OFS Capital Corp (OFS) 2015 Q1 法說會逐字稿

Good morning and welcome to the OFS Capital first-quarter 2015 earnings conference call.

(Operator Instructions)

Please note this conference is being recorded. I would now like to turn the conference over to Steve Altebrando, please go ahead.

Thank you. Good morning, everyone, and thank you for joining us. With me today is Bilal Rashid, our Chairman and Chief Executive Officer; and Jeff Cerny our Chief Financial Officer and Treasurer. We issued a press release and Form 8-K with the SEC this morning announcing our first-quarter results. Both documents can be obtained under the investor relations section of our website, OFSCaptital.com. We plan on filing our 10-Q this afternoon.

Before we begin, please note 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 reflected 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 SEC. 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 could also be incorrect.

You should not place undue reliance on any of these forward-looking statements, OFS Capital undertakes no duty to update any forward-looking statement made herein. All forward-looking statements speak only as of the date of this call. A replay of this call will be available until May 18, 2015, beginning approximately two 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 OFSCaptital.com.

With that I'll turn the call over to our Chairman and Chief Executive Officer, Bilal Rashid.

Thank you, Steve. Good morning and welcome.

As you probably saw we issued a press release earlier this morning detailing our performance in the first quarter of 2015. We are pleased with our performance, which was a result of our focus on originating quality loans to middle-market borrowers, with the goal of increasing distributions to our shareholders. We continue to meet the growing need for capital within the capital constrained lower-middle-market. This is where we continue to see significant opportunity for investing in high-yielding assets while maintaining our underwriting standards.

We believe that the lower-middle-market provides us better pricing and stronger governance that will generate attractive risk-adjusted returns. OFS Capital's credit and sense of culture, it's thorough due diligence process, and its expertise in structuring transactions, give us an advantage in this important and underserved market segment. We expect to continue to originate effectively priced loans in the lower-middle-market with a focus on nonsponsored transactions.

Our net investment income for the first quarter was $0.28 per share compared to $0.15 per share in the first quarter of last year. Our adjusted net investment income per share for the quarter, a non-GAAP measure, was $0.29 per share. This adjustment was driven by a non-cash charge related to our voluntary reduction of our senior loan credit facility as we continue to reduce the size of that pool.

The growth in our net investment income was largely a result of an increase in the weighted average yield of our portfolio. While industry-wide spreads have tightened since the beginning of the year, the weighted average yield of our portfolio improved to 10.24% in the first quarter of 2015, compared to 9.56% in the fourth quarter of last year. This noteworthy improvement was due to a steady growth in the higher-yielding direct lending portfolio in our SBIC, and decrease in the lower yielding senior sub-loan portfolio.

As we mentioned on our last earnings call, we expect to reduce our exposure to lower yielding senior sub-loans and redeploy that capital in higher yielding direct loans. We expect to monetize the remaining pool of senior sub-loans as, and when, we need additional capital to [originate] our higher-yielding loans. We feel good about the credit quality of our portfolio. At the end of the first quarter, we had just one loan on non-accrual representing less than 1% of the fair value of our total assets. We had virtually no exposure to the oil and gas sector. Approximately 73% of the fair value of our portfolio were senior secured, and approximately 70% was floating rate.

We believe that OFS Capital's credit intensive culture and its expertise in structuring transactions has served us well so far. We have a highly experienced investment team with a hands-on approach to managing the portfolio and working with our borrowers. We continue to put an emphasis on companies with strong management teams, high values to entry, and strong free cash flow characteristics. We focus on avoiding highly cyclical and commodity-based industries. Our strong origination capabilities enable us to be more selective. The OFS Capital brand continues to be recognized in the marketplace for our ability to provide flexible capital and being responsive to the needs of our borrowers.

Our sourcing capabilities demonstrate the strength of our platform and our investment team's extensive experience and relationships in the middle-market. We continue to receive positive feedback from market participants, which has led to repeat business. Going forward our primary focus remains the same, to grow our earnings while being a conservative stewart of our shareholder's capital. As a 30% shareholder of the Company, the external manager is incentivized to do so. We believe that we have a winning combination of attractively priced assets matched with attractive long-term financing through our SBIC. Our outstanding full SBIC debentures, which totaled of $127.3 million as of March 31, 2015, have a fixed weighted average interest rate of 3.18% with no maturities until 2022.

In the coming quarters, we will continue to originate loans that meet our strict underwriting criteria, and we have access to sufficient resources to meet our annual origination targets. As of March 31, 2015 we have several potential sources of capital available to us. Number one, $23 million of capital available within our existing SBIC. Number two, $47 million of equity capital invested in our senior sub-loan portfolio that can be redeployed in high yielding investments. Number three, we have the ability to raise capital in the bank loan or the bond market, and we have an active dialogue with bankers and lenders in this regard. Lastly, our second SBIC license is under review, and we have been in dialogue with the SBA regarding our application. However, at this point we do not have any updates on the timing.

As you can see, we have several financing options available to us, and we are working diligently on each of those options to continue to execute our business brand of originating quality loans. As we have done so far, we will continue to finance the Company in a thoughtful manner. We will only raise additional capital if it is accretive to our shareholders. As a 30% shareholder of the Company, the external manager's interests are aligned with those of our shareholders. To summarize, I'm encouraged by OFS Capital's results in the first quarter of this year, but I'm even more excited about the opportunities ahead.

At this point I will turn the call over to our Chief Financial Officer, Jeff Cerny, who will provide more details on the financials. Upon the completion of Jeff's comments, I will follow-up with some concluding remarks, and then we will open up the lines for questions.

Turning to our first quarter results, our investment portfolio totaled $316.2 million on a fair value basis as of March 31, equating to 99.7% of cost. Looking at where the portfolio stood at March 31, the portfolio is comprised of 60 companies, including 26 in the SBIC fund. As a percentage of fair value at quarter-end, our investments were comprised of approximately 73% in senior secured loans, 20% in subordinated debt and 7% in equity. At March 31, the 60 companies in our portfolio were diversified across 19 industries. Our largest portfolio company accounted for 4.6% of the aggregate fair value of our portfolio. Our five largest investments accounted for approximately 22% of the portfolio's total fair value.

Our average investment in each portfolio company was $5.3 million at fair value, or 1.67% of the portfolio's total fair value. The weighted average yield to fair value was 6.8% on debt investments in our senior loan fund, and 12.1% on debt investments in our SBIC fund. The overall weighted average yield to fair value on our debt investments continues to move in a positive direction. It increased 68 basis points since last quarter, from 9.56% to 10.24%. The 68 basis point pickup in weighted average yield fair value, quarter over quarter, reflects the continued ramp-up in our SBIC fund and pay downs in our senior loan funds. On a fair value basis at March 31, the debt investments in the SBIC fund now represent approximately 64% of the overall debt portfolio, versus 60% last quarter.

As Bilal mentioned, our intention is to continue to fully ramp up our SBIC fund and redeploy capital from our senior loan funds into higher-yielding assets. Our one non-accrual investment was omitted from the weighted average yield for fair value calculation. At the end of the first quarter floating-rate loans comprise 70% of our loan portfolio. This is down from 73% last quarter largely driven by the growth in our SBIC portfolio. The SBIC portfolio includes certain unitranche and subordinated debt investments that tend to be structured with fixed rates. All of our floating-rate loans contain LIBOR floors. As I noted earlier, we had one non-accrual at March 31, Strata Pathology Services. It had a fair value of $713,000 and has been on non-accrual since the first quarter of 2013.

Moving on to deal activities. During the first quarter we closed five transactions with portfolio companies in an aggregate principal amount of $24.8 million. This included $18 million of investments in three new portfolio companies and $6.8 million of follow on investments in two portfolio companies. These investments included senior secured loans, subordinated loans, and preferred stock with approximately 92% constituting loan investments. We derived approximate $7.6 million in total investment income in the first quarter compared to $6.9 million in the fourth quarter.

This 10% improvement, quarter-over-quarter, was largely due to achieving a full quarter of interest income from investments closed during the fourth quarter, as well as, the new first-quarter investments, and a 68 basis point increase in the weighted average yield to fair value quarter-over-quarter reflecting our stated goal of shifting away from the senior loan fund. Approximately $1.9 million of the first quarters total investment income was derived from our senior loan fund, and $5.7 million came from our SBIC fund. The percentage of total investment income derived from the SBIC fund was 75% versus 67% in the prior quarter. Again, this highlights our efforts to optimize our portfolio into higher yielding investments.

Expenses total $4.9 million for the first quarter compared with $4.2 million for the prior quarter. The $700,000 increase in expenses was largely driven by our management fees returning to contractual levels, plus a seasonal increase in our administrative fee during the first quarter. It is important to note that there is a $430,000 non-cash write-off of deferred financing closing costs related to our voluntary commitment reduction of our senior loan fund debt facility, versus $665,000 last quarter. This reduction was initiated to eliminate fees on the unused portion of our line of credit that was not needed as we shrink the senior loan fund portfolio.

Net investment income for the first quarter was approximately $2.7 million, or $0.28 per share, which was unchanged from the prior quarter. Our adjusted net investment income was $2.8 million, or $0.29 per share, excluding the non-cash write-off of $430,000, but adding back $336,000 in additional incentive fees we would have paid in the absence of the write-off. We believe this adjusted net investment income of $0.29 per share, which is a non-GAAP measure, provides greater transparency and insight into our ongoing operations. We expect to continue presenting this non-GAAP adjusted net investment income amount in the future as we are likely to incur additional non-cash charges related to further reductions of our senior loan fund debt facility.

The facility reductions will be determined as we continue our efforts to shift our capital toward supporting higher-yielding investments. As of March 31, we had $1.3 million of deferred financing closing costs related to the senior loan fund debt facility on our books. The unamortized portion of the $1.3 million that remains upon the full repayment and cancellation of our senior loan fund debt facility, will be written off. For the first quarter we had a net increase in net assets resulting from operations of $3.2 million, or $0.33 per share, compared with $3.5 million, or $0.36 per share, for the fourth quarter.

Turning to our capacity to make additional investments, as of March 31, our existing SBIC fund had approximately $23 million in liquidity, which included $9 million in incremental SBA debentured borrowing capacity. As Bilal just described, we have several other liquidity options, including the redeployment of capital from our senior loan fund. Our goal is to prudently generate liquidity on a timeline that allows us to maximize our interest income, only selling lower yielding assets, or otherwise generating capital when we believe we can timely redeploy the cash.

With that I will turn the call back over to Bilal.

Thank you, Jeff.

To summarize, we continue to focus on growing the earnings of the Company. We will do so by originating quality assets, by financing those assets in a manner that is accretive to our shareholders. We will continue to focus on mitigating downside risk by adhering to our underwriting standards, and by a continued focus on portfolio management. I would like to reiterate that our core values remain the same, which are to put the interest of our shareholders first. As the largest shareholder of the Company, the external manager's interests are well aligned with those of our shareholders. The outlook for OFS Capital is exciting. The earnings of the Company have almost doubled over the last year, and we believe that we have a lot more run rate to grow our earnings.

Given our current balance sheet resources and access to additional capital, we have the dry powder to do so by originating quality higher-yielding assets. Our team has been working efficiently, and our reputation as a flexible capital provider to middle-market companies is growing. Overall I am pleased with the performance over the last year, but I'm even more excited about the future of our Company, it's growing market presence, the strength of our team and the continued success of our time-tested underwriting process.

With that, operator, please open up the call for questions.

(Operator Instructions)

Terry Ma, Barclays Capital.

Can you maybe just characterize the level of competition you guys are seeing in your SBIC loans when you go out to originate? And maybe talk about whether or not you're seeing other BDCs or other lenders.

Yes, with respect to the lower-middle-market, and especially the nonsponsored market, we are not seeing any more competition than we have seen in the past. I think this segment of the market that we believe is relatively insulated from the populace of the larger markets and certainly the traditional middle-market. With respect to competition from other BDCs, we see some competition from other BDCs, but I would say not from a vast majority of the BDCs. I think we see some competition from independent SBICs from time to time.

One of the reasons why we think this sector is so attractive, and we've been focusing on this sector, is that it is a clearly underserved sector, there's less -- relatively less competition in it and because of that we're able to get quite attractive returns, as you can see the average yield on that SBIC portfolio is almost close to about 12%. And we are getting more governance, stronger structures and leverage levels are almost the same as you would get on the larger middle-market in that sector. With those leverage levels you are getting returns that are several hundred basis points lesser than what you are getting in the lower-middle-market, which is broadly represented in our SBIC portfolio.

Got it, and what's the debt to EBITDA and interest coverage of your SBIC portfolio on a weighted average basis?

On a weighted average basis we're running in the mid-3s, the 3.45s or so. Interest coverage on a weighted average basis well over 2 times, but I don't have that number handy.

I know we touched on this last quarter. I guess you guys are leaning more toward higher-yielding loans and SBA loans. At any point could this be a portfolio that entirely consists of SBA loans and you get rid of the senior loan bucket? How are you guys thinking about that longer-term?

I think that certainly our expertise is in both the lower-middle-market, that actually originated loans, which are broadly represented in the SBIC, and the senior club loans, as we call them. I think at this point we are seeing very attractive opportunities in the lower-middle-market. I think we will continue to focus our origination efforts on the lower-middle-market, especially the loan sponsored part of the market, and deemphasize the senior club loan portfolio. So the mix is definitely going in the direction of more lower-middle-market and less, sort of, the traditional middle-market to senior club loans. It may be possible that the dominant majority, or essentially a very large part of the portfolio is lower-middle-market focused. It would depend on how things are going in both those markets.

Right now, as I mentioned, we are seeing very attractive opportunities in the lower-middle-market, and that plays to our strengths here because we have a competitive advantage in that part of the market; we've got long-term relationships there. It's harder to source those types transactions. It's also harder to underwrite those types of transactions. So we've got the expertise to do that, and so we want to continue to play on that strength. I think if you look at the combination of these higher-yielding assets combined with long-term fixed rate financing, as I mentioned on the SBIC, the old debentures, the average cost is 3.2% fixed rate, and these are very long-term financings. I think that's a very powerful combination, and we'll continue to play to that strength.

Got it. How do you manage them? I guess you think about the risk of the portfolio given these loans are to smaller companies. I think GDP was negative the first quarter, and how do you think about the risk at a higher-level when the economy -- or if and when the economy turns?

I would say that really the lower-middle-market companies, we don't have any data that would suggest that the lower middle-market companies are withstanding more risky than the traditional middle-market or the larger market companies, but I would say the majority of the differential between the spread in the lower-middle-market portfolio and the traditional middle-market portfolio is really because it's a much more underserved sector of the market. You have less competition here. It is harder to originate these types of transactions; you need a full origination team, and thankfully we have that.

If you look at the overall risk, as I mentioned, in the lower-middle-market you're getting, at least our experience has been that you're getting better covenants. The leverage is actually the same overall, if not better, than the larger middle-market, and so the structures are much more lender friendly. I think we're -- it's a sector where you need to have that expertise and not just have that expertise in this environment, but actually through several credit cycles and we certainly, as a manager, have that expertise and we've seen these companies perform over several credit cycles. We feel pretty good about the risk going forward on this, and I think, certainly, if we didn't feel comfortable with it, we wouldn't be going into it. We own, obviously, as a manager, more than 30% of the shares of the company. So our interests are certainly aligned with the shareholders here.

That is it for me. Thank you.

(Operator Instructions)

It looks like this concludes our question and answer session. I can turn the conference back over to Bilal 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 is now concluded. Thank you for attending today's presentation. You may now disconnect.