OFS

OFS Capital Corp. 10-Q Summary: Period Ended June 30, 2017

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 companies in the United States. It operates through a wholly-owned Small Business Investment Company (SBIC) subsidiary, OFS SBIC I, LP. This report covers the quarterly period ended June 30, 2017.

Key Financial Metrics

Material Changes vs. Prior Period

• Capital Raise: In April 2017, the company completed a follow-on public offering of 3.6 million shares, raising net proceeds of approximately $53.7 million. The investment advisor paid all underwriting discounts and commissions.
• Portfolio Valuation: The company recognized a net unrealized loss of $6.1 million for the six months ended June 30, 2017, compared to a net unrealized loss of $3.1 million in the prior year period. This was driven by portfolio company-specific performance factors, including a significant unrealized loss on the My Alarm Center, LLC investment.
• Non-Accrual Status: Two loans (Community Intervention Services, Inc. and My Alarm Center, LLC) were placed on non-accrual status with an aggregate fair value of $5.0 million. My Alarm Center was subsequently restructured in July 2017.
• Expense Reduction: Total expenses decreased slightly to $8.4 million from $8.4 million in the prior year, primarily due to a reduction in the incentive fee expense ($1.2 million vs. $1.6 million) resulting from the share issuance adjustment related to the public offering.

Guidance, Outlook, and Risks

• Outlook: Management expects to continue deploying capital into middle-market companies. The weighted average yield on the debt portfolio decreased to 11.66% from 12.08% in the prior year due to the deployment of new capital into senior secured debt investments with lower yields.
• Liquidity: The company holds $46.9 million in cash and cash equivalents. Additionally, $19.0 million remains available under its $25 million revolving credit facility with Pacific Western Bank.
• Internal Controls: Management disclosed a material weakness in internal control over financial reporting related to investment valuations identified in the prior year. Remediation efforts are ongoing, including a shift from discounted cash flow to market approach valuations for certain equity investments.
• Risks: Key risks include the illiquidity of portfolio investments, the impact of credit spreads on fair value, and the company's ability to meet distribution requirements to maintain its Regulated Investment Company (RIC) tax status.

Investor Verification Checklist

• Valuation Methodology: Verify the impact of the shift from discounted cash flow to market approach valuations on future NAV stability.
• Non-Accrual Loans: Monitor the restructuring progress of My Alarm Center, LLC and the recovery potential of Community Intervention Services, Inc.
• Capital Deployment: Assess the rate at which the $53.7 million raised in the April offering is being deployed into new investments.
• Internal Controls: Review future filings for confirmation that the material weakness in internal controls has been fully remediated.
• Yield Trends: Track the weighted average yield of the portfolio to ensure it remains sufficient to cover the cost of debt and operating expenses.