OFS Capital Corp. 10-Q Summary: Period Ended September 30, 2013
Business Context and Reporting Period
OFS Capital Corporation (OFS Capital) is an externally managed, closed-end, non-diversified management investment company that elected to be treated as a Business Development Company (BDC) under the Investment Company Act of 1940 and a Regulated Investment Company (RIC) for tax purposes. The company primarily invests in senior secured debt of middle-market U.S. companies. This report covers the quarterly period ended September 30, 2013, and the nine months ended September 30, 2013, compared to the same periods in 2012.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2013 | Nine Months Ended Sep 30, 2013 | Dec 31, 2012 (Balance Sheet) |
|---|---|---|---|
| Total Investment Income | $4.02 million | $12.62 million | - |
| Net Investment Income | $1.43 million | $4.34 million | - |
| Net Increase in Net Assets (Operations) | $0.37 million | $6.49 million | - |
| Total Assets | - | - | $229.6 million |
| Total Investments (Fair Value) | - | - | $219.3 million |
| Cash and Cash Equivalents | - | - | $6.8 million |
| Revolving Line of Credit (Debt) | - | - | $84.1 million |
| Net Asset Value (NAV) per Share | $14.46 | $14.46 | $14.80 |
| Dividends Declared per Share | $0.34 | $1.02 | - |
Material Changes vs. Prior Period
- Investment Income: For the nine months ended September 30, 2013, total investment income increased by approximately $3.4 million (37%) compared to the prior year period. This increase was primarily driven by nine months of interest income generated by the consolidated subsidiary OFS Capital WM in 2013, compared to only six months in 2012 following its consolidation in April 2012.
- Expenses: Total expenses for the nine months ended September 30, 2013, increased by approximately $1.9 million (29%) year-over-year. This was due to increased management fees, professional fees, and general administrative expenses associated with public company operations and the Tamarix LP acquisition process. Interest expense decreased by $0.4 million due to a lower outstanding balance on revolving credit lines.
- Realized and Unrealized Gains: The company recorded a net realized and unrealized gain of $2.16 million for the nine months ended September 30, 2013, compared to a net loss of $1.02 million in the prior year period. The 2013 gain was driven by $1.6 million in unrealized appreciation on affiliate investments (Tamarix LP) and $0.55 million in unrealized gains on non-affiliate investments.
- Portfolio Composition: As of September 30, 2013, the portfolio consisted of 55 portfolio companies. One loan (Strata Pathology Services, Inc.) was placed on non-accrual status with a fair value of $2.1 million, representing 1.0% of the debt portfolio.
Guidance, Outlook, and Risks
- Tamarix LP Acquisition: OFS Capital has reached an agreement to acquire all remaining limited partnership interests in Tamarix LP and Tamarix GP, pending SBA approval. If approved, Tamarix LP would become a wholly-owned subsidiary ("drop-down" SBIC). The company intends to increase its capital commitment to Tamarix LP to $75 million, requiring funding of $40 million to $50 million at closing. Failure to obtain SBA approval or funding constraints could limit growth and returns.
- Dividend Policy: The Board aims to distribute approximately 90-100% of taxable quarterly income. For the nine months ended September 30, 2013, approximately 54% of distributions were characterized as a return of capital.
- Interest Rate Risk: As of September 30, 2013, 100% of the debt portfolio bore floating interest rates, though interest rate floors effectively converted many to fixed rates. A 100 basis point increase in rates would result in a net decrease in net assets of approximately $0.7 million due to higher borrowing costs outweighing income increases.
- Liquidity and Borrowing: The company maintains a $135 million revolving credit facility (Class A loans only, as Class B was terminated in January 2013). The asset coverage ratio was approximately 264% as of September 30, 2013, well above the 200% regulatory minimum.
Investor Verification Checklist
- SBA Approval Status: Verify the status of the SBA approval for the Tamarix LP "drop-down" acquisition, as this is critical for the company's capital deployment strategy and potential consolidation of Tamarix assets.
- Non-Accrual Loan Performance: Monitor the performance and potential write-downs of the Strata Pathology Services, Inc. loan, which is currently on non-accrual status.
- Capital Commitment Funding: Assess the company's ability to fund the $40 million to $50 million capital commitment to Tamarix LP without forcing the sale of existing portfolio assets at disadvantageous prices.
- Dividend Tax Characterization: Review the annual Form 1099-DIV to confirm the final tax characterization of distributions (ordinary income vs. return of capital), as quarterly estimates indicated a significant return of capital component.
- Reinvestment Period Extension: Confirm whether the OFS Capital WM credit facility reinvestment period (expiring December 31, 2013) is extended, as failure to do so would limit new investment capacity.