OFS

OFS Capital Corp. Q1 2014 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2014. OFS Capital Corp. is an externally managed, closed-end, non-diversified management investment company operating as a Business Development Company (BDC) and a Regulated Investment Company (RIC). The company primarily invests in senior secured debt and, to a lesser extent, equity of middle-market U.S. companies. A significant development in the prior period was the consolidation of SBIC I LP (a Small Business Investment Company) as a wholly-owned subsidiary following the "Tamarix Acquisitions" on December 4, 2013.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income: Increased 15% to $5.01 million, driven by the consolidation of SBIC I LP, which added interest income from affiliate and control investments not present in the Q1 2013 comparison.
• Expenses: Increased 24% to $3.61 million. This was primarily due to a scheduled increase in the base management fee rate (from 0.875% to 1.75% annually) effective November 2013, and higher professional fees related to the Tamarix Acquisitions. Interest expense rose slightly due to SBA debenture interest, partially offset by lower rates on the revolving credit facility.
• Unrealized Gains/Losses: Net unrealized gains decreased significantly to $0.65 million from $1.43 million. This was largely due to a $0.79 million unrealized depreciation on a control investment (Tangible Software, Inc.), offset by unrealized appreciation on affiliate investments.
• Liquidity: Cash and cash equivalents increased to $37.0 million from $28.6 million at year-end 2013, supported by strong operating cash flows of $17.2 million.

Guidance, Outlook, and Management Commentary

• Management Fee Reduction: On May 5, 2014, the Investment Advisor agreed to reduce its base management fee by two-thirds for the remainder of fiscal 2014 (Q2-Q4). This reduction lowers the effective annual fee to 0.875% (from 1.75%) to account for delays in the Tamarix Acquisitions.
• Portfolio Composition: As of March 31, 2014, the portfolio consisted of 56 companies. 92% of the portfolio was senior secured loans, 4% subordinated loans, and 4% equity. The top three industries were Healthcare & Pharmaceuticals (23%), Services: Business (14.8%), and Banking/Finance (12.1%).
• Credit Quality: 88.3% of debt investments were rated "Average" (Risk Rating 3), 8.3% "Special Mention" (Rating 4), and 2.9% "Substandard" (Rating 5). There was one non-accrual loan (Strata Pathology Services, Inc.) with a fair value of $1.05 million.
• Capital Resources: The company has $14.7 million available under its revolving credit facility and $35.4 million of incremental borrowing capacity under SBA regulations, contingent on funding additional capital into SBIC I LP.
• Subsequent Events: The Board declared a Q2 2014 distribution of $0.34 per share. The company also dismissed McGladrey LLP as its auditor and engaged BDO USA, LLP.

Investor Verification Checklist

• Fee Structure Impact: Verify the financial impact of the management fee reduction effective April 1, 2014, on future Net Investment Income.
• Control Investment Valuation: Review the valuation methodology and credit status of "Tangible Software, Inc." (Control Investment), which contributed a $0.79 million unrealized loss.
• Non-Accrual Status: Monitor the status of the single non-accrual loan (Strata Pathology Services) and its potential impact on future interest income.
• SBIC I LP Funding: Assess the company's ability and timeline to fund the remaining $13.6 million commitment to SBIC I LP to unlock full SBA leverage capacity.
• Dividend Tax Characterization: Note that approximately 56% of the Q1 2014 distribution was characterized as a return of capital for tax purposes.