Steve Altebrando - Vice President, Investor Relations Bilal Rashid - Chairman and Chief Executive Officer Jeff Cerny - Chief Financial Officer and Treasurer.

Good morning and welcome to the OFS Capital Fourth Quarter and Year End 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] 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..

Good morning, everyone. Thank you for joining us. With me today is Bilal Rashid, Chairman and Chief Executive Officer of OFS Capital and Jeff Cerny, the company’s Chief Financial Officer and Treasurer. Please note that we issued a press release this morning announcing our fourth quarter results.

This press release was subsequently filed on Form 8-K with the SEC. Both documents can be obtained under our 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 as defined under applicable securities laws.

Such statements reflect various assumptions, expectations and opinions by OFS Capital management’s 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 way 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.

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

Thank you, Steve. Good morning and welcome. Reflecting on 2017 and looking ahead, we remain focused on maintaining a stable NAV per share and growing our net investment income in a thoughtful and sustainable manner. We intend to increase our net investment income by deploying cash on hand and raising additional debt capital.

As you know, we have significant room to grow our regulatory leverage as our SBIC debt does not count towards the BDC asset coverage ratio. We have a strong pipeline to support our growth. And so far this quarter, we have already deployed $44.4 million.

Given our capital resources, we believe that we are poised to grow our net investment income above our distributions in the near future. In the fourth quarter, we generated net investment income of $0.29 per share.

As we had indicated on our call in November of last year, we expected the net investment income per share to be lower for this quarter due to unusually high prepayment activity. As you can see in our press release from this morning, we had $73 million in cash at the end of 2017.

This prepayment activity in part reflects the quality of our portfolio companies as evidenced by the significant capital gains we realized in 2017. However, the prepayments also acted as a drag on our earnings in the fourth quarter.

Even in the face of such prepayment activity, we have maintained the same discipline and a long-term approach to investing, which emphasizes capital preservation over near-term results. Fortunately, our pipeline is strong and our team is actively working to redeploy this capital in a prudent manner.

This focus on capital preservation is further solidified by the fact that our external manager owns 22% of the common shares outstanding ensuring strong alignment of interest between all stakeholders. Our net asset value per share at the end of the fourth quarter was stable at $14.12.

Since the beginning of 2011, we have invested $827 million with a cumulative net realized gain on principal of $4.8 million. As you know, we recently declared a special dividend of $0.37 per share in addition to our regular quarterly distributions.

This special dividend was a result of ordinary income and realized gains in 2017 which exceeded our regular quarterly distributions. In terms of market opportunity, we continue to focus on the lower middle market, specifically on the non-sponsored space.

We believe that capital is more constrained here and our extensive sourcing underwriting and portfolio management expertise gives us a competitive advantage. Our larger equity capital base enables us to make larger investments, while maintaining concentration risks at acceptable levels.

We believe this has given us a strategic advantage in this segment of the market as we are increasingly able to meet the full borrowing needs of our clients. This in turn provides higher certainty of execution to our borrowers and allows us to win deals without sacrificing our underwriting standards.

We believe that our track record is a result of our sourcing, diligence and loan management capabilities. Our platform has been operating since 1994 and we see a high volume of deals because of our name recognition in the market. In fact over 700 new deals came through our pipeline in 2017. Our sourcing capability allows us to be highly selective.

In terms of diligence, we take a private equity approach to lending. Our primary due diligence process includes multiple on-site meetings with management, independent accounting reports, background checks and extensive industry analysis. In many situations, we secure board seats or board observation rights in our portfolio companies.

Turning to the balance sheet, we continue to believe that we are well positioned for a rising interest rate environment. Approximately 76% of our loans are floating rate, while 89% of our debt at the end of the quarter was fixed rate.

We have $150 million in fixed rate financing through the SBIC program with a weighted average coupon of 3.18% with no maturities until 2022. This low stable cost of debt has a meaningful positive impact on our return on equity.

We remain confident that our long-term focus and emphasis on capital preservation as reflected by our track record will continue to serve the company. At this point I turn the call over to Jeff Cerny, our Chief Financial Officer..

Thank you. Good morning everyone. Our goal remains and has always been to maintain a stable net asset value and generate investment income above our distribution. While we had elevated repayment activity in 2017 as Bilal just discussed, our pipeline is strong.

We believe we will achieve our goal by prudently deploying our capital and restoring leverage and earnings to prior levels. We deployed $28 million in the fourth quarter across nine investments, primarily senior secured loans. OFS Capital invested $143 million in 2017 compared to $69 million over the same period in 2016.

We have closed additional transactions totaling $44.4 million so far in 2018 and our pipeline still remained strong. Our equity capital raise in early 2017 gave us comfort to speak for larger investments.

More broadly, our deal pipeline has increased as a result, better positioning us with respect to existing and potential clients that seek larger and more flexible mandates, especially in a market where certainty of closing continues to be important.

We had $141 million of prepayments and loan sales in 2017, which was approximately 4x higher than what we saw in 2016. This resulted in a higher than normal cash position during the third and fourth quarters, which led to earnings softness in the fourth quarter. We expect the softness to continue in the first quarter of 2018 as we deploy capital.

However, given our pipeline and recent originations, we believe we will see a significant financial benefit from our investments starting in the second quarter. We are optimistic about 2018. The repayments create a challenge and a priority that we focus on everyday keeping capital deployed in good credits.

While we deploy our idle cash and continue to make it a top priority, we need to remain disciplined and believe that the strong performance of our portfolio has been driven by a commitment to rigorous credit analysis, prudent underwriting and creative structuring, a commitment that we intend to maintain.

As Bilal mentioned, we recently declared a $0.37 special dividend resulting from two large realized gains in the fourth quarter, our equity investments in Malabar and smarTours. The Malabar investment was a non-sponsored deals that was sourced by one of the key members of our investment team.

We had a strong view that the company would benefit from our pickup in the commercial aerospace cycle and the structure of the investment included equity participation. In addition, the deal was structured with key lender protections, including a tight covenant package, low leverage and a board seat.

We realized a gain of $5.6 million on our preferred equity investment, which was convertible to common stock. The smarTours investment was also a non-sponsored deal in which we backed a search fund by providing debt and equity to support their acquisition.

We believe that smarTours would benefit from the operational improvements implemented by the search fund managers who ran the business post close. The deal was structured with key lender protections, including a senior secured position, a tight covenant package, low leverage and a board observation seat.

We realized a gain of $1.8 million on our equity investment. As far as liquidity, at quarter’s end, we had approximately $73 million of cash, of which $72 million was in our SBIC. We also had $17.4 million available on our line of credit. This line of credit continues to be a valuable source of financing for us.

It acts as a working capital facility and a warehouse line that we can ramp up prior to a capital markets transaction to reduce the risk of sitting on cash after an offering. This line of credit is very flexible.

Due to the deployment of capital in the first quarter, our cash level in the SBIC now stands at $40 million with a robust pipeline and a path to deploy remaining cash.

We continue to believe that we have access to liquidity, including the flexibility to access the capital markets to enable us to meet our borrowers’ needs and increase our earnings per share. Due to our strong pipeline and deployment of capital during the first quarter of 2018, we are actively evaluating our options to raise additional debt capital.

Our net asset value at the end of the quarter was $14.12 compared to $14.15 at the end of the September quarter. This small decline was primarily due to our distribution in the fourth quarter being in excess of our net investment income, which was partially offset by an increase in the fair value of our investments.

We are very well positioned in a rising rate environment. 76% of our loan portfolio had floating rate coupons at year end, while 89% of our debt was long-term fixed rate. For each 50 basis points of LIBOR increase, we realized an organic increase of $0.07 per share per annum or approximately a 6% increase in net investment income.

Turning to the income statement, we derived approximately $8.3 million in total investment income in the quarter, a decrease of approximately $800,000 over the third quarter.

The decrease was due to lower fee income, which was higher than average in the prior quarter and a slight decline in total interest income due to above average idle cash resulting from the 2017 payoffs. Total expenses of $4.5 million improved compared to $4.7 million in the prior quarter.

The improvement was primarily driven by lower net investment income incentive fees. For the fourth quarter, net investment income was $3.8 million or $0.29 per share compared to $4.4 million in the third quarter. Turning to our portfolio at the end of the quarter, we had investments in 37 companies totaling $277.5 million on a fair value basis.

As a percentage of cost, our investments were approximately 67% senior secured loans, 22% subordinated debt and 11% equity, of which 8% of the 11% in equity investments is actually in preferred securities with coupons ranging from 8% to 15.75%.

Our portfolio remains diversified with an average investment in each portfolio company of $7.5 million or 2.7% of the portfolio’s fair value. The overall weighted average yield to cost on our debt investments increased 61 basis points to 12.11.

This increase was driven by several sales of lower yielding loans as well as an average LIBOR increase of approximately 32 basis points during the quarter. We currently have two loans on non-accrual Community Intervention Services and Southern Tech. Both loans are non-accrual due to their continued weak performance.

Community Intervention Services provides behavioral health and substance abuse services and we reduced its fair value to zero. Southern Tech is a for profit education provider and is one of our smallest loans that we mark down to $1.2 million. With that, I will turn the call back over to Bilal..

Thank you, Jeff. We remain focused on generating net investment income that will exceed our distribution, while maintaining the quality of our portfolio. We are confident about the earnings potential of our company given our strong pipeline.

We believe that our thorough underwriting process has produced a low loss experience and will continue to guide us going forward. We are well positioned for rising interest rates given our attractive long-term fixed rate financing through the SBIC program with a weighted average coupon of 3.18%.

Approximately 76% of our loan portfolio is floating rate. In addition, the manager is strongly aligned with our shareholders with 22% ownership of the BDC. Our investment platform has a long history and has weathered multiple credit cycles and changes in the economic environment since its inception in 1994.

Our BDC benefits from the breadth and depth of our investment platform which has over $2 billion of assets under management. Our focus is to provide long-term value to all of our stakeholders including both shareholders and borrowers.

As a lender we intend to continue to meet the growing and varying needs of our borrowers by providing them flexible capital solutions. With that operator, please open the call for questions..

Operator:.

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

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect..