UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
(Mark One)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 814-00813
OFS Capital Corporation
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware
(State or jurisdiction of
incorporation or organization)
10 S. Wacker Drive, Suite 2500
Chicago, Illinois
(Address of principal executive offices)
46-1339639
(I.R.S. Employer
Identification No.)
60606
(Zip Code)
REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:
(847) 734-2000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value per share
6.375% Notes due 2025
6.50% Notes due 2025
5.95% Notes due 2026
OFS
OFSSL
OFSSZ
OFSSI
The Nasdaq Global Select Market
The Nasdaq Global Select Market
The Nasdaq Global Select Market
The Nasdaq Global Select Market
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☐ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ☐ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter periods as the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit such files). Yes ☐ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated
filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Non-accelerated filer
☐
☐
Accelerated filer
Smaller reporting company
Emerging growth company
x
☐
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) YES ☐ NO x
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting
standards provided pursuant to Section 13(a) of the Exchange Act. ☐
The aggregate market value of the registrant's voting shares of common stock held by non-affiliates of the registrant as of June 30, 2019, was approximately $125.0 million based on $12.00
per share, the last reported sale price of the shares of common stock on the Nasdaq Global Select Market. For the purpose of calculating this amount only, shares held by certain stockholders and
by directors and executive officers of the registrant have been excluded. On March 11, 2020, there were 13,376,836 shares outstanding of the Registrant’s common stock, $0.01 par value.
Portions of the registrant’s definitive Proxy Statement relating to the registrant’s 2020 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange
Commission, are incorporated by reference in Part III of this Annual Report on Form 10-K as indicated herein.
DOCUMENTS INCORPORATED BY REFERENCE
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
TABLE OF CONTENTS
PART 1
PART II
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Consolidated Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
Item 7.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Item 8.
Item 9.
Item 9A.
Item 9B.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Item 15.
Item 16.
Signatures
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
PART III
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
Exhibits and Financial Statement Schedules
Form 10-K Summary
PART IV
Page
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27
55
55
55
55
56
64
66
85
86
153
153
153
154
154
154
154
154
155
158
159
OFS Capital Corporation, our logo and other trademarks of OFS Capital Corporation are the property of OFS Capital Corporation. All other
trademarks or trade names referred to in this Annual Report on Form 10-K are the property of their respective owners.
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Defined Terms
We have used "we," "us," "our," "our company," and "the Company" to refer to OFS Capital Corporation in this report. We also have used several other
terms in this report, which are explained or defined below:
1940 Act
Investment Company Act of 1940, as amended
Administration Agreement
Administration Agreement between the Company and OFS Services dated November 7, 2012
Advisers Act
Investment Advisers Act of 1940, as amended
Annual Distribution Requirement
Distributions to our stockholders, for each taxable year, of at least 90% of our ICTI
ASC
ASC Topic 820
ASC Topic 946
ASU
BDC
BLA
BNP Facility
Board
CLO
Code
Company
Direct Investment
DRIP
EBITDA
Exchange Act
FASB
FDIC
GAAP
HPCI
ICTI
Accounting Standards Codification, as issued by the FASB
ASC Topic 820, "Fair Value Measurements and Disclosures"
ASC Topic 946, "Financial Services-Investment Companies"
Accounting Standards Updates, as issued by the FASB
Business Development Company under the 1940 Act
Business Loan Agreement, as amended, with Pacific Western Bank, as lender, which provides the Company with a
senior secured revolving credit facility
Revolving credit and security agreement by and among OFSCC-FS, the lenders from time to time parties thereto,
BNP Paribas, as administrative agent, OFSCC-FS Holdings, LLC, a wholly owned subsidiary of the Company, as
equityholder, the Company, as servicer, Citibank, N.A., as collateral agent and Virtus Group, LP, as collateral
administrator, which provides for borrowings in an aggregate principal amount up to $150,000,000
The Company's board of directors
Collateralized loan obligation
Internal Revenue Code of 1986, as amended
OFS Capital Corporation and its consolidated subsidiaries
A debt or equity investment in a portfolio company. Direct investments exclude Structured Finance Notes
Distribution reinvestment plan
Earnings before interest, taxes, depreciation, and amortization
Securities Exchange Act of 1934, as amended
Financial Accounting Standards Board
Federal Deposit Insurance Corporation
Accounting principles generally accepted in the United States
Hancock Park Corporate Income, Inc., a Maryland corporation and non-traded BDC for whom OFS Advisor serves
as investment adviser
Investment company taxable income, which is generally net ordinary income plus net short-term capital gains in
excess of net long-term capital losses
Indicative Prices
Market quotations, prices from pricing services or bids from brokers or dealers
Investment Advisory Agreement
Investment Advisory and Management Agreement between the Company and OFS Advisor dated November 7, 2012
IPO
LIBOR
Net Loan Fees
NBIB
OCCI
Offering
OFS Advisor
OFSC
OFS Services
OFSAM
Initial Public Offering
London Interbank Offered Rate
The cumulative amount of fees, such as discounts, premiums and amendment fees that are deferred and recognized
as income over the life of the loan.
Non-binding indicative bid
OFS Credit Company, Inc., a Delaware corporation and a non-diversified, closed-end management investment
company for whom OFS Advisor serves as investment adviser
Follow-on public offering of 3,625,000 shares of our common stock in April 2017
OFS Capital Management, LLC, a wholly owned subsidiary of OFSAM and registered investment advisor under the
Advisers Act
Orchard First Source Capital, Inc., a wholly owned subsidiary of OFSAM
OFS Capital Services, LLC, a wholly owned subsidiary of OFSAM and affiliate of OFS Advisor
Orchard First Source Asset Management, LLC, a full-service provider of capital and leveraged finance solutions to
U.S. corporations
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OFSCC-FS
OFSCC-MB
Parent
PIK
Prime Rate
PWB Credit Facility
RIC
SBA
SBCAA
SBIC
SBIC Acquisition
SBIC Act
SBIC I LP
SEC
Securities Act
Stock Repurchase Program
Structured Finance Notes
The Order
Transaction Price
Unsecured Notes
OFSCC-FS, LLC, an indirect wholly owned subsidiary of the Company
OFSCC-MB, LLC, a wholly owned subsidiary taxed under subchapter C of the Code and generally holds the
equity investments of the Company that are taxed as pass-through entities.
OFS Capital Corporation
Payment-in-kind, non-cash interest or dividends payable as an addition to the loan or equity security producing the
income.
United States Prime interest rate
Senior secured revolving credit facility between the Company and Pacific Western Bank, as lender
Regulated investment company under the Code
U.S. Small Business Administration
Small Business Credit Availability Act
A fund licensed under the SBA small business investment company program
The Company's acquisition of the remaining ownership interests in SBIC I LP and OFS SBIC I GP, LLC on
December 4, 2013
Small Business Investment Act of 1958, as amended
OFS SBIC I, LP, a wholly owned SBIC subsidiary of the Company
U.S. Securities and Exchange Commission
Securities Act of 1933, as amended
The open market stock repurchase program for shares of the Company’s common stock under Rule 10b-18 of the
Exchange Act
CLO subordinated debt positions. CLO subordinated debt positions are entitled to recurring distributions which are
generally equal to the remaining cash flow of payments made by underlying securities less contractual payments to
debt holders and fund expenses
An exemptive relief order from the SEC to permit us to co-invest in portfolio companies with certain funds managed
by OFS Advisor in a manner consistent with our investment objectives, positions, policies, strategies and restrictions
as well as regulatory requirements and other pertinent factors, subject to compliance with certain conditions.
The cost of an arm's length transaction occurring in the same security
The combination of the Unsecured Notes Due April 2025, the Unsecured Notes Due October 2025 and the
Unsecured Notes Due October 2026
Unsecured Notes Due April 2025
The Company's $50.0 million aggregate principal amount of 6.375% notes due April 30, 2025
Unsecured Notes Due October 2025
The Company's $46.0 million aggregate principal amount of 6.5% notes due October 30, 2025
Unsecured Notes Due October 2026
The Company's $54.3 million aggregate principal amount of 5.95% notes due October 31, 2026
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As used in this Annual Report on Form 10-K, except as otherwise indicated, the terms “OFS Capital,” “the Company,” “we,” “us,” and “our”
refer to OFS Capital Corporation and its consolidated subsidiaries.
PART I
Item 1. Business
GENERAL
We are an externally managed, closed-end, non-diversified management investment company and have elected to be treated as a BDC under the
1940 Act, which imposes certain investment restrictions on our portfolio. Our investment objective is to provide our stockholders with both current income
and capital appreciation primarily through debt investments and, to a lesser extent, equity investments. Our investment strategy focuses primarily on
investments in middle-market companies in the United States. We use the term “middle-market” to refer to companies that may exhibit one or more of the
following characteristics: number of employees between 150 and 2,000; revenues between $15 million and $300 million; annual EBITDA between $3
million and $50 million; generally, private companies owned by private equity firms or owners/operators; and enterprise value between $10 million and
$500 million. For additional information about how we define the middle-market, see “—Investment Criteria/Guidelines.”
As of December 31, 2019, the fair value of our debt investment portfolio totaled $451.8 million in 79 portfolio companies, of which 90% was
comprised of senior secured loans and 10% of subordinated loans, respectively, and approximately $43.5 million in equity investments, at fair value, in 15
portfolio companies in which we also held debt investments. We also have six portfolio companies in which we solely held equity investments, as well as
four investments in Structured Finance Notes with a fair value of $21.6 million.
Our investment strategy focuses primarily on middle-market companies in the United States, including senior secured loans, which includes first-
lien, second-lien and unitranche loans, as well as subordinated loans and, to a lesser extent, warrants and other equity securities and Structured Finance
Notes. We also may invest up to 30% of our portfolio in opportunistic investments not otherwise eligible under BDC regulations. Specifically, as part of
this 30% basket, we may consider investments in investment funds that are operating pursuant to certain exceptions to the 1940 Act and in advisers to
similar investment funds, as well as in debt or equity of middle-market portfolio companies located outside of the United States and debt and equity of
public companies that do not meet the definition of eligible portfolio companies because their market capitalization of publicly traded equity securities
exceeds the levels provided for in the 1940 Act.
We have executed our investment strategy, in part, through SBIC I LP, a licensee under the SBA's SBIC program, which is subject to SBA
regulations and policies, including periodic audits by the SBA. On a stand-alone basis, SBIC I LP held approximately $249.6 million and $251.1 million in
assets, or approximately 46% and 57% of our total consolidated assets, at December 31, 2019 and 2018, respectively. As part of our plans to focus on
lower-yielding, first lien senior secured loans to larger borrowers, which we believe will improve our overall risk profile, SBIC I LP intends, over time, to
repay its outstanding SBA debentures prior to the scheduled maturity dates of its debentures. We do not expect to make new investments through SBIC I
LP, other than follow-on investments. We believe that investing in more senior loans to larger borrowers is consistent with our view of the private loan
market and will reduce our overall leverage on a consolidated basis. For additional information regarding the regulation of SBIC I LP, see “Regulation—
Small Business Investment Company Regulations.”
We also execute on our investment strategy, in part, through OFSCC-FS, which established the BNP Facility on June 20, 2019, to provide
borrowings in an aggregate principal amount up to $150.0 million. We believe that the BNP Facility will enable us to provide more first lien loans to large
companies at more competitive pricing, due to this lower cost of financing. On a stand-alone basis, OFSCC-FS held approximately $92.5 million and $-0-
million in assets at December 31, 2019 and 2018, respectively, which accounted for approximately 17% and -0-% of our total consolidated assets,
respectively.
Our investment activities are managed by OFS Advisor and supervised by our Board a majority of whom are independent of us, OFS Advisor and
its affiliates. Under the Investment Advisory Agreement we have agreed to pay OFS Advisor an annual base management fee based on the average value of
our total assets (other than cash and cash equivalents but including assets purchased with borrowed funds and including assets owned by any consolidated
entity) as well as an incentive fee based on our investment performance. We have elected to exclude from the base management fee calculation any base
management fee that would be owed in respect of the intangible asset and goodwill resulting from the SBIC Acquisition. OFS Advisor also serves as the
investment adviser or collateral manager to CLOs and other assets, including HPCI, a non-traded BDC with an investment strategy similar to the
Company's, and OCCI, a non-diversified, externally managed, closed-end management investment company that has registered as an investment company
under the 1940 Act that primarily invests in Structured Finance Notes. See "Item 1A. Risk Factors — Risks Related to OFS Advisor and its Affiliates —
We have potential conflicts of interest related to obligations that OFS Advisor or its affiliates may have to other clients" and "Item 1A. Risk Factors —
Risks Related to OFS Advisor and its Affiliates —We have potential conflicts of interest related to the purchases and sales that OFS Advisor makes on our
behalf and/or on behalf of Affiliated Accounts."
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We have also entered into an Administration Agreement with OFS Services. Under our Administration Agreement, we have agreed to reimburse
OFS Services for our allocable portion (subject to the oversight of our independent directors) of overhead and other expenses incurred by OFS Services in
performing its obligations under the Administration Agreement. See “—Management and Other Agreements–Administration Agreement.”
As a BDC, we must not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at
least 70% of our assets, as defined by the 1940 Act, are qualifying assets (with certain limited exceptions). Qualifying assets include investments in
“eligible portfolio companies.” Under the relevant SEC rules, the term “eligible portfolio company” includes all private companies, companies whose
securities are not listed on a national securities exchange, and certain public companies that have listed their securities on a national securities exchange and
have a market capitalization of less than $250 million, in each case organized in the United States.
A BDC is generally not permitted to incur indebtedness unless immediately after such borrowing it has an asset coverage ratio for total borrowings
of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). However, certain provisions of the Small Business Credit
Availability Act (the "SBCAA"), permit BDCs to be subject to a minimum asset coverage ratio of 150%, if specific conditions are satisfied, when issuing
senior securities (i.e., the amount of debt may not exceed 66 2/3% of the value of our assets). As an approximation, prior to the enactment of the SBCAA,
the most that a BDC could borrow for investment purposes was $1 for every $1 of investor equity. Now, for those BDCs that satisfy the SBCAA’s approval
and disclosure requirements and become subject to the reduced asset coverage ratio, the BDC can borrow $2 for investment purposes for every $1 of
investor equity.
On May 3, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the
application of the modified asset coverage requirements made available under the SBCAA and, as a result, the asset coverage ratio test applicable to us was
decreased from 200% to 150%, effective May 3, 2019. See "Item 1A. Risk Factors — Risks Related to our Business and Structure — Because we have
received the approval of our Board, we are subject to 150% Asset Coverage effective May 3, 2019." Additionally, we received exemptive relief from the
SEC effective November 26, 2013, which allows us to exclude our SBA guaranteed debentures from the definition of senior securities in the statutory asset
coverage ratio under the 1940 Act.
We may borrow money when the terms and conditions available are favorable to do so and are aligned with our investment strategy and portfolio
composition. The use of borrowed funds or the proceeds of preferred stock to make investments would have its own specific benefits and risks, and all of
the costs of borrowing funds or issuing preferred stock would be borne by holders of our common stock.
We have elected to be treated for tax purposes as a RIC under Subchapter M of the Code. To continue to qualify as a RIC, we must, among other
things, meet certain source-of-income and asset diversification requirements. Pursuant to this election, we generally will not have to pay corporate-level
taxes on any income we distribute to our stockholders.
About OFS and Our Advisor
OFS (which refers to the collective activities and operations of OFSAM, its subsidiaries, and certain affiliates) is a full-service provider of capital
and leveraged finance solutions to U.S. companies.
As of December 31, 2019, OFS had 44 full-time employees. OFS is headquartered in Chicago, Illinois and also has offices in New York, New
York and Los Angeles, California.
Our investment activities are managed by OFS Advisor, our investment adviser. OFS Advisor is responsible for sourcing potential investments,
conducting research and diligence on potential investments and equity sponsors, analyzing investment opportunities, structuring our investments and
monitoring our investments and portfolio companies on an ongoing basis. OFS Advisor is a registered investment adviser under the Advisers Act and a
wholly-owned subsidiary of OFSAM.
Our relationship with OFS Advisor is governed by and dependent on the Investment Advisory Agreement and may be subject to conflicts of
interest. See "Item 1A. Risk Factors — Risks Related to OFS Advisor and its Affiliates." OFS Advisor provides us with advisory services in exchange for a
base management fee and incentive fee; see “Management and Other Agreements—Investment Advisory Agreement”. The base management fee is based
on our total assets (other than cash and cash equivalents, and the intangible asset and goodwill resulting from the SBIC Acquisition, but including assets
purchased with borrowed funds and assets owned by any consolidated entity) and, therefore, OFS Advisor will benefit when we incur debt or use leverage.
Our board of directors is charged with protecting our interests by monitoring how OFS Advisor addresses these and other conflicts of interest associated
with its management services and compensation. While our board of directors is not expected to review or approve each borrowing or incurrence of
leverage, our independent directors periodically review OFS Advisor’s services and fees as well as its portfolio management decisions and portfolio
performance.
OFS Advisor has entered into a Staffing Agreement (the "Staffing Agreement") with OFSC, a wholly-owned subsidiary of OFSAM. Under the
Staffing Agreement, OFSC makes experienced investment professionals available to OFS
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Advisor and provides access to the senior investment personnel of OFS and its affiliates. The Staffing Agreement provides OFS Advisor with access to deal
flow generated by OFS and its affiliates in the ordinary course of their businesses and commits the members of OFS Advisor’s investment committee to
serve in that capacity. As our investment adviser, OFS Advisor is obligated to allocate investment opportunities among us and any other clients fairly and
equitably over time in accordance with its allocation policy.
OFS Advisor capitalizes on the deal origination and sourcing, credit underwriting, due diligence, investment structuring, execution, portfolio
management and monitoring experience of OFS’s professionals. The senior management team of OFS, including Bilal Rashid and Jeff Cerny, provides
services to OFS Advisor. These managers have developed a broad network of contacts within the investment community, and possess an average of over 20
years of experience investing in debt and equity securities of middle-market companies. In addition, these managers have extensive experience investing in
assets that constitute our primary focus and have expertise in investing across all levels of the capital structure of middle-market companies.
Competitive Strengths and Core Competencies
Deep Management Team Experienced in All Phases of Investment Cycle and Across All Levels of the Capital Structure. We are managed by
OFS Advisor, which has access to the resources and expertise of OFS’s investment professionals through the Staffing Agreement with OFSC. As of
December 31, 2019, OFS’s credit and investment professionals (including all investment committee members) employed by OFSC had an average of over
15 years of investment experience with strong institutional backgrounds.
Significant Investment Capacity. The net proceeds of equity and debt offerings and borrowing capacity under our credit facilities will provide us
with a substantial amount of capital available for deployment into new investment opportunities in our targeted asset class.
Scalable Infrastructure Supporting the Entire Investment Cycle. We believe that our loan acquisition, origination and sourcing, underwriting,
administration and management platform is highly scalable (that is, it can be expanded on a cost-efficient basis within a timeframe that meets the demands
of business growth). Our platform extends beyond origination and sourcing and includes a regimented credit monitoring system. We believe that our
careful approach, which involves ongoing review and analysis by an experienced team of professionals, should enable us to identify problems early and to
assist borrowers before they face difficult liquidity constraints.
Extensive Loan Sourcing Capabilities. OFS Advisor gives us access to the deal flow of OFS. We believe OFS’s 20-year history as a middle-
market lending platform, extensive relationships with potential borrowers and other lenders, and its market position make it a leading lender to many
sponsors and other deal sources, especially in the currently under-served lending environment.
Structuring with a High Level of Service and Operational Orientation. We provide client-specific and creative financing structures to our
portfolio companies. Based on our experience in lending to, and investing in, middle-market companies, we believe that the middle-market companies we
target, as well as sponsor groups we may pursue, require a higher level of service, creativity and knowledge than has historically been provided by other
service providers more accustomed to participating in commodity-like loan transactions.
Rigorous Credit Analysis and Approval Procedures. OFS Advisor utilizes an established, disciplined investment process of OFS for reviewing
lending opportunities, structuring transactions and monitoring investments. Using a disciplined approach to lending, OFS Advisor seeks to minimize credit
losses through effective underwriting, comprehensive due diligence investigations, structuring and, where appropriate, the implementation of restrictive
debt covenants.
Our Administrator
We do not have any direct employees, and our day-to-day investment operations are managed by OFS Advisor. We have a chief executive officer,
chief financial officer, chief compliance officer, chief accounting officer, corporate secretary and, to the extent necessary, our board of directors may elect
to appoint additional officers going forward. Our officers are employees of OFSC, an affiliate of OFS Advisor, and a portion of the compensation paid to
our officers is paid by us pursuant to the Administration Agreement. All of our executive officers are also officers of OFS Advisor.
OFS Services, an affiliate of OFS Advisor, provides the administrative services necessary for us to operate. OFS Services furnishes us with office
facilities and equipment, necessary software licenses and subscriptions and clerical, bookkeeping and recordkeeping services at such facilities. OFS
Services oversees our financial reporting as well as prepares our reports to stockholders and all other reports and materials required to be filed with the SEC
or any other regulatory authority. OFS Services also manages the determination and publication of our net asset value and the preparation and filing of our
tax returns and generally monitors the payment of our expenses and the performance of administrative and professional services rendered to us by others.
OFS Services may retain third parties to assist in providing administrative services to us. To
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the extent that OFS Services outsources any of its functions, we will pay the fees associated with such functions at cost, on a direct basis.
Market Opportunity
Our investment strategy is focused primarily on investments in middle-market companies in the United States. We find the middle-market
attractive for the following reasons:
Large Target Market. According to the National Center for the Middle Market, there were approximately 200,000 companies in the United States
with annual revenues between $10 million and $1.0 billion as of the fourth quarter of 2019. We believe that these middle-market companies represent a
significant growth segment of the U.S. economy and often require substantial capital investments to grow. Middle-market companies have historically
constituted the vast bulk of OFS’s portfolio companies since its inception, and constituted the majority of our portfolio as of December 31, 2019. We
believe that this market segment will continue to produce significant investment opportunities for us.
Specialized Lending Requirements with High Barriers to Entry. We believe that several factors render many U.S. financial institutions ill-suited
to lend to U.S. middle-market companies. For example, based on the experience of our management team, lending to private middle-market companies in
the United States (a) is generally more labor-intensive than lending to larger companies due to the smaller size of each investment and the fragmented
nature of information for such companies, (b) requires due diligence and underwriting practices consistent with the demands and economic limitations of
the middle-market and (c) may also require more extensive ongoing monitoring by the lender. As a result, middle-market companies historically have been
served by a limited segment of the lending community. As a result of the unique challenges facing lenders to middle-market companies, we believe that
there are high barriers to entry that a new lender must overcome.
Robust Demand for Debt Capital. We believe that private equity firms have significant committed but uncalled capital, a large portion of which is
still available for investment in the United States. Subject to market conditions, we expect the large amount of unfunded buyout commitments will drive
demand for leveraged buyouts over the next several years, which should, in turn, create leveraged lending opportunities for us.
Competition
Our primary competitors include public and private funds, other BDCs, commercial and investment banks, commercial finance companies and, to
the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have
considerably greater financial, technical, and marketing resources than we do. Some competitors may have access to funding sources that are not available
to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider
variety of investments and establish more relationships than us. Further, many of our competitors are not subject to the regulatory restrictions that the 1940
Act imposes on us as a BDC, or to the distribution and other requirements we must satisfy to maintain our RIC status.
We expect to continue to use the expertise of the investment professionals of OFS to which we have access, to assess investment risks and
determine appropriate pricing for our investments in portfolio companies. In addition, we expect that the relationships of the senior members of OFS and its
affiliates will enable us to learn about, and compete effectively for, financing opportunities with attractive middle-market companies in the industries in
which we seek to invest. For additional information concerning the competitive risks we face.
Investment Criteria/Guidelines
Our investment objective is to generate current income and capital appreciation by investing primarily in middle-market companies in the United
States. We focus on investments in senior secured loans, including first lien, second lien, and unitranche loans, as well as subordinated loans and, to a lesser
extent, warrants and other equity securities and Structured Finance Notes. In particular, we believe that structured equity with debt investments (i.e.,
typically senior secured unitranche loans, often with warrant coverage, and often in companies with no financial sponsor) represent a strong relative value
opportunity offering the borrower the convenience of dealing with one lender, which may result in a higher blended rate of interest to us than we might
expect to receive under a traditional multi-tranche structure. We expect that our investments in the equity securities of portfolio companies, such as
warrants, preferred stock, common stock and other equity interests, will principally be made in conjunction with our debt investments. Generally, we do not
expect to make investments in companies or securities that OFS Advisor determines to be distressed investments (such as discounted debt instruments that
have either experienced a default or have a significant potential for default), other than follow-on investments in portfolio companies of ours. We intend to
continue to generate strong risk-adjusted net returns by assembling a diversified portfolio of investments across a broad range of industries.
We target U.S. middle-market companies through OFS’s access to a network of financial institutions, private equity sponsors, investment banks,
consultants and attorneys, and our proprietary database of borrowers developed over OFS’s more
6
than 20 years in lending to middle-market companies. A typical targeted borrower will exhibit certain of the following characteristics:
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number of employees between 150 and 2,000;
revenues between $15 million and $300 million;
annual EBITDA between $3 million and $50 million;
generally, private companies owned by private equity firms or owners/operators;
enterprise value between $10 million and $500 million;
effective and experienced management teams;
defensible market share;
solid historical financial performance, including a steady stream of cash flow;
high degree of recurring revenue;
diversity of customers, markets, products and geography; and
differentiated products or services.
While we believe that the characteristics listed above are important in identifying and investing in prospective portfolio companies, not all of
these criteria will be met by each prospective portfolio company.
Due Diligence and Investment Process Overview
We employ a thorough and disciplined underwriting and due diligence process that is conducted in accordance with established credit policies and
procedures, and that is focused on investment recovery. Our process involves a comprehensive analysis of a prospective portfolio company’s market,
operational, financial, and legal position, as well as its future prospects. In addition to our own analysis, we may use the services of third parties for
environmental reviews, quality of earnings reports, industry surveys, background checks on key managers, and insurance reviews.
We seek to invest in companies that have experienced and incentivized management teams, that have stable and predictable cash flows, and that
have defensible market positions. We underwrite our investments with the expectation that we will hold them for a number of years, and we structure and
document our investments accordingly.
Our due diligence and underwriting process typically addresses the following elements (although certain elements may not be included in every
due diligence undertaking):
Prospective Portfolio Company Characteristics - focusing on primary drivers of the company’s revenues and cash flows, including its key
products and services; customer and supplier concentrations, and contractual relationships; depth, breadth, and quality of company management, as well as
the extent to which the management team is appropriately compensated with equity incentives; and any regulatory, labor, or litigation matters impacting the
company.
Industry and Competitive Overview - including industry size and the company’s position within it; growth potential and barriers to entry;
governmental, regulatory, or technological issues potentially affecting the industry; and cyclicality or seasonality risks associated with the industry.
Financial Analysis - involving an understanding of the company’s historical financial results, focusing on actual operating trends experienced over
time, in order to forecast future performance, including in various sensitized performance scenarios; attention to projected cash flows, debt service
coverage, and leverage multiples under such scenarios; and an assessment of enterprise valuations and debt repayment/investment recovery prospects given
such sensitized performance scenarios.
Investment Documentation - focusing on obtaining the best legal protections available to us given our position within the capital structure,
including, as appropriate, financial covenants; collateral liens and stock pledges; review of loan documents of other of the prospective portfolio company’s
creditors; and negotiation of inter-creditor agreements.
Portfolio Review/Risk Monitoring
We view active portfolio monitoring as a vital part of our investment process, and we benefit from a portfolio management system developed by
OFS that includes daily, weekly, monthly, and quarterly components, and that involves comprehensive review of the performance of each of our portfolio
companies. As part of the portfolio management process, OFS Advisor performs ongoing risk assessments on each of our investments and assigns each
debt investment a credit rating based on OFS’s internal ratings scale.
7
We categorize debt investments into the following risk categories based on relevant information about the ability of borrowers to service their
debt:
1 (Low Risk) – The debt investment has mostly satisfactory asset quality and liquidity, as well as good leverage capacity. It maintains predictable
and strong cash flows from operations. The trends and outlook for the portfolio company's operations, balance sheet, and industry are neutral to favorable.
Collateral, if appropriate, has maintained value and would be capable of being liquidated on a timely basis. Overall a debt investment with a 1 risk rating is
considered to be of investment grade quality.
2 (Below Average Risk) – The debt investment has acceptable asset quality, moderate excess liquidity, and modest leverage capacity. It could have
some financial/non-financial weaknesses which are offset by strengths; however, the credit demonstrates an ample current cash flow from operations. The
trends and outlook for the portfolio company's operations, balance sheet, and industry are generally positive or neutral to somewhat negative. Collateral, if
appropriate, has maintained value and would be capable of being liquidated successfully on a timely basis.
3 (Average) – The debt investment has acceptable asset quality, somewhat strained liquidity, and minimal leverage capacity. It is at times
characterized by acceptable cash flows from operations. Under adverse market conditions, the debt service could pose difficulties for the borrower. The
trends and conditions of the portfolio company's operations and balance sheet are neutral to slightly negative.
4 (Special Mention) – The debt investment has not lost, and is not expected to lose, principal or interest but it possesses credit deficiencies or
potential weaknesses which deserve management’s close and continued attention. The portfolio company’s operations and/or balance sheet have
demonstrated an adverse trend or deterioration which, while serious, has not reached the point where the liquidation of debt is jeopardized. These
weaknesses are generally considered correctable by the borrower in the normal course of business but may weaken the asset or inadequately protect our
credit position if not checked or corrected.
5 (Substandard) – The debt investment is protected inadequately by the current enterprise value or paying capacity of the obligor or of the
collateral, if any. The portfolio company has well-defined weaknesses based upon objective evidence, such as recurring or significant decreases in revenues
and cash flows. These assets are characterized by the possibility that we may sustain loss if the deficiencies are not corrected. The possibility that
liquidation would not be timely (e.g., bankruptcy or foreclosure) requires a Substandard classification even if there is little likelihood of loss.
6 (Doubtful) – The debt investment has all the weaknesses inherent in those classified as Substandard, with the additional factor that the
weaknesses are pronounced to the point that collection or liquidation in full, on the basis of currently existing facts, conditions and values, is deemed
uncertain. The possibility of loss on a Doubtful asset is high but, because of certain important and reasonably specific pending factors which may
strengthen the asset, its classification as an estimated loss is deferred until its more exact status can be determined.
7 (Loss) – The debt investment is considered almost fully uncollectible and of such little value that its continuance as an asset is not warranted. It
is generally a credit that is no longer supported by an operating company, a credit where the majority of our assets have been liquidated or sold and a few
assets remain to be sold over many months or even years, or a credit where the remaining collections are expected to be minimal.
As of December 31, 2019, we had debt investments in 79 portfolio companies, totaling $451.8 million at fair value, of which $18.0 million,
$387.7 million, $45.5 million, and $0.0 million, and $0.7 million were rated 2, 3, 4, 5, and 6, respectively.
Investment Committees
OFS Advisor’s Pre-Allocation Investment Committee, CLO Investment Committee, Structured Credit Investment Committee and Middle-Market
Investment Committee, (collectively, the “Advisor Investment Committees”), are responsible for the overall asset allocation decisions and the evaluation
and approval of investments of OFS Advisor’s advisory clients.
The Middle-Market Investment Committee, which is comprised of Richard Ressler (Chairman), Jeffrey Cerny, Kyde Sharp and Bilal Rashid,
along with the investment committee for SBIC I LP (the “SBIC Investment Committee”), which is comprised of Bilal Rashid, Jeffrey Cerny and Tod
Reichert, are responsible for the evaluation and approval of all the investments made by us directly or through our wholly owned subsidiaries, as
appropriate.
The process employed by the Advisor Investment Committees, including the Middle-Market Investment Committee, and the SBIC Investment
Committee is intended to bring the diverse experience and perspectives of the committees’ members to the investment process. The Middle-Market
Investment Committee and SBIC Investment Committee serve to provide investment consistency and adherence to our core investment philosophy and
policies. The Middle-Market Investment Committee and SBIC Investment Committee also determine appropriate investment sizing and implement ongoing
monitoring requirements of our investments.
8
In certain instances, management may seek the approval of our Board prior to the making of an investment. In addition to reviewing investments,
the meetings of the Middle-Market Investment Committee and SBIC Investment Committee, where applicable, serve as a forum to discuss credit views and
outlooks. Potential transactions and deal flows are reviewed on a regular basis. Members of the investment team are encouraged to share information and
views on credits with members of the Middle-Market Investment Committee and SBIC Investment Committee, where applicable, early in their analysis.
We believe this process improves the quality of the analysis and assists the deal team members in working efficiently.
Investments
We pursue an investment strategy focused primarily on investments in middle-market companies in the United States. We focus on investments in
loans, in which OFS Advisor’s investment professionals have expertise, including investments in first-lien, unitranche, second-lien, and mezzanine loans
and, to a lesser extent, on warrants and other equity securities and Structured Finance Notes. We seek to create a diverse portfolio by making investments in
the securities of middle-market companies that we expect to range generally from $3.0 million to $25.0 million each, although we expect this investment
size will vary proportionately with the size of our capital base.
Structure of Investments
We anticipate that our loan portfolio will continue to contain investments of the following types with the following characteristics:
Senior Secured First-Lien Loans. First-lien senior secured loans comprise, and will continue to comprise, a significant portion of our investment
portfolio. We obtain security interests in the assets of these portfolio companies as collateral in support of the repayment of these loans (in certain cases,
subject to a payment waterfall). The collateral takes the form of first-priority liens on specified assets of the portfolio company borrower and, typically,
first-priority pledges of the ownership interests in the borrower. Our first lien loans may provide for moderate loan amortization in the early years of the
loan, with the majority of the amortization deferred until loan maturity.
Senior Secured Unitranche Loans. Unitranche loans are loans that combine both senior and subordinated debt into one loan under which the
borrower pays a single blended interest rate that is intended to reflect the relative risk of the secured and unsecured components. We typically structure our
unitranche loans as senior secured loans. We obtain security interests in the assets of these portfolio companies as collateral in support of the repayment of
these loans. This collateral takes the form of first-priority liens on the assets of a portfolio company and, typically, first-priority pledges of the ownership
interests in the company. We believe that unitranche lending represents a significant growth opportunity for us, offering the borrower the convenience of
dealing with one lender, which may result in a higher blended rate of interest to us than we might realize in a traditional multi-tranche structure. Unitranche
loans typically provide for moderate loan amortization in the initial years of the facility, with the majority of the amortization deferred until loan maturity.
Unitranche loans generally allow the borrower to make a large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the
borrower is unable to pay the lump sum or refinance the amount owed at maturity. In many cases, we will be the sole lender, or we, together with our
affiliates, will be the sole lender, of unitranche loans, which can afford us additional influence with a borrower in terms of monitoring and, if necessary,
remediation in the event of under performance.
Senior Secured Second-lien Loans. Second-lien senior secured loans obtain security interests in the assets of these portfolio companies as
collateral in support of the repayment of such loans. This collateral typically takes the form of second-priority liens on the assets of a portfolio company,
and we may enter into an inter-creditor agreement with the holders of the portfolio company’s first-lien senior secured debt. These loans typically provide
for no contractual loan amortization in the initial years of the facility, with all amortization deferred until loan maturity. These loans are categorized as
Senior Secured Loans in our consolidated schedule of investments included in the financial statements included elsewhere in this prospectus supplement.
Broadly Syndicated Loans. Broadly Syndicated Loans (whose features are similar to those described under “Senior Secured First-Lien Loans”
and “Senior Secured Second-Lien Loans” above) are typically originated and structured by banks on behalf of large corporate borrowers with employee
counts, revenues, EBITDAs and enterprise values larger than the middle-market characteristics described above. The proceeds of Broadly Syndicated
Loans are often used for leveraged buyout transactions, mergers and acquisitions, recapitalizations, refinancings, and financing capital expenditures.
Broadly Syndicated Loans are typically distributed by the arranging bank to a diverse group of investors primarily consisting of: CLOs; senior secured loan
and high yield bond mutual funds; closed-end funds, hedge funds, banks, and insurance companies; and finance companies. A borrower must comply with
various covenants contained in a loan agreement or note purchase agreement between the borrower and the holders of the Broadly Syndicated Loan (the
“Loan Agreement”). In a typical Broadly Syndicated Loan, an administrative agent (the “Agent”) administers the terms of the Loan Agreement. In such
cases, the Agent is normally responsible for the collection of principal and interest payments from the borrower and the apportionment of these payments to
the credit of all institutions that are parties to the Loan Agreement. We will generally rely upon the Agent or an intermediate participant to receive and
forward to us our portion of the principal and interest payments on the Broadly Syndicated Loan.
9
Additionally, we normally will rely on the Agent and the other loan investors to use appropriate credit remedies against the borrower. The Agent is
typically responsible for monitoring compliance with covenants contained in the Loan Agreement based upon reports prepared by the borrower. The Agent
may monitor the value of the collateral and, if the value of the collateral declines, may accelerate the Broadly Syndicated Loan, may give the borrower an
opportunity to provide additional collateral or may seek other protection for the benefit of the participants in the Broadly Syndicated Loan. The Agent is
compensated by the borrower for providing these services under a Loan Agreement, and such compensation may include special fees paid upon structuring
and funding the Broadly Syndicated Loan and other fees paid on a continuing basis. The Broadly Syndicated Loans in which we invest may include loans
that are considered “covenant-lite” loans, because of their lack of a full set of financial maintenance covenants.
These above loans are categorized as Senior Secured Loans in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements
and Supplementary Data."
Subordinated (“Mezzanine”) Loans. These investments are typically structured as unsecured, subordinated loans that typically provide for
relatively high, fixed interest rates that provide us with significant current interest income. These loans typically will have interest-only payments (often
representing a combination of cash pay and payment-in-kind ("PIK") interest) in the early years, with amortization of principal deferred to maturity.
Mezzanine loans generally allow the borrower to make a large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the
borrower is unable to pay the lump sum or refinance the amount owed at maturity. Mezzanine investments are generally more volatile than secured loans
and may involve a greater risk of loss of principal. Mezzanine loans often include a PIK feature (meaning a feature allowing for the payment of interest in
the form of additional principal amount of the loan instead of in cash), which effectively operates as negative amortization of loan principal, thereby
increasing credit risk exposure over the life of the loan. These loans are categorized as Subordinated Loans in our consolidated schedule of investments
included in the financial statements included elsewhere in this prospectus supplement.
These above loan is categorized as Subordinated Loans in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and
Supplementary Data."
Equity Securities. Equity securities typically consist of either a direct minority equity investment in common or membership/partnership interests
or preferred stock of a portfolio company, and are typically not control-oriented investments. Our preferred equity investments typically contain a fixed
dividend yield based on the par value of the equity security. Preferred equity dividends may be paid in cash at a stipulated date, usually quarterly, and are
participating and/or cumulative. We may structure such equity investments to include provisions protecting our rights as a minority-interest holder, as well
as a “put,” or right to sell such securities back to the issuer, upon the occurrence of specified events. In many cases, we may also seek to obtain registration
rights in connection with these equity interests, which may include demand and “piggyback” registration rights, which grants us the right to register our
equity interest when either the portfolio company or another investor in the portfolio company files a registration statement with the SEC to issue
securities. Our equity investments typically are made in connection with debt investments to the same portfolio companies. These securities are categorized
as a Preferred Equity or Common Equity in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and Supplementary
Data."
Warrants. In some cases, we may receive nominally priced warrants to buy a minority equity interest in the portfolio company in connection with
a loan. As a result, as a portfolio company appreciates in value, we may achieve additional investment return from this equity interest. We may structure
such warrants to include provisions protecting our rights as a minority-interest holder, as well as a put to sell such securities back to the issuer, upon the
occurrence of specified events. In many cases, we may also seek to obtain registration rights in connection with these equity interests, which may include
demand and “piggyback” registration rights. These securities are categorized as Warrants in our consolidated schedule of investments included in "Part II,
Item 8. Financial Statements and Supplementary Data."
Structured Finance Notes. We may purchase interests in the equity securities of CLOs collateralized by portfolios consisting primarily of below
investment grade U.S. senior secured loans with a large number of distinct underlying borrowers across various industry sectors. The equity of a CLO is
unrated and subordinated to the debt tranches and typically represents approximately 8% to 11% of a CLO’s capital structure. A CLO’s equity represents
the first loss position in the CLO. The holders of CLO equity interests are typically entitled to any cash reserves that form part of the structure when such
reserves are permitted to be released. Structured Finance Notes are considered CLO subordinated debt positions. CLO subordinated debt positions are
entitled to recurring distributions which are generally equal to the remaining cash flow of payments made by underlying securities less contractual
payments to debt holders and fund expenses. Economically, CLO equity benefits from gains and suffers from losses and generally receive the difference
between the interest received from the investment portfolio and the interest paid to the holders of debt tranches of the CLO structure. In addition, the CLO
equity securities in which we may invest in the future are highly leveraged (with CLO equity securities typically being leveraged 9 to 13 times), which
magnifies our risk of loss on such investments.
10
General Structuring Considerations. We tailor the terms of each investment to the facts and circumstances of the transaction and the prospective
portfolio company, negotiating a structure that protects our rights and manages our risk while creating incentives for the portfolio company to achieve its
business plan and improve its operating results. We seek to limit the downside potential of our investments by:
•
•
•
selecting investments that we believe have a very low probability of loss;
requiring a total return on our investments (including both interest and potential equity appreciation) that we believe will compensate us
appropriately for credit risk; and
negotiating covenants in connection with our investments that afford our portfolio companies as much flexibility in managing their businesses as
possible, consistent with the preservation of our capital. Such restrictions may include affirmative and negative covenants, default penalties, lien
protection, change of control provisions and board rights, including either observation or rights to a seat on the board of directors under some
circumstances.
We expect to hold most of our investments to maturity or repayment, but we may sell some of our investments earlier if a liquidity event occurs,
such as a sale, recapitalization or worsening of the credit quality of the portfolio company.
MANAGEMENT AND OTHER AGREEMENTS
Investment Advisory Agreement
OFS Advisor is registered as an investment adviser under the Advisers Act. OFS Advisor is a wholly owned subsidiary of OFSAM. Pursuant to
the Investment Advisory Agreement with and subject to the overall supervision of our board of directors and in accordance with the 1940 Act, OFS
Advisor provides investment advisory services to us. Under the terms of the Investment Advisory Agreement, OFS Advisor:
•
•
•
•
determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;
assists us in determining what securities we purchase, retain or sell;
identifies, evaluates and negotiates the structure of the investments we make (including performing due diligence on our prospective portfolio
companies); and
executes, closes, services and monitors the investments we make.
Management and Incentive Fee
For providing these services, OFS Advisor receives a fee from us, consisting of two components—a base management fee and an incentive fee.
The base management fee is calculated at an annual rate of 1.75% based on the average value of our total assets (other than cash and cash equivalents but
including assets purchased with borrowed amounts and including assets owned by any consolidated entity), adjusted for stock issuances and stock
purchases, at the end of the two most recently completed calendar quarters. We have excluded from the base management fee calculation any base
management fee that would be owed in respect of the intangible asset and goodwill resulting from the SBIC Acquisition. The base management fee is
payable quarterly in arrears. Base management fees for any partial quarter are prorated based on the number of days in the quarter.
On June 11, 2019, OFS Advisor agreed to reduce a portion of its base management fee by reducing the portion of such fee from 0.4375% per
quarter (1.75% annualized) to 0.25% per quarter (1.00% annualized) of the average value of the portion of the total assets held by the Company through
OFSCC-FS (the "OFSCC-FS Assets"), at the end of the two most recently completed calendar quarters to the extent that such portion of the OFSCC-FS
Assets are financed using leverage (also calculated on an average basis) that causes the Company’s statutory asset coverage ratio to fall below 200%. When
calculating its statutory asset coverage ratio, the Company excludes its SBA guaranteed debentures from its total outstanding senior securities as permitted
pursuant to exemptive relief granted by the SEC dated November 26, 2013. Effective January 1, 2020, OFS Advisor agreed to further reduce the base
management fee to 0.25% per quarter (1.00% annualized) of the average value of the portion of total assets held by the Company through OFSCC-FS at the
end of the two most recently completed calendar quarters without regard to the statutory asset coverage ratio. The base management fee reduction by OFS
Advisor is renewable on an annual basis and the amount of the base management fee reduced with respect to the OFSCC-FS Assets shall not be subject to
recoupment by OFS Advisor.
The incentive fee has two parts. One part ("Part One") is calculated and payable quarterly in arrears based on our pre-incentive fee net investment
income for the immediately preceding calendar quarter. “Pre-incentive fee net investment income” means interest income, dividend income and any other
income (including any other fees such as commitment, origination and sourcing, structuring, diligence and consulting fees or other fees that we receive
from portfolio companies but excluding fees for providing managerial assistance) accrued during the calendar quarter, minus operating expenses for the
quarter (including
11
the base management fee, any expenses payable under the Administration Agreement and any interest expense and dividends paid on any outstanding
preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest or
dividend feature (such as original issue discount, or "OID", debt instruments with PIK interest, equity investments with accruing or PIK dividend, and zero
coupon securities), accrued income that we have not yet received in cash.
Pre-incentive fee net investment income does not include any realized gains, realized losses, unrealized capital appreciation or unrealized capital
depreciation. Because of the structure of the incentive fee, it is possible that we may pay an incentive fee in a quarter where we incur a loss. For example, if
we receive pre-incentive fee net investment income in excess of the hurdle rate (as defined below) for a quarter, we will pay the applicable incentive fee
even if we have incurred a loss in that quarter due to realized capital losses and unrealized capital depreciation.
Pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets (defined as total assets less indebtedness and
before taking into account any incentive fees payable during the period) at the end of the immediately preceding calendar quarter, is compared to a fixed
“hurdle rate” of 2.0% per quarter. If market interest rates rise, we may be able to invest our funds in debt instruments that provide for a higher return, which
would increase our pre-incentive fee net investment income and make it easier for OFS Advisor to surpass the fixed hurdle rate and receive an incentive fee
based on such net investment income. There is no accumulation of amounts on the hurdle rate from quarter to quarter and, accordingly, there is no
clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle rate, and there is no delay of payment if prior quarters are below
the quarterly hurdle rate. Pre-incentive fee net investment income fees are prorated for any partial quarter based on the number of days in such quarter.
•
•
We pay OFS Advisor an incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows:
no incentive fee in any calendar quarter in which the pre-incentive fee net investment income does not exceed the hurdle rate;
100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that
exceeds the hurdle rate but is less than 2.5% in any calendar quarter. We refer to this portion of our pre-incentive fee net investment income
(which exceeds the hurdle rate but is less than 2.5%) as the “catch-up” provision. The catch-up is meant to provide OFS Advisor with 20.0% of
the pre-incentive fee net investment income as if a hurdle rate did not apply if this pre-incentive fee net investment income exceeds 2.5% in any
calendar quarter; and
•
20.0% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.5% in any calendar quarter.
The following is a graphical representation of the calculation of the income-related portion of the incentive fee:
Quarterly Incentive Fee Based on Net Investment Income
The second part ("Part Two") of the incentive fee (the “Capital Gains Fee”) is determined and payable in arrears as of the end of each calendar
year (or upon termination of the Investment Advisory Agreement, as of the termination date) and is calculated at the end of each applicable year by
subtracting (a) the sum of our cumulative aggregate realized capital losses and our aggregate unrealized capital depreciation from (b) our cumulative
aggregate realized capital gains. If such amount is positive at the end of such year, then the Capital Gains Fee for such year is equal to 20.0% of such
amount, less the aggregate amount of Capital Gains Fees paid in all prior years. If such amount is negative, then there is no Capital Gains Fee for such year.
The Company accrues the Capital Gains Fee if, on a cumulative basis, the sum of net realized capital gains and (losses) plus net unrealized appreciation and
(depreciation) is positive.
The cumulative aggregate realized capital gains are calculated as the sum of the differences, if positive, between (a) the net sales price of each
investment in our portfolio when sold and (b) the accreted or amortized cost basis of such investment.
12
The cumulative aggregate realized capital losses are calculated as the sum of the amounts by which (a) the net sales price of each investment in
our portfolio when sold is less than (b) the accreted or amortized cost basis of such investment.
The aggregate unrealized capital depreciation is calculated as the sum of the differences, if negative, between (a) the valuation of each investment
in our portfolio as of the applicable Capital Gains Fee calculation date and (b) the accreted or amortized cost basis of such investments. Unrealized capital
appreciation is accrued, but not paid until said appreciation is realized. We accrue the Capital Gains Fee if, on a cumulative basis, the sum of the net
realized capital gains (and losses) plus net unrealized appreciation (and depreciation) is positive. OFS Advisor has excluded from the Capital Gains Fee
calculation the realized gain with respect to the step acquisitions resulting from the SBIC Acquisition. The Capital Gains Fee for any partial year is prorated
based on the number of days in such year.
The base management fee is payable quarterly in arrears and was $8.3 million, $6.3 million, and $5.0 million, for the years ended December 31,
2019, 2018, and 2017, respectively.
The incentive fee is payable quarterly in arrears and was $4.8 million, $4.4 million, and $3.0 million for the years ended December 31, 2019,
2018, and 2017, respectively. Incentive fees for the years ended December 31, 2019, 2018, and 2017, included Part One incentive fees (based on net
investment income) of $4.8 million, $4.4 million, which included an irrevocable waiver of receipt of $22,000 by OFS Advisor, and $3.0 million
respectively, which included a share issue adjustment of $(0.6) million related to the Company's Offering and Part Two incentive fees (based upon net
realized and unrealized gains and losses, or capital gains) of $0, $0 and $0, respectively.
Examples of Incentive Fee Calculation
Example 1—Income Related Portion of Incentive Fee:
Assumptions
•
Hurdle rate(1) = 2.0%
• Management fee(2) = 0.44%
•
Other estimated expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.20%
(1) Represents a quarter of the 8.0% annualized hurdle rate.
(2) Represents a quarter of the 1.75% annualized management fee, which became effective October 31, 2013.
(3) Excludes estimated offering expenses.
Alternative 1
Additional Assumptions
•
•
Investment income (including interest, dividends, fees, etc.) = 1.25%
Pre-incentive fee net investment income (investment income – (management fee + other expenses)) = 0.61%
Pre-incentive fee net investment income does not exceed the hurdle rate, therefore there is no incentive fee.
Alternative 2
Additional Assumptions
•
•
Investment income (including interest, dividends, fees, etc.) = 2.80%
Pre-incentive fee net investment income (investment income – (management fee + other expenses)) = 2.16%
Pre-incentive fee net investment income exceeds hurdle rate, therefore there is an incentive fee.
Incentive Fee
=
=
=
=
100% × “Catch-Up” + the greater of 0% AND (20% × (pre-incentive fee net investment income –
2.5%))
(100% ×(2.16% – 2.0%)) + 0%
100% × 0.16%
0.16%
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Alternative 3
Additional Assumptions
•
•
Investment income (including interest, dividends, fees, etc.) = 3.50%
Pre-incentive fee net investment income (investment income – (management fee + other expenses)) = 2.86%
Pre-incentive fee net investment income exceeds hurdle rate, therefore there is an incentive fee.
Incentive Fee
=
=
=
=
=
100% × “Catch-Up” + the greater of 0% AND (20% × (pre-incentive fee net investment income –
2.5%))
(100% × (2.5% – 2.0%)) + (20% × (2.86% – 2.5%))
0.5% + (20% × 0.36%)
0.5% + 0.07%
0.57%
Example 2—Capital Gains Portion of Incentive Fee:
Alternative 1
Assumptions
•
•
•
•
•
•
•
•
Year 1: $20 million investment made in Company A (“Investment A”), and $30 million investment made in Company B (“Investment B”)
Year 2: Investment A is sold for $50 million and fair market value (“FMV”) of Investment B determined to be $32 million
Year 3: FMV of Investment B determined to be $25 million
Year 4: Investment B sold for $31 million
The capital gains portion of the incentive fee, if any, would be:
Year 1: None (no sales transactions)
Year 2: $6 million (20% multiplied by $30 million realized capital gains on sale of Investment A)
Year 3: None; $5 million (20% multiplied by $30 million cumulative realized capital gains less $5 million cumulative unrealized capital
depreciation) less $6 million (Capital Gains Fee paid in Year 2)
Year 4: $200,000; $6.2 million (20% multiplied by $31 million cumulative realized capital gains) less $6 million (Capital Gains Fee paid in Year
2)
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Alternative 2
Assumptions
•
•
•
•
•
•
•
•
•
•
Year 1: $20 million investment made in Company A (“Investment A”), $30 million investment made in Company B (“Investment B”) and $25
million investment made in Company C (“Investment C”)
Year 2: Investment A sold for $50 million, FMV of Investment B determined to be $25 million and FMV of Investment C determined to be $25
million
Year 3: FMV of Investment B determined to be $27 million and Investment C sold for $30 million
Year 4: FMV of Investment B determined to be $35 million
Year 5: Investment B sold for $20 million
The capital gains portion of the incentive fee, if any, would be:
Year 1: None (no sales transactions)
Year 2: $5 million (20% multiplied by $30 million realized capital gains on Investment A less $5 million unrealized capital depreciation on
Investment B)
Year 3: $1.4 million; $6.4 million (20% multiplied by $32 million ($35 million cumulative realized capital gains on Investment A and Investment
C less $3 million cumulative unrealized capital depreciation on Investment B)) less $5 million (Capital Gains Fee paid in Year 2)
Year 4: $0.6 million; $7 million (20% multiplied by $35 million (cumulative realized capital gains on Investment A and Investment C)) less $6.4
million (cumulative Capital Gains Fee paid in all prior years)
Year 5: None; $5 million (20% multiplied by $25 million ($35 million cumulative realized capital gains on Investments A and C less $10 million
realized capital losses on Investment B)) less $7 million (cumulative Capital Gains Fee paid in all prior years))
Payment of Our Expenses.
All investment professionals of OFS Advisor and/or its affiliates, when and to the extent engaged in providing investment advisory and
management services to us, and the compensation and routine overhead expenses of personnel allocable to these services to us, are provided and paid for by
OFS Advisor and not by us. We bear all other out-of-pocket costs and expenses of our operations and transactions. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations—Results of Operations—Key Financial Measures—Expenses.”
Duration and Termination
Unless terminated earlier as described below, the Investment Advisory Agreement will remain in effect from year to year if approved annually by
our board of directors or by the affirmative vote of the holders of a majority of our outstanding voting securities, and, in either case, if also approved by a
majority of our directors who are not “interested persons” as defined in the 1940 Act. The Investment Advisory Agreement automatically terminates in the
event of its assignment, as defined in the 1940 Act, by OFS Advisor and may be terminated by either party without penalty upon not less than 60 days’
written notice to the other. The holders of a majority of our outstanding voting securities may also terminate the Investment Advisory Agreement without
penalty upon not less than 60 days’ written notice. See “Item 1A. Risk Factors—Risks Related to our Business and Structure—We are dependent upon the
OFS senior professionals for our future success and upon their access to the investment professionals and partners of OFS and its affiliates.”
Administration Agreement
Pursuant to the Administration Agreement, OFS Services, an affiliate of OFS Advisor, provides the administrative services necessary for us to
operate. OFS Services furnishes us with office facilities and equipment, necessary software licenses and subscriptions and clerical, and bookkeeping and
record keeping services at such facilities. Under the Administration Agreement, OFS Services performs, or oversees the performance of, our required
administrative services, which include being responsible for the financial records that we are required to maintain and preparing reports to our stockholders
and all other reports and materials required to be filed with the SEC or any other regulatory authority. In addition, OFS Services assists us in determining
and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders,
and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. Under the
Administration Agreement, OFS Services provides managerial assistance on our behalf to certain portfolio companies that accept our offer to provide such
assistance. Payments under the Administration Agreement are equal to an amount based upon our allocable portion (subject to the review and approval of
our board of directors) of OFS Services’ overhead in performing its obligations under the Administration
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Agreement, including rent, information technology, and our allocable portion of the cost of our officers, including our chief executive officer, chief
financial officer, chief compliance officer, chief accounting officer, and their respective staffs. The Administration Agreement may be renewed annually
with the approval of our board of directors, including a majority of our directors who are not “interested persons.” The Administration Agreement may be
terminated by either party without penalty upon 60 days’ written notice to the other party. To the extent that OFS Services outsources any of its functions
we pay the fees associated with such functions at cost without incremental profit to OFS Services.
Indemnification
The Investment Advisory Agreement and the Administration Agreement both provide that OFS Advisor, OFS Services and their affiliates’
respective officers, directors, members, managers, stockholders and employees are entitled to indemnification from us from and against any claims or
liabilities, including reasonable legal fees and other expenses reasonably incurred, arising out of or in connection with our business and operations or any
action taken or omitted on our behalf pursuant to authority granted by the Investment Advisory Agreement or the Administration Agreement, except where
attributable to willful misfeasance, bad faith or gross negligence in the performance of such person’s duties or reckless disregard of such person’s
obligations and duties under the Investment Advisory Agreement or the Administration Agreement.
Board Approval of the Investment Advisory and Administrative Agreements
Our board, including our independent directors, approved the continuation of the Investment Advisory Agreement at a meeting held on April 4,
2019. In reaching a decision to approve the continuation of the Investment Advisory Agreement, the board of directors reviewed a significant amount of
information and considered, among other things:
•
•
•
•
•
•
the nature, quality and extent of the advisory and other services to be provided to us by OFS Advisor;
the fee structures of comparable externally managed BDCs that engage in similar investing activities;
our projected operating expenses and expense ratio compared to BDCs with similar investment objectives;
any existing and potential sources of indirect income to OFS Advisor from its relationship with us and the profitability of that relationship,
including through the Investment Advisory Agreement;
information about the services to be performed and the personnel performing such services under the Investment Advisory Agreement; and
the organizational capability and financial condition of OFS Advisor and its affiliates.
Based on the information reviewed and the discussion thereof, the board of directors, including a majority of the non-interested directors,
concluded that the investment advisory fee rates are reasonable in relation to the services to be provided and approved the Investment Advisory Agreement
as being in the best interests of our stockholders.
Our board also reviewed services provided under the Administrative Agreement, and approved its continuation at the April 4, 2019 meeting.
License Agreement
We have entered into a license agreement with OFSAM under which OFSAM has agreed to grant us a non-exclusive, royalty-free license to use
the name “OFS.” Under this agreement, we have a right to use the “OFS” name for so long as OFS Advisor or one of its affiliates remains our investment
adviser. Other than with respect to this limited license, we have no legal right to the “OFS” name. This license agreement will remain in effect for so long
as the Investment Advisory Agreement with OFS Advisor is in effect.
REGULATION
General
We have elected to be regulated as a BDC under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between
BDCs and their affiliates (including any investment advisers or sub-advisers), principal underwriters and affiliates of those affiliates or underwriters and
requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act.
In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC
unless approved by “a majority of our outstanding voting securities” as defined in the 1940 Act. A majority of the outstanding voting securities of a
company is defined under the 1940 Act as the lesser of: (a) 67% or more of such company’s voting securities present at a meeting if more than 50% of the
outstanding voting securities of such company are present or represented by proxy, or (b) more than 50% of the outstanding voting securities of such
company. We do not anticipate any substantial change in the nature of our business.
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We generally cannot issue and sell our common stock at a price below net asset value per share. We may, however, issue and sell our common
stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value of our common stock if (1) our board of
directors determines that such sale is in our best interests and the best interests of our stockholders, and (2) our stockholders have approved our policy and
practice of making such sales within the preceding 12 months. In any such case, the price at which our securities are to be issued and sold may not be less
than a price which, in the determination of our board of directors, closely approximates the market value of such securities.
The 1940 Act generally prohibits BDCs from making certain negotiated co-investments with certain affiliates absent an order from the SEC
permitting the BDC to do so. On October 12, 2016, we received the Order from the SEC to permit us to co-invest in portfolio companies with certain
BDCs, registered investment companies and private funds managed by OFS Advisor, or any adviser that controls, is controlled by, or is under common
control with, OFS Adviser and is registered as an investment adviser under the Advisers Act, in a manner consistent with our investment strategy as well as
applicable law, including the terms and conditions of the Order. Pursuant to the Order, we are generally permitted to participate in a co-investment
transaction if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors makes certain conclusions in connection with
a co-investment transaction, including that (1) the terms of the transaction, including the consideration to be paid, are reasonable and fair to us and our
stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the
interests of our stockholders and is consistent with our investment objective and strategies. We have applied for a new exemptive order (the “New Order”),
which, if granted, would supersede the Order and would permit us greater flexibility to enter into co-investment transactions. There can be no assurance
that we will obtain such new exemptive relief from the SEC.
We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such
securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities Act. Our intention is to not write
(sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies, except that we may enter into
hedging transactions to manage the risks associated with interest rate fluctuations. However, we may purchase or otherwise receive warrants to purchase
the common stock of our portfolio companies in connection with acquisition financing or other investments. Similarly, in connection with an acquisition,
we may acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under certain circumstances. We also do not intend
to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, except for registered money
market funds, we generally cannot acquire more than 3% of the voting stock of any registered investment company, invest more than 5% of the value of our
total assets in the securities of one investment company, or invest more than 10% of the value of our total assets in the securities of more than one
investment company. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such
investments might subject our stockholders to additional expenses as they will be indirectly responsible for the costs and expenses of such companies.
None of our investment policies are fundamental and may be changed without stockholder approval.
Qualifying Assets
Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in section 55(a) of the 1940 Act, which are referred to as
“qualifying assets,” unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s assets, as defined by the 1940 Act.
The principal categories of qualifying assets relevant to our business are the following:
(a) Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited
exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an
eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is
defined in the 1940 Act as any issuer that:
•
•
•
is organized under the laws of, and has its principal place of business in, the United States;
is not an investment company (other than a small business investment company wholly-owned by the BDC) or a company that would be an
investment company but for certain exclusions under the 1940 Act; and
satisfies either of the following:
◦
◦
does not have any class of securities listed on a national securities exchange or has any class of securities listed on a national
securities exchange subject to a $250 million market capitalization maximum; or
is controlled by a BDC or a group of companies including a BDC, the BDC actually exercises a controlling influence over the
management or policies of the eligible portfolio company, and, as a result, the BDC has an affiliated person who is a director of the
eligible portfolio company;
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(b) Securities of any eligible portfolio company which we control;
(c) Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in
transactions incident to such a private transaction, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to
the purchase of its securities, was unable to meet its obligations as they came due without material assistance other than conventional lending or
financing arrangements;
(d) Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and
we already own 60% of the outstanding equity of the eligible portfolio company;
(e) Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the exercise of warrants or rights
relating to such securities; and
(f) Cash, cash equivalents, U.S. government securities or high-quality debt securities that mature in one year or less from the date of investment.
Control, as defined by the 1940 Act, is presumed to exist where a BDC beneficially owns more than 25% of the outstanding voting securities of
the portfolio company.
The regulations defining qualifying assets may change over time. We may adjust our investment focus as needed to comply with and/or take
advantage of any regulatory, legislative, administrative or judicial actions in this area.
Managerial Assistance to Portfolio Companies
A BDC must have been organized and have its principal place of business in the United States and must be operated for the purpose of making
investments in the types of securities described in (a), (b) or (c) above. However, in order to count portfolio securities as qualifying assets for the purpose of
the 70% test, the BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and
solvent companies described above) significant managerial assistance. Where the BDC purchases such securities in conjunction with one or more other
persons acting together, the BDC will satisfy this test if one of the other persons in the group makes available such managerial assistance, although this may
not be the sole method by which the BDC satisfies the requirement to make available managerial assistance. Making available managerial assistance
means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted, does so
provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company. With respect
to an SBIC, making available managerial assistance means the making of loans to a portfolio company.
Temporary Investments
Pending investment in other types of qualifying assets, as described above, our investments may consist of cash, cash equivalents, U.S.
government securities, repurchase agreements and high-quality debt investments that mature in one year or less from the date of investment, which we refer
to, collectively, as temporary investments, so that 70% of our assets, as defined by the 1940 Act, are qualifying assets or temporary investments. We may
invest in highly rated commercial paper, U.S. Government agency notes, and U.S. Treasury bills or repurchase agreements relating to such securities that
are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor,
such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater
than the purchase price by an amount that reflects an agreed-upon interest rate. Consequently, repurchase agreements are functionally similar to loans.
There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, the 1940 Act and certain
diversification tests in order to qualify as a RIC for U.S. federal income tax purposes typically require us to limit the amount we invest with any one
counterparty. Accordingly, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. OFS Advisor monitors
the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
Warrants and Options
Under the 1940 Act, a BDC is subject to restrictions on the amount of warrants, options, restricted stock or rights to purchase shares of capital
stock that it may have outstanding at any time. Under the 1940 Act, we may generally only offer warrants provided that (i) the warrants expire by their
terms within ten years, (ii) the exercise or conversion price is not less than the current market value at the date of issuance, (iii) our stockholders authorize
the proposal to issue such warrants, and our board of directors approves such issuance on the basis that the issuance is in the best interests of OFS Capital
and its stockholders and (iv) if the warrants are accompanied by other securities, the warrants are not separately transferable unless no class of such
warrants and the securities accompanying them has been publicly distributed. The 1940 Act also provides that the amount of our voting securities that
would result from the exercise of all outstanding warrants, as well as options and rights, at the time of issuance may not exceed 25% of our outstanding
voting securities. In particular, the amount of capital stock that
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would result from the conversion or exercise of all outstanding warrants, options or rights to purchase capital stock cannot exceed 25% of the BDC’s total
outstanding shares of capital stock.
Senior Securities
A BDC generally is not permitted to incur indebtedness unless immediately after such borrowing it has an asset coverage ratio for total borrowings
of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). Certain provisions of the SBCAA permit BDCs to be subject to a
minimum asset coverage ratio of 150%, if specific conditions are satisfied, when issuing senior securities (i.e., the amount of debt may not exceed 66 2/3%
of the value of our assets). As an approximation, prior to the enactment of the SBCAA, the most that a BDC could borrow for investment purposes was $1
for every $1 of investor equity. Now, for those BDCs that satisfy the SBCAA’s approval and disclosure requirements and become subject to the reduced
asset coverage ratio, the BDC can borrow $2 for investment purposes for every $1 of investor equity.
The SBCAA provides that in order for a BDC whose common stock is traded on a national securities exchange to be subject to 150% asset
coverage, the BDC must either obtain: (i) approval of the required majority of its non-interested directors who have no financial interest in the proposal,
which would become effective one year after the date of such approval, or (ii) obtain stockholder approval (of more than 50% of the votes cast for the
proposal at a meeting in which quorum is present), which would become effective on the first day after the date of such stockholder approval.
On May 3, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the
application of the modified asset coverage requirements made available under the SBCAA and, as a result, the asset coverage ratio test applicable to us was
decreased from 200% to 150%, effective May 3, 2019. See "Item 1A. Risk Factors — Risks Related to our Business and Structure — Because we have
received the approval of our Board, we are subject to 150% Asset Coverage effective May 3, 2019." Additionally, we received exemptive relief from the
SEC effective November 26, 2013, which allows us to exclude our SBA guaranteed debentures from the definition of senior securities in the statutory asset
coverage ratio under the 1940 Act.
We may borrow money when the terms and conditions available are favorable to do so and are aligned with our investment strategy and portfolio
composition. The use of borrowed funds or the proceeds of preferred stock to make investments would have its own specific benefits and risks, and all of
the costs of borrowing funds or issuing preferred stock would be borne by holders of our common stock.
For a discussion of the risks associated with leverage, see “Item 1A. Risk Factors—Risks Related to BDCs—Regulations governing our operation
as a BDC affect our ability to and the way in which we raise additional capital. As a BDC, we will need to raise additional capital, which will expose us to
risks, including the typical risks associated with leverage.”
Compliance with the Sarbanes-Oxley Act of 2002 and the Nasdaq Global Select Market Corporate Governance Regulations
The Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) imposes a wide variety of regulatory requirements on publicly held companies and
their insiders. Many of these requirements affect us. The Sarbanes-Oxley Act has required us to review our policies and procedures to determine whether
we comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We will continue to monitor our compliance with all future
regulations that are adopted under the Sarbanes-Oxley Act and will take actions necessary to ensure that we are in compliance therewith.
In addition, the Nasdaq Global Select Market has adopted various corporate governance requirements as part of its listing standards. We believe
we are in compliance with such corporate governance listing standards. We will continue to monitor our compliance with all future listing standards and
will take actions necessary to ensure that we are in compliance therewith.
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Exemptive Relief
We are generally prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval
of our board of directors who are not interested persons and, in some cases, prior approval by the SEC. The SEC has interpreted the BDC prohibition on
transactions with affiliates to prohibit all “joint transactions” between entities that share a common investment adviser. Further, the 1940 Act generally
prohibits BDCs from making certain negotiated co-investments with certain affiliates absent an order from the SEC permitting the BDC to do so.
On October 12, 2016, we received the Order from the SEC to permit us to co-invest in portfolio companies with certain BDCs, registered investment
companies and private funds managed by OFS Advisor or any adviser that controls, is controlled by, or is under common control with, OFS Adviser, and is
registered as an investment adviser under the Advisers Act, in a manner consistent with our investment strategy as well as applicable law, including the
terms and conditions of the Order. Pursuant to the Order, we are generally permitted to participate in a co-investment transaction if a “required majority”
(as defined in Section 57(o) of the 1940 Act) of our independent directors makes certain conclusions in connection with a co-investment transaction,
including that (1) the terms of the transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve
overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is
consistent with our investment objective and strategies. The Order is subject to additional terms and conditions; there can be no assurance that we will be
permitted to co-invest with certain of our affiliates other than in the circumstances currently permitted by regulatory guidance and in compliance with
conditions of the Order. We have applied for the New Order which, if granted, would supersede the Order and would permit us greater flexibility to enter
into co-investment transactions. There can be no assurance that we will obtain such new exemptive relief from the SEC.
The staff of the SEC has granted no-action relief permitting purchases of a single class of privately placed securities provided that the adviser
negotiates no term other than price and certain other conditions are met. As a result, unless under the Order, we only expect to co-invest on a concurrent
basis with certain funds advised by OFS Advisor when each of us will own the same securities of the issuer and when no term is negotiated other than
price. Any such investment would be made, subject to compliance with existing regulatory guidance, applicable regulations and OFS Advisor’s allocation
policy. If opportunities arise that would otherwise be appropriate for us and for another fund advised by OFS Advisor to invest in different securities of the
same issuer, OFS Advisor will need to decide which fund will proceed with the investment. The decision by OFS Advisor to allocate an opportunity to
another entity could cause us to forego an investment opportunity that we otherwise would have made. Moreover, except in certain circumstances, we will
be unable to invest in any issuer in which another fund advised by OFS Advisor has previously invested.
Small Business Investment Company Regulations
Our wholly owned subsidiary, SBIC I LP, is an SBIC and must maintain compliance with SBA regulations.
SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to
eligible small businesses and invest in the equity securities of small businesses. The SBIC license enabled SBIC I LP to receive SBA-guaranteed debenture
funding, subject to the issuance of a leverage commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse,
interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not
required to be paid prior to maturity but may be prepaid without penalty twice each year on certain dates. The interest rate of SBA-guaranteed debentures is
fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.
SBA regulations currently limit the amount that an SBIC may borrow to up to a maximum of $150 million (or $175 million with SBA approval)
when it has at least $75 million in regulatory capital (or $87.5 million with approval to borrow up to $175 million), receives a leverage commitment from
the SBA and has been through an examination by the SBA subsequent to licensing.
The investments of an SBIC are limited to loans to, and equity securities of, eligible small businesses. Under present SBA regulations, eligible
small businesses generally include businesses that (together with their affiliates) have a tangible net worth (total assets less goodwill less total liabilities)
not exceeding $19.5 million and have average annual net income after U.S. federal income taxes not exceeding $6.5 million (average net income to be
computed without benefit of any carryover loss) for the two most recent fiscal years. In addition, an SBIC must devote 25% of its investment activity to
“smaller concerns,” as defined by the SBA. A smaller concern generally includes businesses that have a tangible net worth not exceeding $6 million and
have average annual net income after U.S. federal income taxes not exceeding $2 million (average net income to be computed without benefit of any net
carryover loss) for the two most recent fiscal years. SBA regulations also provide alternative criteria to determine eligibility, which may include, among
other things, the industry in which the business is engaged, the number of employees of the business, its gross sales, and the extent to which the SBIC is
proposing to participate in a change of ownership of the business. According to SBA regulations, SBICs may make long-term loans to small businesses,
invest in the equity securities of such businesses and provide them with consulting and advisory services.
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The SBA prohibits an SBIC from providing funds to small businesses for certain purposes, such as relending, real estate or investing in companies
outside of the United States, and from providing funds to businesses engaged in a few prohibited industries and to certain “passive” (i.e., non-operating)
companies. In addition, without prior SBA approval, an SBIC may not invest an amount equal to more than approximately 30% of the SBIC’s regulatory
capital in any one company and its affiliates.
SBICs must invest idle funds that are not being used to make investments permitted under SBA regulations in the following limited types of
securities: (i) direct obligations of, or obligations guaranteed as to principal and interest by, the U.S. government, which mature within 15 months from the
date of the investment; (ii) repurchase agreements with federally insured institutions with a maturity of seven days or less (and the securities underlying the
repurchase obligations must be direct obligations of or guaranteed by the federal government); (iii) certificates of deposit with a maturity of one year or
less, issued by a federally insured institution; (iv) a deposit account in a federally insured institution that is subject to a withdrawal restriction of one year or
less; (v) a checking account in a federally insured institution; or (vi) a reasonable petty cash fund.
SBA regulations include restrictions on a “change of control” or other transfers of limited partnership interests in an SBIC. In addition, SBIC I LP
may also be limited in its ability to make distributions to us if it does not have sufficient accumulated net profit, in accordance with SBA regulations.
SBIC I LP is subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios
and other covenants.
The SBA, as a creditor, will have a superior claim to the SBIC I LP’s assets over our stockholders in the event that SBIC I LP is liquidated or the
SBA exercises its remedies under the SBA debentures issued by SBIC I LP in the event of a default.
As part of our plans to focus on lower-yielding, first lien senior secured loans to larger borrowers, which we believe will improve our overall risk
profile, SBIC I LP intends, over time, to repay its outstanding SBA debentures prior to the scheduled maturity dates of its debentures. We do not expect to
make new investments through SBIC I LP, other than follow-on investments. We believe that investing in more senior loans to larger borrowers is
consistent with our view of the private loan market and will reduce our overall leverage on a consolidated basis.
Other
We are subject to periodic examination by the SEC for compliance with the Exchange Act, and the 1940 Act.
We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement.
Furthermore, as a BDC, we are prohibited from protecting any director or officer against any liability to OFS Capital or our stockholders arising from
willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.
We and OFS Advisor each have adopted and implemented written policies and procedures reasonably designed to prevent violation of relevant
federal securities laws, will review these policies and procedures annually for their adequacy and the effectiveness of their implementation, and have
designated a chief compliance officer to be responsible for administering the policies and procedures.
Our internet address is www.ofscapital.com. We make available free of charge on our website our annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, proxy statements and amendments to those reports as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the SEC.
Codes of Ethics
We and OFS Advisor have each adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act that establishes procedures for personal
investments and restricts certain personal securities transactions. Personnel subject to either code may invest in securities for their personal investment
accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code’s requirements. Our
code of ethics is available, free of charge, on our website at www.ofscapital.com. The code of ethics is available on the EDGAR Database on the SEC’s
website at http://www.sec.gov. You may also obtain copies of the code of ethics, after paying a duplicating fee, by electronic request at the following e-mail
address: publicinfo@sec.gov.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to OFS Advisor. The proxy voting policies and procedures of OFS Advisor are set out below.
The guidelines are reviewed periodically by OFS Advisor and our directors who are not “interested persons,” and, accordingly, are subject to change. For
purposes of these proxy voting policies and procedures described below, “we,” “our” and “us” refer to OFS Advisor.
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Introduction
As an investment adviser registered under the Advisers Act, we have a fiduciary duty to act solely in the best interests of our clients. As part of
this duty, we recognize that we must vote client securities in a timely manner free of conflicts of interest and in the best interests of our clients.
These policies and procedures for voting proxies for our investment advisory clients are intended to comply with Section 206 of, and Rule
206(4)-6 under, the Advisers Act.
Proxy Policies
We vote proxies relating to our portfolio securities in what we perceive to be the best interest of our clients. We review on a case-by-case basis
each proposal submitted to a stockholder vote to determine its effect on the portfolio securities held by our clients. In most cases we will vote in favor of
proposals that we believe are likely to increase the economic value of the underlying portfolio securities held by our clients. Although we will generally
vote against proposals that may have a negative effect on our clients’ portfolio securities, we may vote for such a proposal if there exist compelling long-
term reasons to do so.
Our proxy voting decisions are made by those senior officers who are responsible for monitoring each of our clients’ investments. To ensure that
our vote is not the product of a conflict of interest, we require that (1) anyone involved in the decision-making process disclose to our chief compliance
officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and
(2) employees involved in the decision-making process or vote administration are prohibited from revealing how we intend to vote on a proposal in order to
reduce any attempted influence from interested parties. Where conflicts of interest may be present, we will disclose such conflicts to our client, including
with respect to OFS Capital, those directors who are not interested persons and we may request guidance from such persons on how to vote such proxies
for their account.
Proxy Voting Records
You may obtain information about how we voted proxies for the Company free of charge, by making a written request for proxy voting
information to: OFS Capital Corporation, 10 S. Wacker Drive, Suite 2500, Chicago, Illinois 60606, Attention: Investor Relations, or by calling OFS Capital
Corporation at (847) 734-2000. The SEC also maintains a website at http://www.sec.gov that contains such information.
Privacy Principles
We are committed to maintaining the privacy of our stockholders and to safeguarding their nonpublic personal information. The following
information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may
share information with select other parties.
Generally, we do not receive any nonpublic personal information relating to our stockholders, although certain nonpublic personal information of
our stockholders may become available to us. We do not disclose any nonpublic personal information about our stockholders or former stockholders to
anyone, except as permitted by law or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third-party administrator).
We restrict access to nonpublic personal information about our stockholders to employees of OFS Advisor and its affiliates with a legitimate
business need for the information. We maintain physical, electronic and procedural safeguards designed to protect the nonpublic personal information of
our stockholders.
Material U.S. Federal Income Tax Considerations
Election to be Taxed as a RIC
We have elected to be taxed as a RIC under Subchapter M of the Code. As a RIC, we are not required to pay corporate-level U.S. federal income
taxes on any income that we distribute to our stockholders from our otherwise taxable earnings and profits. To maintain our qualification as a RIC, we
must, among other things, meet certain source-of-income and asset diversification requirements, as described below. In addition, to receive RIC tax
treatment, we must meet the Annual Distribution Requirement. The excess of net long-term capital gains over net short-term capital losses, if any ("Net
Capital Gains"), are not a component of the Annual Distribution Requirement, but impacts taxable income if not distributed as discussed below.
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Taxation as a RIC
If we:
• maintain our qualification as a RIC; and
•
satisfy the Annual Distribution Requirement;
then we will not be subject to U.S. federal income tax on the portion of our ICTI or Net Capital Gains we distribute to stockholders. We will be subject to
U.S. federal income tax at the regular corporate rates on any ICTI or Net Capital Gain not distributed (or deemed distributed) to our stockholders.
We are also subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income unless we distribute in a timely manner an
amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98.2% of our capital gain net income (both long-term
and short-term) for the one-year period ending October 31 in that calendar year (or, if we so elect, for that calendar year) and (3) any income and gains
recognized, but not distributed, in preceding years and on which we paid no U.S. federal income tax (the “Excise Tax Avoidance Requirement”). We may
choose to retain a portion of our ordinary income and/or capital gain net income in any year and pay the 4% U.S. federal excise tax on the retained
amounts.
•
•
In order to maintain our qualification as a RIC for U.S. federal income tax purposes, we must, among other things:
continue to qualify as a BDC under the 1940 Act at all times during each taxable year;
derive in each taxable year at least 90% of our gross income from dividends, interest, certain payments with respect to loans of stock and
securities, gains from the sale or other disposition of stock, securities, or foreign currencies and other income (including but not limited to gains
from options, futures or forward contracts) derived with respect to our business of investing in such stock, securities or currencies, and net income
derived from interests in “qualified publicly traded partnerships,” as such term is defined in the Code (the "90% Income Test"); and
•
diversify our holdings so that at the end of each quarter of the taxable year:
•
•
at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other
securities, with such other securities limited, in respect of any one issuer, to an amount not greater than 5% of the value of our assets and
10% of the outstanding voting securities of such issuer; and
no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other
RICs, of one issuer, of two or more issuers that we control (as determined under applicable tax rules) and that are engaged in the same,
similar or related trades or businesses or of one or more qualified publicly traded partnerships (the “Diversification Tests”).
We may invest in partnerships, including qualified publicly traded partnerships, which may result in our being subject to state, local or foreign
income taxes, franchise taxes, or withholding liabilities.
We are required to recognize ICTI in circumstances in which we have not received a corresponding payment in cash. For example, we hold debt
obligations that are treated under applicable tax rules as issued with OID and debt instruments with PIK interest, and we must include in ICTI each year the
portion of the OID and PIK interest that accrues for that year (as it accrues over the life of the obligation), irrespective of whether the cash representing
such income is received by us in that taxable year. The continued recognition of non-cash ICTI may cause difficulty in meeting the Annual Distribution
Requirement. We may be required to sell investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital,
or forgo new investment opportunities to meet this requirement. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax
treatment and thus become subject to corporate-level U.S. federal income tax.
We are authorized to borrow funds and to sell assets in order to satisfy distribution requirements. However, under the 1940 Act, we are not
permitted to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage”
tests are met. Moreover, our ability to dispose of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio
and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the Annual
Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not
advantageous. See “Regulation—Senior Securities.”
Certain of our investment practices may be subject to special and complex U.S. federal income tax provisions that may, among other things, (1)
treat dividends that would otherwise qualify for the dividends received deduction or constitute qualified dividend income as ineligible for such treatment,
(2) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (3) convert lower-taxed long-term capital gain into higher-taxed
short-term capital gain or ordinary income, (4) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (5)
cause us
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to recognize income or gain without receipt of a corresponding distribution of cash, (6) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur, (7) adversely alter the characterization of certain complex financial transactions and (8) produce income that will not be
considered "qualifying income" for purposes of the 90% Income Test. We will monitor our transactions and may make certain tax elections to mitigate the
potential adverse effect of these provisions, but there can be no assurance that any adverse effects of these provisions will be mitigated.
If we purchase shares in a “passive foreign investment company” (a “PFIC”), we may be subject to U.S. federal income tax on our allocable share
of a portion of any “excess distribution” received on, or any gain from the disposition of, such shares even if our allocable share of such income is
distributed as a taxable dividend to our stockholders. Additional charges in the nature of interest generally will be imposed on us in respect of deferred
taxes arising from any such excess distribution or gain. If we invest in a PFIC and elect to treat the PFIC as a “qualified electing fund” under the Code (a
“QEF”), in lieu of the foregoing requirements, we will be required to include in income each year our proportionate share of the ordinary earnings and net
capital gain of the QEF, even if such income is not distributed by the QEF. Alternatively, we may be able to elect to mark-to-market at the end of each
taxable year our shares in a PFIC; in this case, we will recognize as ordinary income our allocable share of any increase in the value of such shares, and as
ordinary loss our allocable share of any decrease in such value to the extent that any such decrease does not exceed prior increases included in its income.
Under either election, we may be required to recognize in a year income in excess of distributions from PFICs and proceeds from dispositions of PFIC
stock during that year, and such income will nevertheless be subject to the Annual Distribution Requirement and will be taken into account for purposes of
the 4% U.S. federal excise tax.
Some of the income and fees that we recognize may result in ICTI that will not be "qualifying income" for the 90% Income Test. In order to
ensure that such income and fees do not disqualify us as a RIC for a failure to satisfy the 90% Income Test, we may recognize such income and fees
directly or indirectly through one or more entities taxed as corporations for U.S. federal income tax purposes. Such corporations are required to pay U.S.
corporate income tax on their earnings, which ultimately reduces our return on such income and fees.
Failure to Qualify as a RIC
If we are unable to maintain our qualification as a RIC, we will be subject to tax on all of our ICTI and Net Capital Gains at regular corporate
rates; we will not receive a dividend deduction for any distributions to our stockholders. Distributions would not be required, and any distributions would
be taxable to our stockholders as ordinary dividend income that would, for qualifying non-corporate U.S. stockholders, be eligible for the current 20%
maximum rate to the extent of our current and accumulated earnings and profits (subject to limitations under the Code). Subject to certain limitations under
the Code, corporate distributions would be eligible for the dividends-received deduction. Distributions in excess of our current and accumulated earnings
and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis (reducing that basis accordingly), and any remaining
distributions would be treated as a capital gain. To qualify again to be taxed as a RIC in a subsequent year, we would be required to distribute to our
stockholders our earnings and profits attributable to non-RIC years. In addition, if we failed to qualify as a RIC for a period greater than two taxable years,
then we would be required to elect to recognize and pay tax on any net built-in gain (the excess of aggregate gain, including items of income, over
aggregate loss that would have been realized if we had been liquidated) or, alternatively, be subject to taxation on such built-in gain recognized for a period
of five years, in order to qualify as a RIC in a subsequent year.
Conflicts of Interests
BDCs generally are prohibited under the 1940 Act from knowingly participating in certain transactions with their affiliates without the prior
approval of their independent directors and, in some cases, of the SEC. Those transactions include purchases and sales, and so-called “joint” transactions,
in which a BDC and one or more of its affiliates engage in certain types of profit-making activities. Any person that owns, directly or indirectly, five
percent or more of a BDC’s outstanding voting securities will be considered an affiliate of the BDC for purposes of the 1940 Act, and a BDC generally is
prohibited from engaging in purchases from, sales of assets to, or joint transactions with, such affiliates, absent the prior approval of the BDC’s
independent directors. Additionally, without the approval of the SEC, a BDC is prohibited from engaging in purchases from, sales of assets to, or joint
transactions with, the BDC’s officers, directors, and employees, and advisor (and its control affiliates).
BDCs may, however, invest alongside certain related parties or their respective other clients in certain circumstances where doing so is consistent
with current law and SEC staff interpretations. For example, a BDC may invest alongside such accounts consistent with guidance promulgated by the SEC
staff permitting the BDC and such other accounts to purchase interests in a single class of privately placed securities so long as certain conditions are met,
including that the BDC’s advisor, acting on the BDC’s behalf and on behalf of other clients, negotiates no term other than price. Co-investment with such
other accounts is not permitted or appropriate under this guidance when there is an opportunity to invest in different securities of the same issuer or where
the different investments could be expected to result in a conflict between the BDC’s interests and those of other accounts.
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Conflicts Related to Portfolio Investments
Conflicts may arise when we make an investment in conjunction with an investment being made by another account managed by OFS Advisor or
an affiliate of OFS Advisor (each, an "Affiliated Account"), or in a transaction where an Affiliated Account has already made an investment. Investment
opportunities are, from time to time, appropriate for more than one account in the same, different or overlapping securities of a portfolio company’s capital
structure. Conflicts arise in determining the terms of investments, particularly where these accounts may invest in different types of securities in a single
portfolio company. Questions arise as to whether payment obligations and covenants should be enforced, modified or waived, or whether debt should be
restructured, modified or refinanced.
We may invest in debt and other securities of companies in which Affiliated Accounts hold those same securities or different securities, including
equity securities. In the event that such investments are made by us, our interests will at times conflict with the interests of such Affiliated Accounts,
particularly in circumstances where the underlying company is facing financial distress. Decisions about what action should be taken, particularly in
troubled situations, raise conflicts of interest, including, among other things, whether or not to enforce claims, whether or not to advocate or initiate a
restructuring or liquidation inside or outside of bankruptcy, and the terms of any work-out or restructuring. The involvement of Affiliated Accounts at both
the equity and debt levels could inhibit strategic information exchanges among fellow creditors, including among us or Affiliated Accounts. In certain
circumstances, we or an Affiliated Account may be prohibited from exercising voting or other rights and may be subject to claims by other creditors with
respect to the subordination of their interest.
In the event that we or an Affiliated Account has a controlling or significantly influential position in a portfolio company, that account may have
the ability to elect some or all of the board of directors of such a portfolio company, thereby controlling the policies and operations of such portfolio
company, including the appointment of management, future issuances of securities, payment of dividends, incurrence of debt and entering into
extraordinary transactions. In addition, a controlling account is likely to have the ability to determine, or influence, the outcome of operational matters and
to cause, or prevent, a change in control of such a company. Such management and operational decisions may, at times, be in direct conflict with other
accounts that have invested in the same portfolio company that do not have the same level of control or influence over the portfolio company.
If additional capital is necessary as a result of financial or other difficulties, or to finance growth or other opportunities, the accounts may or may
not provide such additional capital, and if provided each account will supply such additional capital in such amounts, if any, as determined by OFS Advisor.
In addition, a conflict arises in allocating an investment opportunity if the potential investment target could be acquired by us, an Affiliated Account, or a
portfolio company of an Affiliated Account. Investments by more than one account of OFS Advisor or its affiliates in a portfolio company also raise the
risk of using assets of an account of OFS Advisor or its affiliates to support positions taken by other accounts of OFS Advisor or its affiliates, or that an
account may remain passive in a situation in which it is entitled to vote. In addition, there may be differences in timing of entry into, or exit from, a
portfolio company for reasons such as differences in strategy, existing portfolio or liquidity needs, different account mandates or fund differences, or
different securities being held. These variations in timing may be detrimental to us.
The application of our or an Affiliated Account's governing documents and the policies and procedures of OFS Advisor are expected to vary based
on the particular facts and circumstances surrounding each investment by two or more accounts, in particular when those accounts are in different classes of
an issuer’s capital structure (as well as across multiple issuers or borrowers within the same overall capital structure) and, as such, there may be a degree of
variation and potential inconsistencies, in the manner in which potential or actual conflicts are addressed.
Co-Investment with Affiliates
On October 12, 2016, we received the Order from the SEC that permits us to co-invest in portfolio companies with certain affiliates, provided that
we comply with the conditions of the Order. Pursuant to the Order, we are generally permitted to co-invest with BDCs, registered investment companies
and private funds managed by OFS Advisor or any adviser that controls, is controlled by, or is under common control with, OFS Advisor, and is registered
as an investment adviser under the Advisers Act, in a manner consistent with our investment strategy as well as applicable law, including the terms and
conditions of the Order. Under the terms of the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must
make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transaction, including the consideration to be
paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and
(2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies. We have applied for a
new exemptive order (the “New Order”), which, if granted, would supersede the Order and would permit us greater flexibility to enter into co-investment
transactions. There can be no assurance that we will obtain such new exemptive relief from the SEC.
When we invest alongside Affiliated Accounts, OFS Advisor will, to the extent consistent with applicable law, regulatory guidance, or the Order,
allocate investment opportunities in accordance with its allocation policy. Under this allocation policy, if two or more investment vehicles with similar or
overlapping investment strategies are in their investment
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periods, an available opportunity will be allocated based on the provisions governing allocations of such investment opportunities in the relevant
organizational, offering or similar documents, if any, for such investment vehicles. In the absence of any such provisions, OFS Advisor will consider the
following factors and the weight that should be given with respect to each of these factors:
•
•
•
•
•
•
•
•
investment guidelines and/or restrictions, if any, set forth in the applicable organizational, offering or similar documents for the investment
vehicles;
the status of tax restrictions and tests and other regulatory restrictions and tests;
risk and return profile of the investment vehicles;
suitability/priority of a particular investment for the investment vehicles;
if applicable, the targeted position size of the investment for the investment vehicles
level of available cash for investment with respect to the investment vehicles;
total amount of funds committed to the investment vehicles; and
the age of the investment vehicles and the remaining term of their respective investment periods, if any.
When not relying on the Order, priority as to opportunities will generally be given to clients that are in their “ramp-up” period, or the period
during which the account has yet to reach sufficient scale such that its investment income covers its operating expenses, over the accounts that are outside
their ramp-up period but still within their investment or re-investment periods. However, application of one or more of the factors listed above, or other
factors determined to be relevant or appropriate, may result in the allocation of an investment opportunity to a fund no longer in its ramp-up period over a
fund that is still within its ramp-up period.
In situations where co-investment with Affiliated Accounts is not permitted or appropriate, OFS Advisor will need to decide which account will
proceed with the investment. The decision by OFS Advisor to allocate an opportunity to another entity could cause us to forego an investment opportunity
that we otherwise would have made. These restrictions, and similar restrictions that limit our ability to transact business with our officers or directors or
their affiliates, may limit the scope of investment opportunities that would otherwise be available to us.
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Item 1A.
Risk Factors
RISK FACTORS
Investing in our common stock involves a number of significant risks. In addition to the other information contained in this Annual Report on
Form 10-K, you should consider carefully the following information before making an investment in our common stock. The risks set out below are not the
only risks we face. Additional risks and uncertainties not presently known to us or not presently deemed material by us might also impair our operations
and performance. If any of the following events occur, our business, financial condition and results of operations could be materially and adversely
affected. In such case, our net asset value and the trading price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business and Structure
We are dependent upon the OFS senior professionals for our future success and upon their access to the investment professionals and partners of OFS
and its affiliates.
We do not have any internal management capacity or employees. We will depend on the diligence, skill and network of business contacts of the
OFS senior professionals to achieve our investment objective. Our future success will depend, to a significant extent, on the continued service and
coordination of the OFS senior management team, particularly Bilal Rashid, Senior Managing Director and President of OFSC, and Jeffrey Cerny, Senior
Managing Director and Treasurer of OFSC. Each of these individuals is an employee at will of OFSC. In addition, we rely on the services of Richard
Ressler, Chairman of the executive committee of OFSAM and Chairman of certain of the Advisor Investment Committees, pursuant to a consulting
agreement with Orchard Capital Corporation. The departure of Mr. Ressler or any of the senior managers of OFSC, or of a significant number of its other
investment professionals, could have a material adverse effect on our ability to achieve our investment objective.
We expect that OFS Advisor will continue to evaluate, negotiate, structure, close and monitor our investments in accordance with the terms of the
Investment Advisory Agreement. We can offer no assurance, however, that OFS senior professionals will continue to provide investment advice to us. If
these individuals do not maintain their existing relationships with OFS and its affiliates and do not develop new relationships with other sources of
investment opportunities, we may not be able to grow our investment portfolio or achieve our investment objective. In addition, individuals with whom the
OFS senior professionals have relationships are not obligated to provide us with investment opportunities. Therefore, we can offer no assurance that such
relationships will generate investment opportunities for us.
OFS Advisor is a subsidiary of OFSAM that has no employees and depends upon access to the investment professionals and other resources of
OFS and its affiliates to fulfill its obligations to us under the Investment Advisory Agreement. OFS Advisor also depends upon OFS to obtain access to
deal flow generated by the professionals of OFS and its affiliates. Under a Staffing Agreement between OFSC, a subsidiary of OFSAM that employs OFS’s
personnel, and OFS Advisor, OFSC has agreed to provide OFS Advisor with the resources necessary to fulfill these obligations. The Staffing Agreement
provides that OFSC will make available to OFS Advisor experienced investment professionals and access to the senior investment personnel of OFSC for
purposes of evaluating, negotiating, structuring, closing and monitoring our investments. We are not a party to this Staffing Agreement and cannot assure
stockholders that OFSC will fulfill its obligations under the agreement. If OFSC fails to perform, we cannot assure stockholders that OFS Advisor will
enforce the Staffing Agreement or that such agreement will not be terminated by either party or that we will continue to have access to the investment
professionals of OFSC and its affiliates or their information and deal flow.
The investment committees that oversee our investment activities are provided by OFS Advisor under the Investment Advisory Agreement. The
loss of any member of the Advisor Investment Committees or of other OFS senior professionals could limit our ability to achieve our investment objective
and operate as we anticipate. This could have a material adverse effect on our financial condition and results of operation.
Our business model depends to a significant extent upon strong referral relationships with financial institutions, sponsors and investment
professionals. Any inability of OFS Advisor to maintain or develop these relationships, or the failure of these relationships to generate investment
opportunities, could adversely affect our business.
We depend upon OFS Advisor to maintain relationships with financial institutions, sponsors and investment professionals, and we will continue to
rely to a significant extent upon these relationships to provide us with potential investment opportunities. If OFS Advisor fails to maintain such
relationships, or to develop new relationships with other sources of investment opportunities, we will not be able to grow our investment portfolio. In
addition, individuals with whom the principals of OFS Advisor have relationships are not obligated to provide us with investment opportunities, and,
therefore, we can offer no assurance that these relationships will generate investment opportunities for us in the future.
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Our financial condition and results of operation will depend on our ability to manage our business effectively.
Our ability to achieve our investment objective and grow will depend on our ability to manage our business. This will depend, in turn, on the
ability of the Advisor Investment Committees to identify, invest in and monitor companies that meet our investment criteria. The achievement of our
investment objectives on a cost-effective basis will depend upon the Advisor Investment Committees' ability to execute our investment process, their ability
to provide competent, attentive and efficient services to us and, to a lesser extent, our access to financing on acceptable terms. OFS Advisor has substantial
responsibilities under the Investment Advisory Agreement. OFS Advisor's senior professionals and other personnel of OFS Advisor's affiliates, including
OFSC, may be called upon to provide managerial assistance to our portfolio companies. These activities may distract them or slow our rate of investment.
Any failure to manage our business and our future growth effectively could have a material adverse effect on our business, financial condition and results
of operations.
To the extent PIK interest and PIK dividends constitute a portion of our income, we will be required to include such income in taxable and accounting
income prior to receipt of cash representing such income.
Our investments may include contractual PIK interest or PIK dividends, which represents contractual interest or dividends added to a loan balance
or equity security and due at the end of such loan’s or equity security’s term. To the extent PIK interest and PIK dividends constitute a portion of our
income, we will be exposed to typical risks associated with such income being required to be included in taxable and accounting income prior to receipt of
cash. Such risks include:
•
•
•
•
•
The higher interest or dividend rates of PIK instruments reflect the payment deferral and increased risk associated with these instruments, and PIK
instruments often represent a significantly higher risk than non-PIK instruments.
Even if the accounting conditions for income accrual are met, the borrower could still default when our actual collection is supposed to occur at
the maturity of the obligation.
PIK instruments may have unreliable valuations because their continuing accruals require continuing judgments about the collectability of the
deferred payments and the value of any associated collateral. PIK income may also create uncertainty about the source of our cash distributions.
For accounting purposes, any cash distributions to stockholders representing PIK income are not treated as coming from paid-in capital, even
though the cash to pay them comes from the offering proceeds. As a result, despite the fact that a distribution representing PIK income could be
paid out of amounts invested by our stockholders, the 1940 Act does not require that stockholders be given notice of this fact by reporting it as a
return of capital.
PIK interest or dividends have the effect of generating investment income at a compounding rate, thereby further increasing the incentive fees
payable to OFS Advisor. Similarly, all things being equal, the deferral associated with PIK interest or dividends also decreases the investment
principal-to-value ratio at a compounding rate.
A significant amount of our portfolio investments are recorded at fair value as determined in good faith by our board of directors and, as a result, there
may be uncertainty as to the value of our portfolio investments.
Many of our portfolio investments take the form of securities that are not publicly traded. The fair value of securities and other investments that
are not publicly traded may not be readily determinable. We value these securities at fair value as determined in good faith by our board of directors,
including to reflect significant events affecting the value of our securities. All of our investments (other than cash and cash equivalents) are classified as
Level 3 under Accounting Standards Codification Topic 820, Fair Value Measurement and Disclosures (ASC Topic 820). This means that our portfolio
valuations are based on unobservable inputs and our own assumptions about how market participants would price the asset or liability in question. Inputs
into the determination of fair value of our portfolio investments require significant management judgment or estimation. Even if observable market data are
available, such information may be the result of consensus pricing information or broker quotes, which include a disclaimer that the broker would not be
held to such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by disclaimers materially reduces the
reliability of such information. We presently retain the services of an independent service provider to prepare the valuation of these securities.
The types of factors that the board of directors takes into account in determining the fair value of our investments generally include, as
appropriate, comparison to third-party yield benchmarks and comparison to publicly traded securities including such factors as yield, maturity and
measures of credit quality, the enterprise value of a portfolio company, the nature and realizable value of any collateral, the portfolio company’s ability to
make payments and its earnings and cash flow, the markets in which the portfolio company does business and other relevant factors. Because such
valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and
may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these
securities existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher
than the values that we ultimately realize upon the disposal of such securities.
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We adjust quarterly the valuation of our portfolio to reflect our board of directors’ determination of the fair value of each investment in our
portfolio. Any changes in fair value are recorded in our statement of income as net change in unrealized appreciation or depreciation.
SBIC I LP is subject to SBA regulations.
Our current investment strategy includes SBIC I LP, which is regulated by the SBA. The SBA regulations require that a licensed SBIC be
periodically examined and audited by the SBA to determine its compliance with the relevant SBA regulations. If SBIC I LP fails to comply with applicable
SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit its use of debentures, declare outstanding debentures
immediately due and payable, and/or limit its ability to make new investments. The SBA, as a creditor, will have a superior claim to SBIC I LP’s assets
over SBIC I LP’s limited partners and our stockholders in the event SBIC I LP is liquidated or the SBA exercises its remedies under the SBA debentures
issued by SBIC I LP in the event of a default. In addition, the SBA can revoke or suspend a license for willful or repeated violation of, or willful or
repeated failure to observe, any provision of the Small Business Investment Act of 1958 or any rule or regulation promulgated thereunder. These actions by
the SBA would, in turn, negatively affect us because of our ownership interest in SBIC I LP.
The SBA places certain limitations on the financing terms of investments by SBICs in portfolio companies and prohibits an SBIC from providing
funds to small businesses for certain purposes, such as relending, real estate or investing in companies outside of the United States, and providing funds to
businesses engaged in a few prohibited industries and to certain “passive” (i.e., non-operating) companies. In addition, without prior SBA approval, an
SBIC may not invest an amount equal to more than approximately 30% of the SBIC’s regulatory capital in any one company and its affiliates.
SBIC I LP is subject to ongoing regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum
financial ratios and other covenants. In addition, SBIC I LP may also be limited in its ability to make distributions to us if it does not have sufficient
accumulated net profit, in accordance with SBA regulations. These requirements may make it more difficult for us to achieve our investment objectives.
We finance our investments with borrowed money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of
investing in us.
The use of leverage magnifies the potential for gain or loss on amounts invested. The use of leverage is generally considered a speculative
investment technique and increases the risks associated with investing in our securities. We may pledge up to 100% of our assets and may grant a security
interest in all of our assets, other than assets held in SBIC I LP and OFSCC-FS, and our ownership interest in SBIC I LP and SBIC I GP, under the terms of
any debt instruments we may enter into with lenders. In addition, under the terms of any credit facility or other debt instrument we enter into, we are likely
to be required by its terms to use the net proceeds of any investments that we sell to repay a portion of the amount borrowed under such facility or
instrument before applying such net proceeds to any other uses. If the value of our assets decreases, leveraging would cause net asset value to decline more
sharply than it otherwise would have had we not leveraged, thereby magnifying losses or eliminating our equity stake in a leveraged investment. Similarly,
any decrease in our revenue or income will cause our net income to decline more sharply than it would have had we not borrowed. Such a decline would
also negatively affect our ability to make dividend payments on our common stock or preferred stock. Our ability to service our debt will depend largely on
our financial performance and will be subject to prevailing economic conditions and competitive pressures. Moreover, because the management fee payable
to OFS Advisor is payable based on our total assets (other than cash and cash equivalents and goodwill and intangible assets related to the SBIC
Acquisition but including assets purchased with borrowed amounts and including assets owned by any consolidated entity), OFS Advisor has a financial
incentive to incur leverage which may not be consistent with our stockholders’ interests. In addition, our common stockholders will bear the burden of any
increase in our expenses as a result of our use of leverage, including interest expenses and any increase in the management fee payable to OFS Advisor.
On May 3, 2018, the Board, including a "required majority" (as such item is determined in section 57(o) of the 1940 Act) of the Board, approved
the application of a reduced 150% asset coverage ratio to us; therefore provided certain conditions are met, we are subject to the reduced asset coverage
ratio as of May 3, 2019. See "Item 1A. Risk Factors--Risks Related to our Business and Structure--Because we have received the approval of our Board, we
are subject to 150% effective May 3, 2019." As of December 31, 2019, our asset coverage ratio was 180%, excluding the debt held by SBIC I LP.
The following table illustrates the effect of leverage on returns from an investment in our common stock assuming various annual returns, net of
expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing in the table below.
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Corresponding return to common stockholder (1)
Assumed Return on Our Portfolio (Net of Expenses)
(10)%
(5)%
—%
(41.9)%
(26.4)%
(10.9)%
5%
4.6%
10%
20.1%
(1) Assumes $516.9 million in investments at fair value, $359.2 million in debt outstanding, $166.6 million in net assets, and an average cost of funds of
5.06%. Assumptions are based on our financial condition and our average cost of funds at December 31, 2019.
Based on our outstanding indebtedness of $359.2 million as of December 31, 2019 and the average cost of funds of 5.06% as of that date, our
investment portfolio must experience an annual return of 3.52% at least to cover interest payments on the outstanding debt.
This example is for illustrative purposes only, and actual interest rates on our borrowings are likely to fluctuate. See “Management’s Discussion
and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources— Borrowings” for additional information.
The amount of our debt outstanding increased due to the issuance of the Unsecured Notes and the establishment of the BNP Facility.
Our ability to generate sufficient cash flow in the future is, to some extent, subject to general economic, financial, competitive, legislative and
regulatory factors as well as other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations to
meet the payment obligations of our debt.
Because we have received the approval of our Board, we became subject to 150% Asset Coverage effective May 3, 2019.
The 1940 Act generally prohibits a BDC from incurring indebtedness unless immediately after such borrowing it has an asset coverage for total
borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). However, the SBCAA has modified the 1940 Act by
allowing a BDC to increase the maximum amount of leverage it may incur from an asset coverage ratio of 200% to an asset coverage ratio of 150%, if
certain requirements are met.
On May 3, 2018 our Board approved the application of the reduced asset coverage ratio to us made available under the SBCAA. As a result, we
were able to increase our leverage up to an amount that reduces our asset coverage ratio from 200% to 150% (i.e., the amount of debt may not exceed 66
2/3% of the value of our assets) effective May 3, 2019. Leverage magnifies the potential for loss on investments in our indebtedness and on invested equity
capital. As we use leverage to partially finance our investments, you will experience increased risks of investing in our securities. If the value of our assets
increases, then the additional leverage would cause the net asset value attributable to our common stock to increase more sharply than it would have had we
not increased our leverage. Conversely, if the value of our assets decreases, the additional leverage would cause net asset value to decline more sharply than
it otherwise would have had we not increased our leverage. Similarly, any increase in our income in excess of interest payable on the borrowed funds
would cause our net investment income to increase more than it would without the additional leverage, while any decrease in our income would cause net
investment income to decline more sharply than it would have had we not increased our leverage. Such a decline could negatively affect our ability to pay
common stock dividends, scheduled debt payments or other payments related to our securities. Leverage is generally considered a speculative investment
technique. See “Risks Related to Our Business and Structure - We finance our investments with borrowed money, which magnifies the potential for gain or
loss on amounts invested and may increase the risk of investing in us.”
In addition, the ability of BDCs to increase their leverage will increase the capital available to BDCs and thus competition for the investments that
we seek to make. This may negatively impact pricing on the investments that we do make and adversely affect our net investment income and results of
operations.
Changes in interest rates will affect our cost of capital and net investment income.
To the extent we borrow money or issue preferred stock to make investments, our net investment income will depend, in part, upon the difference
between the rate at which we borrow funds or pay dividends on preferred stock and the rate at which we invest those funds. As a result, we can offer no
assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income in the event we use debt to
finance our investments. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income. We may use
interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate
hedging activities to the extent permitted by the 1940 Act.
A rise in the general level of interest rates typically leads to higher interest rates applicable to our debt investments. Accordingly, an increase in
interest rates may result in an increase of the amount of incentive fees payable to OFS Advisor.
We may enter into reverse repurchase agreements, which are another form of leverage.
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We may enter into reverse repurchase agreements as part of our management of our temporary investment portfolio. Under a reverse repurchase
agreement, we will effectively pledge our assets as collateral to secure a short-term loan. Generally, the other party to the agreement makes the loan in an
amount equal to a percentage of the fair value of the pledged collateral. At the maturity of the reverse repurchase agreement, we will be required to repay
the loan and correspondingly receive back our collateral. While used as collateral, the assets continue to pay principal and interest which are for the benefit
of us.
Our use of reverse repurchase agreements, if any, involves many of the same risks involved in our use of leverage, as the proceeds from reverse
repurchase agreements generally will be invested in additional securities. There is a risk that the market value of the securities acquired in the reverse
repurchase agreement may decline below the price of the securities that we have sold but remain obligated to purchase. In addition, there is a risk that the
market value of the securities retained by us may decline. If a buyer of securities under a reverse repurchase agreement were to file for bankruptcy or
experience insolvency, we may be adversely affected. Also, in entering into reverse repurchase agreements, we would bear the risk of loss to the extent that
the proceeds of such agreements at settlement are less than the fair value of the underlying securities being pledged. In addition, due to the interest costs
associated with reverse repurchase agreements transactions, our net asset value would decline, and, in some cases, we may be worse off than if we had not
used such instruments.
Our ability to enter into transactions involving derivatives and financial commitment transactions may be limited.
In November 2019, the SEC published a proposed rule regarding the ability of a BDC (or a registered investment company) to use derivatives and
other transactions that create future payment or delivery obligations (except reverse repurchase agreements and similar financing transactions). If adopted
as proposed, BDCs that use derivatives would be subject to a value-at-risk leverage limit, certain other derivatives risk management program and testing
requirements and requirements related to board reporting. These new requirements would apply unless the BDC qualified as a “limited derivatives user,” as
defined in the SEC’s proposal. A BDC that enters into reverse repurchase agreements or similar financing transactions would need to aggregate the amount
of indebtedness associated with the reverse repurchase agreements or similar financing transactions with the aggregate amount of any other senior
securities representing indebtedness when calculating the BDC’s asset coverage ratio. Under the proposed rule, a BDC may enter into an unfunded
commitment agreement that is not a derivatives transaction, such as an agreement to provide financing to a portfolio company, if the BDC has a reasonable
belief, at the time it enters into such an agreement, that it will have sufficient cash and cash equivalents to meet its obligations with respect to all of its
unfunded commitment agreements, in each case as it becomes due. If the BDC cannot meet this test, it is required to treat unfunded commitments as a
derivatives transaction subject to the requirements of the rule. Collectively, these proposed requirements, if adopted, may limit our ability to use derivatives
and/or enter into certain other financial contracts.
We may in the future determine to fund a portion of our investments with preferred stock, which would magnify the potential for gain or loss and the
risks of investing in us in the same way as our borrowings.
Preferred stock, which is another form of leverage, has the same risks to our common stockholders as borrowings because the dividends on any
preferred stock we issue must be cumulative. Payment of such dividends and repayment of the liquidation preference of such preferred stock must take
preference over any dividends or other payments to our common stockholders, and preferred stockholders are not subject to any of our expenses or losses
and are not entitled to participate in any income or appreciation in excess of their stated preference.
We operate in a highly competitive market for investment opportunities, which could reduce returns and result in losses.
A number of entities compete with us to make the types of investments that we plan to make. We compete with public and private funds, other
BDCs, commercial and investment banks, commercial finance companies and, to the extent they provide an alternative form of financing, private equity
and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do.
For example, some of our competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have
higher risk tolerances or different risk assessments than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940
Act imposes on us as a BDC or the source of income, asset diversification and distribution requirements we must satisfy to maintain our RIC tax treatment.
These characteristics could allow our competitors to consider a wider variety of instruments, establish more relationships and offer better pricing and more
flexible structuring than we are able to. The competitive pressures we face may have a material adverse effect on our business, financial condition and
results of operations. As a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we
may not be able to identify and make investments that are consistent with our investment objective.
With respect to the investments we make, we will not seek to compete based primarily on the interest rates we will offer, and we believe that some
of our competitors may make loans with interest rates that will be lower than the rates we offer. In the secondary market for acquiring existing loans, we
expect to compete generally on the basis of pricing terms. With respect to all investments, we may lose some investment opportunities if we do not match
our competitors’ pricing, terms and structure. However, if we match our competitors’ pricing, terms and structure, we may experience decreased net
interest income, lower
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yields and increased risk of credit loss. We may also compete for investment opportunities with OFSAM and its other affiliates or accounts managed by
OFSAM or one of its other affiliates. Although OFS Advisor will allocate opportunities in accordance with its policies and procedures, allocations to such
other accounts will reduce the amount and frequency of opportunities available to us and may not be in the best interests of us and our stockholders.
Moreover, the performance of investments will not be known at the time of allocation.
We may suffer credit losses.
Investment in middle-market companies is highly speculative and involves a high degree of risk of credit loss, and therefore our securities may not
be suitable for someone with a low tolerance for risk. These risks are likely to increase during volatile economic periods, such as the U.S. and many other
economies have recently been experiencing.
We will be subject to corporate-level U.S. federal income tax if we are unable to maintain our qualification as a RIC.
We have elected to be treated as a RIC under Subchapter M of the Code, but no assurance can be given that we will be able to maintain RIC status.
As a RIC, we are not required to pay corporate-level U.S. federal income taxes on our income and capital gains distributed (or deemed distributed) to our
stockholders, provided that we satisfy certain distribution and other requirements. To continue to qualify for tax treatment as a RIC under the Code and to
be relieved of federal taxes on income and gains distributed to our stockholders, we must meet certain source-of-income, asset diversification and
distribution requirements. The distribution requirement for a RIC is satisfied if we distribute at least 90% of our net ordinary income and net short-term
capital gains in excess of net long-term capital losses, if any, to our stockholders on an annual basis. Because we use debt financing, and may, in the future,
issue preferred stock, we are subject to certain asset coverage ratio requirements under the 1940 Act and financial covenants under loan and credit
agreements or preferred stock that could, under certain circumstances, restrict us from making distributions necessary to qualify for tax treatment as a RIC.
If we are unable to obtain cash from other sources, we may fail to maintain our qualification for the tax benefits available to RICs and, thus, may be subject
to corporate-level U.S. federal income tax. To maintain our qualification as a RIC, we must also meet certain asset diversification requirements at the end
of each calendar quarter. Failure to meet these tests may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC
status. Because most of our investments are in private or thinly traded public companies, any such dispositions could be made at disadvantageous prices
and may result in substantial losses. If we fail to continue to qualify for tax treatment as a RIC for any reason and become subject to corporate-level U.S.
federal income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distributions to stockholders
and the amount of our distributions and the amount of funds available for new investments. Such a failure would have a material adverse effect on us and
our stockholders.
Our subsidiaries and portfolio companies may be unable to make distributions to us that will enable us to meet RIC requirements, which could result in
the imposition of an entity-level tax.
In order for us to maintain our tax treatment as a RIC and to minimize corporate-level taxes, we are required to distribute on an annual basis
substantially all of our taxable income, which includes income from our subsidiaries and portfolio companies. SBIC I LP may be limited by the SBIC Act
and SBA regulations governing SBICs from making certain distributions to us that may be necessary to enable us to continue to qualify as a RIC. We may
have to request a waiver of the SBA’s restrictions for SBIC I LP to make certain distributions to maintain our tax treatment as a RIC and we cannot assure
stockholders that the SBA will grant such waiver. If our subsidiaries and portfolio companies are unable to make distributions to us, this may result in loss
of RIC tax treatment and a consequent imposition of a corporate-level federal income tax on us.
We may have difficulty paying our required distributions if we recognize income before, or without, receiving cash representing such income.
For U.S. federal income tax purposes, we will include in income certain amounts that we have not yet received in cash, such as the accretion of
OID. This may arise if we purchase assets at a discount, receive warrants in connection with the making of a loan or in other circumstances, or through
contracted PIK interest or dividends (meaning interest or dividends paid in the form of additional principal amount of the loan or equity security instead of
in cash), which represents contractual interest or dividends added to the loan balance or equity security and due at the end of the investment term. Such
OID, which could be significant relative to our overall investment activities, or increases in loan or equity investment balances as a result of contracted PIK
arrangements, will be included in income before we receive any corresponding cash payments. We also may be required to include in income certain other
amounts that we will not receive in cash.
Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the
requirement to distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to
maintain the tax benefits available to RICs. In such a case, we may have to sell some of our investments at times and/or at prices we would not consider
advantageous, raise additional debt or equity capital or reduce new investment originations and sourcings to meet these distribution requirements. If we sell
built-in-gain assets, we may be required to recognize taxable income in respect of the built-in-gain on such assets. In such a case, we would have to
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distribute all of our taxable gain (including the built-in-gain) in respect of such sale to avoid the imposition of entity-level tax on such gain. If we are not
able to obtain such cash from other sources, we may fail to maintain the tax benefits available to RICs and thus be subject to corporate-level U.S. federal
income tax.
We may in the future choose to pay distributions in our own stock, in which case stockholders may be required to pay tax in excess of the cash they
receive.
We distribute taxable distributions that are payable in cash or shares of our common stock at the election of each stockholder. In accordance with
guidance issued by the Internal Revenue Service, a publicly traded RIC should generally be eligible to treat a distribution of its own stock as fulfilling its
RIC distribution requirements if each stockholder is permitted to elect to receive his or her distribution in either cash or stock of the RIC (even where there
is a limitation on the percentage of the distribution payable in cash, provided that the limitation is at least 20%), subject to the satisfaction of certain
guidelines. If too many stockholders elect to receive their distributions in cash, each such stockholder would receive a pro rata share of the total cash to be
distributed and would receive the remainder of their distribution in shares of stock. If this and certain other requirements are met, for U.S. federal income
tax purposes, the amount of the distribution paid in stock generally will be a taxable distribution in an amount equal to the amount of cash that could have
been received instead of stock. If we decide to make any distributions consistent with this guidance that are payable in part in our stock, stockholders
receiving such distribution would be required to include the full amount of the distribution (whether received in cash, our stock, or a combination thereof)
as ordinary income (or as long-term capital gain to the extent such distribution is properly designated as a capital gain dividend) to the extent of our current
and accumulated earnings and profits for United States federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with respect
to such dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, it may be subject to
transaction fees (e.g., broker fees or transfer agent fees) and the sales proceeds may be less than the amount included in income with respect to the
dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to
withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a
significant number of our stockholders determine to sell shares of our stock in order to pay taxes owed on dividends, it may put downward pressure on the
trading price of our stock.
Because we expect to distribute substantially all of our net investment income and net realized capital gains to our stockholders, we may need
additional capital to finance our growth and such capital may not be available on favorable terms or at all.
We have elected to be taxed for U.S. federal income tax purposes as a RIC under Subchapter M of the Code. If we meet certain requirements,
including source of income, asset diversification and distribution requirements, and if we continue to qualify as a BDC, we will continue to qualify for tax
treatment as RIC under the Code and will not have to pay corporate-level taxes on income we distribute to our stockholders as dividends, allowing us to
substantially reduce or eliminate our corporate-level U.S. federal tax liability. Because we received the approval of our Board, we are generally required to
meet a coverage ratio of total assets to total senior securities, which includes all of our borrowings and any preferred stock we may issue in the future, of at
least 150% at the time we issue any debt or preferred stock. See "Item 1A. Risk Factors - Because we received the approval of our Board, we are subject to
150% Asset Coverage, effective May 3, 2019". This requirement limits the amount that we may borrow. Because we will continue to need capital to grow
our investment portfolio, this limitation may prevent us from incurring debt or preferred stock and require us to raise additional equity at a time when it
may be disadvantageous to do so. We cannot assure investors that debt and equity financing will be available to us on favorable terms, or at all, and debt
financings may be restricted by the terms of any of our outstanding borrowings. In addition, as a BDC, we are generally not permitted to issue common
stock priced below net asset value without stockholder approval. If additional funds are not available to us, we could be forced to curtail or cease new
lending and investment activities, and our net asset value could decline.
Our PWB Credit Facility contains various covenants and restrictions which, if not complied with, could accelerate our repayment obligations under the
PWB Credit Facility or limit its use, thereby materially and adversely affecting our liquidity, financial condition, results of operations and ability to pay
distributions.
The PWB Credit Facility provides us with a senior secured revolving line of credit of up to $100.0 million, with maximum availability equal to
50% of the aggregate outstanding principal amount of eligible loans included in the borrowing base and otherwise specified in the PWB Credit Facility.
The PWB Credit Facility is guaranteed by OFSCC-MB and secured by all of our current and future assets excluding assets held by SBIC I LP, OFSCC-FS,
and our SBIC I LP and SBIC I GP partnership interests. The PWB Credit Facility contains customary terms and conditions, including, without limitation,
affirmative and negative covenants such as information reporting requirements, a minimum tangible net asset value, a minimum quarterly net investment
income after incentive fees, and a statutory asset coverage test. The PWB Credit Facility also contains customary events of default, including, without
limitation, nonpayment, misrepresentation of representations and warranties in a material respect, breach of covenant, cross-default to other indebtedness,
bankruptcy, change in investment advisor, and the occurrence of a material adverse change in our financial condition. The PWB Credit Facility permits us
to fund additional
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investments as long as we are within the conditions set out in the PWB Credit Facility. Our continued compliance with these covenants depends on many
factors, some of which are beyond our control, and there are no assurances that we will continue to comply with these covenants. Our failure to satisfy
these covenants could result in foreclosure by our lender, which would accelerate our repayment obligations under the PWB Credit Facility and thereby
have a material adverse effect on our business, liquidity, financial condition, results of operations and ability to pay distributions to our stockholders. We
had $-0- million outstanding under the PWB Credit Facility as of December 31, 2019. Availability under the PWB Credit Facility as of December 31, 2019
was $69.0 million based on the stated advance rate of 50% under the borrowing base.
Global capital markets could enter a period of severe disruption and instability. These conditions have historically affected and could again materially
and adversely affect debt and equity capital markets in the United States and around the world and our business.
The current worldwide financial market situation, as well as various social and political tensions in the United States and around the world, may
contribute to increased market volatility, may have long-term effects on the United States and worldwide financial markets and may cause economic
uncertainties or deterioration in the United States and worldwide. The impact of downgrades by rating agencies to the United States government’s
sovereign credit rating or its perceived creditworthiness as well as potential government shutdowns could adversely affect the United States and global
financial markets and economic conditions. Since 2010, several European Union, or EU, countries have faced budget issues, some of which may have
negative long-term effects for the economies of those countries and other EU countries. There is continued concern about national-level support for the
Euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member countries. In addition, the
fiscal policy of foreign nations, such as Russia and China, may have a severe impact on the worldwide and United States financial markets. The decision
made in the United Kingdom referendum to leave the EU (commonly known as “Brexit”) has led to volatility in global financial markets and may lead to
weakening in consumer, corporate and financial confidence in the United Kingdom and Europe. Since the Brexit referendum, the EU has extended the
Brexit deadline several times to allow the UK parliament to ratify a withdrawal agreement, and most recently, under current Prime Minister Boris Johnson,
the House of Commons passed the Brexit deal on December 20, 2019. The European Parliment ratified the Brexit deal, and on January 31, 2020, the UK
formally left the EU. The UK will now enter into a transition period until December 31, 2020, where agreements surrounding trade and other aspects of the
UK's future relationship with the EU will be formalized. It is unclear what form the future relationship between the UK and the EU will take, and it may
have a significant impact on the economies of the UK and EU, as well as the broader global economy, which may cause increased volatility and illiquidity.
Failure to come to terms on a free trade deal could result in checks and tariffs on UK goods traveling to the EU and thus prolong economic uncertainty.
Additionally, volatility in the Chinese stock markets and global markets for commodities and as a result of global health emergencies may affect other
financial markets worldwide. We cannot predict the effects of these or similar events in the future on the United States and global economies and securities
markets or on our investments. We monitor developments in economic, political and market conditions and seek to manage our investments in a manner
consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
Events outside of our control, including public health crises, may negatively affect the results of our operations.
Periods of market volatility may continue to occur in response to pandemics or other events outside of our control. These types of events could
adversely affect our operating results. For example, in December 2019, a novel strain of coronavirus surfaced in Wuhan, China, which has resulted in the
temporary closure of many corporate offices, retail stores, and manufacturing facilities and factories across China. As the potential impact on global
markets from the coronavirus is difficult to predict, the extent to which the coronavirus may negatively affect our operating results or the duration of any
potential business disruption is uncertain. Any potential impact to our results will depend to a large extent on future developments and new information that
may emerge regarding the duration and severity of the coronavirus and the actions taken by authorities and other entities to contain the coronavirus or treat
its impact, all of which are beyond our control. These potential impacts, while uncertain, could adversely affect our operating results.
Adverse developments in the credit markets may impair our ability to secure debt financing.
During the economic downturn in the United States that began in mid-2007, many commercial banks and other financial institutions stopped
lending or significantly curtailed their lending activity. In addition, in an effort to stem losses and reduce their exposure to segments of the economy
deemed to be high risk, some financial institutions limited routine refinancing and loan modification transactions and even reviewed the terms of existing
facilities to identify bases for accelerating the maturity of existing lending facilities. As a result, should we experience another economic downturn in the
United States, it may be difficult for us to obtain desired financing to finance the growth of our investments on acceptable economic terms, or at all.
If we are unable to consummate credit facilities on commercially reasonable terms, our liquidity may be reduced significantly. If we are unable to
repay amounts outstanding under any facility we may enter into and are declared in default or
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are unable to renew or refinance any such facility, it would limit our ability to initiate significant originations or to operate our business in the normal
course. These situations may arise due to circumstances that we may be unable to control, such as inaccessibility of the credit markets, a severe decline in
the value of the U.S. dollar, a further economic downturn or an operational problem that affects third parties or us, and could materially damage our
business. Moreover, we are unable to predict when economic and market conditions may become more favorable. Even if such conditions improve broadly
and significantly over the long term, adverse conditions in particular sectors of the financial markets could adversely impact our business.
Terrorist attacks, acts of war, global health emergencies or natural disasters may impact the businesses in which we invest and harm our business,
operating results and financial condition.
Terrorist acts, acts of war, global health emergencies or natural disasters may disrupt our operations, as well as the operations of the businesses in
which we invest. Such acts have created, and continue to create, economic and political uncertainties and have contributed to global economic instability.
Future terrorist activities, military or security operations, global health emergencies or natural disasters could further weaken the domestic/global
economies and create additional uncertainties, which may negatively impact the businesses in which we invest directly or indirectly and, in turn, could have
a material adverse impact on our business, operating results and financial condition. Losses from terrorist attacks, global health emergencies and natural
disasters are generally uninsurable.
The failure in cybersecurity systems, as well as the occurrence of events unanticipated in our disaster recovery systems and management continuity
planning could impair our ability to conduct business effectively.
The occurrence of a disaster such as a cyberattack, a natural catastrophe, an industrial accident, events unanticipated in our disaster recovery
systems, or a support failure from external providers, could have an adverse effect on our ability to conduct business and on our results of operations and
financial condition, particularly if those events affect our computer-based data processing, transmission, storage, and retrieval systems or destroy data. If a
significant number of our managers were unavailable in the event of a disaster, our ability to effectively conduct our business could be severely
compromised.
We depend heavily upon computer systems to perform necessary business functions. Despite our implementation of a variety of security measures,
our computer systems could be subject to cyberattacks and unauthorized access, such as physical and electronic break-ins or unauthorized tampering. Like
other companies, we may experience threats to our data and systems, including malware and computer virus attacks, unauthorized access, system failures
and disruptions. If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and
stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations, which could
result in damage to our reputation, financial losses, litigation, increased costs, regulatory penalties and/or customer dissatisfaction or loss.
Third parties with whom we do business may also be sources of cybersecurity or other technological risks. We outsource certain functions and
these relationships allow for the storage and processing of our information, as well as customer, counterparty, employee and borrower information. While
we engage in actions to reduce our exposure resulting from outsourcing, ongoing threats may result in unauthorized access, loss, exposure or destruction of
data, or other cybersecurity incidents, with increased costs and other consequences, including those described above.
We may experience fluctuations in our quarterly operating results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including the interest rate payable on the debt
securities we acquire, the default rate on such securities, the level of our expenses, variations in and the timing of the recognition of realized and unrealized
gains or losses, distributions from our subsidiaries and portfolio companies, the degree to which we encounter competition in our markets and general
economic conditions. In light of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
Changes in the laws or regulations governing our business, or changes in the interpretations thereof, and any failure by us to comply with these laws
or regulations, could have a material adverse effect on our, and our portfolio companies’ business, results of operations or financial condition.
We and our portfolio companies are subject to regulation by laws at the U.S. federal, state and local levels, including those that govern BDCs,
SBICs, RICs, or non-depository commercial lenders. These laws and regulations, including applicable accounting standards, as well as their interpretation,
may change from time to time, and new laws, regulations, accounting standards and interpretations may also come into effect. Any such new or changed
laws or regulations could have a material adverse effect on our business.
We are also subject to judicial and administrative decisions that affect our operations, including our loan originations, maximum interest rates, fees
and other charges, disclosures to portfolio companies, the terms of secured transactions, collection and foreclosure procedures and other trade practices. If
these laws, regulations or decisions change, or if we expand our
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business into jurisdictions that have adopted more stringent requirements than those in which we currently conduct business, we may have to incur
significant expenses in order to comply, or we might have to restrict our operations. If we do not comply with applicable laws, regulations and decisions,
we may lose licenses needed for the conduct of our business and may be subject to civil fines and criminal penalties.
In addition, changes to the laws and regulations governing our operations related to permitted investments may cause us to alter our investment
strategy. Such changes could result in material differences to the strategies and plans set forth in this Annual Report on Form 10-K and our accounting
practices described in this Annual Report on Form 10-K, and may shift our investment focus from the areas of expertise of OFS Advisor to other types of
investments in which OFS Advisor may have little or no expertise or experience. Any such changes, if they occur, could have a material adverse effect on
our results of operations and the value of a stockholder’s investment.
Over the last several years, there has been an increase in regulatory attention to the extension of credit outside of the traditional banking sector,
raising the possibility that some portion of the non-bank financial sector will be subject to new or different regulation. While it cannot be known at this
time whether these regulations will be implemented or what form they will take, increased regulation of non-bank credit extension could negatively impact
our operations, cash flows or financial condition, impose additional costs on us, intensify the regulatory supervision of us or otherwise adversely affect our
business.
Legislative or other actions relating to taxes could have a negative effect on us.
Significant U.S. federal tax reform legislation was recently enacted that, among other things, permanently reduces the maximum federal corporate
income tax rate, reduces the maximum individual income tax rate (effective for taxable years 2018 through 2025), restricts the deductibility of business
interest expense, changes the rules regarding the calculation of net operating loss deductions that may be used to offset taxable income, expands the
circumstances in which a foreign corporation will be treated as a “controlled foreign corporation” and, under certain circumstances, requires accrual
method taxpayers to recognize income for U.S. federal income tax purposes no later than the income is taken into account as revenue in an applicable
financial statement. The impact of this new legislation on us, our stockholders and the entities in which we may invest is uncertain. Prospective investors
are urged to consult their tax advisors regarding the effects of the new legislation on an investment in us.
We cannot predict with certainty how any future changes in the tax laws might affect us, our investors or our portfolio investments. New
legislation and any U.S. Treasury regulations, administrative interpretations or court decisions interpreting such legislation could significantly and
negatively affect our ability to qualify for tax treatment as a RIC or the U.S. federal income tax consequences to us and our investors of such qualification,
or could have other adverse consequences. Investors are urged to consult with their tax advisor regarding tax legislative, regulatory or administrative
developments and proposals and their potential effect on an investment in our securities.
Changes to United States tariff and import/export regulations may have a negative effect on our portfolio companies and, in turn, harm us.
There has been on-going discussion and commentary regarding potential significant changes to United States trade policies, treaties and tariffs.
There is significant uncertainty about the future relationship between the United States and other countries with respect to the trade policies, treaties and
tariffs. These developments, or the perception that any of them could occur, may have a material adverse effect on global economic conditions and the
stability of global financial markets, and may significantly reduce global trade and, in particular, trade between the impacted nations and the United States.
Any of these factors could depress economic activity and restrict our portfolio companies’ access to suppliers or customers and have a material adverse
effect on their business, financial condition and results of operations, which in turn would negatively impact us.
The effect of global climate change may impact the operations of our portfolio companies.
There may be evidence of global climate change. Climate change creates physical and financial risk and some of our portfolio companies may be
adversely affected by climate change. For example, the needs of customers of energy companies vary with weather conditions, primarily temperature and
humidity. To the extent weather conditions are affected by climate change, energy use could increase or decrease depending on the duration and magnitude
of any changes. Increases in the cost of energy could adversely affect the cost of operations of our portfolio companies if the use of energy products or
services is material to their business. A decrease in energy use due to weather changes may affect some of our portfolio companies’ financial condition,
through decreased revenues. Extreme weather conditions in general require more systems backup, adding to costs, and can contribute to increased system
stresses, including service interruptions.
Loss of status as a RIC would reduce our net asset value and distributable income.
We have qualified as a RIC under the Code. As a RIC we do not have to pay federal income taxes on our income (including realized gains) that we
distribute to our stockholders, provided that we satisfy certain distribution and other
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requirements. Accordingly, we are not permitted under accounting rules to establish reserves for taxes on our unrealized capital gains. If we fail to qualify
for RIC status in any year, to the extent that we had unrealized gains, we would have to establish reserves for taxes, which would reduce our net asset value
and the amount potentially available for distribution. In addition, if we, as a RIC, were to decide to make a deemed distribution of net realized capital gains
and retain the net realized capital gains, we would have to establish appropriate reserves for taxes that we would have to pay on behalf of stockholders. It is
possible that establishing reserves for taxes could have a material adverse effect on the value of our common stock.
Our board of directors may change our investment objectives, operating policies and strategies without prior notice or stockholder approval.
Our board of directors has the authority, except as otherwise provided in the 1940 Act, to modify or waive certain of our operating policies and
strategies without prior notice and without stockholder approval. However, absent stockholder approval, we may not change the nature of our business so
as to cease to be, or withdraw our election as, a BDC. Under Delaware law, we also cannot be dissolved without prior stockholder approval except by
judicial action. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and
the price value of our common stock. Nevertheless, any such changes could adversely affect our business and impair our ability to make distributions.
We incur significant costs as a result of being a publicly traded company.
As a publicly traded company, we incur legal, accounting and other expenses, including costs associated with the periodic reporting requirements
applicable to a company whose securities are registered under the Exchange Act, as well as additional corporate governance requirements, including
requirements under the Sarbanes-Oxley Act and other rules implemented by the SEC.
Efforts to comply with the Sarbanes-Oxley Act involve significant expenditures, and non-compliance with Section 404 of the Sarbanes-Oxley Act may
adversely affect us and the market price of our securities.
Under current SEC rules, we are required to report on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley
Act and related rules and regulations of the SEC. We are required to review our internal control over financial reporting on an annual basis, and evaluate
and disclose changes in our internal control over financial reporting on a quarterly and annual basis.
As a result, we expect to continue to incur additional expenses that may negatively impact our financial performance and our ability to make
distributions. This process also results in a diversion of management’s time and attention. In the event that we are unable to maintain compliance with
Section 404 of the Sarbanes-Oxley Act and related rules, we and the market price of our securities may be adversely affected.
We previously identified a material weakness in our internal control over financial reporting, which has since been remediated. Any future failure to
establish and maintain effective internal control over financial reporting could have an adverse effect on our business and stock price.
Effective internal controls over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure
controls and procedures, are designed to prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered in their
implementation could cause us to fail to meet our reporting obligations.
We previously identified a material weakness related to the design and operating effectiveness of controls over the reliability of financial
information reported by portfolio companies that is used as financial inputs in the Company’s investment valuations. We addressed the material
weakness through, among other things, adding new and/or enhanced existing controls surrounding the valuation process and financial reporting oversight
of various controlled/affiliated portfolio companies.
Although we have remediated this material weakness in our internal control over financial reporting, any failure to improve our disclosure controls
and procedures or internal control over financial reporting to address any identified weaknesses in the future, if and when they are identified, could prevent
us from maintaining accurate accounting records and discovering material accounting errors. Any of these results could adversely affect our business and
the value of our common stock.
Capital markets may experience periods of disruption and instability and we cannot predict when these conditions will occur. Such market conditions
could materially and adversely affect debt and equity capital markets in the United States and abroad, which could have a negative impact on our
business, financial condition and results of operations.
The global capital markets have experienced a period of disruption as evidenced by a lack of liquidity in the debt capital markets, write-offs in the
financial services sector, the re-pricing of credit risk and the failure of certain major financial institutions. While the capital markets have improved, these
conditions could deteriorate again in the future. During such market disruptions, we may have difficulty raising debt or equity capital, especially as a result
of regulatory constraints.
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Market conditions may in the future make it difficult to extend the maturity of or refinance our existing indebtedness and any failure to do so
could have a material adverse effect on our business. The illiquidity of our investments may make it difficult for us to sell such investments if required. As
a result, we may realize significantly less than the value at which we have recorded our investments. In addition, significant changes in the capital markets,
including the disruption and volatility, have had, and may in the future have, a negative effect on the valuations of our investments and on the potential for
liquidity events involving our investments. An inability to raise capital, and any required sale of our investments for liquidity purposes, could have a
material adverse impact on our business, financial condition and results of operations.
Various social and political tensions in the United States and around the world, including in the Middle East, Eastern Europe and Russia, may
continue to contribute to increased market volatility, may have long-term effects on the United States and worldwide financial markets, and may cause
further economic uncertainties or deterioration in the United States and worldwide. Several EU countries, including Greece, Ireland, Italy, Spain, and
Portugal, continue to face budget issues, some of which may have negative long-term effects for the economies of those countries and other EU countries.
There is also continued concern about national-level support for the euro and the accompanying coordination of fiscal and wage policy among European
Economic and Monetary Union member countries. The recent United States and global economic downturn, or a return to the recessionary period in the
United States, could adversely impact our investments. We cannot predict the duration of the effects related to these or similar events in the future on the
United States economy and securities markets or on our investments. We monitor developments and seek to manage our investments in a manner consistent
with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
We are subject to risks related to corporate social responsibility.
Our business faces increasing public scrutiny related to environmental, social and governance (“ESG”) activities. We risk damage to our brand and
reputation if we fail to act responsibly in a number of areas, such as environmental stewardship, corporate governance and transparency and considering
ESG factors in our investment processes. Adverse incidents with respect to ESG activities could impact the value of our brand, the cost of our operations
and relationships with investors, all of which could adversely affect our business and results of operations. Additionally, new regulatory initiatives related
to ESG could adversely affect our business.
Risks Related to OFS Advisor and its Affiliates
We have potential conflicts of interest related to obligations that OFS Advisor or its affiliates may have to other clients.
OFS Advisor and its affiliates manage other assets, including those of other BDCs, registered investment companies, separately managed
accounts, accounts for which OFS Advisor or its affiliates may serve as a subadvisor and CLOs, and may manage other entities in the future, and these
other funds and entities may have similar or overlapping investment strategies. Our executive officers, directors and members of the Advisor Investment
Committees serve as officers, directors or principals of entities that operate in the same or a related line of business as we do, or of investment funds or
other investment vehicles managed by OFS Advisor or its affiliates. Accordingly, they may have obligations to investors in those entities, the fulfillment of
which might not be in our or our stockholders’ best interests or may require them to devote time to services for other entities, which could interfere with the
time available to provide services to us. For example, OFS Advisor currently serves as the investment adviser to HPCI, a non-traded BDC, that invests in
senior secured loans of middle-market companies in the United States, similar to those we target for investment, including first-lien, second-lien and
unitranche loans as well as subordinated loans and, to a lesser extent, warrants and other equity securities. OFS Advisor also serves as the investment
adviser to OCCI, a closed-end management investment company that primarily invests in CLO debt and subordinated securities.Therefore, many
investment opportunities will satisfy the investment criteria for both HPCI and us and, in certain instances, investment opportunities may be appropriate for
OCCI and us. HPCI operates as a distinct and separate entity and any investment in our common stock will not be an investment in HPCI. In addition, our
executive officers and certain of our independent directors serve in substantially similar capacities for HPCI and OCCI. Similarly, OFS Advisor and/or its
affiliates may have other clients with, similar, different or competing investment objectives. In serving in these multiple capacities, our executive officers
and directors, OFS Advisor and/or its affiliates, and members of the Advisor Investment Committees may have obligations to other clients or investors in
those entities, the fulfillment of which may not be in the best interests of us or our stockholders.
OFS Advisor and OFSAM have procedures and policies in place designed to manage the potential conflicts of interest between OFS Advisor’s
fiduciary obligations to us and its fiduciary obligations to other clients. For example, such policies and procedures are designed to ensure that investment
opportunities are allocated in a fair and equitable manner among us and other clients of OFS Advisor. An investment opportunity that is suitable for clients
of OFS Advisor may not be capable of being shared among some or all of such clients due to the limited scale of the opportunity or other factors, including
regulatory restrictions imposed by the 1940 Act.
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There can be no assurance that we will be able to participate in all investment opportunities that are suitable to us. OFS Advisor will seek to
allocate investment opportunities among eligible accounts in a manner that is fair and equitable over time and consistent with its allocation policy.
We have potential conflicts of interest related to the purchases and sales that OFS Advisor makes on our behalf and/or on behalf of Affiliated
Accounts.
Conflicts may arise when we make an investment in conjunction with an investment being made by Affiliated Accounts, or in a transaction where
another Affiliated Account has already made an investment. Investment opportunities are, from time to time, appropriate for more than one Affiliated
Account in the same, different or overlapping securities of a portfolio company’s capital structure. Conflicts arise in determining the terms of investments,
particularly where these Affiliated Accounts may invest in different types of securities in a single portfolio company. Questions arise as to whether payment
obligations and covenants should be enforced, modified or waived, or whether debt should be restructured, modified or refinanced.
We may invest in debt and other securities of companies in which other Affiliated Accounts hold those same securities or different securities,
including equity securities. In the event that such investments are made by us, our interests will at times conflict with the interests of such other Affiliated
Accounts, particularly in circumstances where the underlying company is facing financial distress. Decisions about what action should be taken,
particularly in troubled situations, raises conflicts of interest, including, among other things, whether or not to enforce claims, whether or not to advocate or
initiate a restructuring or liquidation inside or outside of bankruptcy, and the terms of any work-out or restructuring. The involvement of multiple Affiliated
Accounts at both the equity and debt levels could inhibit strategic information exchanges among fellow creditors, including among us and other Affiliated
Accounts. In certain circumstances, we or other Affiliated Accounts may be prohibited from exercising voting or other rights and may be subject to claims
by other creditors with respect to the subordination of their interest.
For example, in the event that one Affiliated Account has a controlling or significantly influential position in a portfolio company, that Affiliated
Account may have the ability to elect some or all of the board of directors of such a portfolio company, thereby controlling the policies and operations,
including the appointment of management, future issuances of securities, payment of dividends, incurrence of debt and entering into extraordinary
transactions. In addition, a controlling Affiliated Account is likely to have the ability to determine, or influence, the outcome of operational matters and to
cause, or prevent, a change in control of such a portfolio company. Such management and operational decisions may, at times, be in direct conflict with us
or other Affiliated Accounts that have invested in the same portfolio company that do not have the same level of control or influence over the portfolio
company.
If additional capital is necessary as a result of financial or other difficulties, or to finance growth or other opportunities, we or other Affiliated
Accounts may or may not provide such additional capital, and if provided each Affiliated Account will supply such additional capital in such amounts, if
any, as determined by OFS Advisor and/or OFS Advisor’s affiliates. Investments by more than one Affiliated Account in a portfolio company also raises
the risk of using assets of an Affiliated Account of OFS Advisor to support positions taken by other Affiliated Accounts, or that a client may remain passive
in a situation in which it is entitled to vote. In addition, there may be differences in timing of entry into, or exit from, a portfolio company for reasons such
as differences in strategy, existing portfolio or liquidity needs, different Affiliated Account mandates or fund differences, or different securities being held.
These variations in timing may be detrimental to us.
The application of our investment mandate as compared to investment mandates of other Affiliated Accounts and the policies and procedures of
OFS Advisor and OFS Advisor's affiliates are expected to vary based on the particular facts and circumstances surrounding each investment by two or
more Affiliated Accounts, in particular when those Affiliated Accounts are in different classes of an issuer’s capital structure (as well as across multiple
issuers or borrowers within the same overall capital structure) and, as such, there may be a degree of variation and potential inconsistencies, in the manner
in which potential or actual conflicts are addressed.
Our independent directors may face conflicts of interest related to their obligations to the affiliated funds for which they also serve as independent
directors.
The independent directors of our board of directors also comprise the independent directors of the board of directors of HPCI, an affiliated BDC
that is also managed by OFS Advisor. Additionally, one of our independent directors also serves as an independent director on the board of directors of
OCCI. In their capacities as directors for an affiliated fund board, the independent directors have a duty to make decisions on behalf of that affiliated fund
that are in the best interests of that affiliated fund and its stockholders. Accordingly, our independent directors may face conflicts of interest when making
a decision on behalf of one affiliated fund that may not be in the best interest of the other affiliated fund(s). For example, the SEC has granted exemptive
relief to us, OFS Advisor, HPCI, OCCI, and certain other of our affiliates to co-invest in certain transactions that would otherwise be prohibited by the
1940 Act. In accordance with that relief, the independent directors must
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make certain findings on behalf of each affiliated fund with respect to initial co-investment transactions, including that the terms of the proposed
transaction, including the consideration to be paid, are reasonable and fair to the affiliated fund and its stockholders and do not involve overreaching in
respect of the affiliated fund or its stockholders on the part of any of the other participants in the proposed transaction. Under such circumstances, the
independent directors may face conflicts of interest when making these determinations on behalf of us, HPCI and OCCI.
Members of the Advisor Investment Committees, OFS Advisor or its affiliates may, from time to time, possess material non-public information, limiting
our investment discretion.
OFS senior professionals and members of the Advisor Investment Committees may serve as directors of, or in a similar capacity with, companies
in which we invest, the securities of which are purchased or sold on our behalf. In the event that material nonpublic information is obtained with respect to
such companies, or we become subject to trading restrictions under the internal trading policies of those companies or as a result of applicable law or
regulations, we could be prohibited for a period of time from purchasing or selling the securities of such companies, and this prohibition may have an
adverse effect on us and our stockholders.
The valuation process for certain of our portfolio holdings may create a conflict of interest.
Many of our portfolio investments are made in the form of securities that are not publicly traded. As a result, our board of directors will determine
the fair value of these securities in good faith as described below in “Many of our portfolio investments are recorded at fair value as determined in good
faith by our board of directors and, as a result, there may be uncertainty as to the value of our portfolio investments.” In connection with that determination,
investment professionals from OFS Advisor may provide our board of directors with portfolio company valuations based upon the most recent portfolio
company financial statements available and projected financial results of each portfolio company. In addition, the members of our board of directors who
are not independent directors have a substantial indirect pecuniary interest in OFS Advisor. The participation of the OFS Advisor’s investment
professionals in our valuation process, and the indirect pecuniary interest in OFS Advisor by those members of our board of directors, could result in a
conflict of interest since OFS Advisor’s management fee is based, in part, on our total assets (other than cash and cash equivalents but including assets
purchased with borrowed amounts and including assets owned by any consolidated entity).
We may have additional conflicts related to other arrangements with OFS Advisor or its affiliates.
We have entered into a license agreement with OFSAM under which OFSAM has granted us a non-exclusive, royalty-free license to use the name
“OFS.” See “Item 1. Business—License Agreement.” In addition, we rent office space from a subsidiary of OFSAM and pay to that subsidiary our
allocable portion of overhead and other expenses incurred in performing its obligations under the Administration Agreement, such as rent and our allocable
portion of the cost of our officers, including our chief executive officer, chief financial officer, chief compliance officer and chief accounting officer. This
will create conflicts of interest that our board of directors must monitor.
The Investment Advisory Agreement with OFS Advisor and the Administration Agreement with OFS Services were not negotiated on an arm’s length
basis and may not be as favorable to us as if they had been negotiated with an unaffiliated third party.
The Investment Advisory Agreement and the Administration Agreement were negotiated between related parties. Consequently, their terms,
including fees payable to OFS Advisor, may not be as favorable to us as if they had been negotiated with an unaffiliated third party. In addition, we could
choose not to enforce, or to enforce less vigorously, our rights and remedies under these agreements because of our desire to maintain our ongoing
relationship with OFS Advisor, OFS Services and their respective affiliates. Any such decision, however, would breach our fiduciary obligations to our
stockholders.
Our ability to enter into transactions with our affiliates is restricted, which may limit the scope of investments available to us.
BDCs generally are prohibited under the 1940 Act from knowingly participating in certain transactions with their affiliates without the prior
approval of their independent directors and, in some cases, of the SEC. Those transactions include purchases and sales, and so-called “joint” transactions,
in which a BDC and one or more of its affiliates engage in certain types of profit-making activities. Any person that owns, directly or indirectly, five
percent or more of a BDC’s outstanding voting securities will be considered an affiliate of the BDC for purposes of the 1940 Act, and a BDC generally is
prohibited from engaging in purchases or sales of assets or joint transactions with such affiliates, absent the prior approval of the BDC’s independent
directors. Additionally, without the approval of the SEC, a BDC is prohibited from engaging in purchases or sales of assets or joint transactions with the
BDC’s officers, directors, and employees, and advisor (and its affiliates).
BDCs may, however, invest alongside certain related parties or their respective other clients in certain circumstances where doing so is consistent
with current law and SEC staff interpretations. For example, a BDC may invest alongside such accounts consistent with guidance promulgated by the SEC
staff permitting us and such other accounts to purchase interests in a
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single class of privately placed securities so long as certain conditions are met, including that the BDC’s advisor, acting on the BDC’s behalf and on behalf
of other clients, negotiates no term other than price. Co-investment with such other accounts is not permitted or appropriate under this guidance when there
is an opportunity to invest in different securities of the same issuer or where the different investments could be expected to result in a conflict between the
BDC’s interests and those of other accounts.
On October 12, 2016, we received the Order from the SEC that permits us to co-invest in portfolio companies with certain affiliates, provided that
we comply with the conditions of the Order. Pursuant to the Order, we are generally permitted to co-invest with BDCs, registered investment companies
and private funds managed by OFS Advisor or any adviser that controls, is controlled by, or is under common control with, OFS Advisor, and is registered
as an investment adviser under the Advisers Act, in a manner consistent with our investment strategy as well as applicable law, including the terms and
conditions of the Order. Under the terms of the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must
make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transaction, including the consideration to be
paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and
(2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies.
When we invest alongside clients of OFSAM and its affiliates or their respective other clients, OFS Advisor will, to the extent consistent with
applicable law, regulatory guidance, or the Order, allocate investment opportunities in accordance with its allocation policy. Under this allocation policy, if
two or more investment vehicles with similar or overlapping investment strategies are in their investment periods, an available opportunity will be allocated
based on the provisions governing allocations of such investment opportunities in the relevant organizational, offering or similar documents, if any, for
such investment vehicles. In the absence of any such provisions, OFS Advisor will consider the following factors and the weight that should be given with
respect to each of these factors:
•
•
•
•
•
•
•
•
investment guidelines and/or restrictions, if any, set forth in the applicable organizational, offering or similar documents for the investment
vehicles;
the status of tax restrictions and tests and other regulatory restrictions and tests;
risk and return profile of the investment vehicles;
suitability/priority of a particular investment for the investment vehicles;
if applicable, the targeted position size of the investment for the investment vehicles
level of available cash for investment with respect to the investment vehicles;
total amount of funds committed to the investment vehicles; and
the age of the investment vehicles and the remaining term of their respective investment periods, if any.
When not relying on the Order, priority as to opportunities will generally be given to clients that are in their “ramp-up” period, or the period
during which the account has yet to reach sufficient scale such that its investment income covers its operating expenses, over the accounts that are outside
their ramp-up period but still within their investment or re-investment periods. However, application of one or more of the factors listed above, or other
factors determined to be relevant or appropriate, may result in the allocation of an investment opportunity to a fund no longer in its ramp-up period over a
fund that is still within its ramp-up period.
In situations where co-investment with other accounts is not permitted or appropriate, OFS Advisor will need to decide which account will
proceed with the investment. The decision by OFS Advisor to allocate an opportunity to another entity could cause us to forego an investment opportunity
that we otherwise would have made. These restrictions, and similar restrictions that limit our ability to transact business with our officers or directors or
their affiliates, may limit the scope of investment opportunities that would otherwise be available to us.
Our base management fee may induce OFS Advisor to cause us to incur leverage.
Our base management fee is payable based upon our total assets, other than cash and cash equivalents but including assets purchased with
borrowed amounts and including assets owned by any consolidated entity. This fee structure may encourage OFS Advisor to cause us to borrow money to
finance additional investments. Under certain circumstances, the use of borrowed money may increase the likelihood of default, which would disfavor
holders of our common stock. Given the subjective nature of the investment decisions made by OFS Advisor on our behalf, our board of directors may not
be able to monitor this potential conflict of interest effectively.
Our incentive fee may induce OFS Advisor to make certain investments, including speculative investments.
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The incentive fee payable by us to OFS Advisor may create an incentive for OFS Advisor to make investments on our behalf that are riskier or
more speculative than would be the case in the absence of such compensation arrangement. The way in which the incentive fee payable to OFS Advisor is
determined may encourage OFS Advisor to use leverage to increase the return on our investments. Under certain circumstances, the use of leverage may
increase the likelihood of default, which would disfavor our stockholders.
OFS Advisor receives an incentive fee based, in part, upon net capital gains realized on our investments. Unlike that portion of the incentive fee
based on income, there is no hurdle rate applicable to the portion of the incentive fee based on net capital gains. As a result, OFS Advisor may have a
tendency to invest more capital in investments that are likely to result in capital gains as compared to income producing securities. Such a practice could
result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during
economic downturns.
We may invest, to the extent permitted by law, in the securities and instruments of other investment companies, including private funds, and, to the
extent we so invest, will bear our ratable share of any such investment company’s expenses, including management and performance fees. We remain
obligated to pay management and incentive fees to OFS Advisor with respect to the assets invested in the securities and instruments of other investment
companies. With respect to each of these investments, each of our stockholders will bear his or her share of the management and incentive fee of OFS
Advisor as well as indirectly bearing the management and performance fees and other expenses of any investment companies in which we invest.
Our board of directors is charged with protecting our interests by monitoring how OFS Advisor addresses these and other conflicts of interests
associated with its management services and compensation. While our board of directors is not expected to review or approve each borrowing or incurrence
of leverage, our independent directors will periodically review OFS Advisor’s services and fees. In connection with these reviews, our independent
directors will consider whether our fees and expenses (including those related to leverage) remain appropriate.
Our incentive fee structure may create incentives for OFS Advisor that are not fully aligned with the interests of our stockholders.
In the course of our investing activities, we will pay management and incentive fees to OFS Advisor. The base management fee is based on our
total assets (other than cash and cash equivalents and the intangible asset and goodwill resulting from the SBIC Acquisition, but including assets purchased
with borrowed amounts and including assets owned by any consolidated entity). As a result, investors in our common stock will invest on a “gross” basis
and receive distributions on a “net” basis after expenses, resulting in a lower rate of return than one might achieve through direct investments. Because
these fees are based on our total assets, other than cash and cash equivalents but including assets purchased with borrowed amounts and including any
assets owned by any consolidated entity, OFS Advisor will benefit when we incur debt or use leverage. Our board of directors is charged with protecting
our interests by monitoring how OFS Advisor addresses these and other conflicts of interests associated with its management services and compensation.
While our board of directors is not expected to review or approve each borrowing or incurrence of leverage, our independent directors will periodically
review OFS Advisor’s services and fees as well as its portfolio management decisions and portfolio performance. In connection with these reviews, our
independent directors will consider whether our fees and expenses (including those related to leverage) remain appropriate. As a result of this arrangement,
OFS Advisor or its affiliates may from time to time have interests that differ from those of our stockholders, giving rise to a conflict.
We may pay an incentive fee on income we do not receive in cash.
The part of the incentive fee payable to OFS Advisor that relates to our pre-incentive fee net investment income is computed and paid on income
that may include interest income that has been accrued but not yet received in cash. This fee structure may be considered to involve a conflict of interest for
OFS Advisor to the extent that it may encourage OFS Advisor to favor debt financings that provide for deferred interest, rather than current cash payments
of interest. OFS Advisor may have an incentive to invest in deferred interest securities in circumstances where it would not have done so but for the
opportunity to continue to earn the incentive fee even when the issuers of the deferred interest securities would not be able to make actual cash payments to
us on such securities. This risk could be increased because OFS Advisor is not obligated to reimburse us for any incentive fees received even if we
subsequently incur losses or never receive in cash the deferred income that was previously accrued.
OFS Advisor’s liability is limited under the Investment Advisory Agreement, and we have agreed to indemnify OFS Advisor against certain liabilities,
which may lead OFS Advisor to act in a riskier manner on our behalf than it would when acting for its own account.
Under the Investment Advisory Agreement, OFS Advisor will not assume any responsibility to us other than to render the services called for
under that agreement, and it will not be responsible for any action of our board of directors in following or declining to follow OFS Advisor’s advice or
recommendations. Under the terms of the Investment Advisory Agreement, OFS
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Advisor and its affiliates’ respective officers, directors, members, managers, stockholders and employees will not be liable to us, any subsidiary of ours,
our directors, our stockholders or any subsidiary’s stockholders or partners for acts or omissions performed in accordance with and pursuant to the
Investment Advisory Agreement, except those resulting from acts constituting gross negligence, willful misconduct, bad faith or reckless disregard of such
person’s duties under the Investment Advisory Agreement. In addition, we have agreed to indemnify OFS Advisor and its affiliates’ respective officers,
directors, members, managers, stockholders and employees from and against any claims or liabilities, including reasonable legal fees and other expenses
reasonably incurred, arising out of or in connection with our business and operations or any action taken or omitted on our behalf pursuant to authority
granted by the Investment Advisory Agreement, except where attributable to gross negligence, willful misconduct, bad faith or reckless disregard of such
person’s duties under the Investment Advisory Agreement. These protections may lead OFS Advisor to act in a riskier manner when acting on our behalf
than it would when acting for its own account.
OFS Advisor can resign on 60 days’ notice, and we may not be able to find a suitable replacement within that time, resulting in a disruption in our
operations that could adversely affect our financial condition, business and results of operations.
OFS Advisor has the right, under the Investment Advisory Agreement, to resign at any time upon not less than 60 days’ written notice, whether
we have found a replacement or not. If OFS Advisor resigns, we may not be able to find a new investment advisor or hire internal management with similar
expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our
operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are
likely to be adversely affected and the value of our shares may decline. In addition, the coordination of our internal management and investment activities
is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by the
OFS Advisor and its affiliates. Even if we are able to retain comparable management, whether internal or external, the integration of such management and
their lack of familiarity with our investment objectives may result in additional costs and time delays that may adversely affect our financial condition,
business and results of operations.
OFS Services can resign from its role as our Administrator under the Administration Agreement, and we may not be able to find a suitable
replacement, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.
OFS Services has the right to resign under the Administration Agreement, whether we have found a replacement or not. If OFS Services resigns,
we may not be able to find a new administrator or hire internal management with similar expertise and ability to provide the same or equivalent services on
acceptable terms, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and
results of operations as well as our ability to pay distributions are likely to be adversely affected and the value of our shares may decline. In addition, the
coordination of our internal management and administrative activities is likely to suffer if we are unable to identify and reach an agreement with a service
provider or individuals with the expertise possessed by OFS Services. Even if we are able to retain a comparable service provider or individuals to perform
such services, whether internal or external, their integration into our business and lack of familiarity with our investment objectives may result in additional
costs and time delays that may adversely affect our financial condition, business and results of operations.
Risks Related to BDCs
Regulations governing our operation as a BDC affect our ability to and the way in which we raise additional capital. As a BDC, we will need to raise
additional capital, which will expose us to risks, including the typical risks associated with leverage.
We may issue debt securities or preferred stock and/or borrow money from banks or other financial institutions, which we refer to collectively as
“senior securities,” up to the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act, as modified by the SBCAA, we are
permitted as a BDC to issue senior securities in amounts such that our asset coverage ratio, as defined in the 1940 Act, equals at least 150% of gross assets
less all liabilities and indebtedness not represented by senior securities, after each issuance of senior securities. If the value of our assets decline, we may be
unable to satisfy this test. If that happens, we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a
portion of our indebtedness at a time when such sales may be disadvantageous. Also, any amounts that we use to service our indebtedness would not be
available for distributions to our common stockholders. If we issue senior securities, we will be exposed to typical risks associated with leverage, including
an increased risk of loss.
On May 3, 2018, the Board, including a "required majority" (as such item is determined in section 57(o) of the 1940 Act) of the Board, approved
the application of a reduced 150% asset coverage ratio to us and, as a result, the reduced asset coverage ratio applicable to us was decreased from 200% to
150% effective May 3, 2019. See "Item 1A. Risk Factors--Risks
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Related to our Business and Structure--Because we have received the approval of our Board, we are subject to 150% Asset Coverage beginning on May 3,
2019."
As of December 31, 2019, we had $359.2 million of debt outstanding. Our ability to incur additional debt and remain in compliance with the asset
coverage test will be limited. We may seek an additional credit facility to finance investments or for working capital requirements. There can be no
assurance that we will be able to obtain such financing on favorable terms or at all. We have received an exemptive order from the SEC to permit us to
exclude the debt of SBIC I LP guaranteed by the SBA from our definition of senior securities in our statutory asset coverage ratio under the 1940 Act.
If we issue preferred stock, the preferred stock would rank “senior” to common stock in our capital structure, preferred stockholders would have
separate voting rights on certain matters and might have other rights, preferences or privileges more favorable than those of our common stockholders, and
the issuance of preferred stock could have the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium
price for holders of our common stock or otherwise be in our stockholders’ best interest. Holders of our common stock will directly or indirectly bear all of
the costs associated with offering and servicing any preferred stock that we issue. In addition, any interests of preferred stockholders may not necessarily
align with the interests of holders of our common stock and the rights of holders of shares of preferred stock to receive dividends would be senior to those
of holders of shares of our common stock. We are not generally able to issue and sell our common stock at a price below net asset value per share. We may,
however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value per share of
our common stock if our board of directors determines that such sale is in the best interests of us and our stockholders, and if our stockholders approve any
such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price that, in the determination of our board of
directors, closely approximates the market value of such securities (less any distributing commission or discount). If we raise additional funds by issuing
common stock or senior securities convertible into, or exchangeable for, our common stock, then the percentage ownership of our stockholders at that time
will decrease, and our stockholders might experience dilution.
Our ability to invest in public companies may be limited in certain circumstances.
To maintain our status as a BDC, we are not permitted to acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the
time the acquisition is made, at least 70% of our assets, as defined by the 1940 Act, are qualifying assets (with certain limited exceptions). Subject to
certain exceptions for follow-on investments and distressed companies, an investment in an issuer that has outstanding securities listed on a national
securities exchange may be treated as a qualifying asset only if such issuer has a common equity market capitalization that is less than $250 million at the
time of such investment and meets the other specified requirements.
If we do not invest a sufficient portion of our assets in qualifying assets, we could fail to continue to qualify as a BDC or be precluded from investing
according to our current business strategy.
As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least
70% of our assets, as defined by the 1940 Act, are qualifying assets.
We believe that most of the investments that we may acquire in the future will constitute qualifying assets. However, we may be precluded from
investing in what we believe are attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If a sufficient portion of
our assets are not qualifying assets, we could violate the 1940 Act provisions applicable to BDCs. As a result of such violation, specific rules under the
1940 Act could prevent us, for example, from making follow-on investments in existing portfolio companies (which could result in the dilution of our
position) or could require us to dispose of investments at inappropriate times in order to come into compliance with the 1940 Act. If we need to dispose of
such investments quickly, it could be difficult to dispose of such investments on favorable terms. We may not be able to find a buyer for such investments
and, even if we do find a buyer, we may have to sell the investments at a substantial loss. Any such outcomes would have a material adverse effect on our
business, financial condition and results of operations
If we do not maintain our status as a BDC, we would be subject to regulation as a registered closed-end investment company under the 1940 Act.
As a registered closed-end fund, we would be subject to substantially more regulatory restrictions under the 1940 Act which would significantly decrease
our operating flexibility.
Risks Related to Our Investments
Economic recessions or downturns could impair our portfolio companies and harm our operating results.
Many of our portfolio companies are susceptible to economic slowdowns or recessions and may be unable to repay our loans during these periods.
Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during these periods. Adverse economic
conditions may decrease the value of collateral securing some of our loans and the value of our equity investments. Economic slowdowns or recessions
could lead to financial losses in our portfolio and a
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decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets
or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing our investments and harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially,
termination of its loans and foreclosure on its assets, which could trigger cross-defaults under other agreements and jeopardize our portfolio company’s
ability to meet its obligations under the debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to
negotiate new terms with a defaulting portfolio company. In addition, lenders in certain cases can be subject to lender liability claims for actions taken by
them when they become too involved in the borrower’s business or exercise control over a borrower. It is possible that we could become subject to a lender
liability claim, including as a result of actions taken if we render significant managerial assistance to the borrower. Furthermore, if one of our portfolio
companies were to file for bankruptcy protection, even though we may have structured our investment as senior secured debt, depending on the facts and
circumstances, including the extent to which we provided managerial assistance to that portfolio company, a bankruptcy court might re-characterize our
debt holding and subordinate all or a portion of our claim to claims of other creditors.
Our investments in the debt instruments of leveraged portfolio companies may be risky and, due to the significant volatility of such companies, we
could lose all or part of our investment in bankruptcy proceedings or otherwise.
Investment in leveraged companies involves a number of significant risks. Leveraged companies in which we invest may have limited financial
resources and may be unable to meet their obligations under their debt securities that we hold due to the significant volatility of such companies. Negative
developments may be accompanied by deterioration of the value of any collateral and a reduction in the likelihood of our realizing any guarantees that we
may have obtained in connection with our investment. Such developments may ultimately result in the leveraged companies in which we invest entering
into bankruptcy proceedings, which have a number of inherent risks. Many events in a bankruptcy proceeding are the product of contested matters and
adversary proceedings and are beyond the control of the creditors. A bankruptcy filing by an issuer may adversely and permanently affect the issuer. If the
proceeding is converted to a liquidation, the value of the issuer may not equal the liquidation value that was believed to exist at the time of the investment.
The duration of a bankruptcy proceeding is also difficult to predict, and a creditor’s return on investment can be adversely affected by delays until the plan
of reorganization or liquidation ultimately becomes effective. The administrative costs in connection with a bankruptcy proceeding are frequently high and
would be paid out of the debtor’s estate prior to any return to creditors. Because the standards for classification of claims under bankruptcy law are vague,
our influence with respect to the class of securities or other obligations we own may be lost by increases in the number and amount of claims in the same
class or by different classification and treatment. In the early stages of the bankruptcy process, it is often difficult to estimate the extent of, or even to
identify, any contingent claims that might be made. In addition, certain claims that have priority by law (for example, claims for taxes) may be substantial.
In addition, since our mezzanine loans are generally subordinated to senior loans and are generally unsecured, other creditors may rank senior to us in the
event of a bankruptcy proceeding.
Our investments in debt instruments may include “covenant-lite” loans. Covenants are contractual restrictions that lenders place on companies to
limit the corporate actions a company may pursue. Generally, the loans in which we expect to invest will have financial maintenance covenants, which are
used to proactively address materially adverse changes in a portfolio company’s financial performance. However, to a lesser extent, we may invest in
“covenant-lite” loans. We use the term “covenant-lite” to refer generally to loans that do not have a complete set of financial maintenance covenants.
Generally, “covenant-lite” loans provide borrower companies more freedom to negatively impact lenders because their covenants are incurrence-based,
which means they are only tested and can only be breached following an affirmative action of the borrower, rather than by a deterioration in the borrower’s
financial condition. Accordingly, to the extent we invest in “covenant-lite” loans, we may have fewer rights against a borrower and may have a greater risk
of loss on such investments as compared to investments in or exposure to loans with financial maintenance covenants.
Our investments in private and middle-market portfolio companies are generally considered lower credit quality obligations, are risky, and we could
lose all or part of our investment.
Investment in private and middle-market companies involves a number of significant risks. Generally, little public information exists about these
companies, and we rely on the ability of OFS Advisor’s investment professionals to obtain adequate information to evaluate the potential returns from
investing in these companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment
decision, and we may lose money on our investments. Middle-market companies may have limited financial resources and may be unable to meet their
obligations under their debt securities that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the
likelihood of our realizing any guarantees we may have obtained in connection with our investment. Such companies typically have shorter operating
histories, narrower product lines and smaller market shares than larger businesses,
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which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns.
Middle-market companies are more likely to be considered lower grade investments, commonly called “junk bonds,” which are either rated below
investment grade by one or more nationally-recognized statistical rating agencies at the time of investment, or may be unrated but determined by the OFS
Advisor to be of comparable quality. Lower grade securities or comparable unrated securities are considered predominantly speculative regarding the
issuer’s ability to pay interest and principal, and are susceptible to default or decline in market value due to adverse economic and business developments.
The market values for lower grade debt tend to be very volatile and are less liquid than investment grade securities. For these reasons, an investment in our
company is subject to the following specific risks: increased price sensitivity to a deteriorating economic environment; greater risk of loss due to default or
declining credit quality; adverse company specific events are more likely to render the issuer unable to make interest and/or principal payments; and if a
negative perception of the lower grade debt market develops, the price and liquidity of lower grade securities may be depressed. This negative perception
could last for a significant period of time.
Additionally, middle-market companies are more likely to depend on the management talents and efforts of a small group of persons. Therefore,
the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn,
on us. Middle-market companies also may be parties to litigation and may be engaged in rapidly changing businesses with products subject to a substantial
risk of obsolescence. In addition, our executive officers, directors and OFS Advisor may, in the ordinary course of business, be named as defendants in
litigation arising from our investments in the portfolio companies.
Investments in equity securities involve a substantial degree of risk.
We have purchased, and may purchase in the future, common stock and other equity securities, including warrants, in various portfolio companies.
Although equity securities historically have generated higher average total returns than debt securities over the long term, equity securities may experience
more volatility in those returns than debt securities. The equity securities we acquire may fail to appreciate, decline in value or lose all value, and our
ability to recover our investment will depend on our portfolio company's success. Investments in equity securities involve a number of significant risks,
including the risk of further dilution in the event the portfolio company issues additional securities. Investments in preferred securities involve special risks,
such as the risk of deferred distributions, illiquidity and limited voting rights.
Our equity ownership in a portfolio company may represent a control investment. Our ability to exit a control investment in a timely manner could
result in a realized loss on the investment.
If we obtain a control investment in a portfolio company, our ability to divest ourselves from a debt or equity investment could be restricted due to
illiquidity in a private stock, limited trading volume on a public company’s stock, inside information on a company’s performance, insider blackout periods,
or other factors that could prohibit us from disposing of the investment as we would if it were not a control investment. Additionally, we may choose not to
take certain actions to protect a debt investment in a control investment portfolio company. As a result, we could experience a decrease in the value of our
portfolio company holdings and potentially incur a realized loss on the investment.
Our investments in CLOs carry additional risks to the risks associated with investing in private debt.
In addition to the general risks associated with debt securities and structured products discussed herein, CLOs carry additional risks, including, but
not limited to (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the quality of the
collateral may decline in value or default; (iii) the possibility that the investments in CLOs are subordinate to other classes or tranches thereof, (iv) the
potential of spread compression in the underlying loans of the CLO, which could reduce credit enhancement in the CLOs and (v) the complex structure of
the security may not be fully understood at the time of investment and may produce disputes with the issuer or unexpected investment results. CLO equity
securities that we may acquire are subordinated to more senior tranches of CLO debt. CLO equity securities are subject to increased risks of default relative
to the holders of superior priority interests in the same securities. In addition, at the time of issuance, CLO equity securities are under-collateralized in that
the liabilities of a CLO at inception exceed its total assets. When we invest in CLOs, we may be in a first loss or subordinated position with respect to
realized losses on the assets of the CLOs in which it is invested. We may recognize phantom taxable income from our investments in the subordinated
tranches of CLOs.
Between the closing date and the effective date of a CLO, the CLO collateral manager will generally expect to purchase additional collateral
obligations for the CLO. During this period, the price and availability of these collateral obligations may be adversely affected by a number of market
factors, including price volatility and availability of investments suitable for the CLO, which could hamper the ability of the collateral manager to acquire a
portfolio of collateral obligations that will satisfy specified concentration limitations and allow the CLO to reach the initial par amount of collateral prior to
the effective date. An inability or delay in reaching the target initial par amount of collateral may adversely affect the timing and
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amount of interest or principal payments received by the holders of the CLO debt securities and distributions of the CLO on equity securities and could
result in early redemptions which may cause CLO debt and equity investors to receive less than the face value of their investment.
In addition, the portfolios of certain CLOs in which we may invest may contain “covenant-lite” loans. Accordingly, to the extent we are exposed
to “covenant-lite” loans, we may have a greater risk of loss on such investments as compared to investments in or exposure to loans with financial
maintenance covenants.The failure by a CLO in which we invest to satisfy financial covenants, including with respect to adequate collateralization and/or
interest coverage tests, could lead to a reduction in the payments we receive from the CLO. In the event that a CLO fails certain tests, holders of CLO
senior debt may be entitled to additional payments that would, in turn, reduce the payments we would otherwise be entitled to receive. Separately, we may
incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial
covenants, with a defaulting CLO or any other investment we may make. If any of these occur, it could adversely affect our operating results and cash
flows.
Our CLO investments will be exposed to leveraged credit risk. If a CLO does not meet certain minimum collateral value ratios and/or interest
coverage ratios, primarily due to senior secured loan defaults, then cash flow that otherwise would have been available to pay us distributions may instead
be used to redeem any senior notes or to purchase additional senior secured loans, until the ratios again exceed the minimum required levels or any senior
notes are repaid in full.
We may suffer a loss if a portfolio company defaults on a loan and the underlying collateral is not sufficient.
We will at times take a security interest in the available assets of our portfolio companies, including the equity interests of their subsidiaries and, in
some cases, the equity interests of our portfolio companies held by their stockholders. In the event of a default by a portfolio company on a secured loan,
we will only have recourse to the assets collateralizing the loan. There is a risk that the collateral securing our loans may decrease in value over time, may
be difficult to sell in a timely manner, may be difficult to appraise, and may fluctuate in value based upon the success or deterioration of the business and
market conditions, including as a result of the inability of a portfolio company to raise additional capital. Additionally, in the case of certain of our
investments, we do not have a first lien position on the collateral and may not receive the full value of the collateral upon liquidation. If the underlying
collateral value is less than the loan amount, we will suffer a loss.
In the event of bankruptcy of a portfolio company, we may not have full recourse to its assets in order to satisfy our loan, or our loan may be
subject to equitable subordination. In addition, certain of our loans are subordinate to other debt of the portfolio company. If a portfolio company defaults
on our loan or on debt senior to our loan, or in the event of a portfolio company bankruptcy, our loan will be satisfied only after the senior debt receives
payment. Where debt senior to our loan exists, the presence of inter-creditor arrangements may limit our ability to amend our loan documents, assign our
loans, accept prepayments, exercise our remedies (through “standstill” periods) and control decisions made in bankruptcy proceedings relating to the
portfolio company. Bankruptcy and portfolio company litigation can significantly increase collection losses and the time needed for us to acquire the
underlying collateral in the event of a default, during which time the collateral may decline in value, causing us to suffer losses.
Borrowers of Broadly Syndicated Loans may be permitted to designate unrestricted subsidiaries under the terms of their financing agreements,
which would exclude such unrestricted subsidiaries from restrictive covenants under the financing agreement with the borrower. Without restriction under
the financing agreement, the borrower could take various actions with respect to the unrestricted subsidiary including, among other things, incur debt, grant
security on its assets, sell assets, pay dividends or distribute shares of the unrestricted subsidiary to the borrower’s shareholders. Any of these actions could
increase the amount of leverage that the borrower is able to incur and increase the risk involved in our investments in Broadly Syndicated Loans
accordingly.
If the value of collateral underlying our loan declines or interest rates increase during the term of our loan, a portfolio company may not be able to
obtain the necessary funds to repay our loan at maturity through refinancing. Decreasing collateral value and/or increasing interest rates may hinder a
portfolio company’s ability to refinance our loan because the underlying collateral cannot satisfy the debt service coverage requirements necessary to obtain
new financing. If a borrower is unable to repay our loan at maturity, we could suffer a loss which may adversely impact our financial performance.
The lack of liquidity in our investments may adversely affect our business.
All of our assets are presently invested in illiquid securities, and a substantial portion of our investments in leveraged companies is subject to legal
and other restrictions on resale or is otherwise less liquid than more broadly traded public securities. The illiquidity of these investments may make it
difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize
significantly less than the value at which we have previously recorded these investments. We may also face other restrictions on our ability to liquidate an
investment in a portfolio company to the extent that we, OFS Advisor, OFSAM or any of its other affiliates have material nonpublic information regarding
such portfolio company.
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Price declines and illiquidity in the corporate debt markets may adversely affect the fair value of our portfolio investments, reducing our net asset value
through increased net unrealized depreciation.
As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good
faith by our board of directors. As part of the valuation process, we may take into account the following types of factors, if relevant, in determining the fair
value of our investments:
•
•
•
•
•
•
a comparison of the portfolio company’s securities to publicly traded securities;
the enterprise value of a portfolio company;
the nature and realizable value of any collateral;
the portfolio company’s ability to make payments and its earnings and discounted cash flow;
the markets in which the portfolio company does business; and
changes in the interest rate environment and the credit markets generally that may affect the price at which similar investments may be made in the
future and other relevant factors.
When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we will use the pricing indicated by the
external event to corroborate our valuation. We will record decreases in the market values or fair values of our investments as unrealized depreciation.
Declines in prices and liquidity in the corporate debt markets may result in significant net unrealized depreciation in our portfolio. The effect of all of these
factors on our portfolio may reduce our net asset value by increasing net unrealized depreciation in our portfolio. Depending on market conditions, we
could incur substantial realized losses and may suffer additional unrealized losses in future periods, which could have a material adverse effect on our
business, financial condition and results of operations.
We are a non-diversified management investment company within the meaning of the 1940 Act, and therefore we are not limited by the 1940 Act with
respect to the proportion of our assets that may be invested in securities of a single issuer.
We are classified as a non-diversified management investment company within the meaning of the 1940 Act, which means that we are not limited
by the 1940 Act with respect to the proportion of our assets that we may invest in securities of a single issuer. To the extent that we assume large positions
in the securities of a small number of issuers, our net asset value may fluctuate to a greater extent than that of a diversified investment company as a result
of changes in the financial condition or the market’s assessment of the issuer. We may also be more susceptible to any single economic or regulatory
occurrence than a diversified investment company. Beyond our asset diversification requirements as a RIC under the Code, we do not have fixed guidelines
for diversification, and our investments could be concentrated in relatively few portfolio companies.
Our portfolio may be concentrated in a limited number of portfolio companies and industries, which will subject us to a risk of significant loss if any of
these companies defaults on its obligations under any of its debt instruments or if there is a downturn in a particular industry.
Although we believe our portfolio is well-diversified across companies and industries, our portfolio is, and may in the future be, concentrated in a
limited number of portfolio companies and industries. Beyond the asset diversification requirements associated with our qualification as a RIC under the
Code, we do not have fixed guidelines for diversification. As a result, the aggregate returns we realize may be significantly adversely affected if a small
number of investments perform poorly or if we need to write down the value of any one investment. Additionally, while we are not targeting any specific
industries, our investments may be concentrated in relatively few industries. As a result, a downturn in any particular industry in which we are invested
could also significantly impact the aggregate returns we realize.
Our failure to make follow-on investments in our portfolio companies could impair the value of our portfolio.
Following an initial investment in a portfolio company, we may make additional investments in that portfolio company as “follow-on”
investments, in seeking to:
•
•
•
increase or maintain in whole or in part our position as a creditor or equity ownership percentage in a portfolio company;
exercise warrants, options or convertible securities that were acquired in the original or subsequent financing; or
preserve or enhance the value of our investment.
We have discretion to make follow-on investments, subject to the availability of capital resources. Failure on our part to make follow-on
investments may, in some circumstances, jeopardize the continued viability of a portfolio company and our initial investment, or may result in a missed
opportunity for us to increase our participation in a successful operation. Even if we have sufficient capital to make a desired follow-on investment, we may
elect not to make a follow-on investment because
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we may not want to increase our level of risk, because we prefer other opportunities or because we are inhibited by compliance with BDC requirements or
the desire to maintain our RIC status. Our ability to make follow-on investments may also be limited by OFS Advisor’s allocation policy.
Because we generally do not hold controlling equity interests in our portfolio companies, we may not be able to exercise control over our portfolio
companies or to prevent decisions by management of our portfolio companies that could decrease the value of our investments.
We generally do not hold controlling equity positions in our portfolio companies. For portfolio companies in which we do not hold a controlling
equity interest, we are subject to the risk that a portfolio company may make business decisions with which we disagree, and that the management and/or
stockholders of a portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due to the lack of liquidity of the debt and
equity investments that we typically hold in our portfolio companies, we may not be able to dispose of our investments in the event we disagree with the
actions of a portfolio company and may therefore suffer a decrease in the value of our investments.
Defaults by our portfolio companies will harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially,
termination of its loans and foreclosure on its assets. This could trigger cross-defaults under other agreements and jeopardize such portfolio company’s
ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default
or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
We have invested a substantial portion of our capital in senior secured, unitranche, second-lien and mezzanine loans issued by our portfolio
companies. The portfolio companies may be permitted to incur, other debt that ranks equally with, or senior to, the debt securities in which we invest. By
their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we
are entitled to receive payments in respect of the debt securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization
or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to
receive payment in full before we receive any distribution in respect of our investment. After repaying senior creditors, the portfolio company may not have
any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt securities in which we invest, we would have to
share any distributions on an equal and ratable basis with other creditors holding such debt in the event of an insolvency, liquidation, dissolution,
reorganization or bankruptcy of the relevant portfolio company.
Additionally, certain loans that we make to portfolio companies may be secured on a second-priority basis by the same collateral securing first-
priority debt of such companies. The senior-secured liens on the collateral will secure the portfolio company’s obligations under any outstanding senior
debt and may secure certain other future debt that may be permitted to be incurred by the portfolio company under the agreements governing the loans. The
holders of obligations secured by first-priority liens on the collateral will generally control the liquidation of, and be entitled to receive proceeds from, any
realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on
market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of all of the
collateral would be sufficient to satisfy the loan obligations secured by the second-priority liens after payment in full of all obligations secured by the first-
priority liens on the collateral. If such proceeds were not sufficient to repay amounts outstanding under the loan obligations secured by the second-priority
liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, would only have an unsecured claim against the portfolio company’s
remaining assets, if any.
The rights we may have with respect to the collateral securing the loans we make to our portfolio companies with more senior debt outstanding
may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of such senior debt. Under a typical
intercreditor agreement, at any time that obligations that have the benefit of the first-priority liens are outstanding, any of the following actions that may be
taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first-priority liens:
•
•
•
•
•
the ability to cause the commencement of enforcement proceedings against the collateral;
the ability to control the conduct of such proceedings;
the approval of amendments to collateral documents;
releases of liens on the collateral; and
waivers of past defaults under collateral documents.
49
We may not have the ability to control or direct such actions, even if our rights are adversely affected.
We may also make unsecured loans to portfolio companies, meaning that such loans will not benefit from any interest in collateral of such
companies. Liens on such portfolio companies’ collateral, if any, will secure the portfolio company’s obligations under its outstanding secured debt and
may secure certain future debt that is permitted to be incurred by the portfolio company under its secured loan agreements. The holders of obligations
secured by such liens will generally control the liquidation of, and be entitled to receive proceeds from, any realization of such collateral to repay their
obligations in full before us. In addition, the value of such collateral in the event of liquidation will depend on market and economic conditions, the
availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of such collateral would be sufficient to satisfy our
unsecured loan obligations after payment in full of all secured loan obligations. If such proceeds were not sufficient to repay the outstanding secured loan
obligations, then our unsecured claims would rank equally with the unpaid portion of such secured creditors’ claims against the portfolio company’s
remaining assets, if any.
Cybersecurity risks and cyber incidents may adversely affect our business or the business of our portfolio companies by causing a disruption to our
operations or the operations of our portfolio companies, a compromise or corruption of our confidential information or the confidential information of
our portfolio companies and/or damage to our business relationships or the business relationships of our portfolio companies, all of which could
negatively impact the business, financial condition and operating results of us or our portfolio companies.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of the information resources of us
or our portfolio companies. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our
information systems or those of our portfolio companies for purposes of misappropriating assets, stealing confidential information, corrupting data or
causing operational disruption. We and OFS Advisor’s employees have been and expect to continue to be the target of fraudulent calls, emails and other
forms of activities. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen assets or
information, increased cybersecurity protection and insurance costs, litigation damage to business relationships and damage to our competitiveness, stock
price, and long-term stockholder value. The costs related to cyber or other security threats or disruptions may not be fully insured or indemnified by other
means. As our and our portfolio companies’ reliance on technology has increased, so have the risks posed to our information systems, both internal and
those provided by OFS Services and third-party service providers, and the information systems of our portfolio companies. OFS Advisor has implemented
processes, procedures and internal controls to help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness
of the nature and extent of a risk of a cyber incident, do not guarantee that a cyber incident will not occur and/or that our financial results, operations or
confidential information will not be negatively impacted by such an incident. In addition, cybersecurity has become a top priority for regulators around the
world, and some jurisdictions have enacted laws requiring companies to notify individuals of data security breaches involving certain types of personal
data. If we fail to comply with the relevant laws and regulations, we could suffer financial losses, a disruption of our businesses, liability to investors,
regulatory intervention or reputational damage.
If we make subordinated investments, the obligors or the portfolio companies may not generate sufficient cash flow to service their debt obligations to
us.
We make subordinated investments that rank below other obligations of the obligor in right of payment. Subordinated investments are subject to
greater risk of default than senior obligations as a result of adverse changes in the financial condition of the obligor or in general economic conditions. If
we make a subordinated investment in a portfolio company, the portfolio company may be highly leveraged, and its relatively high debt-to-equity ratio may
create increased risks that its operations might not generate sufficient cash flow to service all of its debt obligations.
The disposition of our investments may result in contingent liabilities.
A significant portion of our investments involve private securities. In connection with the disposition of an investment in private securities, we
may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale
of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate,
or with respect to potential liabilities. These arrangements may result in contingent liabilities that ultimately result in funding obligations that we must
satisfy through our return of distributions previously made to us.
We may be subject to additional risks if we engage in hedging transactions and/or invest in foreign securities.
The 1940 Act generally requires that 70% of our investments be in issuers each of whom is organized under the laws of, and has its principal place
of business in, any state of the United States, the District of Columbia, Puerto Rico, the Virgin Islands or any other possession of the United States. Our
investment strategy does not presently contemplate investments in securities of non-U.S. companies. We expect that these investments would focus on the
same debt investments that we make in U.S. middle-market companies and accordingly would be complementary to our overall strategy and enhance the
diversity of
50
our holdings. Investing in securities of emerging market issuers involves many risks, including economic, social, political, financial, tax and security
conditions in the emerging market, potential inflationary economic environments, regulation by foreign governments, different accounting standards and
political uncertainties. Economic, social, political, financial, tax and security conditions also could negatively affect the value of emerging market
companies. These factors could include changes in the emerging market government’s economic and fiscal policies, the possible imposition of, or changes
in, currency exchange laws or other laws or restrictions applicable to the emerging market companies or investments in their securities and the possibility
of fluctuations in the rate of exchange between currencies.
Engaging in either hedging transactions or investing in foreign securities would entail additional risks to our stockholders. We could, for example,
use instruments such as interest rate swaps, caps, collars and floors and, if we were to invest in foreign securities, we could use instruments such as forward
contracts or currency options and borrow under a credit facility in currencies selected to minimize our foreign currency exposure. In each such case, we
generally would seek to hedge against fluctuations of the relative values of our portfolio positions from changes in market interest rates or currency
exchange rates. Hedging against a decline in the values of our portfolio positions would not eliminate the possibility of fluctuations in the values of such
positions or prevent losses if the values of the positions declined. However, such hedging could establish other positions designed to gain from those same
developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions could also limit the opportunity for gain if
the values of the underlying portfolio positions increased. Moreover, it might not be possible to hedge against an exchange rate or interest rate fluctuation
that was so generally anticipated that we would not be able to enter into a hedging transaction at an acceptable price.
While we may enter into such transactions to seek to reduce currency exchange rate and interest rate risks, unanticipated changes in currency
exchange rates or interest rates could result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In
addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions
being hedged could vary. Moreover, for a variety of reasons, we might not seek to establish a perfect correlation between the hedging instruments and the
portfolio holdings being hedged. Any such imperfect correlation could prevent us from achieving the intended hedge and expose us to risk of loss. In
addition, it might not be possible to hedge fully or perfectly against currency fluctuations affecting the value of securities denominated in non-U.S.
currencies because the value of those securities would likely fluctuate as a result of factors not related to currency fluctuations.
We may not realize gains from our equity investments.
When we invest in senior secured, unitranche, second-lien and mezzanine loans, we may acquire warrants or other equity securities of portfolio
companies as well. We may also invest in equity securities directly. To the extent we hold equity investments, except as described below, we will attempt to
dispose of them and realize gains upon our disposition of them. However, the equity interests we receive may not appreciate in value and may decline in
value. As a result, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests
may not be sufficient to offset any other losses we experience. In the case of SBIC I LP, our wholly owned subsidiary, we will not receive direct benefits
from the sale of assets in its portfolio. Rather, our return on our investment in such assets will depend on the ability of SBIC I LP’s portfolio to generate
cash flow in excess of payments required, as appropriate, to be made to other parties under the terms of the SBA debentures, and distribution, subject to
SBA regulation, of the excess to us.
Uncertainty relating to the LIBOR calculation process may adversely affect the value of any portfolio of LIBOR-indexed, floating-rate debt securities.
Concerns have been publicized that some of the member banks surveyed by the British Bankers' Association (“BBA”) in connection with the
calculation of LIBOR across a range of maturities and currencies may have been under-reporting or otherwise manipulating the inter-bank lending rate
applicable to them in order to profit on their derivatives positions or to avoid an appearance of capital insufficiency or adverse reputational or other
consequences that may have resulted from reporting inter-bank lending rates higher than those they actually submitted. A number of BBA member banks
have entered into settlements with their regulators and law enforcement agencies with respect to alleged manipulation of LIBOR, and investigations by
regulators and governmental authorities in various jurisdictions are ongoing.
Actions by the BBA, regulators or law enforcement agencies may result in changes to the manner in which LIBOR is determined. Uncertainty as
to the nature of such potential changes may adversely affect the market for LIBOR-based securities, including our potential portfolio of LIBOR-indexed,
floating-rate debt securities. In addition, any further changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged
increase or decrease in reported LIBOR, which could have an adverse impact on the market for LIBOR-based securities or the value of our potential
portfolio of LIBOR-indexed, floating-rate debt securities.
On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by
the end of 2021. It is expected that a transition away from the widespread use of LIBOR to
51
alternative rates will occur over the course of the next several years. As a result of this transition, interest rates on financial instruments tied to LIBOR
rates, as well as the revenue and expenses associated with those financial instruments, may be adversely affected. Further, any uncertainty regarding the
continued use and reliability of LIBOR as a benchmark interest rate could adversely affect the value of our financial instruments tied to LIBOR rates. The
U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions,
is considering replacing U.S. dollar LIBOR with a new index calculated by short term repurchase agreements, backed by Treasury securities, called the
Secured Overnight Financing Rate (“SOFR”). The first publication of SOFR was released in April 2018. Whether or not SOFR attains market traction as a
LIBOR replacement remains a question and the future of LIBOR at this time is uncertain.
Additionally, on July 12, 2019 the Staff of the SEC’s Division of Corporate Finance, Division of Investment Management, Division of Trading and
Markets, and Office of the Chief Accountant issued a statement about the potentially significant effects on financial markets and market participants when
LIBOR is discontinued in 2021 and no longer available as a reference benchmark rate. The Staff encouraged all market participants to identify contracts
that reference LIBOR and begin transitions to alternative rates. On December 30, 2019, the SEC’s Chairman, Division of Corporate Finance and Office of
the Chief Accountant issued a statement to encourage audit committees in particular to understand management’s plans to identify and address the risks
associated with the elimination of LIBOR, and, specifically, the impact on accounting and financial reporting and any related issues associated with
financial products and contracts that reference LIBOR, as the risks associated with the discontinuation of LIBOR and transition to an alternative reference
rate will be exacerbated if the work is not completed in a timely manner.
The elimination of LIBOR or any other changes or reforms to the determination or supervision of LIBOR could have an adverse impact on the market for
or value of any LIBOR-linked securities, loans, and other financial obligations or extensions of credit held by or due to us, or on our overall financial
condition or results of operations. If LIBOR ceases to exist, we may need to renegotiate the credit agreements extending beyond 2021 with our portfolio
companies that utilize LIBOR as a factor in determining the interest rate to replace LIBOR with the new standard that is established.
Risks Related to Our Securities
There is a risk that stockholders may not receive distributions or that our distributions may not grow over time and a portion of our distributions may
be a return of capital.
We have made distributions on a quarterly basis to our stockholders out of assets legally available for distribution. We cannot assure stockholders
that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. Our
ability to pay distributions might be adversely affected by the impact of one or more of the risk factors described in this Annual Report on Form 10-K. Due
to the asset coverage test applicable to us under the 1940 Act as a BDC, we may be limited in our ability to make distributions. Our ability to make
distributions may also be affected by our ability to receive distributions from SBIC I LP, which is governed by SBA regulations.
When we make distributions, we will be required to determine the extent to which such distributions are paid out of current or accumulated
earnings and profits. Distributions in excess of current and accumulated earnings and profits will be treated as a non-taxable return of capital to the extent
of an investor’s basis in our stock and, assuming that an investor holds our stock as a capital asset, thereafter as a capital gain. A return of capital is a return
to stockholders of a portion of their original investment in us rather than income or capital gains.
The market price of our common stock may fluctuate significantly.
As with any stock, the market price of our common stock will fluctuate with market conditions and other factors. Our common stock is intended
for long-term investors and should not be treated as a trading vehicle. Shares of BDCs frequently trade at a discount from their net asset value. The market
price and liquidity of the market for shares of our common stock may be significantly affected by numerous factors, some of which are beyond our control
and may not be directly related to our operating performance. These factors include:
•
•
•
•
significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which is not necessarily
related to the operating performance of these companies;
exclusion of our common stock from certain market indices, such as the Russell 2000 Financial Services Index, which could reduce the ability of
certain investment funds to own our common stock and put short-term selling pressure on our common stock;
changes in regulatory policies or tax guidelines, particularly with respect to RICs, SBICs or BDCs;
loss of RIC or BDC status;
52
•
•
•
•
•
•
•
•
•
•
•
•
•
failure of SBIC I LP to maintain its status as an SBIC;
our origination activity, including the pace of, and competition for, new investment opportunities;
our ability to incur additional leverage pursuant to the SBCAA and the impact of such leverage on our net investment income and results of
operations;
changes or perceived changes in earnings or variations in operating results;
changes or perceived changes in the value of our portfolio of investments;
changes in accounting guidelines governing valuation of our investments;
any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;
the inability to secure additional debt or equity capital;
potential future sales of common stock or debt securities convertible into or exchangeable or exercisable for our common stock or the conversion
of such securities;
departure of OFS Advisor’s, OFSC’s or any of their affiliates’ key personnel;
operating performance of companies comparable to us;
general economic trends and other external factors; and
loss of a major funding source.
Sales of substantial amounts of our common stock in the public market may have an adverse effect on the market price of our common stock.
The shares of our common stock beneficially owned by our principal stockholders, including OFSAM, are generally available for resale, subject to
the provisions of Rule 144 promulgated under the Securities Act unless registered for sale under the Securities Act. We have entered into a registration
rights agreement granting OFSAM the right to require us to register its shares for resale. Sales of substantial amounts of our common stock, or the
availability of such common stock for sale, could adversely affect the prevailing market prices for our common stock. If this occurs and continues, it could
impair our ability to raise additional capital through the sale of securities should we desire to do so.
Certain provisions of the Delaware General Corporation Law and our certificate of incorporation and bylaws could deter takeover attempts and have
an adverse impact on the price of our common stock.
The Delaware General Corporation Law, our certificate of incorporation and our bylaws contain provisions that may have the effect of
discouraging a third party from making an acquisition proposal for us. We have also adopted measures that may make it difficult for a third party to obtain
control of us, including provisions of our certificate of incorporation dividing our board of directors into three classes with the term of one class expiring at
each annual meeting of stockholders. These anti-takeover provisions may inhibit a change in control in circumstances that could give the holders of our
common stock the opportunity to realize a premium over the market price of our common stock.
Our common stock may trade below its net asset value per share, which limits our ability to raise additional equity capital.
If our common stock is trading below its net asset value per share, we will generally not be able to issue additional shares of our common stock at
its market price without first obtaining the approval for such issuance from our stockholders and our independent directors. Shares of BDCs, including
shares of our common stock, have traded at discounts to their net asset values. As of December 31, 2019, our net asset value per share was $12.46. The
daily average closing price of our shares on the Nasdaq Global Select Market for the year ended December 31, 2019 was $11.74. If our common stock
trades below net asset value, the higher the cost of equity capital may result in it being unattractive to raise new equity, which may limit our ability to grow.
The risk of trading below net asset value is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether
shares of our common stock will trade above, at or below our net asset value.
Our Unsecured Notes are effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future and will rank pari
passu with, or equal to, all outstanding and future unsecured, unsubordinated indebtedness issued by us and our general liabilities.
Our Unsecured Notes are not secured by any of our assets or any of the assets of any of our subsidiaries. As a result, the Unsecured Notes are
effectively subordinated to any secured indebtedness we or our subsidiaries have outstanding (including the PWB Credit Facility and the BNP Facility) or
that we or our subsidiaries may incur in the future (or any indebtedness that is
53
initially unsecured as to which we subsequently grant a security interest) to the extent of the value of the assets securing such indebtedness. In any
liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our secured indebtedness or secured indebtedness of our subsidiaries
may assert rights against the assets pledged to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used
to pay other creditors, including the holders of the Unsecured Notes.
The Unsecured Notes are structurally subordinated to the indebtedness and other liabilities of our subsidiaries.
The Unsecured Notes are obligations exclusively of OFS Capital Corporation, and not of any of our subsidiaries. None of our subsidiaries are a
guarantor of the Unsecured Notes, and the Unsecured Notes will not be required to be guaranteed by any subsidiary we may acquire or create in the future.
Any assets of our subsidiaries will not be directly available to satisfy the claims of our creditors, including holders of the Unsecured Notes. Except to the
extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors of our subsidiaries will have priority over our equity
interests in such entities (and therefore the claims of our creditors, including holders of the Unsecured Notes) with respect to the assets of such entities.
Even if we are recognized as a creditor of one or more of these entities, our claims would still be effectively subordinated to any security interests in the
assets of any such entity and to any indebtedness or other liabilities of any such entity senior to our claims. Consequently, the Unsecured Notes will be
structurally subordinated to all indebtedness and other liabilities, including trade payables, of any of our existing or future subsidiaries, including SBIC I
LP and OFSCC-FS. Certain of these entities currently serve as guarantors under the PWB Credit Facility or the BNP Facility, and in the future our
subsidiaries may incur substantial additional indebtedness, all of which is and would be structurally senior to the Unsecured Notes.
The indenture under which the Unsecured Notes were issued contains limited protection for holders of the Unsecured Notes.
The indenture under which the Unsecured Notes were issued offers limited protection to holders of the Unsecured Notes. The terms of the indenture
and the Unsecured Notes do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions,
circumstances or events that could have a material adverse impact on your investment in the Unsecured Notes. In particular, the terms of the indenture and
the Unsecured Notes will not place any restrictions on our or our subsidiaries’ ability to:
•
•
•
•
issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be
equal in right of payment to the Unsecured Notes, (2) any indebtedness or other obligations that would be secured and therefore rank effectively
senior in right of payment to the Unsecured Notes to the extent of the values of the assets securing such debt, (3) indebtedness of ours that is
guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the Unsecured Notes and (4) securities, indebtedness
or obligations issued or incurred by our subsidiaries that would be senior to our equity interests in those entities and therefore rank structurally
senior to the Unsecured Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other
obligation that would cause a violation of Section 18(a)(1)(A) as modified by such provisions of Section 61(a) of the 1940 Act as may be
applicable to us from time to time or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but
giving effect, in each case, to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from making
additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as
defined in the 1940 Act, equals at least 200% (or 150% on and after May 3, 2019) after such borrowings.
pay dividends on, or purchase or redeem or make any payments in respect of, capital stock or other securities ranking junior in right of payment
to the Unsecured Notes, including subordinated indebtedness, in each case other than dividends, purchases, redemptions or payments that would
cause our asset coverage to fall below the threshold specified in Section 18(a)(1)(B) as modified by such provisions of Section 61(a) of the 1940
Act as may be applicable to us from time to time or any successor provisions, giving effect to (i) any exemptive relief granted to us by the SEC
and (ii) no-action relief granted by the SEC to another BDC (or to us if we determine to seek such similar no-action or other relief) permitting the
BDC to declare any cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by such
provisions of Section 61(a) of the 1940 Act as may be applicable to us from time to time in order to maintain the BDC’s status as a RIC under
Subchapter M of the Code. These provisions generally prohibit us from declaring any cash dividend or distribution upon any class of our capital
stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, is below 200% (or 150% on and after May 3, 2019)
at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or
purchase;
sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or substantially all of our assets);
enter into transactions with affiliates;
54
•
•
•
create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions;
make investments; or
create restrictions on the payment of dividends or other amounts to us from our subsidiaries.
In addition, the indenture does not require us to make an offer to purchase the Unsecured Notes in connection with a change of control or any other
event.
Furthermore, the terms of the indenture and the Unsecured Notes do not protect holders of the Unsecured Notes in the event that we experience
changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, if any, as they do not require that we or
our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income, cash flow, or liquidity.
Our ability to recapitalize, incur additional debt (including additional debt that matures prior to the maturity of the Unsecured Notes), and take a
number of other actions that are not limited by the terms of the Unsecured Notes may have important consequences for you as a holder of the Unsecured
Notes, including making it more difficult for us to satisfy our obligations with respect to the Unsecured Notes or negatively affecting the trading value of
the Unsecured Notes.
Other debt we issue or incur in the future could contain more protections for its holders than the indenture and the Unsecured Notes, including
additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for, trading
levels, and prices of the Unsecured Notes.
We may choose to redeem the Unsecured Notes when prevailing interest rates are relatively low.
On or after April 30, 2020 for the Unsecured Notes Due April 2025, October 31, 2020 for the Unsecured Notes Due October 2025 or October 31, 2021
for the Unsecured Notes Due October 2026, we may choose to redeem the Unsecured Notes from time to time, especially if prevailing interest rates are
lower than the rate borne by the Unsecured Notes. If prevailing rates are lower at the time of redemption, and we redeem the Unsecured Notes, you likely
would not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as the interest rate on the Unsecured
Notes being redeemed. Our redemption right also may adversely impact your ability to sell the Unsecured Notes as the optional redemption date or period
approaches.
Item 1B.
Unresolved Staff Comments
Not applicable.
Item 2.
Properties
We do not own or lease any real estate or other physical properties material to our operation. Our headquarters are located at 10 S. Wacker Drive,
Suite 2500, Chicago, IL, 60606, and are provided by OFS Services pursuant to the Administration Agreement. Additional operations are conducted from
offices in New York, New York and Los Angeles, California, which are also provided by OFS Services pursuant to the Administration Agreement. We
believe that our office facilities are suitable and adequate for our business as we contemplate continuing to conduct it.
Item 3.
Legal Proceedings
We, OFS Advisor and OFS Services, are not currently subject to any material pending legal proceedings threatened against us as of December 31,
2019. From time to time, we may be a party to certain legal proceedings incidental to the normal course of our business including the enforcement of our
rights under contracts with our portfolio companies. Furthermore, third parties may try to seek to impose liability on us in connection with the activities of
our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will
have a material effect upon our business, financial condition, results of operations or cash flows.
Item 4.
Mine Safety Disclosures
Not applicable.
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PART II
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock and Holders
Our common stock is traded on the Nasdaq Global Select Market under the symbol "OFS". The last reported sale price for our common stock on
the Nasdaq Global Select Market on March 6, 2020 was $10.04 per share. As of March 6, 2020, there were two holders of record of the common stock, one
of which was OFSAM. The other holder of record does not identify stockholders for whom shares are held beneficially in “nominee” or “street name.”
The following table lists the high and low closing sale price for our common stock, net asset value per share, and the cash distributions per share
that we have declared on our common stock for each fiscal quarter during the last two most recently completed fiscal years and the current fiscal year
through March 8, 2020. The stock quotations are inter-dealer quotations and do not include markups, markdowns or commissions.
Period
Fiscal 2020
First Quarter(3)
Fiscal 2019
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
Fiscal 2018
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
NAV Per
Share(1)
Price Range
High
Low
Premium (Discount) of
High Sales Price to NAV
Premium (Discount) of
Low Sales Price to NAV
Cash
Distribution per
Share(2)
*
$11.97
$10.04
*
*
$
0.34
$
$
$
$
$
$
$
$
12.46 $
12.01 $
10.99
12.74 $
12.27 $
10.98
12.95 $
12.80 $
11.85
13.04 $
12.52 $
10.77
13.10 $
11.95 $
9.89
13.75 $
12.70 $
11.48
13.70 $
12.20 $
10.65
13.68 $
12.50 $
10.98
-3.6 %
-3.7 %
-1.2 %
-4.0 %
-8.8 %
-7.6 %
-10.9 %
-8.6 %
-11.8 % $
-13.8 % $
-8.5 % $
-17.4 % $
-24.5 % $
-16.5 % $
-22.3 % $
-19.7 % $
0.34
0.34
0.34
0.34
0.34
0.34
0.34
0.71 (4)
(1) Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect the net asset value per share on the date
of the high and low sales prices. The net asset values shown are based on outstanding shares at the end of each period.
(2) The return of capital portion of these distributions for the years ended December 31, 2019 and 2018 were $-0- and $-0-, respectively.
(3) Period from January 1, 2020 through March 8, 2020.
(4) Includes a special dividend of $0.37 per share representing undistributed net long-term capital gains realized by the Company in 2017.
* Not determinable at the time of filing.
Issuer Purchases of Equity Securities
On May 22, 2018, the Board authorized us to initiate a stock repurchase program under which the we may acquire up to $10.0 million of its
outstanding common stock (the "Stock Repurchase Program"). Under the Stock Repurchase Program, we are authorized to repurchase shares in open-
market transactions, including through block purchases, depending on prevailing market conditions and other factors. The Stock Repurchase Program may
be extended, modified or discontinued at any time for any reason. We expect the Stock Repurchase Program to be in place through May 22, 2020, or until
the approved dollar amount has been used to repurchase shares. The Stock Repurchase Program does not obligate us to acquire any specific number of
shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of
stock repurchases.
56
The following table summarizes the shares of common stock that we repurchased under the Stock Repurchase Program during the years ended
December 31, 2019 and 2018 (amount in thousands except shares).
Period
May 22, 2018 through December 31, 2018
January 1, 2019 through December 31, 2019
Total
Total Number of
Shares
Purchased
Average
Price Paid
Per Share
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
Maximum Number (or
Approximate Dollar
Value) of Shares (or
Units) That May Yet be
Purchased Under the
Plans or Programs
300 $
10.29
—
—
300 $
10.29
300 $
—
300 $
9,997
—
9,997
Sales of Unregistered Securities
There was $0.2 million of distributions reinvested during the year ended December 31, 2019 under the DRIP.
57
Stock Performance Graph
This graph compares the return on our common stock with that of the Standard & Poor’s 500 Stock Index, the Russell 1000 Index and the SNL
U.S. RICs Index, for the last five fiscal years. The graph assumes that, on December 31, 2014, a person invested $100 in our common stock, the
Standard & Poor’s 500 Stock Index, the Russell 1000 Index and the SNL U.S. RICs Index. The graph measures total stockholder return, which takes into
account changes in stock price and assumes reinvestment of all dividends and distributions prior to any tax effect.
December 31,
2014
December 31,
2015
December 31,
2016
December 31,
2017
December 31,
2018
December 31,
2019
OFS Capital Corporation
S&P 500
SNL U.S. RICs
Russell 1000
100.0
100.0
100.0
100.0
109.7
101.4
96.7
100.9
146.0
113.5
119.6
113.1
139.6
138.3
122.1
137.6
143.8
132.2
118.1
131.0
170.1
173.9
152.3
172.2
The graph and other information under the heading "Stock Performance Graph" in Part II Item 5 of this Annual Report on Form 10-K is "furnished" and
shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the
Exchange Act and shall not be deemed incorporated by reference in any filing under the Exchange Act. The stock price performance included in the above
graph is not necessarily indicative of future stock price performance.
58
Fees and Expenses
The following table is intended to assist you in understanding the costs and expenses that you will bear directly or indirectly. We caution you that the
percentages indicated in the table below are estimates and may vary. Except where the context suggests otherwise, whenever this Annual Report on Form
10-K contains a reference to fees or expenses paid by “us,” “the Company” or “OFS Capital,” or that “we” will pay fees or expenses, you will indirectly
bear such fees or expenses as an investor in OFS Capital.
Stockholder transaction expenses:
Sales load borne by us (as a percentage of offering price)
Offering expenses borne by us (as a percentage of offering price)
Dividend reinvestment plan fees (per sales transaction fee)
Total Stockholder transaction expenses (as a percentage of offering price)
Annual expenses (as a percentage of net assets attributable to common stock)(9):
Base management fees payable under the Investment Advisory Agreement
Incentive fees payable under the Investment Advisory Agreement
Interest payments on borrowed funds
Other expenses
Total annual expenses
Base management fee reduction
Total annual expenses, net of fee waiver
— % (1)
— % (1)
(2)
$15.00
— % (1)
5.38 % (3)
2.73 % (4)
10.91 % (5)
2.76 % (6)
21.78 %
(0.08)% (8)
21.70 % (7)
(1) The amounts set forth in this table do not reflect the impact of any sales load, sales commission or other offering expenses borne by the Company and
its stockholders. If applicable, the prospectus or prospectus supplement relating to an offering of our common stock will disclose the offering price and
the estimated offering expenses and total stockholder transaction expenses borne by the Company and its common stockholders as a percentage of the
offering price. In the event that shares of our common stock are sold to or through underwriters, the applicable prospectus or prospectus supplement
will also disclose the applicable sales load.
(2) The expenses of the dividend reinvestment plan are included in “other expenses.” The plan administrator’s fees will be paid by us. There will be no
brokerage charges or other charges to stockholders who participate in the plan except that, if a participant elects by written notice to the plan
administrator to have the plan administrator sell part or all of the shares held by the plan administrator in the participant’s account and remit the
proceeds to the participant, the plan administrator is authorized to deduct a $15.00 transaction fee plus a $0.10 per share brokerage commission from
the proceeds.
(3) Our base management fee is 1.75% of the average value of our total assets (other than cash and cash equivalents, and the intangible asset and goodwill
resulting from the SBIC Acquisitions; but including assets purchased with borrowed amounts, and including assets owned by any consolidated entity).
This item represents projected base management fees for the the next twelve month assuming no additional leverage is incurred. We increased our
leverage to a level below a 200% asset coverage ratio, as permitted under the SBCAA. As discussed in footnote (8), below, OFS Advisor agreed to
reduce a portion of its base management fee on certain assets associated with the increase in leverage; the base management fees of 5.38% presented in
the table above does not reflect the effect of the base management fee reduction on certain assets. See “Management and Other Agreements —
Investment Advisory Agreement”.
(4) The Part One incentive fee was estimated based on our projected results of operations for the next twelve months including the anticipated impact of
additional assets purchased with the added leverage discussed in footnote (5) and assumed yields thereon, and the effects of the expected base
management fee waiver discussed in footnote (3). The Part Two incentive fee will be accrued, but not necessarily become payable, if, on a cumulative
basis, the sum of net realized capital gains and losses plus net unrealized appreciation and depreciation is positive. Net realized gains and losses result
from sales transactions and no such transactions are currently contemplated by OFS Advisor; and unrealized capital gains or losses result from
fluctuations in the fair value of our investments, which vary substantially from period to period and cannot be reasonably predicted. Accordingly, the
Part Two fee in the table above is -0-%.
The two parts of the incentive fee follows:
•
The first ("Part One"), payable quarterly in arrears, equals 20.0% of our pre-incentive fee net investment income initially calculated based on
values at the closing of this offering (including income that is accrued but not yet received in cash), subject to a 2.0% quarterly (8.0% annualized)
hurdle rate and a “catch-up” provision measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, OFS Advisor
receives no incentive fee until our
59
pre-incentive fee net investment income equals the hurdle rate of 2.0% but then receives, as a “catch-up,” 100% of our pre-incentive fee net
investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than
2.5%. The effect of this provision is that, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, OFS Advisor will
receive 20.0% of our pre-incentive fee net investment income as if a hurdle rate did not apply.
The hurdle rate is fixed at 2.0% quarterly (8% annualized), which means that, if interest rates rise, it will be easier for our pre-incentive
fee net investment income to surpass the hurdle rate, which could lead to the payment of fees to OFS Advisor in an amount greater than expected.
There is no accumulation of amounts on the hurdle rate from quarter to quarter and accordingly there is no clawback of amounts previously paid if
subsequent quarters are below the quarterly hurdle rate and there is no delay of payment if prior quarters are below the quarterly hurdle rate.
•
The second part ("Part Two"), payable annually in arrears, equals 20.0% of our realized capital gains on a cumulative basis, if any (or upon the
termination of the Investment Advisory Agreement, as of the termination date), computed net of all realized capital losses and unrealized capital
depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees. The incentive fee is determined
on a consolidated basis. We accrue the Part Two incentive fee if, on a cumulative basis, the sum of net realized capital gains and losses plus net
unrealized appreciation and depreciation is positive. See “Management and Other Agreements — Investment Advisory Agreement.”
(5) The borrowing costs included in the table above are based on our December 31, 2019 balance sheet (which could be subject to change) at a level
equivalent to a debt-to-equity ratio of up to 2.16x (equivalent to $2.16 of debt outstanding for each $1 of equity) which is also equivalent to having an
asset coverage ratio of 180% (which excludes the SBA debentures as a result of exemptive relief granted to us by the SEC) as permitted under the
SBCAA, and assuming a weighted average interest rate for total outstanding debt of 5.06%.
We may borrow additional funds from time to time to make investments to the extent we determine that the economic situation is conducive to
doing so. We do not expect to issue any preferred stock during the next twelve months and, therefore, have not included the cost of issuing and
servicing preferred stock in the table. Availability under the PWB Credit Facility as of December 31, 2019, was $69.0 million based on the stated
advance rate of 50% under the borrowing base, and the $-0- million outstanding as of December 31, 2019. Our stockholders will bear directly or
indirectly the costs of borrowings under any debt instruments we may enter into.
(6) Includes our overhead expenses, including payments under the Administration Agreement based on our allocable portion of overhead and other
expenses incurred by OFS Services. See “Management and Other Agreements — Administration Agreement.”
(7) Our stockholders indirectly bear the expenses of underlying funds or other investment vehicles that would be investment companies under section 3(a)
of the 1940 Act but for the exceptions to that definition provided for in sections 3(c)(1) and 3(c)(7) of the 1940 Act (“Acquired Funds”) in which we
invest. We do not currently invest in underlying funds or other investment companies and therefore do not expect to incur any acquired fund fees and
expenses. The indirect expenses that will be associated with our Structured Finance Note investments are not included in the fee table
presentation, but if such expenses were included in the fee table presentation then our total annual expenses would have been 21.75%.
(8) OFS Advisor agreed to reduce a portion of its base management fee by reducing the portion of such fee from 1.75% to 1.00% on the average total
assets at the end of the two most recently completed quarters on assets held by the Company through OFSCC-FS, LLC, an indirect wholly owned
subsidiary of the Company. The base management fee reduction will be renewable on an annual basis and the amount of the base management fee
reduction with respect to the OFSCC-FS Assets shall not be subject to recoupment by OFS Advisor.
(9) Estimated.
Example
The following example demonstrates the projected dollar amount of total cumulative expenses over various periods with respect to a hypothetical
investment in our common stock. In calculating the following expense amounts, we have assumed we would have no additional leverage and that our
annual operating expenses would remain at the levels set forth in the table above. The expense amounts assume an annual base management fee 1.75% for
each year. Transaction expenses are not included in the following example.
While the example assumes, as required by the applicable rules of the SEC, a 5.0% annual return, our performance will vary and may result in a
return greater or less than 5.0%. The incentive fee under the Investment Management Agreement, which, assuming a 5.0% annual return, would either not
be payable or would have an
60
insignificant impact on the expense amounts shown above, is not included in the above example. The above illustration assumes that we will not realize
any capital gains (computed net of all realized capital losses and unrealized capital depreciation) in any of the indicated time periods. If we achieve
sufficient returns on our investments, including through the realization of capital gains, to trigger an incentive fee of a material amount, our expenses and
returns to our investors would be higher. For example, if we assumed that we received our 5.0% annual return completely in the form of net realized capital
gains on our investments, computed net of all cumulative unrealized depreciation on our investments, the projected dollar amount of total cumulative
expenses set forth in the above illustration would be as follows:
You would pay the following expenses on a $1,000 investment, assuming a 5.0% annual return
1 Year
$163
3 Years
5 Years
10 Years
$421
$610
$888
While the examples assume reinvestment of all distributions at net asset value, participants in our dividend reinvestment plan will receive a
number of shares of our common stock determined by dividing the total dollar amount of the distribution payable to a participant by the market price per
share of our common stock at the close of trading on the dividend payment date. The market price per share of our common stock may be at, above or
below net asset value.
The example should not be considered a representation of future expenses, and actual expenses may be greater or less than those shown.
61
SENIOR SECURITIES
Information about our senior securities (including preferred stock, debt securities and other indebtedness) is shown in the following tables for the years
ended December 31, 2019, 2018, 2017, 2016, 2015, 2014, 2013 and 2012. The senior securities table as of December 31, 2019 was audited by KPMG LLP
and the senior securities table as of December 31, 2018, 2017, 2016, 2015, 2014, 2013, and 2012 were audited by our former independent registered public
accounting firm. Information as of December 31, 2013 and 2012 was audited by our previous independent registered public accounting firm. The “ — ”
indicates information that the SEC expressly does not require to be disclosed for certain types of senior securities. The reports of our current and former
independent registered public accounting firms on the senior securities table are attached as an exhibit to this Annual Report.
(dollar amounts in thousands, except per unit data)
Class and Year
BNP Facility
December 31, 2019
5.95% Notes due 2026
December 31, 2019
6.50% Notes due 2025
December 31, 2019
December 31, 2018
6.375% Notes due 2025
December 31, 2019
December 31, 2018
PWB Credit Facility
December 31, 2019
December 31, 2018
December 31, 2017
December 31, 2016
December 31, 2015
WM Credit Facility(6)
December 31, 2014
December 31, 2013
December 31, 2012
SBA debentures (SBIC I LP)(5)
December 31, 2019
December 31, 2018
December 31, 2017
December 31, 2016
December 31, 2015
December 31, 2014
December 31, 2013
December 31, 2012
Total Amount
Outstanding
Excluding Treasury
Securities(1)
Asset Coverage Per
Unit (2)
Involuntary
Liquidating
Preference Per
Unit (3)
Average Market
Value Per Unit (4)
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
56,450 $
6,659
—
N/A
54,325 $
6,920
—
24.75
7,747
5,817
7,519
5,645
—
23,521
11,540
15,821
—
2,847
2,256
2,429
—
—
—
—
—
—
—
—
48,525 $
48,525 $
50,000 $
50,000 $
— $
12,000 $
17,600 $
9,500 $
— $
72,612 $
108,955 $
99,224 $
149,880 $
149,880 $
149,880 $
149,880 $
149,880 $
127,295 $
26,000 $
— $
62
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
25.29
24.43
25.30
24.84
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
(dollar amounts in thousands, except per unit data)
Class and Year
Total Senior Securities(7)
December 31, 2019
December 31, 2018
December 31, 2017
December 31, 2016
December 31, 2015
December 31, 2014
December 31, 2013
December 31, 2012
Total Amount
Outstanding
Excluding Treasury
Securities(1)
Asset Coverage Per
Unit (2)
Involuntary
Liquidating
Preference Per
Unit (3)
Average Market
Value Per Unit (4)
$
$
$
$
$
$
$
$
359,180 $
260,405 $
167,480 $
159,380 $
149,880 $
199,907 $
134,955 $
99,224 $
1,796
2,554
11,540
15,821
—
2,847
2,256
2,429
—
—
—
—
—
—
—
—
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
(1) Total amount of each class of senior securities outstanding at the end of the period presented.
(2) The asset coverage ratio for a class of senior securities representing indebtedness is calculated as our consolidated total assets, less all liabilities and
indebtedness not represented by senior securities, divided by the class of senior securities representing indebtedness. This asset coverage ratio is
multiplied by $1,000 to determine the “Asset Coverage Per Unit.”
(3) The amount to which such class of senior security would be entitled upon the involuntary liquidation of the issuer in preference to any security junior
to it. The “ — ” indicates information which the SEC expressly does not require to be disclosed for certain types of senior securities.
(4) Average market value per unit for our unsecured notes represents the average of the daily closing prices as reported on the Nasdaq Market during the
period presented. Not applicable to our PWB Credit Facility, BNP Facility, WM Credit Facility or SBA debentures because these senior securities are
not registered for public trading.
(5) The SBA debentures are not subject to the asset coverage requirements of the 1940 Act as a result of exemptive relief granted to us by the SEC.
(6) The secured revolving line of credit with Wells Fargo Bank, N.A., as lender and OFS Capital WM, LLC, a previous wholly owned investment
company subsidiary of the Company, as borrower (the "WM Credit Facility") was terminated on May 25, 2015.
(7) The Asset Coverage Per Unit does not include the SBA debentures as described in footnote 5 above.
63
Item 6.
Selected Consolidated Financial Data
The following selected financial and other data should be read in conjunction with our consolidated financial statements and notes thereto and
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included in this Annual Report on Form 10-K
(amounts in thousands, except per share data and number of portfolio companies at period end):
Statement of Operations Data:
Investment income
Interest income
PIK interest income
Dividend income
Preferred equity PIK dividend income
Fee income
Total investment income
Expenses
Management fees
Incentive fees, net of waiver
Other expenses
Total expenses, net
Net investment income
Net realized gain (loss) on investments
Net unrealized appreciation (depreciation) on investments
Net increase in net assets resulting from operations
Per share data:
Net asset value
Net investment income
Net realized gain (loss) on investments
Net unrealized appreciation (depreciation) on investments
Net increase in net assets resulting from operations
Distributions declared (1)
Total return based on market value (7)
Balance sheet data at period end:
Investments, at fair value
Cash and cash equivalents
Other assets
Total assets
Debt
Total liabilities
Total net assets
Other data (unaudited):
For the Years Ended December 31,
2019
2018
2017
2016
2015
$
48,902
$
38,607
$
28,124
$
26,400
$
27,764
1,508
482
1,399
1,913
1,194
475
1,433
1,592
1,206
245
1,116
1,933
33,426
31,094
32,264
926
502
899
1,292
52,521
8,271
4,760
20,439
33,470
19,098
(3,900)
(5,645)
9,553
12.46
1.43
(0.29)
(0.42)
0.71
$
1,193
315
906
1,813
42,834
6,335
4,387
13,727
24,449
18,385
(4,779)
(4,034)
9,572
13.10
1.38
(0.36)
(0.30)
0.72
$
4,999
2,962
9,588
17,549
15,877
6,833
(14,800)
7,910
4,516
3,333
9,100
16,949
14,145
2,404
(2,721)
13,828
$
14.12
$
14.82
$
1.28
0.55
(1.19)
0.64
1.46
0.25
(0.29)
1.43
1.36
32.3%
1.36
18.3%
1.73
3.5%
1.36
(4.7)%
$
516,931
$
396,797
$
277,499
$
281,627
$
13,447
7,810
538,188
352,478
371,561
166,627
38,172
6,452
441,421
254,826
266,398
175,023
72,952
7,327
357,778
164,823
169,442
188,336
17,659
5,744
305,030
156,343
161,252
143,778
5,225
2,627
11,001
18,853
13,411
(1,562)
6,382
18,231
14.76
1.39
(0.17)
0.66
1.89
1.36
9.0%
257,296
32,714
4,666 (2)
294,676 (2)
146,460 (2)
151,664 (2)
143,012
Weighted average yield on performing debt and Structured Finance Note investments (3) (6)
Weighted average yield on total debt and Structured Finance Note investments (4) (6)
Weighted average yield on total investments (5) (6)
Number of portfolio companies at end of year
10.40%
9.94%
9.59%
85
11.50%
11.12%
10.49%
50
12.11 %
11.59 %
10.35 %
37
12.08%
11.72%
10.88%
41
11.89%
11.84%
10.79%
39
(1) The return of capital portion of these distributions for the years ended December 31, 2019, 2018, 2017, 2016, and 2015, was $0, $0, $0, $0.09, and
$0.23, respectively.
(2) On January 1, 2016, we adopted ASU 2015-03 which requires that debt issuance costs related to a recognized debt liability to be presented on the
balance sheet as a direct deduction from the carrying amount of the debt liability rather than as an asset. Adoption of ASU 2015-03 requires the
changes to be applied retrospectively.
64
(3) The weighted average yield on our performing debt and Structured Finance Note investments is computed as (a) the sum of (i) the annual stated
accruing interest on our debt investments plus the annualized accretion of Net Loan Fees; and (ii) the annual effective yield on Structured Finance
Notes divided by (b) amortized cost of our debt and Structured Finance Note investments, excluding debt investments in non-accrual status as of the
balance sheet date.
(4) The weighted average yield on our total debt and Structured Finance Note investments is computed as (a) the sum of (i) the annual stated accruing
interest on our debt investments plus the annualized accretion of Net Loan Fees and (ii) plus the annual effective yield on Structured Finance Notes
divided by (b) amortized cost of our debt and Structured Finance Note investments, including debt investments in non-accrual status as of the balance
sheet date.
(5) The weighted average yield on total investments is computed as (a) the sum of (i) the annual stated accruing interest on our debt investments plus the
annualized accretion of Net Loan Fees, (ii) the effective yield on our performing preferred equity investments, and (iii) the annual effective yield on
Structured Finance Notes, divided by (b) amortized cost of our total investment portfolio, including debt investments in non-accrual status as of the
balance sheet date.
(6) The weighted average yield of our investments is not the same as a return on investment for our stockholders but, rather, the gross investment income
from our investment portfolio before the payment of all of our fees and expenses. There can be no assurance that the weighted average yield will
remain at its current level.
(7) Calculation is ending market value less beginning market value, adjusting for distributions reinvested at prices based on the Company’s dividend
reinvestment plan for the respective distributions.
65
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking
statements are not historical facts, but rather are based on current expectations, estimates and projections about us, our current and prospective portfolio
investments, our industry, our beliefs, and our assumptions. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,”
“would,” “should,” “targets,” “projects,” and variations of these words and similar expressions are intended to identify forward-looking statements. These
statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and
difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements, including
without limitation:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
our ability and experience operating a BDC or an SBIC, or maintaining our tax treatment as a RIC under Subchapter M of the Code;
our dependence on key personnel;
our ability to maintain or develop referral relationships;
our ability to replicate historical results;
the ability of OFS Advisor to identify, invest in and monitor companies that meet our investment criteria;
actual and potential conflicts of interest with OFS Advisor and other affiliates of OFSAM;
constraint on investment due to access to material nonpublic information;
restrictions on our ability to enter into transactions with our affiliates;
our ability to comply with SBA regulations and requirements;
the use of borrowed money to finance a portion of our investments;
our ability to incur additional leverage pursuant to the SBCAA and the impact of such leverage on our net investment income and results of
operations;
competition for investment opportunities;
our plans to focus on lower-yielding, first lien senior secured loans to larger borrowers and the impact on our risk profile;
the percentage of investments that will bear interest on a floating rate or fixed rate basis;
the ability of SBIC I LP to make distributions enabling us to meet RIC requirements;
plans by SBIC I LP to repay its outstanding SBA debentures;
our ability to raise debt or equity capital as a BDC;
the timing, form and amount of any distributions from our portfolio companies;
the impact of a protracted decline in the liquidity of credit markets on our business;
the general economy and its impact on the industries in which we invest;
uncertain valuations of our portfolio investments; and
the effect of new or modified laws or regulations governing our operations.
Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could
prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. In light of these and other
uncertainties, the inclusion of a projection or forward-looking statement in this Annual Report on Form 10-K should not be regarded as a representation by
us that our plans and objectives will be achieved. These risks and uncertainties include, among others, those described or identified in “Item 1A. Risk
Factors” in this Annual Report on Form 10-K. You should not place undue reliance on these forward-looking statements, which apply only as of the date of
this Annual Report on Form 10-K.
We have based the forward-looking statements on information available to us on the date of this Annual Report on Form 10-K. Except as required
by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information,
future events or otherwise. You are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future
may file with the SEC,
66
including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. The forward-looking statements and
projections contained in this annual report on Form 10-K are excluded from the safe harbor protection provided by Section 21E of the Securities Exchange
Act.
The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial
statements and the related notes thereto contained elsewhere in this Annual Report on Form 10-K.
Critical Accounting Policies and Significant Estimates
The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and contingent assets and liabilities at the date of the financial statements, and
revenues and expenses during the periods reported. Actual results could materially differ from those estimates. Critical accounting policies are those that
require management to make subjective or complex judgments about the effect of matters that are inherently uncertain and may change in subsequent
periods. Changes that may be required in the underlying assumptions or estimates in these areas could have a material impact on our current and future
financial condition and results of operations.
Our critical accounting policies and estimates are those relating to revenue recognition and fair value estimates. Management has discussed the
development and selection of each critical accounting policy and estimate with the Audit Committee of the Board. For a descriptions of our revenue
recognition and fair value policies, see Note 2 to the consolidated financial statements included in "Item 8.–Financial Statements" of this report.
Revenue recognition
Our investment activities frequently involve the acquisition of multiple financial instruments or rights either in an initial transaction, or in
subsequent or "follow-on" transactions, including amendments to existing securities. These financial instruments can include loans, preferred and common
stock, Structured Finance Notes, warrants, or membership interests in limited liability companies. Acquired rights can include fixed or variable fees that
can be either guaranteed or contingent upon operating performance of the underlying portfolio companies. Moreover, these fees may be payable in cash or
additional securities. Acquired rights and financial instruments together, referred to as Instruments.
The revenue recognized on these instruments is a function of the fee or other consideration allocated to them, including amounts allocated to loan
syndication fees or capital structuring fees, at the time of acquisition. Additionally, subsequent amendments to these instruments can involve both:
•
a determination as to whether the amendment is
◦
◦
of such significance to deem it the consummation of the initial investment transaction and the acquisition of new Instruments (i.e., a
"significant modification"), or
a modification of those Instruments to be recognized over their remaining lives, and
•
an additional allocation of consideration among newly acquired Instruments.
These allocations are generally based on the relative fair value of the instruments at the time of the transaction, a process involving fair value
estimates which is also a critical accounting policy and significant estimate. Moreover, these allocations and determinations can differ between GAAP and
federal income tax bases. Once determined, these allocations directly affect the discount/premium and yield on debt securities, the cost and net gains/losses
on equity securities, and capital structuring fees recognized in the statements of operations; and ICTI. These allocations require an understanding of the
terms and conditions of the underlying agreements and requires significant management judgment.
Fair value estimates
As of December 31, 2019, total investments representing approximately 96% of our total assets were carried on the consolidated balance sheet at
fair value. As discussed more fully in “Item 8.–Financial Statements–Note 2” GAAP requires us to categorize fair value measurements according to a
three-level valuation hierarchy. The hierarchy gives the highest priority to quoted, active market prices for identical assets and liabilities (Level 1) and the
lowest priority to valuation techniques that require significant management judgment because one or more of the significant inputs are unobservable in the
market place (Level 3). All of our investments carried at fair value are classified as Level 2 and Level 3, with a significant portion of our investments
classified as Level 3. We typically do not hold equity securities or other instruments that are actively traded on an exchange.
As described in “Item 8.–Financial Statements–Note 5”, we follow a process, under the supervision and review of the Board, to determine these
unobservable inputs used to calculate the fair values of our investments. The most significant unobservable inputs in the Level 3 fair value measurements
are the discount rates, and EBITDA multiples. Investments classified as Level 2 are measured on the basis of NBIB provided by pricing services.
67
Our discounted cash flow valuations involve a determination of discount rate commensurate with the risk inherent in each investment.
Management uses two primary methods to estimate discount rates: a method based upon a hypothetical recapitalization of the entity given its current
operating performance and current market conditions; and a synthetic debt rating method, which assigns a surrogate debt rating to the entity based on
known industry standards for assigning such ratings and then estimates the discount rate based on observed market yields for actual rated debt.
Management may also use a relative value method to estimate yields, which involves measuring the discount rate of non-traded subject debt investments
based on an expected or assumed relationship between NBIB or observed prices on traded debt and the subject debt for a portfolio company. All methods
for estimating the discount rate generally involve calibration of unobservable inputs utilized in estimating the discount rate on the subject investment to its
internal rate of return at close or purchase date. These methods generally produce a range of discount rates, and we generally select the midpoint of the
range for use in fair value measures, subject to limitations on the basis of the borrowers' ability to prepay the debt without penalty.
Our market approach valuations, generally applied to equity investments and investments in non-performing debt, involve a determination of an
enterprise value multiple to a financial performance metric of the portfolio company, generally EBITDA. These determinations are based on identification
of a comparable set of publicly traded companies and determination of a public-to-private liquidity adjustment factor, generally through calibration to
transaction prices in the subject investment instrument. This method generally produces a range of multiplier values and management, under the
supervision of the Board, generally select the midpoint of the range for fair value measures.
The following table illustrates the impact of our fair value measures if we selected the low or high end of the range for all investments at
December 31, 2019 (dollar amounts in thousands):
Investment Type
Debt investments:
Senior Secured
Senior Secured (valued at Transaction Price)
Subordinated
Investments:
Structured Finance Notes
Equity investments:
Preferred equity
Common equity and warrants
Common equity and warrants (valued at Transaction Price)
Related Party Transactions
Fair Value at December
31, 2019
Range of Fair Value
Low-end
High-end
$
375,265 $
370,126 $
33,459
43,090
33,459
42,352
380,219
33,459
43,830
21,610
20,783
22,437
17,729
24,278
1,500
16,595
19,869
1,500
$
516,931 $
504,684 $
20,202
27,645
1,500
529,292
We have entered into a number of business relationships with affiliated or related parties, including the following:
•
•
•
The Investment Advisory Agreement with OFS Advisor to manage our operating and investment activities. Under the Investment Advisory
Agreement we have agreed to pay OFS Advisor an annual base management fee based on the average value of our total assets (other than
cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity) as
well as an incentive fee based on our investment performance. See “Item 1—Management and Other Agreements” and “Item 8–Financial
Statements and Supplementary Data–Note 3.”
The Administration Agreement with OFS Services, an affiliate of OFS Advisor, to provide us with the office facilities and administrative
services necessary to conduct our operations. See “Item 1–Management and Other Agreements” and “Item 8–Financial Statements and
Supplementary Data–Note 3.”
A license agreement with OFSAM, the parent company of OFS Advisor, under which OFSAM has agreed to grant us a non-exclusive,
royalty-free license to use the name “OFS.” Under this agreement, we have a right to use the “OFS” name for so long as OFS Advisor or one
of its affiliates remains our investment adviser. Other than with
68
respect to this limited license, we have no legal right to the “OFS” name. This license agreement will remain in effect for so long as the
Investment Advisory Agreement with OFS Advisor is in effect.
On June 11, 2019, OFS Advisor agreed to reduce a portion of its base management fee by reducing the portion of such fee from 0.4375% per
quarter (1.75% annualized) to 0.25% per quarter (1.00% annualized) of the OFSCC-FS Assets at the end of the two most recently completed calendar
quarters to the extent that such portion of the OFSCC-FS Assets are financed using leverage (also calculated on an average basis) that causes the
Company’s statutory asset coverage ratio to fall below 200%. When calculating its statutory asset coverage ratio, the Company excludes its SBA
guaranteed debentures from its total outstanding senior securities as permitted pursuant to exemptive relief granted by the SEC dated November 26, 2013.
Effective January 1, 2020, OFS Advisor agreed to further reduce the base management fee to 0.25% per quarter (1.00% annualized) of the average value of
the portion of total assets held by the Company through OFSCC-FS at the end of the two most recently completed calendar quarters without regard to the
statutory asset coverage ratio. The base management fee reduction by OFS Advisor is renewable on an annual basis and the amount of the base
management fee reduction with respect to the OFSCC-FS Assets shall not be subject to recoupment by OFS Advisor.
OFS Advisor’s services under the Investment Advisory Agreement are not exclusive to us and OFS Advisor is free to furnish similar services to
other entities, including other BDCs managed by OFS Advisor, so long as its services to us are not impaired. OFS Advisor also serves as the investment
adviser or collateral manager to CLOs and other assets, including HPCI and OCCI. Additionally, OFS Advisor provides sub-advisory services to CMFT
Securities Investments, LLC, a Delaware limited liability company which is a wholly owned subsidiary of CIM Real Estate Finance Trust, Inc., a Maryland
corporation that qualifies as a real estate investment trust. Additionally, OFS Advisor expects to provide sub-advisory services to CIM Real Assets & Credit
Fund, a newly organized externally managed registered investment company that intends to operate as an interval fund that expects to invest primarily in a
combination of real estate, credit and related investments.
BDCs generally are prohibited under the 1940 Act from knowingly participating in certain transactions with their affiliates without the prior
approval of their independent directors and, in some cases, of the SEC. Those transactions include purchases and sales, and so-called “joint” transactions,
in which a BDC and one or more of its affiliates engage in certain types of profit-making activities. Any person that owns, directly or indirectly, five
percent or more of a BDC’s outstanding voting securities will be considered an affiliate of the BDC for purposes of the 1940 Act, and a BDC generally is
prohibited from engaging in purchases from, sales of assets to, or joint transactions with, such affiliates, absent the prior approval of the BDC’s
independent directors. Additionally, without the approval of the SEC, a BDC is prohibited from engaging in purchases from, sales of assets to, or joint
transactions with, the BDC’s officers, directors, and employees, and advisor (and its control affiliates).
BDCs may, however, invest alongside certain related parties or their respective other clients in certain circumstances where doing so is consistent
with current law and SEC staff interpretations. For example, a BDC may invest alongside such accounts consistent with guidance promulgated by the SEC
staff permitting the BDC and such other accounts to purchase interests in a single class of privately placed securities so long as certain conditions are met,
including that the BDC’s advisor, acting on the BDC’s behalf and on behalf of other clients, negotiates no term other than price. Co-investment with such
other accounts is not permitted or appropriate under this guidance when there is an opportunity to invest in different securities of the same issuer or where
the different investments could be expected to result in a conflict between the BDC’s interests and those of other accounts.
The 1940 Act generally prohibits BDCs from making certain negotiated co-investments with certain affiliates absent an order from the SEC
permitting the BDC to do so. On October 12, 2016, we received the Order from the SEC to permit us to co-invest in portfolio companies with certain
BDCs, registered investment companies and private funds managed by OFS Advisor, or any adviser that controls, is controlled by, or is under common
control with, OFS Adviser and is registered as an investment adviser under the Investment Advisers Act of 1940, as amended, in a manner consistent with
our investment strategy as well as applicable law, including the terms and conditions of the Order. Pursuant to the Order, we are generally permitted to
participate in a co-investment transaction if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors makes certain
conclusions in connection with a co-investment transaction, including that (1) the terms of the transaction, including the consideration to be paid, are
reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the
transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies. We have applied for the New
Order, which, if granted, would supersede the Order and would permit us greater flexibility to enter into co-investment transactions. There can be no
assurance that we will obtain such new exemptive relief from the SEC.
Conflicts may arise when we make an investment in conjunction with an investment being made by an Affiliated Account, or in a transaction
where an Affiliated Account has already made an investment. Investment opportunities are, from time to time, appropriate for more than one account in the
same, different or overlapping securities of a portfolio company’s capital structure. Conflicts arise in determining the terms of investments, particularly
where these accounts may invest in different types of securities in a single portfolio company. Questions arise as to whether payment obligations and
covenants
69
should be enforced, modified or waived, or whether debt should be restructured, modified or refinanced. See "Item 1A. Business — Conflicts of Interest",
"Item 1A. Risk Factors — Risks Related to OFS Advisor and its Affiliates —We have potential conflicts of interest related to the purchases and sales that
OFS Advisor makes on our behalf and/or on behalf of Affiliated Accounts" and ""Item 1A. Risk Factors — Regulations — Conflicts of Interest - Conflicts
Related to Portfolio Investments."
Portfolio Composition and Investment Activity
Our portfolio consists of investments in the debt and equity securities of portfolio companies, as well as indirect investments in such securities
through investment in other investment companies including CLO structured finance notes.
Portfolio Composition
As of December 31, 2019, the fair value of our debt investment portfolio totaled $451.8 million in 79 portfolio companies, of which 90% and 10%
were senior secured loans and subordinated loans, respectively, and approximately $43.5 million in equity investments, at fair value, in 15 portfolio
companies in which we also held debt investments. We also have six portfolio companies in which we solely held an equity investment, as well as four
investments in Structured Finance Notes with a fair value of $21.6 million. We had unfunded commitments of $4.8 million to four portfolio companies at
December 31, 2019. Set forth in the tables and charts below is selected information with respect to our portfolio as of December 31, 2019 and 2018.
The following table summarizes the composition of our Direct Investments as of December 31, 2019 and 2018 (dollar amounts in thousands):
Senior secured debt investments (1)
Subordinated debt investments
Preferred equity
Common equity and warrants
Total
Total number of portfolio companies
December 31, 2019
December 31, 2018
Amortized Cost
Fair Value
Amortized
Cost
Fair Value
$
421,970 $
408,724 $
325,873 $
319,017
56,731
21,925
14,919
43,091
17,729
25,777
56,212
19,620
11,606
44,540
14,613
18,627
$
515,545 $
495,321 $
413,311 $
396,797
85
85
50
50
(1) Includes debt investments in which we have entered into a contractual arrangement with co‑lenders whereby, subject to certain conditions, we have
agreed to receive our principal payments after the repayment of certain co-lenders pursuant to a payment waterfall. The aggregate amortized cost and
fair value of these investments was $65,300 and $65,337 at December 31, 2019, respectively, and $68,207 and $67,480, at December 31, 2018,
respectively.
As of December 31, 2019, our investment portfolio’s three largest industry groups by fair value, were (1) Health Care and Social Assistance
(14.8%), (2) Manufacturing (15.8%), and (3) Information (11.4%), totaling approximately 41.9% of the investment portfolio. For a full summary of our
investment portfolio by industry, see "Note 4, Investments" to the consolidated financial statements included in "Part II, Item 8. Financial Statements and
Supplementary Data" of this report.
The following table presents our investment portfolio by each wholly owned legal entity within the consolidated group as of December 31, 2019
and 2018 (in thousands):
December 31, 2019
December 31, 2018
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
OFS Capital Corporation (Parent)
$
181,980 $
169,230 $
185,999 $
256,858
246,371
221,559
88,458
11,375
88,936
12,394
—
5,753
178,772
212,675
—
5,350
$
538,671 $
516,931 $
413,311 $
396,797
70
SBIC LP
OFSCC-FS
OFSCC-MB
Total investments
The following table presents our debt investment portfolio by investment size as of December 31, 2019 and 2018 (dollar amounts in thousands):
Amortized Cost
Fair Value
December 31, 2019
December 31, 2018
December 31, 2019
December 31, 2018
Up to $4,000
$
$4,001 to $7,000
$7,001 to $10,000
$10,001 to $13,000
77,809
71,558
95,567
54,273
Greater than $13,000
179,494
16.3% $
14.9
20.0
11.3
37.5
24,785
66,756
92,389
44,527
153,628
6.4% $
17.5
24.2
11.7
40.2
75,033
68,806
77,978
53,903
176,095
16.6% $
15.2
17.3
11.9
39.0
25,117
60,151
92,687
34,032
151,570
6.9%
16.5
25.5
9.4
41.7
Total
$
478,701
100.0% $
382,085
100.0% $
451,815
100.0% $
363,557
100.0%
The following table displays the composition of our performing debt investment and Structured Finance Note portfolio by weighted average yield
as of December 31, 2019 and 2018:
Weighted Average Yield -
Performing Debt
Investments (1)
Less than 8%
8% – 10%
10% – 12%
12% – 14%
Greater than 14%
Total
Weighted average yield –
performing debt and
Structured Finance Note
investments (1)
Weighted average yield – total
debt and Structured Finance
Note investments (2)
December 31,
2019
Subordinated
Debt
Structured
Finance Notes
Total
Senior
Secured
Debt
2018
Subordinated
Debt
—%
—
8.6
38.3
53.1
—%
—
—
25.1
74.9
17.3%
0.7%
18.5
42.7
12.0
9.5
22.5
42.9
29.5
4.4
—%
—
26.9
56.5
16.6
Senior
Secured
Debt
20.1%
21.5
48.8
8.4
1.2
Total
0.7%
19.8
41.0
32.7
5.8
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
9.80%
13.52%
15.13%
10.40%
11.33%
12.74%
11.50%
9.57%
10.57%
15.13%
9.94%
11.33%
9.93%
11.12%
(1) The weighted average yield on our performing debt and Structured Finance Note investments is computed as (a) the sum of (i) the annual stated
accruing interest on debt investments plus the annualized accretion of Net Loan Fees; and (ii) the annual effective yield on Structured Finance Notes
divided by (b) the sum of the amortized cost of our debt and Structured Finance Note investments, in each case, excluding debt investments in non-
accrual status as of the balance sheet date.
(2) The weighted average yield on our total debt and Structured Finance Note investments is computed as (a) the sum of (i) the annual stated accruing
interest on debt investments plus the annualized accretion of Net Loan Fees and (ii) plus the annual effective yield on Structured Finance Notes divided
by (b) the sum of the amortized cost of our debt and Structured Finance Note investments, in each case, including debt investments in non-accrual
status as of the balance sheet date.
The weighted average yield on total investments was 9.59% and 10.49%, at December 31, 2019 and 2018, respectively. Weighted average yield on
total investments is computed as (a) the sum of (i) the annual stated accruing interest on our debt investments at the balance sheet date, plus the annualized
accretion of Net Loan Fees, (ii) plus the annual effective yield on Structured Finance Notes, (iii) plus the effective yield on our performing preferred equity
investments, divided by (b) the sum of the amortized cost of our total investment portfolio, in each case, including assets in non-accrual status as of the
balance sheet date. The weighted average yield of our investments is not the same as a return on investment for our stockholders but, rather, the gross
investment income from our investment portfolio before the payment of all of our fees and expenses. There can be no assurance that the weighted average
yield will remain at its current level.
The weighted average yield on our performing debt and Structured Finance Notes decreased from 11.5% at December 31, 2018 to 10.40% at
December 31, 2019, primarily due to the deployment of $196.2 million in new originations with a weighted average yield of 9.3% during the year ended
December 31, 2019, as well as a decrease in three-month LIBOR of 0.83% from December 31, 2018 to December 31, 2019.
71
As of December 31, 2019 and 2018, floating rate loans at fair value were 93% and 87% of our debt investment portfolio, respectively, and fixed
rate loans at fair value were 7% and 13% of our debt investment portfolio, respectively.
Non-Accrual Loans
At December 31, 2019, we had four loans (Community Intervention Services, Inc., Master Cutlery, LLC, Southern Technical Institute, LLC and
Constellis Holdings, LLC) on non-accrual status with respect to all interest and Net Loan Fee amortization, with an aggregate amortized cost and fair value
of $22.2 million and $0.7 million, respectively. The change to non-accrual status for our investment in Constellis Holdings, LLC was effective November
1, 2019.
At December 31, 2018, we had three loans (Community Intervention Services, Inc., Master Cutlery, LLC and Southern Technical Institute, LLC)
on non-accrual status with respect to all interest and unamortized Net Loan Fees with an aggregate amortized cost and fair value of $12.4 million and $0.9
million, respectively. See "Item 8.–Financial Statements–Note 4" for further information.
PIK and Cash Dividend Accruals
Payment-in-kind dividends on preferred equity securities are recognized at fair value when earned. However, at December 31, 2019, we owned
four preferred equity securities (Master Cutlery, LLC, Stancor, L.P., My Alarm Center, LLC and TRS Services, LLC), with an aggregate amortized cost and
fair value of $9.9 million and $5.7 million, respectively, for which, notwithstanding the fair value of the preferred equity securities, the fair value of those
securities most-recent PIK dividend as of December 31, 2019, was recognized at $-0-. At December 31, 2018, we owned four preferred equity securities
(Master Cutlery, LLC, Stancor, L.P., Southern Technical Institute, LLC and TRS Services, LLC), with an aggregate amortized cost and fair value
of $9.9 million and $3.8 million, respectively, for which the fair value of the most-recently recognized PIK dividend as of December 31, 2018, was $0. In
addition, beginning June 30, 2017, the Company discontinued recognition of the cash preferred dividend from its investment in Master Cutlery, LLC.
Investment Activity
The following is a summary of our Direct Investment cash investment activity for the years ended December 31, 2019 and 2018 (dollar amounts in
millions):
Year Ended December 31, 2019
Year Ended December 31, 2018
Debt
Investments
Equity
Investments
Debt
Investments
Equity
Investments
Investments in new portfolio companies
Investments in existing portfolio companies:
Follow-on investments
Delayed draw funding
Total investments in existing portfolio companies
Total investments in new and existing portfolio companies
Number of new portfolio company investments
Number of existing portfolio company investments
Proceeds/distributions from principal payments/equity
investments
Proceeds from investments sold or redeemed
Total proceeds from principal payments, equity distributions
and investments sold
$
$
$
$
141.6
$
5.6 $
196.4 $
42.0
9.6
51.6
193.2
$
45
29
60.9 $
34.8
95.7 $
—
—
—
5.6 $
3
—
— $
0.2
0.2 $
63.6
6.2
69.8
266.2 $
28
20
100.7 $
39.1
139.8 $
4.7
1.3
—
1.3
6.0
4
4
—
8.3
8.3
We also invested $23.4 million in Structure Finance Notes with a weighted average annual effective yield of 15.1% during the year ended
December 31, 2019.
Notable investments in new portfolio companies during the year ended December 31, 2019 include Chemical Resources Holdings, Inc. ($13.6
million senior secured loan and $1.8 million in common equity), TTG Healthcare, LLC ($11.9 million senior secured loan and $2.3 million preferred
equity), TalentSmart Holdings, LLC ($9.8 million senior secured loan and $1.5 million common equity), as well as $11.5 million and $10.1 million senior
secured loans in Milrose Consultants, LLC and SSJA Bariatric, respectively.
72
The weighted-average yield of direct debt investments in new portfolio companies during the year ended December 31, 2019 was 8.5%.
Non-cash Investment Activity
On January 31, 2019, Maverick Healthcare Equity, LLC was acquired by a third party in a purchase transaction. Proceeds from this transaction
were insufficient to redeem the class of equity held by the Company. Accordingly, we received $-0- proceeds and recognized a net loss of $0.1 million,
comprised of $0.9 million realized loss net of $(0.8) million unrealized loss reversal, for the year ended December 31, 2019.
In June 2018, our investment in Southern Technical Institute, LLC was restructured. We converted our subordinated note, SP-1 preferred shares,
and warrants for a $1.5 million subordinated loan and 1,764,720 shares of Class A-1 common units. Subsequent to the conversion, we sold our Class A-1
common units but retained a significant economic interest in the units. The cost and fair value of the subordinated loan and economic interest were $0 and
$0, respectively, as of December 31, 2018. We recognized a realized loss on the restructuring of Southern Technical Institute, LLC of $5.6 million for the
year ended December 31, 2018, of which $4.4 million was recognized as unrealized losses as of December 31, 2017.
Our level of investment activity may vary substantially from period to period depending on various factors, including, but not limited to, the
amount of debt and equity capital available to middle-market companies, the level of merger and acquisition activity, the general economic environment
and the competitive environment for the types of investments we make.
We categorize debt investments into seven risk categories based on relevant information about the ability of borrowers to service their debt. For
additional information regarding our risk categories, see “Item 1. Business—Portfolio Review/Risk Monitoring.” The following table shows the
classification of our debt investments portfolio by risk category as of December 31, 2019 and 2018 (dollar amounts in thousands):
Risk Category
1 (Low Risk)
2 (Below Average Risk)
3 (Average)
4 (Special Mention)
5 (Substandard)
6 (Doubtful)
7 (Loss)
As of December 31,
2019
2018
Debt
Investments, at
Fair Value
% of Debt
Investments
Debt
Investments, at
Fair Value
% of Debt
Investments
$
—
17,953
387,654
45,546
—
662
—
—% $
4.0
85.8
10.1
—
0.1
—
—
3,788
329,635
29,284
—
850
—
—%
1.0
90.7
8.1
—
0.2
—
$
451,815
100.0% $
363,557
100.0%
During the year ended December 31, 2019, we had a debt investment with a risk upgrade from risk category 3 to risk category 2 with a fair value
of $14.2 million at December 31, 2019. We also had a debt investment with a risk upgrade from risk category 4 to risk category 3 with a fair value of $14.6
million at December 31, 2019. We had debt investments with risk rating downgrades from risk category 3 to risk category 4 with an aggregate fair value of
$34.0 million for the year ended December 31, 2019. We also had a debt investment with risk rating downgrade from risk category 4 to risk category 6 with
a fair value of $0.4 million for the year ended December 31, 2019. All other year-over-year changes in the fair value of our debt investments within each
category, were a result of new debt investments, the receipt of amortization payments on existing debt investments, repayment of certain debt investments
in full, changes in the fair value of our existing debt investments within the categories, and other investment activity.
During the year ended December 31, 2018, we reclassified three debt investments (TRS Services, LLC, GGC Aerospace Topco L.P. and MTE
Holdings Corp.) from risk category 3 to risk category 4, with an aggregate fair value of $21.46 million at December 31, 2017, primarily due to declining
performance in the underlying businesses of the portfolio companies. We also reclassified our debt investment in Master Cutlery, LLC, with a fair value of
$2.87 million at December 31, 2017, from risk category 5 to risk category 6 and classified the investment as non-accrual with respect to PIK interest and
Net Loan Fees. All other year-over-year changes in the fair value of our debt investments within each category, were a result of new debt investments, the
receipt of amortization payments on existing debt investments, repayment of certain debt investments in full, changes in the fair value of our existing debt
investments within the categories, and other investment activity.
73
Results of Operations
Key Financial Measures
The following is a discussion of the key financial measures that management employs in reviewing the performance of our operations.
Total Investment Income. We generate revenue primarily in the form of interest income on debt investments and dividend income from our equity
investments. Our debt investments typically have a term of three to eight years and bear interest at fixed and floating rates. As of December 31, 2019,
floating rate and fixed rate loans comprised 93% and 7%, respectively, of our current debt investment portfolio at fair value; however, in accordance with
our investment strategy, we expect that over time the proportion of fixed rate loans will continue to increase. In some cases, our investments provide for
PIK interest, or PIK dividends (meaning interest or dividends paid in the form of additional principal amount of the loan or equity security instead of in
cash). We also generate revenue in the form of management, valuation, and other contractual fees, which are recognized as the related services are
rendered. In the general course of business, we receive certain fees from portfolio companies which are non-recurring in nature. Such non-recurring fees
include prepayment fees on certain loans repaid prior to their scheduled due date, which are recognized as earned when received, and loan syndication fees
from certain portfolio companies, which are recognized as earned upon closing of the investment. Net Loan Fees are capitalized, and accreted or amortized
over the life of the loan as interest income. When we receive principal payments on a loan in an amount that exceeds its amortized cost, we recognize the
excess principal payment as income in the period it is received.
Expenses. Our primary operating expenses include interest expense due under our outstanding borrowings, the payment of fees to OFS Advisor
under the Investment Advisory Agreement, our allocable portion of overhead expenses under the Administration Agreement and other operating costs
described below. Additionally, we will pay interest expense on any outstanding debt under any new credit facility or other debt instrument we may enter
into. We will bear all other out-of-pocket costs and expenses of our operations and transactions, whether incurred by us directly, OFS Services or its
affiliates, or on our behalf by a third party, including:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
the cost of calculating our net asset value, including the cost of any third-party valuation services;
the cost of effecting sales and repurchases of shares of our common stock and other securities;
fees payable to third parties relating to making investments, including out-of-pocket fees and expenses associated with performing due
diligence and reviews of prospective investments;
transfer agent and custodial fees;
out-of-pocket fees and expenses associated with marketing efforts;
federal and state registration fees and any stock exchange listing fees;
U.S. federal, state and local taxes;
independent directors’ fees and expenses;
brokerage commissions;
fidelity bond, directors’ and officers’ liability insurance and other insurance premiums;
direct costs, such as printing, mailing and long-distance telephone;
fees and expenses associated with independent audits and outside legal costs;
costs associated with our reporting and compliance obligations under the 1940 Act and other applicable U.S. federal and state securities laws;
and
other expenses incurred by either OFS Services or us in connection with administering our business.
Net Gain (Loss) on Investments. Net gain (loss) on investments consists of the sum of: (a) realized gains and losses from the sale of debt or equity
securities, or the redemption of equity securities; and (b) net unrealized appreciation or depreciation on debt and equity investments, net of applicable taxes
to the extent the investments are held through taxable wholly owned subsidiaries. In the period in which a realized gain or loss is recognized, such gain or
loss will generally be offset by the reversal of previously recognized unrealized appreciation or depreciation, and the net gain recognized in that period will
generally be smaller. The unrealized appreciation or depreciation on debt securities is also reversed when those investments are redeemed or paid off prior
to maturity. In such instances, the reversal of accumulated unrealized appreciation or depreciation will be reported as a net loss or gain, respectively, and
may be partially offset by the acceleration of any premium or discount on the debt security, which is reported in interest income, and any prepayment fees
on the debt security, which is reported in fee income.
74
We do not believe that our historical operating performance is necessarily indicative of our future results of operations that we expect to report in
future periods. We are primarily focused on investments in middle-market companies in the United States, including debt investments and, to a lesser
extent, equity investments, including warrants and other minority equity securities. Moreover, as a BDC and a RIC, we are also subject to certain
constraints on our operations, including, but not limited to, limitations imposed by the 1940 Act and the Code. In addition, SBIC I LP is subject to
regulation and oversight by they SBA. For the reasons described above, the results of operations described below may not necessarily be indicative of the
results we expect to report in future periods.
Net increase in net assets resulting from operations can vary substantially from period to period for various reasons, including the recognition of
realized gains and losses and unrealized appreciation and depreciation. As a result, annual comparisons of net increase in net assets resulting from
operations may not be meaningful.
Comparison of years ended December 31, 2019, 2018 and 2017.
Consolidated operating results for the years ended December 31, 2019, 2018 and 2017 are as follows (in thousands):
Investment income
Interest income:
Cash interest income
Net Loan Fee amortization
Other interest income
Total interest income
PIK income:
PIK interest income
Preferred equity PIK dividends
Total PIK income
Dividend income:
Preferred equity cash dividends
Common equity dividends
Total dividend income
Fee income:
Management, valuation, and syndication
Prepayment, structuring, and other fees
Total fee income
Total investment income
Total expenses, net
Net investment income
Net loss on investments
Years Ended December 31,
2019
2018
2017
$
47,510
$
36,068
$
26,444
1,245
147
48,902
2,288
251
38,607
927
898
1,825
1,193
906
2,099
—
502
502
773
519
1,292
52,521
33,423
19,098
—
315
315
922
891
1,813
42,834
24,449
18,385
(9,545)
(8,813)
1,450
230
28,124
1,508
1,399
2,907
165
317
482
163
1,750
1,913
33,426
17,549
15,877
(7,967)
Net increase in net assets resulting from operations
$
9,553
$
9,572
$
7,910
Interest and PIK interest income by debt investment type for the years ended December 31, 2019, 2018 and 2017 are summarized below (in
thousands):
Interest and PIK interest income:
Senior secured debt investments
Subordinated debt investments
Structured Finance Notes
Total interest and PIK interest income
Years Ended December 31,
2019
2018
2017
$
41,300 $
32,127 $
21,785
5,667
2,861
7,673
—
7,847
—
$
49,828 $
39,800 $
29,632
Comparison of investment income for the years ended December 31, 2019 and 2018:
Interest and PIK interest income increased approximately $10.0 million, due to a $12.7 million increase in recurring interest income caused by a
$103 million increase in the average outstanding loan balance during 2019 along with a decrease of
75
$1.8 million in recurring interest income resulting from a 43 basis point decrease in the weighted average yield in our debt portfolio during the year ended
December 31, 2019. Acceleration of Net Loan Fees of $0.3 million and $1.1 million were included in interest income for the years ended December 31,
2019 and 2018, respectively, from the repayment of loans prior to their scheduled due dates.
We recognized prepayment fees of $0.4 million resulting from $56.8 million of unscheduled principal payments during the year ended
December 31, 2019, compared to $0.9 million from $50.0 million of unscheduled principal payments during the year ended December 31, 2018. We
recognized syndication fees of $0.7 million and $0.7 million for the years ended December 31, 2019 and 2018, respectively, resulting from approximately
$91.5 million and $64.0 million in loan originations during that period in which OFS Advisor sourced, structured, and arranged the lending group, and for
which we were additionally compensated.
Comparison of investment income for the years ended December 31, 2018 and 2017:
Interest and PIK interest income increased approximately $10.2 million, due to a $8.9 million increase in recurring interest income caused by a
$76.8 million increase in the average outstanding loan balance during 2018 along with an increase of $0.7 million in recurring interest income resulting
from a 23 basis point increase in the weighted average yield in our debt portfolio during the year ended December 31, 2018. Acceleration of Net Loan Fees
of $1.1 million and $0.6 million were included in interest income for the years ended December 31, 2018 and 2017, respectively, from the repayment of
loans prior to their scheduled due dates.
We recorded prepayment fees of $0.9 million resulting from $50.0 million of unscheduled principal payments during the year ended December 31,
2018, compared to $1.0 million from $60.2 million of unscheduled principal payments during 2017. We recognized capital structuring fees of $0.0 million
and $0.5 million for the years ended December 31, 2018 and 2017, respectively, upon the closing of $0 and $55.7 million of debt and equity investments,
respectively. We ceased recognition of such fees with the adoption of ASC 606. We recognized syndication fees of $0.7 million and $0.2 million for the
years ended December 31, 2018 and 2017, respectively, resulting from approximately $64 million and $21 million in loan originations during that period in
which OFS Advisor sourced, structured, and arranged the lending group, and for which we were additionally compensated.
Expenses
Interest expense
Management fees
Incentive fee, net of waiver
Professional fees
Administration fee
General and administrative expenses
Total expenses, net of waiver
Years Ended December 31,
2019
2018
2017
(Amounts in thousands)
15,829 $
9,232 $
8,271
4,760
1,814
1,747
1,002
6,335
4,387
1,245
1,601
1,649
5,813
4,999
2,962
1,115
1,314
1,346
33,423 $
24,449 $
17,549
$
$
Comparison of expenses for the years ended December 31, 2019 and 2018:
Interest expense increased by $6.6 million primarily due to an increase of $100.9 million in the average amount of outstanding borrowings,
primarily due to a full year of the Unsecured Notes Due October 2025 outstanding, the establishment of the BNP Facility in June 2019, and the issuance of
the Unsecured Notes Due 2026 in October 2019. See "Item 8.–Financial Statements–Note 7" for details.
Management fee expense increased by $2.0 million due to an increase in our average total assets, primarily due to an increase in net investment
activity from our increase in leverage through the establishment of the BNP Facility and the issuance of the Unsecured Notes Due 2026.
Incentive fee expense increased by $0.4 million primarily due to a $0.7 million increase in net investment income relating to the increase in our
leverage throughout the fiscal year.
Professional fees increased $0.6 million primarily due to the retention of third-party valuation services, as well as an increase in internal and
external audit costs.
Administration fees increased by $0.1 million primarily due to the growth in assets.
76
General and administrative expenses decreased $0.6 million primarily due to non-recurring legal and other offering costs incurred during the first
quarter of 2018 in connection with a foreign debt transaction that we elected not to pursue due to regulatory changes and market conditions.
Comparison of expenses for the years ended December 31, 2018 and 2017:
Interest expense increased by $3.4 million primarily due to interest expense of $3.1 million associated with the Unsecured Notes issued in April
and October of 2018.
Management fee expense increased by $1.3 million due to an increase in our average total assets, primarily due to an increase in net investment
activity, including deployment of $95.4 million in proceeds from the issuance of the Unsecured Notes.
Incentive fee expense increased by $1.4 million primarily due to a $2.5 million increase in net investment income relating to the deployment of the
proceeds from the Unsecured Notes, as well as a decrease in 2017 relating to Part One incentive fees, due to a share issuance adjustment related to the
Offering, which raised the hurdle rate to a level that was not exceeded in the second quarter because the Offering proceeds were not fully deployed.
Administration fees increased by $0.3 million primarily due to an increase in allocated accounting labor and software costs.
General and administrative expenses increased $0.3 million primarily due to legal and other offering costs incurred during the first quarter of 2018
in connection with a foreign debt transaction that we elected not to pursue due to regulatory changes and market conditions.
Net realized and unrealized gain (loss) on investments
Senior secured debt
Subordinated debt
Preferred equity
Common equity and warrants
Structured Finance Notes
Net loss on investments
Year ended December 31, 2019
Years Ended December 31,
2019
2018
2017
(Amounts in thousands)
(9,809) $
(9,020) $
(1,968)
(89)
3,837
(1,516)
(3,308)
(1,993)
5,508
—
(9,545) $
(8,813) $
$
$
(4,441)
(8,667)
5,373
(232)
—
(7,967)
We recognized net losses of $9.8 million on senior secured debt during the year ended December 31, 2019, primarily as a result of an unrealized
loss of $9.0 million on our senior secured debt investment in Constellis Holdings, LLC, offset by unrealized gains of $2.2 million in our remaining senior
secured debt investments. We also recognized a realized loss of $2.9 million on the sale of MAI Holdings, LLC.
We recognized net losses of $2.0 million on subordinated debt during the year ended December 31, 2019, primarily as a result of unrealized losses
of $1.5 million and $0.6 million on our subordinated debt investments in Online Tech Stores, LLC and Master Cutlery, LLC, respectively, due to the
negative impact of specific performance factors.
We recognized net losses of $0.1 million on preferred equity investments for the year ended December 31, 2019, primarily as a result of a $2.3
million unrealized gain on TRS Services, LLC, offset by $2.3 million of unrealized losses on our remaining preferred equity investments. We also
recognized a realized loss of $0.1 million on the sale of Maverick Healthcare Equity, LLC.
We recognized net gains of $3.8 million on common equity and warrant investments for the year ended December 31, 2019, as a result of
unrealized gains of $3.6 million and $1.6 million on our common equity investments in Pfanstiehl Holdings, Inc. and Professional Pipe Holdings LLC,
respectively, offset by net unrealized losses of $1.4 million in our remaining common equity and warrant investments due to net negative impact of
portfolio company-specific performance factors.
We recognized net losses of $1.5 million on Structured Finance Notes for the year ended December 31, 2019, as a result of net unrealized losses of
$1.5 million, primarily driven by a $0.9 million and $0.6 unrealized loss on Elevation CLO 2017-7, Ltd. and THL Credit Wind River 2019‐3 CLO Ltd.,
respectively.
77
Year ended December 31, 2018
We recognized net losses of $9.0 million on senior secured debt during the year ended December 31, 2018, primarily as a result of a realized loss
of $3.5 million on our senior secured debt investment in Jobson recognized upon the sale in the second quarter of 2018, as well as by the negative net
impact of mark-to-market adjustments in the fourth quarter relating to our Broadly Syndicated Loan investments resulting in an unrealized loss of $5.5
million.
We recognized net losses of $3.3 million on subordinated debt during the year ended December 31, 2018, primarily as a result of a realized loss of
$3.5 million on the restructuring of the Southern Technical Institute, LLC subordinated debt investment, of which $2.3 million was recognized as
unrealized losses in prior years, and net unrealized depreciation of $2.1 from the negative impact of specific performance factors, principally related to
Master Cutlery LLC.
We recognized net losses of $2.0 million on preferred equity investments for the year ended December 31, 2018, primarily as a result of a $1.4
million unrealized loss on TRS Services, LLC, and other negative net impact of portfolio company-specific performance factors on other investments
resulting in an additional unrealized loss of $0.6 million.
We recognized net gains of $5.5 million on common equity and warrant investments for the year ended December 31, 2018, as a result of net
realized gains of $3.7 million, primarily driven by a $4.1 million realized gain on the sale of All Metal Holdings, LLC, and the positive impact of portfolio
company-specific performance factors resulting in unrealized appreciation of $1.8 million for the year ended December 31, 2018.
Year ended December 31, 2017
We recognized net losses of $4.4 million on senior secured debt during the year ended December 31, 2017, primarily as a result of a realized loss
of $5.0 million on our senior secured debt investment in My Alarm recognized upon restructuring in the third quarter of 2017, offset by the positive net
impact of portfolio company-specific performance factors on other investments. We held the My Alarm investment from the fourth quarter of 2015 and
recognized unrealized appreciation of $0.2 million and $0 during the years ended December 31, 2016 and 2015, respectively.
We recognized net losses of $8.7 million on subordinated debt during the year ended December 31, 2017, primarily as a result of the net negative
impact of portfolio company-specific performance factors, including unrealized depreciation of $5.4 million recognized on our debt investment in
Community Intervention Services, Inc., which was placed on non-accrual status during 2016, unrealized depreciation of $2.1 million recognized on our
debt investment in Southern Technical Institute, LLC, which was placed on non-accrual status during the fourth quarter of 2017, and $1.6 million of
unrealized depreciation on our debt investment in Master Cutlery, LLC.
We recognized net gains of $5.4 million on preferred equity investments for the year ended December 31, 2017, primarily as a result of $7.7
million of net realized gains recognized upon sale of three equity investments, offset by the negative impact from changes to EBITDA multiples used in our
valuations and negative impacts of portfolio company-specific performance factors, including a $2.1 million unrealized loss recognized on our equity
investment in Southern Technical Institute, LLC. Included in net gains of $7.7 million for the year ended December 31, 2017, were realized gains of $11.0
million we recognized upon sale of the three aforementioned equity investments. We recognized cumulative unrealized appreciation of approximately $3.3
million on these investments through December 31, 2016, which resulted in an aggregate net gain of $7.7 million during the year ended December 31,
2017. In addition, previously recognized cumulative unrealized depreciation of $0.3 million at June 30, 2017, on our preferred equity investment in My
Alarm, was realized upon restructuring.
We recognized net losses of $0.2 million on common equity and warrant investments for the year ended December 31, 2017, primarily as a result
of the negative impact of portfolio company-specific performance factors, offset by a $0.4 million net gain realized upon sale of a common equity
investment, which includes a realized gain of $0.9 million, for which we had recognized cumulative unrealized appreciation of $0.5 million through
December 31, 2016.
Liquidity and Capital Resources
At December 31, 2019, we held cash and cash equivalents of $13.4 million, which includes cash and cash equivalents of $1.9 million held by
SBIC I LP, our wholly owned SBIC. Our use of cash held by SBIC I LP is restricted by SBA regulation, including limitations on the amount of cash SBIC I
LP can distribute to OFS Capital Corporation as parent company (the "Parent"). Any such distributions to the Parent from SBIC I LP are generally
restricted to a statutory measure of undistributed accumulated earnings of SBIC I LP under SBA regulation. During the year ended December 31, 2019, the
Parent received cash distributions of $19.0 million from SBIC I LP. At December 31, 2019, the Parent had $13.4 million of cash and cash equivalents
available for general corporate activities, including approximately $1.9 million held by SBIC I LP that was available for distribution to it. Additionally, as
of December 31, 2019, we had $69.0 million of borrowings available through our PWB Credit Facility, as well as unused commitments of $93.6 million
under the BNP Facility.
As of December 31, 2019, the aggregate amount outstanding of the senior securities issued by us was $359.2 million, for which our asset coverage
was 180%. The SBA debentures are not subject to the asset coverage requirements of the 1940 Act
78
as a result of exemptive relief granted to us by the SEC effective November 26, 2013. The asset coverage ratio for a class of senior securities representing
indebtedness is calculated as our consolidated total assets, less all liabilities and indebtedness not represented by senior securities, divided by total senior
securities representing indebtedness.
Sources and Uses of Cash and Cash Equivalents
We generate cash through operations from net investment income and the net liquidation of portfolio investments, and use cash in our operations
in the net purchase of portfolio investments. Significant variations may exist between net investment income and cash from net investment income,
primarily due to the recognition of non-cash investment income, including Net Loan Fee amortization, PIK interest, and PIK dividends, which generally
will not be fully realized in cash until we exit the investment. As discussed in "Item 8. Financial Statements—Note 3", we pay OFS Advisor a quarterly
incentive fee with respect to our pre-incentive fee net investment income, which includes investment income that has not been received in cash. In addition,
we must distribute substantially all our taxable income, which approximates, but will not always equal, the cash we generate from net investment income to
maintain our RIC tax treatment. Historically, our distributions have been in excess of taxable income and we have limited history of net taxable gains. We
also obtain cash to fund investments or general corporate activities from the issuance of securities and our revolving line of credit. These principal sources
and uses of cash and liquidity are presented below (in thousands):
Years Ended December 31,
2019
2018
2017
Cash from net investment income
$
20,333
$
18,782 $
Net (purchases and originations) repayments of portfolio investments
Net cash provided by (used in) operating activities
Proceeds from common stock offering, net of expenses
Proceeds from issuance of the Unsecured Notes, net of discounts
Distributions paid to stockholders
Net borrowings (repayments) under revolving line of credits
Payment of debt issuance costs and other financing costs
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Comparison of the years ended December 31, 2019 and 2018:
(121,969)
(101,636)
—
52,270
(17,949)
44,450
(1,860)
76,911
(119,870)
(101,088)
—
95,446
(22,895)
(5,600)
(643)
66,308
$
(24,725) $
(34,780) $
11,451
(778)
10,673
53,423
—
(16,700)
8,100
(203)
44,620
55,293
At December 31, 2019, we held cash and cash equivalents of $13.4 million, a decrease of $24.7 million from December 31, 2018.
Cash from net investment income
Cash from net investment income increased $2.7 million for the year ended December 31, 2019, compared to the prior year. The increase to cash
from net investment income was principally due to an increase in interest income resulting from the deployment of the Unsecured Notes proceeds and the
establishment of the BNP Facility.
Net (purchases and originations) repayments of portfolio investments
During the year ended December 31, 2019, net purchases and repayments of portfolio investments decreased $3.3 million compared to the prior
year primarily due to a decrease of $52.2 million of principal payments and sale proceeds, offset by a decrease $50.0 million in purchases of portfolio
companies.
Proceeds from issuance of the Unsecured Notes, net of expenses
During the year ended December 31, 2019, we issued $54.3 million in Unsecured Notes, with net proceeds of $52.3 million after deducting
underwriting discounts and offering costs, which was a decrease of $43.2 million in Unsecured Note issuances compared to the prior year.
Cash distributions paid
Cash distributions decreased $4.9 million for the year ended December 31, 2019 compared to the prior year, due to the $4.9 million special
dividend paid in the first quarter of 2018 for an undistributed net long-term capital gains realized by the Company in 2017.
Net borrowings (repayments) under revolving line of credits
79
During the year ended December 31, 2019, net borrowings increased $50.1 million compared to the prior year, primarily due to the establishment
of the BNP Facility to purchase additional first lien senior secured loans. Aggregate borrowings under the BNP Faciliy were $56.5 million as of December
31, 2019.
Payment of debt issuance costs and other financing costs
Payment of debt issuance costs increased $1.2 million for the year ended December 31, 2019 compared to the prior year, primarily due to $1.3
million of costs associated with the closing of the BNP Facility.
Comparison of the years ended December 31, 2018 and 2017:
At December 31, 2018, we held cash and cash equivalents of $38.2 million, a decrease of $34.8 million from December 31, 2017.
Cash from net investment income
Cash from net investment income increased $7.3 million for the year ended December 31, 2018, compared to the prior year. The increase to cash
from net investment income was principally due to an increase in interest income resulting from the deployment of the Unsecured Notes proceeds.
Net (purchases and originations) repayments of portfolio investments
During the year ended December 31, 2018, net purchases and originations of portfolio investments were primarily due to $272.2 million of cash
we used to purchase portfolio investments, offset by $148.0 million of cash we received from amortized cost repayments and sales on our portfolio
investments. During the year ended December 31, 2017, net purchases were due to $142.9 million of cash we used to purchase portfolio investments, offset
by $142.1 million of cash we received from amortized cost repayments on our portfolio investments.
Proceeds from issuance of the Unsecured Notes, net of expenses
During the year ended December 31, 2018, we issued $98.5 million in Unsecured Notes, with net proceeds of $95.4 million after deducting
underwriting discounts and offering costs.
Cash distributions paid
Cash distributions increased $6.2 million for the year ended December 31, 2018 compared to the prior year, mostly due to the $4.9 million special
dividend paid in the first quarter of 2018 for an undistributed net long-term capital gains realized by the Company in 2017.
Borrowings
SBA Debentures
SBIC I LP has a SBIC license that allowed it to obtain leverage by issuing SBA-guaranteed debentures. These debentures are non-recourse to us,
and bear interest payable semi-annually, and each debenture has a maturity date that is ten years following issuance. The interest rate on SBA debentures
are fixed at the first pooling date after issuance, which is March and September of each year, at market-driven spreads over U.S. Treasury Notes with ten-
year maturities. SBA regulations currently limit the amount that an SBIC may borrow up to a maximum of $150 million (or $175 million with SBA
approval) when it has at least $75 million in regulatory capital (or $87.5 million with approval to borrow up to $175 million), receives a leverage
commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of December 31, 2019 and 2018, SBIC I LP had
fully drawn the $149.9 million of leverage commitments from the SBA, which bears interest at a weighted-average fixed cash interest rate of 3.18%.
80
The following table shows our outstanding SBA debentures payable as of December 31, 2019 and 2018 (in thousands):
Pooling Date
September 19, 2012
September 25, 2013
March 26, 2014
September 24, 2014
September 24, 2014
March 25, 2015
September 23, 2015
SBA debentures outstanding
Unamortized debt issuance costs
Maturity Date
September 1, 2022
September 1, 2023
March 1, 2024
September 1, 2024
September 1, 2024
March 1, 2025
September 1, 2025
SBA debentures outstanding
Fixed Interest
Rate
December 31, 2019 December 31, 2018
3.049% $
14,000 $
4.448
3.995
3.819
3.370
2.872
3.184
7,000
5,000
4,110
31,265
65,920
22,585
149,880
(1,904)
14,000
7,000
5,000
4,110
31,265
65,920
22,585
149,880
(2,280)
147,600
SBA debentures outstanding, net of unamortized debt issuance costs
$
147,976 $
On a stand-alone basis, SBIC I LP held $249.6 million and $251.1 million in assets at December 31, 2019 and 2018, respectively, which
accounted for approximately 46% and 57% of the Company’s total consolidated assets, respectively.
As part of our plans to focus on lower-yielding, first lien senior secured loans to larger borrowers, which we believe will improve our overall risk
profile, SBIC I LP intends, over time, to repay its outstanding SBA debentures prior to the scheduled maturity dates of its debentures. We do not expect to
make new investments through SBIC I LP, other than follow-on investments. We believe that investing in more senior loans to larger borrowers is
consistent with our view of the private loan market and will reduce our overall leverage on a consolidated basis.
SBIC I LP is periodically examined and audited by the SBA’s staff to determine its compliance with SBA regulations. If SBIC I LP fails to comply
with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit SBIC I LP’s use of debentures, declare
outstanding debentures immediately due and payable, and/or limit SBIC I LP from making new investments. In addition, SBIC I LP may also be limited in
its ability to make distributions to the Company if it does not have sufficient capital in accordance with SBA regulations. Such actions by the SBA would in
turn, negatively affect the Company.
PWB Credit Facility
We are party to a BLA with Pacific Western Bank, as lender, to provide us with a senior secured revolving credit facility, or PWB Credit Facility.
The PWB Credit Facility is available for general corporate purposes including investment funding. The maximum availability of the PWB Credit Facility is
equal to 50% of the aggregate outstanding principal amount of eligible loans included in the borrowing base, which excludes subordinated loan investments
(as defined in the BLA) and as otherwise specified in the BLA. The PWB Credit Facility is guaranteed by OFSCC-MB and secured by all of our current
and future assets excluding assets held by SBIC I LP, OFSCC-FS, and the Company’s partnership interests in SBIC I LP and SBIC I GP.
The BLA contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information
reporting requirements, a minimum tangible net asset value, a minimum quarterly net investment income after incentive fees, and a statutory asset coverage
test. The BLA also contains customary events of default, including, without limitation, nonpayment, misrepresentation of representations and warranties in
a material respect, breach of covenant, cross-default to other indebtedness, bankruptcy, change in investment advisor, and the occurrence of a material
adverse change in our financial condition. As of December 31, 2019, we were in compliance with the applicable covenants.
The terms of the PWB Credit Facility as of December 31, 2019 are as follows (amounts in thousands):
Maximum
Availability
Floor Rate
Interest Rate
Unused Fee
Maturity Date
PWB Credit Facility
$
100,000
5.25%
Prime + 0.25%
0.50%
February 28, 2021
Availability under the PWB Credit Facility was $69.0 million, based on the stated advance rate of 50% under the borrowing base, and no
outstanding balance as of December 31, 2019.
81
BNP Facility
On June 20, 2019, we entered into the a revolving credit and security agreement by and among OFSCC-FS, the lenders from time to time parties
thereto, BNP Paribas, as administrative agent, OFSCC-FS Holdings, LLC, a wholly owned subsidiary of the Company, as equityholder, the Company, as
servicer, Citibank, N.A., as collateral agent and Virtus Group, LP, as collateral administrator, which provides for borrowings in an aggregate principal
amount up to $150.0 million. Borrowings under the BNP Facility bear interest of LIBOR plus an applicable spread, which is determined on the basis of
industry-recognized portfolio company metrics at the time of funding. The BNP Facility will mature on the earlier of June 20, 2024 or upon certain other
events defined in the credit agreement which result in accelerated maturity. The BNP Facility also contains customary events of default, including, without
limitation, nonpayment, failure to maintain valid ownership interest in all of the collateral and bankruptcy. Borrowings under the BNP Facility are secured
by substantially all of the assets held by OFSCC-FS. OFSCC-FS incurred fees to the lenders as well as legal costs of approximately $1.3 million to
establish the BNP Facility, which are amortized over the life of the facility.
As of December 31, 2019, the BNP Facility had the following terms and balances (amounts in thousands):
Principal
Unused
Commitment
Effective Interest
Rate(1)
Maturity
2019 Interest
Expense(2)
BNP Facility
$
56,450 $
93,550
4.72%
June 20, 2024 $
905
(1) The effective interest rate includes deferred debt issuance cost amortization and unused commitment fees.
(2) Interest expense includes deferred issuance costs amortization and unused commitment fees of $0.1 million and $16,000 for the year ended December
31, 2019. Under the terms of the revolving credit and security agreement, BNP waived the unused commitment fees through December 20, 2019.
Unsecured Notes
In April 2018, we publicly offered the Unsecured Notes Due April 2025 with aggregate principal of $50.0 million. The total net proceeds to us
from the Unsecured Notes Due April 2025, after deducting underwriting discounts and offering costs of $1.8 million were $48.2 million. In October and
November 2018, we publicly offered the Unsecured Notes Due October 2025 with aggregate principal of $48.5 million, which included a partial exercise
of the underwriters overallotment option. The total net proceeds to us from the Unsecured Notes Due October 2025, after deducting underwriting discounts
and offering expenses of $1.7 million, were $46.8 million. In October and November 2019, we publicly offered the Unsecured Notes Due October 2026
with an aggregate principal of $54.3 million, which included a partial exercise of the underwriters overallotment option. The total net proceeds to us from
the Unsecured Notes Due October 2026, after deducting underwriting discounts and offering costs of $1.9 million were $52.4 million. The Unsecured
Notes totaled $152.9 million in aggregate principal debt, with net proceeds of $147.4 million to us.
The Unsecured Notes are direct unsecured obligations and rank equal in right of payment with all of our current and future unsecured
indebtedness. Because the Unsecured Notes are not secured by any of our assets, they are effectively subordinated to all existing and future secured
unsubordinated indebtedness (or any indebtedness that is initially unsecured as to which we subsequently grant a security interest), to the extent of the
value of the assets securing such indebtedness, including, without limitation, borrowings under the PWB Credit Facility and BNP Facility.
As of December 31, 2019, the Unsecured Notes had the following terms and balances (amounts in thousands):
Unsecured Notes
Unsecured Notes Due April 2025
Unsecured Notes Due October 2025
Unsecured Notes Due October 2026
Total
Principal
$
$
50,000
48,525
54,325
152,850
Stated Interest
Rate (1)
Effective
Interest Rate
(2)
Maturity (3)
2019 Interest
Expense (4)
6.375%
6.50%
5.95%
6.88%
7.01%
6.49%
4/30/2025 $
10/31/2025
10/31/2026
$
3,444
3,483
723
7,650
(1) The weighted-average fixed cash interest rate on the Unsecured Notes as of December 31, 2019 was 6.26%.
(2) The effective interest rate on the Unsecured Notes includes deferred debt issuance cost amortization.
(3) The Unsecured Notes Due April 2025 may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after
April 30, 2020. The Unsecured Notes Due October 2025 may be redeemed in whole or in part at any time or from time to time at the Company’s option
on or after October 31, 2020. The Unsecured Notes Due October 2026 may be redeemed in whole or in part at any time or from time to time at the
Company’s option on or after October 31, 2021.
(4) Interest expense includes deferred issuance costs amortization of $0.6 million for the year ended December 31, 2019.
82
The average dollar borrowings and average interest rate for all debt the years ended December 31, 2019, 2018 and 2017, were as follows:
Year ended
December 31, 2019
December 31, 2018
December 31, 2017
Other Liquidity Matters
Average Dollar
Borrowings
Weighted Average
Interest Rate
$
307,826
206,936
158,368
4.99%
4.37
3.55
We expect to fund the growth of our investment portfolio utilizing future equity offerings, and issuances of senior securities or future borrowings
to the extent permitted by the 1940 Act. We cannot assure stockholders that our plans to raise capital will be successful. In addition, we intend to distribute
to our stockholders substantially all of our taxable income in order to satisfy the requirements applicable to RICs under Subchapter M of the Code.
Consequently, we may not have the funds or the ability to fund new investments or make additional investments in our portfolio companies. The illiquidity
of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may
realize significantly less than their recorded value.
A BDC generally is not permitted to incur indebtedness unless immediately after such borrowing it has an asset coverage ratio for total borrowings
of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). Certain provisions of the SBCAA permit BDCs to be subject to a
minimum asset coverage ratio of 150%, if specific conditions are satisfied, when issuing senior securities (i.e., the amount of debt may not exceed 66 2/3%
of the value of our assets). As an approximation, prior to the enactment of the SBCAA, the most that a BDC could borrow for investment purposes was $1
for every $1 of investor equity. Now, for those BDCs that satisfy the SBCAA’s approval and disclosure requirements and become subject to the reduced
asset coverage ratio, the BDC can borrow $2 for investment purposes for every $1 of investor equity.
The SBCAA provides that in order for a BDC whose common stock is traded on a national securities exchange to be subject to 150% asset
coverage, the BDC must either obtain: (i) approval of the required majority of its non-interested directors who have no financial interest in the proposal,
which would become effective one year after the date of such approval, or (ii) obtain stockholder approval (of more than 50% of the votes cast for the
proposal at a meeting in which quorum is present), which would become effective on the first day after the date of such stockholder approval.
On May 3, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the
application of the modified asset coverage requirements made available under the SBCAA and, as a result, the asset coverage ratio test applicable to us was
decreased from 200% to 150%, effective May 3, 2019. See "Item 1A. Risk Factors — Risks Related to our Business and Structure — Because we have
received the approval of our Board, we are subject to 150% Asset Coverage effective May 3, 2019." Additionally, we received exemptive relief from the
SEC effective November 26, 2013, which allows us to exclude our SBA guaranteed debentures from the definition of senior securities in the statutory asset
coverage ratio under the 1940 Act.
This requirement limits the amount that we may borrow. To fund growth in our investment portfolio in the future, we anticipate needing to raise
additional capital from various sources, including the equity markets and the securitization or other debt-related markets, which may or may not be
available on favorable terms, if at all.
Contractual Obligations and Off-Balance Sheet Arrangements
The following table shows our contractual obligations as of December 31, 2019 (in thousands):
Contractual Obligations (1)
PWB Credit Facility (3)
BNP Facility
SBA Debentures(4)
Unsecured Notes
Total
Principal and Interest Payments due by period (2)
Total
Less than 1
year
1-3 years
3-5 years
$
$
496 $
425 $
71 $
— $
61,502
174,101
191,189
2,021
4,774
9,574
2,021
23,522
9,574
57,460
55,642
9,574
427,288 $
16,794 $
35,188 $
122,676 $
After
5 years
—
—
90,163
162,467
252,630
(1) Excludes commitments to extend credit to our portfolio companies.
83
(2) The PWB Credit Facility is scheduled to mature on February 28, 2021. The BNP Facility is scheduled to mature on June 20, 2024. The SBA
debentures are scheduled to mature between September 2022 and 2025. The Unsecured Notes are scheduled to mature between April 2025 and
October 2026.
(3) Contractual interest is based on LIBOR at December 31, 2019 and assumes no interim additional borrowings or repayments under the credit facilities
between December 31, 2019 and maturity.
(4) SBIC I LP intends, over time, to repay its outstanding SBA debentures prior to the scheduled maturity date of its debentures. SBIC I LP does not
expect to make new investments, other than follow-on investments.
We have entered into contracts with affiliates under which we will incur material future commitments—the Investment Advisory Agreement,
pursuant to which OFS Advisor has agreed to serve as our investment adviser, and the Administration Agreement, pursuant to which OFS Services has
agreed to furnish us with the facilities and administrative services necessary to conduct our day-to-day operations.
We may become a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our
portfolio companies. These instruments may include commitments to extend credit and involve, to varying degrees, elements of liquidity and credit risk in
excess of the amount recognized in the balance sheet. We had $4.8 million of total unfunded commitments to four portfolio companies at December 31,
2019. See Note 6 for details.
Distributions
We are taxed as a RIC under the Code. Generally, a RIC is entitled to deduct dividends it pays to its stockholders from its income to determine
“taxable income.” Taxable income includes our taxable interest, dividend and fee income, and taxable net capital gains. Taxable income generally differs
from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally
excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized
for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale
treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as
consideration from the sale of investments are collected in cash. Taxable income includes non-cash income, such as changes in accrued and reinvested
interest and dividends, which includes contractual PIK interest, and the amortization of discounts and fees. Cash collections of income resulting from
contractual PIK interest and dividends or the amortization of discounts and fees generally occur upon the repayment of the loans or debt securities that
include such items. Non-cash taxable income is reduced by non-cash expenses, such as realized losses and depreciation, and amortization expense.
Our board of directors maintains a variable dividend policy with the objective of distributing four quarterly distributions in an amount not less
than 90-100% of our taxable quarterly income or potential annual income for a particular year. In addition, at the end of the year, we may also pay an
additional special dividend, or fifth dividend, such that we may distribute approximately all of our annual taxable income in the year it was earned, while
maintaining the option to spill over our excess taxable income to a following year. Each year, a statement on Form 1099-DIV identifying the source of the
distribution is mailed to the Company’s stockholders. For the year ended December 31, 2019, approximately $1.36 per share, $0.00 per share, and $0.00
per share of the Company’s distributions represented ordinary income, long-term capital gain, and a return of capital to its stockholders, respectively.
For a detailed description of our distributions paid for the years ended December 31, 2019, 2018, and 2017, see "Item 8.–Financial Statements–
Note 10."
Recent Developments
On March 11, 2020, our Board declared a distribution of $0.34 per share for the first quarter of 2019, payable on March 31, 2020 to stockholders
of record as of March 24, 2020.
On March 1, 2020, SBIC I LP prepaid $16.11 million of SBA debentures that were contractually due September 1, 2023, March 1, 2024 and
September 1, 2024.
84
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
We are subject to financial market risks, including changes in interest rates. Changes in interest rates affect both our cost of funding and the
valuation of our investment portfolio. As of December 31, 2019, 93% of our debt investments bore interest at floating interest rates and 7% of our debt
investments bore fixed interest rates, at fair value. The interest rates on our debt investments bearing floating interest rates are usually based on a floating
LIBOR, and the debt investments typically contain interest rate re-set provisions that adjust applicable interest rates to current rates on a periodic basis. A
significant portion of our loans that are subject to the floating LIBOR rates are also subject to a minimum base rate, or floor, that we charge on our loans if
the current market rates are below the respective floors. As of December 31, 2019, substantially all of our floating rate loans were based on a floating
LIBOR (not subject to a floor).
Our outstanding SBA debentures and Unsecured Notes bear interest at a fixed rate. Our PWB Credit Facility and BNP Facility have floating
interest rate provisions based on the Prime Rate and LIBOR, with effective interest rates of 6.03% and 4.72%, respectively, as of December 31, 2019.
Assuming that the consolidated balance sheet as of December 31, 2019, were to remain constant and that we took no actions to alter our existing
interest rate sensitivity, the following tables show the annualized impact of hypothetical base rate changes in interest rates (in thousands):
Basis point increase
Interest income
Interest expense
50
100
150
200
250
$
1,875
3,941
6,007
8,073
10,139
$
(287)
$
(573)
(859)
(1,145)
(1,431)
Basis point decrease
Interest income
Interest expense (1)
50
100
150
200
250
$
(2,064)
$
(3,433)
(3,833)
(4,096)
(4,096)
$
286
572
858
1,091
1,091
Net increase
(decrease)
1,588
3,368
5,148
6,928
8,708
Net increase
(decrease)
(1,778)
(2,861)
(2,975)
(3,005)
(3,005)
(1) Our PWB Credit Facility contains a 5.25% interest rate floor, and therefore a decline in the Prime Rate would not materially impact interest expense.
The BNP Facility does not contain an interest rate floor.
Although we believe that the foregoing analysis is indicative of our sensitivity to interest rate changes as of December 31, 2019, it does not adjust
for potential changes in the credit market, credit quality, size and composition of the assets in our portfolio, and other business developments, including
borrowings under our credit facility, that could affect net increase in net assets resulting from operations, or net income. Accordingly, no assurances can be
given that actual results would not differ materially from the statement above.
We are subject to financial market risks, including changes in interest rates. Changes in interest rates affect both our cost of funding and the
valuation of our investment portfolio. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate
policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and
programs. Our investment portfolio and investment income may be affected by changes in various interest rates, including LIBOR and the Prime Rate.
85
ITEM 8. FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firms
Index to Financial Statements
Consolidated Statements of Assets and Liabilities as of December 31, 2018 and 2017
Consolidated Statements of Operations for the Years Ended December 31, 2018, 2017, and 2016
Consolidated Statements of Changes in Net Assets for the Years Ended December 31, 2018, 2017, and 2016
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017, and 2016
Consolidated Schedules of Investments as of December 31, 2018 and 2017
Notes to Consolidated Financial Statements
86
87
90
91
92
94
95
116
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
OFS Capital Corporation:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statement of assets and liabilities of OFS Capital Corporation and subsidiaries (the Company), including
the consolidated schedule of investments, as of December 31, 2019, the related consolidated statements of operations, changes in net assets, and cash flows
for the year ended December 31, 2019, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial
statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019, and the results of its operations, changes
in its net assets and its cash flows for the year ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s
internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued
by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 13, 2020 expressed an unqualified opinion on the
effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with
respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange
Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audit included
performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing
procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the
consolidated financial statements. Such procedures also included confirmation of investments owned as of December 31, 2019, by correspondence with the
custodian, loan agents, or portfolio companies, or by other appropriate auditing procedures where replies were not received. Our audit also included
evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated
financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/KPMG LLP
We have served as the Company’s auditor since 2019.
Chicago, Illinois
March 13, 2020
87
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
OFS Capital Corporation:
Opinion on Internal Control Over Financial Reporting
We have audited OFS Capital Corporation and subsidiaries’ (the Company’s) internal control over financial reporting as of December 31, 2019, based on
criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on
criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated
statements of assets and liabilities, including the consolidated schedule of investments, of the Company as of December 31, 2019, the related consolidated
statements of operations, changes in net assets, and cash flows for the year ended December 31, 2019, and the related notes (collectively, the consolidated
financial statements), and our report dated March 13, 2020 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our
responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm
registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the
applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over
financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control
over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
/s/KPMG LLP
Chicago, Illinois
March 13, 2020
88
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
OFS Capital Corporation
Chicago, Illinois
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statement of assets and liabilities of OFS Capital Corporation (the “Company”), including the
consolidated schedule of investments, as of December 31, 2018, the related consolidated statements of operations, changes in net assets, and cash flows for
each of the two years in the period ended December 31, 2018, and the related notes, including the financial highlights for each of the four years in the
period ended December 31, 2018 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements
present fairly, in all material respects, the financial position of the Company at December 31, 2018, and the results of their operations, the changes in their
net assets, and their cash flows for each of the two years in the period ended December 31, 2018, and their financial highlights for each of the four years in
the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s
consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board
(United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the
applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or
fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and
disclosures in the consolidated financial statements. Our procedures included confirmation of securities owned as of December 31, 2018 by correspondence
with the custodian, loan agent, portfolio companies, or by other appropriate auditing procedures where replies were not received. Our audits also included
evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated
financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
We served as the Company’s auditor from 2014 to 2019.
Chicago, Illinois
March 15, 2019
89
OFS Capital Corporation and Subsidiaries
Consolidated Statements of Assets and Liabilities
(Dollar amounts in thousands, except per share data)
Assets
Investments, at fair value
December 31,
2019
2018
Non-control/non-affiliate investments (amortized cost of $396,201 and $312,223, respectively)
$
372,535
$
Affiliate investments (amortized cost of $131,950 and $90,751, respectively)
Control investment (amortized cost of $10,520 and $10,337, respectively)
Total investments at fair value (amortized cost of $538,671 and $413,311, respectively)
Cash and cash equivalents
Interest receivable
Prepaid expenses and other assets
Total assets
Liabilities
Revolving line of credits
SBA debentures (net of deferred debt issuance costs of $1,904 and 2,280, respectively)
Unsecured notes (net of discounts and deferred debt issuance costs of $4,798 and $3,299, respectively)
Interest payable
Payable to investment adviser and affiliates (Note 3)
Payable for investments purchased
Accrued professional fees
Other liabilities
Total liabilities
Commitments and contingencies (Note 6)
Net Assets
Preferred stock, par value of $0.01 per share, 2,000,000 shares authorized, 0 shares issued and outstanding as of December
31, 2019 and December 31, 2018, respectively
Common stock, par value of $0.01 per share, 100,000,000 shares authorized, 13,376,836 and 13,357,337 shares issued and
outstanding as of December 31, 2019 and December 31, 2018, respectively
Paid-in capital in excess of par
Total distributable earnings (accumulated losses)
Total net assets
Total liabilities and net assets
Number of shares outstanding
Net asset value per share
See Notes to Consolidated Financial Statements.
90
135,679
8,717
516,931
13,447
3,349
4,461
297,749
89,103
9,945
396,797
38,172
2,787
3,665
$
$
$
$
$
$
$
538,188
$
441,421
56,450
$
147,976
148,052
3,505
4,106
10,264
621
587
12,000
147,600
95,226
2,791
3,700
4,151
637
293
371,561
$
266,398
— $
134
187,305
(20,812)
166,627
538,188
$
$
—
134
187,540
(12,651)
175,023
441,421
13,376,836
13,357,337
12.46
$
13.10
OFS Capital Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollar amounts in thousands, except per share data)
Investment income
Interest income:
Non-control/non-affiliate investments
$
37,535
$
27,547
$
Years Ended December 31,
2019
2018
2017
Affiliate investments
Control investment
Total interest income
Payment-in-kind interest and dividend income:
Non-control/non-affiliate investments
Affiliate investments
Control investment
Total payment-in-kind interest and dividend income:
Dividend income:
Non-control/non-affiliate investments
Affiliate investments
Control investment
Total dividend income
Fee income:
Non-control/non-affiliate investments
Affiliate investments
Control investment
Total fee income
Total investment income
Expenses
Interest and financing expense
Management fees
Incentive fees
Professional fees
Administration fees
Other expenses
Total expenses before incentive fee waiver
Incentive fee waiver (see Note 3)
Total expenses, net of incentive fee waiver
Net investment income
Net realized and unrealized gain (loss) on investments
Net realized loss on non-control/non-affiliate investments
Net realized gain on affiliate investments
Net unrealized depreciation on non-control/non-affiliate investments
Net unrealized appreciation (depreciation) on affiliate investments
Net unrealized appreciation (depreciation) on control investment
Net loss on investments
Net increase in net assets resulting from operations
Net investment income per common share - basic and diluted
Net increase in net assets resulting from operations per common share - basic and diluted
Distributions declared per common share
Basic and diluted weighted average shares outstanding
See Notes to Consolidated Financial Statements.
91
10,364
1,003
48,902
399
1,257
169
1,825
—
413
89
502
1,029
221
42
1,292
52,521
15,829
8,271
4,760
1,814
1,747
1,002
33,423
—
33,423
19,098
(3,900)
—
(9,610)
5,376
(1,411)
(9,545)
9,553
1.43
0.71
1.36
$
$
$
$
$
$
$
$
10,055
1,005
38,607
668
1,321
110
2,099
—
130
185
315
987
760
66
1,813
42,834
9,232
6,335
4,409
1,245
1,601
1,649
24,471
(22)
24,449
18,385
(4,966)
187
(2,484)
(803)
(747)
(8,813)
9,572
1.38
0.72
1.73
$
$
$
$
20,078
6,506
1,540
28,124
1,400
1,375
132
2,907
50
140
292
482
1,086
675
152
1,913
33,426
5,813
4,999
2,962
1,115
1,314
1,346
17,549
—
17,549
15,877
(3,248)
10,081
(9,715)
(5,088)
3
(7,967)
7,910
1.28
0.64
1.36
13,364,244
13,348,203
12,403,706
OFS Capital Corporation and Subsidiaries
Consolidated Statements of Changes in Net Assets
(Dollar amounts in thousands, except per share data)
Balances at January 1, 2017
Net increase in net assets resulting from
operations:
Net investment income
Net realized gain on investments
Unrealized depreciation on investments, net of
deferred taxes
Tax reclassifications of permanent differences
Distributions to stockholders:
Common stock issued from reinvestment of
stockholder distributions
Common stock issued from public offering
Dividends declared
Net increase (decrease) for the year ended
December 31, 2017
Balances at December 31, 2017
Net increase in net assets resulting from
operations:
Net investment income
Net realized losses on investments
Unrealized depreciation on investments, net of
deferred taxes
Tax reclassifications of permanent differences
Distributions to stockholders:
Common stock issued from reinvestment of
stockholder distributions, net of repurchases
Repurchase of common stock
Dividends declared
Net increase (decrease) for the year ended
December 31, 2018
Balances at December 31, 2018
Net increase in net assets resulting from
operations:
Net investment income
Net realized losses on investments
Unrealized depreciation on investments, net of
deferred taxes
Tax reclassifications of permanent differences
Distributions to stockholders:
Preferred Stock
Common Stock
Number of
shares
Par value
Number of
shares
Par value
Paid-in capital
in excess of par
Total
distributable
earnings
(accumulated
losses)
Total net assets
— $
—
9,700,297 $
97 $
134,300 $
9,381 $
143,778
—
—
—
—
—
—
—
—
— $
—
—
—
—
—
—
—
—
— $
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
14,920
3,625,000
—
3,639,920
—
—
—
—
—
36
—
36
—
—
—
(409)
195
53,312
—
53,098
13,340,217 $
133 $
187,398 $
—
—
—
—
17,420
(300)
—
17,120
—
—
—
—
1
—
—
1
—
—
—
(62)
204
—
—
15,877
6,833
15,877
6,833
(14,800)
(14,800)
409
—
—
—
(16,895)
195
53,348
(16,895)
(8,576)
805 $
44,558
188,336
18,385
(4,779)
(4,034)
62
18,385
(4,779)
(4,034)
—
—
—
205
—
(23,090)
(23,090)
142
(13,456)
(13,313)
13,357,337 $
134 $
187,540 $
(12,651) $
175,023
—
—
—
—
—
—
—
—
—
—
—
(462)
19,098
(3,900)
(5,645)
462
19,098
(3,900)
(5,645)
—
92
Preferred Stock
Common Stock
Number of
shares
Par value
Number of
shares
Par value
Paid-in capital
in excess of par
Total
distributable
earnings
(accumulated
losses)
Total net assets
Common stock issued from reinvestment of
stockholder distributions
Dividends declared
Net increase (decrease) for the year ended
December 31, 2019
Balances at December 31, 2019
See Notes to Consolidated Financial Statements.
—
—
—
— $
—
—
—
—
19,499
—
19,499
—
—
—
227
—
—
227
(18,176)
(18,176)
(235)
(8,161)
(8,396)
13,376,836 $
134 $
187,305 $
(20,812) $
166,627
93
OFS Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
Cash flows from operating activities
Net increase in net assets resulting from operations
$
9,553
$
9,572
$
7,910
Adjustments to reconcile net increase in net assets resulting from operations to net cash
Years Ended December 31,
2019
2018
2017
provided by (used in) operating activities:
Net realized (gain) loss on investments
Net change in unrealized depreciation on investments
Amortization of net loan fees
Amendment fees collected
Payment-in-kind interest and dividend income
Accretion of interest income on structured finance notes
Amortization and write-off of debt issuance costs
Amortization of intangible asset
Purchase and origination of portfolio investments
Proceeds from principal payments on portfolio investments
Proceeds from sale or redemption of portfolio investments
Distributions received from portfolio investments
Changes in operating assets and liabilities:
Interest receivable
Interest payable
Payable to investment adviser and affiliates
Payable for investments purchased
Other assets and liabilities
3,900
5,645
(1,424)
177
(1,825)
(2,861)
1,332
195
(222,173)
60,883
35,033
3,076
(562)
714
406
6,113
182
4,779
4,034
(2,288)
161
(2,099)
—
781
195
(272,155)
100,699
47,435
—
(53)
1,195
1,237
4,151
1,268
(6,833)
14,800
(1,450)
175
(2,907)
—
553
195
(142,900)
105,078
37,044
—
(964)
(3)
(91)
—
66
Net cash provided by (used in) operating activities
(101,636)
(101,088)
10,673
Cash flows from financing activities
Proceeds from common stock offering, net of expenses
Payment of common stock offering costs
Proceeds from unsecured notes offerings, net of discounts
Distributions paid to stockholders
Borrowings under revolving line of credit
Repayments under revolving line of credit
Payment of deferred financing costs and other financing costs
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents — beginning of year
Cash and cash equivalents — end of year
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for interest
Reinvestment of stockholder distributions
See Notes to Consolidated Financial Statements.
—
—
—
—
52,270
95,446
(17,949)
151,975
(107,525)
(1,860)
76,911
(24,725)
38,172
13,447
13,754
227
$
$
(22,895)
96,500
(102,100)
(643)
66,308
(34,780)
72,952
38,172
7,256
195
$
$
53,423
(72)
—
(16,700)
44,700
(36,600)
(131)
44,620
55,293
17,659
72,952
5,263
196
$
$
94
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
Non-control/Non-affiliate Investments
Acrisure, LLC (14) (15) (19)
Senior Secured Loan
Insurance Agencies and Brokerages
AHP Health Partners (14) (15) (19)
Hospitals
Senior Secured Loan
General Medical and Surgical
Albertson's Holdings LLC (14) (15)
(19)
Supermarkets and Other Grocery
(except Convenience) Stores
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
6.19%
(L +4.25%)
10/29/2019
11/15/2023
$ 1,995
$
1,971
$2,004
1.2%
6.30%
(L +4.50%)
6/27/2019
6/30/2025
2,607
2,612
2,632
1.6
Senior Secured Loan
4.55%
(L +2.75%)
6/24/2019
11/17/2025
1,082
1,081
1,094
0.7
All Star Auto Lights, Inc. (4)
Senior Secured Loan
Motor Vehicle Parts (Used)
Merchant Wholesalers
American Bath Group, LLC (14) (15)
(19)
Plastics Plumbing Fixture
Manufacturing
9.24%
(L +7.50%)
12/19/2019
8/20/2024
13,250
13,119
13,119
7.9
Senior Secured Loan
6.05%
(L +4.25%)
6/24/2019
9/30/2023
1,489
1,484
1,498
0.9
AppLovin Corporation (14) (15) (19)
Advertising Agencies
Senior Secured Loan
5.30%
(L +3.50%)
6/24/2019
8/15/2025
1,985
1,987
2,001
1.2
Asurion, LLC (14) (15) (19)
and Maintenance
Communication Equipment Repair
Senior Secured Loan
Senior Secured Loan
Senior Secured Loan
4.80%
4.80%
8.30%
(L +3.00%)
6/24/2019
11/3/2024
(L +3.00%)
7/24/2019
11/3/2023
(L +6.50%)
11/19/2019
8/24/2025
1,985
995
1,500
4,480
1,985
997
1,511
4,493
1,998
1,002
1,511
4,511
Athenahealth, Inc. (14) (15) (19)
Software Publishers
Senior Secured Loan
6.40%
(L +4.50%)
6/24/2019
2/11/2026
1,985
1,990
1,998
1.2
0.6
0.9
2.7
1.2
Bass Pro Group, LLC (14) (15) (19)
Sporting Goods Stores
Senior Secured Loan
6.80%
(L +5.00%)
6/24/2019
9/25/2024
1,985
1,921
1,983
1.2
95
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
BayMark Health Services, Inc.
Senior Secured Loan
Industry
Outpatient Mental Health and
Substance Abuse Centers
Blackhawk Network Holdings, Inc.
(14) (15) (19)
Equipment and Software
Merchant Wholesalers
Computer and Computer Peripheral
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
10.21%
(L +8.25%)
3/22/2018
3/1/2025
$ 4,000
$
3,970
$4,000
2.4%
Senior Secured Loan
4.80%
(L +3.00%)
10/30/2019
6/15/2025
1,995
1,982
1,999
1.2
BrightSpring Health Services (14)
(15) (19)
Senior Secured Loan
Residential Intellectual and
Developmental Disability
Facilities
Brookfield WEC Holdings Inc. (14)
(15) (19)
Business to Business Electronic
Markets
6.21%
(L +4.50%)
6/24/2019
3/5/2026
2,985
2,991
3,006
1.8
Senior Secured Loan
4.67%
(L +3.00%)
7/25/2019
8/1/2025
1,990
2,000
2,000
1.2
Carolina Lubes, Inc.
Senior Secured Loan (4) (8)
Senior Secured Loan (Revolver) (5)
Charter NEX US, Inc. (14) (15) (19)
Senior Secured Loan
CHG Healthcare Services, Inc. (15)
(19)
Senior Secured Loan
Automotive Oil Change and
Lubrication Shops
Unlaminated Plastics Profile Shape
Manufacturing
All Other Outpatient Care Centers
Cirrus Medical Staffing, Inc. (4)
Temporary Help Services
Senior Secured Loan
Senior Secured Loan (Revolver)
Community Intervention Services,
Inc. (4) (6) (10) (11)
Outpatient Mental Health and
Substance Abuse Centers
Subordinated Loan
9.83%
(L +7.73%)
8/23/2017
8/23/2022
20,268
20,172
20,466
0.25% (18)
(L +7.25%)
8/23/2017
8/23/2022
—
(8)
(8)
20,268
20,164
20,458
12.3
—
12.3
5.30%
(L +3.50%)
10/30/2019
5/16/2024
2,000
1,985
1,985
1.2
4.80%
(L +3.00%)
7/24/2019
6/7/2023
1,999
2,001
2,015
1.2
10.19%
10.19%
(L +8.25%)
(L +8.25%)
3/5/2018
3/5/2018
10/19/2022
10/19/2022
12,564
1,408
13,972
12,458
12,358
1,408
1,384
13,866
13,742
7.4
0.8
8.2
N/A
7/16/2015
1/16/2021
9,624
7,639
—
—
7.00% cash /
6.00% PIK
96
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
Confie Seguros Holdings II Co. (14)
Insurance Agencies and Brokerages
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
Senior Secured Loan
10.41%
(L +8.50%)
7/7/2015
11/1/2025
$ 9,678
$
9,515
$9,382
5.6%
Connect U.S. Finco LLC (14) (15)
(19)
Taxi Service
Senior Secured Loan
Constellis Holdings, LLC (6)
Safety Activities
Other Justice, Public Order, and
6.29%
(L +4.50%)
11/20/2019
12/11/2026
2,000
1,990
1,990
1.2
Senior Secured Loan
10.93%
(L +9.00%)
4/28/2017
4/21/2025
9,950
9,846
407
0.2
Convergint Technologies Holdings,
LLC
Security Systems Services (except
Locksmiths)
Senior Secured Loan
8.55%
(L +6.75%)
9/28/2018
2/2/2026
3,481
3,430
3,424
2.1
Curium BidCo S.A R.L. (14) (15) (19)
Manufacturing
Pharmaceutical and Medicine
Senior Secured Loan
Davis Vision, Inc.
Senior Secured Loan
Direct Health and Medical
Insurance Carriers
5.94%
(L +4.00%)
10/29/2019
7/1/2026
848
853
853
0.5
8.55%
(L +6.75%)
10/31/2019
12/1/2025
405
395
405
0.2
Dexko Global Inc. (14) (15) (19)
Motor Vehicle Body Manufacturing
Senior Secured Loan
5.30%
(L +3.50%)
10/30/2019
7/24/2024
1,995
1,970
1,997
1.2
Diamond Sports Group, LLC (14)
(15) (19)
Senior Secured Loan
Television Broadcasting
DuPage Medical Group (15) (19)
Health Specialists
Offices of Physicians, Mental
5.03%
(L +3.25%)
11/19/2019
8/24/2026
1,995
1,997
1,997
1.2
Senior Secured Loan
8.80%
(L +7.00%)
8/22/2017
8/15/2025
10,098
10,170
10,098
6.1
Eblens Holdings, Inc.
Shoe Store
Subordinated Loan (11)
Common Equity (71,250 Class A
units) (10)
12.00% cash /
1.00% PIK
97
7/13/2017
1/13/2023
9,010
8,962
9,025
7/13/2017
9,010
713
9,675
892
9,917
5.4
0.5
5.9
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
Endo International PLC (14) (15)
(19)
Pharmaceutical Preparation
Manufacturing
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
Senior Secured Loan
6.06%
(L +4.25%)
6/24/2019
4/29/2024
$ 1,985
$
1,897
$1,906
1.1%
Envocore Holding, LLC (FKA LRI
Holding, LLC) (4)
Electrical Contractors and Other
Wiring Installation Contractors
Senior Secured Loan
Preferred Equity (238,095 Series B
units) (10)
Preferred Equity (13,315 Series C
units) (10)
6.00% cash /
5.00% PIK
(L +6.00%)
6/30/2017
6/30/2022
16,367
16,207
14,639
6/30/2017
8/13/2018
300
13
—
—
16,367
16,520
14,639
Excelin Home Health, LLC
Home Health Care Services
Senior Secured Loan
11.50%
(L +9.50%)
10/25/2018
4/25/2024
4,250
4,183
4,070
8.8
—
—
8.8
2.4
Explorer Holdings, Inc. (14) (15) (19) Testing Laboratories
Senior Secured Loan
5.60%
(L +3.75%)
6/25/2019
5/2/2023
1,985
1,987
2,004
1.2
Garda World Security (14) (15) (19)
Locksmiths)
Security Systems Services (except
Senior Secured Loan
6.66%
(L +4.75%)
10/24/2019
10/30/2026
1,667
1,634
1,680
1.0
Other Aircraft Parts and Auxiliary
Equipment Manufacturing
GGC Aerospace Topco L.P.
Senior Secured Loan
Common Equity (368,852 Class A
units) (10)
Common Equity (40,984 Class B
units) (10)
12/29/2017
12/29/2017
10.65%
(L +8.75%)
12/29/2017
9/8/2024
5,000
4,912
4,084
Hyland Software, Inc.
Software Publishers
Senior Secured Loan (14) (15) (19)
Senior Secured Loan
5.30%
8.80%
(L +3.50%)
10/24/2018
(L +7.00%)
10/24/2018
7/1/2024
7/7/2025
450
50
124
5
5,000
5,412
4,213
1,660
2,601
4,261
1,655
2,614
4,269
1,672
2,617
4,289
2.5
0.1
—
2.6
1.0
1.6
2.6
9.9
Inergex Holdings, LLC
Other Computer Related Services
Senior Secured Loan
Senior Secured Loan (Revolver) (5)
(18)
8.94%
(L +7.00%)
10/1/2018
10/1/2024
16,590
16,389
16,489
6.05%
(L +7.00%)
10/1/2018
10/1/2024
1,875
18,465
1,853
1,864
18,242
18,353
1.1
11.0
98
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Institutional Shareholder Services,
Inc.
Senior Secured Loan
Intouch Midco Inc. (15) (19)
Senior Secured Loan
Kindred Healthcare, Inc. (FKA
Kindred at Home) (14) (15) (19)
Senior Secured Loan
Industry
Administrative Management and
General Management Consulting
Services
All Other Professional, Scientific,
and Technical Services
Home Health Care Services
McAfee, LLC (14) (15) (19)
Software Publishers
Senior Secured Loan
Senior Secured Loan
Internet Publishing and
Broadcasting and Web Search
Portals
Administrative Management and
General Management Consulting
Services
Security Systems Services (except
Locksmiths)
Micro Holding Corp (14) (15) (19)
Senior Secured Loan
Milrose Consultants, LLC (4) (8)
Senior Secured Loan
My Alarm Center, LLC (4) (10) (13)
Preferred Equity (1,485 Class A
units), 8% PIK
Preferred Equity (1,198 Class B
units)
Preferred Equity (335 Class Z units)
25% PIK
Common Equity (64,149 units)
Online Tech Stores, LLC (4)
Subordinated Loan
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
10.44%
(L +8.50%)
3/4/2019
3/5/2027
$ 6,244
$
6,075
$6,098
3.7%
6.05%
(L +4.25%)
12/20/2019
8/24/2025
1,995
1,925
1,925
1.2
5.56%
(L +3.75%)
6/25/2019
7/2/2025
2,985
2,998
3,004
1.8
5.55%
10.30%
(L +3.75%)
6/25/2019
9/30/2024
(L +8.50%)
11/15/2019
9/29/2025
1,985
2,000
3,985
1,987
2,002
3,989
1,996
2,018
4,014
1.2
1.2
2.4
5.55%
(L +3.75%)
6/25/2019
9/13/2024
1,985
1,969
1,991
1.2
8.14%
(L +6.20%)
7/16/2019
7/16/2025
11,500
11,420
11,394
6.7
7/14/2017
7/14/2017
9/12/2018
7/14/2017
1,571
1,198
325
—
984
—
1,136
—
3,094
2,120
0.6
—
0.7
—
1.3
Stationery and Office Supplies
Merchant Wholesalers
10.50% cash /
3.00% PIK
N/A
2/1/2018
8/1/2023
16,323
16,113
14,559
8.7
OnSite Care, PLLC (4) (8)
Home Health Care Services
Senior Secured Loan
9.09%
(L +7.78%)
8/10/2018
8/10/2023
9,541
9,446
9,162
5.5
99
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
Other Commercial and Service
Panther BF Aggregator 2 LP (14)
(15) (19)
Industry Machinery
Manufacturing
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
Senior Secured Loan
5.30%
(L +3.50%)
11/19/2019
4/30/2026
$ 1,995
$
1,978
$2,006
1.2%
Parfums Holding Company, Inc.
Perfume Stores
Cosmetics, Beauty Supplies, and
Senior Secured Loan (14) (15) (19)
Senior Secured Loan
Pelican Products, Inc.
Senior Secured Loan
Unlaminated Plastics Profile Shape
Manufacturing
Performance Team LLC (4)
General Warehousing and Storage
6.16%
10.70%
(L +4.25%)
6/25/2019
6/30/2024
(L +8.75%)
11/16/2017
6/30/2025
87
6,320
6,407
87
6,332
6,419
87
6,276
6,363
0.1
3.8
3.9
9.49%
(L +7.75%)
9/24/2018
5/1/2026
6,055
6,059
5,969
3.6
Senior Secured Loan
11.80%
(L +10.00%)
5/24/2018
11/24/2023
13,889
13,790
14,165
8.4
PM Acquisition LLC
Stores
All Other General Merchandise
Senior Secured Loan
Common Equity (499 units) (10) (13)
Quest Software US Holdings Inc. (14)
(15) (19)
Equipment and Software
Merchant Wholesalers
Computer and Computer Peripheral
Senior Secured Loan
Refinitiv (14) (15) (19)
Senior Secured Loan
Resource Label Group, LLC
Senior Secured Loan
Public Finance Activities
Commercial Printing (except
Screen and Books)
Restaurant Technologies, Inc. (15)
(19)
Other Grocery and Related
Products Merchant Wholesalers
11.50% cash /
2.50% PIK
N/A
9/30/2017
10/29/2021
4,963
9/30/2017
4,963
4,903
499
5,402
4,800
220
5,020
2.9
0.1
3.0
6.18%
(L +4.25%)
6/25/2019
5/16/2025
1,990
1,973
1,978
1.2
5.05%
(L +4.25%)
6/24/2019
10/1/2025
1,987
1,941
2,007
1.2
10.60%
(L +8.50%)
6/7/2017
11/26/2023
4,821
4,777
4,591
2.8
Senior Secured Loan
5.05%
(L +3.25%)
8/8/2019
10/1/2025
1,990
1,994
2,003
1.2
100
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
Rocket Software, Inc. (15) (19)
Software Publishers
Senior Secured Loan
Senior Secured Loan
RPLF Holdings, LLC (10) (13)
Common Equity (254,110 Class A
units)
Sentry Centers Holdings, LLC (10)
(13)
Common Equity (5,000 Series C
units)
Software Publishers
Other Professional, Scientific, and
Technical Services
Southern Technical Institute, LLC (4)
(6) (10)
Colleges, Universities, and
Professional Schools
Subordinated Loan
Other
Spring Education Group, Inc. (F/K/A
SSH Group Holdings, Inc.)
Child Day Care Services
Senior Secured Loan
Senior Secured Loan
Sprint Communications, Inc. (14)
(15) (19)
Wired Telecommunications
Carriers
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
6.05%
10.05%
(L +4.25%)
11/20/2018
11/28/2025
$
665
$
663
$ 649
(L +8.25%)
11/20/2018
11/28/2026
6,275
6,940
6,167
6,830
6,094
6,743
0.4%
3.7
4.1
1/17/2018
254
186
0.1
3/31/2014
—
500
1,490
0.9
6.00% PIK
N/A
6/27/2018
12/31/2021
6/27/2018
6.19%
10.19%
(L +4.25%)
7/26/2018
7/30/2025
(L +8.25%)
7/26/2018
7/30/2026
1,611
—
1,611
972
7,216
8,188
—
—
—
—
—
—
970
7,157
8,127
978
7,288
8,266
—
—
—
0.6
4.4
5.0
Senior Secured Loan
4.81%
(L +3.00%)
6/24/2019
2/2/2024
1,985
1,972
1,980
1.2
SSJA Bariatric Management LLC
(15) (19)
Offices of Physicians, Mental
Health Specialists
Senior Secured Loan
Senior Secured Loan (Revolver) (5)
Stancor, L.P. (4) (10)
Preferred Equity (1,250,000 Class A
units), 8% PIK
Pump and Pumping Equipment
Manufacturing
Staples, Inc. (14) (15) (19)
Markets
Senior Secured Loan
Business to Business Electronic
6.94%
(L +5.00%)
8/26/2019
8/26/2024
0.50% (18)
(L +5.00%)
8/26/2019
8/26/2024
9,975
—
9,975
9,883
9,861
(6)
(14)
9,877
9,847
5.9
—
5.9
8/19/2014
—
1,501
1,607
1.0
6.69%
(L +5.00%)
6/24/2019
4/16/2026
1,990
1,920
1,960
1.1
101
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
STS Operating, Inc.
Senior Secured Loan (14) (15) (19)
Senior Secured Loan
Industry
Industrial Machinery and
Equipment Merchant
Wholesalers
Sunshine Luxembourg VII SARL (14)
(15) (19)
Pharmaceutical Preparation
Manufacturing
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
6.05%
9.80%
(L +4.25%)
5/16/2018
12/11/2024
$
632
$
631
$ 632
(L +8.00%)
5/15/2018
4/30/2026
9,073
9,705
9,070
9,701
9,030
9,662
0.4%
5.4
5.8
Senior Secured Loan
6.19%
(L +4.25%)
11/20/2019
9/25/2026
2,000
2,010
2,021
1.2
Tank Holding Corp. (14) (15) (19)
Manufacturing
Unlaminated Plastics Profile Shape
Senior Secured Loan
6.41%
(L +4.00%)
6/24/2019
3/26/2026
1,995
2,002
2,005
1.2
The Escape Game, LLC (4)
industries
Other amusement and recreation
Senior Secured Loan
Senior Secured Loan
Senior Secured Loan
8.80%
10.55%
10.55%
(L +7.00%)
7/18/2019
3/31/2020
(L +8.75%)
12/22/2017
12/22/2022
(L +8.75%)
7/20/2018
12/22/2022
4,667
7,000
7,000
4,642
6,969
7,000
4,648
6,972
6,972
18,667
18,611
18,592
2.8
4.2
4.2
11.2
Truck Hero, Inc. (15) (19)
Truck Trailer Manufacturing
Senior Secured Loan
10.05%
(L +8.25%)
5/30/2017
4/21/2025
7,014
6,990
6,690
4.0
United Biologics Holdings, LLC (4)
(10)
Preferred Equity (151,787 units)
Warrants (29,374 units)
Medical Laboratories
U.S. Anesthesia Partners (14) (15)
(19)
Freestanding Ambulatory Surgical
and Emergency Centers
4/16/2013
7/26/2012
3/05/2022
(12)
—
—
—
9
82
91
15
7
22
—
—
—
Senior Secured Loan
4.80%
(L +3.00%)
6/24/2019
6/23/2024
2,980
2,950
2,976
1.8
Verifone Intermediate Holdings, Inc.
(14) (15) (19)
Industry Machinery
Manufacturing
Other Commercial and Service
Senior Secured Loan
5.90%
(L +4.00%)
6/24/2019
8/20/2025
258
252
256
0.2
Wastebuilt Environmental Solutions,
LLC (4)
Industrial Supplies Merchant
Wholesalers
Senior Secured Loan
10.69%
(L +8.75%)
10/11/2018
10/11/2024
7,000
6,883
6,584
4.0
102
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Total Debt and Equity
Investments
Structured Finance Note
Investments (7)
Dryden 76 CLO, Ltd.
Subordinated Notes
Elevation CLO 2017-7, Ltd.
Subordinated Notes
Flatiron CLO 18, Ltd.
Subordinated Notes
THL Credit Wind River 2019‐3 CLO
Ltd.
Subordinated Notes
Total Structured Finance Note
Investments
Total Non-control/Non-affiliate
Investments
Industry
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value (3)
Percent
of
Net
Assets
15.37% (9)
15.71% (9)
16.68% (9)
12.33% (9)
$372,094
$373,074
$350,925
210.7%
9/27/2019
10/20/2032
(17)
2,750
2,491
2,509
1.5
2/6/2019
7/15/2030
(17)
10,000
7,485
6,559
3.9
1/2/2019
4/17/2031
(17)
9,680
7,355
7,345
4.4
4/5/2019
4/15/2031
(17)
7,000
5,796
5,197
3.1
$ 29,430
$ 23,127
$ 21,610
12.9%
$401,524
$396,201
$372,535
223.6%
Affiliate Investments
3rd Rock Gaming Holdings, LLC
Software Publishers
Senior Secured Loan
Common Equity (2,547,250 units)
(10) (13)
Chemical Resources Holdings, Inc.
Senior Secured Loan (4)(8)
Common Equity (1,832 Class A
shares) (10) (13)
Custom Compounding of
Purchased Resins
9.44% cash /
1.00% PIK
(L +7.50%)
3/13/2018
3/12/2023
21,373
21,176
20,099
3/13/2018
—
21,373
2,547
23,723
1,044
21,143
9.82%
(L +7.89%)
1/25/2019
1/25/2024
13,743
13,592
13,746
1/25/2019
13,743
1,813
15,405
2,662
16,408
103
12.1
0.6
12.7
8.2
1.6
9.8
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
Office Machinery and Equipment
Contract Datascan Holdings, Inc. (4)
Rental and Leasing
Subordinated Loan
Preferred Equity (3,061 Series A
shares) 10% PIK (10)
Common Equity (11,273 shares) (10)
DRS Imaging Services, LLC
Senior Secured Loan (4) (8)
Common Equity (1,135 units) (10)
(13)
Master Cutlery, LLC (4) (6) (10)
Subordinated Loan (11)
Preferred Equity (3,723 Series A
units), 8% PIK
Common Equity (15,564 units)
Data Processing, Hosting, and
Related Services
Sporting and Recreational Goods
and Supplies Merchant
Wholesalers
NeoSystems Corp. (4) (10)
Preferred Equity (521,962 convertible
shares) 10% PIK
Other Accounting Services
Pfanstiehl Holdings, Inc. (4)
Subordinated Loan
Common Equity (400 Class A shares)
Pharmaceutical Preparation
Manufacturing
Professional Pipe Holdings, LLC
Plumbing, Heating, and Air-
Conditioning Contractors
Senior Secured Loan
Common Equity (1,414 Class A
units) (10)
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
12.00%
N/A
8/5/2015
2/5/2021
$ 8,000
$
7,995
$8,000
4.8%
8/5/2015
6/28/2016
5,599
104
5,671
671
8,000
13,698
14,342
11.21%
(L +9.27%)
3/8/2018
11/20/2023
10,741
10,670
10,569
3/8/2018
1,135
1,331
10,741
11,805
11,900
13.00%
N/A
4/17/2015
4/17/2020
5,947
4/17/2015
4/17/2015
—
—
5,947
4,764
3,483
—
8,247
255
—
—
255
3.4
0.4
8.6
6.3
0.8
7.1
0.2
—
—
0.2
8/14/2014
—
1,698
2,250
1.4
10.50%
N/A
1/1/2014
1/1/2014
9/29/2022
3,788
—
3,788
3,807
217
4,024
3,788
11,979
15,767
10.55% cash /
1.50% PIK
(L +9.27%)
3/23/2018
3/23/2023
7,099
7,008
7,170
3/23/2018
—
7,099
1,414
8,422
2,413
9,583
2.3
7.2
9.5
4.3
1.4
5.7
104
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
Industry
Professional and Management
Development Training
Commercial and Industrial
Machinery and Equipment
(except Automotive and
Electronic) Repair and
Maintenance
Portfolio Company (1)
Investment Type
TalentSmart Holdings, LLC
Senior Secured Loan (4)
Senior Secured Loan (Revolver) (5)
(18)
Common Equity (1,500 Class A
shares) (10) (13)
TRS Services, LLC (4) (11)
Senior Secured Loan
Preferred Equity (329,266 Class AA
units), 15% PIK (10)
Preferred Equity (3,000,000 Class A
units), 11% PIK (10)
Common Equity (3,000,000 units)
(10)
TTG Healthcare, LLC
Diagnostic Imaging Centers
Senior Secured Loan (4)
Preferred Equity ( 2,309 Class B
units) (10) (13)
Total Affiliate Investments
Control Investment
MTE Holding Corp. (4)
Subordinated Loan (to Mirage
Trailers, LLC, a controlled,
consolidated subsidiary of MTE
Holding Corp.)
Common Equity (554 shares)
Total Control Investment
Total Investments
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value (3)
Percent
of
Net
Assets
8.50%
(L +6.75%)
10/11/2019
10/11/2024
$ 10,000
$
9,833
$
9,833
5.9%
8.50%
(L +6.75%)
10/11/2019
10/11/2024
10/11/2019
250
—
10,250
242
242
1,500
11,575
1,500
11,575
10.55% cash /
1.00% PIK
(L +8.75%)
12/10/2014
3/16/2020
14,624
14,615
14,623
6/30/2016
12/10/2014
12/10/2014
—
—
—
545
547
3,374
3,095
572
—
14,624
19,106
18,265
10.71%
(L +9.00%)
3/1/2019
3/1/2024
12,103
11,938
11,767
3/1/2019
12,103
2,309
14,247
2,424
14,191
0.1
0.9
6.9
8.8
0.3
1.9
—
11.0
7.1
1.5
8.6
Travel Trailer and Camper
Manufacturing
10.26% cash /
4.50% PIK
(L +8.50%)
11/25/2015
11/25/2020
11/25/2015
105
$107,668
$131,950
$135,679
81.5%
7,464
—
7,464
7,451
3,069
10,520
7,464
1,253
8,717
4.5
0.8
5.3
$
7,464
$ 10,520
$
8,717
5.3%
$516,656
$538,671
$516,931
310.4%
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2019
(Dollar amounts in thousands)
(1) Equity ownership may be held in shares or units of companies affiliated with the portfolio company. The Company's investments are generally classified as "restricted securities" as such
term is defined under Regulation S-X Rule 6-03(f) or Securities Act Rule 144.
(2) Substantially all of the investments that bear interest at a variable rate are indexed to LIBOR (L), generally between 1.7% and 2.1% at December 31, 2019, and reset monthly, quarterly, or
semi-annually. Variable-rate loans with an aggregate cost of $420,410 include LIBOR reference rate floor provisions of generally 1% to 2%; at December 31, 2019, the reference rate on all
such instruments was above the stated floors. For each investment, the Company has provided the spread over the reference rate and current interest rate in effect at December 31, 2019.
Unless otherwise noted, all investments with a stated PIK rate require interest payments with the issuance of additional securities as payment of the entire PIK provision.
(3) Unless otherwise noted with footnote 14, fair value was determined using significant unobservable inputs for all of the Company's investments and are considered Level 3 under GAAP.
(4)
See Note 5 for further details.
Investments (or portion thereof) held by SBIC I LP. These assets (or a portion thereof) are held to support the SBA debentures and can not be pledged under any debt obligation of the
Company.
(5) Subject to unfunded commitments. See Note 6 for further details.
(6)
Investment was on non-accrual status as of December 31, 2019, meaning the Company has ceased recognition of all or a portion of income on the investment. See Note 4 for further details.
(7) Structured Finance Notes are considered CLO subordinated debt positions. CLO subordinated debt positions are entitled to recurring distributions which are generally equal to the remaining
cash flow of payments made by underlying securities less contractual payments to debt holders and fund expenses.
(8) The Company has entered into a contractual arrangement with co‑lenders whereby, subject to certain conditions, it has agreed to receive its payment after the repayment of certain co‑lenders
pursuant to a payment waterfall. The table below provides additional details as of December 31, 2019:
Portfolio Company
Carolina Lubes, Inc.
Chemical Resources Holdings, Inc.
DRS Imaging Services, LLC
Milrose Consultants, LLC
OnSite Care, PLLC
Reported Interest
Rate
Interest Rate per
Credit Agreement
Additional Interest per
Annum
9.83%
9.82%
11.21%
8.14%
9.49%
9.35%
7.93%
9.94%
7.44%
7.96%
0.48%
1.89%
1.27%
0.70%
1.53%
(9) The rate disclosed is an estimated effective yield based upon the current projection of the amount and timing of distributions in addition to the estimated amount and timing of terminal
principal payments. Effective yields for the Company's Structured Finance Note investments are monitored and evaluated at each reporting date. The estimated yield and investment cost
may ultimately not be realized.
(10) Non-income producing.
(11)The interest rate on these investments contains a PIK provision, whereby the issuer has the option to make interest payments in cash or with the issuance of additional securities as payment of
the entire PIK provision. The interest rate in the schedule represents the current interest rate in effect for these investments. The following table provides additional details on these PIK
investments, including the maximum annual PIK interest rate allowed as of December 31, 2019:
Portfolio Company
Community Intervention Services, Inc.
Eblens Holdings, Inc.
Master Cutlery, LLC
TRS Services, LLC
Investment Type
Subordinated Loan
Subordinated Loan
Senior Secured Loan
Senior Secured Loan
Range of PIK
Option
Range of Cash
Option
Maximum PIK
Rate Allowed
0% or 6.00% 13.00% or 7.00%
0% or 1.00% 13.00% or 12.00%
0% to 13.00%
13.00% to 0%
0% or 1.00% 12.65% or 1.00%
6.00%
1.00%
13.00%
1.00%
(12) Represents expiration date of the warrants.
(13) All or portion of investment held by OFSCC-MB.
(14) Fair value was determined by reference to observable inputs other than quoted prices in active markets and are considered Level 2 under GAAP. See Note 5 for further details.
(15) Investments (or portion thereof) held by OFSCC-FS. These assets are pledged as collateral of the BNP Credit Facility and can not be pledged under any other debt obligation of the
Company.
(16) Amortized cost reflects accretion of effective yield less any cash distributions received or entitled to be received from CLO Structured Finance Note investments.
(17) Maturity represents the contractual maturity date of the structured finance notes. Expected maturity and cash flows, not contractual maturity and cash flows, were utilized in deriving the
effective yield of the investments.
(18) Commitment fee on undrawn funds.
See Notes to Financial Statements.
106
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
Non-control/Non-affiliate Investments
BayMark Health Services
Senior Secured Loan
Outpatient Mental Health and
Substance Abuse Centers
Brookfield WEC Holdings Inc.,
Markets
Business to Business Electronic
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
10.60%
(L +8.25%)
3/22/2018 3/1/2025 $ 4,000 $
3,964 $3,933
2.2%
Senior Secured Loan
9.27%
(L +6.75%)
12/6/2018 8/3/2026
1,959
1,959
1,914
1.1
Carolina Lubes, Inc. (4)
Senior Secured Loan (8)
Senior Secured Loan (Revolver) (7)
Automotive Oil Change and
Lubrication Shops
Cirrus Medical Staffing, Inc. (4)
Temporary Help Services
Senior Secured Loan
Senior Secured Loan (Revolver) (7)
Community Intervention Services,
Inc. (4) (6) (10) (11)
Outpatient Mental Health and
Substance Abuse Centers
10.24%
9.65%
(L +7.82%)
(L +7.25%)
8/23/2017 8/23/2022
8/23/2017 8/23/2022
11.05%
11.05%
(L +8.25%)
3/5/2018
(L +8.25%)
3/5/2018
10/19/2022
10/19/2022
20,840
—
20,840
20,705 20,839
—
20,694 20,839
(11)
12,926
1,280
14,206
12,779 12,732
1,280
1,261
14,059 13,993
11.9
—
11.9
7.3
0.7
8.0
Subordinated Loan
7.0% cash /
6.0% PIK
N/A
7/16/2015 1/16/2021
9,060
7,639
—
—
Confie Seguros Holdings II Co.
Insurance Agencies and Brokerages
Senior Secured Loan
Constellis Holdings, LLC
Senior Secured Loan
Other Justice, Public Order, and
Safety Activities
Convergint Technologies Holdings,
LLC
Security Systems Services (except
Locksmiths)
Senior Secured Loan
Davis Vision, Inc.
Senior Secured Loan
Direct Health and Medical
Insurance Carriers
11.24%
(L +8.50%)
7/7/2015
11/1/2025
9,678
9,489
9,290
5.3
11.52%
(L +9.00%)
4/28/2017 4/21/2025
9,950
9,832
9,437
5.4
9.27%
(L +6.75%)
9/28/2018 2/2/2026
3,481
3,422
3,327
1.9
9.28%
(L +6.75%)
7/17/2018 12/1/2025
5,854
5,700
5,570
3.2
107
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
DuPage Medical Group
Senior Secured Loan
Industry
Offices of Physicians, Mental
Health Specialists
Eblens Holdings, Inc.
Shoe Store
Subordinated Loan (11)
Common Equity (71,250 Class A
units) (10)
Elgin Fasteners Group
Senior Secured Loan
Bolt, Nut, Screw, Rivet, and
Washer Manufacturing
Envocore Holding, LLC (FKA LRI
Holding, LLC) (4)
Electrical Contractors and Other
Wiring Installation Contractors
Senior Secured Loan
Preferred Equity (238,095 Series B
units) (10)
Preferred Equity (13,315 Series C
units) (10)
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
9.50%
(L +7.00%)
8/22/2017 8/15/2025 $ 10,098 $ 10,185 $9,771
5.6%
12.0% cash /
1.00% PIK
N/A
7/13/2017 1/13/2023
8,920
8,855
8,821
7/13/2017
713
9,568
722
9,543
8,920
5
0.4
5.4
9.30%
(L +6.50%)
10/31/2011 8/27/2018
3,645
3,645
3,509
2.0
12.05%
(L +9.25%)
6/30/2017 6/30/2022
17,344
17,212 16,821
6/30/2017
8/13/2018
300
300
13
13
17,525 17,134
17,344
9.6
0.2
—
9.8
Excelin Home Health, LLC
Home Health Care Services
Senior Secured Loan
12.31%
(L +9.50%)
10/25/2018 4/25/2024
4,250
4,168
4,168
2.4
GGC Aerospace Topco L.P.
Senior Secured Loan
Common Equity (368,852 Class A
units) (10)
Common Equity (40,984 Class B
units) (10)
GOBP Holdings, Inc.
Senior Secured Loan
Hyland Software, Inc.
Senior Secured Loan
Senior Secured Loan
Other Aircraft Parts and Auxiliary
Equipment Manufacturing
Supermarkets and Other Grocery
(except Convenience) Stores
Software Publishers
11.49%
(L +8.75%)
12/29/2017 9/8/2024
5,000
4,894
4,033
12/29/2017
12/29/2017
450
104
50
5,394
4
4,141
5,000
2.3
0.1
—
2.4
10.05%
(L +7.25%)
10/17/2018 10/22/2026
1,400
1,386
1,349
0.8
6.02%
9.52%
(L +3.50%)
(L +7.00%)
10/24/2018 7/1/2024
10/24/2018 7/7/2025
173
2,601
2,774
173
2,620
2,793
166
2,534
2,700
0.1
1.4
1.5
108
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Inergex Holdings
Senior Secured Loan
Senior Secured Loan (Revolver) (7)
JBR Clinical Research, Inc. (4) (8)
Senior Secured Loan
Industry
Other Computer Related Services
Research and Development in the
Social Sciences and Humanities
MAI Holdings, Inc. (4)
Manufacturing
Printing Machinery and Equipment
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value (3)
9.39%
0.50%
(L +7.00%)
10/1/2018 10/1/2024 $ 13,092 $ 12,904 $ 12,904
—
10/1/2018 10/1/2024
12,904
—
13,092
(27)
12,877
Percent
of
Net
Assets
7.4%
—
7.4
9.10%
(L +6.71%)
8/2/2018
8/2/2023
29,943
29,693
29,016
16.5
Senior Secured Loan
9.50%
N/A
6/21/2018 6/1/2023
5,000
5,000
4,841
2.8
My Alarm Center, LLC (4) (10) (13)
Preferred Equity (1,485 Class A
units), 8% PIK
Preferred Equity (1,198 Class B
units)
Preferred Equity (335 Class Z units)
25% PIK
Common Equity (64,149 units)
Online Tech Stores, LLC (4)
Subordinated Loan
Security Systems Services (except
Locksmiths)
7/14/2017
7/14/2017
9/12/2018
7/14/2017
1,571
1,536
1,198
325
—
3,094
—
1,038
—
2,574
0.9
—
0.6
—
1.5
Stationery and Office Supplies
Merchant Wholesalers
10.50% cash /
1.0% PIK
N/A
2/1/2018
8/1/2023
16,150
15,882
15,785
8.9
OnSite Care, PLLC (4) (8)
Home Health Care Services
Senior Secured Loan
10.22%
(L +7.85%)
8/10/2018 8/10/2023
7,100
7,035
7,008
4.0
Parfums Holding Company, Inc.
Perfume Stores
Cosmetics, Beauty Supplies, and
Senior Secured Loan
11.56%
(L +8.75%)
11/16/2017 6/30/2025
6,320
6,334
6,292
3.6
Pelican Products, Inc.
Manufacturing
Unlaminated Plastics Profile Shape
Senior Secured Loan
10.13%
(L +7.75%)
9/24/2018 5/1/2026
6,055
6,060
5,901
3.4
Performance Team LLC (4)
General Warehousing and Storage
Senior Secured Loan
12.52%
(L +10.00%)
5/24/2018 11/24/2023
20,300
20,118
20,647
11.7
109
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
110
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
All Other General Merchandise
PM Acquisition LLC
Stores
Senior Secured Loan
Common Equity (499 units) (10) (13)
Resource Label Group, LLC
Senior Secured Loan
Rocket Software, Inc.
Senior Secured Loan
Senior Secured Loan
Commercial Printing (except
Screen and Books)
Software Publishers
RPLF Holdings, LLC (10) (13)
Common Equity (254,110 Class A
units)
Software Publishers
Sentry Centers Holdings, LLC
Technical Services
Other Professional, Scientific, and
Senior Secured Loan (14)
Common Equity (5,000 Series C
units) (10) (13)
Southern Technical Institute, LLC (4)
(6) (10)
Colleges, Universities, and
Professional Schools
Subordinated Loan
Other
SSH Group Holdings, Inc.
Child Day Care Services
Senior Secured Loan
Senior Secured Loan
Stancor, L.P. (4) (10)
Preferred Equity (1,250,000 Class A
units), 8% PIK
Pump and Pumping Equipment
Manufacturing
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
11.50% cash /
2.50% PIK
N/A
9/30/2017 10/29/2021 $ 5,512 $
9/30/2017
5,512
5,431 $5,217
137
5,354
499
5,930
3.0%
0.1
3.1
10.90%
(L +8.50%)
6/7/2017
11/26/2023
4,821
4,767
4,772
2.7
6.77%
10.77%
(L +4.25%)
(L +8.25%)
11/20/2018 11/19/2025
11/20/2018 11/19/2026
670
5,187
5,857
667
5,136
5,803
645
5,046
5,691
0.4
2.9
3.3
1/17/2018
254
291
0.2
13.50%
(L +11.50%)
1/25/2016 7/24/2020
8,855
8,802
8,753
3/31/2014
—
8,855
500
9,302
983
9,736
6.00% PIK
N/A
6/27/2018 12/31/2021
6/27/2018
6.77%
10.77%
(L +4.25%)
(L +8.25%)
7/26/2018 7/30/2025
7/26/2018 7/30/2026
1,517
—
1,517
982
7,216
8,198
—
—
—
—
—
—
979
7,147
8,126
920
6,839
7,759
5.0
0.6
5.6
—
—
—
0.5
3.9
4.4
8/19/2014
—
1,501
1,416
0.8
111
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
STS Operating, Inc.
Senior Secured Loan
Senior Secured Loan
The Escape Game, LLC (4)
Senior Secured Loan
Senior Secured Loan (Delayed
Draw) (7)
Truck Hero, Inc.
Senior Secured Loan
Industry
Industrial Machinery and
Equipment Merchant
Wholesalers
Other amusement and recreation
industries
Truck Trailer Manufacturing
United Biologics Holdings, LLC (4)
(10)
Medical Laboratories
Preferred Equity (151,787 units)
Warrants (29,374 units)
Wand Intermediate I LP
Senior Secured Loan
Automotive Body, Paint, and
Interior Repair and Maintenance
Wastebuilt Environmental Solutions,
LLC
Industrial Supplies Merchant
Wholesalers
Senior Secured Loan
Other
Total Non-control/Non-affiliate
Investments
Affiliate Investments
3rd Rock Gaming Holdings, LLC
Software Publishers
Senior Secured Loan
Common Equity (2,547,250 units)
(10) (13)
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
6.77%
10.52%
(L +4.25%)
(L +8.00%)
5/16/2018 12/11/2024 $
5/15/2018 4/30/2026
638 $
637 $
9,073
9,711
9,069
9,706
602
8,484
9,086
11.27%
11.22%
(L +8.75%)
12/22/2017 12/22/2022
7,000
6,958
6,855
(L +8.75%)
7/20/2018 12/22/2022
3,733
10,733
3,656
3,733
10,691 10,511
0.3%
4.8
5.1
3.9
2.1
6.0
10.76%
(L +8.25%)
5/30/2017 4/21/2025
7,014
6,977
6,808
3.9
7/26/2012
7/26/2012 3/5/2022
—
—
—
9
82
91
20
25
45
—
—
—
9.84%
(L +7.25%)
5/14/2018 9/19/2022
3,770
3,802
3,747
2.1
11.27%
(L +8.75%)
10/11/2018 10/11/2024
7,000
6,858
6,858
3.9
900
89
0.1
309,407
312,223 297,749
169.9
10.30%
(L +7.50%)
3/13/2018 3/12/2023
21,626
21,353 20,023
3/13/2018
—
21,626
2,547
1,073
23,900 21,096
11.4
0.6
12.0
112
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1)
Investment Type
Industry
Office Machinery and Equipment
Contract Datascan Holdings, Inc. (4)
Rental and Leasing
Subordinated Loan
Preferred Equity (3,061 Series A
shares), 10% PIK
Common Equity (11,273 shares) (10)
DRS Imaging Services, LLC
Senior Secured Loan (4) (8)
Common Equity (1,135 units) (10)
(13)
Master Cutlery, LLC (4) (6) (10)
Subordinated Loan (11)
Preferred Equity (3,723 Series A
units), 8% PIK
Common Equity (15,564 units)
Data Processing, Hosting, and
Related Services
Sporting and Recreational Goods
and Supplies Merchant
Wholesalers
NeoSystems Corp. (4) (10)
Preferred Equity (521,962 convertible
shares), 10% PIK
Other Accounting Services
Pfanstiehl Holdings, Inc. (4)
Pharmaceutical Preparation
Manufacturing
Subordinated Loan
Common Equity (400 Class A shares)
Professional Pipe Holdings, LLC
Senior Secured Loan
Common Equity (1,414 Class A
units) (10)
Plumbing, Heating, and Air-
Conditioning Contractors
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value
(3)
Percent
of
Net
Assets
11.50%
N/A
8/5/2015
2/5/2021 $ 8,000 $
7,990 $8,000
4.6%
8/5/2015
6/28/2016
—
—
8,000
4,944
104
6,652
2,313
13,038 16,965
12.23%
(L +9.42%)
3/8/2018
11/20/2023
10,864
10,774 10,617
3/8/2018
—
10,864
1,135
1,197
11,909 11,814
13.00% PIK
N/A
4/17/2015 4/17/2020
5,229
4,764
850
4/17/2015
4/17/2015
—
—
5,229
3,483
—
8,247
—
—
850
3.8
1.3
9.7
6.1
0.7
6.8
0.5
—
—
0.5
8/14/2014
—
1,537
2,250
1.3
10.50%
N/A
1/1/2014
9/29/2022
1/1/2014
3,788
—
3,788
3,814
217
3,788
8,360
4,031 12,148
12.77%
(L +10.25%)
3/23/2018 3/23/2023
7,779
7,647
7,466
3/23/2018
—
7,779
1,414
9,061
769
8,235
2.2
4.8
7.0
4.3
0.4
4.7
113
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Industry
Commercial and Industrial
Machinery and Equipment
(except Automotive and
Electronic) Repair and
Maintenance
Travel Trailer and Camper
Manufacturing
Portfolio Company (1)
Investment Type
TRS Services, LLC (4) (11)
Senior Secured Loan
Preferred Equity (329,266 Class
AA units), 15% PIK
Preferred Equity (3,000,000 Class
A units), 11% PIK (10)
Common Equity (3,000,000 units)
(10)
Total Affiliate Investments
Control Investment
MTE Holding Corp. (4)
Subordinated Loan (to Mirage
Trailers, LLC, a controlled,
consolidated subsidiary of MTE
Holding Corp.)
Common Equity (554 shares)
Total Control Investment
Total Investments
Interest Rate
(2)
Spread
Above
Index (2)
Initial
Acquisition
Date
Maturity
Principal
Amount
Amortized
Cost
Fair
Value (3)
Percent
of
Net
Assets
11.27% cash /
1.0% PIK
(L +8.75%)
12/10/2014 12/10/2019 $ 14,681 $ 14,617 $ 14,446
8.3%
6/30/2016
12/10/2014
12/10/2014
—
—
—
14,681
71,967
465
3,374
572
19,028
90,751
473
826
—
15,745
89,103
0.3
0.5
—
9.1
51.1
14.00% cash /
1.50% PIK
(L +11.50%)
11/25/2015 11/25/2020
11/25/2015
7,296
—
7,296
7,296
7,268
3,069
10,337
10,337
7,296
2,649
9,945
9,945
4.2
1.5
5.7
5.7
$388,670 $ 413,311 $396,797
226.7%
(1) Equity ownership may be held in shares or units of companies affiliated with the portfolio company. The Company's investments are generally classified as "restricted securities" as such
term is defined under Regulation S-X Rule 6-03(f) or Securities Act Rule 144.
(2) Substantially all of the investments that bear interest at a variable rate are indexed to LIBOR (L), and reset monthly, quarterly, or semi-annually. Variable-rate loans with an aggregate cost of
$420,410 include LIBOR reference rate floor provisions of generally 1% to 2%. At December 31, 2019, the reference rate on all such instruments was above the stated floors. For each
investment, the Company has provided the spread over the reference rate and current interest rate in effect at December 31, 2019. Unless otherwise noted, all investments with a stated PIK
rate require interest payments with the issuance of additional securities as payment of the entire PIK provision.
(3) Fair value was determined using significant unobservable inputs for all of the Company's investments. See Note 5 for further details.
Investments (or portion thereof) held by SBIC I LP. All other investments pledged as collateral under the PWB Credit Facility.
(4)
(5) Elgin Fasteners Group became contractually due on August 27, 2018. The lending group entered into a forbearance agreement to extend the maturity through September 26, 2019. The
investment shall continue to accrue interest as the borrower has continued to make interest and amortization payments.
Investment was on non-accrual status as of December 31, 2019, meaning the Company has ceased recognizing all or a portion of income on the investment. See Note 5 for further details.
(6)
(7) Subject to unfunded commitments. See Note 6 for further details.
114
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
(8) The Company has entered into a contractual arrangement with co‑lenders whereby, subject to certain conditions, it has agreed to receive its principal payment after the repayment of certain
co‑lenders pursuant to a payment waterfall. The table below provides additional details as of December 31, 2018:
Portfolio Company
Carolina Lubes, Inc.
DRS Imaging Services, LLC
JBR Clinical Research, Inc.
OnSite Care, PLLC
Reported Interest
Rate
Interest Rate per
Credit Agreement
Additional Interest per
Annum
10.24%
12.23%
9.10%
10.22%
9.65%
10.80%
8.64%
8.60%
0.59%
1.43%
0.46%
1.62%
(9) Reserved.
(10) Non-income producing.
(11)The interest rate on these investments contains a PIK provision, whereby the issuer has the option to make interest payments in cash or with the issuance of additional securities as payment of
the entire PIK provision. The interest rate in the schedule represents the current interest rate in effect for these investments. The following table provides additional details on these PIK
investments, including the maximum annual PIK interest rate allowed as of December 31, 2019
Portfolio Company
Community Intervention Services, Inc.
Eblens Holdings, Inc.
Master Cutlery, LLC
TRS Services, LLC
Investment Type
Subordinated Loan
Subordinated Loan
Senior Secured Loan
Senior Secured Loan
Range of PIK
Option
Range of Cash
Option
Maximum PIK
Rate Allowed
0% or 6.00% 13.00% or 7.00%
0% or 1.00% 14.00% or 12.00%
0% to 13.00%
13.00% to 0%
0% or 1.00% 11.25% or 1.00%
6.00%
1.50%
13.00%
1.00%
(12) Represents expiration date of the warrants.
(13) All or portion of investment held by a wholly owned subsidiary subject to corporate income tax. See Note 8 for further details.
(14) Maximum interest rate allowable under the terms of this investment is 13.50%
See Notes to Financial Statements.
115
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 1. Organization
OFS Capital Corporation (the "Company"), a Delaware corporation, is an externally managed, closed-end, non-diversified management investment
company. The Company has elected to be regulated as a business development company ("BDC") under the Investment Company Act of 1940, as amended
("1940 Act"). In addition, for income tax purposes, the Company has elected to be treated as a regulated investment company ("RIC") under Subchapter M
of Code under the Internal Revenue Code of 1986, as amended (the "Code").
The Company’s investment objective is to provide stockholders with current income and capital appreciation through its strategic investment focus
primarily on debt investments and, to a lesser extent, equity investments primarily in middle-market companies principally in the United States. OFS
Capital Management, LLC, a registered investment advisor under the Advisers Act ("Advisor"), and a wholly owned subsidiary of Orchard First Source
Asset Management, LLC, a full-service provider of capital and leveraged finance solutions to U.S. Corporations ("OFSAM"), manages the day-to-day
operations of, and provides investment advisory services to, the Company.
In addition, OFS Advisor also serves as the investment adviser for Hancock Park Corporate Income, Inc. ("HPCI"), a Maryland corporation and a BDC.
HPCI’s investment objective is similar to that of the Company. OFS Advisor also serves as the investment adviser for OFS Credit Company, Inc. ("OCCI"),
a non-diversified, externally managed, closed-end management investment company that has registered as an investment company under the 1940 Act that
primarily invests in CLO debt and subordinated securities. In addition, OFSAM owns 2,946,474 shares, or approximately 22%, of the outstanding common
stock of the Company.
The Company may make investments directly, or follow-on investments in current portfolio companies held through OFS SBIC I LP ("SBIC LP"), its
investment company subsidiary licensed under the U.S. Small Business Administration's ("SBA") small business investment company program ("SBIC
Program"). The SBIC Program is designed to stimulate the flow of capital into eligible businesses. SBIC I LP is subject to SBA regulatory requirements,
including limitations on the businesses and industries in which it can invest, requirements to invest at least 25% of its "regulatory capital" in "eligible
smaller businesses", as defined under the Small Business Investment Act of 1958, as amended ("SBIC Act"), limitations on the financing terms of
investments, and capitalization thresholds that may limit distributions to the Company; and is subject to periodic audits and examinations of its financial
statements.
The Company may make investments through OFSCC-FS, LLC ("OFSCC-FS"), a special-purpose vehicle formed in April 2019 for the purpose of
acquiring senior secured loan investments. OFSCC-FS entered into a debt financing through a revolving credit and security agreement by and among
OFSCC-FS, the lenders from time to time parties thereto, BNP Paribas, as administrative agent, OFSCC-FS Holdings, LLC, a wholly owned subsidiary of
the Company, as equity holder, the Company, as servicer, Citibank, N.A., as collateral agent and Virtus Group, LP, as collateral administrator, which
provides for borrowings in an aggregate principal amount up to $150,000,000.
The Company may also make investments through OFSCC-MB, LLC ("OFSCC-MB"), a wholly owned subsidiary taxed under subchapter C of the Code
and generally holds the equity investments of the Company that are taxed as pass-through entities.
Note 2. Summary of Significant Accounting Policies
Basis of presentation: The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the
United States of America ("GAAP"), including ASC Topic 946, Financial Services-Investment Companies, and the requirements for reporting on Form 10-
K, the 1940 Act, and Articles 6 and 12 of Regulation S-X. In the opinion of management, the consolidated financial statements include all adjustments,
consisting only of normal and recurring accruals and adjustments, necessary for fair presentation in accordance with GAAP. Certain amounts in the prior
period financial statements have been reclassified to conform to the current year presentation.
Principles of consolidation: The Company consolidates majority-owned investment company subsidiaries. The Company does not own any controlled
operating company whose business consists of providing services to the Company, which would also require consolidation. All intercompany balances and
transactions are eliminated upon consolidation.
Investments: The Company applies fair value accounting in accordance with ASC Topic 820, Fair Value Measurements, which defines fair value,
establishes a framework to measure fair value, and requires disclosures regarding fair value measurements.
116
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Fair value is defined as the price to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. Fair
value is determined through the use of models and other valuation techniques, valuation inputs, and assumptions market participants would use to value the
investment. Highest priority is given to prices for identical assets quoted in active markets (Level 1) and the lowest priority is given to unobservable
valuation inputs (Level 3). The availability of observable inputs can vary significantly and is affected by many factors, including the type of product,
whether the product is new to the market, whether the product is traded on an active exchange or in the secondary market, and the current market
conditions. To the extent that the valuation is based on less observable or unobservable inputs, the determination of fair value requires more judgment.
Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for financial instruments classified as Level 3 (i.e.,
those instruments valued using non-observable inputs), which comprise the majority of the Company’s investments. See footnote 5 for details.
Changes to the valuation policy are reviewed by management and the Company’s board of directors (the "Board"). As the Company’s investments change,
markets change, new products develop, and valuation inputs become more or less observable, the Company will continue to refine its valuation
methodologies.
See Note 5 for more detailed disclosures of the Company’s fair value measurements of its financial instruments.
Investment classification: The Company classifies its investments in accordance with the 1940 Act. Under the 1940 Act, “Control Investments” are
defined as investments in those companies in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50%
of board representation, “Affiliate Investments” are defined as investments in those companies in which the Company owns between 5% and 25% of the
voting securities, and “Non-Control/Non-Affiliate Investments” are those that neither qualify as Control Investments nor Affiliate Investments.
Use of estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported
amounts of investment income, expenses, gains and losses during the reporting period. Actual results could differ significantly from those estimates.
Cash and cash equivalents:Cash and cash equivalents consist of cash and highly liquid investments not held for resale with original maturities of three
months or less. The Company’s cash and cash equivalents are maintained with a member bank of the FDIC and at times, such balances may be in excess of
the Federal Deposit Insurance Corporation ("FDIC") insurance limits. Included in cash and cash equivalents was $13,447 and $38,172 held in a US Bank
Money Market Deposit Account as of December 31, 2019 and 2018, respectively. In addition, the Company's use of cash and cash equivalents held by
SBIC I LP is limited by SBA regulation, including, but not limited to, investment in eligible portfolio companies and general corporate purposes, subject to
a statutory measure of undistributed accumulated earnings.
Revenue recognition:
Interest income:Interest income is recorded on an accrual basis and reported as an interest receivable until collected. Interest income is accrued daily based
on the outstanding principal amount and the contractual terms of the debt investment. Certain of the Company’s investments contain a payment-in-kind
interest income provision (“PIK interest”). The PIK interest, computed at the contractual rate specified in the applicable investment agreement, is added to
the principal balance of the investment, rather than being paid in cash, and recorded as interest income at fair value, as applicable, on the consolidated
statements of operations. The Company discontinues accrual of interest income, including PIK interest, when there is reasonable doubt that the interest
income will be collected.
Loan origination fees, original issue discount (“OID”), market discount or premium, and loan amendment fees (collectively, “Net Loan Fees”) are recorded
as an adjustment to the amortized cost of the investment, and accreted or amortized as an adjustment to interest income over the life of the respective debt
investment using a method that approximates the effective interest method. When the Company receives a loan principal payment, the unamortized Net
Loan Fees related to the paid principal is accelerated and recognized in interest income.
Further, the Company may acquire or receive equity, warrants or other equity-related securities (“Equity”) in connection with the Company’s acquisition of,
or subsequent amendment to, debt investments. The Company determines the cost basis of Equity based on its fair value, and the fair value of debt
investments and other securities or consideration received. Any resulting difference between the face amount of the debt and its recorded cost resulting
from the assignment of value to the Equity is treated as OID, and accreted into interest income as described above.
117
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Interest income - Structured Finance Notes: Interest income from investments in Structured Finance Notes is recognized on the basis of the estimated
effective yield to expected redemptions utilizing assumed cash flows in accordance with ASC Sub-topic 325-40, Beneficial Interests in Securitized
Financial Assets. The Company monitors the expected cash flows from its Structured Finance Notes and the effective yield is determined and updated
periodically.
Dividend income: Dividend income on common equity securities in limited liability companies, partnerships and other private entities, generally payable in
cash, is recorded at the time dividends are declared. Dividend income on preferred equity investments is accrued daily based on the contractual terms of the
preferred equity investment. Dividends on preferred equity securities may be payable in cash or in additional preferred securities, and are generally not
payable unless declared or upon liquidation. Declared dividends payable in cash are reported as dividend receivables until collected. Non-cash dividends
payable in additional preferred securities or contractually earned but not declared (“PIK dividends”) are recognized at fair value and recorded as an
adjustment to the cost basis of the investment. Distributions in excess of the accumulated net income of the underlying portfolio company are recorded as a
reduction in the cost of the common or preferred stock investment.
Fee income: The Company generates revenue in the form of management, valuation, and other contractual fees, that is recognized as the related services
are rendered. In the general course of its business, the Company receives certain fees from portfolio companies which are non-recurring in nature. Such
non-recurring fees include prepayment fees on certain loans repaid prior to their scheduled due date, which are recognized as earned when received, and
fees for capital structuring, loan syndication or advisory services from certain portfolio companies, which are recognized as earned upon closing of the
investment.
Investment Transactions and net realized and unrealized gain or loss on investments: Investment transactions are reported on a trade-date basis. Unsettled
trades as of the balance sheet date are included in payable for investments purchased. Realized gains or losses on investments are measured by the
difference between the net proceeds from the disposition and the amortized cost basis of the investment. Investments are valued at fair value as determined
in good faith by Company management under the supervision and review of the Board. After recording all appropriate interest, dividend, and other income,
some of which is recorded as an adjustment to the cost basis of the investment as described above, the Company reports changes in the fair value of
investments as net changes in unrealized appreciation (depreciation) on investments in the consolidated statements of operations.
Non-accrual loans: When there is reasonable doubt that principal, cash interest, or PIK interest, will be collected, debt investments are placed on non-
accrual status and the Company will cease recognizing cash interest, PIK interest, or Net Loan Fee amortization, as applicable. When an investment is
placed on non-accrual status, all interest previously accrued but not collected is reserved against current period interest income. Interest payments
subsequently received on non-accrual investments may be recognized as income or applied to principal depending upon management’s judgment. Interest
accruals and Net Loan Fee amortization are resumed on non-accrual investments only when they are brought current with respect to principal, interest, and
when, in the judgment of management, the investments are estimated to be fully collectible as to all principal and interest. In the opinion of management, if
there is a question as to the ability of the debtor to meet the terms of the loan agreement, or interest or principal is more than 90 days contractually past due,
the loan investment will be placed on non-accrual status. Past due status is based on how long after the contractual due date a principal or interest payment
is received. See Note 4 for further information.
Income taxes: The Company has elected to be treated, and intends to qualify annually, as a RIC under Subchapter M of the Code. To qualify as a RIC, the
Company must, among other things, meet certain source of income and asset diversification requirements, and timely distribute at least 90% of its
investment company table income ("ICTI") to its stockholders. The Company has made, and intends to continue to make, the requisite distributions to its
stockholders, which generally relieves the Company from U.S. federal income taxes.
Depending on the level of ICTI earned in a tax year, the Company may choose to retain ICTI in an amount less than that which would trigger U.S. federal
income tax liability under Subchapter M of the Code. However, the Company would be liable for a 4% excise tax on such income. Excise tax liability is
recognized when the Company determines its estimated current year annual ICTI, as defined in the Code, exceeds distributions from current year ICTI.
The Company may utilize OFSCC-MB ("OFSCC-MB"), a wholly owned holding company taxed under Subchapter C of the Code, when making equity
investments in portfolio companies taxed as pass-through entities to meet its source-of-income requirements as a RIC. OFSCC-MB is an investment
company under GAAP, and is consolidated in the Company’s GAAP financial statements and may incur current and deferred federal and state income tax
expense with respect to income derived
118
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
from those investments. Such income, net of applicable income taxes, is not included in the Company’s tax-basis net investment income until distributed by
OFSCC-MB which may result in timing and character differences between the Company’s GAAP and tax-basis net investment income and realized gains
and losses. Income tax expense from OFSCC-MB related to net investment income is included in general and administrative expenses, or the applicable net
realized or unrealized gain (loss) line item from which the federal or state income tax originated for capital gains and losses. See Note 8 for further
information.
The Company evaluates tax positions taken in the course of preparing its tax returns to determine whether they are “more-likely-than-not” to be sustained
by the applicable tax authority. Tax benefits of positions not deemed to meet the more-likely-than-not threshold could result in greater and undistributed
ICTI, income and excise tax expense, and, if involving multiple years, a re-assessment of the Company’s RIC status. GAAP requires recognition of accrued
interest and penalties related to uncertain tax benefits as income tax expense. There were no uncertain income tax positions at December 31, 2019 and
2018. The current and prior three tax years remain subject to examination by U.S. federal and most state tax authorities.
Distributions: Distributions to common stockholders are recognized on the record date. The timing of distributions as well as the amount to be paid out as
a distribution is determined by the Board each quarter. Distributions from net investment income and net realized gains are determined in accordance with
the Code. Net realized capital gains, if any, are distributed at least annually, although the Company may decide to retain such capital gains for investment.
Distributions paid in excess of ICTI and not capital gains are considered returns of capital to stockholders.
The Company has adopted a distribution reinvestment plan ("DRIP") that provides for reinvestment of any distributions the Company declares in cash on
behalf of its stockholders, unless a stockholder elects to receive cash. As a result, if the Board authorizes and the Company declares a cash distribution,
then stockholders who have not “opted out” of the DRIP will have their cash distribution automatically reinvested in additional shares of the Company’s
common stock, rather than receiving the cash distribution.
The Company may use newly issued shares under the guidelines of the DRIP, or the Company may purchase shares in the open market in connection with
its obligations under the plan.
Deferred debt issuance costs: Deferred debt issuance costs represent fees and other direct incremental costs incurred in connection with the Company’s
borrowings. Deferred debt issuance costs are presented as a direct reduction of the related debt liability on the consolidated statements of assets and
liabilities except for deferred debt issuance costs associated with the Company’s line of credit arrangements, which are included in prepaid expenses and
other assets on the consolidated statements of assets and liabilities. Unamortized debt issuance costs included in prepaid expenses and other assets on the
consolidated statements of assets and liabilities as of December 31, 2019 and 2018 were $1,628 and $180, respectively. Deferred debt issuance costs are
amortized to interest expense over the term of the related debt.
Goodwill: On December 4, 2013, in connection with the the Company's acquisition of the remaining ownership interests in SBIC I LP and SBIC I GP, LLC
on December 4, 2013, making SBIC I LP a wholly owned subsidiary of the Company ("SBIC Acquisition"), the Company recorded goodwill of $1,077,
which is included in prepaid expenses and other assets on the consolidated statements of assets and liabilities. Goodwill is not subject to amortization.
Goodwill is evaluated for impairment annually or more frequently if events occur or circumstances change that indicate goodwill may be impaired. There
have been no goodwill impairments since the date of the SBIC Acquisition.
Intangible asset: On December 4, 2013, in connection with the SBIC Acquisition, the Company recorded an intangible asset of $2,500 attributable to the
SBIC license. The Company amortizes this intangible asset on a straight-line basis over its estimated useful life of 13 years. The Company expects to incur
annual amortization expense of $195 in each annual period through December 31, 2025 and $145 in 2026.
The Company tests its intangible asset for impairment if events or circumstances suggest that the asset carrying value may not be fully recoverable. The
intangible asset, net of accumulated amortization of $1,186 and $991 at December 31, 2019 and 2018, respectively, is included in prepaid expenses and
other assets in the consolidated statements of assets and liabilities.
Interest expense: Interest expense is recognized on an accrual basis as incurred.
Concentration of credit risk: Aside from its debt instruments, financial instruments that potentially subject the Company to concentrations of credit risk
consist principally of cash deposits at financial institutions. At various times during the year, the Company may exceed the federally insured limits. To
mitigate this risk, the Company places cash deposits only with high credit quality institutions. Management believes this risk of loss is minimal. The
amount of loss due to credit risk from debt investments if borrowers fail to perform according to the terms of the contracts, and the collateral or other
security for those
119
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
instruments proved to be of no value to the Company, is equal to the Company's recorded investment in debt instruments and the unfunded loan
commitments as disclosed in Note 6.
New Accounting Standards
The following table discusses recently issued ASUs by the FASB:
Standard
Description
Period of Adoption
Effect of Adoption on the Financial Statements
Standards that were adopted
ASU 2017-04, Intangibles -
Goodwill and Other (Topic
350): Simplifying the Test for
Goodwill Impairment
ASU 2017-08, Premium
Amortization on Purchased
Callable Debt Securities
Removes Step 2 of the goodwill
impairment test, which requires a
hypothetical purchase price
allocation. A goodwill impairment
will now be the amount by which a
reporting unit's carrying value
exceeds its fair value, not to exceed
the carrying amount of goodwill.
Shortens the amortization period for
certain purchased callable debt
securities held at a premium to the
earliest call date. Securities held at a
discount are to continue to be
amortized to maturity.
Note 3. Related Party Transactions
Fourth Quarter
2019 prospectively
No material impact to the Company's consolidated
financial statements.
Fourth Quarter
2019 prospectively
No material impact to the Company's consolidated
financial statements.
Investment Advisory and Management Agreement: OFS Advisor manages the day-to-day operations of, and provides investment advisory services to,
the Company pursuant to an agreement dated November 7, 2012 ("Investment Advisory Agreement"). The Investment Advisory Agreement was most
recently re-approved on April 4, 2019. Under the terms of the Investment Advisory Agreement, which are in accordance with the 1940 Act and subject to
the overall supervision of the Company’s Board, OFS Advisor is responsible for sourcing potential investments, conducting research and diligence on
potential investments and equity sponsors, analyzing investment opportunities, structuring investments, and monitoring investments and portfolio
companies on an ongoing basis. OFS Advisor is a subsidiary of OFSAM and a registered investment advisor under the Investment Advisers Act of 1940, as
amended.
OFS Advisor’s services under the Investment Advisory Agreement are not exclusive to the Company and OFS Advisor is free to furnish similar services to
other entities, including other BDCs affiliated with OFS Advisor, so long as its services to the Company are not impaired. OFS Advisor also serves as the
investment adviser or collateral manager to CLOs and other companies, including HPCI and OCCI.
OFS Advisor receives fees for providing services, consisting of two components: a base management fee and an incentive fee. The base management fee is
calculated at an annual rate of 1.75% and based on the average value of the Company’s total assets (other than cash and cash equivalents but including
assets purchased with borrowed amounts and including assets owned by any consolidated entity) at the end of the two most recently completed calendar
quarters, adjusted for any share issuances or repurchases during the quarter. OFS Advisor has elected to exclude the value of the intangible asset and
goodwill resulting from the SBIC Acquisition from the base management fee calculation.
On June 11, 2019, OFS Advisor agreed to reduce a portion of its base management fee by reducing the portion of such fee from 0.4375% per quarter
(1.75% annualized) to 0.25% per quarter (1.00% annualized) of the average value of the portion of the total assets held by the Company through OFSCC-
FS (the "OFSCC-FS Assets"), at the end of the two most recently completed calendar quarters to the extent that such portion of the OFSCC-FS Assets are
financed using leverage (also calculated on an average basis) that causes the Company’s statutory asset coverage ratio to fall below 200%. When
calculating its statutory asset coverage ratio, the Company excludes its SBA guaranteed debentures from its total outstanding senior securities as permitted
120
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
pursuant to exemptive relief granted by the SEC dated November 26, 2013. Effective January 1, 2020, OFS Advisor agreed to further reduce the base
management fee to 0.25% per quarter (1.00% annualized) of the average value of the portion of total assets held by the Company through OFSCC-FS at the
end of the two most recently completed calendar quarters without regard to the statutory asset coverage ratio. The base management fee reduction by OFS
Advisor is renewable on an annual basis and the amount of the base management fee reduced with respect to the OFSCC-FS Assets shall not be subject to
recoupment by OFS Advisor.
The base management fee is payable quarterly in arrears and was $8,271, $6,335, and $4,999, for the years ended December 31, 2019, 2018 and 2017,
respectively. The Company owed the Advisor management fees of $2,209 and $1,749 as of December 31, 2019 and 2018, respectively.
The incentive fee has two parts. The first part ("Part One") is calculated and payable quarterly in arrears based on the Company’s pre-incentive fee net
investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net investment income means interest income,
dividend income and any other income (including any other fees such as commitment, origination and sourcing, structuring, diligence and consulting fees
or other fees that the Company receives from portfolio companies but excluding fees for providing managerial assistance) accrued during the calendar
quarter, minus operating expenses for the quarter (including the base management fee, any expenses payable under the Administration Agreement (as
defined below) and any interest expense and dividends paid on any outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net
investment income includes, in the case of investments with a deferred interest or dividend feature (such as OID, debt instruments with PIK interest, equity
investments with accruing or PIK dividend and zero coupon securities), accrued income that the Company has not yet received in cash.
Pre-incentive fee net investment income is expressed as a rate of return on the value of the Company’s net assets (defined as total assets less indebtedness
and before taking into account any incentive fees payable during the period) at the end of the immediately preceding calendar quarter and adjusted for any
share issuances or repurchases during such quarter. Accordingly, as a result of the follow-on public offering of 3,625,000 shares of common stock in April
2017 (the "Offering"), the Part One incentive fee was reduced by $593 for the three months ended June 30, 2017, determined by adjusting the value of net
assets, as defined above, at March 31, 2017 by the daily weighted average of the Offering proceeds available to the Company during the three months
ended June 30, 2017. The incentive fee with respect to pre-incentive fee net income is 20.0% of the amount, if any, by which the pre-incentive fee net
investment income for the immediately preceding calendar quarter exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up” provision
measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, OFS Advisor receives no incentive fee until the net
investment income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100.0% of the pre-incentive fee net investment income with respect to
that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5%. The effect of this provision is that, if
pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, OFS Advisor will receive 20.0% of the pre-incentive fee net investment
income.
Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or
depreciation. Because of the structure of the incentive fee, it is possible that the Company may pay an incentive fee in a quarter in which the Company
incurs a loss. For example, if the Company receives pre-incentive fee net investment income in excess of the quarterly minimum hurdle rate, the Company
will pay the applicable incentive fee even if the Company has incurred a loss in that quarter due to realized and unrealized capital losses. The Company’s
net investment income used to calculate this part of the incentive fee is also included in the amount of the Company’s gross assets used to calculate the base
management fee. These calculations are appropriately prorated for any period of less than three months.
The second part ("Part Two") of the incentive fee (the “Capital Gain Fee”) is determined and payable in arrears as of the end of each calendar year (or upon
termination of the Investment Advisory Agreement, as of the termination date), commencing on December 31, 2012, and equals 20.0% of the Company’s
aggregate realized capital gains, if any, on a cumulative basis from the date of the election to be a BDC through the end of each calendar year, computed net
of all realized capital losses and unrealized capital depreciation through the end of such year, less all previous amounts paid in respect of the Capital Gain
Fee; provided that the incentive fee determined as of December 31, 2012, was calculated for a period of shorter than twelve calendar months to take into
account any realized capital gains computed net of all realized capital losses and unrealized capital depreciation for the period beginning on the date of the
Company’s election to be a BDC and ending December 31, 2012.
The Company accrues the Capital Gain Fee if, on a cumulative basis, the sum of net realized capital gains and (losses) plus net unrealized appreciation and
(depreciation) is positive. If, on a cumulative basis, the sum of net realized capital gains (losses) plus net unrealized appreciation (depreciation) decreases
during a period, the Company will reverse any excess Capital Gain
121
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Fee previously accrued such that the amount of Capital Gains Fee accrued is no more than 20% of the sum of net realized capital gains (losses) plus net
unrealized appreciation (depreciation). OFS Advisor has excluded from the Capital Gain Fee calculation any realized gain with respect to (1) the SBIC
Acquisition, and (2) the WM Asset Sale.
The Company incurred incentive fee expense of $4,760, $4,409, and $2,962 for the years ended December 31, 2019, 2018 and 2017, respectively. Incentive
fees for the years ended December 31, 2019, 2018 and 2017, included Part One incentive fees (based on net investment income) of $4,760, $4,409, which
included an irrevocably waiver of receipt of $22 by OFS Advisor, and $2,962 respectively, which included a share issue adjustment of $(593) related to the
Company's Offering, and Part Two incentive fees (based upon net realized and unrealized gains and losses, or capital gains) of $0, $0 and $0, respectively.
The Company owed the Advisor incentive fees of $1,138 and $1,368 as of December 31, 2019 and 2018, respectively.
License Agreement: The Company entered into a license agreement with OFSAM under which OFSAM has agreed to grant the Company a non-
exclusive, royalty-free license to use the name “OFS.”
Administration Agreement: OFS Services furnishes the Company with office facilities and equipment, necessary software licenses and subscriptions, and
clerical, bookkeeping and record keeping services at such facilities pursuant to an Administration Agreement. The Administration Agreement was most
recently re-approved by the Board on April 4, 2019. Under the Administration Agreement, OFS Services performs, or oversees the performance of, the
Company’s required administrative services, which include being responsible for the financial records that the Company is required to maintain and
preparing reports to its stockholders and all other reports and materials required to be filed with the SEC or any other regulatory authority. In addition, OFS
Services assists the Company in determining and publishing its net asset value, oversees the preparation and filing of its tax returns and the printing and
dissemination of reports to its stockholders, and generally oversees the payment of the Company’s expenses and the performance of administrative and
professional services rendered to the Company by others. Under the Administration Agreement, OFS Services also provides managerial assistance on the
Company’s behalf to those portfolio companies that have accepted the Company’s offer to provide such assistance. Payment under the Administration
Agreement is equal to an amount based upon the Company’s allocable portion of OFS Services’s overhead in performing its obligations under the
Administration Agreement, including, but not limited to, rent, information technology services and the Company’s allocable portion of the cost of its
officers, including its chief executive officer, chief financial officer, chief compliance officer, chief accounting officer, and their respective staffs. To the
extent that OFS Services outsources any of its functions, the Company will pay the fees associated with such functions on a direct basis without profit to
OFS Services.
Administration fee expense was $1,747, $1,601 and $1,314 for the years ended December 31, 2019, 2018 and 2017, respectively. The Company owed OFS
Services administration fees of $759 and $577 as of December 31, 2019 and 2018, respectively.
Note 4. Investments
As of December 31, 2019, the Company had loans to 79 portfolio companies, of which 90% were senior secured loans and 10% were subordinated loans, at
fair value, as well as equity investments in 15 of these portfolio companies. The Company also held an equity investment in six portfolio companies in
which it did not hold a debt investment, as well as four investments in Structured Finance Notes. At December 31, 2019, investments consisted of the
following:
Senior secured debt investments
Subordinated debt investments
Preferred equity
Common equity and warrants
Total debt and equity investments
Structured Finance Notes
Percentage of Total
Percentage of Total
Amortized
Cost
Amortized Cost Net Assets
Fair Value
Fair Value Net Assets
$
421,970
78.3%
253.2% $
408,724
79.1%
245.3%
56,731
21,925
14,919
515,545
23,126
10.5
4.1
2.8
34.0
13.2
9.0
43,091
17,729
25,777
8.3
3.4
5.0
25.9
10.6
15.5
95.7%
309.4%
495,321
95.8%
297.3%
4.3
14.0
21,610
4.2
12.9
310.2%
Total
$
538,671
100.0%
323.4% $
516,931
100.0%
At December 31, 2019, the Company had four loans (Community Intervention Services, Inc., Southern Technical Institute, LLC, Master Cutlery, LLC and
Constellis Holdings, LLC) on non-accrual status with respect to all interest and Net Loan Fee
122
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
amortization, with an aggregate amortized cost and fair value of $22,249 and $662, respectively. The change to non-accrual status for the Company's
investment in Constellis Holdings, LLC was effective November 1, 2019.
On January 31, 2019, Maverick Healthcare Equity, LLC was acquired in a purchase transaction. Proceeds from this transaction were insufficient to redeem
the class of equity held by the Company. Accordingly, the Company recognized a net loss of $89, which is comprised of $900 realized loss net of $811
unrealized loss reversal, in the year ended December 31, 2019.
At December 31, 2019, the Company had international domiciled debt investments, all denominated in US dollars, with an amortized cost and fair value of
$10,309 and $10,374, respectively, and debt and equity investments with an amortized cost and fair value of $505,232 and $484,945 domiciled in the
United States. The industry compositions of the Company’s debt and equity investment portfolio were as follows:
Percentage of Total
Percentage of Total
Amortized
Cost
Amortized Cost Net Assets Fair Value
Fair Value Net Assets
Administrative and Support and Waste Management
and Remediation Services
Security Systems Services (except Locksmiths)
$
Temporary Help Services
Arts, Entertainment, and Recreation
Other Amusement and Recreation Industries
Construction
Electrical Contractors and Other Wiring Installation
Contractors
Plumbing, Heating, and Air-Conditioning Contractors
Education Services
Colleges, Universities, and Professional Schools
Professional and Management Development Training
Finance and Insurance
Direct Health and Medical Insurance Carriers
Insurance Agencies and Brokerages
Health Care and Social Assistance
All Other Outpatient Care Centers
Child Day Care Services
Diagnostic Imaging Centers
Freestanding Ambulatory Surgical and Emergency
Centers
General Medical and Surgical Hospitals
Home Health Care Services
Medical Laboratories
Offices of Physicians, Mental Health Specialists
Outpatient Mental Health and Substance Abuse
Centers
Residential Intellectual and Developmental Disability
Facilities
Information
8,158
13,866
18,611
16,520
8,422
—
11,574
395
11,487
2,001
8,126
14,247
2,950
2,612
16,627
91
20,047
11,609
2,991
123
1.6%
4.9% $
7,224
1.5%
2.7
3.6
3.2
1.6
8.3
11.2
9.9
5.1
—
—
2.2
0.1
2.2
0.4
1.6
2.8
0.6
0.5
3.2
—
3.9
2.3
0.6
6.9
0.2
6.9
1.2
4.9
8.6
1.8
1.6
10.0
0.1
12.0
7.0
1.8
13,742
18,592
14,639
9,583
—
11,575
405
11,386
2,015
8,266
14,191
2,976
2,632
16,236
22
19,945
4,000
3,006
2.8
3.8
3.0
1.9
—
2.3
0.1
2.3
0.4
1.7
2.9
0.6
0.5
3.3
—
4.0
0.8
0.6
4.3%
8.2
11.2
8.8
5.8
—
6.9
0.2
6.8
1.2
5.0
8.5
1.8
1.6
9.7
—
12.0
2.4
1.8
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Data Processing, Hosting, and Related Services
Internet Publishing and Broadcasting and Web Search
Portals
Software Publishers
Television Broadcasting
Wired Telecommunications Carriers
Manufacturing
Commercial Printing (except Screen and Books)
Custom Compounding of Purchased Resins
Motor Vehicle Body Manufacturing
Other Aircraft Parts and Auxiliary Equipment
Manufacturing
Other Commercial and Service Industry Machinery
Manufacturing
Pharmaceutical and Medicine Manufacturing
Pharmaceutical Preparation Manufacturing
Plastics Plumbing Fixture Manufacturing
Pump and Pumping Equipment Manufacturing
Travel Trailer and Camper Manufacturing
Truck Trailer Manufacturing
Unlaminated Plastics Profile Shape Manufacturing
Other Services (except Public Administration)
Automotive Oil Change and Lubrication Shops
Commercial and Industrial Machinery and Equipment
(except Automotive and Electronic) Repair and
Maintenance
Communication Equipment Repair and Maintenance
Professional, Scientific, and Technical Services
Administrative Management and General Management
Consulting Services
Advertising Agencies
All Other Professional, Scientific, and Technical Services
Other Accounting Services
Other Computer Related Services
Other Professional, Scientific, and Technical Services
Testing Laboratories
Percentage of Total
Percentage of Total
Amortized
Cost
Amortized
Cost
Net Assets Fair Value
Fair Value Net Assets
11,805
1,969
41,054
1,997
1,972
4,778
15,405
1,970
5,412
2,229
853
7,931
1,484
1,501
10,520
6,990
10,046
20,165
19,106
4,493
17,496
1,987
1,925
1,698
18,242
500
1,987
124
2.3
7.1
11,900
2.4
7.1
0.4
8.0
0.4
0.4
0.9
3.0
0.4
1.2
24.5
1.2
1.2
2.9
9.2
1.2
1,992
38,373
1,997
1,980
4,591
16,408
1,997
1.0
3.2
4,213
0.4
0.2
1.5
0.3
0.3
2.0
1.4
1.9
1.3
0.5
4.8
0.9
0.9
6.3
4.2
6.0
2,262
853
19,694
1,498
1,607
8,717
6,690
9,959
0.4
7.7
0.4
0.4
0.9
3.3
0.4
0.9
0.5
0.2
4.0
0.3
0.3
1.7
1.4
2.0
1.2
22.9
1.1
1.2
2.8
9.8
1.2
2.5
1.4
0.5
11.8
0.9
1.0
5.2
4.0
6.0
3.9
12.1
20,458
4.0
12.3
3.7
0.9
11.5
2.7
18,265
4,512
3.4
0.4
0.4
0.3
3.5
0.1
0.4
10.5
17,492
1.2
1.2
1.0
10.9
0.3
1.2
2,001
1,925
2,250
18,353
1,490
2,004
3.7
0.9
3.5
0.4
0.4
0.5
3.7
0.3
0.4
11.0
2.7
10.5
1.2
1.2
1.4
11.0
0.9
1.2
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Public Administration
Other Justice, Public Order, and Safety Activities
Public Finance Activities
Real Estate and Rental and Leasing
Amortized
Cost
9,846
1,941
Office Machinery and Equipment Rental and Leasing
13,698
Retail Trade
Cosmetics, Beauty Supplies, and Perfume Stores
Shoe Store
Sporting Goods Stores
Supermarkets and Other Grocery (except
Convenience) Stores
All Other General Merchandise Stores
Transportation and Warehousing
General Warehousing and Storage
Taxi Service
Wholesale Trade
Business to Business Electronic Markets
Computer and Computer Peripheral Equipment and
Software Merchant Wholesalers
Industrial Machinery and Equipment Merchant
Wholesalers
Industrial Supplies Merchant Wholesalers
Motor Vehicle Parts (Used) Merchant Wholesalers
Other Grocery and Related Products Merchant
Wholesalers
Sporting and Recreational Goods and Supplies
Merchant Wholesalers
Stationery and Office Supplies Merchant Wholesalers
6,419
9,675
1,921
1,081
5,402
13,790
1,990
3,920
3,955
9,700
6,883
13,119
1,995
8,247
16,113
Percentage of Total
Percentage of Total
Amortized Cost Net Assets Fair Value
Fair Value Net Assets
1.9
0.4
2.7
1.2
1.8
0.4
0.2
1.0
2.7
0.4
0.8
0.8
1.9
1.3
2.5
0.4
1.6
3.1
5.9
1.2
8.2
3.9
5.8
1.2
0.6
3.2
—
8.3
1.2
2.4
2.4
5.8
4.1
7.9
1.2
4.9
9.7
407
2,007
14,342
6,363
9,917
1,983
1,094
5,020
14,165
1,990
3,960
3,976
9,662
6,584
13,119
2,003
255
14,559
0.1
0.4
2.9
1.3
2.0
0.4
0.2
1.0
2.9
0.4
0.8
0.8
2.0
1.3
2.6
0.4
0.1
2.9
0.2
1.2
8.6
3.8
6.0
1.2
0.7
3.0
8.5
1.2
2.4
2.4
5.8
4.0
7.9
1.2
0.2
8.7
Total debt and equity investments
Structured Finance Notes
Total investments
$
515,545
100.0%
309.4% $
495,321
23,126
—
14.0%
21,610
100.0%
—
$
538,671
100.0%
323.4% $
516,931
100.0%
297.3%
12.9%
310.2%
As of December 31, 2018, the Company had loans to 44 portfolio companies, of which 88% were senior secured loans and 12% were subordinated loans, at
fair value, as well as equity investments in 13 of these portfolio companies. The Company also held an equity investment in six portfolio companies in
which it did not hold a debt investment. At December 31, 2018, investments consisted of the following:
125
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
At December 31, 2018, investments consisted of the following:
Senior secured debt investments
Subordinated debt investments
Preferred equity
Common equity and warrants
Total
Percentage of Total
Percentage of Total
Amortized
Cost
Amortized Cost Net Assets Fair Value
Fair Value Net Assets
$
325,873
56,212
19,620
11,606
78.8%
13.6%
4.7%
2.8%
186.2% $
319,017
32.1
11.2
6.6
44,540
14,613
18,627
80.4%
11.2%
3.7%
4.7%
182.3%
25.4
8.4
10.6
$
413,311
100.0%
236.1% $
396,797
100.0%
226.7%
In June 2018, the Company's investment in Southern Technical Institute, LLC was restructured. The Company converted its subordinated note, SP-1
preferred shares, and warrants for a $1,471 subordinated loan and 1,764,720 shares of Class A-1 common units. The cost and fair value of the securities
received were $-0- and $-0- as of December 31, 2018. The Company recognized a realized loss on the restructuring of $5,608 for the year ended December
31, 2018, of which $4,407 was recognized as unrealized losses as of December 31, 2017.
At December 31, 2018, the Company had three loans (Community Intervention Services, Inc., Southern Technical Institute, LLC and Master Cutlery, LLC)
on non-accrual status with respect to all interest and Net Loan Fee amortization, with an aggregate amortized cost and fair value of $12,403 and $850,
respectively.
In August 2018, the Elgin Fasteners Group senior secured loan became contractually due. The lending group entered into a forbearance agreement with
respect to the maturity date through September 26, 2019, subject to other terms and conditions. The investment continues to accrue interest as the borrower
has continued to make interest and amortization payments. On October 9, 2019 the Company sold the investment for proceeds of $3,361.
At December 31, 2018, all of the Company’s investments were domiciled in the United States. The industry compositions of the Company’s investment
portfolio were as follows:
Percentage of Total
Percentage of Total
Amortized Cost
Amortized
Cost
Net Assets
Fair Value
Fair Value Net Assets
Administrative and Support and Waste
Management and Remediation Services
Security Systems Services (except Locksmiths)
$
Temporary Help Services
Arts, Entertainment, and Recreation
6,516
14,059
Other Amusement and Recreation Industries
10,691
Construction
Electrical Contractors and Other Wiring
Installation Contractors
Plumbing, Heating, and Air-Conditioning
Contractors
Education Services
17,525
9,061
1.6%
3.7% $
3.4
2.6
4.2
2.2
8.0
6.1
10.0
5.2
5,901
13,993
10,511
17,134
8,235
1.5%
3.5
2.6
4.3
2.1
Colleges, Universities, and Professional Schools
—
—
—
—
—
Finance and Insurance
Direct Health and Medical Insurance Carriers
5,700
1.4
3.3
5,570
1.4
3.4%
8.0
6.0
9.8
4.7
—
3.2
126
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Insurance Agencies and Brokerages
Health Care and Social Assistance
Child Day Care Services
Home Health Care Services
Medical Laboratories
Offices of Physicians, Mental Health Specialists
Outpatient Mental Health and Substance Abuse
Centers
Information
Data Processing, Hosting, and Related Services
Software Publishers
Manufacturing
Bolt, Nut, Screw, Rivet, and Washer Manufacturing
Commercial Printing (except Screen and Books)
Other Aircraft Parts and Auxiliary Equipment
Manufacturing
Pharmaceutical Preparation Manufacturing
Printing Machinery and Equipment Manufacturing
Pump and Pumping Equipment Manufacturing
Travel Trailer and Camper Manufacturing
Truck Trailer Manufacturing
Unlaminated Plastics Profile Shape Manufacturing
Other Services (except Public Administration)
Automotive Body, Paint, and Interior Repair and
Maintenance
Automotive Oil Change and Lubrication Shops
Commercial and Industrial Machinery and
Equipment (except Automotive and Electronic)
Repair and Maintenance
Professional, Scientific, and Technical Services
Other Accounting Services
Other Computer Related Services
Other Professional, Scientific, and Technical
Services
Research and Development in the Social Sciences
and Humanities
Public Administration
9,489
2.3
5.4
9,290
2.3
8,126
11,203
91
10,185
2.0
2.7
—
2.5
4.6
6.4
0.1
5.8
7,759
11,176
45
9,771
2.0
2.8
—
2.5
11,603
2.8
6.6
3,933
1.0
11,909
32,750
3,645
4,767
5,394
4,031
5,000
1,501
10,337
6,977
6,060
2.9
7.9
0.9
1.2
1.3
1.0
1.2
0.4
2.5
1.7
1.5
6.8
18.6
2.1
2.7
3.1
2.3
2.9
0.9
5.9
4.0
3.5
11,814
29,778
3,509
4,772
4,141
12,148
4,841
1,416
9,945
6,808
5,901
3.0
7.5
0.9
1.2
1.0
3.1
1.2
0.4
2.5
1.7
1.5
5.3
4.4
6.4
—
5.6
2.2
6.7
16.9
2.0
2.7
2.4
6.9
2.8
0.8
5.7
3.9
3.4
3,802
20,694
0.9
5.0
2.2
11.8
3,747
20,839
0.9
5.3
2.1
11.9
19,028
4.6
10.9
15,745
4.0
1,537
12,877
0.4
3.1
0.9
7.4
2,250
12,904
0.6
3.3
9,302
2.3
5.3
9,736
2.5
9.0
1.3
7.4
5.6
29,693
7.2
17.0
29,016
7.3
16.5
Other Justice, Public Order, and Safety Activities
9,832
2.4
5.6
9,437
2.4
5.4
127
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Real Estate and Rental and Leasing
Home Health Equipment Rental
Office Machinery and Equipment Rental and
Leasing
Retail Trade
Cosmetics, Beauty Supplies, and Perfume Stores
Shoe Store
Supermarkets and Other Grocery (except
Convenience) Stores
All Other General Merchandise Stores
Transportation and Warehousing
General Warehousing and Storage
Wholesale Trade
Business to Business Electronic Markets
Industrial Machinery and Equipment Merchant
Wholesalers
Industrial Supplies Merchant Wholesalers
Sporting and Recreational Goods and Supplies
Merchant Wholesalers
Stationery and Office Supplies Merchant
Wholesalers
900
13,038
6,334
9,568
1,386
5,930
20,118
1,959
9,706
6,858
8,247
15,882
413,311
$
128
0.2
3.2
1.5
2.2
0.3
1.4
4.9
0.5
2.3
1.7
2.0
3.7
0.5
7.4
3.6
5.5
0.8
3.4
89
—
16,965
6,292
9,543
1,349
5,354
11.5
20,647
1.1
5.5
3.9
4.7
9.1
1,914
9,086
6,858
850
15,785
4.3
1.6
2.4
0.3
1.2
5.2
0.5
2.3
1.7
0.2
4.0
0.1
9.7
3.6
5.5
0.8
3.1
11.8
1.1
5.2
3.9
0.5
9.0
100.0%
236.1% $
396,797
100.0%
226.7%
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Unconsolidated Significant Subsidiaries: In accordance with Regulation S-X and GAAP, the Company is not permitted to consolidate any subsidiary or
other entity that is not an investment company, including those in which the Company has a controlling interest unless the business of the controlled
operating company consists of providing services to the Company. In accordance with Regulation S-X Rules 3-09 and 4-08(g), the Company evaluates its
unconsolidated controlled portfolio companies as significant subsidiaries under the respective rules. MTE Holding Corp. and Subsidiaries were not
considered a significant unconsolidated subsidiary under Regulation S-X Rule 4-08(g) as of December 31, 2019 and 2018, respectively.
As of December 31, 2017, MTE Holding Corp. and Subsidiaries was considered a significant unconsolidated subsidiary under Regulation S-X Rule 4-
08(g). The Company's voting ownership in MTE Holding Corp. and Subsidiaries is limited to 50% through a substantive participating voting rights
agreement with an unaffiliated investor. Based on the requirements under Regulation S-X Rule 4-08(g), the summarized consolidated financial information
of MTE Holding Corp. and Subsidiaries is presented below:
Balance Sheet:
Current assets
Noncurrent assets
Total assets
Current liabilities
Noncurrent liabilities
Total liabilities
Non-controlling interest
Controlling interest
Total equity
Summary of Operations:
Net Sales
Gross Profit
Net income (loss)
Net income (loss) attributable to MTE Holding Corp.
Note 5. Fair Value of Financial Instruments
Investments
December 31
2019
2018
$
$
$
4,619 $
19,802
24,421 $
19,586 $
—
19,586
78
4,757
$
4,835 $
5,900
25,103
31,003
979
19,886
20,865
4,526
5,612
10,138
Year Ended December 31
2019
2018
2017
$
25,268 $
29,902 $
31,614
6,278
(4,985)
(766)
3,216
(597)
191
9,857
2,106
1,594
The Company’s investments are valued at fair value as determined by the Company's board of directors. These fair values are determined in accordance
with a documented valuation policy and a consistently applied valuation process.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at
the measurement date. Fair values are determined with models or other valuation techniques, valuation inputs, and assumptions market participants would
use in pricing an asset or liability. Valuation inputs are organized in a hierarchy that gives the highest priority to prices for identical assets or liabilities
quoted in active markets (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of inputs in the fair value hierarchy are
described below:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
Level 2: Inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or
liability has a specified term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs
include: (i) quoted prices for similar assets or liabilities in
129
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
active markets, (ii) quoted prices for identical or similar assets or liabilities in markets that are not active, (iii) inputs other than quoted
prices that are observable for the asset or liability, and (iv) inputs that are derived principally from or corroborated by observable market
data.
Level 3: Unobservable inputs for the asset or liability, and situations where there is little, if any, market activity for the asset or liability at the
measurement date.
The inputs into the determination of fair value are based upon the best information under the circumstances and may require significant management
judgment or estimation. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an
investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s
assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the
investment. The Company generally categorizes its investment portfolio into Level 2 and Level 3 of the hierarchy.
The Company assesses the levels of the investments at each measurement date, and transfers between levels are recognized on the measurement date.
Senior securities with a fair value of $2,321, $-0- and $-0- were transfered from Level 3 to Level 2 during the years ended December 31, 2019, 2018 and
2017.
Certain of the Company's investments are exchanged in the non-public market among banks, CLOs and other institutional investors for loans to large U.S.
corporations. The Company classifies these loan investments as Level 2 when a sufficient number of market quotations or indicative prices from pricing
services or broker/dealers (collectively, “Indicative Prices”) are available, and the depth of the market is sufficient to transact to those prices in amounts
approximating the Company's investment position at the measurement date. Investments for which sufficient Indicative Prices exist are generally valued
consistent with such Indicative Prices.
In addition, each quarter, the Company assesses whether an arm’s length transaction occurred in the same security, including the Company's new
investments during the quarter, the cost of which (“Transaction Prices”), may be considered a reasonable indication of fair value for up to three months
after the transaction date. Senior securities with a fair value of $10,266 were valued at their Transaction Price at December 31, 2019. Based on liquidity and
other market factors, these securities are designated as Level 2 in the fair value hierarchy.
Investments that are not valued using Indicative Prices or Transaction Prices are typically valued using two different valuation techniques. The Company
typically estimates the fair value of debt investments by a discounted cash flows technique in which a current price is imputed for the investment based
upon an assessment of the expected market yield (or discount rate) for similarly structured investments with a similar level of risk. The Company considers
the current contractual interest rate, the maturity and other terms of the investment relative to risk of the portfolio company and various market indices. A
key determinant of portfolio-company risk is the leverage through the investment relative to earnings metrics of the portfolio company. The fair value of
Structured Finance Notes in the Company's portfolio are also estimated primarily by discounted cash flow fair value analytics. In valuing such investments,
the Company considers CLO performance metrics, including prepayment rates, default rates, loss-on-default and recovery rates, and other metrics, as well
as estimated market yields provided by a recognized industry pricing service as a primary source for discounted cash flow fair value estimates,
supplemented by actual trades executed in the market at or around period-end, as well as the indicative prices provided by broker-dealers in its estimate of
the fair value of such investments. The Company also considers the operating metrics of the CLO vehicle, including compliance with collateralization tests,
concentration limits, defaults, restructuring activity and prepayment rates on the underlying loans, if applicable.
The fair value of Company’s equity investments as well as certain of its non-performing debt investments are estimated through analysis of the portfolio
companies’ enterprise value under a market approach. Enterprise value means the entire value of the portfolio company to a market participant, including
the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. The primary method for determining enterprise value
under the market approach involves multiple analysis whereby appropriate multiples are applied to an earnings metric of the portfolio company, typically
earnings before net interest expense, income tax expense, depreciation and amortization (“EBITDA”). EBITDA multiples are typically determined based
upon review of market comparable transactions and publicly traded comparable companies, if any. The Company may also utilize other portfolio-company
earnings metrics to determine enterprise value, such as recurring monthly revenue ("RMR”) or a delineated measure of portfolio company EBITDA.
Application of these valuation methodologies involves a significant degree of judgment by management.
130
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Due to the inherent uncertainty of determining the fair value of Level 3 investments, the fair value of the investments may differ significantly from the
values that would have been used had a ready market or observable inputs existed for such investments and may differ materially from the values that may
ultimately be received or settled. Further, such investments are generally subject to legal and other restrictions, or otherwise are less liquid than publicly
traded instruments. If the Company were required to liquidate a portfolio investment in a forced or liquidation sale, the Company might realize
significantly less than the value at which such investment had previously been recorded. The Company’s investments are subject to market risk. Market
risk is the potential for changes in the value due to market changes. Market risk is directly impacted by the volatility and liquidity in the markets in which
the investments are traded.
The following tables presents the Company's investment portfolio measured at fair value on a recurring basis as of December 31, 2019 and 2018,
respectively.
Security
Debt investments
Equity investments
Structured Finance Notes
Security
Debt investments
Equity investments
Structured Finance Notes
$
$
$
$
Level 1
Level 2
Level 3
Fair Value at December
31, 2019
— $
—
—
— $
74,666 $
377,149 $
—
—
43,506
21,610
74,666 $
442,265 $
451,815
43,506
21,610
516,931
Level 1
Level 2
Level 3
Fair Value at December
31, 2018
— $
—
—
— $
363,557 $
33,240
—
396,797 $
363,557
33,240
—
396,797
— $
—
—
— $
131
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The following tables provide quantitative information about the Company’s significant Level 3 fair value inputs to the Company’s fair value measurements
as of December 31, 2019 and 2018. In addition to the techniques and inputs noted in the tables below, according to the Company’s valuation policy, the
Company may also use other valuation techniques and methodologies when determining the Company’s fair value measurements. The table below provides
information on the significant Level 3 inputs as they relate to the Company’s fair value measurements.
Debt investments:
Senior secured
Senior secured
Senior secured
Subordinated
Subordinated
Subordinated
Fair Value at
December 31, 2019
Valuation technique
Unobservable inputs
Range
(Weighted average)
$
295,835 Discounted cash flow
Discount rates
5.64% - 17.42% (11.17%)
15,031 Market approach
23,193 Market approach
EBITDA multiples
8.09x - 13.22x (13.08x)
Transaction Price
35,371 Discounted cash flow
Discount rates
6.38% - 18.86% (14.32%)
7,464 Market approach
EBITDA multiples
4.75x - 6.35x (6.35x)
255 Market approach
Revenue multiple
Structured Finance Notes:
Subordinated Notes(2)
21,610 Discounted cash flow
Equity investments:
Preferred equity
Preferred equity
Preferred equity
Common equity and warrants
Common equity and warrants
Common equity and warrants
13,185 Market approach
2,424 Market approach
2,120 Market approach
22,788 Market approach
1,489 Market approach
1,500
Transaction Price
$
442,265
Discount rates
Constant default rate(1)
Recovery rate
14.50% - 19.50% (17.16%)
1.26% - 1.40% (1.33%)
69.30% - 70.00% (69.70%)
EBITDA multiples
Revenue multiples
Recurring monthly
revenue
EBITDA multiples
Revenue multiples
6.25x - 13.22x (4.96x)
0.23x - 9.58x (9.58x)
40.00x - 40.00x (40.00x)
4.50x - 13.22x (13.03x)
0.23x - 7.00x (7.00x)
(1) Constant default rates for the next twelve months.
(2) The cash flows utilized in the discounted cash flow calculations assume liquidation at current market prices and redeployment of proceeds on all assets
currently in default and all assets below specified fair value thresholds.
132
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Debt investments:
Senior secured
Senior secured
Subordinated
Subordinated
Equity investments
Preferred equity
Preferred equity
Common equity and
warrants
Fair Value at
December 31,
2018 (1)
Valuation technique
Unobservable inputs
Range
(Weighted average)
$
295,087 Discounted cash flow
Discount rates
6.94% - 19.70% (12.49%)
23,930 Market approach
Transaction Price
36,394 Discounted cash flow
Discount rates
7.16% - 15.40% (7.21%)
8,146 Market approach
EBITDA multiples
3.50x - 7.65x (5.10x)
12,039 Market approach
EBITDA multiples
4.50x - 8.50x (7.42x)
2,574 Market approach
Reoccurring Monthly Revenue 38.0x - 42.0x (40.0x)
18,627 Market approach
EBITDA multiples
3.50x - 11.00x (8.68x)
$
396,797
Changes in market credit spreads or events impacting the credit quality of the underlying portfolio company (both of which could impact the discount rate),
as well as changes in EBITDA and/or EBITDA multiples, among other things, could have a significant impact on fair values, with the fair value of a
particular debt investment susceptible to change in inverse relation to the changes in the discount rate. Changes in EBITDA and/or EBITDA multiples, as
well as changes in the discount rate, could have a significant impact on fair values, with the fair value of an equity investment susceptible to change in
tandem with the changes in EBITDA and/or EBITDA multiples, and in inverse relation to changes in the discount rate. Due to wide range of approaches
towards developing input assumptions to these valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the
Company’s disclosures and those of other companies may not be meaningful.
The following tables present changes in investments measured at fair value using Level 3 inputs for the years ended December 31, 2019 and 2018:
Level 3 assets, January 1, 2019
Net realized loss on investments
Net change in unrealized appreciation (depreciation) on
investments
Amortization of net loan origination fees
Accretion of interest income on Structured Finance Notes
Capitalized PIK interest, dividends, and fees
Purchase and origination of portfolio investments
Proceeds from principal payments on portfolio
investments
Sale and redemption of portfolio investments
Proceeds from distributions received from portfolio
investments
Transfers out of Level 3
Senior
Secured Debt
Investments
Subordinated
Debt
Investments
$
319,017
$
44,540
Year Ended December 31, 2019
Preferred
Equity
$ 14,613
Common
Equity and
Warrants
$
18,627
Structured
Finance Notes
$
— $
Total
396,797
(3,000)
(8,405)
1,278
—
489
122,184
(57,150)
(38,033)
—
(2,321)
—
(900)
—
—
(3,900)
(1,968)
86
—
432
—
—
—
—
—
811
—
—
896
2,309
—
—
—
—
3,837
(1,516)
(7,242)
—
—
—
—
2,861
—
1,364
2,861
1,817
3,313
23,341
151,147
—
—
—
—
—
—
(3,076)
—
(57,150)
(38,033)
(3,076)
(2,321)
Level 3 assets, December 31, 2019
$
334,059
$
43,090
$ 17,729
$
25,777
$
21,610 $
442,264
133
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Level 3 assets, January 1, 2018
Net realized gain on investments
Net unrealized appreciation (depreciation) on investments
Amortization of Net Loan Fees
Capitalized PIK interest and dividends
Amendment fees
Purchase and origination of portfolio investments
Proceeds from principal payments on portfolio investments
Sale and redemption of portfolio investments
Reclassification between preferred equity and common
equity and warrants
Year Ended December 31, 2018
Senior
Secured Debt
Investments
Subordinated
Debt
Investments
Preferred Equity
Common Equity
and Warrants
$
195,112 $
51,198 $
19,200 $
11,989 $
(3,076)
(5,944)
2,076
388
(159)
245,278
(75,541)
(39,117)
(3,469)
161
212
668
(2)
20,930
(25,158)
(1,889)
(104)
—
907
—
338
—
—
(3,339)
3,655
1,853
—
—
—
5,609
—
(4,979)
Total
277,499
(4,779)
(4,034)
2,288
1,963
(161)
272,155
(100,699)
(47,435)
—
—
(500)
500
—
Level 3 assets, December 31, 2018
$
319,017 $
44,540 $
14,613 $
18,627 $
396,797
The net unrealized appreciation (depreciation) reported in the Company’s consolidated statements of operations for the years ended December 31, 2019 and
2018, attributable to the Company’s Level 3 assets still held at those respective year ends was as follows:
Senior secured debt investments
Subordinated debt investments
Preferred equity
Common equity and warrants
Structured Finance Notes
Net unrealized depreciation on investments held
Other Financial Assets and Liabilities
Year Ended December 31,
2019
2018
$
$
(7,793) $
(1,968)
—
3,837
(1,516)
(7,440) $
(6,738)
138
(2,172)
2,573
—
(6,199)
GAAP requires disclosure of the fair value of financial instruments not reported at fair value on a recurring basis for which it is practical to estimate such
value. The Company believes that the carrying amounts of its other financial instruments such as cash, receivables and payables approximate the fair value
of such items due to the short maturity of such instruments. The PWB Credit Facility and BNP Facility are variable rate instruments and fair value is
approximately book value.
134
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The following tables present the fair value measurements of the Company's debt and indicate the fair value hierarchy of the significant unobservable inputs
utilized by the Company to determine such fair values as of December 31, 2019 and 2018:
Description
PWB Credit Facility
BNP Facility
OFS Capital Corporation 6.375% Notes due 2025
OFS Capital Corporation 6.5% Notes due 2025
OFS Capital Corporation 5.95% Notes due 2026
SBA-guaranteed debentures
Total debt, at fair value
Description
PWB Credit Facility
OFS Capital Corporation 6.375% Notes due 2025
OFS Capital Corporation 6.5% Notes due 2025
SBA-guaranteed debentures
Total debt, at fair value
Level 1
Level 2
Level 3 (1)
Total
December 31, 2019
— $
—
50,600
49,282
54,282
—
154,164 $
— $
—
—
—
—
—
— $
— $
56,450
—
—
—
155,562
212,012 $
—
56,450
50,600
49,282
54,282
155,562
366,176
Level 1
Level 2
Level 3 (1)
Total
December 31, 2018
— $
48,500
46,603
—
95,103 $
— $
—
—
—
— $
12,000 $
—
—
147,956
159,956 $
12,000
48,500
46,603
147,956
255,059
$
$
$
$
(1) For Level 3 measurements, fair value is estimated by discounting remaining payments using current market rates for similar instruments at the
measurement date and considering such factors as the legal maturity date.
The following are the carrying values and fair values of the Company’s debt as of December 31, 2019 and 2018:
Description
PWB Credit Facility
BNP Facility
OFS Capital Corporation 6.375% Notes due 2025
OFS Capital Corporation 6.5% Notes due 2025
OFS Capital Corporation 5.95% Notes due 2026
SBA-guaranteed debentures
Total debt, at fair value
Note 6. Commitments and Contingencies
As of December 31, 2019
As of December 31, 2018
Carrying Value
Fair Value
Carrying Value
Fair Value
$
$
— $
— $
12,000 $
56,450
48,634
47,093
56,450
50,600
49,282
—
48,377
46,849
52,325
54,282
—
147,976
352,478 $
155,562
366,176 $
147,600
254,826 $
12,000
—
48,500
46,603
—
147,956
255,059
The Company has the following unfunded commitments to portfolio companies as of December 31, 2019:
Name of Portfolio Company
Carolina Lubes, Inc.
Inergex Holdings
SSJA Bariactric Management LLC
TalentSmart Holdings, LLC
Investment Type
Amount
Senior Secured Loan (Revolver)
Senior Secured Loan (Revolver)
Senior Secured Loan (Revolver)
Senior Secured Loan (Revolver)
135
$
$
2,920
937
667
250
4,774
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
From time to time, the Company is involved in legal proceedings in the normal course of its business. Although the outcome of such litigation cannot be
predicted with any certainty, management is of the opinion, based on the advice of legal counsel, that final disposition of any litigation should not have a
material adverse effect on the financial position of the Company as of December 31, 2019.
Additionally, the Company is subject to periodic inspection by regulators to assess compliance with applicable BDC regulations and the SBIC I LP is
subject to periodic inspections by the SBA.
In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties that provide
general indemnifications. The Company’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made
against the Company that have not occurred. The Company believes the risk of any material obligation under these indemnifications to be low.
Note 7. Borrowings
SBA Debentures: The SBIC Program enabled SBIC I LP to obtain leverage by issuing SBA-guaranteed debentures, subject to issuance of a capital
commitment by the SBA and customary procedures. These debentures are non-recourse to the Company, have interest payable semi-annually and a ten-
year maturity. The interest rate is fixed at the time of SBA pooling, which is March and September of each year, at a market-driven spread over U.S.
Treasury Notes with ten-year maturities.
Under present regulations of the SBIC Act, the maximum amount of SBA-guaranteed debt that may be issued by a single SBIC licensee is $150,000 (or
$175,000 with SBA approval). An SBIC fund may borrow up to two times the amount of its regulatory capital, subject to customary regulatory
requirements. In connection with the SBIC Acquisition, the Company increased its total commitments to SBIC I LP to $75,000, which became a drop down
SBIC fund of the Company on December 4, 2013. During 2014, the Company fully funded its $75,000 commitment to SBIC I LP. As of December 31,
2019 and 2018, SBIC I LP had fully drawn the $149,880 of leverage commitments from the SBA.
On a stand-alone basis, SBIC I LP held $249,576 and $251,060 in assets at December 31, 2019 and 2018, respectively, which accounted for approximately
46% and 57% of the Company’s total consolidated assets, respectively. These assets can not be pledged under any debt obligation of the Company.
The following table shows the Company’s outstanding SBA debentures payable as of December 31, 2019 and 2018:
Pooling Date
September 19, 2012
September 25, 2013
March 26, 2014
September 24, 2014
September 24, 2014
March 25, 2015
September 23, 2015
SBA debentures outstanding
Unamortized debt issuance costs
Maturity Date
September 1, 2022
September 1, 2023
March 1, 2024
September 1, 2024
September 1, 2024
March 1, 2025
September 1, 2025
Fixed Interest
SBA debentures outstanding
Rate
December 31, 2019 December 31, 2018
3.049% $
14,000 $
4.448
3.995
3.819
3.370
2.872
3.184
7,000
5,000
4,110
31,265
65,920
22,585
149,880
(1,904)
14,000
7,000
5,000
4,110
31,265
65,920
22,585
149,880
(2,280)
147,600
SBA debentures outstanding, net of unamortized debt issuance costs
$
147,976 $
The Company received exemptive relief from the SEC effective November 26, 2013, which permits the Company to exclude SBA guaranteed debentures
from the definition of senior securities in the statutory asset coverage ratio under the 1940 Act, allowing for greater capital deployment.
The effective interest rate on the SBA debentures, which includes amortization of deferred debt issuance costs, was 3.43% as of December 31, 2019 and
2018. Interest expense on the SBA debentures was $5,137, $5,137, and $5,141 for the years ended December 31, 2019, 2018 and 2017, respectively, which
includes $377, $377, and $380 of debt issuance costs amortization, respectively.
136
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The weighted-average fixed cash interest rate on the SBA debentures as of December 31, 2019 and 2018, was 3.18%.
Unsecured Notes: In April 2018, the Company publicly offered the Unsecured Notes Due April 2025 with an aggregate principal of $50,000. The total net
proceeds to the Company from the Unsecured Notes Due April 2025, after deducting underwriting discounts and offering costs of $1,804 were $48,196. In
October and November 2018, the Company publicly offered the Unsecured Notes Due October 2025 with an aggregate principal of $48,525, which
included a partial exercise of the underwriters overallotment option. The total net proceeds to the Company from the Unsecured Notes Due October 2025,
after deducting underwriting discounts and offering expenses of $1,724, were $46,801. In October and November 2019, the Company publicly offered the
Unsecured Notes Due October 2026 with an aggregate principal of $54,325, which included a partial exercise of the underwriters overallotment option. The
total net proceeds to the Company from the Unsecured Notes Due October 2026, after deducting underwriting discounts and offering costs of $2,054 were
$52,270. The Unsecured Notes Due April 2025, the Unsecured Notes Due October 2025 and the Unsecured Notes Due October 2026, combined (the
“Unsecured Notes”), totaled $152,850 in aggregate principal debt, with net proceeds of $147,267 to the Company.
The Unsecured Notes are direct unsecured obligations and rank equal in right of payment with all current and future unsecured indebtedness of the
Company. Because the Unsecured Notes are not secured by any of the Company's assets, they are effectively subordinated to all existing and future secured
unsubordinated indebtedness (or any indebtedness that is initially unsecured as to which the Company subsequently grant a security interest), to the extent
of the value of the assets securing such indebtedness, including, without limitation, borrowings under the senior secured revolving credit facility between
the Company and Pacific Western Bank ("PWB Credit Facility") and borrowings under the revolving credit and security agreement by and among OFSCC-FS,
the lenders from time to time parties thereto, BNP Paribas, as administrative agent, OFSCC-FS Holdings, LLC, a wholly owned subsidiary of the Company, as
equityholder, the Company, as servicer, Citibank, N.A., as collateral agent and Virtus Group, LP, as collateral administrator("BNP Facility").
The indenture governing the Unsecured Notes contains certain covenants (i) prohibiting additional borrowings, including through the issuance of additional
debt securities, unless the Company's asset coverage, as defined in the 1940 Act, after giving effect to any exemptive relief granted to the Company by the
SEC, equals at least 200% (or 150% on and after May 3, 2019) after such borrowings; and (ii) prohibiting (a) the declaration of any cash dividend or
distribution upon any class of the Company’s capital stock (except to the extent necessary for the Company to maintain its treatment as a RIC under
Subchapter M of the Code), or (b) the purchase of any capital stock if the Company’s asset coverage, as defined in the 1940 Act, were below 200% (or
150% on and after May 3, 2019) at the time of such capital transaction and after deducting the amount of such transaction.
As of December 31, 2019, the Unsecured Notes had the following terms and balances:
Unsecured Notes
Principal
Unsecured Notes Due April 2025
$
50,000 $
Unsecured Notes Due October 2025
Unsecured Notes Due October 2026
Total
48,525
54,325
$
152,850 $
Unamortized
Discount and
Issuance Costs
Stated Interest
Rate (1)
Effective
Interest Rate
(2)
Maturity (3)
2019 Interest
Expense (4)
1,366
1,432
2,000
4,798
6.375%
6.50%
5.95%
6.88%
7.01%
6.49%
4/30/2025 $
10/31/2025
10/31/2026
$
3,444
3,483
723
7,650
(1) The weighted-average fixed cash interest rate on the Unsecured Notes as of December 31, 2019, was 6.26%.
(2) The effective interest rate on the Unsecured Notes includes deferred debt issuance cost amortization.
(3) The Unsecured Notes Due April 2025, the Unsecured Notes Due October 2025, and the Unsecured Notes Due 2026 may be redeemed in whole or in
part at any time or from time to time at the Company’s option on or after April 30, 2020, October 31, 2020, and October 31, 2021, respectively.
(4) Interest expense includes debt issuance costs amortization of $584 for the year ended December 31, 2019.
PWB Credit Facility: The Company is party to a business loan agreement ("BLA") with Pacific Western Bank, as lender, to provide the Company with a
$100,000 senior secured revolving credit facility. The PWB Credit Facility is available for general corporate purposes including investment funding and is
scheduled to mature on February 28, 2021. The maximum availability of the PWB Credit Facility is equal to 50% of the aggregate outstanding principal
amount of eligible loans included in the borrowing base, which excludes subordinated loan investments and as otherwise specified in the BLA. The PWB
Credit
137
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Facility is guaranteed by OFSCC-MB and secured by all of our current and future assets excluding assets held by SBIC I LP, OFSCC-FS, and the
Company’s partnership interests in SBIC I LP and SBIC I GP. The PWB Credit Facility bears interest at a variable rate of the Prime Rate plus a 0.25%
margin, with a 5.25% floor, and includes an unused commitment fee, payable monthly in arrears, equal to 0.50% per annum on any unused portion. As of
December 31, 2019, the stated interest rate of the PWB Credit Facility was 5.25%.
The average dollar amount of borrowings outstanding during the year ended December 31, 2019, was $28,061. The effective interest rate, which includes
amortization of deferred debt issuance costs as of December 31, 2019, was 6.03% based on the maximum amount available under the PWB Credit Facility.
Interest expense on the PWB Credit Facility was $2,136, $959 and $672 for the years ended December 31, 2019, 2018, and 2017, respectively, which
includes $283, $180 and $172 of deferred financing amortization, respectively Unamortized debt issuance costs included in prepaid expenses and other
assets on the consolidated statements of assets and liabilities as of December 31, 2019 and 2018 were $399 and $180, respectively.
Availability under the PWB Credit Facility was $69,005 based on the stated advance rate of 50% under the borrowing base, and the $-0- outstanding as of
December 31, 2019.
The BLA contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting
requirements, a minimum tangible net asset value, a minimum quarterly net investment income after incentive fees, and a statutory asset coverage test. The
BLA also contains customary events of default, including, without limitation, nonpayment, misrepresentation of representations and warranties in a
material respect, breach of covenant, cross-default to other indebtedness, bankruptcy, change in investment advisor, and the occurrence of a material
adverse change in our financial condition. As of December 31, 2019, the Company was in compliance with the applicable covenants.
BNP Facility: On June 20, 2019, OFSCC-FS entered into the BNP Facility, which provides for borrowings in an aggregate principal amount up to
$150,000, of which $56,450 was drawn as of December 31, 2019. Borrowings under the BNP Facility bear interest of LIBOR plus an applicable spread,
which is determined on the basis of industry-recognized portfolio company metrics at the time of funding. The effective interest rate on the BNP Facility
was 4.72% at December 31, 2019. The BNP Facility will mature on the earlier of June 20, 2024 or upon certain other events defined in the credit agreement
which result in accelerated maturity. The BNP Facility also contains customary events of default, including, without limitation, nonpayment, failure to
maintain valid ownership interest in all of the collateral and bankruptcy. Borrowings under the BNP Facility are secured by substantially all of the assets
held by OFSCC-FS, which were $92,513 and $-0-, or 17% and 0.0% of the Company's total consolidated assets at December 31, 2019 and 2018,
respectively. OFSCC-FS incurred fees to the lenders as well as legal costs of approximately $1,346 to establish the BNP Facility, which are amortized over
the life of the facility. Unamortized debt issuance costs included in prepaid expenses and other assets on the consolidated statements of assets and liabilities
as of December 31, 2019 and 2018 were $1,229 and $-0-, respectively. The unused commitment under the BNP Facility was $93,550 as of December 31,
2019.
The average dollar amount of borrowings outstanding during the year ended December 31, 2019, was $20,000. Interest expense on the BNP Facility was
$905, which included $118 of deferred financing amortization, for the year ended December 31, 2019.
The average dollar borrowings and average interest rate for all Company debt during the years ended December 31, 2019, 2018 and 2017, were as follows:
Year ended
December 31, 2019
December 31, 2018
December 31, 2017
Average Dollar
Borrowings
Weighted Average
Interest Rate
$
307,826
206,936
158,368
4.99%
4.37
3.55
138
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
As of December 31, 2019, the Company's debt liabilities are scheduled to mature as follows:
Debt liabilities(1)
PWB Credit Facility
BNP Facility
SBA Debentures(2)
Unsecured Notes
Total
Principal Due by Year
Total
2020
2021
2022
2023
2024
Thereafter
$
$
— $
— $
— $
56,450
149,880
152,850
—
—
—
—
—
—
— $
—
— $
—
14,000
7,000
—
—
— $
56,450
40,375
—
—
—
88,505
152,850
359,180 $
— $
— $ 14,000 $
7,000 $
96,825 $
241,355
(1) The PWB Credit Facility is scheduled to mature on February 28, 2021. The BNP Facility is scheduled to mature on June 20, 2024. The SBA
debentures are scheduled to mature between September 2022 and 2025. The Unsecured Notes are scheduled to mature between April 2025 and
October 2026.
(2) SBIC I LP intends, over time, to repay outstanding SBA debentures prior to the scheduled maturity date of its debentures. See footnote 13 for
additional information.
Note 8. Federal Income Tax
Filing status: The Company has elected to be taxed as a RIC under Subchapter M of the Code. In order to maintain its status as a RIC, the Company is
required to distribute annually to its stockholders at least 90% of its ICTI, as defined by the Code. Additionally, to avoid a 4% U.S. federal excise tax on
undistributed earnings the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2%
of its net capital gains for the one-year period ending October 31 of that calendar year, and (iii) any income recognized, but not distributed, in preceding
years and on which the Company paid no U.S. federal income tax. Maintenance of the Company's RIC status also requires adherence to certain source of
income and asset diversification requirements.
Taxable income and distributions: The Company has met the required distribution, source of income and asset diversification requirements as of
December 31, 2019, and intends to continue meeting these requirements. Accordingly, there is no liability for federal income taxes at the Company level.
The Company’s ICTI differs from the net increase in net assets resulting from operations primarily due to differences in income recognition on the
unrealized appreciation/depreciation of investments, income from Company’s equity investments in pass-through entities, PIK dividends that have not yet
been declared and paid by underlying portfolio companies, capital gains and losses and the net creation or utilization of capital loss carryforwards. The
Company recognized approximately $18,355 of ordinary taxable income during the year ended December 31, 2019.
The distributions paid to stockholders are reported as ordinary income, long-term capital gains, and returns of capital. The tax character of distributions
paid were as follows:
Ordinary taxable income
Long-term capital gain
Total distributions to stockholders
Years Ended December 31,
2019
2018
2017
$
$
18,176
—
18,176
$
$
18,053
$
5,036
23,089 $
14,158
2,738
16,896
Tax-basis components of distributable earnings (accumulated losses) as of December 31, 2019 and 2018, were as follows:
Ordinary income
Net long-term capital loss carryforward – non-expiring
December 31,
2019
2018
$
2,578
$
(8,578)
3,712
(5,176)
The Company records reclassifications to its capital accounts related to permanent differences between GAAP and tax treatment related to goodwill
amortization, excise taxes, and other permanent differences; and temporary differences between GAAP and tax treatment of realized gains and losses,
income arising from Company’s equity investments in pass-through entities, PIK dividends, and other temporary differences. The Company recorded
reclassifications to increase (decrease)
139
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
additional paid-in capital against total distributable earnings (accumulated loss) of $(462), $(62) and $(409) for the years ended December 31, 2019, 2018
and 2017, respectively.
The tax-basis cost of investments and associated tax-basis gross unrealized appreciation (depreciation) inherent in the fair value of investments as of
December 31, 2019 and 2018, were as follows:
Tax-basis amortized cost of investments
Tax-basis gross unrealized appreciation on investments
Tax-basis gross unrealized depreciation on investments
Tax-basis net unrealized depreciation on investments
Fair value of investments
December 31,
2019
2018
$
$
531,781 $
24,326
(39,176)
(14,850)
516,931 $
408,715
18,426
(30,344)
(11,918)
396,797
Deferred taxes: The Company recognizes deferred taxes on the unrealized appreciation or depreciation of securities held through Taxable Blockers.
Deferred tax assets and liabilities are measured using enacted corporate federal tax rates expected to apply to taxable income in the years in which those
unrealized gains and losses are realized. The recoverability of deferred tax assets is assessed and a valuation allowance is recorded to the extent that it is
more likely than not that any portion of the deferred tax asset will not be realized on the basis of the projected taxable income or other taxable events in the
Taxable Blocker. Deferred tax assets and liabilities, and related valuation allowance, as of December 31, 2019 and 2018, were as follows:
Total deferred tax assets
Total deferred tax liabilities
Valuation allowance on net deferred tax assets
December 31,
2019
2018
$
442 $
(838)
—
310
(225)
(85)
Net unrealized appreciation (depreciation) on investments reported in the consolidated statements of operations includes $(416), $(4) and $4 of net deferred
tax (benefit) expense for the years ended December 31, 2019, 2018 and 2017, respectively.
140
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 9. Financial Highlights
The following is a schedule of financial highlights for the years ended December 31, 2019, 2018, 2017, 2016 and 2015:
2019
2018
2017
2016
2015
Years Ended December 31,
Per share operating performance:
Net asset value per share at beginning of year
$
13.10
$
14.12
$
Net investment income(10)
Net realized gain (loss) on non-control/non-affiliate investments(10)
Net realized gain on affiliate investments(10)
Net unrealized appreciation (depreciation) on non-control/non-affiliate investments(10)
Net unrealized appreciation (depreciation) on affiliate investments(10)
Net unrealized appreciation (depreciation) on control investment(10)
Total from investment operations
Distributions
Issuance of common stock (5)
Other (6)
Net asset value per share at end of year
Per share market value, end of period
Total return based on market value (1)
Total return based on net asset value (2)
Shares outstanding at end of period
Weighted average shares outstanding
Ratio/Supplemental Data (in thousands except ratios)
Average net asset value (3)
Net asset value at end of year
Net investment income
Ratio of total expenses, net to average net assets (8)
Ratio of net investment income to average net assets (9)
Portfolio turnover (7)
1.43
(0.29)
—
(0.72)
0.40
(0.10)
0.72
(1.36)
—
—
12.46
11.17
18.3%
6.7%
13,376,836
13,364,244
171,889
166,627
19,098
19.4%
11.1%
21.2%
$
$
$
$
$
1.38
(0.37)
0.01
(0.19)
(0.06)
(0.06)
0.71
(1.73)
—
—
13.10
10.60
3.5%
7.8%
13,357,337
13,348,203
182,468
175,023
18,385
13.4%
10.5%
41.9%
$
$
$
$
$
$
$
$
$
$
14.24
1.39
(0.31)
0.14
0.53
0.13
—
1.88
(1.36)
—
—
14.76
11.48
9.0%
16.0%
$
14.76
$
1.46
0.25
—
(0.69)
0.33
0.07
1.42
(1.36)
—
—
14.82
1.28
(0.26)
0.81
(0.78)
(0.41)
0.64
(1.36)
(0.03)
0.05
14.12
—
$
14.82
$
$
11.90
(4.7)%
5.0 %
$
13.76
32.3%
10.9%
13,340,217
12,403,706
9,700,297
9,693,801
9,691,170
9,670,153
171,631
188,336
15,877
$
$
$
10.2 %
8.4 %
50.4 %
142,818
143,778
14,145
$
$
$
11.9%
9.8%
18.1%
140,002
143,012
13,411
13.5%
9.6%
44.6%
(1) Calculated as ending market value less beginning market value, adjusted for distributions reinvested at prices based on the Company’s dividend
reinvestment plan for the respective distributions.
(2) Calculated as ending net asset value less beginning net asset value, adjusting for distributions reinvested at the Company’s dividend reinvestment plan
for the respective distributions.
(3) Based on the average of the net asset value at the beginning of the indicated period and the end of each calendar quarter within the period indicated.
(4) Reserved.
(5) The issuance of common stock on a per share basis reflects the incremental net asset value change as a result of the Offering.
(6) Represents the impact of different share amounts used in calculating per share data as a result of calculating certain per share data based on a weighted
average shares outstanding during the period and certain per share data based on the shares outstanding as of a period end or transaction date.
(7) Portfolio turnover rate is calculated using the lesser of year-to-date sales and principal payments or year-to-date purchases over the average of the
invested assets at fair value at the beginning of the indicated period and the end of each calendar quarter within the period indicated.
(8) Ratio of total expenses before incentive fee waiver to average net assets was 13.4% for the year ended December 31, 2018.
(9) Ratio of net investment income before incentive fee waiver to average net assets was 10.5% for the year ended December 31, 2018.
(10) Calculated on the average share method.
141
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 10. Capital Transactions
Distributions: The Company intends to make distributions to stockholders on a quarterly basis of substantially all of its net investment income. In addition,
although the Company intends to make distributions of net realized capital gains, if any, at least annually, out of assets legally available for such
distributions. The Company may in the future decide to retain such net investment income and capital gains for investment or corporate purposes.
The Company may be limited in its ability to make distributions due to the BDC asset coverage requirements of the 1940 Act. The Company’s ability to
make distributions may also be affected by its restrictions imposed by the SBA regulations on the Company's wholly owned SBIC subsidiary. In addition,
distributions from OFSCC-FS to the Company are restricted by the terms and conditions of the BNP Facility. At December 31, 2019 and December 31,
2018, net assets of SBIC I LP were $99,848 and $101,727, respectively, which included cash of $1,851 and $36,031, of which $1,851 and $9,677 were
available for distribution at December 31, 2019 and 2018, respectively. At December 31, 2019 and December 31, 2018, net assets of OFSCC-FS
were $25,578 and $-0-, respectively, which included cash of $2,172 and $-0-, of which $-0- and $-0- were available for distribution to the Company at
December 31, 2019 and 2018, respectively.
The following table summarizes distributions declared and paid for the years ended December 31, 2019, 2018 and 2017:
Date Declared
Record Date
Payment Date
Amount
Per Share
Cash
Distribution
DRIP Shares
Issued
DRIP Shares
Value
Year ended December 31, 2017
March 9, 2017
May 2, 2017
August 1, 2017
October 31, 2017
Year ended December 31, 2018
February 12, 2018 (1)
February 27, 2018
May 1, 2018
August 3, 2018
October 30, 2018
Year ended December 31, 2019
March 5, 2019
April 30, 2019
July 30, 2019
March 17, 2017
June 16, 2017
March 31, 2017
$
0.34 $
June 30, 2017
September 15, 2017
September 29, 2017
December 15, 2017
December 29, 2917
March 22, 2018
March 22, 2018
June 22, 2018
March 29, 2018
March 29, 2018
June 29, 2018
September 14, 2018
September 28, 2018
December 17, 2018
December 31, 2018
March 22, 2019
June 21, 2019
March 29, 2019
June 28, 2019
September 23, 2019
September 30, 2019
0.34
0.34
0.34
3,257
4,483
4,491
4,469
2,919 $
3,439
3,196
5,366
41
49
42
64
$
$
1.36 $
16,700
14,920 $
196
0.37 $
0.34
0.34
0.34
0.34
4,886
4,490
4,518
4,511
4,489
4,459 $
4,098
1,684
2,366
4,813
50
46
20
28
51
$
1.73 $
22,894
17,420 $
195
$
$
0.34
0.34
0.34
0.34
1.36
$
4,497
4,479
4,487
4,486
3,797
$
5,327
4,990
5,385
45
64
58
60
$
17,949
19,499
$
227
November 6, 2019
December 24, 2019
December 31, 2019
(1) Special distribution representing undistributed net long-term capital gains realized by the Company in 2017.
The following table represents DRIP participation for the years ended December 31, 2019, 2018 and 2017, respectively:
For the Year Ended
December 31, 2019
December 31, 2018
December 31, 2017
DRIP Shares
Value
Total Distribution
Declared
DRIP Shares
Issued
Average Value Per
Share
227 $
195
196
18,176
23,089
16,896
19,500 $
17,420
14,920
11.62
11.16
13.18
Since the Company’s IPO, distributions to stockholders total $109,040, or $9.72 per share on a cumulative basis.
Distributions in excess of the Company’s current and accumulated ICTI would be treated first as a return of capital to the extent of the stockholder’s tax
basis, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of the Company’s distributions is made
annually as of the end of its fiscal year based upon its ICTI for the full year and distributions paid for the full year. Therefore, a determination made on a
quarterly basis may not be representative of the
142
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
actual tax attributes of the Company’s distributions for a full year. Each year, a statement on Form 1099-DIV identifying the source of the distribution is
mailed to the Company’s stockholders. For the year ended December 31, 2019, approximately $1.36 per share, $0.00 per share, and $0.00 per share of the
Company’s distributions represented ordinary income, long-term capital gain, and a return of capital to its stockholders, respectively.
Stock repurchase program: On May 22, 2018, the Board authorized the Company to initiate the Stock Repurchase Program under which the Company
may acquire up to $10,000 of its outstanding common stock. Under the Stock Repurchase Program, the Company is authorized to repurchase shares in
open-market transactions, including through block purchases, depending on prevailing market conditions and other factors. The Stock Repurchase Program
may be extended, modified or discontinued at any time for any reason. The Company expects the Stock Repurchase Program to be in place through May
22, 2020, or until the approved dollar amount has been used to repurchase shares. The Stock Repurchase Program does not obligate the Company to
acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method,
timing, price and volume of stock repurchases.
The following table summarizes the shares of common stock the Company repurchased under the Stock Repurchase Program during the years
ended December 31, 2019 and 2018 (amount in thousands except shares):
Period
May 22, 2018 through December 31, 2018
January 1, 2019 through December 31, 2019
Total
Total Number of
Shares
Purchased
Average
Price Paid
Per Share
300 $
10.29
—
300
—
10.29
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
Maximum Number (or
Approximate Dollar Value) of
Shares (or Units) That May Yet
be Purchased Under the Plans
or Programs
300 $
—
300
9,997
—
9,997
Note 11. Selected Quarterly Financial Data (Unaudited)
Total investment income
Net investment income
Net loss on investments
Net increase in net assets resulting from operations
Net investment income per share – basic and diluted (1)
Net increase in net assets resulting from operations per share – basic and
diluted (1)
Net asset value per share (2)
Total investment income
Net investment income
Net gain (loss) on investments
Net increase (decrease) in net assets resulting from operations
Net investment income per share – basic and diluted (1)
Net increase (decrease) in net assets resulting from operations per share –
basic and diluted (1)
Net asset value per share (2)
(1) Based on weighted average shares outstanding for the respective period.
December 31,
2019
September 30,
2019
June 30,
2019
March 31,
2019
Three Months Ended
13,418
$
13,858
$
12,900
$
4,557
(3,851)
706
4,853
(3,091)
1,762
4,860
(1,507)
3,353
0.34 $
0.36 $
0.36 $
0.05
12.46
$
$
0.13
12.74
$
$
0.25
12.95
$
$
12,345
4,828
(1,096)
3,732
0.36
0.28
13.04
December 31,
2018
September 30,
2018
June 30,
2018
March 31,
2018
Three Months Ended
12,571 $
10,982 $
10,278 $
5,321
(9,416)
(4,095)
4,690
489
5,179
4,558
437
4,995
0.40 $
0.35 $
0.34 $
(0.30) $
13.10 $
0.39 $
13.75 $
0.37 $
13.70 $
9,003
3,816
(323)
3,493
0.29
0.26
13.67
$
$
$
$
$
$
$
$
143
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
(2) Based on shares outstanding at the end of the respective period.
144
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 12. Consolidated Schedule of Investments In and Advances To Affiliates
Name of
Portfolio
Company
Control
Investment
MTE
Holding
Corp.
Total
Control
Investment
Affiliate
Investments
3rd Rock
Gaming
Holdings,
LLC
Chemical
Resources
Holdings,
Inc.
Contract
Datascan
Holdings,
Inc.
Year Ended December 31, 2019
Net
Realized
Gain
(Loss)
Net change in
unrealized
appreciation/
(depreciation)
Investment
Type (1)
Interest
& PIK
Interest Dividends Fees
Total
Income
(2)
December 31,
2018, Fair
Value
Gross
Additions
(3)
Gross
Reductions
(4)
December 31,
2019, Fair
Value (5)
Subordinated
Loan
Common
Equity
Senior Secured
Loan
Common
Equity(6)
Senior Secured
Loan
Common
Equity(6)
Subordinated
Loan
Preferred
Equity(7)
Common
Equity(6)
$ — $
(15)
$ 1,172
$ — $ 42
$ 1,214
$
7,296
$
183
$
(15)
$
7,464
—
—
(1,396)
—
(1,411)
1,172
89
89
—
42
89
1,303
2,649
9,945
—
183
(1,396)
(1,411)
1,253
8,717
—
(1,411)
1,172
89
42
1,303
9,945
183
(1,411)
8,717
—
—
—
—
—
—
—
—
—
—
253
2,360
(29)
224
—
2,360
—
—
—
— 2,360
20,023
—
—
— 2,360
1,073
21,096
451
—
451
(375)
20,099
(29)
(404)
1,044
21,143
154
1,395
— 204
1,599
849
—
—
—
—
1,003
1,395
— 204
1,599
—
—
—
13,932
(186)
13,746
2,662
16,594
—
(186)
2,662
16,408
(5)
931
(1,636)
656
(1,642)
—
(3,283)
1,587
—
—
—
—
145
—
—
—
931
656
—
— 1,587
8,000
6,652
2,313
16,965
5
656
—
661
(5)
8,000
(1,637)
5,671
(1,642)
(3,284)
671
14,342
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Year Ended December 31, 2019
Net
Realized
Gain
(Loss)
Net change in
unrealized
appreciation/
(depreciation)
Investment
Type (1)
Interest
& PIK
Interest Dividends Fees
Total
Income
(2)
December 31,
2018, Fair
Value
Gross
Additions
(3)
Gross
Reductions
(4)
December 31,
2019, Fair
Value (5)
Name of
Portfolio
Company
DRS
Imaging
Services,
LLC
Master
Cutlery,
LLC
Senior Secured
Loan
Common
Equity(6)
Subordinated
Loan (6)
Preferred
Equity(6)
Common
Equity(6)
NeoSystems
Corp.
Preferred
Stock(7)
Pfanstiehl
Holdings,
Inc.
Subordinated
Loan
Common
Equity
Professional
Pipe
Holdings,
LLC
Senior Secured
Loan
Common
Equity(6)
$ — $
56
$ 1,317
$ — $ — $ 1,317
$
10,617
$
75
$
(123)
$
10,569
—
—
—
—
—
—
—
—
—
—
—
—
—
134
190
—
1,317
(595)
—
—
(595)
—
—
—
—
—
—
—
—
—
—
—
—
— 1,317
1,197
11,814
—
—
—
—
—
—
—
—
850
—
—
850
134
209
718
—
—
718
—
(123)
1,331
11,900
(1,313)
—
—
(1,313)
255
—
—
255
(161)
162
—
—
162
2,250
162
(162)
2,250
7
3,619
3,626
343
1,644
1,987
390
—
390
999
—
999
390
413
803
999
—
999
—
—
—
—
—
—
—
413
413
—
—
—
146
3,788
8
8,360
12,148
3,619
3,627
(8)
—
(8)
3,788
11,979
15,767
7,466
470
(766)
7,170
769
8,235
1,644
2,114
—
(766)
2,413
9,583
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Name of
Portfolio
Company
TalentSmart
Holdings,
LLC
TRS
Services,
Inc.
Investment
Type (1)
Senior
Secured Loan
Senior
Secured Loan
(Revolver)
Common
Equity(6)
Senior
Secured Loan
Preferred
Equity (Class
AA units)(7)
Preferred
Equity (Class
A units)(6)
Common
Equity(6)
TTG
Healthcare,
LLC
Senior
Secured Loan
Preferred
Equity(6)
Total
Affiliate
Investments
Total
Control and
Affiliate
Investments
Year Ended December 31, 2019
Net
Realized
Gain
(Loss)
Net change in
unrealized
appreciation/
(depreciation)
Interest
& PIK
Interest Dividends Fees
Total
Income
(2)
December 31,
2018, Fair
Value
Gross
Additions
(3)
Gross
Reductions
(4)
December 31,
2019, Fair
Value (5)
$ — $
— $
203
$ — $ — $
203
$
— $ 10,008
$
(175)
$
9,833
—
—
—
—
—
—
—
—
—
—
—
—
—
—
4
—
207
—
—
—
—
—
—
4
—
207
—
—
—
251
(9)
242
1,500
11,759
—
(184)
1,500
11,575
179
1,842
—
6
1,848
14,446
14,995
(14,818)
14,623
(6)
2,269
—
80
—
—
2,442
1,922
—
—
—
—
—
—
—
6
80
—
—
473
826
—
80
(6)
547
2,269
—
—
—
3,095
—
1,928
15,745
17,344
(14,824)
18,265
(171)
1,282
—
11
1,293
115
(56)
1,282
—
11
1,293
—
—
—
—
14,951
(3,184)
11,767
2,424
17,375
—
(3,184)
2,424
14,191
—
5,376
11,621
413
221
12,255
89,103
71,014
(24,438)
135,679
— $
3,965
$12,793
$
502
$ 263
$13,558
$
99,048
$ 71,197
$ (25,850)
$ 144,396
(1) Principal balance of debt investments and ownership detail for equity investments are shown in the consolidated schedule of investments. The
Company's investments are generally classified as "restricted securities" as such term is defined under Regulation S-X Rule 6-03(f) or Securities Act
Rule 144.
(2) Represents the total amount of interest, fees or dividends included in 2019 income for the portion of the year ended December 31, 2019, that an
investment was included in Control or Affiliate Investment categories, respectively.
147
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
(3) Gross additions include increases in cost basis resulting from a new portfolio investment, PIK interest, fees and dividends, accretion of OID, and net
increases in unrealized net appreciation or decreases in net unrealized depreciation.
(4) Gross reductions include decreases in the cost basis of investments resulting from principal repayments and sales, if any, and net decreases in net
unrealized appreciation or net increases in net unrealized depreciation.
(5) Fair value was determined using significant unobservable inputs. See Note 5 for further details.
(6) Non-income producing.
(7) Dividends credited to income include dividends contractually earned but not declared.
Year ended December 31, 2018
Net
Realized
Gain
(Loss)
Net change in
unrealized
appreciation/
(depreciation)
Interest &
PIK
Interest
Investment
Type (1)
Dividends Fees
Total
Income
(2)
December 31,
2017, Fair
Value
Gross
Additions
(3)
Gross
Reductions
(4)
December 31,
2018, Fair
Value (5)
Subordinated
Secured Loan $ — $
54 $
1,115 $ — $ 66 $ 1,181 $
7,118
$
177 $
— $
7,296
Name of
Portfolio
Company
Control
Investment
MTE
Holding
Corp.
Common
Equity
Total
Control
Investment
Affiliate
Investments
3rd Rock
Gaming
Holdings,
LLC
All Metals
Holding,
LLC
Senior
Secured Loan
Common
Equity (6)
Senior
Secured Loan
Common
Equity (6)
—
—
(801)
(747)
—
185 —
185
3,450
1,115
185
66
1,366
10,568
—
177
(801)
(801)
2,649
9,945
(747)
1,115
185
66
1,366
10,568
177
(801)
9,945
—
(1,330)
1,777
— —
1,777
—
21,750
(1,727)
20,023
—
—
(1,474)
—
— —
—
—
2,560
(1,487)
(2,804)
1,777
— —
1,777
—
24,310
(3,214)
1,073
21,096
—
(471)
2,748
— 588
3,336
12,759
7,230
(19,989)
4,118
4,118
(1,220)
—
— —
—
1,785
258
(2,043)
(1,691)
2,748
— 588
3,336
14,544
7,488
(22,032)
—
—
—
148
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Year ended December 31, 2018
Net
Realized
Gain
(Loss)
Net change in
unrealized
appreciation/
(depreciation)
Interest &
PIK
Interest
Investment
Type (1)
Dividends Fees
Total
Income
(2)
December 31,
2017, Fair
Value
Gross
Additions
(3)
Gross
Reductions
(4)
December 31,
2018, Fair
Value (5)
Name of
Portfolio
Company
Contract
Datascan
Holdings,
Inc.
DRS
Imaging
Services,
LLC
Jobson
Healthcare
Information
(8)
Master
Cutlery,
LLC
Subordinated
Loan
Preferred
Equity A (7)
Common
Equity (6)
Senior Secured
Loan
Common
Equity (6)
Senior Secured
Loan
Common
Equity (6)
Warrants (6)
Subordinated
Loan
Preferred
Equity (6)
Common
Equity (6)
NeoSystems
Corp.
Subordinated
Loan
Preferred
Stock (7)
—
—
—
—
(5)
950
— —
950
8,000
6
(6)
8,000
91
597
— —
597
5,964
688
—
6,652
2,053
2,139
—
— —
—
260
1,547
— — 1,547
14,224
2,053
2,747
—
(6)
2,313
16,965
—
(157)
659
— 163
822
—
10,802
(185)
10,617
—
—
62
(95)
—
659
— —
—
—
1,197
— 163
822
—
11,999
—
(185)
1,197
11,814
(3,477)
2,331
905
— —
905
12,910
2,751
(15,661)
—
(454)
—
454
(3,931)
2,785
—
—
905
— —
— —
—
—
—
—
—
454
—
(454)
— —
905
12,910
3,205
(16,115)
—
(2,095)
156
— —
156
2,873
117
(2,140)
—
—
— —
—
—
—
—
—
(2,095)
—
156
— —
—
—
—
—
— —
156
2,873
117
(2,140)
—
—
—
—
850
—
—
850
(7)
283
— —
283
2,143
47
(2,190)
—
(145)
(152)
146
429
— —
— —
146
429
2,248
4,391
147
194
(145)
(2,335)
2,250
2,250
149
—
—
—
—
—
—
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Name of
Portfolio
Company
Pfanstiehl
Holdings,
Inc.
Investment
Type (1)
Subordinated
Loan
Common
Equity
Professional
Pipe
Holdings,
LLC
TRS
Services,
Inc.
Senior
Secured Loan
Common
Equity (6)
Senior
Secured Loan
Preferred
Equity (Class
AA units) (7)
Preferred
Equity (Class
A units) (6)
Common
Equity (6)
Year ended December 31, 2018
Net
Realized
Gain
(Loss)
Net change in
unrealized
appreciation/
(depreciation)
Interest &
PIK
Interest
Dividends Fees
Total
Income
(2)
December 31,
2017, Fair
Value
Gross
Additions
(3)
Gross
Reductions
(4)
December 31,
2018, Fair
Value (5)
—
—
—
42
392
— —
392
3,755
42
(9)
3,788
3,605
3,647
—
392
130 —
130 —
130
522
4,755
8,510
3,605
3,647
—
(9)
8,360
12,148
—
(181)
845
— —
845
—
8,355
(889)
7,466
—
—
(645)
(826)
—
845
— —
— —
—
845
—
—
1,414
9,769
(645)
(1,534)
769
8,235
—
(307)
1,856
—
9
1,865
9,466
7,942
(2,962)
14,446
—
—
62
— —
62
409
64
—
473
—
(1,404)
—
— —
—
2,230
—
(1,404)
—
—
—
—
— —
—
—
—
—
(1,711)
1,918
—
9
1,927
12,105
8,006
(4,366)
15,745
826
—
Total
Affiliate
Investments
Total
Control and
Affiliate
Investments
187
(803)
11,376
130 760 12,266
69,557
71,482
(51,936)
89,103
$
187 $
(1,550) $ 12,491 $
315 $826 $13,632 $
80,125
$ 71,659 $ (52,737) $
99,048
(1) Principal balance of debt investments and ownership detail for equity investments are shown in the consolidated schedule of investments. The
Company's investments are generally classified as "restricted securities" as such term is defined under Regulation S-X Rule 6-03(f) or Securities Act
Rule 144.
(2) Represents the total amount of interest, fees or dividends included in 2018 income for the portion of the year ended December 31, 2018, that an
investment was included in Control or Affiliate Investment categories, respectively.
(3) Gross additions include increases in cost basis resulting from a new portfolio investment, PIK interest, fees and dividends, accretion of OID, and net
increases in unrealized net appreciation or decreases in net unrealized depreciation.
150
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
(4) Gross reductions include decreases in the cost basis of investments resulting from principal repayments and sales, if any, and net decreases in net
unrealized appreciation or net increases in net unrealized depreciation.
(5) Fair value was determined using significant unobservable inputs. See Note 5 for further details.
(6) Non-income producing.
(7) Dividends credited to income include dividends contractually earned but not declared.
(8) Jobson became an affiliate investment effective December 31, 2017, due to an increase in voting ownership interest.
151
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 13. Subsequent Events Not Disclosed Elsewhere
On March 11, 2020, the Company’s Board declared a distribution of $0.34 per share for the first quarter of 2020, payable on March 31, 2020 to
stockholders of record as of March 24, 2020.
On March 1, 2020, SBIC I LP prepaid $16,110 of SBA debentures that were contractually due September 1, 2023, March 1, 2024 and September 1, 2024.
152
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our disclosure
controls and procedures as of December 31, 2019. The term “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act) means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in
reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s
rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be
disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management,
including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of
achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Based on the foregoing evaluation of our disclosure controls and procedures as of December 31, 2019, our Chief Executive Officer and our Chief Financial
Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management, including our Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate
internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the Exchange Act). Our internal control over financial reporting is
a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for
external reporting purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP,
and that the receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with polices or procedures may deteriorate.
Our management (with the supervision and participation of our Chief Executive Officer and Chief Financial Officer) conducted an evaluation of
the effectiveness of our internal control over financial reporting as of December 31, 2019 based on the framework in Internal Control – Integrated
Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on our assessment, management concluded that, as of December 31, 2019, our internal control over financial reporting is effective based on
those criteria.
Attestation Report of the Registered Public Accounting Firm
Our internal control over financial reporting as of December 31, 2019, has been audited by KPMG LLP, an independent registered public
accounting firm, as stated in their report, which is included in Item 8 of Part II of this Annual Report under the heading Report of Independent Registered
Public Accounting Firm.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that
occurred during the fiscal quarter ended December 31, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
Item 9B.
Other Information
None.
153
Item 10.
Directors, Executive Officers and Corporate Governance
PART III
The information required by Item 10 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the
Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the
Company’s fiscal year.
Item 11.
Executive Compensation
The information required by Item 11 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the
Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the
Company’s fiscal year.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters
The information required by Item 12 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the
Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the
Company’s fiscal year.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the
Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the
Company’s fiscal year.
Item 14. Principal Accountant Fees and Services
The information required by Item 14 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the
Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the
Company’s fiscal year.
154
Item 15.
Exhibits and Financial Statement Schedules
a. Documents Filed as Part of this Report
PART IV
1. Financial Statements: See "Part II, Item 8. Financial Statements and Supplementary Data" of this report for a list of financial statements.
2. Financial Statement Schedules: Schedule 12-14 Investments in and Advances to Affiliates—See "Part II, Item 8. Financial Statements and
Supplementary Data—Note 12" of this report.
3. Exhibits required to be filed by Item 601 of Regulation S-K: See Item 15b. below.
b. Exhibits
The following table lists exhibits filed as part of this report, according to the number assigned to them in Item 601 of Regulation S-K. All exhibits
listed in the following table are incorporated by reference except for those exhibits denoted in the last column. Please note that the agreements included as
exhibits to this Form 10-K are included to provide information regarding their terms and are not intended to provide any other factual or disclosure
information about us or the other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable
agreement that have been made solely for the benefit of the other parties to the applicable agreement and may not describe the actual state of affairs as of
the date they were made or at any other time.
Exhibit
Number
Description
Incorporated by Reference
Form and SEC File
No.
Filing Date with SEC
Filed with this
10-K
3.1
3.2
3.3
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
Certificate of Incorporation of OFS Capital Corporation
N-2 (333-166363)
March 18, 2011
Certificate of Correction to Certificate of Incorporation of OFS Capital
Corporation
10-K (814-00813)
March 26, 2013
Bylaws of OFS Capital Corporation
N-2/A (333-166363)
March 18, 2011
Form of Stock Certificate of OFS Capital Corporation
N-2/A (333-166363)
March 18, 2011
Form of Base Indenture
N-2 (333-200376)
November 19, 2014
Form of Warrant Agreement
N-2/A (333-200376)
December 16, 2014
Form of Subscription Agent Agreement
N-2/A (333-200376)
December 16, 2014
Form of Subscription Certificate
N-2/A (333-200376)
December 16, 2014
Form of Certificate of Designation
N-2/A (333-200376)
December 16, 2014
First Supplemental Indenture dated as of April 16, 2018, between OFS
Capital Corporation and U.S. Bank National Association, as trustee
POS EX (333-
217302)
April 16, 2018
Form of 6.375% Note due 2025 (incorporated by reference to Exhibit
4.8 hereto and Exhibit A therein)
POS EX (333-
217302)
April 16, 2018
155
Exhibit
Number
4.9
4.10
4.11
4.12
Description
Second Supplemental Indenture dated as of October 16, 2018 between
OFS Capital Corporation and U.S. Bank National Association, as
trustee
Incorporated by Reference
Form and SEC File
No.
POS EX (333-
222419)
Filing Date with SEC
October 16, 2018
Filed with this
10-K
Form of 6.50% Note due 2025 (incorporated by reference to Exhibit
4.10 hereto and Exhibit A therein)
POS EX (333-
222419)
October 16, 2018
Third Supplemental Indenture dated as of October 15, 2019 between
OFS Capital Corporation and U.S. National Bank Association, as
trustee
POS EX
October 15, 2019
Form of 5.95% Note due 2026 (incorporated by reference to Exhibit
4.11 hereto and Exhibit A therein)
POS EX
October 15, 2019
4.13
Description of Securities
*
10.1
Form of Dividend Reinvestment Plan
N-2/A (333-166363)
March 18, 2011
10.2
Investment Advisory and Management Agreement between OFS
Capital Corporation and OFS Capital Management, LLC
10-Q (814-00813)
November 7, 2014
10.3
Form of Custody Agreement
N-2/A (333-166363)
March 18, 2011
10.4
10.5
10.6
10.7
10.9
10.10
10.11
10.13
10.14
Administration Agreement between OFS Capital Corporation and OFS
Capital Services, LLC
N-2/A (333-166363)
March 18, 2011
License Agreement between OFS Capital Corporation and Orchard
First Source Asset Management, LLC
N-2/A (333-166363)
March 18, 2011
Form of Indemnification Agreement between OFS Capital
Corporation and each of its directors and executive officers
N-2/A (333-166363)
March 18, 2011
Form of Registration Rights Agreement between OFS Capital
Corporation and Orchard First Source Asset Management, LLC
N-2/A (333-166363)
July 24, 2012
Business Loan Agreement between OFS Capital Corporation and
Pacific Western Bank dated March 7, 2018
10-K (814-00813)
March 12, 2018
Promissory Note between OFS Capital Corporation and Pacific
Western Bank dated November 5, 2015
10-Q (814-00813)
November 6, 2015
Change in terms to the Business Loan Agreement between OFS
Capital Corporation and Pacific Western Bank dated March 7, 2018
10-K (814-00813)
March 12, 2018
Business Loan Agreement between OFS Capital Corporation and
Pacific Western Bank, dated April 10, 2019
Change in terms to the Business Loan Agreement between OFS
Capital Corporation and Pacific Western Bank, dated April 10, 2019
Form 8-K
(333-00813)
Form 8-K
(333-00813)
April 15, 2019
April 15, 2019
156
Exhibit
Number
10.15
10.16
10.17
10.18
10.19
10.2
Description
Form and SEC File
No.
Incorporated by Reference
Commercial Guaranty Agreement between OFS Capital Corporation
and Pacific Western Bank, dated April 10, 2019
Commercial Guaranty Agreement between among OFS Capital
Corporation, OFSCC-MB, Inc., and Pacific Western Bank, dated April
10, 2019
Revolving Credit and Security Agreement by and among OFSCC-FS,
LLC, as borrower, the lenders from time to time parties thereto, BNP
Paribas, as administrative agent, OFSCC-FS Holdings LLC, as
equityholder, OFS Capital Corporation, LLC, as servicer, and
Citibank, N.A., as collateral agent, dated June 20, 2019.
Securities Account Control Agreement by and among OFSCC-FS,
LLC, as pledgor, BNP Paribas, as administrative agent, and Citibank,
N.A., as secured party and securities intermediary, dated June 20,
2019.
Filing Date with SEC
April 15, 2019
Filed with this
10-K
April 15, 2019
June 24, 2019
Form 8-K
(333-00813)
Form 8-K
(333-00813)
Form 8-K
(814-00813)
Form 8-K
(814-00813)
June 24, 2019
Custodian and Loan Administration Agreement by and among
OFSCC-FS, LLC, Citibank, N.A., as custodian, and Virtus Group, LP,
as collateral administrator, dated June 20, 2019.
Loan Sale and Contribution Agreement by and between OFSCC-FS,
LLC, as the buyer, and OFSCC-FS Holdings, LLC, as the seller, dated
June 20, 2019.
Form 8-K
(814-00813)
Form 8-K
(814-00813)
June 24, 2019
June 24, 2019
11.1
Computation of Per Share Earnings
14.1
Joint Code of Ethics of OFS Capital Corporation and OFS Advisor
10-K (814-00813)
March 15, 2019
21.1
List of Subsidiaries
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14 of the
Securities Exchange Act of 1934, as amended
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14 of the
Securities Exchange Act of 1934, as amended
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2
Certificate of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.1
99.2
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
* Filed herewith.
+ Included in the notes to the financial statements contained in this report
† Furnished herewith
157
+
*
*
*
†
†
*
*
Item 16.
Form 10-K Summary
None.
158
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
OFS Capital Corporation
Date: March 13, 2020
/s/ Bilal Rashid
Bilal Rashid
Chief Executive Officer and Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the
registrant and in the capacity and on the dates indicated.
Date: March 13, 2020
/s/ Bilal Rashid
Bilal Rashid, Chief Executive Officer and Chairman of the Board of Directors
(Principal Executive Officer)
Date: March 13, 2020
Date: March 13, 2020
Date: March 13, 2020
/s/ Marc Abrams
Marc Abrams, Director
/s/ Robert J. Cresci
Robert J. Cresci, Director
/s/ Elaine E. Healy
Elaine E. Healy, Director
Date: March 13, 2020
/s/ Jeffrey A. Cerny
Jeffrey A. Cerny, Chief Financial Officer, Treasurer (Principal Financial Officer)
and Director
Date: March 13, 2020
/s/ Jeffery S. Owen
Jeffery S. Owen, Chief Accounting Officer (Principal Accounting Officer)
159
DESCRIPTION OF SECURITIES
Exhibit 4.13
As of December 31, 2019, OFS Capital Corporation (the “Company,” “we,” “our,” or “us”) had two classes of securities registered under Section
12 of the Securities Exchange Act of 1934, as amended: (1) our common stock and (2) our debt securities.
Capitalized terms used but not defined herein shall have the meaning ascribed to them in the Annual Report on Form 10-K to which this
Description of Securities is attached as an exhibit.
A. Common Stock, $0.01 par value per share
As of December 31, 2019, the authorized capital stock of OFS Capital Corporation consisted of 100,000,000 shares of common stock, par value
$0.01 per share, and 2,000,000 shares of preferred stock, par value $0.01 per share. Our common stock is quoted on The Nasdaq Global Select Market
under the symbol “OFS.”
Common Stock
All shares of our common stock have equal rights as to earnings, assets, distributions and voting and, when they are issued, will be duly
authorized, validly issued, fully paid and nonassessable. Distributions may be paid to the holders of our common stock if, as and when authorized by our
board of directors and declared by us out of funds legally available therefor. Shares of our common stock have no preemptive, exchange, conversion or
redemption rights and are freely transferable, except when their transfer is restricted by federal and state securities laws or by contract. In the event of our
liquidation, dissolution or winding up, each share of our common stock would be entitled to share ratably in all of our assets that are legally available for
distribution after we pay all debts and other liabilities and subject to any preferential rights of holders of our preferred stock, if any preferred stock is
outstanding at such time. Each share of our common stock is entitled to one vote on all matters submitted to a vote of stockholders, including the election
of directors. Except as provided with respect to any other class or series of stock, the holders of our common stock will possess exclusive voting power.
There is no cumulative voting in the election of directors, which means that holders of a majority of the outstanding shares of common stock can elect all of
our directors, and holders of less than a majority of such shares will not be able to elect any directors.
Our certificate of incorporation authorizes our board of directors to classify and reclassify any unissued shares of stock into other classes or series
of stock, including preferred stock. Prior to issuance of shares of each class or series, the board of directors is required by Delaware law and by our
certificate of incorporation to set the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications
and terms or conditions of redemption for each class or series.
Provisions of the DGCL and Our Certificate of Incorporation and Bylaws
Limitation on Liability of Directors and Officers; Indemnification and Advance of Expenses
The indemnification of our officers and directors is governed by Section 145 of the DGCL, our certificate of incorporation and bylaws. Our
certificate of incorporation provides that our directors will not be liable to us or our stockholders for monetary damages for breach of fiduciary duty as a
director to the fullest extent permitted by the current DGCL or as the DGCL may hereafter be amended. DGCL Section 102(b)(7) provides that the
personal liability of a director to a corporation or its stockholders for breach of fiduciary duty as a director may be eliminated except for liability (a) for any
breach of the director’s duty of loyalty to the registrant or its stockholders, (b) for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (c) under Section 174 of the DGCL, relating to unlawful payment of distributions or unlawful stock purchases or
redemption of stock or (d) for any transaction from which the director derives an improper personal benefit.
Our bylaws provide for the indemnification of any person to the full extent permitted by law as currently in effect or as may hereafter be amended.
In addition, we have entered into indemnification agreements with each of our directors and officers in order to effect the foregoing.
Delaware Anti-Takeover Law
The DGCL and our certificate of incorporation and bylaws contain provisions that could make it more difficult for a potential acquirer to acquire
us by means of a tender offer, proxy contest or otherwise. These provisions are expected to
discourage certain coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of us to negotiate first with
our board of directors. These measures may delay, defer or prevent a transaction or a change in control that might otherwise be in the best interests of our
stockholders. We believe, however, that the benefits of these provisions outweigh the potential disadvantages of discouraging any such acquisition
proposals because the negotiation of such proposals may improve their terms.
Classified Board of Directors
Our board of directors is divided into three classes of directors serving staggered three-year terms, with the term of office of only one of the three
classes expiring each year. A classified board may render a change in control of us or removal of our incumbent management more difficult. We believe,
however, that the longer time required to elect a majority of a classified board of directors helps to ensure the continuity and stability of our management
and policies.
Number of Directors; Removal; Vacancies
Our certificate of incorporation provides that the number of directors will be set only by the board of directors in accordance with our bylaws. Our
bylaws provide that a majority of our entire board of directors may at any time increase or decrease the number of directors. However, unless our bylaws
are amended, the number of directors may never be less than four nor more than eight. Under our certificate of incorporation and bylaws, any vacancy on
the board of directors, including a vacancy resulting from an enlargement of the board of directors, may be filled only by vote of a majority of the directors
then in office. The limitations on the ability of our stockholders to fill vacancies could make it more difficult for a third party to acquire, or discourage a
third-party from seeking to acquire, control of us.
Our charter provides that a director may be removed only for cause, as defined in our charter, and then only by the affirmative vote of at least two-
thirds of the votes entitled to be cast in the election of directors.
Advance Notice Provisions for Stockholder Nominations and Stockholder Proposals
Our bylaws provide that with respect to an annual meeting of stockholders, nominations of persons for election to the board of directors and the
proposal of business to be considered by stockholders may be made only (a) by or at the direction of the board of directors, (b) pursuant to our notice of
meeting or (c) by a stockholder who is entitled to vote at the meeting and who has complied with the advance notice procedures of the bylaws.
Nominations of persons for election to the board of directors at a special meeting may be made only by or at the direction of the board of directors, and
provided that the board of directors has determined that directors will be elected at the meeting, by a stockholder who is entitled to vote at the meeting and
who has complied with the advance notice provisions of the bylaws.
The purpose of requiring stockholders to give us advance notice of nominations and other business is to afford our board of directors a meaningful
opportunity to consider the qualifications of the proposed nominees and the advisability of any other proposed business and, to the extent deemed necessary
or desirable by our board of directors, to inform stockholders and make recommendations about such qualifications or business, as well as to provide a
more orderly procedure for conducting meetings of stockholders. Although our bylaws do not give our board of directors any power to disapprove
stockholder nominations for the election of directors or proposals recommending certain action, they may have the effect of precluding a contest for the
election of directors or the consideration of stockholder proposals if proper procedures are not followed and of discouraging or deterring a third party from
conducting a solicitation of proxies to elect its own slate of directors or to approve its own proposal without regard to whether consideration of such
nominees or proposals might be harmful or beneficial to us and our stockholders.
Action by Stockholders
Under the DGCL, stockholder action can be taken only at an annual or special meeting of stockholders or by unanimous written consent in lieu of
a meeting, unless the certificate of incorporation provides for stockholder action by less than unanimous written consent (which our certificate of
incorporation does not). These provisions, combined with the requirements of our bylaws regarding the calling of a stockholder-requested special meeting
of stockholders discussed below, may have the effect of delaying consideration of a stockholder proposed until the next annual meeting.
Stockholder Meetings
Our certificate of incorporation and bylaws provide that, except as otherwise required by law, special meetings of the stockholders can only be
called by the chairman of the board, the vice chairman of the board, the president, the board of
directors or stockholders who own of record a majority of the outstanding shares of each class of stock entitled to vote at the meeting. In addition, our
bylaws establish an advance notice procedure for stockholder proposals to be brought before an annual meeting of stockholders, including proposed
nominations of candidates for election to the board of directors. Stockholders at an annual meeting may only consider proposals or nominations specified in
the notice of meeting or brought before the meeting by or at the direction of the board of directors, or by a stockholder of record on the record date for the
meeting who is entitled to vote at the meeting and who has delivered timely written notice in proper form to the secretary of the stockholder’s intention to
bring such business before the meeting. These provisions could have the effect of delaying until the next stockholder meeting stockholder actions that are
favored by the holders of a majority of our outstanding voting securities.
Conflict with 1940 Act
Our bylaws provide that, if and to the extent that any provision of the DGCL or any provision of our certificate of incorporation or bylaws
conflicts with any provision of the 1940 Act, the applicable provision of the 1940 Act will control.
B. Debt Securities
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6.375% Notes due 2025
6.50% Notes due 2025
5.95% Notes due 2026
In April 2018, we issued $50,000,000 in aggregate principal amount of notes due April 2025 (the “April 2025 Notes”). The April 2025 Notes bear
interest at a rate of 6.375% per year payable quarterly on January 31, April 31, July 31 and October 31 of each year, commencing July 31, 2018. The April
2025 Notes are issued in minimum denominations of $25 and integral multiples of $25 in excess thereof. The April 2025 Notes were issued under a certain
Indenture, dated April 16, 2018 (the “Base Indenture”), by and between the Company and U.S. Bank National Association (the “Trustee”), as supplemented
by the First Supplemental Indenture, dated April 16, 2018 (the “First Supplemental Indenture”). As of December 31, 2019, we had $50,000,000 in
aggregate principal amount of April 2025 Notes outstanding. The April 2025 Notes are scheduled to mature on April 30, 2025. Additionally, the April 2025
Notes will not be subject to any sinking fund and are subject to defeasance and covenant defeasance by us. We have listed the April 2025 Notes on The
Nasdaq Global Select Market under the trading symbol “OFSSL.”
In October 2018, we issued $46,000,000 in aggregate principal amount of notes due October 2025 (the “October 2025 Notes”). The October 2025
Notes bear interest at a rate of 6.50% per year payable quarterly on January 15, April 15, July 15 and October 15 of each year, commencing January 15,
2019. The October 2025 Notes are issued in minimum denominations of $25 and integral multiples of $25 in excess thereof. The October 2025 Notes were
issued under the Base Indenture, by and between the Company and the Trustee, as supplemented by the Second Supplemental Indenture, dated October 16,
2018 (the “Second Supplemental Indenture”). As of December 31, 2019, we had $46,000,000 in aggregate principal amount of October 2025 Notes
outstanding. The October 2025 Notes are scheduled to mature on October 30, 2025. Additionally, the October 2025 Notes will not be subject to any sinking
fund and are subject to defeasance and covenant defeasance by us. We have listed the October 2025 Notes on The Nasdaq Global Select Market under the
trading symbol “OFSSZ.”
In October 2019, we issued $54,325,000 in aggregate principal amount of notes due October 2026 (the “October 2026 Notes”, and collectively
with the April 2025 Notes and the October 2025 Notes, the “Notes”). The October 2026 Notes bear interest at a rate of 5.95% per year payable quarterly on
January 31, April 31, July 31 and October 31 of each year, commencing January 31, 2020. The October 2026 Notes are issued in minimum denominations
of $25 and integral multiples of $25 in excess thereof. The October 2026 Notes were issued under the Base Indenture, by and between the Company and
the Trustee, as supplemented by the Third Supplemental Indenture, dated October 15, 2019 (the “Third Supplemental Indenture”, and collectively with the
Base Indenture, the First Supplemental Indenture, and the Second Supplemental Indenture, the “Indentures”). As of December 31, 2019, we had
$54,325,000 in aggregate principal amount of October 2026 Notes outstanding. The October 2026 Notes are scheduled to mature on October 31, 2026.
Additionally, the October 2026 Notes will not be subject to any sinking fund and are subject to defeasance and covenant defeasance by us. We have listed
the October 2026 Notes on The Nasdaq Global Select Market under the trading symbol “OFSSI.”
General
For purposes of this exhibit, any reference to the payment of principal of or premium or interest, if any, on the Notes will include additional
amounts if required by the terms of the Notes.
The Indentures do not limit the amount of debt securities that may be issued thereunder from time to time. Debt securities issued under the
Indentures, when a single trustee is acting for all debt securities issued under the Indentures, are called the “Indenture Securities.” The Indentures also
provides that there may be more than one trustee thereunder, each with respect to one or more different series of Indenture Securities. See “Resignation of
Trustee” section below. At a time when two or more trustees are acting under the Indentures, each with respect to only certain series, the term “Indenture
Securities” means the one or more series of debt securities with respect to which each respective trustee is acting. In the event that there is more than one
trustee under the Indentures, the powers and trust obligations of each trustee described in the applicable prospectus supplement will extend only to the one
or more series of Indenture Securities for which it is trustee. If two or more trustees are acting under the Indentures, then the Indenture Securities for which
each trustee is acting would be treated as if issued under separate Indentures.
We have the ability to issue Indenture Securities with terms different from those of Indenture Securities previously issued and, without the consent
of the holders thereof, to reopen a previous issue of a series of Indenture Securities and issue additional Indenture Securities of that series unless the
reopening was restricted when that series was created.
We expect that we will usually issue debt securities in book entry only form represented by global securities.
When we refer to “you” in this exhibit, we mean those who invest in the debt securities being offered under the Indentures, whether they are the
holders or only indirect holders of those debt securities. When we refer to your debt securities, we mean the debt securities in which you hold a direct or
indirect interest.
Global Securities
The Notes were issued as registered securities in book-entry form only. A global security represents one or any other number of individual debt
securities. Generally, all debt securities represented by the same global securities will have the same terms.
Each debt security issued in book-entry form will be represented by a global security that we deposit with and register in the name of a financial
institution or its nominee that we select. The financial institution that we select for this purpose is called the depositary. Unless we specify otherwise in the
applicable prospectus supplement, The Depository Trust Company, New York, New York, known as DTC, will be the depositary for all debt securities
issued in book-entry form.
A global security may not be transferred to or registered in the name of anyone other than the depositary or its nominee, unless special termination
situations arise. We describe those situations below under “- Termination of a Global Security.” As a result of these arrangements, the depositary, or its
nominee, will be the sole registered owner and holder of all debt securities represented by a global security, and investors will be permitted to own only
beneficial interests in a global security. Beneficial interests must be held by means of an account with a broker, bank or other financial institution that in
turn has an account with the depositary or with another institution that has an account with the depositary. Thus, an investor whose security is represented
by a global security will not be a holder of the debt security, but only an indirect holder of a beneficial interest in the global security.
Special Considerations for Global Securities
As an indirect holder, an investor’s rights relating to a global security will be governed by the account rules of the investor’s financial institution
and of the depositary, as well as general laws relating to securities transfers. The depositary that holds the global security will be considered the holder of
the debt securities represented by the global security.
If debt securities are issued only in the form of a global security, an investor should be aware of the following:
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an investor cannot cause the debt securities to be registered in his or her name and cannot obtain certificates for his or her interest in the
debt securities, except in the special situations we describe below;
an investor will be an indirect holder and must look to his or her own bank or broker for payments on the debt securities and protection of
his or her legal rights relating to the debt securities;
an investor may not be able to sell interests in the debt securities to some insurance companies and other institutions that are required by
law to own their securities in non-book-entry form;
an investor may not be able to pledge his or her interest in a global security in circumstances where certificates representing the debt
securities must be delivered to the lender or other beneficiary of the pledge in order for the pledge to be effective;
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the depositary’s policies, which may change from time to time, will govern payments, transfers, exchanges and other matters relating to
an investor’s interest in a global security. We and the trustee have no responsibility for any aspect of the depositary’s actions or for its
records of ownership interests in a global security. We and the trustee also do not supervise the depositary in any way;
if we redeem less than all the debt securities of a particular series being redeemed, DTC’s practice is to determine by lot the amount to be
redeemed from each of its participants holding that series;
an investor is required to give notice of exercise of any option to elect repayment of its debt securities, through its participant, to the
applicable trustee and to deliver the related debt securities by causing its participant to transfer its interest in those debt securities, on
DTC’s records, to the applicable trustee;
DTC requires that those who purchase and sell interests in a global security deposited in its book-entry system use immediately available
funds; your broker or bank may also require you to use immediately available funds when purchasing or selling interests in a global
security; and
financial institutions that participate in the depositary’s book-entry system, and through which an investor holds its interest in a global
security, may also have their own policies affecting payments, notices and other matters relating to the debt securities; there may be more
than one financial intermediary in the chain of ownership for an investor; we do not monitor and are not responsible for the actions of any
of those intermediaries.
Termination of a Global Security
If a global security is terminated for any reason, interests in it will be exchanged for certificates in non-book-entry form (certificated securities).
After that exchange, the choice of whether to hold the certificated debt securities directly or in street name will be up to the investor. Investors must consult
their own banks or brokers to find out how to have their interests in a global security transferred on termination to their own names, so that they will be
holders.
The applicable prospectus supplement may list situations for terminating a global security that would apply only to the particular series of debt
securities covered by the applicable prospectus supplement. If a global security is terminated, only the depositary, and not we or the applicable trustee, is
responsible for deciding the investors in whose names the debt securities represented by the global security will be registered and, therefore, who will be
the holders of those debt securities.
Payment and Paying Agents
We will pay interest to the person listed in the applicable trustee’s records as the owner of the debt security at the close of business on a particular
day in advance of each due date for interest, even if that person no longer owns the debt security on the interest due date. That day, often approximately two
weeks in advance of the interest due date, is called the “record date.” Because we will pay all the interest for an interest period to the holders on the record
date, holders buying and selling debt securities must work out between themselves the appropriate purchase price. The most common manner is to adjust
the sales price of the debt securities to prorate interest fairly between buyer and seller based on their respective ownership periods within the particular
interest period. This prorated interest amount is called “accrued interest.”
Payments on Global Securities
We will make payments on a global security in accordance with the applicable policies of the depositary as in effect from time to time. Under
those policies, we will make payments directly to the depositary, or its nominee, and not to any indirect holders who own beneficial interests in the global
security. An indirect holder’s right to those payments will be governed by the rules and practices of the depositary and its participants.
Payment when Offices are Closed
If any payment is due on a debt security on a day that is not a business day, we will make the payment on the next day that is a business day.
Payments made on the next business day in this situation will be treated under the Indentures as if they were made on the original due date, except as
otherwise indicated in the applicable prospectus supplement. Such payment will not result in a default under any debt security or the Indentures, and no
interest will accrue on the payment amount from the original due date to the next day that is a business day.
Book-entry and other indirect holders should consult their banks or brokers for information on how they will receive payments on their debt
securities.
Events of Default
You will have rights if an Event of Default occurs in respect of the Notes and is not cured, as described later in this subsection.
The term “Event of Default” in respect of our debt securities means any of the following (unless the prospectus supplement relating to such debt
securities states otherwise):
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we do not pay the principal of, or any premium on, any of the Notes on the due dates, and do not cure this default within five days;
we do not pay interest on the Notes when due, and such default is not cured within 30 days;
we do not deposit any sinking fund payment in respect of the Notes on the due date, and do not cure this default within five days;
we remain in breach of a covenant in respect of the Notes for 60 days after we receive a written notice of default stating we are in breach.
The notice must be sent by either the trustee or holders of at least 25% of the principal amount of the respective series of Notes;
we file for bankruptcy or certain other events of bankruptcy, insolvency or reorganization occur and remain undischarged or unstayed for
a period of 60 days;
on the last business day of each of 24 consecutive calendar months, we have an asset coverage of less than 100%; and
any other Event of Default in respect of the Notes as described in the applicable prospectus supplement occurs.
An Event of Default for a particular series of Notes does not necessarily constitute an Event of Default for any other series of Notes issued under
the same or any other indenture. The trustee may withhold notice to the holders of Notes of any default, except in the payment of principal, premium or
interest, if it considers the withholding of notice to be in the best interests of the holders.
Remedies if an Event of Default Occurs
If an Event of Default has occurred and has not been cured, the trustee or the holders of at least 25% in principal amount of the debt securities of
the affected series may declare the entire principal amount of all the debt securities of that series to be due and immediately payable. This is called a
declaration of acceleration of maturity. In certain circumstances, a declaration of acceleration of maturity may be canceled by the holders of a majority in
principal amount of the debt securities of the affected series.
The trustee is not required to take any action under the Indentures at the request of any holders unless the holders offer the trustee reasonable
protection from expenses and liability (called an “indemnity”). If reasonable indemnity is provided, the holders of a majority in principal amount of the
outstanding debt securities of the relevant series may direct the time, method and place of conducting any lawsuit or other formal legal action seeking any
remedy available to the trustee. The trustee may refuse to follow those directions in certain circumstances. No delay or omission in exercising any right or
remedy will be treated as a waiver of that right, remedy or Event of Default.
Before you are allowed to bypass your trustee and bring your own lawsuit or other formal legal action or take other steps to enforce your rights or
protect your interests relating to the debt securities, the following must occur:
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the holder must give your trustee written notice that an Event of Default has occurred and remains uncured;
the holders of at least 25% in principal amount of all outstanding debt securities of the relevant series must make a written request that
the trustee take action because of the default and must offer reasonable indemnity to the trustee against the cost and other liabilities of
taking that action;
the trustee must not have taken action for 60 days after receipt of the above notice and offer of indemnity; and
the holders of a majority in principal amount of the debt securities must not have given the trustee a direction inconsistent with the above
notice during that 60 day period.
However, you are entitled at any time to bring a lawsuit for the payment of money due on your debt securities on or after the due date.
Holders of a majority in principal amount of the debt securities of the affected series may waive any past defaults other than:
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the payment of principal, any premium or interest; or
in respect of a covenant that cannot be modified or amended without the consent of each holder.
Book-entry and other indirect holders should consult their banks or brokers for information on how to give notice or direction to or make
a request of the trustee and how to declare or cancel an acceleration of maturity.
Each year, we will furnish to each trustee a written statement of certain of our officers certifying that to their knowledge we are in compliance with
the Indentures and the debt securities, or else specifying any default.
Merger or Consolidation
Under the terms of the Indentures, we are generally permitted to consolidate or merge with another entity. We may also be permitted to sell all or
substantially all of our assets to another entity. However, unless the prospectus supplement relating to certain debt securities states otherwise, we may not
take any of these actions unless all the following conditions are met:
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where we merge out of existence or sell our assets, the resulting entity must agree to be legally responsible for our obligations under the
debt securities;
immediately after giving effect to such transaction, no Default or Event of Default shall have happened and be continuing;
under the Indentures, no merger or sale of assets may be made if as a result any of our property or assets or any property or assets of one
of our subsidiaries, if any, would become subject to any mortgage, lien or other encumbrance unless either (a) the mortgage, lien or other
encumbrance could be created pursuant to the limitation on liens covenant in the Indentures without equally and ratably securing the
Indenture Securities or (b) the Indenture Securities are secured equally and ratably with or prior to the debt secured by the mortgage, lien
or other encumbrance;
we must deliver certain certificates and documents to the trustee; and
we must satisfy any other requirements specified in the applicable prospectus supplement relating to a particular series of the Notes.
Modification or Waiver
There are three types of changes we can make to the Indentures and the debt securities issued thereunder.
Changes Requiring Approval
First, there are changes that we cannot make to debt securities without specific approval of all of the holders. The following is a list of those types
of changes:
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change the stated maturity of the principal of or interest on a debt security;
reduce any amounts due on a debt security;
reduce the amount of principal payable upon acceleration of the maturity of a security following a default;
adversely affect any right of repayment at the holder’s option;
change the place (except as otherwise described in the applicable prospectus or prospectus supplement) or currency of payment on a debt
security;
impair your right to sue for payment;
adversely affect any right to convert or exchange a debt security in accordance with its terms;
modify the subordination provisions in the Indentures in a manner that is adverse to holders of the debt securities;
reduce the percentage of holders of debt securities whose consent is needed to modify or amend the Indentures;
reduce the percentage of holders of debt securities whose consent is needed to waive compliance with certain provisions of the Indentures
or to waive certain defaults;
modify any other aspect of the provisions of the Indentures dealing with supplemental indentures, modification and waiver of past
defaults, changes to the quorum or voting requirements or the waiver of certain covenants; and
change any obligation we have to pay additional amounts.
Changes Not Requiring Approval
The second type of change does not require any vote by the holders of the debt securities. This type is limited to clarifications and certain other
changes that would not adversely affect holders of the outstanding debt securities in any material respect. We also do not need any approval to make any
change that affects only debt securities to be issued under the Indentures after the change takes effect.
Changes Requiring Majority Approval
Any other change to the Indentures and the debt securities would require the following approval:
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if the change affects only one series of debt securities, it must be approved by the holders of a majority in principal amount of that series;
and
if the change affects more than one series of debt securities issued under the same indenture, it must be approved by the holders of a
majority in principal amount of all of the series affected by the change, with all affected series voting together as one class for this
purpose.
The holders of a majority in principal amount of all of the series of debt securities issued under an indenture, voting together as one class for this
purpose, may waive our compliance with some of our covenants in that indenture. However, we cannot obtain a waiver of a payment default or of any of
the matters covered by the bullet points included above under “- Changes Requiring Approval.”
Further Details Concerning Voting
When taking a vote, we will use the following rules to decide how much principal to attribute to a debt security:
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for original issue discount securities, we will use the principal amount that would be due and payable on the voting date if the maturity of
these debt securities were accelerated to that date because of a default;
for debt securities whose principal amount is not known (for example, because it is based on an index), we will use a special rule for that
debt security described in the prospectus supplement; and
for debt securities denominated in one or more foreign currencies, we will use the U.S. dollar equivalent.
Debt securities will not be considered outstanding, and therefore not eligible to vote, if we have deposited or set aside in trust money for their
payment or redemption. Debt securities will also not be eligible to vote if they have been fully defeased as described later under “Defeasance - Full
Defeasance.”
We will generally be entitled to set any day as a record date for the purpose of determining the holders of outstanding Indenture Securities that are
entitled to vote or take other action under the Indentures. If we set a record date for a vote or other action to be taken by holders of one or more series, that
vote or action may be taken only by persons who are holders of outstanding Indenture Securities of those series on the record date and must be taken within
eleven months following the record date.
Book-entry and other indirect holders should consult their banks or brokers for information on how approval may be granted or denied if
we seek to change the Indenture or the debt securities or request a waiver.
Defeasance
The following provisions will be applicable to each series of debt securities unless we state in the applicable prospectus supplement that the
provisions of covenant defeasance and full defeasance will not be applicable to that series.
Covenant Defeasance
Under current U.S. federal tax law, we can make the deposit described below and be released from some of the restrictive covenants in the
Indentures under which the particular series was issued. This is called “covenant defeasance.” In that event, you would lose the protection of those
restrictive covenants but would gain the protection of having money and government securities set aside in trust to repay your debt securities. If applicable,
you also would be released from the subordination provisions as described under the “Indenture Provisions - Subordination” section below. In order to
achieve covenant defeasance, we must do the following:
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if the debt securities of the particular series are denominated in U.S. dollars, we must deposit in trust for the benefit of all holders of such debt
securities a combination of money and U.S. government or U.S. government agency notes or bonds that will generate enough cash to make
interest, principal and any other payments on the debt securities on their various due dates;
we must deliver to the trustee a legal opinion of our counsel confirming that, under current U.S. federal income tax law, we may make the
above deposit without causing you to be taxed on the debt securities any differently than if we did not make the deposit and just repaid the
debt securities ourselves at maturity; and
we must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940
Act, as amended, and a legal opinion and officers’ certificate stating that all conditions precedent to covenant defeasance have been complied
with.
If we accomplish covenant defeasance, you can still look to us for repayment of the debt securities if there were a shortfall in the trust deposit or
the trustee is prevented from making payment. For example, if one of the remaining Events of Default occurred (such as our bankruptcy) and the debt
securities became immediately due and payable, there might be a shortfall. Depending on the event causing the default, you may not be able to obtain
payment of the shortfall.
Full Defeasance
If there is a change in U.S. federal tax law, as described below, we can legally release ourselves from all payment and other obligations on the debt
securities of a particular series (called “full defeasance”) if we put in place the following other arrangements for you to be repaid:
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if the debt securities of the particular series are denominated in U.S. dollars, we must deposit in trust for the benefit of all holders of such
debt securities a combination of money and United States government or United States government agency notes or bonds that will
generate enough cash to make interest, principal and any other payments on the debt securities on their various due dates;
we must deliver to the trustee a legal opinion confirming that there has been a change in current U.S. federal tax law or an IRS ruling that
allows us to make the above deposit without causing you to be taxed on the debt securities any differently than if we did not make the
deposit and just repaid the debt securities ourselves at maturity. Under current U.S. federal tax law, the deposit and our legal release from
the debt securities would be treated as though we paid you your share of the cash and notes or bonds at the time the cash and notes or
bonds were deposited in trust in exchange for your debt securities and you would recognize gain or loss on the debt securities at the time
of the deposit; and
we must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the
1940 Act, as amended, and a legal opinion and officers’ certificate stating that all conditions precedent to defeasance have been complied
with.
If we ever did accomplish full defeasance, as described above, you would have to rely solely on the trust deposit for repayment of the debt
securities. You could not look to us for repayment in the unlikely event of any shortfall. Conversely, the trust deposit would most likely be protected from
claims of our lenders and other creditors if we ever became bankrupt or insolvent. If applicable, you would also be released from the subordination
provisions described later under “Indenture Provisions - Subordination.”
Form, Exchange and Transfer of Certificated Registered Securities
The Notes are represented by global securities that were deposited and registered in the name of DTC or its nominee. Beneficial interests in the
Notes are represented through book-entry accounts of financial institutions acting on behalf of beneficial owners as direct and indirect participants in DTC.
Investors may elect to hold interests in the Notes through either DTC, if they are a participant, or indirectly through organizations that are participants in
DTC.
Resignation of Trustee
Each trustee may resign or be removed with respect to one or more series of Indenture Securities provided that a successor trustee is appointed to
act with respect to these series. In the event that two or more persons are acting as trustee with respect to different series of Indenture Securities under the
Indentures, each of the trustees will be a trustee of a trust separate and apart from the trust administered by any other trustee.
Indenture Provisions - Subordination
Upon any distribution of our assets upon our dissolution, winding up, liquidation or reorganization, the payment of the principal of (and premium,
if any) and interest, if any, on any Indenture Securities denominated as subordinated debt securities is to be subordinated to the extent provided in the
Indentures in right of payment to the prior payment in full of all senior indebtedness (as defined below), but our obligation to you to make payment of the
principal of (and premium, if any) and interest, if any, on such subordinated debt securities will not otherwise be affected. In addition, no payment on
account of principal (or premium, if any), sinking fund or interest, if any, may be made on such subordinated debt securities at any time unless full payment
of all amounts due in respect of the principal (and premium, if any), sinking fund and interest on senior indebtedness has been made or duly provided for in
money or money’s worth.
In the event that, notwithstanding the foregoing, any payment by us is received by the trustee in respect of subordinated debt securities or by the
holders of any of such subordinated debt securities before all senior indebtedness is paid in full, the payment or distribution must be paid over to the
holders of the senior indebtedness or on their behalf for application to the payment of all the senior indebtedness remaining unpaid until all the senior
indebtedness has been paid in full, after giving effect to any concurrent payment or distribution to the holders of the senior indebtedness. Subject to the
payment in full of all senior indebtedness upon this distribution by us, the holders of such subordinated debt securities will be subrogated to the rights of
the holders of the senior indebtedness to the extent of payments made to the holders of the senior indebtedness out of the distributive share of such
subordinated debt securities.
By reason of this subordination, in the event of a distribution of our assets upon our insolvency, certain of our senior creditors may recover more,
ratably, than holders of any subordinated debt securities. The Indentures provide that these subordination provisions will not apply to money and securities
held in trust under the defeasance provisions of the Indentures.
Senior indebtedness is defined in the Indentures as the principal of (and premium, if any) and unpaid interest on:
•
•
our indebtedness (including indebtedness of others guaranteed by us), whenever created, incurred, assumed or guaranteed, for money
borrowed (other than Indenture Securities issued under the Indentures and denominated as subordinated debt securities), unless in the
instrument creating or evidencing the same or under which the same is outstanding it is provided that this indebtedness is not senior or
prior in right of payment to the subordinated debt securities; and
renewals, extensions, modifications and refinancings of any of this indebtedness.
The applicable prospectus supplement will set forth the approximate amount of our senior indebtedness outstanding as of a recent date.
The Trustee under the Indenture
U.S. Bank National Association will serve as the trustee under the Indentures.
LIST OF SUBSIDIARIES
Exhibit 21.1
OFSCC-FS, LLC, a Delaware limited liability company.
OFSCC-FS Holdings, LLC, a Delaware limited liability company.
OFSCC-MB, LLC, a Delaware limited liability company.
OFS SBIC I GP, LLC, a Delaware limited liability company.
OFS SBIC I, LP, a Delaware limited liability company.
Exhibit 31.1
I, Bilal Rashid, Chief Executive Officer of OFS Capital Corporation certify that:
1.
I have reviewed this annual report on Form 10-K of OFS Capital Corporation;
Certification of Chief Executive Officer
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for
the registrant and have:
(a)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
(b)
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles;
(c)
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most
recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to
the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a)
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
Dated this 13th day of March 2020.
By:
/s/ Bilal Rashid
Bilal Rashid
Chief Executive Officer
Exhibit 31.2
I, Jeffrey A. Cerny, Chief Financial Officer of OFS Capital Corporation certify that:
1.
I have reviewed this annual report on Form 10-K of OFS Capital Corporation;
Certification of Chief Financial Officer
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this
report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for
the registrant and have:
(a)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
(b)
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles;
(c)
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most
recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to
the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a)
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
Dated this 13th day of March 2020.
By:
/s/ Jeffrey A. Cerny
Jeffrey A. Cerny
Chief Financial Officer
Certification of Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1
In connection with the Annual Report on Form 10-K for the year ended December 31, 2019 (the “Report”) of OFS Capital Corporation (the
“Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Bilal Rashid, the Chief Executive Officer of the Registrant,
hereby certify, to the best of my knowledge, pursuant to 18 U.S.C. Section 1350, that:
(1)
(2)
Registrant.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Name:
Date:
/s/ Bilal Rashid
Bilal Rashid
March 13, 2020
Certification of Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2
In connection with the Annual Report on Form 10-K for the year ended December 31, 2019 (the “Report”) of OFS Capital Corporation (the
“Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Jeffrey A. Cerny, the Chief Financial Officer of the Registrant,
hereby certify, to the best of my knowledge, pursuant to 18 U.S.C. Section 1350, that:
(1)
(2)
Registrant.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Name:
Date:
/s/ Jeffrey A. Cerny
Jeffrey A. Cerny
March 13, 2020
Report of Independent Registered Public Accounting Firm on Supplemental Information
To the Stockholders and Board of Directors
OFS Capital Corporation:
We have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) the consolidated statement of assets
and liabilities of OFS Capital Corporation and subsidiaries (the Company), including the consolidated schedule of investments, as of December 31, 2019,
the related consolidated statements of operations, changes in net assets, and cash flows for the year ended December 31, 2019, and the related notes
(collectively, the consolidated financial statements), and our report dated March 13, 2020 expressed an unqualified opinion on those consolidated financial
statements.
The senior securities information as of December 31, 2019 included in Part II, Item 5 of the Annual Report on Form 10‑K of the Company under the
caption “Senior Securities” (the senior securities table) has been subjected to audit procedures performed in conjunction with the audit of the Company’s
consolidated financial statements. The senior securities table is the responsibility of the Company’s management. Our audit procedures included
determining whether the senior securities table reconciles to the Company’s consolidated financial statements or the underlying accounting and other
records, as applicable, and performing procedures to test the completeness and accuracy of the information presented in the senior securities table. In
forming our opinion on the senior securities table, we evaluated whether the senior securities table, including its form and content, is presented in
conformity with the instructions to Form N‑2. In our opinion, the senior securities table as of December 31, 2019, is fairly stated, in all material respects, in
relation to the consolidated financial statements as a whole.
/s/KPMG LLP
Chicago, Illinois
March 13, 2020
Report of Independent Registered Public Accounting Firm on Supplemental Information
To the Board of Directors and Stockholders
OFS Capital Corporation
Chicago, Illinois
We have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial
statements of OFS Capital Corporation and Subsidiaries (the “Company”) as of December 31, 2018, and for each of the two years in the period ended
December 31, 2018, included in the Annual Report on Form 10-K, and have expressed an unqualified opinion therein dated March 15, 2019. We have also
previously audited the consolidated financial statements of the Company as of and for the years ended December 31, 2017, 2016, 2015 and 2014 (not
presented herein), and we expressed an unqualified opinion on those consolidated financial statements.
The senior securities table included in Part II, Item 5 of the Annual Report on Form 10-K of the Company under the caption “Senior Securities” (the
“Senior Securities Table”) has been subjected to audit procedures performed in conjunction with the audit of the Company’s consolidated financial
statements for the aforementioned years. The Senior Securities Table is the responsibility of the Company’s management. Our audit procedures included
determining whether the Senior Securities Table reconciles to the consolidated financial statements or the underlying accounting and other records, as
applicable, and performing procedures to test the completeness and accuracy of the information presented in the Senior Securities Table. In forming our
opinion on the Senior Securities Table, we evaluated whether the Senior Securities Table, including its form and content, is presented in conformity with
Item 4.3 and the Instructions to Item 4.3 of Form N-2. In our opinion, the Senior Securities Table for each of the five years in the period ended December
31, 2018 is fairly stated, in all material respects, in relation to the consolidated financial statements as a whole.
/s/ BDO USA, LLP
Chicago, Illinois
March 15, 2019, except for the additions related to Total Senior Securities and related information reflected in the Senior Securities Table, as to which the
date is June 21, 2019.