OFS Capital(OFS) - 2020 Q2 - Quarterly Report

PART I. FINANCIAL INFORMATION This section provides the unaudited consolidated financial statements and management's discussion and analysis for OFS Capital Corporation as of June 30, 2020, and for the three and six-month periods then ended Item 1. Consolidated Financial Statements This section presents the unaudited consolidated financial statements for OFS Capital Corporation as of June 30, 2020, and for the three and six-month periods then ended, including statements of assets, operations, changes in net assets, cash flows, and detailed notes Consolidated Statements of Assets and Liabilities As of June 30, 2020, total assets decreased to $475.4 million from $538.2 million, primarily due to a decline in investment fair value, leading to a drop in net asset value per share from $12.46 to $10.10 | Financial Metric | June 30, 2020 (unaudited) | December 31, 2019 | | :--- | :--- | :--- | | Total Investments at Fair Value | $435,762 | $516,931 | | Total Assets | $475,442 | $538,188 | | Total Liabilities | $340,045 | $371,561 | | Total Net Assets | $135,397 | $166,627 | | Net Asset Value Per Share | $10.10 | $12.46 | Consolidated Statements of Operations For Q2 2020, total investment income decreased to $11.0 million, but a net increase in net assets of $7.7 million was reported due to significant net unrealized appreciation, contrasting with a six-month net decrease of $24.5 million | Metric (in thousands, except per share) | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :--- | :--- | :--- | :--- | :--- | | Total Investment Income | $10,981 | $12,900 | $23,851 | $25,245 | | Total Expenses, net | $8,374 | $8,040 | $17,272 | $15,557 | | Net Investment Income | $2,607 | $4,860 | $6,579 | $9,688 | | Net Gain (Loss) | $5,051 | $(1,507) | $(31,081) | $(2,603) | | Net Increase (Decrease) in Net Assets | $7,658 | $3,353 | $(24,502) | $7,085 | | Net Investment Income Per Share | $0.19 | $0.36 | $0.49 | $0.73 | | Net Increase (Decrease) in Net Assets Per Share | $0.57 | $0.25 | $(1.83) | $0.53 | Consolidated Statements of Changes in Net Assets For the six months ended June 30, 2020, net assets decreased by $31.2 million, driven by a $24.5 million net decrease from operations and $6.8 million in dividends declared | Description (in thousands) | Six Months Ended June 30, 2020 | | :--- | :--- | | Net Assets at January 1, 2020 | $166,627 | | Net Decrease from Operations | $(24,502) | | Dividends Declared | $(6,824) | | Common Stock Issued (Reinvestment) | $96 | | Net Assets at June 30, 2020 | $135,397 | Consolidated Statements of Cash Flows For the six months ended June 30, 2020, net cash from operating activities was $45.9 million, a significant reversal from the prior year, resulting in an overall cash increase of $18.3 million | Cash Flow Activity (in thousands) | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :--- | :--- | :--- | | Net Cash Provided (Used) in Operating Activities | $45,872 | $(44,403) | | Net Cash Provided (Used) by Financing Activities | $(27,538) | $15,635 | | Net Increase (Decrease) in Cash | $18,334 | $(28,768) | | Cash at End of Period | $31,781 | $9,404 | Consolidated Schedules of Investments The schedules detail the company's $435.8 million investment portfolio as of June 30, 2020, primarily comprising senior secured loans across diverse industries, with specific non-accrual assets identified | Investment Type | Fair Value (June 30, 2020) | % of Total Fair Value | | :--- | :--- | :--- | | Senior secured debt investments | $325,659 | 74.7% | | Subordinated debt investments | $35,755 | 8.2% | | Preferred equity | $11,757 | 2.7% | | Common equity, warrants and other | $32,561 | 7.5% | | Structured Finance Notes | $30,030 | 6.9% | | Total Investments | $435,762 | 100.0% | - As of June 30, 2020, the top three industry concentrations by fair value were Manufacturing, Wholesale Trade, and Health Care and Social Assistance[90][91] - As of June 30, 2020, five portfolio company investments were on non-accrual status: Community Intervention Services, Inc., Online Tech Stores, LLC, 3rd Rock Gaming Holdings, LLC, Master Cutlery, LLC, and Southern Technical Institute, LLC[22][24][29] Notes to Consolidated Financial Statements These notes explain accounting policies, fair value measurements, related party transactions, outstanding debt facilities, and unfunded commitments, highlighting the impact of COVID-19 on valuations - OFS Advisor manages the company's operations and receives a base management fee (1.75% of total assets, with certain reductions) and a two-part incentive fee[76][77] For Q1 2020, OFS Advisor waived $441 thousand in Income Incentive Fees[84] - Due to significant market liquidity declines from the COVID-19 pandemic, the company adjusted its valuation process, resulting in the transfer of certain securities between Level 2 and Level 3 fair value categories[101][102] | Debt Facility | Outstanding Principal (June 30, 2020) | | :--- | :--- | | SBA Debentures | $133,770 | | BNP Facility | $30,650 | | PWB Credit Facility | $21,100 | | Unsecured Notes | $152,850 | - The company has unfunded commitments of $4.3 million to two portfolio companies as of June 30, 2020[118] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the COVID-19 pandemic's impact on portfolio performance, including a decline in net investment income, partial valuation recovery, and liquidity management, while maintaining compliance with regulatory ratios - The COVID-19 pandemic has severely impacted global economic activity, causing significant volatility and negative pressure in financial markets, which presents material uncertainty and risks to the company's portfolio companies and its own financial condition[145][155] - Net investment income per share declined to $0.19 in Q2 2020 from $0.36 in Q2 2019, primarily due to a shift to lower-yielding loans, new non-accrual loans, and higher interest costs[148] - The company's asset coverage ratio was 166% as of June 30, 2020, remaining in compliance with the 150% minimum requirement under the 1940 Act[153][252] Portfolio Composition and Investment Activity As of June 30, 2020, the $435.8 million investment portfolio was 90% senior secured loans, with investment activity significantly slowed due to COVID-19, and a decreased weighted average yield - As of June 30, 2020, 80% of Portfolio Company Investments at fair value were senior securities, which management believes provides greater downside protection against the impact of the COVID-19 pandemic[169] | Investment Activity (in millions) | Six Months Ended June 30, 2020 | | :--- | :--- | | Total Investments in New and Existing Portfolio Companies | $58.9 | | Total Proceeds from Principal Payments and Sales | $121.8 | | Net Proceeds | $62.9 | - The weighted average yield on total debt and Structured Finance Note investments decreased to 9.01% at June 30, 2020, from 9.94% at December 31, 2019, primarily due to new non-accrual loans[172][176] Risk Monitoring Credit quality deteriorated in H1 2020, with debt investments rated 'Special Mention' or worse increasing to 19.7% of fair value, and non-accrual loans rising significantly to $21.2 million | Risk Category | % of Debt Investments (Fair Value) - June 30, 2020 | % of Debt Investments (Fair Value) - Dec 31, 2019 | | :--- | :--- | :--- | | 1-3 (Low to Average Risk) | 80.3% | 89.8% | | 4 (Special Mention) | 17.7% | 10.1% | | 5-7 (Substandard to Loss) | 2.0% | 0.1% | - The aggregate fair value of loans on non-accrual status increased to $21.2 million as of June 30, 2020, from $0.9 million at December 31, 2019, with Online Tech Stores, LLC and 3rd Rock Gaming Holding, LLC being placed on non-accrual during the period[188] Results of Operations Q2 2020 saw decreased investment income and higher interest expense, but a net gain of $5.1 million due to unrealized appreciation, contrasting with a six-month net loss of $31.1 million from COVID-19 impacts - Recurring interest income decreased by $1.9 million for Q2 2020 compared to Q2 2019, due to a lower average loan balance and a 189 basis point decrease in the recurring earned yield[196] - Interest expense increased for the three and six months ended June 30, 2020, compared to the prior year, due to higher average borrowings from the issuance of Unsecured Notes and borrowings under the BNP Facility[199] - The portfolio's net gain of $5.1 million in Q2 2020 was primarily driven by a combined $7.9 million appreciation in the equity of Pfanstiehl Holdings, Inc. and Southern Technical Institute, LLC, and a $9.0 million improvement in the fair value of Structured Finance Notes and broadly syndicated loans[208] Liquidity and Capital Resources As of June 30, 2020, the company had $31.8 million in cash and substantial unused credit facility capacity, with long-dated debt maturities, and subsequently reduced its PWB Credit Facility commitment - As of June 30, 2020, the company had $31.8 million in cash, an unused commitment of $78.9 million under its PWB Credit Facility, and an unused commitment of $119.4 million under its BNP Facility, subject to borrowing base and covenants[220][221] - On July 29, 2020, the company reduced its PWB Credit Facility commitment from $100 million to $50 million[221] - The company's financing is long-term, with approximately 90% of total debt contractually maturing in 2024 and beyond, providing operational flexibility[255] Item 3. Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate volatility, with 87% of debt investments being floating-rate, and a 100 basis point interest rate increase projected to yield a $3.5 million annual net income increase | Basis Point Change | Annualized Impact on Net Income (in thousands) | | :--- | :--- | | +100 | $3,469 | | +50 | $808 | | -25 | $(242) | | -100 | $(242) | - As of June 30, 2020, 87% of the company's debt investments (at fair value) bore floating interest rates, many of which are subject to a minimum base rate floor[264][265] Item 4. Controls and Procedures Management concluded that disclosure controls and procedures were effective as of June 30, 2020, with no material changes to internal control over financial reporting during the quarter - The Chief Executive Officer and Chief Financial Officer concluded that the company's disclosure controls and procedures were effective as of June 30, 2020[270] - No changes in internal control over financial reporting occurred during the quarter that materially affected, or are reasonably likely to materially affect, internal controls[271] PART II. OTHER INFORMATION This section provides additional information including legal proceedings, updated risk factors related to the COVID-19 pandemic and LIBOR phase-out, and details on equity security sales and repurchases Item 1. Legal Proceedings As of June 30, 2020, the company reports that it is not currently subject to any material pending legal proceedings - The company, along with its affiliates OFS Advisor and OFS Services, is not currently subject to any material pending legal proceedings[273] Item 1A. Risk Factors This section highlights heightened risks due to the COVID-19 pandemic's adverse economic impact and the uncertainty surrounding the planned phase-out of LIBOR by the end of 2021 - The COVID-19 pandemic has caused a global economic slowdown and is expected to continue to adversely impact the company, with the severity and duration being difficult to predict[276] - The planned phase-out of LIBOR by the end of 2021 creates uncertainty that may adversely affect the value of the company's portfolio of LIBOR-indexed, floating-rate debt securities[277][278] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds During Q2 2020, the company issued 7,165 shares via its Distribution Reinvestment Plan, made no share repurchases, and extended its $10.0 million stock repurchase program through May 2022 - In Q2 2020, 7,165 shares of common stock were issued to stockholders through the company's DRIP[283] - No shares were repurchased under the Stock Repurchase Program during the three months ended June 30, 2020[285] The program was extended to May 22, 2022, with approximately $10.0 million remaining authorized for repurchases[287] Item 5. Other Information Subsequent to quarter-end, on July 29, 2020, the company reduced its PWB Credit Facility commitment from $100 million to $50 million to reduce unused commitment fees - On July 29, 2020, the company reduced the total commitment under its PWB Credit Facility with Pacific Western Bank from $100 million to $50 million[290]