OFS Capital Corp (OFS) 2016 Q1 法說會逐字稿

Good day and welcome to the OFS Capital Corporation Q1 2016 earnings conference call and webcast.

(Operator Instructions)

Please note this event is being recorded.

I would now like to turn the conference over to Mr. Steve Altebrando, 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, our Chairman and Chief Executive Officer, and Jeff Cerny, our Chief Financial Officer and Treasurer.

Please note that we issued a press release this morning announcing our first-quarter results. This press release was subsequently filed on Form 8-K with the SEC. Both documents can be obtained under the investor relations section of our website at ofscapital.com.

Before we begin, please note that the statements made of 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 SEC. 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 could also be inaccurate.

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.

Our comments may reference adjusted net investment income, a non-GAAP measure. Please refer to our earnings press release for a reconciliation.

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

Thank you, Steve. Good morning and welcome.

The first quarter of 2016 gave us a solid start to the year, with continued increases in net investment income and net asset value compared to the first quarter of last year. Applying our strict underwriting standards, focusing on the credit quality of our portfolio, and diligently sourcing new investments has enabled us to prudently grow our business in a market environment that has been somewhat challenging.

Specifically, our net investment income increased to $0.38 per share compared to $0.28 in the first quarter of last year. Our adjusted net investment income, a non-GAAP measure, was $0.36 per share compared to $0.29 in the year earlier period. This growth was mainly due to an increase in the weighted average yield on the portfolio as we continue to shift towards the lower middle market.

Our adjusted net investment income per share has exceeded our distribution for four consecutive quarters, and was 113% of our distribution. Our net asset value was relatively stable at $14.65 per share compared to $14.76 per share in the prior quarter, and up from $14.24 per share at March 31, 2015.

We credit our stable net asset value to the strength of our underwriting standards and the alignment of interests between the shareholders of the BDC and our external manager, which owns more than 30% of the Company. In the first quarter, we realized a gain of approximately $2.6 million, or $0.26 per share related to a warrant position in a portfolio company called HealthFusion. This marks the third quarter over the past year that we have had a significant realization on a warrant.

We have just one loan on nonaccrual at the end of the quarter, representing less than 1% of the portfolio at fair value. Since the beginning of 2011, we have invested $618 million and had a cumulative net realized loss of just $600,000, which is less than 1/10 of 1%.

We will continue to focus on the underserved lower middle market, especially in the nonsponsored segment. Given our long-standing relationships and track record in the non-sponsored segment of the market, we foresee continued opportunity to generate strong risk adjusted returns in that part of the market.

We believe that OFS Capital benefits from the strength of our external manager, which has a $1.85 billion credit platform, and has weathered multiple credit cycles since its inception in 1994. Our team has the size and breadth of expertise across all parts of the leverage loan market, and this provides us considerable capital markets intelligence, as well as expertise across industries.

On our last call in March, we mentioned a lower amount of deal flow in the first two months of 2016, which in part was related to seasonal factors. Given our focus on selectivity and a cautious approach to investing, we did not deploy a significant amount of capital in the first quarter.

Given recent repayments and lighter investment activity early in the year, we expect second-quarter net investment income to be below the first quarter. However, we expect our net investment income to continue to grow over time, given the amount of capital we have at hand, and the attractive long-term financing we have in place already.

We have seen an improvement in our deal flow. Typically there is a two- to three-month lag to close deals. We will continue to rely on our team's long-standing sourcing relationships, which allow us to see a broad array of potential transactions and to be highly selective in making investments.

Although we are committed to growing our originations, as always, we remain highly selective and cautious. We believe our singular focus on credit quality has led to long-term stability in our net asset value, low loan accruals, and strong investment track record. Overall, our investment capacity and the strength of our balance sheet puts us in a strong position.

Looking ahead, we will continue to focus on what has benefited shareholders most over the past several quarters. One, maintaining our strict underwriting standards: this has resulted in low loan accruals and in avoidance of portfolio companies in the highly cyclical oil and gas sector. Two, being responsive to our borrowers' needs by providing flexible capital solutions: this has led to repeat business, a reputation as a reliable partner, and ultimately good quality deal flow. Three, always focusing on the best risk adjusted returns for the long term: in terms of investment capacity, we have significant capital resources on hand, and several additional sources to raise new capital, to grow net investment income, and our distribution.

As of the end of the first quarter we had: number one, $42 million in cash. Number two: $20 million invested in the senior club loan portfolio that can be redeployed in higher yielding investments. Number three: an untapped $15 million revolving credit facility. Number four: the ability to raise additional capital in the bank loan or the bond market.

As a reminder, SBIC debt does not count towards the BDC leverage test. So we have not tapped any of our available statutory leverage. Number five, our second SBIC license was submitted last year. If approved, we would have access to additional capital in SBA debentures.

We do not have an update regarding its timing and status, but we continue to have an ongoing dialogue with the SBA as our portfolio continues to perform. We will continue to work hard to generate long-term value for our shareholders through strong current cash flows and stability in the value of our portfolio.

As we have done so far, we will continue to finance the Company in a thoughtful manner and only raise additional capital if it is accretive. We have $150 million in fixed-rate SBA debentures with a weighted average coupon of 3.18% with no maturities until 2022. Our portfolio is positioned to benefit from a meaningful increase in interest rates if and when that were to happen. A majority of our loan assets are floating rate, while our debt is 100% fixed rate.

At this point, I will turn the call over to Jeff Cerny, our Chief Financial Officer.

Thank you.

We are pleased with our first-quarter results. As Bilal just mentioned, we continue to focus on the credit quality and stability of our portfolio. We have 30% of our net asset value in cash, and the potential to borrow additional capital.

As you probably know, our only debt is long-term fixed rate SBA debentures with a weighted average coupon of 3.18%. This debt does not count towards our leverage test. It gives us flexibility and room to grow our net investment income even in a tough equity capital raising environment.

Turning to our portfolio, this quarter we had investments in 36 companies totaling $245.4 million on a fair value basis, equating to 100.5% of cost. The debt portfolio is at 98.4%, and the equity portfolio is at 116.8% of cost. The fair value of our loan portfolio declined slightly, primarily due to widening credit spreads, in particular in the larger second-lien market.

As a percentage of fair value, our investments were approximately 61% senior secured loans, 26% subordinated debt, and 13% equity. As a percentage of cost our equity investments were just under 11%. More than one third of these equity investments have contractual coupons attached to them.

Our average investment in each portfolio Company was $6.8 million at fair value, or 2.8% of the total portfolio. The overall weighted average yield to fair value on our debt investments continues to move in a positive direction. It increased 33 basis points since last quarter to 12.34%.

At the end of the quarter, 61% of our loan portfolio had floating rate coupons. Non-accruals consist of a single loan, Phoenix Brands, with a principal balance of less than $1 million, and a fair value of $743,000. This loan went on nonaccrual during the third quarter of 2015.

We derived approximately $7.8 million in total investment income in the first quarter, compared with $8.9 million last quarter. This quarter-over-quarter decrease was largely due to a decline in the acceleration of original issue discount, and a decrease in prepayment fees due to several investments being repaid in the prior quarter.

Expenses totaled $4.2 million for the quarter compared with $4.6 million for the prior quarter. The $400,000 decrease in expenses was largely driven by a decline in the incentive fee expense due to lower net investment income, and a decrease in administrative fees. Net investment income for the quarter was approximately $3.7 million, or $0.38 per share, which decreased compared to the prior quarter's net investment income of $0.44 per share.

On an adjusted basis, which is a non-GAAP measure, first-quarter net investment income was $0.36 per share, which exceeded our distribution of $0.34. As Bilal previously mentioned, we have fully covered our distribution on this basis for four consecutive quarters.

As far as deal activity, during the first quarter we closed transactions in two portfolio companies with an aggregate invested amount of $6.7 million. We have the ability to execute on our investment strategy with approximately $42 million of cash, $20 million remaining in lower yielding assets, and the potential to borrow significant additional capital.

We continue to prudently deploy capital and generate liquidity on a timeline that allows us to maximize our interest income. We intend to sell lower yielding assets or otherwise raise capital when we believe it is accretive and can be deployed in a timely manner.

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

Thank you, Jeff.

We are pleased with our start of 2016 with a strong first quarter. Our results demonstrate the strength of our investment platform, and our increased brand awareness among borrowers. Our investment track record has been solid and our net asset value has been stable.

This highlights the strength of our underwriting capabilities and the long-term alignment of interest between the shareholders of the BDC and our external manager. OFS Capital has strong value-added origination capabilities. Our focus has been to deliver capital to the lower middle market, especially to the nonsponsored community.

This underserved segment requires specialized expertise and a network of relationships. This is where we continue to find attractive risk adjusted returns, compared to other parts of the middle market. Our team's underwriting expertise and sourcing relationships have allowed us to successfully participate in that part of the middle market.

In terms of our balance sheet, we have attractive long-term fixed rate financing through the SBIC program that positions us well for an expected increase in interest rates. And, we have sufficient capital available to take advantage of opportunities in the market.

OFS capital remains committed to providing long-term value to all its stakeholders, including both shareholders and borrowers. As a lender, we remain focused on being responsive to the needs of our borrowers by providing them flexible capital solutions. We think this goes hand-in-hand with creating value for our shareholders.

With that, Operator, please open the call for questions.

Thank you. We will now begin the question and answer session.

(Operator Instructions)

Today's first question comes from Mickey Schleien of Ladenburg. Please go ahead.

Yes, good morning Bilal and Jeff. My first question relates to the health of your borrowers, because we're seeing very mixed signals in the more liquid markets. We saw weak jobs report number today. And generally speaking if you look at sort of the performance of S&P 500 companies, earnings are confronting headwinds related to slowdowns abroad and maybe the strong dollar and things like that.

But we haven't seen that trickle down yet into the middle market. And I'm trying to understand why we haven't seen that. And do you have a thesis on that? And when you expect perhaps a slowdown to be more evident in the metrics, whether it's revenue or EBITDA for middle market borrowers?

Yes Mickey, hi, this is Jeff.

We would agree that the lower middle market has been a little more insulated from some of these trends. We remain in very close contact with our borrowers. We think that the structures and the covenants in our particular loans allow us to head off issues sooner rather than later with respect to credit.

The overall leverage in our portfolio remains, and this includes the senior and the sub through the lowest tranche under four times. So I think, while each credit and company is different, I would say on an overall basis as we look at the performance of our portfolio and the underlying companies from a top line and EBITDA perspective, we've been pretty stable.

Okay. Thanks for that information.

And just one follow up. Can you remind me when you applied for the second SBA license?

Yes. We applied for that in the first quarter of last year.

So we're a year into the process. And my question, Bilal, usually the second license gets approved in the neighborhood of six months, maybe nine months. So you know, from our perspective it appears there is some sort of issue.

Is there any color you can provide whether it's the SBA concerned, or wants to see how the portfolio performs with the change in management a while back? Or is there something else that's stopping them from giving you that second license?

Yes, I mean that I think that there are times, I believe, where the second SBIC licenses have come in earlier. But, we continue to be in dialogue with the SBA. We provide them quarterly information on the portfolio. The portfolio performance, as you know has been very good. So we've been quite good about it.

So I think from our standpoint, although it has been more than a year, we continue to have a very positive dialogue with the SBA, and have been providing them with all the information as it relates to progressing on the second SBIC license. You know having said that, I should just step back from there. Although we're working very, very diligently to get the second SBIC license and we -- as I mentioned we have a good relationship with the SBA, I would say that our business plan is not dependent on getting the second SBIC license.

As I mentioned earlier on, we have significant amount of cash that we are sitting on. We also have some low yielding loans where we can monetize. We have a credit facility that we have. In addition to that, we can tap the bank loan market for a bigger credit facility. We also have the bond market that we can tap into.

So, although -- I would say that it's been more than a year since we applied for the SBIC license. And we, having said that, that process, we continue to have a dialogue with the SBA. It's -- and provide them with all the information that they need.

I would say that we have several financing options available to us as well. So, we will continue with our investment strategy and our business plan regardless.

Okay. I understand.

Just one more follow-up if I may. Has there been any delay on OFS's behalf in responding to comment letters you receive from the SBA?

No. I mean, we -- no, we continue to provide them with the information that we are requested, that is requested from us. And so I would say no to that.

Okay. Thank you for your time. Those are all my questions.

Thank you.

And our next question comes from Terry Ma of Barclays. Please go ahead.

Hello. It sounds like deal flow has picked up a little bit in the second quarter relative the first quarter, but it still -- it sounds like it's a lot lower than you were expecting. Can you maybe just talk about what's driving that, and also the pricing in the level of competition you're seeing in the market right now?

Yes, I think the deal flow as we mentioned on our call about six or so weeks ago, back in March -- you know, I think the -- it's -- in our opinion a lot of it has to do with the seasonal factors. Q1 tends to be a little bit lower in general. And as we mentioned, it's -- the deal flow has improved since the first couple of months of the year.

And we have several term sheets that are out there, and as you mentioned, there's generally a two- to three-month lag to close these transactions. And there are several -- there are some transactions that don't get to the final closing. But I would say that -- I would attribute a lot of the slowness to seasonal factors in Q1.

And having said that, the deal flow is, you know, picking up now. There is also a lag between originations and earnings. But over time we feel very, very good about the ability for us to grow our net investment income and we have no reason to believe that the deal flow will not be good going forward from here.

In terms of pricing I would say the competition within our market, within the lower middle market especially, the loan-sponsored part of the market, I think it hasn't changed dramatically. So, that is one of the reasons why we like this part of the market.

So I think we don't see the types of pricing pressures that you see sometimes in the broader market. So I would say from a yield standpoint we -- you know, we believe that it will be stable -- relatively stable.

Okay, got it. And can you just talk about dividend policy? I think you guys have said you covered the dividend last few quarters. At what point would you -- would the Board feel comfortable increasing the dividend, if at all?

Yes that's a good question. We have actually, you know, been having the dialogue with the Board on that matter. And I think it's hard to pin down the timing here.

But you know, we take it -- we take that seriously. So we don't have any specific timing on that, but it is certainly something that we are -- that we will consider very seriously going forward.

Okay, got it. And just a couple housekeeping questions.

Can you give us a sense of the level of repayment going forward the next couple quarters? And also on the $6.7 million of interest income, how much accelerated OID was in there?

As far as pre-payments in the portfolio going forward, it's obviously a little bit difficult to predict. I mean that does -- you know, sometimes you have very strong quarters and very weak quarters.

I mean, see I really hate to throw out a number on that. As far as the NII -- and you asked what amount related to OID accelerations and amendment fee accelerations?

Yes.

(Multiple speakers). Yes, accelerated OID was a little over $100,000.

Okay. All right. Thank you.

Thank you.

(Operator Instructions)

Our next question comes from Christopher Testa of National Securities Corp. Please go ahead.

Hey, good morning, Bilal and Jeff. How are you?

Morning.

So, given the volume that's been a little light, and that seems to be the theme across the lower middle market. Just wondering if you had obtained the SBIC license, the second license already, were there deals that you passed on during the first quarter that would have only fit into the SBIC? Could that be something that could potentially drive volume if and when you are granted the second license?

Yes Chris, this is Jeff. No, I mean, there are -- it's rare for a deal to only fit into the SBIC. I'd say it's actually the other way where it might not fit into the SBIC, so we'll take it into the BDC.

We've got sufficient capital, as Bilal described. And we have not been passing on any deals as a result of inability to fund.

Yes. I think that I agree with Jeff. I think if anything it's the opposite. I mean, the capital that we have out -- you know, outside the SBIC is more flexible. As you know, we have to follow certain criteria when we're investing in assets within the SBIC.

Got it.

And out of the roughly $4.1 million of unrealized marks in the quarter, how much of that was technical versus credit specific, and how have you seen those marks change quarter to date so far?

You know, most of the marks for the first quarter were really not credit-related, really technical-related. And some of that was a reversal of marks shifting into realize.

So we're -- I would say as you look at the overall net loss, it was not material. And it was mostly driven by the technical factors in second week spreads.

Got it. And just with Phoenix Brands, I know it's small. It seems like the fair value went down -- went down a bit again this quarter. Has there been any significant news, anything new coming out of that company that you've seen?

You know, we generally don't discuss specific credits, but I would say I think it's probably more related to delays. And the change was relatively immaterial, I would say. Really more delays in the sale process and discount rate-related.

I think that credit, the principal balance is under $1 million and the fair value is about $700,000. So relatively immaterial.

Great. That's all for me, thank you.

Yep. Thanks, Chris.

And our next question comes from James Soltesz of BDC Income. Please go ahead.

Hello. Appreciate you taking the time to answer my question.

I was just more curious about your focus on the lower middle market on sponsored transactions. Do you have a breakout in your portfolio of what is sponsored versus unsponsored, and do you see any type of shift in that breakout of that metric going forward?

Yes James, this is Jeff Cerny.

I think if you look across our portfolio, I would say probably -- and these are big picture numbers. Let's call it maybe a third sponsored -- we talk about unsponsored. That could be working with the management team, but that could also be working with a fundless sponsor who raises capital through its relationships on a deal by deal basis.

So I would say it's probably about a third direct with the Company and the management team, and another third where there is a kind of a fundless sponsor. So hopefully that gives you a decent feel for -- .

Got it. And then Mickey brought this up earlier. But just regards to the leveraged multiples and how those trended over time, do you have any data on the level of EBITDA from the past 12 quarters? If you are going more up in the lower middle market, or down, or how have those trended the past 12 months or so?

You know that -- you're saying on an overall portfolio basis?

Yes, on an overall portfolio basis.

You know I would say probably relatively flat to slightly up. I mean it's really tough to say over the last 12 quarters or 12 months. We did have a senior loan fund that tended to be larger companies, so we exited. We exited that primarily last May.

And those tended to be on average, you know, $20 million plus type EBITDA companies. Our lower middle market portfolio tends to be closer to $8 million, $9 million, $10 million EBITDA companies on average. I would say on an overall portfolio basis, relatively flat.

Great. That's it for me. Thank you.

And this concludes the question and answer session. I'd like to turn the conference back over to Bilal Rashid for any closing remarks.

Thank you all for joining our call today, and we look forward to speaking with everyone again next quarter. Operator, you may now end the call. Thank you.

Thank you, sir.

Today's conference has now concluded and we thank you all for attending today's presentation. You may now disconnect your lines. And have a wonderful day.