OFS

OFS Capital Corp. Q1 2018 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2018. OFS Capital Corp. 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. It operates through a wholly-owned Small Business Investment Company (SBIC) subsidiary, OFS SBIC I, LP.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Portfolio Growth: Total investments at fair value increased by approximately $58 million (21%) compared to the prior year, driven by $93.3 million in new and follow-on debt investments and $4.9 million in equity investments.
• Net Income Decline: While Net Investment Income increased by $0.48 million, the Net Increase in Net Assets from Operations decreased by $1.38 million. This was primarily due to a shift from a net gain on investments of $1.53 million in Q1 2017 to a net loss of $0.32 million in Q1 2018.
• Unrealized Losses: The Company recognized net unrealized depreciation of $1.56 million on non-control/non-affiliate investments and $1.11 million on preferred equity, offset by unrealized appreciation on affiliate investments ($1.25 million) and common equity ($1.91 million).
• Expense Increases: Total expenses rose by $0.50 million, driven by higher interest expense ($0.25 million increase) due to increased utilization of the PWB Credit Facility and higher administration fees ($0.18 million increase).
• Fee Waiver: The investment advisor waived $22,000 of Part One incentive fees for the quarter.

Guidance, Outlook, and Risks

• Asset Coverage Ratio Change: Following the passage of the Small Business Credit Availability Act (SBCAA), the Board approved a reduction in the required asset coverage ratio from 200% to 150%, effective May 3, 2019. This allows for increased leverage capacity.
• Recent Capital Raise: In April 2018 (subsequent to the period end), the Company closed a public offering of $50 million in 6.375% notes due 2025, netting approximately $48.1 million.
• Non-Accrual Loans: Two loans (Community Intervention Services, Inc. and Southern Technical Institute, LLC) remain on non-accrual status with an aggregate amortized cost of $11.1 million and a fair value of $0.
• Internal Control Weakness: Management disclosed a material weakness in internal controls over financial reporting related to the reliability of financial information from portfolio companies used in investment valuations. Remediation efforts are underway.
• Liquidity: Cash decreased by $41.0 million during the quarter due to net investment purchases. Approximately $31.2 million of cash is held by the SBIC subsidiary and is restricted from distribution to the parent company under SBA regulations.

Investor Verification Checklist

• Non-Accrual Exposure: Verify the status and potential recovery value of the $11.1 million in non-accrual loans, specifically the write-down of Southern Technical Institute, LLC to $0 fair value.
• Internal Control Remediation: Monitor progress on the remediation plan for the material weakness regarding portfolio company financial data inputs.
• Leverage Utilization: Assess the impact of the upcoming 150% asset coverage ratio change on future borrowing capacity and risk profile.
• Unrealized Volatility: Review the sensitivity of Level 3 fair value measurements to changes in discount rates and EBITDA multiples, given the significant unrealized depreciation in certain asset classes.
• Cash Flow vs. Distributions: Confirm the ability to maintain quarterly distributions ($0.71 per share declared for Q1) given the cash outflow from operations and restricted cash held by the SBIC subsidiary.