Steve Altebrando - VP, IR Bilal Rashid - Chairman and CEO Jeff Cerny - CFO and Treasurer.

Christopher Testa - National Securities Corporation.

Good day, and welcome to the OFS Capital Corporation First Quarter Earnings Conference Call. All participants will be in listen only mode. [Operator Instructions] Please note this event is being recorded. Please note this event is being recorded. I would now like to turn the conference over to Steve Altebrando, Vice President of Investor Relations.

Please go ahead..

Thank you. Good morning, everyone, and thank you for joining us today. With me today is Bilal Rashid, our Chairman and Chief Executive Officer; and Jeff Cerny, our Chief Financial Officer and Treasurer. Please note that we issued a press release this morning announcing our first quarter results.

This press release was subsequently filed on Form 8-K with the SEC. Both documents can be obtained under the Investor Relations section of our website at ofscapital.com.

Before we begin, please note that statements made on this call and webcast may constitute forward-looking statements within the meaning of the Securities Act of 1933 as amended under applicable securities laws.

Such statements reflect various assumptions, expectations and opinions by OFS Capital management concerning anticipated results, are not guarantees of future performance and are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from such statements.

The uncertainties and other factors are, in some ways, beyond management's control, including the risk factors described from time to time in our filings with the SEC.

Although we believe these assumptions are reasonable, any of those assumptions could prove inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. You should not place undue reliance on those forward-looking statements.

OFS Capital undertakes no duty to update any forward-looking statements made herein. All forward-looking statements speak only as of the date of this call. Also during this call, management will be referring to a non-GAAP financial measure, adjusted net investment income. This measure is not prepared in accordance with U.S.

generally accepted accounting principles.

You can find a reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measures and other related information in OFS Capital's first quarter 2017 earnings release and in the Investor Relations section of our website, ofscapital.com, under the heading Tax and Non-GAAP Information.

With that, I'll turn the call over to our Chairman and Chief Executive Officer, Bilal Rashid..

Thank you, Steve. Good morning, and welcome. The first quarter of 2017 was another strong period for us. Adjusted net investment income of $0.37 per share exceeded our $0.34 distribution. This was the eighth straight quarter that our adjusted net investment income exceeded our distribution on a non-GAAP basis.

At the beginning of the second quarter, we raised approximately 53.7 million of capital to support our strong pipeline. We believed it would be in the best long-term interest of our shareholders to raise that capital through an equity offering. On a net basis, the capital was raised at NAV.

The manager paid for the underwriting spread and continues to own the nearly 3 million shares that it has owned since the IPO of the company. These shares now represent over 22% of the total shares outstanding, reserving our long-term alignment of interests with all shareholders, which is among the highest in our BDC peer group.

We used the offering proceeds to pay off our revolving line of credit and have begun deploying the remaining proceeds to fund our strong pipeline. So far in the second quarter, we have already invested 29 million and have several more investments under LOI. We believe the equity capital raise benefits us in multiple ways.

First, we expect that this will improve our competitive position when vying for business and reduce our risk profile given our larger equity base. Second, we anticipate that our larger scale will reduce our fixed costs as a percentage of our equity capital, thereby improving our long-term earnings profile.

Lastly, it increases our shareholder base, which we believe will create additional value for our shareholders over time. In addition to raising capital in the equity market, the offering expands our capacity to issue debt for our future growth. As you know, our existing SBIC debt does not count towards the BDC asset coverage tests.

Net asset value increased from $14.82 per share for the fourth quarter of 2016 to $14.98 per share in the first quarter of 2017. We believe that this stability of our net asset value is a result of our core underwriting standards, which have resulted in a strong overall credit quality of our portfolio.

Once again, we had no loans on cash nonaccrual at the end of the quarter. Jeff will have more color on the quality and construction of our portfolio later in the call.

Putting the quarter's results and the performance of the portfolio into historical context, it is helpful to mention that since the beginning of 2012, we have invested $492 million and have accumulative net unrealized loss of just $800,000, which is less than 0.002%.

As measured by distributions plus the change in our net asset value since our IPO in late 2012, our total return has been 37%, which compares favorably to our peer group. The strength of our platform is a key to this performance, which relies on our time tested underwriting standards and our hands on portfolio management approach.

Looking forward, we believe that we are well positioned for a rising interest rate environment as approximately two thirds of our loans are floating rate, while 100% of our debt is fixed rate.

Also, our attractive long term financing includes $150 million in fixed rate SBA debentures through the SBIC program with a weighted average coupon of 3.18% and no maturities until 2022. This low cost of debt continues to have a meaningful positive impact on our return on equity.

In terms of our investments, 74% of our loan portfolio is senior secured. As we move deeper into 2017, our focus remains on the lower middle market, particularly the non-sponsored segment of that market.

Over the years, we have been able to establish a competitive advantage in this underserved part of the market having cultivated long standing relationships and having a team with deep experience in this segment. We continue to believe that currently, our best opportunity to generate strong risk adjusted returns is in this part of the middle market.

As, we also utilized the broad expertise of OFS Capital's experienced external manager, which is an approximately $1.7 billion credit platform.

We believe that we are well positioned to continue our growth and navigate any potential changes in the market environment given that the manager has successfully navigated multiple credit cycles since its inception in 1994.

Our team has the size, relationships and breadth of expertise across all parts of the leveraged loan market to provide us with both industry expertise and considerable capital markets intelligence. The OFS platform allows us to see a broad array of potential transactions and to be highly selective in making investments.

We are confident that our long-term focus will continue to serve us well. We expect to maintain our reputation as a reliable partner and continue to receive good quality deal flow. At this point, I'll turn the call over to Jeff Cerny, our Chief Financial Officer..

Thank you. This has been an exciting quarter for us and we continue to execute our investment strategy and balance sheet. As Bilal just mentioned, we continue to focus on the credit quality and stability of our portfolio, which has resulted in a steady net asset value over time. At quarter's end, we had 30% of our net asset value in cash.

The vast majority of our debt is long-term fixed-rate SBA debentures with a weighted average coupon of 3.18%. These debentures do not count towards our asset coverage ratio and, as such, gives us flexibility to grow our capital base and net investment income.

We believe our minimal regulatory leverage gives us a competitive advantage relative to many of our peers. In addition to our leverage capacity as Bilal just mentioned, we executed on a secondary offering in the second quarter. We raised $53.7 million and promptly repaid $8 million in outstandings on our PacWest line of credit.

We believe this offering was good for our risk profile and scale and we intend to deploy the remaining capital as our robust pipeline continues to provide opportunities. Turning to our portfolio. At the end of the quarter, we had investments in 38 companies totaling $258.3 million on a fair value basis, which is above our cost.

At March 31, 2017, the debt portfolio is at 97.2% of cost and the equity portfolio is at 133.1% of cost. As a percentage of fair value, our investments were approximately 64% senior secured loans, 20% subordinated debt and 16% equity. As a percentage of cost, our equity investments were approximately 12%.

It is important to note that approximately 57% of the equity investment is producing investment income due to their contractual coupons. We believe that our portfolio is well diversified with an average investment in each portfolio company of $6.8 million or 2.6% of the total portfolio.

The overall weighted average yield to cost in our debt investments was stable at 12.03% versus 12.08% last quarter. At the end of the quarter, the majority of our loan portfolio had floating rate coupons, which is just beginning to benefit from rising rates.

About 38% of floating rate portfolio is tied to three month and six month LIBOR and recently, both rates cleared the typical one percent LIBOR floor, resulting in additional interest income starting in the first quarter of 2017. 62% of our floating rate portfolio is tied to one month LIBOR that continues to remain just below the 1% floor.

We currently have no debt investments on cash nonaccrual and just one PIK non-accrual debt investment, Community Intervention Services, which continues to pay it's cash interest. We have left this debt investment on PIK non-accrual until we recognize further improvement in the underlying performance of the company.

We derived approximately $8 million in total investment income in the first quarter compared with $8.2 million in the fourth quarter. This decrease was primarily driven by lower average investment outstandings. Total expenses of $4.7 million increased compared to $4.5 million in the prior quarter.

The change was primarily driven by a $283,000 accrual for our capital gains incentive fee. Adjusted net investment income, a non-GAAP measure, was $3.6 million for the first quarter or $0.37 per share, exceeding our distribution of $0.34.

As Bilal previously mentioned, we have more than covered our distribution for 8 consecutive quarters on an adjusted NII basis. As to deal activity, during the first quarter, we closed transactions with an aggregate invested amount of $6.1 million.

We continue to maintain a consistent risk tolerance in our sourcing and underwriting and expect to maintain access to meaningful deal flow that allows us to be selective. We believe that the strong historical performance of our portfolio has been driven by our commitment to underwriting and structuring, a commitment that we will maintain.

As the broader middle market tightens, we continue to believe that the non-sponsored lower middle market segment provides the best risk adjusted returns and, as such, we will continue to place an emphasis on that sector of the market. At quarter's end, we had approximately $44 million of cash, of which $43 million was in the SBIC.

We had $8 million drawn on the $25 million line of credit. As previously mentioned, at the beginning of the second quarter, we successfully completed a share issuance which raised approximately $53.7 million and we promptly repaid the $8 million in outstands in the line of credit.

We continue to believe that we have the flexibility to execute on our investment strategy and increase our earnings per share, however, we do expect him softness in the second quarter earnings as we deploy the capital.

In addition, we anticipate a $225,000 write off of deferred offering costs in the second quarter related to the expiration of the legacy shelf registration statement that expired on April 30, 2017. These costs include capitalized legal accounting and printing expenses relating to the unused portion of the legacy shelf registration statement.

As mentioned, we remain selective on credit structure and pricing. We intend to continue to prudently deploy capital on a timeline that allows us to maximize our earnings for our shareholders. As we mentioned in the past, we expect to raise capital when we believe it is accretive and can be deployed in a timely manner.

With that, I will turn the call back over to Bilal..

Thank you, Jeff. This quarter, we successfully raised equity capital to fund our strong pipeline of investments and improve our competitive position for the long term. We believe that the continued strong performance of the portfolio is a result of our consistent approach to underwriting and portfolio management.

The long term alignment of interest between our shareholders and our external manager, which owns 22% of our company have also contributed to our strong results.

We intend to maintain our focus on delivering capital to the lower middle market especially to the non-sponsored community, which is where we continue to find attractive risk-adjusted returns as evidenced by the attractive yield on of our loan portfolio of more than 12%.

We have significant capital resources available to continue investing and grow our earnings over time. Our investment platform has a long history and it has weathered multiple credit cycles and changes in the economic environment since its inception in 1994.

We believe, that we are well-positioned for rising interest rate environment given our attractive long-term fixed-rate financing through the SBIC program with a weighted average coupon of 3.18%. Additionally, about two thirds of our loan portfolio is floating rate.

Our focus is to provide long-term value to all of our stakeholders including both shareholders and borrowers. As a lender, we will continue being responsive to the needs of our borrowers by providing them flexible capital solutions. With that, operator, please open up the call for questions..

[Operator Instructions] The first question comes from Christopher Testa of National Securities Corporation. Please go ahead..

Just curios, Bilal, just on the origination side. Obviously, the volumes picked up for you guys in the current quarter.

Just wondering how the usage of capital for the originations has varied from the first quarter into the second?.

Yes, so I think the usage of capital is very similar to what we have done historically. As we said on the call, our focus is the lower middle market, focusing on the non-sponsored community. And so the usage will remain the same. I think that as we mentioned, there's a certain amount of capital that's left in the SBIC.

And once that's deployed, then we will be deploying capital in the BDC outside the SBIC. So the strategy is the same. It's just a different way of financing it..

Right.

What I'm getting at, is there now significantly less refinancing and significantly more new money for the originations you've done in the second quarter relative to the first or just what you've seen in the pipeline?.

Yes, I would say that there were seven deals that were slated in the first quarter that moved into the second quarter. So that was that increased the pipeline for the second quarter.

The other thing I would say also is that while focusing on the lower middle market, and focusing on the same size borrower, we are looking to hold larger sizes of the tranche and perhaps, in many cases, doing the whole tranche of debt. So I think that is another reason why the growth..

Okay, great. And obviously, the share issuance probably weighing on earnings a bit here in the second quarter as you guys alluded to.

Is there potential for the management company to implement a advisory fee waiver for if the NII fall short of the dividend?.

It's still early in the quarter, so we haven't discussed that. So we are still looking through the origination process here..

Okay, that's fair. And just kind of looking at the right hand side of the balance sheet for a moment. I know it's been a couple of years since the first -- since you guys applied for an additional SBIC license. It hasn't come yet. Are you guys thinking about additional sources of potentially fixed rate funding maybe on unsecured bond by yearend.

Are you looking to maybe upsize the revolver.

Just curious how you're thinking about debt as your equity basis now is larger?.

Yes, most definitely, I think we are looking at all of debt options and unsecured bond offering would be an option, certainly, on the table..

The existing line of credit is also an option. We're continuing to look at all leverage options, Chris..

Got it.

And do you guys have an indication on how long approximately it's going to take you to deploy the capital rates from the equity offering?.

We expect to deploy it here, hopefully in this quarter..

Okay, great. That's all from me. Thank you for taking my questions..

This concludes our question-and-answer session. I would like to turn the conference back over to Bilal Rashid, CEO for any closing remarks..

Thank you all for joining our call today, and we look forward to speaking with everyone again next quarter. Operator, you may know end the call. Thank you..

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..