OFS Capital Corp. 10-Q Summary: Quarter Ended September 30, 2018
Business Context and Reporting Period
OFS Capital Corporation is an externally managed, closed-end, non-diversified management investment company regulated as a Business Development Company (BDC) under the Investment Company Act of 1940. The company invests primarily in debt and, to a lesser extent, equity of middle-market U.S. companies. This report covers the quarterly period ended September 30, 2018. As of November 1, 2018, there were 13,352,824 shares of common stock outstanding.
Key Financial Metrics
| Metric | Q3 2018 (Three Months) | YTD 2018 (Nine Months) | YTD 2017 (Nine Months) |
|---|---|---|---|
| Total Investment Income | $10.98 million | $30.26 million | $25.13 million |
| Net Investment Income | $4.69 million | $13.06 million | $12.06 million |
| Net Increase in Net Assets from Operations | $5.18 million | $13.67 million | $3.76 million |
| Net Asset Value (NAV) per Share | $13.75 | $13.75 | $14.12 (Dec 31, 2017) |
| Total Assets | $408.54 million | $408.54 million | $357.78 million (Dec 31, 2017) |
| Total Investments (Fair Value) | $396.03 million | $396.03 million | $277.50 million (Dec 31, 2017) |
| Cash and Cash Equivalents | $6.04 million | $6.04 million | $72.95 million (Dec 31, 2017) |
| Total Debt Outstanding | $214.82 million | $214.82 million | $164.82 million (Dec 31, 2017) |
| Weighted Average Yield (Performing Debt) | 12.14% | 12.14% | 12.11% (Dec 31, 2017) |
Debt Composition: Includes $17.0 million under the PWB Credit Facility, $149.9 million in SBA Debentures, and $50.0 million in Unsecured Notes Due April 2025.
Material Changes vs. Prior Period
- Portfolio Growth: Total investments at fair value increased by approximately $118.5 million (43%) compared to December 31, 2017, driven by significant new originations and follow-on investments.
- Investment Activity: During the nine months ended September 30, 2018, the company invested $187.3 million in debt and $5.2 million in equity. Notable new investments included Online Tech Stores, LLC ($16.1M), 3rd Rock Gaming ($21.6M debt + $2.5M equity), and Performance Team, LLC ($20.3M).
- Realized Losses: The company recognized significant realized losses due to restructurings and sales. A $5.6 million realized loss was recognized on the restructuring of Southern Technical Institute, LLC, and a $3.9 million loss was recognized on the sale of Jobson Healthcare Information, LLC.
- Cash Position: Cash and cash equivalents decreased from $72.95 million at year-end 2017 to $6.04 million at September 30, 2018, primarily due to aggressive portfolio deployment and distributions.
- Non-Accrual Status: Loans on non-accrual status increased to $12.4 million (amortized cost) from $11.1 million at year-end 2017. Master Cutlery, LLC was placed on non-accrual and written down to a fair value of $1.7 million.
Guidance, Outlook, Risks, and Unusual Items
- Capital Markets Activity: In April 2018, the company issued $50 million of Unsecured Notes Due April 2025. Subsequent to the reporting period (October/November 2018), the company closed an additional offering of $48.5 million in 6.5% Unsecured Notes Due October 2025.
- Stock Repurchase Program: The Board authorized a $10 million stock repurchase program in May 2018. No shares were repurchased as of September 30, 2018.
- Distributions: The company declared a distribution of $0.34 per share for the fourth quarter of 2018, payable December 31, 2018. The company intends to distribute substantially all of its taxable income to maintain RIC status.
- Regulatory Changes: The Small Business Credit Availability Act (SBCAA) allows the company to reduce its asset coverage ratio requirement from 200% to 150%, effective May 3, 2019, potentially allowing for increased leverage.
- Internal Controls: Management disclosed a material weakness in internal controls over financial reporting related to the reliability of financial information from portfolio companies used in valuations. Remediation efforts are underway but not yet fully tested.
- Risks: Key risks include the illiquidity of portfolio investments, the impact of interest rate changes (79% of debt portfolio is floating rate), and the ability to meet distribution requirements given non-cash income (PIK interest).
Investor Verification Checklist
- Non-Accrual Portfolio: Verify the status and recovery prospects of the $12.4 million in non-accrual loans, specifically Master Cutlery, LLC and Community Intervention Services, Inc.
- Realized Losses: Review the details of the $5.6 million loss on Southern Technical Institute and the $3.9 million loss on Jobson Healthcare to understand the impact on future NAV.
- Liquidity Constraints: Assess the impact of the $5.0 million cash held by the SBIC subsidiary, which is restricted from distribution to the parent company under SBA regulations.
- Internal Control Remediation: Monitor the progress of remediation efforts for the material weakness in internal controls regarding portfolio company financial data.
- Debt Covenants: Confirm continued compliance with asset coverage ratios, noting the upcoming reduction to 150% in May 2019.