluded. Thank you all for attending today’s presentation. You may now disconnect.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!