OFS Capital Corp. 10-Q Summary: Period Ended June 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 June 30, 2018. The company operates through a wholly-owned Small Business Investment Company (SBIC) subsidiary, OFS SBIC I, LP, which holds approximately 64% of the company's total consolidated assets.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2018 | Six Months Ended June 30, 2017 |
|---|---|---|
| Net Investment Income | $8.37 million | $7.66 million |
| Net Increase in Net Assets from Operations | $8.49 million | $2.59 million |
| Net Investment Income Per Share | $0.63 | $0.67 |
| Net Asset Value (NAV) Per Share | $13.70 | $14.12 (Dec 31, 2017) |
| Total Investments (Fair Value) | $362.83 million | $277.50 million (Dec 31, 2017) |
| Cash and Cash Equivalents | $22.67 million | $72.95 million (Dec 31, 2017) |
| Total Debt Outstanding | $205.71 million | $164.82 million (Dec 31, 2017) |
| Weighted Average Yield (Total Debt) | 11.80% | 11.59% (Dec 31, 2017) |
Debt Composition: As of June 30, 2018, debt included $149.88 million in SBA debentures, $50.0 million in unsecured notes (6.375% due 2025), and $8.0 million drawn on a revolving credit facility.
Material Changes vs. Prior Period
- Investment Portfolio Growth: Total investments at fair value increased by approximately $85.3 million (30.7%) compared to December 31, 2017, driven by $145.2 million in new portfolio investments during the six-month period.
- Realized Losses: The company recognized significant realized losses totaling $9.02 million for the six months ended June 30, 2018. This was primarily due to a $5.6 million loss on the restructuring of Southern Technical Institute, LLC, and a $3.9 million loss on the sale of Jobson Healthcare Information, LLC.
- Unrealized Gains: Despite realized losses, the company recorded net unrealized appreciation of $9.14 million, largely driven by gains in common equity and warrant investments ($4.8 million) and subordinated debt ($1.86 million).
- Liquidity Position: Cash and cash equivalents decreased by $50.3 million, primarily due to net purchases of portfolio investments ($83.9 million net outflow) and distributions paid to stockholders ($13.9 million), partially offset by proceeds from the issuance of unsecured notes ($48.2 million).
- Expense Increase: Total expenses increased to $10.91 million from $8.36 million in the prior year period, driven by higher interest expense ($3.80 million vs. $2.73 million) due to the new unsecured notes and increased management fees.
Guidance, Outlook, and Risks
- Asset Coverage Ratio: The company approved the application of the Small Business Credit Availability Act (SBCAA), which will lower the required asset coverage ratio from 200% to 150% effective May 3, 2019, potentially allowing for increased leverage.
- Stock Repurchase Program: On May 22, 2018, the Board authorized a $10.0 million stock repurchase program. No shares were repurchased during the quarter ended June 30, 2018.
- Distributions: The company declared a distribution of $0.34 per share for the third quarter of 2018. The company intends to distribute substantially all of its taxable income to maintain Regulated Investment Company (RIC) status.
- 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.
- Non-Accrual Loans: Loans on non-accrual status increased to $12.4 million (amortized cost) from $11.1 million at year-end 2017, representing 3.7% of the debt portfolio.
Investor Verification Checklist
- Realized Loss Drivers: Verify the specific terms and future cash flow implications of the Southern Technical Institute and Jobson Healthcare restructurings/sales.
- Non-Accrual Status: Review the credit quality and recovery prospects of the $12.4 million in non-accrual loans, specifically Master Cutlery, LLC and Community Intervention Services, Inc.
- Internal Control Remediation: Monitor the progress of remediation efforts regarding the material weakness in portfolio company financial reporting controls.
- Liquidity Constraints: Assess the impact of SBA regulations on the $20.6 million of cash held by the SBIC subsidiary, which is restricted from distribution to the parent company.
- Debt Covenants: Confirm continued compliance with asset coverage ratios and other covenants under the PWB Credit Facility and Unsecured Notes indenture.