OFS Capital Corp (OFS) 2014 Q2 法說會逐字稿

Good morning and welcome to the OFS Capital second-quarter 2014 earnings conference call.(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 today. With me today is Bilal Rashid, Chief Executive Officer, and Jeff 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 10-Q later this evening.

Before we begin, please note that 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 guaranteed to 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 those 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 put 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 this call will be available until August 18, 2014, beginning approximately 2 hours after we conclude this morning. Alternatively, the webcast will be available for the next 30 days. To access either replay, please visit our website at ofscapital.com.

With that, I will 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 insight into our Company.

On this call, I will explain my vision for the Company's growth and provide insight 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 for 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 in 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 long-standing 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 interests 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 at 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 and long-standing relationships in the investment community that go back decades. As CFO, I expect to not only add 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 ensure 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 cost. 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 $213.4 million; subordinated debt investments in 2 borrowers with an aggregate fair value of $9.1 million, and equity investments in 8 of the SBIC fund's 12 portfolio companies, which had an aggregate fair value of $8.2 million.

At June 30, the 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 5 largest investments accounted for just under 18% of the portfolio's total fair value at June 30.

Our average portfolio company loan size was approximately $4.1 million at June 30, 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 nonaccrual status in June. In addition, a number of our senior loan fund portfolio companies were repriced 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 amendments. However, the leveraged 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 nonaccruals at June 30: 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 on nonaccrual since the first quarter of 2013; and Tangible Software which had a fair value of $6 million compared to approximately $6.4 million at March 31, 2014, and was placed on nonaccrual 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 and 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-rate 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 per quarter in 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 pre-payments 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 30, 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 one-time 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 approximately $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 a $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 nonaccrual loans previously mentioned.

For the three months ended June 30, we had an increase in net assets of $0.6 million or $0.06 per share, compared with $2.1 million or $0.21 per share for the three months ended March 31. In July 2014, we amended our senior loan funds credit facility, pursuant to which the calculation of the borrowing base was adjusted and the minimum equity requirement was lowered from $50 million to $35 million, resulting in additional liquidity for OFS Capital.

In addition, the maximum facility was reduced from $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 resulted in access to the full $150 million in SBA debentures, subject to proper approval and customary procedures at the SBA.

Upon final approval to access the full $150 million in 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 will 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 am 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.

(Operator Instructions) Terry Ma, Barclays.

So it seems like your originations have been picking up relative to the last couple of quarters. So can you maybe just talk more specifically about what resources you have added to your sourcing capabilities? Maybe more broadly about what changes, if any, you guys have made to origination strategy since taking over?

Yes, so I think we have been adding personnel. We have been adding some marketing and origination personnel to our roster. So that is one of the changes we have made. The other aspect to the increase in origination is, as I mentioned in my prepared remarks, the 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 has made the process of origination much more efficient for us.

And I think the other changes we have made is we have streamlined the process of evaluating transactions since we have taken over. And so the proportion of transactions where we have signed term sheets to the closing of the transactions, that proportion has increased over time as well. So we are working harder to go from taking the loan from the pipeline to the closing.

We have added resources, as I mentioned, on the marketing side, personnel resources. We have 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.

Okay, got it. And just can you maybe give a little more color on maybe the yield or returns on the SBIC assets that you have originated quarter to date? And what is that relative to the 11.2% in your book right now?

So I think Jeff can answer that question.

So the quarter-to-date investments, we've got three new investments and two add-on investments. The add-ons are relatively small to Sentry Centers and Malabar, were the two add-ons, and then we have three new investments. And the yield range exceeds the 11.2%. We have got a range from about 9.75% to 14.5%. And that is -- there is one asset that has 2.5% of that 14.5% is PIK.

Okay, got it. So I think most shareholders appreciate the reduction in the management fee. Has the Board considered maybe realigning the dividend, at least temporarily, until you guys can earn it?

You know, we're -- as you've seen, we have been reducing the gap between our earnings and our dividend. Now most of that has come through the reduction 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 payout of the dividend every quarter, and I think it will make that decision at the right time for next quarter. But our strategy here really is to grow our earnings so that we can meet our dividend, as opposed to cutting our dividend at this time.

Okay, got it. That is it for me. Thanks.

Patrick Buckley, UBS.

Thank you, gentlemen, and congratulations on the quarter. I just wanted to see if we can follow up on the question about yield. I noticed that over the past two quarters, yield has gone down about 20 basis points per quarter. It was about 8.53% fourth quarter, is down to 8.08% this quarter. It doesn't -- seems like that is a bit much for that just to be a function of turnover or the lower yields on new investments. Could you shed some light on what is happening?

The reduction in yield, there is some spread compassion, repricing amendments that we have experienced in our senior loan fund, as I discussed. Also the Tangible Software which we put on nonaccrual at the end of June was omitted from the calculation and that exceeded the weighted average amount, so that reduced it somewhat.

And some of the assets that were booked in the second quarter, as you will see when we file the Q, the yields were a little bit below the average. So I think those are probably the three primary factors.

And could you offer any expectations about what might happen; further spread compression on new investments, anything like that?

So far as I mentioned in the third quarter, we have actually seen very limited repricing amendments. So we are optimistic, although I'd caution that the market remains competitive, especially in some of the slightly larger deals. On the deals that we've booked quarter to date, of the approximately $26 million, only about $5.5 million were actually below, and the other $20 million plus was in excess of the weighted average spread in the SBIC fund. So I think at least the absence we've booked quarter to date, I would say, exceed that weighted average.

Thank you. That has been very helpful. We wish the new management team the best of luck going forward.

Thank you.

I really appreciate it.

(Operator Instructions). I am showing no further questions. This concludes our question-and-answer session. I would now like to turn the conference back over to Bilal Rashid for any closing remarks.

Thank you all for joining our call 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 for attending today's presentation. You may now disconnect.