Business Context and Reporting Period
OFS Capital Corp (OFS) is an externally managed, closed-end, non-diversified business development company (BDC) and regulated investment company (RIC). The reporting period covers the fiscal year ended December 31, 2013. OFS focuses on providing current income and capital appreciation primarily through debt investments (senior secured, unitranche, second-lien, and subordinated loans) and, to a lesser extent, equity investments in U.S. middle-market companies. A significant corporate development in 2013 was the acquisition of the remaining interests in OFS SBIC I, LP (formerly Tamarix Capital Partners, L.P.), making it a wholly-owned subsidiary effective December 4, 2013.
Key Financial Metrics
| Metric | 2013 | 2012 |
|---|---|---|
| Total Investment Income | $17.07 million | $13.43 million |
| Total Expenses | $11.35 million | $9.34 million |
| Net Investment Income | $5.72 million | $4.10 million |
| Net Increase in Net Assets from Operations | $7.68 million | $6.22 million |
| Net Asset Value (NAV) per Share | $14.58 | $14.80 |
| Total Investments (Fair Value) | $237.92 million | $232.20 million |
| Total Debt Outstanding | $135.0 million | $99.2 million (OFS Capital WM only) |
| Cash and Cash Equivalents | $28.57 million | $8.27 million |
| Weighted Average Yield on Debt | 8.53% | 7.64% |
Note: 2012 figures reflect the full year, including pre-IPO and post-IPO periods. The 2013 net increase in net assets includes a $2.74 million realized gain from the Tamarix Acquisitions.
Material Changes vs. Prior Period
- Portfolio Growth: Total investment portfolio fair value increased by approximately $5.7 million to $237.9 million. The portfolio consists of 58 portfolio companies, with 93% in senior secured loans, 4% in subordinated loans, and 3% in equity investments.
- Acquisition of SBIC I LP: On December 4, 2013, OFS acquired the remaining interests in SBIC I LP, consolidating its financial statements. This resulted in a $2.74 million realized gain and the addition of $26.0 million in SBA-guaranteed debentures to the balance sheet.
- Expense Increases: Total expenses rose 22% year-over-year, driven by a full year of management fees for OFS Capital WM, increased professional fees related to the Tamarix Acquisitions, and higher administrative costs as a public company.
- Credit Quality: As of December 31, 2013, 88.6% of debt investments were rated "3" (Average), 7.5% "4" (Special Mention), 3.4% "5" (Substandard), and 0.5% "6" (Doubtful). There were no "1" or "2" rated credits.
Guidance, Outlook, Risks, and Unusual Items
- Management Commentary: Management views the current market environment as opportune for investing in the lending market for middle-market companies. They intend to fund growth through borrowings under the OFS Capital WM Facility, SBA debentures, and future equity offerings.
- Dividend Policy: The Board maintains a variable dividend policy targeting distributions of 90-100% of taxable quarterly income. For 2013, approximately 67% of distributions represented ordinary income and 33% represented a return of capital.
- Unusual Items: The 2013 results include a significant non-recurring realized gain of $2.74 million from the step acquisition of SBIC I LP and SBIC I GP. Additionally, there was a $1.75 million unrealized depreciation on a control investment (Tangible Software, Inc.).
- Risks and Contingencies:
- Internal Control Weakness: Management identified a material weakness in internal control over financial reporting related to the accounting treatment of the Tamarix Acquisitions.
- Leverage: OFS is subject to a 200% asset coverage ratio under the 1940 Act. However, an exemptive order received in November 2013 allows the exclusion of SBA-guaranteed debt from this ratio.
- Liquidity: The company has $4.8 million in unfunded commitments to portfolio companies and $13.6 million in unfunded commitments to SBIC I LP (as of March 2014).
Important Facts for Investor Verification
- Material Weakness in Internal Controls: Verify the remediation plan for the identified material weakness regarding the accounting treatment of the Tamarix Acquisitions.
- Non-Recurring Gains: Assess the sustainability of earnings by excluding the $2.74 million one-time gain from the Tamarix Acquisitions when evaluating core operating performance.
- Dividend Composition: Confirm the tax attributes of future dividends, noting that a significant portion (33%) of 2013 distributions was a return of capital.
- Asset Coverage Ratio: Monitor the impact of the SEC exemptive order on the company's ability to leverage SBA-guaranteed debt without affecting the statutory 200% asset coverage ratio.
- Credit Concentration: Review the concentration of "Special Mention" (Rating 4) and "Substandard" (Rating 5) credits, which comprised over 10% of the debt portfolio at fair value.