UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2015

 

¨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 46-1339639

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

 

10 S. Wacker Drive, Suite 2500

Chicago, Illinois 60606

(Address of principal executive office)

 

(847) 734-2060

(Registrant’s telephone number, including area code)

 

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 period that 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post 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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer x
       
Non-accelerated filer ¨  (do not check if a smaller reporting company) Smaller reporting company ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨     No  x

 

The number of shares of the issuer’s Common Stock, $0.01 par value, outstanding as of November 3, 2015 was 9,690,129.

 

 

 

 

OFS CAPITAL CORPORATION

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION 3
Item 1. Unaudited Financial Statements 3
  Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014 3
  Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2015 and 2014 4
  Consolidated Statements of Changes in Net Assets for the Nine Months Ended September 30, 2015 and 2014 5
  Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2015 and 2014 6
  Consolidated Schedules of Investments as of September 30, 2015 and December 31, 2014 7
  Notes to Unaudited Consolidated Financial Statements 16
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 36
Item 3. Quantitative and Qualitative Disclosures About Market Risk 58
Item 4. Controls and Procedures 58
   
PART II. OTHER INFORMATION 59
Item 1. Legal Proceedings 59
Item 1A. Risk Factors 59
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 59
Item 3. Defaults Upon Senior Securities 59
Item 4. Mine Safety Disclosures 59
Item 5. Other Information 59
Item 6. Exhibits 60
SIGNATURES 61

 

 2 

 

 

PART I. FINANCIAL INFORMATION

Item 1. Unaudited Financial Statements

 

OFS Capital Corporation and Subsidiaries

 

Consolidated Balance Sheets (unaudited)

(Dollar amounts in thousands, except per share data) 

 

   September 30,   December 31, 
   2015   2014 
Assets          
Investments, at fair value          
Non-control/non-affiliate investments (cost of $192,464 and $258,004, respectively)  $188,884   $254,666 
Affiliate investments (cost of $54,843 and $55,569, respectively)   58,336    57,568 
Total investments at fair value   247,220    312,234 
Cash and cash equivalents   41,508    12,447 
Interest receivable   602    676 
Receivable from investment sold   -    7,223 
Prepaid expenses and other assets   378    556 
Intangible asset, net of accumulated amortization of $356 and $209, respectively   2,144    2,291 
Goodwill   1,077    1,077 
Deferred financing closing costs, net of accumulated amortization of $315 and $2,540, respectively   3,525    4,972 
Total assets  $296,454   $341,476 
           
Liabilities          
Accrued professional fees  $433   $462 
Interest payable   348    1,315 
Management and incentive fees payable   2,028    1,229 
Administration fee payable   281    273 
Payable for investment purchased   2,970    - 
Other payables   184    247 
Deferred loan fee revenue   211    572 
SBA debentures payable   149,880    127,295 
Revolving line of credit   -    72,612 
Total liabilities   156,335    204,005 
           
Commitments and Contingencies (Note 7)          
           
Net Assets          
Preferred stock, par value of $0.01 per share, 2,000,000 shares authorized, 0 shares issued and outstanding as of September 30, 2015 and December 31, 2014   -    - 
Common stock, par value of $0.01 per share, 100,000,000 shares authorized,  9,690,129 and  9,650,834 shares issued and outstanding as of September 30, 2015 and December 31, 2014, respectively   97    97 
Paid-in capital in excess of par   143,830    143,381 
Distributions in excess of net investment income   (8,276)   (7,844)
Accumulated net realized gain (loss)   3,466    (844)
Net unrealized appreciation on investments   1,002    2,681 
Total net assets   140,119    137,471 
           
Total liabilities and net assets  $296,454   $341,476 
           
Number of shares outstanding   9,690,129    9,650,834 
Net asset value per share  $14.46   $14.24 

 

See Notes to Unaudited Consolidated Financial Statements.

 

 3 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Statements of Operations (unaudited)

(Dollar amounts in thousands, except per share data)

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
                 
Investment income                    
Interest income                    
Non-control/non-affiliate investments  $5,387   $4,420   $17,319   $11,730 
Affiliate investments   1,308    896    4,062    2,515 
Control investment   -    277    -    843 
Total interest income   6,695    5,593    21,381    15,088 
Dividend income                    
Non-control/non-affiliate investments   185    -    333    - 
Affiliate investments   406    335    1,016    394 
Total dividend income   591    335    1,349    394 
Fee income                    
Non-control/non-affiliate investments   310    205    448    213 
Affiliate investments   92    89    213    147 
Control investment   -    (25)   -    25 
Total fee income   402    269    661    385 
                     
Total investment income   7,688    6,197    23,391    15,867 
                     
Expenses                    
Interest expense   1,089    1,001    3,642    2,989 
Amortization and write-off of deferred financing closing costs (see Note 8)   96    167    2,004    469 
Amortization of intangible asset   48    49    146    161 
Management fees   1,120    543    4,101    2,341 
Incentive fee   908    723    1,514    723 
Professional fees   262    382    857    1,112 
Administration fee   281    212    1,148    972 
General and administrative expenses   254    227    848    708 
                     
Total expenses   4,058    3,304    14,260    9,475 
                     
Net investment income   3,630    2,893    9,131    6,392 
                     
Net realized and unrealized gain (loss) on investments                    
Net realized gain on non-control/non-affiliate investments   254    17    3,132    17 
Net realized gain on affiliate investments   -    -    1,471    28 
Net change in unrealized appreciation/depreciation on non-control/non-affiliate investments   (2,115)   427    (3,173)   106 
Net change in unrealized appreciation/depreciation on affiliate investments   (348)   964    1,494    1,591 
Net change in unrealized depreciation on control investment   -    (466)   -    (1,691)
                     
Net realized and unrealized gain (loss) on investments   (2,209)   942    2,924    51 
                     
Net increase in net assets resulting from operations  $1,421   $3,835   $12,055   $6,443 
                     
Net investment income per common share - basic and diluted  $0.38   $0.30   $0.94   $0.66 
Net increase in net assets resulting from operations per common share - basic and diluted  $0.15   $0.40   $1.25   $0.67 
Dividends and distributions declared per common share  $0.34   $0.34   $1.02   $1.02 
Basic and diluted weighted average shares outstanding   9,675,930    9,635,943    9,663,418    9,633,214 

 

See Notes to Unaudited Consolidated Financial Statements.

 

 4 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Statements of Changes in Net Assets (unaudited)
(Dollar amounts in thousands) 

 

               Distributions       Net     
           Paid-in   in Excess of       Unrealized     
           Capital in   Net   Accumulated   Appreciation     
   Common Stock   Excess   Investment   Net Realized   (Depreciation) on   Total Net 
   Shares   Par   of Par   Income   Gain (Loss)   Investments   Assets 
                             
Balance at January 1, 2014   9,629,797   $96   $143,126   $(4,103)  $2,742   $(1,483)  $140,378 
                                    
Net increase in net assets resulting from operations   -    -    -    6,392    45    6    6,443 
Stock issued in connection with dividend reinvestment plan   8,264    -    105    -    -    -    105 
Dividends and distributions (1)   -    -    -    (9,780)   (45)   -    (9,825)
                                    
Balance at September 30, 2014   9,638,061   $96   $143,231   $(7,491)  $2,742   $(1,477)  $137,101 
                                    
Balance at January 1, 2015   9,650,834   $97   $143,381   $(7,844)  $(844)  $2,681   $137,471 
                                    
Net increase in net assets resulting from operations   -    -    -    9,131    4,603    (1,679)   12,055 
Stock issued in connection with dividend reinvestment plan   39,295    -    449    -    -    -    449 
Dividends and distributions (1)   -    -    -    (9,563)   (293)   -    (9,856)
                                    
Balance at September 30, 2015   9,690,129   $97   $143,830   $(8,276)  $3,466   $1,002   $140,119 

 

(1) If the tax characteristics of these distributions were determined as of September 30, 2015 and 2014, the Company estimated that approximately 86%, 1% and 13% of the distributions would have represented ordinary income, capital gains, and return of capital, respectively, as of September 30, 2015, and approximately 66% and 34% would have represented ordinary income and return of capital, respectively, as of September 30, 2014. See Note 10 - Financial Highlights for detailed disclosure of the tax characteristics of these distributions.

 

See Notes to Unaudited Consolidated Financial Statements.

 

 5 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Statements of Cash Flows (unaudited)

(Dollar amounts in thousands)

 

   Nine Months Ended September 30, 
   2015   2014 
         
Cash Flows From Operating Activities          
Net increase in net assets resulting from operations  $12,055   $6,443 
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by (used in) operating activities:          
Amortization and write-off of deferred financing closing costs   2,004    469 
Amortization of discounts and premiums   (913)   (895)
Amortization of deferred loan fee revenue   (448)   (199)
Amortization of intangible assets   146    161 
Cash collection of deferred loan fee revenue   58    294 
Payment-in-kind interest and dividends   (1,983)   (765)
Reversal of payment-in-kind interest income on non-accrual loans   -    64 
Net realized gain on non-control/non-affiliate investments   (3,132)   (17)
Net realized gain on affiliate investments   (1,471)   (28)
Net change in unrealized appreciation/depreciation on non-control/non-affiliate investments   3,173    (106)
Net change in unrealized appreciation/depreciation on affiliate investments   (1,494)   (1,591)
Net change in unrealized depreciation on control investment   -    1,691 
Purchase of portfolio investments   (78,578)   (90,662)
Proceeds from principal payments on portfolio investments   61,904    59,132 
Proceeds from sale or redemption of portfolio investments   97,687    9,493 
Cash distribution received from equity investment   51    11 
Changes in operating assets and liabilities:          
Interest receivable   66    (46)
Prepaid expenses and other assets   157    95 
Accrued professional fees   (29)   (117)
Due to/from affiliated entities, net   -    218 
Interest payable   (967)   (240)
Management and incentive fees payable   800    1,590 
Administration fee payable   8    692 
Other payables   (47)   (81)
Net cash provided by (used in) operating activities   89,047    (14,394)
           
Cash Flows From Investing Activities          
Change in restricted cash   -    450 
Net cash provided by investing activities   -    450 
           
Cash Flows From Financing Activities          
Net repayment of advances from affiliated entities   -    (15)
Cash dividends and distributions paid   (9,407)   (9,720)
Borrowings under the revolving line of credit   1,217    16,138 
Repayments under the revolving line of credit   (73,829)   (40,330)
Draw down on SBA debentures   22,585    35,375 
Change in other liabilities   -   83 
Deferred financing closing costs paid   (548)   (1,684)
Deferred common stock offering costs paid   (4)   (184)
Net cash used in financing activities   (59,986)   (337)
           
Net increase (decrease) in cash and cash equivalents   29,061    (14,281)
           
Cash and cash equivalents — beginning of period   12,447    28,569 
           
Cash and cash equivalents — end of period  $41,508   $14,288 
           
Supplemental Disclosure of Cash Flow Information:          
Cash paid during the period for interest  $4,609   $3,228 
           
Supplemental Disclosure of Noncash Financing and Investing Activities:          
Dividends and distributions paid by issuance of common stock  $449   $105 
Accrued deferred common stock offering costs   -    2 

 

See Notes to Unaudited Consolidated Financial Statements.

 

 6 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Schedule of Investments (unaudited)

September 30, 2015

(Dollar amounts in thousands)

 

Industry
Name of Portfolio Company
  Investment Type  Interest Rate (1)  Spread Above
Index (1)
  Maturity  Principal
Amount
   Cost   Fair Value   Percent of
Net Assets
 
                             
Non-control/Non-affiliate Investments                                
                                 
Aerospace & Defense                                
Aero-Metric, Inc.  Senior Secured Term Loan  6.75% cash / 2.0% PIK  (L +7.50%)  8/27/17  $2,597   $2,585   $2,483    1.8%
                2,597    2,585    2,483    1.8 
Banking, Finance, Insurance & Real Estate                                
Accurate Group Holdings, Inc.  Subordinated Loan  12.50%  N/A  8/23/18   10,000    10,056    10,100    7.2 
H.D. Vest, Inc. (4)  Senior Secured Term Loan  9.25%  (L +8.25%)  3/17/21   6,000    5,945    5,988    4.3 
MYI Acquiror Limited (4)  Senior Secured Term Loan A   5.75%  (L +4.50%)  5/28/19   4,838    4,823    4,755    3.4 
Confie Seguros Holdings II Co.  Senior Secured Term Loan  10.25%  (L +9.00%)  5/8/19   4,000    3,962    3,924    2.8 
                24,838    24,786    24,767    17.7 
Capital Equipment                                
Elgin Fasteners Group  Senior Secured Term Loan   6.00%  (L +4.75%)  8/26/16   4,582    4,557    4,526    3.2 
Stancor, L.P.  Senior Secured  Term Loan   8.75%  (L +8.00%)  8/19/19   13,500    13,408    13,246    9.5 
   1,250,000 Class A Units in SCT Holdings, LLC                 1,364    1,360    1.0 
                13,500    14,772    14,606    10.5 
                                 
                18,082    19,329    19,132    13.7 
Chemicals, Plastics & Rubber                                
Inhance Technologies Holdings LLC  Senior Secured Term Loan A   5.50%  (L +4.50%)  2/7/18   2,279    2,270    2,199    1.6 
VanDeMark Chemical Inc.  Senior Secured Term Loan   6.50%  (L +5.25%)  11/30/17   2,578    2,555    2,549    1.8 
                4,857    4,825    4,748    3.4 
Construction & Building                                
Nudo Products, Inc.  Subordinated Loan   12.00% cash / 2.5% PIK  N/A  1/29/20   11,253    11,175    11,478    8.1 
                11,253    11,175    11,478    8.1 
Consumer goods: Non-durable                                
Phoenix Brands LLC (5)  Senior Secured Term Loan A  9.25%  (L +7.75%)  1/31/16   1,189    1,187    1,088    0.8 
                1,189    1,187    1,088    0.8 
Containers, Packaging & Glass                                
Ranpak Corp.  Senior Secured Term Loan  8.25%  (L +7.25%)  10/3/22   2,000    1,995    1,995    1.4 
                2,000    1,995    1,995    1.4 
Healthcare & Pharmaceuticals                                
HealthFusion, Inc.  Senior Secured Loan   13.00%  N/A  10/7/18   5,750    5,698    5,865    4.2 
   Common Stock Warrants (1,646,666 shares)                 -    809    0.6 
                5,750    5,698    6,674    4.8 
                                 
Intrafusion Holding Corp. (6)  Senior Secured Term Loan B  12.82%  (P +5.75%)  9/25/20   14,250    14,193    14,193    10.0 
Maverick Healthcare Equity, LLC  Preferred Equity (1,250,000 units)                 1,109    1,355    1.0 
   Class A Common Equity (1,250,000 units)                 -    -    - 
                -    1,109    1,355    1.0 
                                 
Physiotherapy Associates Holding, Inc.  Senior Secured Term Loan  9.50%  (L +8.50%)  6/4/22   1,000    990    973    0.7 
Community Intervention Services, Inc. (f/k/a South Bay Mental Health Center, Inc.)  Subordinated  Loan   10.0% cash / 3.0% PIK  N/A  1/16/21   6,621    6,557    6,557    4.6 
Strata Pathology Services, Inc. (5)  Senior Secured Term Loan  11.75%  (P +8.50%)  6/30/16   4,037    3,988    84    0.1 
United Biologics Holdings, LLC  Subordinated  Loan   12.0% cash / 2.0% PIK  N/A  3/5/17   4,083    4,047    3,486    2.5 
   Class A-1 Units (2,686 units) and Kicker Units (2,015 units)                 9    -    - 
   Class A-1 Warrants (2,272 units) and Kicker Warrants (1,704 units)                 8    -    - 
   Class A Warrants (10,160 units)                 67    -    - 
   Class B Warrants (15,238 units)                 7    -    - 
                4,083   4,138   3,486    2.5 
                                 
                35,741    36,673    33,322    23.7 
High Tech Industries                                
B+B SmartWorx Inc. (f/k/a B&B Electronics Manufacturing Company)  Senior Secured Term Loan A   6.50%  (L +5.00%)  3/31/16   2,303    2,303    2,292    1.6 
                2,303    2,303    2,292    1.6 

 

 7 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Schedule of Investments (unaudited) - Continued

September 30, 2015

(Dollar amounts in thousands)

 

Industry
Name of Portfolio Company
  Investment Type  Interest Rate (1)  Spread Above
Index (1)
  Maturity  Principal
Amount
   Cost   Fair Value   Percent of
Net Assets
 
                             
Non-control/Non-affiliate Investments  - Continued                                
                                 
Hotel, Gaming & Leisure                                
TravelCLICK, Inc.  Senior Secured Term Loan  8.75%  (L +7.75%)  11/6/21   3,000    2,970    2,970    2.1 
                3,000    2,970    2,970    2.1 
Media: Advertising, Printing & Publishing                                
Jobson Healthcare Information, LLC  Senior Secured Term Loan  10.13% cash / 2.795% PIK  (L +8.13%)  7/21/19   14,758    14,450    14,113    10.1 
   Warrants (1,056,428 member units)                 454    448    0.3 
                14,758    14,904    14,561    10.4 
                                 
Media: Diversified & Production                                
A.C.T. Lighting, Inc.  Subordinated Loan  12.00% cash / 2.0% PIK  N/A  7/24/19   3,556    3,539    3,607    2.6 
                3,556    3,539    3,607    2.6 
Metals & Mining                                
All Metals Holding, LLC  Senior Secured Term Loan  10.50%  N/A  12/31/19   10,000    9,855    9,955    7.1 
   Common Equity (1.96% member interest)                 69    231    0.2 
                10,000    9,924    10,186    7.3 
                                 
Services: Business                                
BCC Software, LLC  Senior Secured Revolver   N/A  (L +8.00%)  6/20/19   -    (12)   (27)(2)   - 
   Senior Secured Term Loan  9.00%  (L +8.00%)  6/20/19   6,617    6,543    6,453    4.6 
                6,617    6,531    6,426    4.6 
                                 
Caddie Master Enterprises, Inc.  Senior Secured Term Loan  10.00%  (L +9.00%)  12/31/20   9,743    9,211    9,189    6.6 
   Common Stock Warrants (78.97 shares)                 550    789    0.6 
                9,743    9,761    9,978    7.2 
                                 
C7 Data Centers, Inc. (7)  Senior Secured Term Loan  13.36%  (L +8.50%)  6/22/20   11,850    11,826    11,637    8.3 
Riveron Consulting, LLC  Subordinated Loan  13.25%  N/A  3/25/20   10,000    9,910    9,783    7.0 
Sentry Centers Holdings, LLC  Senior Secured Loan  14.00%  N/A  5/29/20   6,105    6,007    5,999    4.3 
                44,315    44,035    43,823    31.4 
Services: Consumer                                
smarTours, LLC  Senior Secured Loan  9.25%  N/A  10/11/18   2,979    2,940    2,966    2.1 
   Preferred Equity A (500,000 units)                 439    733    0.5 
                2,979    3,379    3,699    2.6 
                                 
Southern Technical Institute, LLC  Subordinated Loan  10.75%  (L +9.75%)  12/2/20   5,000    4,978    4,909    3.5 
                                 
                7,979    8,357    8,608    6.1 
Telecommunications                                
NHR Holdings, LLC  Senior Secured Term Loan A  5.50%  (L +4.25%)  11/30/18   1,940    1,925    1,899    1.4 
   Senior Secured Term Loan B  5.50%  (L +4.25%)  11/30/18   1,967    1,952    1,925    1.4 
                3,907    3,877    3,824    2.8 
                                 
Total Non-control/Non-affiliate Investments               190,375    192,464    188,884    134.9 

 

 8 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Schedule of Investments (unaudited) - Continued

September 30, 2015

(Dollar amounts in thousands)

 

Industry
Name of Portfolio Company
  Investment Type  Interest Rate (1)  Spread Above
Index (1)
  Maturity  Principal
Amount
   Cost   Fair Value   Percent of
Net Assets
 
                                 
Affiliate Investments                                
Aerospace & Defense                                
Malabar International  Subordinated Loan   12.5% cash / 2.5% PIK  N/A  5/21/17   7,403    7,446    7,545    5.4 
   Preferred Stock (1,644 shares)                 4,283    5,454    3.9 
                7,403    11,729    12,999    9.3 
Capital Equipment                                
TRS Services, LLC  Senior Secured Term Loan  9.50%  (L +8.50%)  12/10/19   10,395    10,319    10,266    7.3 
   Delayed Draw Senior Secured Term Loan  9.50%  (L +8.50%)  12/10/19   743    739    734    0.5 
   3,000,000 Class A Units in IGT Holdings, LLC                 2,707    2,648    1.9 
   3,000,000 Common Units in IGT Holdings, LLC                 572    121    0.1 
                11,138    14,337    13,769    9.8 
Consumer goods: Non-durable                                
Master Cutlery, LLC  Senior Secured Term Loan  13.00%  N/A  4/17/20   4,789    4,762    4,771    3.4 
   3,723 Preferred Equity A units in MC Parent, LLC.            -    3,751    3,081    2.2 
   15,564 Common Equity units in MC Parent, LLC.            -    -    311    0.2 
                4,789    8,513    8,163    5.8 
Healthcare & Pharmaceuticals                                
Pfanstiehl Holdings, Inc.  Subordinated Loan  13.50%  N/A  9/29/18   3,788    3,857    3,826    2.7 
   Class A Common Equity (400 shares)                 217    1,825    1.3 
                3,788    4,074    5,651    4.0 
Services: Business                                
Contract Datascan Holdings, Inc.  Subordinated Loan  12.00%  N/A  2/5/21   5,350    5,324    5,324    3.8 
   Preferred Equity A (2,463 shares)                 2,618    2,659    1.9 
   Common Equity (9,069 shares)                 -    409    0.3 
                5,350    7,942    8,392    6.0 
                                 
NeoSystems Corp.  Subordinated Loan   10.5% cash / 2.25% PIK  N/A  8/13/19   4,618    4,583    4,641    3.3 
   Convertible Preferred Stock (521,962 shares)                 1,109    2,365    1.7 
                4,618    5,692    7,006    5.0 
                                 
                                 
Tangible Software, Inc.  Senior Secured Loan  4%  N/A  6/17/16   2,639    2,556    2,356    1.7 
   Common Equity (1,285,854 shares)                 -    -    - 
                2,639    2,556    2,356    1.7 
                                 
                12,607    16,190    17,754    12.7 
                                 
Total Affiliate Investments               39,725    54,843    58,336    41.6 
                                 
                                 
Total Investments               230,100    247,307    247,220    176.5 

 

 9 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Schedule of Investments (unaudited) - Continued

September 30, 2015

(Dollar amounts in thousands)

 

Name of Portfolio Company  Investment Type  Principal
Amount
   Cost   Fair Value   Percent of
Net
Assets
 
                        
Money Market                       
                        
US Bank Money Market Deposit Account  Money Market   N/A    41,113(3)   41,113(3)   29.3 
Total Money Market           41,113    41,113    29.3 
                        
Total Investments and Money Market (United States)     $230,100   $288,420   $288,333    205.8%

 

 

(1)The majority of the investments bear interest at a rate that may be determined by reference to LIBOR (L) or Prime (P) and which is reset daily, quarterly or semi-annually. For each investment, the Company has provided the spread over LIBOR and current interest rate in effect at September 30, 2015. Certain investments are subject to a LIBOR or Prime interest rate floor.
(2)The negative fair value is the result of the unfunded commitment being valued below par.
(3)Included in cash and cash equivalents on the consolidated balance sheets.
(4)Indicates assets that the Company deems not "qualifying assets" under Section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the Company's total assets at the time of acquisition of any additional non-qualifying assets.
(5)Non-accrual loan. Strata Pathology Services, Inc. was settled on October 2, 2015.
(6)SBIC I LP has entered into a contractual arrangement whereby, subject to certain conditions being satisfied, it has agreed, with respect to the Senior Secured Tem Loan B, to receive its payment after the repayment of certain lenders pursuant to a payment waterfall. With respect to Intrafusion Holding Corp., the all-in interest rate of 12.82% at September 30, 2015 included an interest rate of 3.82% per annum as specified under the contractual arrangement SBIC I LP entered into with the co-lenders in connection with the credit agreement.
(7)SBIC I LP has entered into a contractual arrangement whereby, subject to certain conditions being satisfied, it has agreed, with respect to the Senior Secured Tem Loan, to receive its payment after the repayment of certain lenders pursuant to a payment waterfall. With respect to C7 Data Centers, Inc., the all-in interest rate of 13.36% at September 30, 2015 included an interest rate of 3.85% per annum as specified under the contractual arrangement SBIC I LP entered into with the co-lenders in connection with the credit agreement.

  

See Notes to Unaudited Consolidated Financial Statements.

 

 10 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Schedule of Investments

December 31, 2014

(Dollar amounts in thousands)

  

Industry
Name of Portfolio Company
  Investment Type  Interest Rate (1)  Spread Above
Index (1)
  Maturity  Principal
Amount
   Cost   Fair Value   Percent of
Net Assets
 
                             
Non-control/Non-affiliate Investments                                
                                 
Aerospace & Defense                                
Aero-Metric, Inc.  Senior Secured Term Loan  8.75%  (L +7.50%)  8/27/17  $2,644   $2,622   $2,619    1.9%
Whitcraft LLC  Senior Secured Term Loan  6.50%  (L +5.00%)  12/16/15   3,788    3,775    3,712    2.7 
                6,432    6,397    6,331    4.6 
Banking, Finance, Insurance & Real Estate                                
Accurate Group Holdings, Inc. (4)  Subordinated Loan  12.50%  N/A  6/11/18   10,000    10,071    10,071    7.3 
Captive Resources Midco LLC  Senior Secured Term Loan   6.50%  (L +5.00%)  1/2/19   4,804    4,757    4,646    3.4 
CSI Financial Services, LLC (5)  Senior Secured Term Loan   7.00%  (L +5.75%)  12/12/18   3,207    3,174    3,173    2.3 
MYI Acquiror Limited (5)  Senior Secured Term Loan A   5.75%  (L +4.50%)  5/28/19   4,875    4,848    4,826    3.5 
Townsend Acquisition LLC  Senior Secured Term Loan   5.25%  (L +4.25%)  5/21/20   4,330    4,296    4,278    3.1 
                27,216    27,146    26,994    19.6 
Capital Equipment                                
Dorner MFG, Corp.  Senior Secured Term Loan   5.75%  (L +4.50%)  6/15/17   3,062    3,032    2,974    2.2 
Elgin Fasteners Group  Senior Secured Term Loan   6.00%  (L +4.75%)  8/26/16   4,679    4,632    4,616    3.4 
Stancor, Inc. (4)  Senior Secured  Term Loan   8.75%  (L +8.00%)  8/19/19   13,500    13,391    13,395    9.7 
   1,250,000 Class A Units in SCT Holdings, LLC                 1,250    1,287    0.9 
                13,500    14,641    14,682    10.6 
                                 
                21,241    22,305    22,272    16.2 
Chemicals, Plastics & Rubber                                
Actagro, LLC  Senior Secured Term Loan   5.50%  (L +4.25%)  12/30/16   3,201    3,182    3,117    2.3 
Accella Holdings LLC (f/k/a Dash Materials LLC)  Senior Secured Term Loan   5.50%  (L +4.50%)  4/30/19   3,424    3,413    3,424    2.5 
ICM Products Inc  Senior Secured Term Loan   5.50%  (L +4.50%)  3/31/19   2,068    2,045    1,952    1.4 
Inhance Technologies Holdings LLC  Senior Secured Term Loan A   5.50%  (L +4.50%)  2/7/18   2,371    2,357    2,271    1.7 
KODA Distribution Group, Inc.  Senior Secured Term Loan A   6.00%  (L +5.00%)  4/9/18   3,835    3,822    3,787    2.7 
VanDeMark Chemical Inc.  Senior Secured Term Loan   6.50%  (L +5.25%)  11/30/17   2,681    2,650    2,636    1.9 
                17,580    17,469    17,187    12.5 
Construction & Building                                
Jameson LLC  Senior Secured Term Loan   7.50%  (L +5.50%)  1/31/17   1,529    1,525    1,529    1.1 
Nudo Products, Inc. (4)  Subordinated Loan   12.00% cash / 1.75% PIK  N/A  1/29/20   11,045    10,953    10,953    7.9 
                12,574    12,478    12,482    9.0 
Consumer goods: Non-durable                                
Phoenix Brands LLC  Senior Secured Term Loan A  7.25%  (L +5.75%)  1/31/16   1,319    1,314    1,230    0.9 
                1,319    1,314    1,230    0.9 
Containers, Packaging & Glass                                
Mold-Rite Plastics, LLC  Senior Secured Term Loan   5.50%  (L +4.25%)  6/30/16   4,009    3,990    3,962    2.9 
                4,009    3,990    3,962    2.9 
Energy: Oil & Gas                                
ANS Distributing, INC.  Senior Secured Term Loan   8.00%  (L +6.50%)  11/1/17   2,810    2,778    2,810    2.0 
                2,810    2,778    2,810    2.0 
Environmental Industries                                
Apex Companies, LLC.  Senior Secured Term Loan   5.50%  (L +4.50%)  3/28/19   3,714    3,695    3,506    2.6 
JWC Environmental, LLC.  Senior Secured Term Loan   6.00%  (L +4.50%)  8/3/16   3,863    3,850    3,810    2.8 
                7,577    7,545    7,316    5.4 

 

 11 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Schedule of Investments - Continued

December 31, 2014

(Dollar amounts in thousands)

 

Industry
Name of Portfolio Company
  Investment Type  Interest Rate (1)  Spread Above
Index (1)
  Maturity  Principal
Amount
   Cost   Fair Value   Percent of
Net Assets
 
                             
Non-control/Non-affiliate Investments  - Continued                                
                                 
Healthcare & Pharmaceuticals                                
Behavioral Health Group  Senior Secured Term Loan A   5.75%  (L +4.50%)  8/18/16   4,552    4,537    4,473    3.3 
Elements Behavioral Health, Inc.  Senior Secured Term Loan A  5.75%  (L +4.75%)  2/12/19   4,694    4,665    4,665    3.4 
HealthFusion, Inc. (4)  Senior Secured Loan   13.00%  N/A  10/7/18   5,750    5,685    5,882    4.3 
   Common Stock Warrants (1,646,666 shares)                 -    498    0.4 
                5,750    5,685    6,380    4.7 
                                 
Hygenic Corporation  Senior Secured Term Loan   6.00%  (L +4.75%)  10/11/18   4,684    4,640    4,671    3.4 
Intrafusion Holding Corp. (4)(10)  Senior Secured Term Loan B  13.58%  (L +9.00%)  6/13/18   2,000    2,016    2,016    1.5 
Maverick Healthcare Equity, LLC (4)  Preferred Equity (1,250,000 units)                 900    900    0.7 
Maverick Healthcare Equity, LLC (4)  Class A Common Equity (1,250,000 units)                 -    -    - 
Vention Medical, Inc. (f/k/a MedTech Group, Inc.)  Senior Secured Term Loan  6.25%  (L +5.25%)  12/31/18   4,575    4,552    4,552    3.3 
South Bay Mental Health Center, Inc. (4)  Subordinated  Loan   12.0% cash / 2.5% PIK  N/A  10/12/17   3,030    3,030    3,027    2.2 
Strata Pathology Services, Inc. (6)  Senior Secured Term Loan   11.00%  (L +9.50%)  6/30/16   4,037    3,988    801    0.6 
Studer Group LLC  Senior Secured Term Loan   6.00%  (L +4.75%)  7/31/18   3,448    3,430    3,322    2.4 
United Biologics Holdings, LLC (4)  Subordinated  Loan   12.0% cash / 2.0% PIK  N/A  3/5/17   4,183    4,126    4,181    3.0 
   Class A-1 Units (2,686 units) and Kicker Units (2,015 units)                 9    22    - 
   Class A-1 Warrants (2,272 units) and Kicker Warrants (1,704 units)                 8    19    - 
   Class A Warrants (10,160 units)                 67    74    0.1 
   Class B Warrants (15,238 units)                 7    38    - 
                4,183   4,217   4,334    3.1 
                                 
                40,953    41,660    39,141    28.6 
High Tech Industries                                
Anaren, Inc. (4)  Senior Secured Term Loan   5.50%  (L +4.50%)  2/18/21   2,970    2,944    2,923    2.1 
B&B Electronics Manufacturing Company  Senior Secured Term Loan A   6.50%  (L +5.00%)  4/4/15   2,440    2,437    2,426    1.8 
OnePath Systems, LLC  Senior Secured Term Loan   7.50%  (L +6.00%)  6/6/17   2,220    2,198    2,220    1.6 
                7,630    7,579    7,569    5.5 
Media: Advertising, Printing & Publishing                                
Content Marketing, LLC  Senior Secured Term Loan   7.50%  (L +6.25%)  12/21/17   3,039    3,012    3,039    2.2 
Jobson Healthcare Information, LLC (4)  Senior Secured Term Loan  10.13% cash / 2.795% PIK  (L +8.13%)  7/21/19   14,704    14,329    14,141    10.3 
   Warrants (1,056,428 member units)                 454    384    0.3 
                14,704    14,783    14,525    10.6 
                                 
Media Source  Senior Secured Term Loan   5.25%  (L +4.25%)  7/16/19   2,386    2,364    2,348    1.7 
                                 
                20,129    20,159    19,912    14.5 
Media: Broadcasting & Subscription                                
Campus Televideo, Inc.  Senior Secured Term Loan   7.25%  (L +5.75%)  10/23/17   3,592    3,542    3,590    2.6 
                3,592    3,542    3,590    2.6 
Media: Diversified & Production                                
A.C.T. Lighting, Inc. (4)  Subordinated Loan  12.00% cash / 2.0% PIK  N/A  7/24/19   3,502    3,482    3,482    2.5 
                3,502    3,482    3,482    2.5 
Metals & Mining                                
All Metals Holding, LLC(4)  Senior Secured Term Loan  10.50%  N/A  12/31/19   14,000    13,763    13,763    10.0 
   Common Equity (2.75% member interest)                 97    97    0.1 
                14,000    13,860    13,860    10.1 
Retail                                
Tharpe Company, Inc.  Senior Secured Term Loan   6.00%  (L +4.75%)  10/19/17   3,589    3,559    3,555    2.6 
                3,589    3,559    3,555    2.6 

 

 12 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Schedule of Investments - Continued

December 31, 2014

(Dollar amounts in thousands)

 

Industry
Name of Portfolio Company
  Investment Type  Interest Rate (1)  Spread Above
Index (1)
  Maturity  Principal
Amount
   Cost   Fair Value   Percent of
Net Assets
 
                             
Non-control/Non-affiliate Investments  - Continued                                
                                 
Services: Business                                
Accuvant Finance, LLC (4)  Senior Secured Initial Loans  7.00%  (P +3.75%)  10/22/20   5,970    5,917    5,970    4.3 
BCC Software, LLC (4)  Senior Secured Revolver   N/A  (L +8.00%)  6/19/19   -    (15)   (24)(2)   - 
BCC Software, LLC (4)  Senior Secured Term Loan   9.00%  (L +8.00%)  6/19/19   6,913    6,820    6,758    4.9 
Caddie Master Enterprises, Inc. (4)  Senior Secured Term Loan  10.00%  (L +9.00%)  12/31/20   10,500    9,845    9,845    7.2 
   Common Stock Warrants (78.97 shares)                 550    550    0.4 
                10,500    10,395    10,395    7.6 
                                 
C7 Data Centers, Inc. (4)  Senior Secured Term Loan   9.50%  (L +7.50%)  9/30/19   7,234    7,234    7,274    5.3 
C7 Data Centers, Inc. (4)  Senior Secured Line of Credit   9.50%  (L +7.50%)  9/30/19   500    500    503    0.4 
Community Investors, Inc. (4)(8)  Senior Secured Term Loan  11.86%  (L +7.25%)  9/30/19   8,500    8,420    8,420    6.1 
   Common Stock (560 shares)                 1    1    - 
   Preferred Stock A (59,258 shares)                 60    155    0.1 
   Preferred Stock A-1 (27,737 shares)                 66    72    0.1 
   Preferred Stock A-2 (16,888 shares)                 44    44    - 
                8,500    8,591    8,692    6.3 
                                 
Revspring Inc. (f/k/a Dantom Systems, Inc.)  Senior Secured Term Loan   5.50%  (L +4.25%)  8/3/17   4,454    4,434    4,454    3.2 
Young Innovations, Inc.  Senior Secured Term Loan A   5.25%  (L +4.25%)  1/30/19   2,663    2,636    2,630    1.9 
                46,734    46,512    46,652    33.9 
                                 
                                 
                                 
Services: Consumer                                
smarTours, LLC (4)  Senior Secured Loan   9.25%  N/A  10/11/18   3,905    3,842    3,901    2.8 
   Preferred Equity A (500,000 units)                 489    671    0.5 
                3,905    4,331    4,572    3.3 
                                 
Southern Technical Institute, LLC (4)  Subordinated Loan  10.75%  (L +9.75%)  12/2/20   5,000    4,975    4,975    3.6 
                                 
                8,905    9,306    9,547    6.9 
Telecommunications                                
Barcodes LLC  Senior Secured Term Loan  7.25%  (P +4.00%)  12/9/19   2,815    2,791    2,791    2.0 
NHR Holdings, LLC  Senior Secured Term Loan A   5.50%  (L +4.25%)  11/30/18   2,072    2,052    1,978    1.4 
NHR Holdings, LLC  Senior Secured Term Loan B   5.50%  (L +4.25%)  11/30/18   2,100    2,080    2,005    1.5 
                6,987    6,923    6,774    4.9 
                                 
Total Non-control/Non-affiliate Investments               256,779    258,004    254,666    185.2 

 

 13 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Schedule of Investments - Continued

December 31, 2014

(Dollar amounts in thousands)

 

Industry
Name of Portfolio Company
  Investment Type  Interest Rate (1)  Spread Above
Index (1)
  Maturity  Principal
Amount
   Cost   Fair Value   Percent of
Net Assets
 
                             
Affiliate Investments                                
Aerospace & Defense                                
Malabar International (4)  Subordinated Loan   12.5% cash / 2.5% PIK  N/A  5/21/17   7,264    7,328    7,376    5.4 
   Preferred Stock (1,644 shares)                 4,283    4,404    3.2 
                7,264    11,611    11,780    8.6 
Capital Equipment                                
TRS Services, LLC (4)  Initial Senior Term Loan  9.50%  (L +8.50%)  12/10/19   10,474    10,383    10,383    7.6 
TRS Services, LLC (4)  Delayed Draw Senior Term Loan  9.50%  (L +8.50%)  12/10/19   499    495    495    0.4 
   3,000,000 Class A Units in IGT Holdings, LLC                 3,020    3,020    2.2 
   3,000,000 Common Units in IGT Holdings, LLC                 -    -    - 
                10,973    13,898    13,898    10.2 
Healthcare & Pharmaceuticals                                
Pfanstiehl Holdings, Inc (4)  Subordinated Loan   12.0% cash / 1.5% PIK  N/A  9/29/18   3,788    3,874    3,864    2.8 
   Class A Common Equity (400 shares)                 217    1,070    0.8 
                3,788    4,091    4,934    3.6 
Services: Business                                
Contract Datascan Holdings, Inc. (4)(9)  Senior Secured Term Loan B   10.75%  (L +9.75%)  12/17/18   9,265    9,192    9,129    6.6 
   Preferred Equity A (2,463 shares)                 2,351    2,468    1.8 
   Preferred Equity B (382 shares)                 483    446    0.3 
   Common Equity (9,069 shares)                 -    -    - 
                9,265    12,026    12,043    8.7 
                                 
NeoSystems Corp. (4)  Subordinated Loan   10.5% cash / 2.25% PIK  N/A  8/13/19   4,540    4,498    4,524    3.3 
   Convertible Preferred Stock (521,962 shares)                 1,029    1,292    0.9 
                4,540    5,527    5,816    4.2 
                                 
Sentry Centers Holdings, LLC (4)  Senior Secured Loan   14.00%  N/A  6/28/18   5,075    4,969    5,104    3.7 
   Senior Secured Loan   14.00%  N/A  1/15/16   1,000    979    1,010    0.7 
   Preferred Equity A (83 units)                 -    520    0.4 
                6,075    5,948    6,634    4.8 
                                 
Tangible Software, Inc. (4)(11)  Senior Secured Loan  4%  N/A  6/17/16   2,639    2,468    2,463    1.8 
   Common Equity (1,285,864 shares)                 -    -    - 
                2,639    2,468    2,463    1.8 
                                 
                22,519    25,969    26,956    19.5 
                                 
Total Affiliate Investments               44,544    55,569    57,568    41.9 
                                 
Total Investments               301,323    313,573    312,234    227.1 

 

 14 

 

  

OFS Capital Corporation and Subsidiaries

 

Consolidated Schedule of Investments - Continued

December 31, 2014

(Dollar amounts in thousands)

 

Name of Portfolio Company  Investment Type  Principal
Amount
   Cost   Fair Value   Percent of
Net
Assets
 
                    
Money Market                       
                        
WF Prime INVT MM #1752  (7)  Money Market   N/A    1,039(3)   1,039(3)   0.8 
US Bank Money Market Deposit Account  Money Market   N/A    8,570(3)   8,570(3)   6.2 
Total Money Market           9,609    9,609    7.0 
                        
Total Investments and Money Market (United States)     $301,323   $323,182   $321,843    234.1%

 

 

(1)The majority of the investments bear interest at a rate that may be determined by reference to LIBOR (L) or Prime (P) and which is reset daily, quarterly or semi- annually. For each investment, we have provided the spread over LIBOR and current interest rate in effect at December 31, 2014. Certain investments are subject to a LIBOR or Prime interest rate floor.
(2)The negative fair value is the result of the unfunded commitment being valued below par.
(3)Included in cash and cash equivalents on the consolidated balance sheets.
(4)Investments held by SBIC I LP. All other investments were held by OFS Capital WM, and were pledged as collateral under the OFS Capital WM credit facility.
(5)Indicates assets that the Company deems not "qualifying assets" under Section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the Company's total assets at the time of acquisition of any additional non-qualifying assets.
(6)Non-accrual loan.
(7)Money market accounts held by OFS Capital WM, and pledged as collateral under the OFS Capital WM credit facility.
(8)SBIC I LP has entered into a contractual arrangement whereby, subject to certain conditions being satisfied, it has agreed, with respect to the Senior Secured Term Loan, to receive its payment after the repayment of certain lenders pursuant to a payment waterfall. With respect to Community Investors, Inc., the all-in interest rate of 11.86% at December 31, 2014 included an interest rate of 3.61% per annum as specified under the contractual arrangement SBIC I LP entered into with the co-lenders in connection with the credit agreement.
(9)SBIC I LP has entered into a contractual arrangement whereby, subject to certain conditions being satisfied, it has agreed, with respect to the Senior Secured Term Loan B, to receive its payment after the repayment of certain lenders pursuant to a payment waterfall.
(10)SBIC I LP has entered into a contractual arrangement whereby, subject to certain conditions being satisfied, it has agreed, with respect to the Senior Secured Tem Loan B, to receive its payment after the repayment of certain lenders pursuant to a payment waterfall. With respect to Intrafusion Holding Corp., the all-in interest rate of 13.58% at December 31, 2014 included an interest rate of 3.08% per annum as specified under the contractual arrangement SBIC I LP entered into with the co-lenders in connection with the credit agreement.
(11)The original debt and equity investments, with a total cost basis of $8,992, were restructured on December 17, 2014, as a result of which SBIC I LP received a cash payment of $2,943, a new note with a fair value of $2,463 on the restructuring date and at December 31, 2014, and common stock in Tangible Software, Inc valued at zero at the restructuring date and at December 31, 2014. In connection with this restructuring, SBIC I LP recognized a loss of $3,586. The post-restructured investments were classified as affiliate investments and the new debt investment was deemed an accrual loan as of December 31, 2014.

 

See Notes to Unaudited Consolidated Financial Statements.

 

 15 

 

  

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 1. Organization

 

OFS Capital Corporation (“OFS Capital”, the “Company”, or “we”) is a Delaware corporation formed on November 7, 2012 and is an externally managed, closed-end, non-diversified management investment company. The Company has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). In addition, for income tax purposes, the Company, other than its tax blocker entity (see below), has elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”).

 

From time to time, the term OFS Capital, the Company, or we may be used herein to refer to OFS Capital Corporation, individually, or OFS Capital Corporation and/or its subsidiaries either collectively or individually, as well as, with respect to all periods prior to the initial public offering (“IPO”) date, OFS Capital, LLC (for income tax purposes, these terms only refer to the RIC reporting group).

 

On November 7, 2012, the Company priced its IPO, selling 6,666,667 shares of its common stock at a public offering price of $15 per share and raising $100,000 in gross proceeds. Immediately prior to the IPO, on November 7, 2012, OFS Capital, LLC converted from a limited liability company to a corporation, as a result of which the sole membership interest held in OFS Capital, LLC by Orchard First Source Asset Management, LLC (“OFSAM”) prior to the conversion was exchanged for 2,912,024 shares of common stock in the Company.

 

On September 28, 2010, OFS Capital, LLC became the 100% equity owner of OFS Capital WM, LLC (“OFS Capital WM”). On September 29, 2011, OFS Capital, LLC became the primary beneficiary in OFS SBIC I, LP (“SBIC I LP”), a variable interest entity (“VIE”) under the applicable provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 810, “Consolidation”. On May 10, 2012, upon SBIC I LP’s receipt of a Small Business Investment Company (“SBIC”) license, OFS Capital, LLC became an approximately 68% limited partner in SBIC I LP. On December 4, 2013, the Company acquired the remaining limited partnership interests in SBIC I LP, as well as the remaining membership interests in OFS SBIC I GP, LLC (“SBIC I GP”), the general partner of SBIC I LP that holds 1% of the limited partnership interest in SBIC I LP (the “SBIC Acquisitions”). As a result of the acquisitions, SBIC I LP and SBIC I GP became wholly owned subsidiaries of the Company effective December 4, 2013.

 

On January 8, 2015, in order to comply with certain requirements necessary to maintain the Company’s RIC status, it formed FQSR II, LLC (“FQSR”), a Delaware limited liability company and wholly owned subsidiary of the Company, to hold an equity investment in a portfolio company. The equity investment was sold in May 2015. As of September 30, 2015, FQSR had nominal assets and liabilities. For income tax purposes, FQSR has elected to be taxed as a C corporation and is excluded from the Company’s RIC tax reporting group.

 

The Company’s investment strategy is to focus primarily on debt investments and, to a lesser extent, equity investments primarily in middle-market companies in the United States. The Company has entered into an investment advisory and management agreement with OFS Capital Management, LLC (“OFS Capital Management” or the “Investment Advisor”), under which the Investment Advisor manages the day-to-day operations of, and provides investment advisory services to, the Company (see Note 4 for more details).

 

Note 2. Summary of Significant Accounting Policies

 

Basis of presentation: The accompanying interim consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and pursuant to the requirements for reporting on Form 10-Q, ASC Topic 946, Financial Services – Investment Companies (“ASC Topic 946”), and Article 6 or 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for annual financial statements. In the opinion of management, the consolidated financial statements reflect all adjustments consisting only of normal recurring accruals and adjustments. All intercompany balances and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation. The December 31, 2014 consolidated balance sheet was derived from the audited balance sheet included in the Company’s annual report on Form 10-K for the year ended December 31, 2014.

 

Principles of consolidation: The Company’s September 30, 2015 consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries OFS Capital WM, SBIC I LP, SBIC I GP and FQSR. The Company consolidates an affiliated subsidiary if it owns more than 50 percent of the subsidiary’s equity and holds the controlling financial interest in such subsidiary. The Company also consolidates a VIE if it is the primary beneficiary in the VIE.

 

Fair value of financial instruments: The Company applies fair value to substantially all of its financial instruments in accordance with Accounting Standards Codification Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”). ASC Topic 820 defines fair value, establishes a framework used to measure fair value and requires disclosures for fair value measurements. In accordance with ASC Topic 820, the Company has categorized its financial instruments carried at fair value, based on the priority of the valuation technique, into a three level fair value hierarchy. Fair value is a market-based measure considered from the perspective of the market participant that holds the financial instrument rather than an entity specific measure. Therefore, when market assumptions are not readily available, the Company’s own assumptions reflect those that management believes market participants would use in pricing the financial instrument at the measurement date.

 

 16 

 

  

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 2. Summary of Significant Accounting Policies (Continued)

 

The availability of observable inputs can vary depending on the financial instrument and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new, 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 models or inputs that are less observable or unobservable in the market, 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).

 

Changes to the valuation policy are reviewed by management and the Company’s board of directors (the “Board”) to confirm that the changes are justified. As the Company’s investments change, markets change, new products develop and the pricing for products becomes more or less transparent, the Company will continue to refine its valuation methodologies.

 

See Note 6 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 requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in those companies where the Company owns more than 25% of the voting securities of such company or has rights to maintain greater than 50% of the board representation. Under the 1940 Act, “Affiliate Investments” are defined as investments in those companies where the Company owns between 5% and 25% of the voting securities of such company. “Non-Control/Non-Affiliate Investments” are those that neither qualify as Control Investments nor Affiliate Investments.

 

Investment risks: The Company’s investments are subject to a variety of risks. These risks may include, but are not limited to the following:

 

Market risk - Market risk represents the potential loss that can be caused by a change in the fair value of the financial instrument due to market changes.

 

Credit risk - Credit risk represents the risk that the Company would incur if the counterparties failed to perform pursuant to the terms of their agreements with the Company.

 

Liquidity risk - Liquidity risk represents the possibility that the Company may not be able to rapidly adjust the size of its positions in times of high volatility and financial stress at a reasonable price.

 

Interest rate risk - Interest rate risk represents the likelihood that a change in interest rates could have an adverse impact on the fair value of an interest-bearing financial instrument.

 

Prepayment risk - Certain of the Company’s debt investments allow for prepayment of principal without penalty. Downward changes in interest rates may cause prepayments to occur at a faster than expected rate, thereby effectively shortening the maturity of the debt investments and making the instrument less likely to be an income producing instrument.

 

Off-Balance sheet risk - Some of the Company’s financial instruments contain off-balance sheet risk. Generally, these financial instruments represent future commitments to purchase other financial instruments at specific terms at specific future dates.

 

Use of estimates: The preparation of the consolidated 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could significantly differ from those estimates.

 

Reportable segments: In accordance with segment guidance set by Accounting Standards Codification 280, “Segment Reporting” (“ASC Topic 280”), the Company has determined that it has a single reportable segment and single operating segment structure.

 

Cash and cash equivalents: Cash and cash equivalents consist of cash and highly liquid investments not held for resale with original maturities at the time of acquisition of three months or less. The Company places its cash in financial institutions and at times, such balances may be in excess of the Federal Deposit Insurance Corporation insurance limits.

 

 17 

 

  

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 2. Summary of Significant Accounting Policies (Continued)

 

Revenue recognition:

 

Interest Income: Interest income is accrued based upon the outstanding principal amount and contractual interest terms of the debt investments. Recognized interest income, if payable monthly or quarterly, is reflected as interest receivable until collected. Recognized interest income that is instead added to the principal balance and generally becomes due at maturity or at some other stipulated date (“PIK interest”) is reflected in the investment account. The Company accrues interest income until certain events take place, which may place a loan into a non-accrual status (see below). The Company will not accrue PIK interest if the portfolio company valuation indicates that the PIK interest is not collectible. Loan origination fees, original issue discount (“OID”), market discount or premium, and loan amendment fees (collectively, “net loan origination fees”) are capitalized, and the Company accretes or amortizes such amounts on a straight-line basis over the life of the loan as additional interest income. When the Company receives a loan principal payment, the OID related to the paid principal is accelerated and recognized in interest income. This method is not materially different than the effective interest rate method. Unamortized OID is reflected in the investment account and unamortized loan amendment fees are reflected as deferred loan fee revenue. All other interest income is recorded into income when earned. Further, in connection with the Company’s debt investments, the Company will sometimes receive warrants or similar no cost equity-related securities (“Warrants”). The Company determines the cost basis of Warrants based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and Warrants received. Any resulting difference between the face amount of the debt and its recorded fair value resulting from the assignment of value to the Warrants is treated as OID, and accreted into interest income as described above.

 

As of September 30, 2015 and December 31, 2014, unamortized net loan origination fees on debt investments amounted to $2,336 and $3,706, respectively. For the three and nine months ended September 30, 2015, the Company recognized net loan origination fee income of $333 and $1,340, respectively. For the three and nine months ended September 30, 2014, the Company recognized net loan origination fee income of $488 and $1,094, respectively. For the three and nine months ended September 30, 2015, the Company recognized PIK interest income in the amount of $330 and $931, respectively. For the three and nine months ended September 30, 2014, the Company recognized PIK interest income in the amount of $161 and $399, respectively. To maintain its status as a RIC, the Company includes non-cash interest income in the amounts that must be paid out to its shareholders in the form of distributions.

 

Dividend Income: Dividend income on common stock, generally payable in cash, is recorded at the time dividends are declared or at the point an obligation exists for the portfolio company to make a distribution supported by tax-basis earnings and profits. Dividend income on preferred equity is accrued as earned. Such dividends on preferred equity securities could 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 reflected as dividend receivables until collected. Dividends payable in additional preferred securities or contractually earned but not declared (“PIK dividends”) are reflected in the investment account. The Company stops accruing PIK dividends on its preferred equity securities when it is determined that the dividend is not collectible. The Company assesses the collectability of the PIK dividends based on factors including the fair value of the preferred equity security, the valuation of the portfolio company’s enterprise value, and proceeds expected to be received over the life of the investments. In addition, the Company may receive distributions from certain of its investments taxed as flow through entities. Each such distribution is evaluated to determine if the distribution should be recorded as dividend income or a return of capital. Generally, the Company will not record distributions from investments taxed as flow through entities as dividend income unless there are sufficient accumulated tax-basis earning and profits prior to the distribution. Distributions that are classified as a return of capital are recorded as a reduction in the cost basis of the investment. For the three and nine months ended September 30, 2015, the Company recognized preferred dividend income of $506 and $1,264, respectively, of which $426 and $1,052, respectively, was contractually earned but not declared. For the three and nine months ended September 30, 2014, the Company recognized preferred dividend income of $335 and $394, respectively, of which $302 was contractually earned but not declared during such periods. For the three and nine months ended September 30, 2015, the Company recognized common stock dividends of $85. The Company did not recognize common stock dividends for the three and nine months ended September 30, 2014.

 

Fee Income: The Company may generate revenue in the form of commitment, structuring or due diligence fees, fees for providing managerial assistance, consulting fees, and other contractual fees. Such revenue is recognized as the related services are rendered and amounted to $401 and $661, for the three and nine months ended September 30, 2015, respectively. For the three and nine months ended September 30, 2014, the Company recognized fee income of $270 and $385, respectively.

 

Net Realized and Unrealized Gain or Loss on Investments: Investment transactions are accounted for on a trade-date basis. Realized gains or losses on investments are measured by the difference between the net proceeds from the disposition and the cost basis of the investment, without regard to unrealized gains or losses previously recognized. Investments are recorded at fair value. The Company’s Board determines the fair value of its portfolio investments. After recording all appropriate interest, dividend, and other income, some of which is reflected in the investment account as described above, the Company reports changes in fair value of investments that are measured at fair value as a component of the net changes in unrealized appreciation/depreciation on investments in the consolidated statements of operations.

 

 18 

 

  

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 2. Summary of Significant Accounting Policies (Continued)

 

Non-accrual loans: Loans on which the accrual of interest income has been discontinued are designated as non-accrual loans, and non-accrual loans are further designated to be accounted for under either a non-accrual cash method or a non-accrual cost recovery method. Loans are generally placed on non-accrual status when a loan either: (i) is delinquent for 90 days or more on principal or interest based on contractual terms of the loan (unless well secured and in the process of collection), or (ii) in the opinion of the Company’s management, there is reasonable doubt about the collectability. When loans are placed on non-accrual status, all interest previously accrued but not collected, other than PIK interest that has already been contractually added to the principal balance, is reversed against current period interest income. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment. Interest accruals are resumed on non-accrual loans only when they are brought current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to all principal and interest. At September 30, 2015, the Company had two non-accrual loans which were accounted for as non-accrual cash method loans with an aggregate fair value of $1,172, one of which was settled on October 2, 2015 (cost and fair value was $3,988 and $84, respectively, at September 30, 2015). At December 31, 2014, the Company had one non-accrual loan which was accounted for as a non-accrual cash method loan with an aggregate fair value of $801.

 

Income taxes: The Company has elected to be treated as a RIC under Subchapter M of the Code and operates in a manner so as to qualify for the tax treatment applicable to RICs. In order to qualify as a RIC, among other things, the Company is required to meet certain source of income and asset diversification requirements and timely distribute to its shareholders at least 90% of investment company taxable income, as defined by the Code, for each year. The Company has made, and intends to continue to make, the requisite distributions to its shareholders, which will generally relieve the Company from U.S. federal income taxes with respect to all income distributed to its shareholders.

 

Depending on the level of taxable income earned in a tax year, the Company may choose to retain taxable income in excess of current year dividend distributions into the next tax year in an amount less than what would trigger payments of federal income tax under Subchapter M of the Code. The Company would then pay a 4% excise tax on such income, as required. To the extent that the Company determines its estimated current year annual taxable income may exceed estimated current year dividend distributions, the Company accrues excise tax on estimated excess taxable income as taxable income is earned. At September 30, 2015 and December 31, 2014, no U.S. federal excise tax was accrued.

 

FQSR has elected to be taxed as a C corporation and will be subject to U.S. federal income taxes on its taxable income. FQSR accounts for income taxes under the asset and liabilities method. For the three and nine months ended September 30, 2015, all related accounting is immaterial.

 

The Company accounts for income taxes in conformity with Accounting Standards Codification 740, “Income Taxes” (“ASC Topic 740”). ASC Topic 740 provides guidelines for how uncertain tax positions should be recognized, measured, presented and disclosed in financial statements. ASC Topic 740 requires the evaluation of tax positions taken in the course of preparing the Company’s tax returns to determine whether the tax positions 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 would be recorded as a tax expense in the current year. It is the Company’s policy to recognize accrued interest and penalties related to uncertain tax benefits in income tax expense. There were no material uncertain income tax positions at September 30, 2015 and December 31, 2014. The current and prior three tax years remain subject to examination by U.S. federal and most state tax authorities.

 

Dividends and distributions: Dividends and distributions to common shareholders are recorded on the declaration date. The timing of dividends and distributions as well as the amount to be paid out as a dividend or distribution is determined by the Board each quarter and is generally based upon the earnings estimated by management. Net realized capital gains, if any, are distributed at least annually, although the Company may decide to retain such capital gains for investment. Dividends paid in excess of net investment income and realized gains are considered returns of capital to shareholders.

 

The Company has adopted a dividend reinvestment plan (“DRIP”) that provides for reinvestment of any distributions the Company declares in cash on behalf of its shareholders, unless a shareholder elects to receive cash. As a result, if the Board authorizes and the Company declares a cash distribution, then shareholders 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 dividend or 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.

 

 19 

 

  

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 2. Summary of Significant Accounting Policies (Continued)

 

Deferred common stock offering costs: The Company defers costs related to its public offerings, including costs incurred in connection with the filing of shelf registration statements which allow for a delayed public offering. These costs include professional fees, registration costs, printing, and other miscellaneous offering costs. Deferred common stock offering costs related to a specific equity raise are charged against the proceeds from that equity raise when received. Deferred offering costs related to a continuous offering are ratably charged to paid-in capital as securities are sold under the shelf registration statement. As of September 30, 2015 and December 31, 2014, the Company had incurred $301 and $297, respectively, of deferred common stock offering costs related to a universal shelf registration statement filed on November 19, 2014, which was declared effective on December 30, 2014 and replaced a previously filed shelf registration statement (filed on June 12, 2014 and declared effective on August 7, 2014). All of these deferred costs are included in prepaid expenses and other assets on the consolidated balance sheets as no equity was raised under the registration statement as of September 30, 2015.

 

Deferred financing closing costs: Deferred financing closing costs represent fees and other direct incremental costs incurred in connection with the Company’s borrowings. These amounts are amortized over the estimated average life of the borrowings. Write-offs of deferred financing closing costs occur when the borrowing capacity on the Company’s revolving line of credit is permanently reduced or the Company’s SBA debentures are repaid prior to maturity. As of September 30, 2015 and December 31, 2014, unamortized deferred financing closing costs recorded by the Company amounted to $3,525 and $4,972, respectively. For the three and nine months ended September 30, 2015, the Company recorded amortization and write-off of deferred financing closing costs in the amount of $96 and $2,004, respectively. For the three and nine months ended September 30, 2014, the Company recorded amortization and write-off of deferred financing closing costs in the amount of $167 and $469, respectively.

 

Goodwill: Goodwill represents the excess of the purchase price of an acquired business over the fair value amounts assigned to assets and liabilities assumed in the business combination. On December 4, 2013, in connection with the SBIC Acquisitions, the Company recorded goodwill in the amount of $1,077.

 

Goodwill is evaluated for impairment at least annually as of October 1 and can be tested more frequently if an event occurs or circumstances change that may reduce the fair value of a reporting unit below its carrying value.

 

ASU 2011-08, Intangibles – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment, which amends ASC Topic 350, “Intangibles – Goodwill and Other”, states that an entity may first elect to assess qualitative factors to determine if it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill (“Step -0-”; or “qualitative assessment”). If based on the results of Step -0-, it is more likely than not that the fair value of a reporting unit is less than its carrying amount, an entity must proceed to the quantitative two-step analysis. An entity may also elect to bypass Step -0- and proceed directly to the quantitative two-step analysis.

 

The quantitative goodwill impairment test is a two-step analysis. First, the fair value of the reporting unit is compared to its book value (“Step-one”). If the fair value of the reporting unit is less than its book value, the entity then performs a hypothetical purchase price allocation based on the reporting unit’s fair value to determine the reporting unit’s implied goodwill (“Step-two”). Goodwill impairment exists in Step-two when the implied fair value of goodwill is less than the carrying value of goodwill. The implied fair value of goodwill is determined based on the difference between the fair value of the reporting unit determined in Step-one and the fair value allocated to the identifiable assets, including unrecognized intangible assets, and liabilities of the reporting unit.

 

A significant amount of judgment is required in performing goodwill impairment analysis. In determining whether to elect the qualitative assessment, management decides based on qualitative information whether it is more than 50% likely that the fair value of a reporting unit is less than its carrying amount, otherwise the quantitative two-step impairment analysis is performed. When using the qualitative approach, the Company considers macroeconomic factors such as industry and market conditions, reporting unit-specific events, actual financial performance, and management's future business expectations. In addition, the Company analyzes the difference between the carrying value of its single reporting unit, which includes most of its assets carried at fair value, and the Company’s total market capitalization taking into account certain factors including control premium. 

 

For the three and nine months ended September 30, 2015, the Company did not record any impairment of goodwill.

 

Intangible asset: In connection with the SBIC Acquisitions, the Company recorded an intangible asset attributable to the SBIC license that SBIC I LP holds in the amount of $2,500. The Company is amortizing this intangible asset over its estimated useful life, which was determined to be approximately 13 years. The estimated amortization expense for the remaining three months of 2015 is $49. The Company expects annual amortization expense of its intangible asset to be $195 for each of the four years ended December 31, 2019 and $1,315 thereafter.

 

The Company tests its intangible asset for impairment if events or circumstances suggest that the asset carrying value may not be fully recoverable. For the three and nine months ended September 30, 2015, the Company did not recognize any impairment charge for its intangible asset.

 

 20 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 2. Summary of Significant Accounting Policies (Continued)

 

Interest expense: Interest expense is recognized on the accrual basis.

 

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 the risk of loss is minimal.

 

Recent accounting pronouncements: In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP. The standard is effective for annual periods beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures).  The Company is currently evaluating the impact of its pending adoption of ASU 2014-09 on the Company’s consolidated financial statements and has not yet determined the method by which it will adopt the standard in 2018.

 

In August 2014, the FASB issued ASU 2014-15, Disclosures of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 provides guidance regarding management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and if such doubt exists, requires specific disclosures. ASU 2014-15 is effective for annual periods ending after December 15, 2016 and is not expected to have a significant impact on the Company’s consolidated financial statements.

 

In February 2015, the FASB issued ASU 2015-02, Consolidation: Amendments to the Consolidation Analysis (“ASU 2015-02”). ASU 2015-02 modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 is effective for fiscal years and interim periods within those years beginning after December 15, 2015, and requires either a retrospective or a modified retrospective approach to adoption. Early adoption is permitted. The Company is currently evaluating the potential impact of this standard on its consolidated financial statements, as well as the available transition methods.

 

In March 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). ASU 2015-03 changes the presentation of debt issuance costs in the financial statements where an entity presents such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense. ASU 2015-03 did not specifically address presentation or subsequent measurement of debt issuance costs related to line of credit arrangements. In response, the FASB issued ASU 2015-15 to incorporate the views of the Securities and Exchange Commission’s (“SEC”), which, given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line of credit arrangements, the SEC would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line of credit arrangement. ASU 2015-03 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015 and requires a retrospective approach to adoption and applicable disclosures for a change in an accounting principle. Early adoption is permitted. This standard will have a balance sheet and statement of operations reclassification impact and disclosure impact on the Company’s consolidated financial statements.

 

Note 3. OFS Capital WM Asset Sale and Related Transactions

 

On May 28, 2015, the Company and OFS Capital WM entered into a Loan Portfolio Purchase Agreement with Madison Capital Funding LLC (“Madison”), pursuant to which OFS Capital WM sold 20 senior secured debt investments with an aggregate outstanding principal balance of $67,807 to Madison (the “WM Asset Sale”) for cash proceeds of $67,309. Madison is an affiliated entity of MCF Capital Management, LLC (“MCF”), which was the loan manager for OFS Capital WM prior to the WM Asset Sale under a Loan and Security Agreement among OFS Capital WM, MCF, Wells Fargo Securities, LLC, each of the Lenders from time to time party thereto, and Wells Fargo Delaware Trust Company, N.A. (the “Loan and Security Agreement”).

 

In connection with the WM Asset Sale, OFS Capital WM recognized a realized gain of $2,696, and reversed previously recorded net unrealized appreciation associated with the sold assets in the total amount of $2,139. The realized gain pertained primarily to the net unrealized depreciation embedded in the sold assets prior to OFS Capital’s IPO.

 

 21 

 

  

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 3. OFS Capital WM Asset Sale and Related Transactions (Continued)

 

On May 28, 2015, pursuant to the Loan and Security Agreement, the Company applied $52,414 from the sale proceeds of the WM Asset Sale to pay in full and retire OFS Capital WM’s secured revolving credit facility with Wells Fargo Bank, N.A. (“WM Credit Facility”). As a result of the termination of the WM Credit Facility, the Company wrote-off the remaining related unamortized deferred financing closing costs of $1,216 on the revolving line of credit.

 

The following unaudited pro forma presentation for the three and nine months ended September 30, 2015 and 2014 assumes the WM Asset Sale and WM Credit Facility payoff took place on January 1, 2014. The unaudited pro forma presentation is not intended to represent or be indicative of the consolidated results of operations that the Company would have reported had the WM Asset Sale and WM Credit Facility payoff been completed on the date indicated and should not be taken as representative of the Company’s future consolidated results of operations or financial position. The pro forma adjustments reflected below primarily include a) the elimination of the actual realized and unrealized gains and losses recorded upon the May 2015 sale and the deferred financing closing costs write-off resulting from the actual WM Credit Facility payoff, b) the elimination of the previously recorded investment income and unrealized gains and losses on the sold investments during the periods presented, c) the elimination of related interest expense under the WM Credit Facility during the periods presented, and d) adjustments to base management fee and incentive fee expenses during the presented periods resulting from the pro forma fair value of investments and net investment income.

 

   Three Months Ended September 30, 2015   Nine Months Ended September 30, 2015 
   Historical   Pro Forma   Historical   Pro Forma 
Total investment income  $7,688   $7,688   $23,391   $21,320 
Total expenses   4,058    4,058    14,260    11,882 
Net investment income   3,630    3,630    9,131    9,438 
Net realized and unrealized gain (loss) on investments   (2,209)   (2,209)   2,924    228 
Net increase in net assets resulting from operations  $1,421   $1,421   $12,055   $9,666 
Net increase in net assets resulting from operations per common - basic and diluted  $0.15   $0.15   $1.25   $1.00 

 

 

   Three Months Ended September 30, 2014   Nine Months Ended September 30, 2014 
   Historical   Pro Forma   Historical   Pro Forma 
Total investment income  $6,197   $5,014   $15,867   $12,186 
Total expenses   3,304    1,508    9,475    5,920 
Net investment income   2,893    3,506    6,392    6,266 
Net realized and unrealized gain on investments   942    474    51    588 
Net increase in net assets resulting from operations  $3,835   $3,980   $6,443   $6,854 
Net increase in net assets resulting from operations per common - basic and diluted  $0.40   $0.41   $0.67   $0.71 

 

The aggregate principal, amortized cost, and fair value of the senior secured debt investments included in the WM Asset Sale, which are included on the consolidated balance sheet as of December 31, 2014 was $69,773, $69,298, and $68,829, respectively.

 

On May 28, 2015, in connection with the WM Asset Sale, the Company entered into a Loan Administration Services Agreement with Madison pursuant to which Madison will provide loan servicing and other administrative services to OFS Capital WM with respect to certain of its remaining loan assets. In return for its loan administration services, Madison will receive a quarterly loan administration fee of 0.25% per annum based on the average daily principal balances of the loan assets for such quarter. For the three and nine months ended September 30, 2015, the Company incurred loan administration fee expense of $15 and $20, respectively.

 

Note 4. Related Party Transactions

 

Investment Advisory and Management Agreement: On November 7, 2012, OFS Capital entered into an Investment Advisory and Management Agreement (“Advisory Agreement”) with OFS Capital Management, the Company’s Investment Advisor, under which the Investment Advisor manages the day-to-day operations of, and provides investment advisory services to, OFS Capital. Under the terms of the Advisory Agreement and subject to the overall supervision of the Company’s Board, the Investment 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. The Investment Advisor is a subsidiary of OFSAM and a registered investment advisor under the Investment Advisers Act of 1940, as amended.

 

 22 

 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 4. Related Party Transactions (Continued)

 

The Investment Advisor’s services under the Advisory Agreement are not exclusive to the Company and the Investment Advisor is free to furnish similar services to other entities so long as its services to the Company are not impaired. The Investment Advisor receives fees for providing services, consisting of two components: a base management fee and an incentive fee. From the completion of the Company’s IPO through October 31, 2013, the base management fee was calculated at an annual rate of 0.875% 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. Beginning on November 1, 2013 and through March 31, 2014, pursuant to the Advisory Agreement, the base management fee was calculated at an annual rate of 1.75% 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. The Investment Advisor has excluded the value of the intangible asset and goodwill resulting from the SBIC Acquisitions from the base management fee calculation.

 

On May 5, 2014, the Investment Advisor agreed to reduce its base management fee by two-thirds for the nine months commencing April 1, 2014 and ending December 31, 2014. Specifically, for the second, third, and fourth quarters of fiscal 2014, the Investment Advisor reduced its base management fee from 0.4375% per quarter to 0.145833% per quarter of the average value of the Company’s total assets (other than cash, 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) at the end of the two most recently completed calendar quarters. The purpose of this was to reduce the effective annual base management fee payable to the Investment Advisor pursuant to the terms of the Advisory Agreement by 50% for the 2014 fiscal year. Accordingly, the effective annual base management fee for the 2014 fiscal year was equal to 50% of the 1.75% required by the Advisory Agreement with the Investment Advisor, or not greater than 0.875%. The Investment Advisor informed the Company that this reduction was made for the benefit of the Company’s shareholders to take into account unforeseen delays in completing the SBIC Acquisitions. The base management fee resumed to its 1.75% annual rate on January 1, 2015.

 

The base management fee is payable quarterly in arrears. For the three and nine months ended September 30, 2015, the base management fee expense was $1,120 and $3,813, respectively. For the three and nine months ended September 30, 2014, the base management fee expense was $370 and $1,750, respectively.

 

The incentive fee has two parts. The first part 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 (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees received from portfolio companies) accrued during the calendar quarter, minus operating expenses for the quarter (including the base management fee, expenses payable under the Administration Agreement (as defined below), and any interest expense and any dividends paid on any issued and 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. The incentive fee with respect to the 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, the Investment 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, the Investment 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 and adjusted for any share issuances or repurchases during such quarter.

 

 23 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 4. Related Party Transactions (Continued)

 

The second part 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 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 incentive 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. The Investment Advisor has excluded from the Capital Gain Fee calculation any realized gain with respect to (1) the step acquisitions resulting from the SBIC Acquisitions, and (2) the WM Asset Sale.

 

The Company incurred incentive fee expense of $908 and $1,514 for the three and nine months ended September 30, 2015, respectively. For both the three and nine months ended September 30, 2014, incentive fee expense was $723.

 

Administration Agreement: On November 7, 2012, OFS Capital entered into an administration agreement (“Administration Agreement”) with OFS Capital Services, LLC (“OFS Capital Services” or the “Administrator”), a wholly-owned subsidiary of OFSAM. Pursuant to the Administration Agreement, the Administrator furnishes the Company with office facilities and equipment, necessary software licenses and subscriptions, and clerical, bookkeeping and record keeping services at such facilities. Under the Administration Agreement, the Administrator 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 shareholders and all other reports and materials required to be filed with the SEC or any other regulatory authority. In addition, the Administrator 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 shareholders, 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, the Administrator 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 the Administrator’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. For the three and nine months ended September 30, 2015, the Company incurred an administration fee expense of $281 and $1,148, respectively. For the three and nine months ended September 30, 2014, the Company incurred an administration fee expense of $212 and $972, respectively.

 

Note 5. Investments

 

At September 30, 2015, investments consisted of the following:

 

   Principal   Cost   Fair Value 
Senior secured debt investments  $158,428   $156,502   $151,366 
Subordinated debt investments   71,672    71,472    71,256 
Equity investments   N/A    19,333    24,598 
Total  $230,100   $247,307   $247,220 

 

 24 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 5. Investments (Continued)

 

At September 30, 2015, the Company’s investments were all domiciled in the United States and the industry compositions of the Company’s portfolio were as follows:

 

   Cost   Fair Value 
Services: Business  $60,225    24.4%  $61,577    24.9%
Capital Equipment   33,666    13.6    32,901    13.3 
Healthcare & Pharmaceuticals   40,747    16.5    38,973    15.8 
Banking, Finance, Insurance & Real Estate   24,786    10.0    24,767    10.0 
Media: Advertising, Printing & Publishing   14,904    6.0    14,561    5.9 
Aerospace & Defense   14,314    5.8    15,482    6.3 
Construction & Building   11,175    4.5    11,478    4.6 
Metals & Mining   9,924    4.0    10,186    4.1 
Consumer goods: Non-durable   9,700    3.9    9,251    3.7 
Services: Consumer   8,357    3.4    8,608    3.5 
Chemicals, Plastics & Rubber   4,825    2.0    4,748    1.9 
Telecommunications   3,877    1.6    3,824    1.5 
Media: Diversified & Production   3,539    1.4    3,607    1.6 
Hotel, Gaming & Leisure   2,970    1.2    2,970    1.2 
High Tech Industries   2,303    0.9    2,292    0.9 
Containers, Packaging & Glass   1,995    0.8    1,995    0.8 
   $247,307    100.0%  $247,220    100.0%

 

At December 31, 2014, investments consisted of the following:

 

   Principal   Cost   Fair Value 
Senior secured debt investments  $248,971   $245,851   $241,749 
Subordinated debt investments   52,352    52,337    52,453 
Equity investments   N/A    15,385    18,032 
Total  $301,323   $313,573   $312,234 

 

 25 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 5. Investments (Continued)

 

At December 31, 2014, the Company’s investments were all domiciled in the United States and the industry compositions of the Company’s portfolio were as follows:

 

   Cost   Fair Value 
Services: Business  $72,481    23.1%  73,608    23.6%
Healthcare & Pharmaceuticals   45,751    14.6    44,075    14.1 
Capital Equipment   36,203    11.6    36,170    11.6 
Banking, Finance, Insurance & Real Estate   27,146    8.7    26,994    8.7 
Media: Advertising, Printing & Publishing   20,159    6.4    19,912    6.4 
Aerospace & Defense   18,008    5.7    18,111    5.8 
Chemicals, Plastics & Rubber   17,469    5.6    17,187    5.5 
Metals & Mining   13,860    4.4    13,860    4.4 
Construction & Building   12,478    4.0    12,482    4.0 
Services: Consumer   9,306    3.0    9,547    3.1 
High Tech Industries   7,579    2.4    7,569    2.4 
Environmental Indus tries   7,545    2.4    7,316    2.3 
Telecommunications   6,923    2.2    6,774    2.2 
Containers, Packaging & Glass   3,990    1.3    3,962    1.3 
Media: Broadcasting & Subscription   3,542    1.1    3,590    1.1 
Retail   3,559    1.1    3,555    1.1 
Media: Diversified & Production   3,482    1.1    3,482    1.1 
Energy: Oil & Gas   2,778    0.9    2,810    0.9 
Consumer goods: Non-durable   1,314    0.4    1,230    0.4 
   $313,573    100.0%  312,234    100.0%

 

Note 6. Fair Value of Financial Instruments

 

Investments for which sufficient market quotations are readily available are valued at such market quotations. The Company may also obtain indicative prices with respect to certain of its investments from pricing services or brokers or dealers in order to value such investments. There is not a readily available market value for many of the Company’s investments; those debt and equity securities that are not publicly traded or whose market prices are not readily available are valued at fair value as determined in good faith by the Board. The Company values such investments at fair value as determined in good faith by the Board using a documented valuation policy and a consistently applied valuation process. The Company’s valuation of each of its assets for which sufficient market quotations are not readily available is reviewed by one or more independent third-party valuation firms at least once every 12 months.

 

The Board is ultimately and solely responsible for determining the fair value of the portfolio investments that are not publicly traded, whose market prices are not readily available on a quarterly basis or any other situation where portfolio investments require a fair value determination.

 

With respect to investments for which sufficient market quotations are not readily available or for which no or an insufficient number of indicative prices from pricing services or brokers or dealers have been received, the Board undertakes, on a quarterly basis, unless otherwise noted, a multi-step valuation process, as described below:

 

 26 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 6. Fair Value of Financial Instruments (Continued)

 

For each debt investment, a basic credit rating review process is completed. The risk rating on every credit facility is reviewed and either reaffirmed or revised by the Investment Advisor’s investment committee.
Each portfolio company or investment is valued by an investment professional.
The preliminary valuations are documented and are then submitted to the Investment Advisor’s investment committee for ratification.
Third-party valuation firm(s) are engaged to provide valuation services as requested, by reviewing the investment committee’s preliminary valuations. The Investment Advisor’s investment committee’s preliminary fair value conclusions on each of the Company’s assets for which sufficient market quotations are not readily available is reviewed and assessed by a third-party valuation firm at least once in every 12-month period, and more often as determined by the audit committee of the Company’s Board or required by the Company’s valuation policy. Such valuation assessment may be in the form of positive assurance, range of values or other valuation method based on the discretion of the Company’s Board.
The audit committee of the Company’s Board reviews the preliminary valuations of the Investment Advisor’s investment committee and independent valuation firms and, if appropriate, recommends the approval of the valuations by the Board.
The Company’s Board discusses valuations and determines the fair value of each investment in the portfolio in good faith based on the input of the Investment Advisor, the audit committee and, where appropriate, the respective independent valuation firms.

 

The Company follows ASC Topic 820 for measuring fair value. Fair value is 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 and sets out a fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Inputs are broadly defined under ASC Topic 820 as assumptions market participants would use in pricing an asset or liability. The three levels of the fair value hierarchy under ASC Topic 820 are described below:

 

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to 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 Level 2 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 the following: (i) quoted prices for similar assets or liabilities in 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: Inputs are unobservable for the asset or liability and include situations where there is little, if any, market activity for the asset or liability. 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 assesses the levels of the investments at each measurement date, and transfers between levels are recognized on the subsequent measurement date closest in time to the actual date of the event or change in circumstances that caused the transfer. There were no transfers among Level 1, 2 and 3 for the nine months ended September 30, 2015 and 2014. The following sections describe the valuation techniques used by the Company to measure different financial instruments at fair value and include the levels within the fair value hierarchy in which the financial instruments are categorized.

 

Investments for which prices are not observable by the Company are generally private investments in the debt and equity securities of operating companies. The primary analytical method used to estimate the fair value of these Level 3 investments is the discounted cash flow method (although a liquidation analysis, option theoretical, or other methodology may be used when more appropriate). The discounted cash flow approach to determine fair value (or a range of fair values) involves applying an appropriate discount rate(s) to the estimated future cash flows using various relevant factors depending on investment type, including the latest arm’s length or market transactions involving the subject security, a benchmark credit spread or other indication of market yields, assumed growth rate (in cash flows), company performance, and capitalization rates/multiples (for determining terminal values of underlying portfolio companies). The valuation based on the inputs determined to be the most reasonable and probable is used as the fair value of the investment. The determination of fair value using these methodologies may take into consideration a range of factors including, but not limited to, the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance, financing transactions subsequent to the acquisition of the investment and anticipated financing transactions after the valuation date. Application of these valuation methodologies involves a significant degree of judgment by management. Fair values of new investments or investments where an arm’s length transaction occurred in the same security are generally assumed to be equal to their cost for up to three months after their initial purchase.

 

 27 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 6. Fair Value of Financial Instruments (Continued)

 

To assess the reasonableness of the discounted cash flow approach, with respect to the fair value of equity securities, including warrants in portfolio companies, the Company may also consider the values as determined using the market approach—that is, through analyzing and applying to the underlying portfolio companies, market valuation multiples of publicly-traded firms engaged in businesses similar to those of the portfolio companies. The market approach to determining the fair value of a portfolio company’s equity security (or securities) will typically involve: (1) applying to the portfolio company’s trailing twelve months (or current year projected) EBITDA a low to high range of enterprise value to EBITDA multiples that are derived from an analysis of publicly-traded comparable companies or the portfolio company’s entry multiple in order to arrive at a range of enterprise values for the portfolio company; (2) subtracting from the range of calculated enterprise values the outstanding balances of any debt or equity securities that would be senior in right of payment to the equity securities held by the Company; and (3) multiplying the range of equity values derived therefrom by the Company’s ownership share of such equity tranche in order to arrive at a range of fair values for the Company’s equity security (or securities). Application of these valuation methodologies involves a significant degree of judgment by management.

 

Equity in a portfolio company that invests in loans will typically be valued by arriving at a fair value of such vehicle’s loan assets (plus, when appropriate, the carrying value of certain other assets), and deducting the book value or fair value (as appropriate) of such vehicle’s liabilities to arrive at a fair value for the equity. When appropriate, in order to recognize value that would be created by growth opportunities of such portfolio company, equity in a portfolio company may also be valued by taking into consideration the magnitude, timing, and effective life of its expected future investments in loans.

 

Due to the inherent uncertainty of determining the fair value of Level 3 investments that do not have a readily available market value, the fair value of the investments may differ significantly from the values that would have been used had a ready market 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 a variety of risks (see Investment Risks in Note 2 for details).

 

The following tables provide quantitative information about the Company’s Level 3 fair value measurements of the Company’s investments as of September 30, 2015 and December 31, 2014. 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 is not intended to be all-inclusive but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements.

 

   Fair Value at
September 30,
2015
   Valuation techniques  Unobservable inputs  Range
(Weighted average)
              
Debt investments:              
Senior secured  $151,366   Discounted cash flow  Discount rates  6.80% - 22.50% (11.61%)
           EBITDA multiples  4.21x - 10.74x (7.40x)
Subordinated   71,256   Discounted cash flow  Discount rates  12.11% - 20.00% (13.85%)
           EBITDA multiples  3.94x - 8.72x (6.49x)
               
Equity investments   24,598   Discounted cash flow  Discount rates  13.82% - 30.00%
           EBITDA multiples  3.98x - 9.48x
        Market approach  EBITDA multiples  3.98x - 15.98x

 

 28 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 6. Fair Value of Financial Instruments (Continued)

 

   Fair Value at
December 31,
2014
   Valuation techniques  Unobservable inputs  Range
(Weighted average)
              
Debt investments:              
Senior secured  $241,749   Discounted cash flow  Discount rates  5.75% - 25.00% (9.46%)
           EBITDA multiples  4.30x - 10.87x (7.24x)
Subordinated   52,453   Discounted cash flow  Discount rates  12.78% - 15.00% (14.21%)
           EBITDA multiples  3.98x - 5.55x (5.43x)
               
Equity investments   18,032   Discounted cash flow  Discount rates  12.25% - 35.00%
           EBITDA multiples  3.98x - 9.48x
        Market approach  EBITDA multiples  3.56x - 14.74x

 

Changes in credit quality (which could impact the discount rate), as well as changes in 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 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 multiples, and in inverse relation to changes in the discount rate.

 

Investments measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations as of September 30, 2015 and as of December 31, 2014.

 

   September 30, 2015 
   Fair Value Measurements Using     
Description  (Level I)   (Level II)   (Level III)   Total 
                 
Assets:                    
Senior secured debt investments  $-   $-   $151,366   $151,366 
Subordinated debt investments   -    -    71,256    71,256 
Equity investments   -    -    24,598    24,598 
Money market funds *   41,113    -    -    41,113 
                     
Total  $41,113   $-   $247,220   $288,333 

 

* included in cash and cash equivalents on the consolidated balance sheet.

 

   September 30, 2015 
   Fair Value Measurements Using     
Description  (Level I)   (Level II)   (Level III)   Total 
                 
Assets:                    
Non-control/non-affiliate investments  $-   $-   $188,884   $188,884 
Affiliate investments   -    -    58,336    58,336 
Money market funds *   41,113    -    -    41,113 
                     
Total  $41,113   $-   $247,220   $288,333 

 

* included in cash and cash equivalents on the consolidated balance sheet.

 

As of September 30, 2015, the Company had loans to 38 portfolio companies, of which 68% were senior secured loans and 32% 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 one additional portfolio company in which it solely held an equity interest at September 30, 2015.

 

 29 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 6. Fair Value of Financial Instruments (Continued)

 

   December 31, 2014 
   Fair Value Measurements Using     
Description  (Level I)   (Level II)   (Level III)   Total 
                 
Assets:                    
Senior secured debt investments  $-   $-   $241,749   $241,749 
Subordinated debt investments   -    -    52,453    52,453 
Equity investments   -    -    18,032    18,032 
Money market funds *   9,609    -    -    9,609 
                     
Total  $9,609   $-   $312,234   $321,843 

 

* included in cash and cash equivalents on the consolidated balance sheet.

 

   December 31, 2014 
   Fair Value Measurements Using     
Description  (Level I)   (Level II)   (Level III)   Total 
                 
Assets:                    
Non-control/non-affiliate investments  $-   $-   $254,666   $254,666 
Affiliate investments   -    -    57,568    57,568 
Money market funds *   9,609    -    -    9,609 
                     
Total  $9,609   $-   $312,234   $321,843 

 

* included in cash and cash equivalents on the consolidated balance sheet.

 

As of December 31, 2014, the Company had loans to 61 portfolio companies, of which 82% were senior secured loans and 18% were subordinated loans, at fair value, as well as equity investments in 15 of these portfolio companies. The Company also held equity investments in one additional portfolio company in which it solely held equity interests at December 31, 2014.

 

The following tables present changes in investments measured at fair value using Level 3 inputs for the nine months ended September 30, 2015 and 2014: 

 

   For the Nine Months Ended September 30, 2015 
   Senior
Secured Debt
Investments
   Subordinated
Debt
Investments
   Equity
Investments
   Total 
                 
Level 3 assets, beginning of period  $241,749   $52,453   $18,032   $312,234 
                     
Net realized gain on non-control/non-affiliate investments   2,947    -    185    3,132 
Net realized gain on affiliate investments   -    -    1,471    1,471 
Net change in unrealized appreciation/depreciation on non-control/non-affiliate investments   (3,618)   (394)   839    (3,173)
Net change in unrealized appreciation/depreciation on affiliate investments   (345)   61    1,778    1,494 
Purchase of portfolio investments   54,087    21,757    5,704    81,548 
Capitalized PIK interest, dividends, and fees   366    602    1,052    2,020 
Proceeds from principal payments on portfolio investments   (58,625)   (3,279)   -    (61,904)
Sale or redemption of portfolio investments   (86,096)   -    (4,368)   (90,464)
Cash distribution received from equity investments   -    -    (51)   (51)
Amortization of discounts and premium   901    12    -    913 
Conversion from equity to debt   -    44    (44)   - 
                     
Level 3 assets, end of period  $151,366   $71,256   $24,598   $247,220 

 

 30 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 6. Fair Value of Financial Instruments (Continued)

 

   For the Nine Months Ended September 30, 2014 
   Senior
Secured Debt
Investments
   Subordinated
Debt
Investments
   Equity
Investments
   Total 
                 
Level 3 assets, beginning of period  $221,546   $9,008   $7,365   $237,919 
                     
Net realized gain on affiliate investments   28    -    -    28 
Net realized gain on non-control/non-affiliate investments   -    17    -    17 
Net change in unrealized appreciation/depreciation on non-control/non-affiliate investments   (407)   -    513    106 
Net change in unrealized appreciation/depreciation on affiliate investments   288    40    1,263    1,591 
Net change in unrealized depreciation on control investment   (1,691)   -    -    (1,691)
Purchase of portfolio investments   78,173    9,445    3,044    90,662 
Capitalized PIK interest, dividends and fees   352    205    302    859 
Reversal of PIK interest on non-acrual loans   (64)   -    -    (64)
Proceeds from principal payments on portfolio investments   (59,132)   -    -    (59,132)
Sale of portfolio investments   (5,000)   -    -    (5,000)
Cash distribution received from equity investments   -    -    (11)   (11)
Amortization of discounts and premium   933    (38)   -    895 
                     
Level 3 assets, end of period  $235,026   $18,677   $12,476   $266,179 

 

The net change in unrealized depreciation for the nine months ended September 30, 2015 and 2014, reported within the net change in unrealized appreciation/depreciation on investments in the Company’s consolidated statements of operations attributable to the Company’s Level 3 assets held at September 30, 2015 and 2014, was $1,306 and $154, respectively.

 

The Company discloses fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. Certain financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

 

The information presented should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only required for a portion of the Company’s assets and liabilities. Due to the wide range of 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.

 

As of September 30, 2015 and December 31, 2014, the carrying value of the Company’s financial instruments, including its debt obligations under its SBA debentures payable, as well as the revolving line of credit (which was terminated on May 28, 2015; see Note 3), approximated their estimated fair value.

 

Note 7. Commitments and Contingencies

 

At September 30, 2015, the Company had $4,586 of total unfunded commitments for four portfolio companies, consisting of $4,222 of unfunded debt commitments and $364 of unfunded equity commitments. At December 31, 2014, the Company had $7,836 of total unfunded commitments for six portfolio companies, consisting of $7,472 of unfunded debt commitments and $364 of unfunded equity commitments. The Company maintains sufficient cash on hand to fund such unfunded commitments.

 

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.

 

Additionally, the Company is subject to periodic inspection by regulators to assess compliance with applicable regulations related to being a BDC and SBIC I LP is subject to periodic inspections by the SBA. Management believes that the Company is in material compliance with such regulations and inspection results do not indicate otherwise.

 

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.

 

 31 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 8. Revolving Line of Credit

 

Prior to the termination of the WM Credit Facility on May 28, 2015 (see Note 3), OFS Capital WM had a $75,000 secured revolving credit facility, as amended from time to time, with Wells Fargo. The WM Credit Facility was secured by all eligible loans acquired by OFS Capital WM, and had a maturity date of December 31, 2018 and a reinvestment period through December 31, 2015. The interest rate on outstanding borrowings was the London Interbank Offered Rate (“LIBOR”) plus 2.50% per annum. The minimum equity requirement was set at $35,000.

 

The investments held by OFS Capital WM, prior to the termination of the WM Credit Facility, were serviced by MCF, as the loan manager, pursuant to the Loan and Security Agreement. Under the WM Credit Facility, the loan manager charged both a senior and subordinated management fee to OFS Capital WM for its services, each at 0.25% per annum of the assigned value of the underlying portfolio investments, plus an accrued fee that was deferred until the earlier of the end of the investment period of the portfolio investments or termination of the Loan and Security Agreement. For the three and nine months ended September 30, 2015, the Company incurred management fee expense of $0 and $288, respectively, to the loan manager. For the three and nine months ended September 30, 2014, the Company incurred management fee expense of $173 and $590, respectively, to the loan manager.

 

The interest rate on the outstanding borrowings at December 31, 2014 was 2.76%. The unused commitment fee on the WM Credit Facility was (1) 0.5% per annum of the first $25,000 of the unused facility and (2) 2% per annum of the balance in excess of $25,000 and was included in interest expense on the consolidated statement of operations. For the three and nine months ended September 30, 2015, interest expense on the revolving line of credit totaled $0 and $787, respectively. For the three and nine months ended September 30, 2014, interest expense on the revolving line of credit totaled $724 and $2,276, respectively.

 

Deferred financing closing costs, net of accumulated amortization, on the WM Credit Facility as of December 31, 2014 were $1,803. For the three and nine months ended September 30, 2015, amortization and write-off of deferred financing closing costs on the revolving line of credit totaled $0 and $1,803, respectively. For the three and nine months ended September 30, 2014, amortization and write-off of deferred financing closing costs on the revolving line of credit totaled $153 and $455, respectively. Write-offs of deferred financing closing costs occurred when the credit facility’s commitment was permanently reduced. On March 12, 2015, OFS Capital WM elected to permanently reduce the maximum facility on the WM Credit Facility from $100,000 to $75,000, resulting in a write-off of deferred financing closing costs of $430 (no costs were incurred in connection with this facility reduction). As a result of the termination of the WM Credit Facility, on May 28, 2015, the Company wrote off the remaining unamortized deferred financing closing costs of $1,216 (see Note 3).

 

Note 9. SBA Debentures Payable

 

Upon the completion of the SBIC Acquisitions, effective December 4, 2013, the Company consolidated the financial statements of SBIC I LP into its own and SBIC I LP’s SBA-guaranteed debentures payable are reflected on the Company’s consolidated balance sheets.

 

The SBIC license allows 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 issuance at a market-driven spread over U.S. Treasury Notes with ten-year maturities.

 

Under present SBIC regulations, the maximum amount of SBA-guaranteed debt that may be issued by a single SBIC licensee is $150,000. An SBIC fund may borrow up to two times the amount of its regulatory capital, subject to customary regulatory requirements. As of September 30, 2015, SBIC I LP had fully drawn the $149,880 of leverage commitments from the SBA. As of December 31, 2014, SBIC I LP had leverage commitments of $149,880 from the SBA, and $127,295 of outstanding SBA-guaranteed debentures, leaving incremental borrowing capacity of $22,585.

 

In January 2015, the Company filed an application with the SBA for a second SBIC license, which, if approved, would provide up to $75,000 in additional SBA debentures for the funding of the Company’s future investments, upon its contribution of at least $37,500 in additional regulatory capital and subject to the issuance of a leverage commitment by the SBA and customary procedures. There can be no assurance as to whether or when this application will be approved by the SBA.

 

On a stand-alone basis, SBIC I LP held $242,490 and $215,728 in assets at September 30, 2015 and December 31, 2014, respectively, which accounted for approximately 82% and 63% of the Company’s total consolidated assets at September 30, 2015 and December 31, 2014, respectively.

 

 32 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 9. SBA Debentures Payable (Continued)

 

The following table shows the Company’s outstanding SBA debentures payable as of September 30, 2015 and December 31, 2014:

 

      Fixed   September 30,   December 31, 
Pooling Date  Maturity Date  Interest Rate   2015   2014 
                
September 19, 2012  September 1, 2022   3.049%  $14,000   $14,000 
September 25, 2013  September 1, 2023   4.448    7,000    7,000 
March 26, 2014  March 1, 2024   3.995    5,000    5,000 
September 24, 2014  September 1, 2024   3.819    4,110    4,110 
September 24, 2014  September 1, 2024   3.370    31,265    31,265 
March 25, 2015  March 1, 2025   2.872    65,920    65,920 
September 23, 2015  September 1, 2025   3.184    22,585    - 
                   
Total SBA debentures outstanding          $149,880   $127,295 

 

The Company received exemptive relief from the SEC effective November 26, 2013. The exemptive relief allows OFS Capital to exclude SBA guaranteed debentures from the definition of senior securities in the statutory 200% asset coverage ratio under the 1940 Act, allowing for greater capital deployment.

 

The weighted average fixed interest rate on the SBA debentures as of September 30, 2015 and December 31, 2014 was 3.18% and 3.50%, respectively. For the three and nine months ended September 30, 2015, interest expense on the SBA debentures was $1,089 and $2,855, respectively. For the three and nine months ended September 30, 2014, interest expense on the SBA debentures was $277 and $713, respectively.

 

Deferred financing closing costs, net of accumulated amortization, on SBA-guaranteed debentures as of September 30, 2015 and December 31, 2014 were $3,515 and $3,169, respectively. For the three and nine months ended September 30, 2015, amortization of deferred financing closing costs on SBA-guaranteed debentures totaled $96 and $200, respectively. For both the three and nine months ended September 30, 2014, amortization of deferred financing closing costs on SBA-guaranteed debentures totaled $14.

 

 33 

 

 

OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 10. Financial Highlights

 

The financial highlights for the Company are as follows:

 

   Three Months September 30,   Nine Months September 30, 
   2015   2014   2015   2014 
                 
Per share data:                    
Net asset value at beginning of period  $14.66   $14.17   $14.24   $14.58 
Distributions (7)                    
Dividends from ordinary income   (0.33)(7)   (0.30)(7)   (0.88)(7)   (0.67)(7)
Dividends from capital gains   (0.01)   -    (0.01)   - 
Return of capital   -    (0.04)   (0.13)   (0.35)
Net investment income   0.38    0.30    0.94    0.66 
Net realized gain on non-control/non-affiliate investments   0.03    -    0.32    - 
Net realized gain on affiliate investments   -    -    0.15    - 
Net change in unrealized appreciation/depreciation on non-control/non-affiliate investments   (0.23)   0.04    (0.32)   0.01 
Net change in unrealized appreciation/depreciation on affiliate investments   (0.04)   0.10    0.15    0.17 
Net change in unrealized depreciation on control investment   -    (0.05)   -    (0.18)
Net asset value at end of period  $14.46   $14.22   $14.46   $14.22 
                     
Per share market value, end of period  $10.24   $12.07   $10.24   $12.07 
Total return based on market value   (11.8)%(1)   (4.5)%(1)   (4.4)%(1)   2.0%(1)
Shares outstanding at end of period   9,690,129    9,638,061    9,690,129    9,638,061 
Ratios to average net assets:                    
Expense without incentive fees   8.9%(2)   7.5%(2)   12.2%(2)   8.5%(2)
Incentive fees   2.6%(2)   2.1%(2)   1.5%(2)   0.7%(2)
Total expenses   11.5%(2)   9.6%(2)   13.7%(2)   9.2%(2)
Net investment income without incentive fees   12.8%(2)   10.5%(2)   10.2%(2)   6.9%(2)
Average net asset value  $140,980(3)  $136,809(4)  $139,250(5)  $138,296(6)

 

(1)Calculation is ending market value less beginning market value, adjusting for dividends and distributions.
(2)Annualized.
(3)Based on average net asset values at June 30, 2015 and September 30, 2015.
(4)Based on average net asset values at June 30, 2014 and September 30, 2014.
(5)Based on average net asset values at December 31, 2014, March 31, 2015, June 30, 2015 and September 30, 2015.
(6)Based on average net asset values at December 31, 2013, March 31, 2014, June 30, 2014 and September 30, 2014.
(7)The components of the distributions are estimated and presented on an income tax basis.

 

Note 11. Dividends and Distributions

 

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, it is required to distribute annually to its shareholders at least 90% of its investment company taxable income, as defined by the Code. To avoid a 4% 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 (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no federal income tax. The Company intends to make distributions to shareholders 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, it may in the future decide to retain such capital gains for investment.

 

In addition, the Company may be limited in its ability to make distributions due to the BDC asset coverage test for borrowings applicable to the Company as a BDC under the 1940 Act.

 

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OFS Capital Corporation and Subsidiaries
 
Notes to Unaudited Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)

 

Note 11. Dividends and Distributions (Continued)

 

The following table summarizes distributions declared and paid for the nine months ended September 30, 2015 and 2014:

 

Date Declared  Record Date  Payment Date  Amount
Per Share (1)
   Cash
Distribution
   DRIP Shares
Issued
   DRIP Shares
Value
 
Nine Months Ended September 30, 2014                          
January 21, 2014  January 31, 2014  February 14, 2014  $0.34   $3,240    2,656   $34 
May 7, 2014  June 16, 2014  June 30, 2014   0.34    3,230    3,467    45 
August 7, 2014  September 16, 2014  September 30, 2014   0.34    3,250    2,141    26 
         $1.02   $9,720    8,264   $105 
Nine Months Ended September 30, 2015                          
March 4, 2015  March 17, 2015  March 31, 2015  $0.34   $3,133    12,106   $148 
May 4, 2015  June 16, 2015  June 30, 2015   0.34    3,132    12,834    154 
August 6, 2015  September 16, 2015  September 30, 2015   0.34    3,142    14,355    147 
         $1.02   $9,407    39,295   $449 

 

(1)The determination of the tax attributes of our distributions is made annually as of the end of the Company’s fiscal year based upon its taxable income for the full year and distributions paid for the full year. If the tax characteristics of these distributions were determined as of September 30, 2015, June 30, 2015, March 31, 2015, September 30, 2014, June 30, 2014, and March 31, 2014, the Company estimated that approximately $0.13, $0.15, $0.07, $0.35, $0.31 and $0.19, respectively would have represented a return of capital.

 

For the nine months ended September 30, 2015, $449 of the total $9,856 paid to shareholders represented DRIP participation, during which the Company satisfied the DRIP participation requirements with the issuance of 39,295 shares at an average value of $11.43 per share at the date of issuance. For the nine months ended September 30, 2014, $105 of the total $9,825 paid to shareholders represented DRIP participation, during which the Company satisfied the DRIP participation requirements with the issuance of 8,264 shares at an average value of $12.71 per share at the date of issuance.

 

Since the Company’s IPO, dividends and distributions to shareholders total $34,401, or $3.57 per share on a cumulative basis.

 

Distributions in excess of the Company’s current and accumulated profits and earnings would be treated first as a return of capital to the extent of the shareholder’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 will be made annually as of the end of its fiscal year based upon its taxable income 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 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 will be mailed to the Company’s shareholders. For the nine months ended September 30, 2015, approximately $0.88 per share, $0.01 per share, and $0.13 per share of the Company’s distributions represented ordinary income, capital gains, and a return of capital to its shareholders, respectively.

 

Note 12. Earnings per Share

 

The following table summarizes the calculations for basic and diluted net increase in net assets resulting from operations per common share for the three and nine months ended September 30, 2015 and 2014.

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
Net increase in net assets resulting from operations  $1,421   $3,835   $12,055   $6,443 
Basic and diluted weighted average shares outstanding   9,675,930    9,635,943    9,663,418    9,633,214 
Net increase in net assets resulting from operations per common share - basic and diluted  $0.15   $0.40   $1.25   $0.67 

 

Note 13. Subsequent Events

 

On November 2, 2015, the Company’s Board declared a distribution of $0.34 per share for the fourth quarter of 2015, payable on December 31, 2015 to shareholders of record as of December 17, 2015. 

 

On November 5, 2015, the Company, as borrower, entered into a Business Loan Agreement (“BLA”) with Pacific Western Bank, as lender, to provide OFS Capital with a $15,000 senior secured revolving credit facility (“PWB Credit Facility”), 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 BLA. The PWB Credit Facility is guaranteed by OFS Capital WM and secured by all of the Company’s current and future assets excluding assets held by SBIC I LP and the Company’s SBIC I LP and SBIC I GP partnership interests. The BLA matures on November 7, 2017. Advances under the facility will bear interest at a fixed rate per annum equal to 4.75%. The Company paid a $150 commitment fee in connection with the closing of the PWB Credit Facility.

 

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 the company’s financial condition.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

This quarterly report on Form 10-Q 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 limited experience operating a business development company, or BDC or a small business investment company, or SBIC, or maintaining our status as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended (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 Capital Management, LLC, or 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 Orchard First Source Asset Management, LLC, or OFSAM, which is the holding company of OFS Advisor and OFS Capital Services, LLC, or OFS Services, and owns approximately 30% of our outstanding shares of common stock;

 

constraint on investment due to access to material nonpublic information;

 

restrictions on our ability to enter into transactions with our affiliates;

 

limitations on the amount of debentures guaranteed by the Small Business Administration, or SBA, that may be issued by an SBIC;

 

our ability to comply with SBA and BDC regulations and requirements;

 

the use of borrowed money to finance a portion of our investments;

 

competition for investment opportunities;

 

our ability to qualify and maintain our qualification as a RIC and as a BDC;

 

the ability of OFS SBIC I LP, or SBIC I LP, and any future portfolio company to make distributions enabling us to meet RIC requirements;

 

our ability to raise 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.

 

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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 quarterly report on Form 10-Q 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 our annual report on Form 10-K for our year ended December 31, 2014. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this quarterly report on Form 10-Q.

 

We have based the forward-looking statements on information available to us on the date of this quarterly report on Form 10-Q. 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 may file with the SEC in the future, 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 quarterly report on Form 10-Q are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

 

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 quarterly report on Form 10-Q.

 

Overview

 

We are an externally managed, closed-end, non-diversified management investment company. Our investment objective is to provide our shareholders 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 earnings before interest, taxes, depreciation and amortization, or 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.

 

As of September 30, 2015, our investment portfolio consisted of outstanding loans of approximately $230.1 million in aggregate principal amount in 38 portfolio companies, of which $191.8 million in aggregate principal amount was held by SBIC I LP, our wholly-owned SBIC subsidiary, in 25 portfolio companies. In addition, as of September 30, 2015, SBIC I LP held equity investments of approximately $24.6 million, at fair value. As of September 30, 2015, 61% of our investment portfolio was comprised of senior secured loans, 29% of subordinated loans and 10% of equity investments, at fair value.

 

While 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 minority equity securities, we also may invest up to 30% of our portfolio in opportunistic investments of non-eligible portfolio companies. Specifically, as part of this 30% basket, we may consider investments in investment funds that are operating pursuant to certain exceptions to the Investment Company Act of 1940, as amended, or the 1940 Act, and in advisers to similar investment funds, as well as in debt of middle-market 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.

 

Our investment strategy includes SBIC I LP, which received an SBIC license from the SBA in May 2012. On December 4, 2013, we received approval from the SBA to acquire all of the limited partnership interests in SBIC I LP and all of the ownership interests of its general partner, OFS SBIC I GP, LLC, or SBIC I GP, that were owned or subscribed for by other persons (the “SBIC Acquisitions”). We acquired the interests on December 4, 2013, which resulted in SBIC I LP becoming a wholly-owned subsidiary. The transaction was finalized in January 2014. The SBIC license allows 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 leverage funding is subject to SBIC I LP’s payment of certain fees to the SBA, and the ability of SBIC I LP to draw on the commitment is subject to its compliance with SBA regulations and policies, including an audit by the SBA.

 

On November 26, 2013, we received an exemptive order from the SEC to permit us to exclude the debt of SBIC I LP guaranteed by the SBA from the definition of senior securities in the statutory 200% asset coverage ratio under the 1940 Act, allowing for greater capital deployment.

 

Our investment activities are managed by OFS Advisor, and supervised by our board of directors, a majority of whom are independent of us, OFS Advisor and its affiliates. Under the Investment Advisory Agreement between us and OFS Advisor, 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), adjusted for any share issuances or repurchases during the quarter, as well as an incentive fee based on our investment performance. We have excluded the value of the intangible asset and goodwill resulting from the SBIC Acquisitions from the base management fee calculation. We have also entered into an Administration Agreement with OFS Services, our Administrator. Under our Administration Agreement, we have agreed to reimburse OFS Services for our allocable portion (subject to policies reviewed and approved by our independent directors) of overhead and other expenses incurred by OFS Services in performing its obligations under the Administration Agreement.

 

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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 total assets 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.

 

We are permitted to borrow money from time to time within the levels permitted by the 1940 Act (which generally allows us to incur leverage for up to 50% of our asset base). 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 qualify as a RIC, we must, among other things, meet certain source-of-income and assets diversification requirements. Pursuant to these elections, we generally will not have to pay corporate-level taxes on any income we distribute to our shareholders.

 

On January 8, 2015, in order to comply with certain requirements necessary to maintain the RIC status, we formed FQSR II, LLC (“FQSR”), a Delaware limited liability company and wholly owned subsidiary of OFS Capital, to hold an equity investment in a portfolio company. The equity investment was sold in May 2015. As of September 30, 2015, FQSR had nominal assets and liabilities. FQSR has elected to be taxed as a C corporation and is excluded from our RIC tax reporting group. For income tax purposes, “we”, “OFS Capital”, or the “Company” only refers to the RIC tax reporting group throughout this document.

 

Critical Accounting Policies

 

The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of 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. We have identified the following items as critical accounting policies:

 

Valuation of Portfolio Investments.

 

The most significant estimate inherent in the preparation of our consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded.

 

Our investments are carried at fair value in accordance with the 1940 Act and ASC Topic 820. At September 30, 2015, approximately 83% of our total assets represented investments in portfolio companies that are valued at fair value by our board of directors. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value as determined in good faith by the board of directors. Our debt and equity securities are primarily comprised of investments in middle market companies whose securities are not publicly traded. Our investments in these portfolio companies are generally considered Level 3 assets under ASC Topic 820 because the inputs used to value the investments are generally unobservable. As such, we value substantially all of our investments at fair value as determined in good faith by our board of directors pursuant to a consistent valuation policy in accordance with the provisions of ASC Topic 820 and the 1940 Act. Due to the inherent uncertainty in determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by our board of directors may differ significantly from the value that would have been used had a readily available market existed for such investments, and the differences could be material.

 

Our policies relating to the valuation of our portfolio investments are as follows:

 

Investments for which sufficient market quotations are readily available are valued at such market quotations. We may also obtain indicative prices with respect to certain of our investments from pricing services or brokers or dealers in order to value such investments. There is not a readily available market value for many of our investments; those debt and equity securities that are not publicly traded or whose market prices are not readily available are valued at fair value as determined in good faith by our board of directors. We value such investments at fair value as determined in good faith by our board of directors using a documented valuation policy and a consistently applied valuation process. Our valuation of each of our assets for which sufficient market quotations are not readily available is reviewed by one or more independent third-party valuation firms at least once every 12 months.

 

Our board of directors is ultimately and solely responsible for determining the fair value of the portfolio investments that are not publicly traded, whose market prices are not readily available on a quarterly basis or any other situation where portfolio investments require a fair value determination.

 

With respect to investments for which sufficient market quotations are not readily available or for which no or an insufficient number of indicative prices from pricing services or brokers or dealers have been received, our board of directors undertakes, on a quarterly basis, unless otherwise noted, a multi-step valuation process, as described below:

 

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For each debt investment, a basic credit rating review process is completed. The risk rating on every credit facility is reviewed and either reaffirmed or revised by OFS Advisor’s investment committee, or the Advisor Investment Committee. This process establishes base information for the quarterly valuation process.

 

Each portfolio company or investment is valued by an investment professional.

 

The preliminary valuations are documented and then submitted to the Advisor Investment Committee for ratification.

 

Third-party valuation firm(s) are engaged to provide valuation services as requested, by reviewing the investment committee’s preliminary valuations. The Investment Advisor’s investment committee’s preliminary fair value conclusions on each of our assets for which sufficient market quotations are not readily available is reviewed and assessed by a third-party valuation firm at least once in every 12-month period, and more often as determined by the audit committee of our board of directors or required by our valuation policy. Such valuation assessment may be in the form of positive assurance, range of values or other valuation method based on the discretion of our board of directors.

 

The audit committee of our board of directors reviews the preliminary valuations of the Advisor Investment Committee and independent valuation firms and, if appropriate, recommends the approval of the valuations by the board of directors.

 

Our board of directors discusses valuations and determines the fair value of each investment in the portfolio in good faith based on the input of OFS Advisor, the audit committee and, where appropriate, the respective independent valuation firms.

 

We follow ASC Topic 820 for measuring fair value. Fair value is 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 and sets out a fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Inputs are broadly defined under ASC Topic 820 as assumptions market participants would use in pricing an asset or liability. The three levels of the fair value hierarchy under ASC Topic 820 are described below:

 

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to 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 Level 2 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 the following: (i) quoted prices for similar assets or liabilities in 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: Inputs are unobservable for the asset or liability and include situations where there is little, if any, market activity for the asset or liability. 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. We assess the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment.

 

The types of factors that we may take into account in fair value pricing our investments include, as relevant, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and cash flows, the markets in which the portfolio company does business, comparison to publicly traded securities and other relevant factors. The primary analytical method used to estimate the fair value of these Level 3 investments is the discounted cash flow method (although a liquidation analysis, option theoretical, or other methodology may be used when more appropriate). The discounted cash flow approach to determine fair value (or a range of fair values) involves applying an appropriate discount rate(s) to the estimated future cash flows using various relevant factors depending on investment type, including the latest arm’s length or market transactions involving the subject security, a benchmark credit spread or other indication of market yields, assumed growth rate (in cash flows), company performance, and capitalization rates/multiples (for determining terminal values of underlying portfolio companies). The valuation based on the inputs determined to be the most reasonable and probable is used as the fair value of the investment. The determination of fair value using these methodologies may take into consideration a range of factors including, but not limited to, the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance, financing transactions subsequent to the acquisition of the investment and anticipated financing transactions after the valuation date. Application of these valuation methodologies involves a significant degree of judgment by management. Fair values of new investments or investments where an arm’s length transaction occurred in the same security are generally assumed to be equal to their cost for up to three months after their initial purchase.

 

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To assess the reasonableness of the discounted cash flow approach, with respect to the fair value of equity securities, including warrants in portfolio companies, we consider the values as determined using the market approach—that is, through analyzing and applying to the underlying portfolio companies, market valuation multiples of publicly-traded firms engaged in businesses similar to those of the portfolio companies. The market approach to determining the fair value of a portfolio company’s equity security (or securities) will typically involve: (1) applying to the portfolio company’s trailing twelve months (or current year projected) EBITDA a low to high range of enterprise value to EBITDA multiples that are derived from an analysis of publicly-traded comparable companies or the portfolio company’s entry multiple in order to arrive at a range of enterprise values for the portfolio company; (2) subtracting from the range of calculated enterprise values the outstanding balances of any debt or equity securities that would be senior in right of payment to the equity securities we hold.; and (3) multiplying the range of equity values derived therefrom by our ownership share of such equity tranche in order to arrive at a range of fair values for our equity security (or securities). Application of these valuation methodologies involves a significant degree of judgment by management.

 

Equity in a portfolio company that invests in loans will typically be valued by arriving at a fair value of such vehicle’s loan assets (plus, when appropriate, the carrying value of certain other assets), and deducting the book value or fair value (as appropriate) of such vehicle’s liabilities to arrive at a fair value for the equity. When appropriate, in order to recognize value that would be created by growth opportunities of such portfolio company, equity in a portfolio company may also be valued by taking into consideration the magnitude, timing, and effective life of its expected future investments in loans.

 

Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our financial statements will express the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our financial statements.

 

Revenue Recognition. Our revenue recognition policies are as follows:

 

Interest Income: Interest income is accrued based upon the outstanding principal amount and contractual interest terms of the debt investments. Recognized interest income, if payable monthly or quarterly, is reflected as interest receivable until collected. Recognized interest income that is instead added to the principal balance and generally becomes due at maturity or at some other stipulated date (“PIK interest”) is reflected in the investment account. We accrue interest income until certain events take place, which may place a loan into a non-accrual status (see below). We will not accrue PIK interest if the portfolio company valuation indicates that the PIK interest is not collectible. Loan origination fees, original issue discount (“OID”), market discount or premium, and loan amendment fees (collectively, “net loan origination fees”) are capitalized, and we accrete or amortize such amounts on a straight-line basis over the life of the loan as additional interest income. When we receive a loan principal payment, the OID related to the paid principal is accelerated and recognized in interest income. This method is not materially different than the effective interest rate method. Unamortized OID is reflected in the investment account and unamortized loan amendment fees are reflected as deferred loan fee revenue. All other interest income is recorded into income when earned. Further, in connection with our debt investments, we will sometimes receive warrants or similar no cost equity-related securities (“Warrants”). We determine the cost basis of Warrants based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and Warrants received. Any resulting difference between the face amount of the debt and its recorded fair value resulting from the assignment of value to the Warrants is treated as OID, and accreted into interest income as described above.

 

As of September 30, 2015 and December 31, 2014, unamortized discounts and origination fees on debt investments amounted to $2.3 million and $3.7 million, respectively. For the three and nine months ended September 30, 2015, we recognized net loan origination fee income of $0.3 million and $1.3 million, respectively. For the three and nine months ended September 30, 2014, we recognized net loan origination fee income of $0.5 million and $1.1 million, respectively. For the three and nine months ended September 30, 2015, we recognized PIK interest income in the amount of $0.3 million and $0.9 million, respectively. For the three and nine months ended September 30, 2014, we recognized PIK interest income in the amount of $0.2 million and $0.4 million, respectively. To maintain its status as a RIC, we include non-cash interest income in the amounts that must be paid out to our shareholders in the form of distributions.

 

Dividend Income: Dividend income on common stock, generally payable in cash, is recorded at the time dividends are declared or at the point an obligation exists for the portfolio company to make a distribution supported by tax-basis earnings and profits. Dividend income on preferred equity is accrued as earned. Such dividends on preferred equity securities could 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 reflected as dividend receivables until collected. Dividends payable in additional preferred securities or contractually earned but not declared (“PIK dividends”) are reflected in the investment account. We stop accruing PIK dividends on our preferred equity securities when it is determined that the dividend is not collectible. We assess the collectability of the PIK dividends based on factors including the fair value of the preferred equity security, the valuation of the portfolio company’s enterprise value, and proceeds expected to be received over the life of the investments. In addition, we may receive distributions from certain of our investments taxed as flow through entities. Each such distribution is evaluated to determine if the distribution should be recorded as dividend income or a return of capital. Generally, we will not record distributions from investments taxed as flow through entities as dividend income unless there are sufficient accumulated tax-basis earnings and profits prior to the distribution. Distributions that are classified as a return of capital are recorded as a reduction in the cost basis of the investment. During the three and nine months ended September 30, 2015, we recognized preferred dividend income of $0.5 million and $1.3 million, respectively, of which $0.4 million and $1.1 million, respectively, was contractually earned but not declared. During the three and nine months ended September 30, 2014, we recognized preferred dividend income of $0.3 million and $0.4 million, respectively, of which $0.3 million was contractually earned but not declared during such periods. During the three and nine months ended September 30, 2015, we recognized common stock dividend income of $0.1 million. We did not recognize any common stock dividend income for the three and nine months ended September 30, 2014.

 

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Fee Income: We may generate revenue in the form of commitment, structuring or due diligence fees, fees for providing managerial assistance, consulting fees, and other contractual fees. Such revenue is recognized as the related services are rendered and amounted to $0.4 million and $0.7 million, for the three and nine months ended September 30, 2015, respectively. For the three and nine months ended September 30, 2014, we recognized fee income of $0.3 million and $0.4 million, respectively.

 

Net Realized and Unrealized Gain or Loss on Investments: Investment transactions are accounted for on a trade-date basis. Realized gains or losses on investments are measured by the difference between the net proceeds from the disposition and the cost basis of the investment, without regard to unrealized gains or losses previously recognized. Investments are recorded at fair value. Our Board determines the fair value of our portfolio investments. After recording all appropriate interest, dividend, and other income, some of which is reflected in the investment account as described above, we report changes in fair value of investments that are measured at fair value as a component of the net changes in unrealized appreciation/depreciation on investments in the consolidated statements of operations.

 

Non-accrual loans: Loans on which the accrual of interest income has been discontinued are designated as non-accrual loans, and non-accrual loans are further designated to be accounted for under either a non-accrual cash method or a non-accrual cost recovery method. Loans are generally placed on non-accrual status when a loan either: (i) is delinquent for 90 days or more on principal or interest based on contractual terms of the loan (unless well secured and in the process of collection), or (ii) in the opinion of management, there is reasonable doubt about the collectability. When loans are placed on non-accrual status, all interest previously accrued but not collected, other than PIK interest that has already been contractually added to the principal balance, is reversed against current period interest income. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment. Interest accruals are resumed on non-accrual loans only when they are brought current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to all principal and interest. At September 30, 2015, we had two non-accrual loans which were accounted for as non-accrual cash method loans with an aggregate fair value of $1.2 million, one of which was settled on October 2, 2015 (cost and fair value was $4.0 million and $0.1 million, respectively, at September 30, 2015). At December 31, 2014, we had one non-accrual loan which was accounted for as a non-accrual cash method loan with an aggregate fair value of $0.8 million.

 

Principles of consolidation.

 

Our September 30, 2015 consolidated unaudited financial statements include the accounts of OFS Capital and its wholly owned subsidiaries, OFS Capital WM, SBIC I LP, SBIC I GP, and FQSR. We consolidate an affiliated subsidiary if we own more than 50 percent of the subsidiary’s equity and hold the controlling financial interest in such subsidiary. We also consolidate a variable interest entity (“VIE”) if we are the primary beneficiary in the VIE.

 

OFS Capital WM Asset Sale and Related Transactions

 

On May 28, 2015, we entered into a Loan Portfolio Purchase Agreement with Madison Capital Funding LLC (“Madison”), pursuant to which we sold 20 senior secured debt investments held by OFS Capital WM with an aggregate outstanding principal balance of $67.8 million to Madison (the “WM Asset Sale”) for cash proceeds of $67.3 million. Madison is an affiliated entity of MCF Capital Management, LLC (“MCF”), which was the loan manager for OFS Capital WM prior to the WM Asset Sale under a Loan and Security Agreement among OFS Capital WM, MCF, Wells Fargo Securities, LLC, each of the Lenders from time to time party thereto, and Wells Fargo Delaware Trust Company, N.A. (the “Loan and Security Agreement”).

 

In connection with the WM Asset Sale, we recognized a realized gain of $2.7 million and reversed previously recorded net unrealized appreciation associated with the sold assets in the total amount of $2.1 million. The realized gain pertained primarily to the net unrealized depreciation embedded in the sold assets prior to our IPO.

 

On May 28, 2015, pursuant to the Loan and Security Agreement, we applied $52.4 million from the sale proceeds of the WM Asset Sale to pay in full and retire OFS Capital WM’s secured revolving credit facility with Wells Fargo Bank, N.A. (“WM Credit Facility”). As a result of the termination of the WM Credit Facility, we wrote-off the remaining related unamortized deferred financing closing costs of $1.2 million on the revolving line of credit.

 

On May 28, 2015, in connection with the WM Asset Sale, we entered into a Loan Administration Services Agreement with Madison pursuant to which Madison will provide loan servicing and other administrative services to OFS Capital WM with respect to certain of its remaining loan assets. In return for its loan administration services, Madison will receive a quarterly loan administration fee of 0.25% per annum based on the average daily principal balances of the loan assets for such quarter. For the three and nine months ended September 30, 2015, we incurred loan administration fee expense of $15 thousand and $20 thousand, respectively.

 

Portfolio Composition and Investment Activity

 

Portfolio Composition

 

The total fair value of our investments was approximately $247.2 million at September 30, 2015 and approximately $312.2 million at December 31, 2014. Our investment portfolio as of September 30, 2015 consisted of outstanding loans to 38 portfolio companies, totaling approximately $230.1 million in aggregate principal amount (including SBIC I LP’s $191.8 million in loans to 25 portfolio companies), of which 69% were senior secured loans and 31% were subordinated loans, as well as $24.6 million in equity investments, at fair value. At September 30, 2015, our equity investments consisted of $24.6 million held by SBIC I LP in 15 portfolio companies in which it also held a debt investment and one portfolio company in which it solely held an equity investment. As of September 30, 2015, we had $4.6 million of unfunded commitments to four portfolio companies, consisting of $4.2 million of unfunded debt commitments and $0.4 million of unfunded equity commitments, all of which were commitments of SBIC I LP.

 

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The following table summarizes the composition of our investment portfolio as of September 30, 2015.

 

   Commitment   Outstanding
Principal
   Fair Value 
   (Dollar amounts in thousands) 
Senior secured term loan  $158,428   $158,428   $151,393 
Subordinated term loan   74,800    71,672    71,256 
Senior secured revolver   1,094    -    (27)
Equity investments   24,962     N/A    24,598 
   $259,284   $230,100   $247,220 
Total # of Obligors   38    38    38 

 

The following table summarizes the composition of our investment portfolio as of December 31, 2014.

 

   Commitment   Outstanding
Principal
   Fair Value 
   (Dollar amounts in thousands) 
Senior secured term loan  $252,471   $248,971   $241,773 
Subordinated term loan   55,230    52,352    52,453 
Senior secured revolver   1,094    -    (24)
Equity investments   18,396     N/A    18,032 
   $327,191   $301,323   $312,234 
Total # of Obligors   61    61    61 

 

Our investment portfolio encompassed a broad range of geographical regions within the United States and industries. The following table provides a regional breakdown of our debt investment portfolio commitments as of September 30, 2015.

 

   Commitment   Percent 
   (Dollar amounts in thousands) 
South  $103,577    44.2%
Northeast   79,077    33.7 
West   37,208    15.9 
Midwest   14,460    6.2 
Total  $234,322    100.0%

 

The following table provides a regional breakdown of our debt investment portfolio commitments as of December 31, 2014.

 

   Commitment   Percent 
   (Dollar amounts in thousands) 
Northeast  $107,769    34.9%
South   98,814    32.0 
West   63,921    20.7 
Midwest   38,291    12.4 
Total  $308,795    100.0%

 

As of September 30, 2015, our debt and equity investment portfolio’s three largest industries were: Services: Business, Healthcare & Pharmaceuticals, and Capital Equipment, totaling approximately 55.4% of the investment portfolio. The following table summarizes our investment portfolio commitments by industry as of September 30, 2015.

 

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   As of September 30, 2015 
Industry  Commitment   Percent 
   (Dollar amounts in thousands) 
Services: Business  $66,238    25.5%
Healthcare & Pharmaceuticals   43,518    16.8 
Capital Equipment   34,099    13.1 
Banking, Finance, Insurance & Real Estate   24,838    9.6 
Aerospace & Defense   15,454    6.0 
Media: Advertising, Printing & Publishing   15,206    5.9 
Construction & Building   11,253    4.3 
Metals & Mining   10,231    3.9 
Consumer goods: Non-durable   9,370    3.6 
Services: Consumer   8,712    3.4 
Chemicals, Plastics & Rubber   4,857    1.8 
Media: Diversified & Production   4,298    1.7 
Telecommunications   3,907    1.5 
Hotel, Gaming & Leisure   3,000    1.2 
High Tech Industries   2,303    0.9 
Containers, Packageing & Glass   2,000    0.8 
   $259,284    100.0%

 

As of December 31, 2014, our debt and equity investment portfolio’s three largest industries were: Services: Business, Healthcare & Pharmaceuticals, and Capital Equipment, totaling approximately 50.7% of the investment portfolio. The following table summarizes our investment portfolio commitments by industry as of December 31, 2014.

 

   As of December 31, 2014 
Industry  Commitment   Percent 
   (Dollar amounts in thousands) 
Services: Business  $77,895    23.9%
Healthcare & Pharmaceuticals   49,862    15.2 
Capital Equipment   38,021    11.6 
Banking, Finance, Insurance & Real Estate   27,216    8.3 
Media: Advertising, Printing & Publishing   20,513    6.3 
Aerospace & Defense   18,100    5.5 
Chemicals, Plastics & Rubber   17,580    5.4 
Metals & Mining   14,097    4.3 
Construction & Building   12,574    3.9 
Services: Consumer   9,576    2.9 
High Tech Industries   7,630    2.3 
Environmental Industries   7,577    2.3 
Telecommunications   6,987    2.1 
Media: Diversified & Production   4,244    1.3 
Containers, Packaging & Glass   4,009    1.2 
Media: Broadcasting & Subscription   3,592    1.1 
Retail   3,589    1.1 
Energy: Oil & Gas   2,810    0.9 
Consumer goods: Non-durable   1,319    0.4 
   $327,191    100.0%

 

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The following tables summarizes our debt investment portfolio by size of exposure as of September 30, 2015 and December 31, 2014. 

 

   As of September 30, 2015 
Debt Investment Size (in millions)  Commitment   Percent   Number 
   (Dollar amounts
in thousands)
         
$0 - $3  $22,564    9.6%   10 
$3 - $4   11,696    5.0    3 
$4 - $5   31,628    13.5    7 
$5 - $10   90,935    38.8    12 
> $10   77,499    33.1    6 
   $234,322    100.0%   38 

 

   As of December 31, 2014 
Debt Investment Size (in millions)  Commitment   Percent   Number 
   (Dollar amounts
in thousands)
         
$0 - $3  $35,555    11.5%   15 
$3 - $4   52,486    17.0    15 
$4 - $5   67,292    21.8    15 
$5 - $10   77,240    25.0    10 
>$10   76,222    24.7    6 
   $308,795    100.0%   61 

 

The following table provides a breakdown of our debt investment portfolio by yield and investment category as of September 30, 2015 and December 31, 2014.

   

   As of September 30, 2015   As of December 31, 2014 
Yield to Fair Value  Senior
Secured
Debt
   Subordinated
Debt
   Senior
Secured
Debt
   Subordinated
Debt
 
Less than 6%   1.3%   -%   11.3%   -%
6% - 7%   12.1    -    37.8    - 
8% - 10%   36.2    -    26.3    - 
Greater than 10%   50.4    100.0    24.6    100.0 
Total   100.0%   100.0%   100.0%   100.0%

 

Investment Activity

 

For the nine months ended September 30, 2015, we closed new debt investments with eight new portfolio companies for an aggregate principal balance of $42.7 million, of which $3.0 million was settled in October 2015. In addition, we made new debt investments of approximately $33.6 million in six existing portfolio companies. For the nine months ended September 30, 2015, we purchased equity interests of $5.7 million in two new portfolio companies. For the nine months ended September 30, 2015, we received approximately $61.9 million in proceeds from principal payments on debt investments, and approximately $97.7 million in proceeds from investments we sold or redeemed by the portfolio company, of which approximately $7.2 million pertained to a debt investment we sold in December 2014, $67.3 million resulted from the WM Asset Sale, and $3.5 million related to the sale of our equity interests in two portfolio companies which we realized a capital gain of approximately $1.5 million.

 

For the three months ended September 30, 2015, we closed new debt investments with two new portfolio companies with an aggregate principal balance of $5.0 million, of which $3.0 million was settled in October 2015. In addition, we closed new debt investments with four existing portfolio companies with an aggregate principal balance of $26.9 million. For the three months ended September 30, 2015, we received approximately $30.7 million in proceeds from principal payments on debt investments, and approximately $8.6 million in proceeds from investments we sold or redeemed by the portfolio company, of which $0.8 million related to the sale of our equity interests in two portfolio companies.

 

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For the nine months ended September 30, 2014, we closed new debt investments with 11 portfolio companies with an aggregate principal balance of $84.9 million and made follow-on debt investments of approximately $3.8 million in three existing portfolio companies. In addition, for the nine months ended September 30, 2014, we purchased new equity interests totaling approximately $2.2 million in two portfolio companies, made a follow-on equity investment of approximately $0.4 million in one existing portfolio company, and received warrants in connection with a new debt investment in the amount of approximately $0.5 million. For the nine months ended September 30, 2014, we received approximately $59.1 million in proceeds from principal payments on debt investments, and approximately $9.5 million in proceeds from debt investments we sold, of which approximately $4.5 million pertained to a debt investment we sold in December 2013.

 

For the three months ended September 30, 2014, we closed new debt investments with seven portfolio companies with an aggregate principal balance of $61.9 million and made follow-on debt investments of approximately $3.0 million in two existing portfolio companies. In addition, for the three months ended September 30, 2014, we purchased new equity interests totaling approximately $2.2 million in two portfolio companies, made a follow-on equity investment of approximately $0.4 million in one existing portfolio company, and received warrants in connection with a new debt investment in the amount of approximately $0.5 million. For the three months ended September 30, 2014, we received approximately $29.4 million in proceeds from principal payments on debt investments, and approximately $2.0 million in proceeds from debt investments we sold.

 

Portfolio Credit Ratings

 

We categorize debt investments into seven risk categories based on relevant information about the ability of borrowers to service their debt.

 

1 (Low Risk) – A risk rated 1, or Low Risk, credit is a credit that has most 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 credit’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 1 rated credit would be considered to be of investment grade quality.

 

2 (Below Average Risk) – A risk rated 2, or Below Average Risk, credit is a credit that has acceptable asset quality, moderate excess liquidity, and modest leverage capacity. It could have some financial/non-financial weaknesses that are offset by strengths; however, the credit demonstrates an ample current cash flow from operations. The trends and outlook for the credit’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) – A risk rated 3, or Average, credit is a credit that has acceptable asset quality, somewhat strained liquidity, and minimal leverage capacity. It is at times characterized by just acceptable cash flows from operations. Under adverse market conditions, carrying the current debt service could pose difficulties for the borrower. The trends and conditions of the credit’s operations and balance sheet are neutral to slightly negative.

 

4 (Special Mention) – A risk rated 4, or Special Mention, credit is a credit with no apparent loss of principal or interest envisioned. Nonetheless, it possesses credit deficiencies or potential weaknesses that deserve management’s close and continued attention. The credit’s operations and/or balance sheet have demonstrated an adverse trend or deterioration that, 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, if not checked or corrected, weaken the asset or inadequately protect our credit position.

 

5 (Substandard) – A risk rated 5, or Substandard, credit is a credit inadequately protected by the current enterprise value or paying capacity of the obligor or of the collateral, if any. These credits have 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) – A risk rated 6, or Doubtful, credit is a credit with 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 that may strengthen the asset, its classification as an estimated loss is deferred until its more exact status can be determined.

 

 7 (Loss) – A risk rated 7, or Loss, credit is a credit 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.

 

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The following table shows the classification of our debt investments portfolio by credit rating as of September 30, 2015 and December 31, 2014:  

 

   September 30, 2015   December 31, 2014 
   Debt
Investments,
at Fair Value
   % of Debt
Investments
   Debt
Investments,
at Fair Value
   % of Debt
Investments
 
Credit Rating  (Dollar amounts in thousands) 
1  $-    -%  $-    -%
2   12,657    5.7    13,646    4.6 
3   200,468    90.0    272,387    92.6 
4   4,838    2.2    7,368    2.5 
5   4,575    2.1    -    - 
6   84    -    801    0.3 
7   -    -    -    - 
   $222,622    100.0%  $294,202    100.0%

 

The following table shows the cost and fair value of our portfolio of investments by asset class as of September 30, 2015 and December 31, 2014.

 

   September 30, 2015   December 31, 2014 
   Cost   Fair Value   Cost   Fair Value 
   (Dollar amounts in thousands) 
Senior Secured                    
Performing  $151,327   $150,194   $241,863   $240,948 
Non-Accrual   5,175    1,172    3,988    801 
Subordinated                    
Performing   71,472    71,256    52,337    52,453 
Non-Accrual   -    -    -    - 
Equity Investments   19,333    24,598    15,385    18,032 
Total  $247,307   $247,220   $313,573   $312,234 

 

At September 30, 2015 we had two non-accrual loans with a fair value of approximately $1.2 million. As of December 31, 2014, we had one non-accrual loan with a fair value of approximately $0.8 million.

 

As of September 30, 2015, the weighted average yield to fair value of our debt investment portfolio was approximately 11.82% comprised of a weighted average yield to fair value of 10.98% and 13.59% from our senior secured debt investments and subordinated debt investments, respectively. Throughout this document, the weighted average yield on debt investments at fair value is computed as (a) total annual stated interest on accruing loans plus the annualized accretion of OID and amortization of deferred loan fees divided by (b) total debt investments at fair value excluding assets on non-accrual basis. The weighted average yield on debt investments at fair value is computed as of the balance sheet date.

 

As of September 30, 2015, floating rate loans comprised 56% of our debt investment portfolio and fixed rate loans comprised 44% of our debt investment portfolio, as a percent of fair value.

 

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.

 

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.

 

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Revenues. We generate revenue in the form of interest income on debt investments, capital gains, 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 September 30, 2015, floating rate and fixed rate loans comprised 56% and 44% respectively, as a percent of fair value, of our current debt investment portfolio; however, in accordance with our investment strategy, we expect that over time the proportion of fixed rate loans will increase. In some cases, our investments will provide for deferred interest or dividend payment, PIK interest, or PIK dividend, respectively (meaning interest or dividend paid in the form of additional principal amount of the loan or equity security instead of in cash). In addition, we may generate revenue in the form of commitment, structuring or due diligence fees, fees for providing managerial assistance, consulting fees, and other contractual fees. Loan origination fees, OID, market discount or premium, and loan amendment fees are capitalized, and we accrete or amortize such amounts over the life of the loan as interest income. When we receive principal payments on a loan in an amount that exceeds its carrying value, we will also record the excess principal payment as income.

 

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 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, including payments under the Administration Agreement that will be based upon our allocable portion (subject to policies reviewed and approved by our board of directors) of overhead.

 

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, which differs to some degree from our historical investment concentration, in senior secured loans to middle-market companies in the United States. Moreover, as a BDC and a RIC, we will also be 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 the 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.

 

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Comparison of the three and nine month periods ended September 30, 2015 and 2014

 

Consolidated operating results for the three and nine month periods ended September 30, 2015 and 2014, are as follows:

  

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
   (Amounts in thousands)   (Amounts in thousands) 
                 
Total investment income  $7,688   $6,197   $23,391   $15,867 
Total expenses   4,058    3,304    14,260    9,475 
Net investment income   3,630    2,893    9,131    6,392 
Net realized and unrealized gain (loss) on investments   (2,209)   942    2,924    51 
Net increase in net assets resulting from operations  $1,421   $3,835   $12,055   $6,443 

 

Net income 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, comparisons of net income may not be meaningful.

 

Investment Income 

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
   (Amounts in thousands)   (Amounts in thousands) 
                 
Interest income                    
Non-control/non-affiliate investments  $5,387   $4,420   $17,319   $11,730 
Affiliate investments   1,308    896    4,062    2,515 
Control investment   -    277    -    843 
Total interest income   6,695    5,593    21,381    15,088 
Dividend income                    
Non-control/non-affiliate investments   185    -    333    - 
Affiliate investments   406    335    1,016    394 
Total dividend income   591    335    1,349    394 
Fee income                    
Non-control/non-affiliate investments   310    205    448    213 
Affiliate investments   92    89    213    147 
Control investment   -    (25)   -    25 
Total fee income   402    269    661    385 
Total investment income  $7,688   $6,197   $23,391   $15,867 

 

Comparison of Investment Income for the Three Months Ended September 30, 2015 and 2014:

 

Total investment income increased by approximately $1.5 million, or 24%, for the three months ended September 30, 2015 as compared to the three months ended September 30, 2014. The $1.5 million increase in total investment income was due to an increase in interest, dividend, and fee income. The increase in interest income was primarily attributable to a significant increase in debt investments originated by SBIC I LP (“SBIC I LP Investments”) since September 30, 2014, which typically have a higher yield than the debt investments held by OFS Capital WM (“OFS Capital WM Investments”). The increase in dividend income was primarily attributable to an increase in recognized dividend income contractually earned but not declared on certain of our preferred equity investments held by SBIC I LP during the three months ended September 30, 2015. The increase in fee income was attributable to an increase in fee income recognized by SBIC I LP in connection with certain of its debt investments. The increase in total investment income from SBIC I LP Investments was offset by a decrease in interest income from OFS Capital WM Investments due to a decrease in OFS Capital WM Investments since the quarter ended September 30, 2014, including the WM Asset Sale which occurred during the second quarter of 2015.

 

Comparison of Investment Income for the Nine Months Ended September 30, 2015 and 2014:

 

Total investment income increased by approximately $7.5 million, or 47%, for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014. The $7.5 million increase in total investment income was due to an increase in interest income, dividend, and fee income. The increase in interest income was primarily attributable to a significant increase in SBIC I LP Investments since September 30, 2014, which typically have a higher yield than OFS Capital WM Investments. The increase in dividend income was primarily attributable to an increase in recognized dividend income contractually earned but not declared on certain of our preferred equity investments primarily held by SBIC I LP during the nine months ended September 30, 2015. The increase in fee income was primarily attributable to an increase in fee income recognized by SBIC I LP in connection with certain of its debt investments. The increase in total investment income from SBIC I LP Investments was offset by a decrease in interest income from OFS Capital WM investments due to a decrease in OFS Capital WM Investments since the quarter ended September 30, 2014.

 

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Interest Income

 

Comparison of Interest Income for the Three Months Ended September 30, 2015 and 2014:

 

 For the three months ended September 30, 2015, we generated total interest income from non-control/non-affiliate of approximately $5.4 million, of which approximately $4.9 million was generated by SBIC I LP Investments and approximately $0.5 million by OFS Capital WM Investments. For the three months ended September 30, 2014, interest income from non-control/non-affiliate investments was approximately $4.4 million, of which approximately $1.7 million was generated by SBIC I LP Investments and $2.7 million by OFS Capital WM Investments. The increase in interest income from non-control/non-affiliate investments generated by SBIC I LP Investments of approximately $3.2 million was attributable to an increase in debt investments originated by SBIC I LP since the quarter ended September 30, 2014. The decrease in interest income from non-control/non-affiliate investments generated by OFS Capital WM Investments of approximately $2.2 million was primarily due to the decrease in OFS Capital WM Investments since the quarter ended September 30, 2014.

 

SBIC I LP holds all of our affiliate investments. For the three months ended September 30, 2015 and 2014, SBIC I LP generated total interest income from affiliate investments of approximately $1.3 million and $0.9 million, respectively. The increase in total interest income from affiliate investments of approximately $0.4 million was primarily due to an increase in debt investments originated by SBIC I LP since the quarter ended September 30, 2014.

 

SBIC I LP held our only control investment in Tangible Software, Inc. (“Tangible”) until December 17, 2014, when the Tangible investment was restructured. The post-restructured debt investment was categorized as an affiliate investment. For the three months ended September 30, 2014, SBIC I LP generated total interest income from its control investment in the amount of approximately $0.3 million.

 

Comparison of Interest Income for the Nine Months Ended September 30, 2015 and 2014:

 

 For the nine months ended September 30, 2015, we generated total interest income from non-control/non-affiliate investments of approximately $17.3 million, of which approximately $13.2 million was generated by SBIC I LP Investments and $4.1 million by OFS Capital WM Investments. For the nine months ended September 30, 2014, interest income from non-control/non-affiliate investments was approximately $11.7 million, of which approximately $2.9 million was generated by SBIC I LP Investments and $8.8 million by OFS Capital WM Investments. The increase in interest income from non-control/non-affiliate investments generated by SBIC I LP Investments of approximately $10.3 million was attributable to an increase in debt investments originated by SBIC I LP since the quarter ended September 30, 2014. The decrease in interest income from non-control/non-affiliate investments generated by OFS Capital WM Investments of approximately $4.7 million was primarily due to the decrease in OFS Capital WM Investments since the quarter ended September 30, 2014.

 

SBIC I LP holds all of our affiliate investments. For the nine months ended September 30, 2015 and 2014, SBIC I LP generated total interest income from affiliate investments of approximately $4.1 million and $2.5 million, respectively. The increase in total interest income from affiliate investments of approximately $1.6 million was primarily due to an increase in debt investments originated by SBIC I LP since the quarter ended September 30, 2014.

 

SBIC I LP held our only control investment in Tangible until December 17, 2014, when the Tangible investment was restructured. The post-restructured debt investment was categorized as an affiliate investment. For the nine months ended September 30, 2014, SBIC I LP generated total interest income from its control investment of approximately $0.8 million.

 

Dividend Income

 

Comparison of Dividend Income for the Three Months Ended September 30, 2015 and 2014:

 

During the three months ended September 30, 2015 and 2014, SBIC I LP generated dividend income of approximately $0.6 million and $0.3 million, respectively. The increase of approximately $0.3 million was primarily due to an increase in recognized dividend income contractually earned but not declared on certain of our preferred equity investments held by SBIC I LP during the three months ended September 30, 2015.

 

Comparison of Dividend Income for the Nine Months Ended September 30, 2015 and 2014:

 

During the nine months ended September 30, 2015 and 2014, SBIC I LP generated dividend income of approximately $1.3 million and $0.4 million, respectively. The increase of approximately $0.9 million was primarily an increase in recognized dividend income contractually earned but not declared on certain of our preferred equity investments primarily held by SBIC I LP during the nine months ended September 30, 2015.

 

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Fee Income

 

Comparison of Fee Income for the Three Months Ended September 30, 2015 and 2014:

 

During the three months ended September 30, 2015 and 2014, SBIC I LP generated fee income of approximately $0.4 million and $0.3 million, respectively. The increase of approximately $0.1 million was primarily due to an increase in fee income recognized by SBIC I LP in connection with certain of its debt investments.

 

Comparison of Fee Income for the Nine Months Ended September 30, 2015 and 2014:

 

During the nine months ended September 30, 2015 and 2014, SBIC I LP generated fee and other income of approximately $0.7 million and $0.4 million, respectively. The increase of approximately $0.3 million was primarily due to an increase in fee income recognized by SBIC I LP in connection with certain of its debt investments.

 

Expenses

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
   (Amounts in thousands)   (Amounts in thousands) 
                 
Interest expense  $1,089   $1,001   $3,642   $2,989 
Amortization and write-off of deferred financing closing costs   96    167    2,004    469 
Amortization of intangible asset   48    49    146    161 
Management fees   1,120    543    4,101    2,341 
Incentive fee   908    723    1,514    723 
Professional fees   262    382    857    1,112 
Administrative fee   281    212    1,148    972 
General and administrative expenses   254    227    848    708 
Total expenses  $4,058   $3,304   $14,260   $9,475 

 

Comparison of Expenses for the Three Months Ended September 30, 2015 and 2014:

 

Total expenses increased by approximately $0.8 million, or 23%, for the three months ended September 30, 2015 as compared to the three months ended September 30, 2014.

 

Interest expense increased by approximately $0.1 million for the three months ended September 30, 2015, compared to the three months ended September 30, 2014, due to an increase of approximately $0.9 million in interest expense incurred on our SBA debentures, which increased substantially at September 30, 2015 compared with the debenture balance at September 30, 2014, offset by a 2015 decrease of approximately $0.8 million in interest expense on the WM Credit Facility, due to termination of the facility on May 28, 2015.

 

Amortization and write-off of deferred financing closing costs decreased by approximately $0.1 million for the three months ended September 30, 2015, compared to the three months ended September 30, 2014. We amortized approximately $0.1 million of deferred financing closing costs in connection with our SBA debentures for the three months ended September 30, 2015, and approximately $0.2 million of deferred financing closing costs primarily in connection with the WM Credit Facility for the three months ended September 30, 2014.

 

Management fee expense totaled approximately $1.1 million and $0.5 million for the three months ended September 30, 2015 and 2014, respectively. The increase of approximately $0.6 million was due to an increase of approximately $0.8 million of base management fee expense we incurred to OFS Advisor, offset by a decrease of approximately $0.2 million of loan management fee charged by MCF. The increase in the base management fee expense we incurred to OFS Advisor was primarily due to the reset of our base management fee to 0.4375% per quarter effective January 1, 2015 as compared with 0.145833% effective April 1, 2014. The decrease in the loan management fee charged by MCF was due to the elimination of the loan management fee as a result of the termination of the Loan and Security Agreement on May 28, 2015.

 

Incentive fee expense totaled approximately $0.9 million and $0.7 million for the three months ended September 30, 2015 and 2014, respectively. The increase of approximately $0.2 million was a result of an increase in our pre-incentive fee net investment income for the quarter ended September 30, 2015, as compared with the quarter ended September 30, 2014.

 

Comparison of Expenses for the Nine Months Ended September 30, 2015 and 2014:

 

Total expenses increased by approximately $4.8 million, or 51%, for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014.

 

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Interest expense increased by approximately $0.7 million for the nine months ended September 30, 2015, compared to the nine months ended September 30, 2014, due to an increase of approximately $2.1 million in interest expense incurred on our SBA debentures, which increased substantially at September 30, 2015 compared with the debenture balance at September 30, 2014, offset by a 2015 decrease of approximately $1.4 million in interest expense on the WM Credit Facility, primarily due to lower borrowings on the facility in 2015 and the termination of the facility on May 28, 2015.

 

Amortization and write-off of deferred financing closing costs increased by approximately $1.5 million for the nine months ended September 30, 2015, compared to the nine months ended September 30, 2014, primarily due to a write-off of deferred financing closing costs in the amount of approximately $0.4 million in connection with our March 2015 permanent reduction of the WM Credit Facility from $100.0 million to $75.0 million, and a write-off of the remaining deferred financing closing costs in the amount of approximately $1.2 million in connection with our full payoff and retirement of the WM Credit Facility on May 28, 2015.

 

Management fee expense totaled approximately $4.1 million for the nine months ended September 30, 2015, consisting of approximately $3.8 million of base management fee expense we incurred to OFS Advisor and approximately $0.3 million of loan management fee charged by MCF. Management fee expense totaled approximately $2.3 million for the nine months ended September 30, 2014, consisting of approximately $1.7 million of base management fee expense we incurred to OFS Advisor and approximately $0.6 million of loan management fee charged by MCF. The base management fee to OFS Advisor increased by a total of approximately $2.1 million, of which approximately $0.7 million was due to an increase in our average total assets at September 30, 2015, June 30, 2015, March 31, 2015, and December 31, 2014 (“2015 Management Fee Base”), as compared to our average total assets at September 30, 2014, June 30, 2014, March 31, 2014, and December 31, 2013 (“2014 Management Fee Base”), and approximately $1.4 million was due to the reset of our base management fee to 0.4375% per quarter effective January 1, 2015 as compared with 0.145833% effective April 1, 2014.

 

Incentive fee expense totaled approximately $1.5 million and $0.7 million for the nine months ended September 30, 2015 and 2014, respectively. The increase of approximately $0.8 million was a result of an increase in our pre-incentive fee net investment income for the applicable quarters during the nine months ended September 30, 2015, as compared with the nine months ended September 30, 2014.

 

Net Realized and Unrealized Gain (Loss) on Investments

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
   (Amounts in thousands)   (Amounts in thousands) 
Net realized gain on non-control/non-affiliate investments  $254   $17   $3,132   $17 
Net realized gain on affiliate investments   -    -    1,471    28 
Net change in unrealized appreciation/depreciation on non-control/non-affiliate investments   (2,115)   427    (3,173)   106 
Net change in unrealized appreciation/depreciation on affiliate investments   (348)   964    1,494    1,591 
Net change in unrealized depreciation on control investment   -    (466)   -    (1,691)
Net realized and unrealized gain (loss) on investments  $(2,209)  $942   $2,924   $51 

 

Comparison of Realized and Unrealized Gain (Loss) on Investments for the Three Months Ended September 30, 2015 and 2014:

 

For the three months ended September 30, 2015, we recorded net realized gain on non-control/non affiliate investments of approximately $0.3 million, primarily related to the sale of an equity investment.

 

For the three months ended September 30, 2015, we recorded net change in unrealized appreciation/depreciation on non-control/non-affiliate investments of approximately $(2.1) million, consisting of approximately $(1.7) million on debt investments held by SBIC I LP, and $(0.4) million on debt investments held by OFS Capital WM (primarily attributable to one of its non-accrual loans which existed at December 31, 2014 and September 30, 2015 and subsequently settled in October 2015). In addition, for the three months ended September 30, 2015, we recorded net change in unrealized appreciation/depreciation on affiliate investments of approximately $(0.3) million on debt and equity investments held by SBIC I LP.

 

For the three months ended September 30, 2014, we recorded approximately $0.4 million of net change in unrealized depreciation on non-control/non-affiliate investments, consisting of approximately $0.5 million of net change in unrealized depreciation on non-control/non-affiliate investments held by OFS Capital WM, and approximately $(0.1) million of net change in unrealized depreciation on non-control/non-affiliate investments held by SBIC I LP. In addition, for the three months ended September 30, 2014, we recorded approximately $1.0 million of net change in unrealized appreciation on affiliate investments held by SBIC I LP, as well as approximately $(0.5) million of net change in unrealized depreciation on a control investment held by SBIC I LP (Tangible).

 

Comparison of Realized and Unrealized Gain (Loss) on Investments for the Nine Months Ended September 30, 2015 and 2014:

 

For the nine months ended September 30, 2015, we recorded net realized gain on non-control/non affiliate investments of approximately $3.1 million, of which approximately $2.7 million represented net realized gain in connection with the WM Asset Sale, $0.2 million resulted from the sale of four of our debt investments, and $0.2 million resulted from the sale of an equity investment. For the nine months ended September 30, 2015, we recorded net realized gain on affiliate investments of approximately $1.5 million related to the sale of two of our equity investments.

 

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For the nine months ended September 30, 2015, we recorded net change in unrealized appreciation/depreciation on non-control/non-affiliate investments of approximately $(3.2) million, consisting of approximately $(2.1) million of a reversal of previously recorded net unrealized appreciation associated with the WM Asset Sale, net unrealized depreciation of $(0.8) million on debt investments held by OFS Capital WM (primarily attributable to one of its non-accrual loans which existed at December 31, 2014 and September 30, 2015 and subsequently settled in October 2015), and approximately $(0.3) million of net unrealized depreciation on our debt and equity investments held by SBIC I LP. In addition, for the nine months ended September 30, 2015, we recorded net change in unrealized appreciation/depreciation on affiliate of investments of approximately $1.5 million, consisting of approximately $2.0 million of net unrealized appreciation on debt and equity investments held by SBIC I LP, offset by approximately $(0.5) million of a reversal of previously recorded net unrealized appreciation in connection with an equity sale.

 

For the nine months ended September 30, 2014, we recorded approximately $0.1 million of net change in unrealized depreciation on non-control/non-affiliate investments, consisting of approximately $(0.5) million of net change in unrealized depreciation on non-control/non-affiliate investments held by OFS Capital WM, and approximately $0.6 million of net change in unrealized depreciation on non-control/non-affiliate investments held by SBIC I LP. In addition, for the nine months ended September 30, 2014, we recorded approximately $1.6 million of net change in unrealized appreciation on affiliate investments held by SBIC I LP, as well as approximately $(1.7) million of net change in unrealized depreciation on a control investment held by SBIC I LP (Tangible).

 

Financial Condition, Liquidity and Capital Resources

 

Cash and Cash Equivalents

 

At September 30, 2015 and December 31, 2014, we had cash and cash equivalents of $41.5 million and $12.4 million, respectively. During the nine months ended September 30, 2015, we had net cash provided by operating activities of $89.1 million, primarily due to cash collections of $97.7 million from sale of our portfolio investments, including $7.2 million of cash collection from an investment we sold in December 2014, $67.3 million from the WM Asset Sale, and $4.4 million from the sale of our equity interests in four portfolio companies, $61.9 million of cash we received from principal payments on our portfolio investments, as well as our $12.1 million net increase in net assets resulting from operations. These cash receipts were offset by $78.6 million of cash we used to purchase portfolio investments.

 

Net cash used in financing activities was $(60.0) million for the nine months ended September 30, 2015, primarily attributable to $22.6 million of draws from our SBA debentures (net of the fees), offset by the $72.6 million of net repayments on the WM Credit Facility which was paid in full and retired on May 28, 2015 and $9.4 million of cash we paid in dividends and distributions.

 

We intend to generate additional cash flows from our operations, future offerings of securities, and future borrowings. Our primary uses of funds are investments in debt and equity investments, interest payments on indebtedness, payment of other expenses, and cash distributions to our shareholders.

 

The WM Credit Facility

 

Prior to the termination of the WM Credit Facility on May 28, 2015, OFS Capital WM had a $75.0 million secured revolving credit facility, as amended from time to time, with Wells Fargo. The WM Credit Facility was secured by all eligible loans acquired by OFS Capital WM, and had a maturity date of December 31, 2018 and a reinvestment period through December 31, 2015. The interest rate on outstanding borrowings was the London Interbank Offered Rate (“LIBOR”) plus 2.50% per annum. The minimum equity requirement was set at $35.0 million.

 

The investments held by OFS Capital WM, prior to the termination of the WM Credit Facility, were serviced by MCF, as the loan manager, pursuant to the Loan and Security Agreement. Under the WM Credit Facility, the loan manager charged both a senior and subordinated management fee to OFS Capital WM for its services, each at 0.25% per annum of the assigned value of the underlying portfolio investments, plus an accrued fee that was deferred until the earlier of the end of the investment period of the portfolio investments or termination of the Loan and Security Agreement. For the three and nine months ended September 30, 2015, we incurred management fee expense of zero and $0.3 million, respectively, to the loan manager. For the three and nine months ended September 30, 2014, we incurred management fee expense of $0.2 million and $0.6 million, respectively, to the loan manager.

 

The interest rate on the outstanding borrowings at December 31, 2014 was 2.76%. The unused commitment fee on the WM Credit Facility was (1) 0.5% per annum of the first $25.0 million of the unused facility and (2) 2% per annum of the balance in excess of $25.0 million, and was included in interest expense on the consolidated statement of operations. For the three and nine months ended September 30, 2015, interest expense on the revolving line of credit totaled zero and $0.8 million, respectively. For the three and nine months ended September 30, 2014, interest expense on the revolving line of credit totaled 0.7 million and $2.3 million, respectively.

 

Deferred financing closing costs, net of accumulated amortization, on the WM Credit Facility as of December 31, 2014 were $1.8 million. For the three and nine months ended September 30, 2015, amortization and write-off of deferred financing closing costs on the revolving line of credit totaled zero and $1.8 million, respectively. For the three and nine months ended September 30, 2014, amortization and write-off of deferred financing closing costs on the revolving line of credit totaled $0.2 million and $0.5 million, respectively. Write-offs of deferred financing closing costs occurred when the credit facility’s commitment was permanently reduced. On March 12, 2015, we elected to permanently reduce the maximum facility on the WM Credit Facility from $100.0 million to $75.0 million, resulting in a write-off of deferred financing closing costs of $0.4 million (no financing costs were incurred in connection with this facility reduction). As a result of the termination of the WM Credit Facility, on May 28, 2015, we wrote off the remaining unamortized deferred financing closing costs of $1.2 million.

 

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SBA Debentures

 

As a result of the SBIC Acquisitions, SBIC I LP became our wholly-owned subsidiary effective December 4, 2013. SBIC I LP has a SBIC license that allows it 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 OFS Capital, and bear interest payable semi-annually, and each debenture has a maturity date that is ten years following issuance. The interest rate is fixed at the first pooling date after issuance, which is March and September of each year, at a market-driven spread over U.S. Treasury Notes with ten-year maturities.

 

Under present SBIC regulations, the maximum amount of SBA-guaranteed debt that may be issued by a single SBIC licensee is $150.0 million. An SBIC fund may borrow up to two times the amount of its regulatory capital, subject to customary regulatory requirements. As of September 30, 2015, SBIC I LP had fully drawn the $149.9 million of leverage commitments from the SBA. As of December 31, 2014, SBIC I LP had leverage commitments of $149.9 million from the SBA, and $127.3 million of outstanding SBA-guaranteed debentures.

 

In January 2015, we filed an application with the SBA for a second SBIC license, which, if approved, would provide up to $75.0 million in additional SBA debentures for the funding of our future investments, upon our contribution of at least $37.5 million in additional regulatory capital and subject to the issuance of a leverage commitment by the SBA and customary procedures. There can be no assurance as to whether or when this application will be approved by the SBA.

 

On a stand-alone basis, SBIC I LP held approximately $242.5 million and $215.7 million in assets at September 30, 2015 and December 31, 2014, respectively, which accounted for approximately 82% and 63% of our total consolidated assets at September 30, 2015 and December 31, 2014, respectively.

 

SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $19.5 million and have average annual fully taxed net income not exceeding $6.5 million for the two most recent fiscal years. In addition, an SBIC must devote 25.0% of its investment activity to “smaller” enterprises as defined by the SBA. A smaller enterprise is one that has a tangible net worth not exceeding $6.0 million and has average annual fully taxed net income not exceeding $2.0 million 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.

 

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 OFS Capital if it does not have sufficient capital in accordance with SBA regulations. Such actions by the SBA would in turn, negatively affect OFS Capital.

 

Other Liquidity Matters

 

We expect to fund the growth of our investment portfolio through future securities offerings, and future borrowings or issuances of senior securities to the extent permitted by the 1940 Act. In addition, we may determine to sell lower-yielding investments in the portfolio to generate liquidity for the acquisition of higher-yielding investments either directly or through subsidiaries. We cannot assure shareholders that our plans to raise capital will be successful. In addition, we intend to distribute to our shareholders 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, including the funding of our unfunded commitments to portfolio companies. The illiquidity of certain of our portfolio investments could make it difficult for us to sell these investments when desired or to realize their recorded value.

 

In addition, as a BDC, we generally will be required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities (including SBIC I LP’s SBA-guaranteed debt), to total senior securities, which include all of our borrowings (excluding SBA-guaranteed debt) and any outstanding preferred stock (of which we had none at September 30, 2015), of at least 200%. We received an exemptive order from the SEC to permit us to exclude the debt of SBIC I LP guaranteed by the SBA from the definition of Senior Securities in the statutory 200% 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 debt and equity offerings, and the securitization or other debt-related markets, which may or may not be available on favorable terms, if at all.

 

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Off-Balance Sheet Arrangements

 

We may be a party to financial instruments with off-balance sheet risk in the normal course of our business to meet the financial needs of our portfolio companies. As of September 30, 2015, we had $4.6 million of total unfunded commitments to four portfolio companies. Unfunded commitments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet and are not reflected on our balance sheet.

 

Contractual Obligations

 

The following table shows our contractual obligations as of September 30, 2015:

 

   Payments due by period 
Contractual Obligations (1)  Total  

Less than

1 year

   1-3 years   3-5 years   After
5 years (2)
 
   (Amounts in thousands) 
SBA Debentures  $149,880   $-   $-   $-   $149,880 
Total  $149,880   $-   $-   $-   $149,880 

 

(1)Excludes commitments to extend credit to our portfolio companies.
(2)The SBA debentures are scheduled to mature between September 2022 and 2025.

 

We have entered into contracts with third parties under which we have 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.

 

Commitments and Contingencies

 

At September 30, 2015, we had $4.6 million of total unfunded commitments for four portfolio companies, consisting of $4.2 million of unfunded debt commitments and $0.4 million of unfunded equity commitments. At December 31, 2014, we had $7.8 million of total unfunded commitments for six portfolio companies, consisting of $7.4 million of unfunded debt commitments and $0.4 million of unfunded equity commitments. We maintain sufficient cash on hand and availability in borrowings to fund such unfunded commitments.

 

From time to time, we are 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 our financial position.

 

Additionally, we are subject to periodic inspection by regulators to assess compliance with applicable regulations related to being a BDC and SBIC I LP is subject to periodic inspections by the SBA. Management believes that the Company is in material compliance with such regulations and inspection results do not indicate otherwise.

 

In the normal course of business, we enter into contracts and agreements that contain a variety of representations and warranties that provide general indemnifications. Our maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against us that have not occurred. We believe the risk of any material obligation under these indemnifications to be low.

 

Distributions

 

We are taxed as a RIC under the Code. Generally, a RIC is entitled to deduct dividends it pays to its shareholders 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. 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 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.

 

The following table summarizes our distributions declared and paid to date on all shares subsequent to our initial public offering (“IPO”) (dollar amounts in thousands except per share data):

 

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Date Declared  Record Date  Payment Date  Amount
Per Share (2)
   Total Amount 
Fiscal 2015                
August 6, 2015  September 16, 2015  September 30, 2015  $0.34   $3,289 
May 4, 2015  June 16, 2015  June 30, 2015   0.34    3,286 
March 4, 2015  March 17, 2015  March 31, 2015   0.34    3,281 
                 
Fiscal 2014                
November 4, 2014  December 17, 2014  December 31, 2014  $0.34   $3,278 
August 7, 2014  September 16, 2014  September 30, 2014   0.34    3,276 
May 7, 2014  June 16, 2014  June 30, 2014   0.34    3,275 
January 21, 2014  January 31, 2014  February 14, 2014   0.34    3,274 
                 
Fiscal 2013                
September 25, 2013  October 17, 2013  October 31, 2013  $0.34   $3,273 
June 25, 2013  July 17, 2013  July 31, 2013   0.34    3,272 
March 26, 2013  April 17, 2013  April 30, 2013   0.34    3,269 
                 
Fiscal 2012                
November 26, 2012 (1)  January 17, 2013  January 31, 2013  $0.17   $1,628 

 

(1)Represents the distribution declared in the specified period, which, if prorated for the number of days remaining in the fourth quarter after our IPO in November 2012, would have been $0.34 per share.

 

(2)The determination of the tax attributes of our distributions is made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. If the tax characteristics of these distributions were determined as of September 30, 2015, June 30, 2015, March 31, 2015, December 31, 2014, September 30, 2014, June 30, 2014, March 31, 2014, December 31, 2013, September 30, 2013, June 30, 2013, March 31, 2013, and December 31, 2012 (for the period November 8, 2012 through December 31, 2012), the Company estimated that approximately zero, $0.08, $0.07, $0.11, $0.04, $0.12, $0.19, zero, $0.18, $0.19, $0.18, and zero, respectively, would have represented a return of capital.

 

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a RIC. We cannot assure shareholders that they will receive any distributions at a particular level.

 

Distributions in excess of our current and accumulated earnings and profits generally are treated first as a return of capital to the extent of the shareholder’s tax basis, and any remaining distributions are treated as a capital gain. The determination of the tax attributes of our distributions is made annually as of the end of our fiscal year based upon our taxable income 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 tax attributes of our annual distributions to shareholders. For the distributions paid during the nine months ended September 30, 2015, out of the approximately $9.9 million distribution, approximately 13% represented a return of capital, 1% represented capital gains and 86% represented ordinary income.

 

Each year a statement on Form 1099-DIV identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gains on the sale of securities, and/or a return of paid-in-capital surplus, which is a nontaxable distribution) is mailed to our U.S. shareholders. To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a portion of those distributions may be deemed a taxable return of capital to our shareholders.

 

We maintain an “opt-out” dividend reinvestment plan for our common shareholders. As a result, if we declare a dividend, cash dividends are automatically reinvested in additional shares of our common stock unless the shareholder specifically “opts out” of the dividend reinvestment plan and chooses to receive cash dividends.

 

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Related Party Transactions

 

Investment Advisory Agreement

 

We have entered into an Investment Advisory Agreement with OFS Advisor and will pay OFS Advisor a management fee and incentive fee. Pursuant to the Investment Advisory Agreement with OFS Advisor 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. For providing these services, OFS Advisor receives a fee from us consisting of two components—a base management fee and an incentive fee. From the completion of our IPO through October 31, 2013, the base management fee was calculated at an annual rate of 0.875% 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) at the end of the two most recently completed calendar quarters, adjusted for any share issuances or repurchases during the quarter. Beginning on November 1, 2013 and through March 31, 2014, pursuant to the Investment Advisory Agreement, the base management fee was 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) at the end of the two most recently completed calendar quarters. OFS Advisor has excluded the value of the intangible asset and goodwill resulting from the SBIC Acquisitions from the base management fee calculation.

 

On May 5, 2014, we were notified by OFS Advisor that, effective as of April 1, 2014, it would reduce its base management fee by two-thirds for the balance of the 2014 fiscal year. Specifically, OFS Advisor agreed to reduce its base management fee from 0.4375% per quarter to 0.145833% per quarter for the second, third, and fourth quarters of 2014. Accordingly, the effective annual base management fee for the 2014 fiscal year was equal to 50% of the 1.75% required by our Advisory Agreement with OFS Advisor, or not greater than 0.875%. OFS Advisor informed us that this reduction was made for the benefit of our shareholders to take into account unforeseen delays in completing the SBIC Acquisitions. The base management fee resumed to its 1.75% annual rate on January 1, 2015.

 

The base management fee is payable quarterly in arrears. The base management fee expense was approximately $1.1 million and $3.8 million for the three and nine months ended September 30, 2015, respectively. The base management fee expense was approximately $0.4 million and $1.7 million for the three and nine months ended September 30, 2014, respectively.

 

The incentive fee has two parts. One part is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the 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 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 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.

 

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 second part 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.

 

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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.

 

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 investment. 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 net realized capital gains and (losses) plus net unrealized appreciation and (depreciation) is positive. OFS Advisor has excluded from the Capital Gains Fee calculation any realized gain with respect to (1) the step acquisitions resulting from the SBIC Acquisitions, and (2) the realized gain resulting from the WM Asset Sale.

 

We incurred incentive fee expense of $0.9 million and $1.5 million for the three and nine months ended September 30, 2015, respectively. For both the three and nine months ended September 30, 2014, we incurred incentive fee expense of $0.7 million.

 

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.”

 

Administration Agreement

 

Pursuant to an Administration Agreement, OFS Services furnishes us with office facilities and equipment, necessary software licenses and subscriptions and clerical, 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 shareholders 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 shareholders, 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 would provide 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 Agreement, including rent 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 corporate secretary, and their respective staffs. The administrative fee is payable quarterly in arrears. For the three and nine months ended September 30, 2015, we incurred and administration fee expense of $0.3 million and $1.1 million, respectively. For the three and nine months ended September 30, 2014, we incurred and administration fee expense of $0.2 million and $1.0 million, respectively.

 

Staffing Agreement

 

OFS Advisor is an affiliate of Orchard First Source Capital, Inc. (“OFSC”), with which it has entered into a staffing and corporate services agreement (“Staffing Agreement”). Under this agreement OFSC will make available to OFS Advisor experienced investment professionals and access to the senior investment personnel and other resources of OFSC and its affiliates. The Staffing Agreement should provide OFS Advisor with access to deal flow generated by the professionals of OFSC and its affiliates and commits the members of the Advisor Investment Committee to serve in that capacity. OFS Advisor intends to capitalize on the significant deal origination and sourcing, credit underwriting, due diligence, investment structuring, execution, portfolio management and monitoring experience of OFSC’s investment professionals.

 

OFSC also has entered into a staffing and corporate services agreement with OFS Services. Under this agreement, OFS Services will make available to OFSC experienced investment professionals and access to the administrative resources of OFS Services.

 

Recent Developments

 

On November 5, 2015, we, as borrower, entered into a Business Loan Agreement (“BLA”) with Pacific Western Bank, as lender, to provide OFS Capital with a $15.0 million senior secured revolving credit facility (“PWB Credit Facility”), 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 BLA. The PWB Credit Facility is guaranteed by OFS Capital WM and secured by all of our current and future assets excluding assets held by SBIC I LP and our SBIC I LP and SBIC I GP partnership interests. The BLA matures on November 7, 2017. Advances under the facility will bear interest at a fixed rate per annum equal to 4.75%. We paid a $150 thousand commitment fee in connection with the closing of the PWB Credit Facility.

 

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.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

We are subject to financial market risks, including changes in interest rates. At September 30, 2015, 56% of our debt investments bore interest at floating interest rates and 44% of our debt investments bore fixed interest rates. 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. All of the debt investments bearing floating interest rates in our portfolio as of September 30, 2015 had interest rate floors, which have effectively converted those debt investments to fixed rate debt investments until LIBOR exceeds the interest rate floor.

 

Assuming that our consolidated balance sheet as of September 30, 2015 was to remain constant, and that we took no actions to alter our existing interest rate sensitivity, the following table shows the annualized impact of hypothetical base rate changes in interest rates.

 

 

   Interest   Interest   Net increase 
Basis point increase (1)  income   expense (2)   (decrease) 
   (Amounts in thousands) 
100  $348   $-   $348 
200   1,514    -    1,514 
300   2,790    -    2,790 
400   4,067    -    4,067 
500   5,344    -    5,344 

 

(1)A decline in interest rates would not have a material impact on our consolidated financial statements.
(2)As of September 30, 2015, our outstanding debt consisted of our SBA debentures payable which carry a fixed interest rate over the term of the debenture.

 

Although we believe that the foregoing analysis is indicative of our sensitivity to interest rate changes, 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 prime rates.

 

Item 4. Controls and Procedures

 

Disclosure Controls and Procedures

 

Our Chief Executive Officer and Chief Financial Officer, under the supervision and with the participation of our management, conducted an evaluation of our disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As of the end of the period covered by this quarterly report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

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Changes in Internal Control Over Financial Reporting

 

There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended) that occurred during the quarter ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We, OFS Advisor and OFS Services, are not currently subject to any material pending or threatened legal proceedings against us as of September 30, 2015. 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. 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 or results of operations.

 

Item 1A. Risk Factors

 

Investing in our common stock may be speculative and involves a high degree of risk. In addition to the other information contained in this Quarterly Report on Form 10-Q, including our financial statements, and the related notes, schedules and exhibits, you should carefully consider the risk factors described in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, which could materially affect our business, financial condition and/or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and/or operating results.

 

There have been no material changes from the risk factors previously disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014, which should be read together with the other risk factors and information disclosed elsewhere in this Quarterly Report on Form 10-Q and our other reports filed with the SEC.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

During the three month period ended September 30, 2015, we issued 14,355 shares of common stock to shareholders in connection with our dividend reinvestment plan. These issuances were not subject to the registration requirements of the Securities Act of 1933, as amended. The aggregate value of the shares of our common stock issued under our dividend reinvestment plan was approximately $147 thousand.

 

Item 3. Defaults Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable.

 

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Item 6. Exhibits

 

Listed below are the exhibits that are filed as part of this report (according to the number assigned to them in Item 601 of Regulation S-K):

 

Exhibit

Number

  Description
     
10.1  

Business Loan Agreement between OFS Capital Corporation and Pacific Western Bank dated November 5, 2015*

     
10.2  

Promissory Note between OFS Capital Corporation and Pacific Western Bank dated November 5, 2015*

     
10.3  

Commercial Guaranty Agreement among OFS Capital Corporation, OFS Capital WM, LLC, and Pacific Western Bank dated November 5, 2015*

     
11.1   Computation of Per Share Earnings for OFS Capital Corporation (included in the notes to the financial statements contained in this report)
     
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*

 

*Filed herewith.

 

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SIGNATURES

 

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.

 

Dated: November 6, 2015 OFS CAPITAL CORPORATION
     
  By: /s/ Bilal Rashid
  Name: Bilal Rashid
  Title: Chief Executive Officer
     
  By: /s/ Jeffrey A. Cerny
    Jeffrey A. Cerny
    Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit

Number

  Description
     
10.1  

Business Loan Agreement between OFS Capital Corporation and Pacific Western Bank dated November 5, 2015*

     
10.2  

Promissory Note between OFS Capital Corporation and Pacific Western Bank dated November 5, 2015*

     
10.3  

Commercial Guaranty Agreement among OFS Capital Corporation, OFS Capital WM, LLC, and Pacific Western Bank dated November 5, 2015*

     
11.1   Computation of Per Share Earnings for OFS Capital Corporation (included in the notes to the financial statements contained in this report)
     
31.1   Chief Executive Officer Certification Pursuant to Exchange Act Rule 13a-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
     
31.2   Chief Financial Officer Certification Pursuant to Exchange Act Rule 13a-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
     
32.1   Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
     
32.2   Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

 

*Filed herewith.

 

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Exhibit 10.1

BUSINESS LOAN AGREEMENT

Principal

$15,000,000.00

Loan Date

11-05-2015

Maturity

11-06-2017

Loan No Call / Coll

Account

Port #618529

Officer

825

Initials
4061100374  

References in the boxes above are for Lender's use only and do not limit the applicability of this document to any particular loan or item.

Any item above containing "***" has been omitted due to text length limitations.

 

Borrower:

OFS Capital Corporation, a Delaware corporation

10 South Wacker Drive, Suite 2500

Chicago, IL 60606

Lender:

Pacific Western Bank

Los Angeles Real Estate and Construction

1880 Century Park East, Suite #800

Los Angeles, CA 90067

 

THIS BUSINESS LOAN AGREEMENT dated November 5, 2015, is made and executed between OFS Capital Corporation, a Delaware corporation ("Borrower") and Pacific Western Bank ("Lender") on the following terms and conditions. Borrower has received prior commercial loans from Lender or has applied to Lender for a commercial loan or loans or other financial accommodations, including those which may be described on any exhibit or schedule attached to this Agreement. Borrower understands and agrees that: (A) in granting, renewing, or extending any Loan, Lender is relying upon Borrower's representations, warranties, and agreements as set forth in this Agreement; (B) the granting, renewing, or extending of any Loan by Lender at all times shall be subject to Lender's sole judgment and discretion; and (C) all such Loans shall be and remain subject to the terms and conditions of this Agreement.

TERM. This Agreement shall be effective as of November 5, 2015, and shall continue in full force and effect until such time as all of Borrower's Loans in favor of Lender have been paid in full, including principal, interest, costs, expenses, attorneys' fees, and other fees and charges, or until such time as the parties may agree in writing to terminate this Agreement.

ADVANCE AUTHORITY. The following person or persons are authorized to request advances and authorize payments under the line of credit until

Lender receives from Borrower, at Lender's address shown above, written notice of revocation of such authority: Bilal Rashid, Jeff Cerny, and Eric Rubenfeld.

CONDITIONS PRECEDENT TO EACH ADVANCE. Lender's obligation to make the initial Advance and each subsequent Advance under this Agreement shall be subject to the fulfillment to Lender's satisfaction of all of the conditions set forth in this Agreement and in the Related Documents.

Advance Rate. The aggregate principal amount of all Advances outstanding at any time shall not exceed 50.00% of all then outstanding non-SBIC investment loans made by Borrower or Guarantor to entities that are acceptable to Lender, which Borrower or Guarantor loans are deemed to be eligible by Lender in its sole discretion (“Eligible Loans”). In addition to the other conditions set forth below, Lender’s obligation to make any Advance shall be subject to receipt by Lender of a consolidated borrowing base certificate from Borrower, in form and substance acceptable to Lender (“Borrowing Base Certificate”), listing all detail requested by Lender with respect to each Borrower and Guarantor loan then outstanding and calculating the availability based on the advance rate set forth above and the eligibility criteria of Lender (the “Borrowing Base”).

Non-Eligible Loan. Without limiting Lender’s discretion, Eligible Loans shall specifically exclude each of the following loans made by Borrower or Guarantor from time to time:

(a)All loans placed on non-accrual;
(b)All loans that are 61-90 days or more past-due;
(c)All loans to an entity if any loan to such entity is 61-90 days or more past-due; and
(d)All foreign loans.

Loan Documents. Borrower shall provide to Lender the following documents for the Loan: (1) the Note; (2) Security Agreements granting to Lender security interests in the Collateral; (3) financing statements and all other documents perfecting Lender's Security Interests; (4) evidence of insurance as required below; (5) together with all such Related Documents as Lender may require for the Loan; all in form and substance satisfactory to Lender and Lender's counsel.

Borrower's Authorization. Borrower shall have provided in form and substance satisfactory to Lender properly certified resolutions, duly authorizing the execution and delivery of this Agreement, the Note and the Related Documents. In addition, Borrower shall have provided such other resolutions, authorizations, documents and instruments as Lender or its counsel, may require.

Payment of Fees and Expenses. Borrower shall have paid to Lender all fees, charges, and other expenses which are then due and payable as specified in this Agreement or any Related Document.

Representations and Warranties. The representations and warranties set forth in this Agreement, in the Related Documents, and in any document or certificate delivered to Lender under this Agreement are true and correct.

No Event of Default. There shall not exist at the time of any Advance a condition which would constitute an Event of Default under this Agreement or under any Related Document.

REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Lender, as of the date of this Agreement, as of the date of each disbursement of loan proceeds, as of the date of any renewal, extension or modification of any Loan, and at such other times expressly noted below:

Eligible Loans. All Eligible Loans are made by and owned entirely either by Borrower or by Guarantor, free and clear of all liens except (A) for liens permitted or provided for under this Agreement or (B) liens in favor of Borrower or Guarantor, as applicable.

Organization. Borrower is a corporation for profit which is, and at all times shall be, duly organized, validly existing, and in good standing under and by virtue of the laws of the State of Delaware. Borrower is, and at all times shall be, duly qualified as a foreign corporation in all states in which the failure to so qualify would have a material adverse effect on its business or financial condition. Borrower has the full power and authority to own its properties and to transact the business in which it is presently engaged or presently proposes to engage. Borrower maintains an office at 10 South Wacker Drive, Suite 2500, Chicago, IL 60606.

 

   
Loan No. 4061100374

BUSINESS LOAN

AGREEMENT

Page 2

 

Unless Borrower has designated otherwise in writing, the offices at which Borrower keeps its books and records including its records concerning the Collateral (other than books and records, including records concerning the Collateral, in the possession of Borrower’s custodian or third-party recordkeepers) are as follows: (1) 10 South Wacker Drive, Suite 2500, Chicago, IL 60606; (2) 4700 Wilshire Boulevard, Los Angeles, CA 90010; and (3) 540 Madison Avenue, New York, NY 10022. Borrower will notify Lender prior to any change in the location of Borrower's state of organization or any change in Borrower's name. Borrower shall do all things necessary to preserve and to keep in full force and effect its existence, and shall comply with all regulations, rules, ordinances, statutes, orders and decrees of any governmental or quasi-governmental authority or court applicable to Borrower and Borrower's business activities, except where the failure to comply could not reasonably be expected to be, have, or result in a material adverse effect on Borrower’s business or financial condition.

Assumed Business Names. Borrower has filed or recorded all documents or filings required by law relating to all assumed business names used by Borrower. Excluding the name of Borrower, the following is a complete list of all assumed business names under which Borrower does business: None.

Authorization. Borrower's execution, delivery, and performance of this Agreement and all the Related Documents have been duly authorized by all necessary action by Borrower and do not result in a violation of or constitute a default under (1) any prov ision of (a) Borrower's articles of incorporation or organization, or bylaws, or (b) any agreement or other instrument binding upon Borrower or (2) any law, governmental regulation, court decree, or order applicable to Borrower or to Borrower's properties, the effect of which, in each case, could reasonably be expected to be, have, or result in a material adverse effect on Borrower’s business or financial condition.

Financial Information. Each of Borrower's financial statements supplied to Lender present fairly in all material respects the financial condition, assets and liabilities and results of operations of Borrower at the dates and for the relevant periods indicated in accordance with GAAP consistently applied, and there has been no material adverse change in Borrower's financial condition subsequent to t he date of the most recent financial statement supplied to Lender. Borrower has no material contingent obligations except as disclosed in such financial statements.

Legal Effect. This Agreement constitutes, and any instrument or agreement Borrower is required to give under this Agreement when delivered will constitute legal, valid, and binding obligations of Borrower enforceable against Borrower in accordance with their respective terms, subject to the effect of any applicable bankruptcy, moratorium, insolvency, reorganization or other similar law affecting the enforceability of creditors’ rights generally and to the effect of general principles of equity which may limit the availability of equitable remedies.

Properties. Except as contemplated by this Agreement or as previously disclosed in Borrower's financial statements or in writing to Lender and as accepted by Lender, and except for liens permitted or provided for under this Agreement, Borrower owns and has good title to all of Borrower's properties free and clear of all Security Interests, and has not executed any security documents or financing statements relating to such properties. All of Borrower's properties are titled in Borrower's legal name, and Borrower has not used or filed a financing statement under any other name since November 7, 2012.

Hazardous Substances. Except as disclosed to and acknowledged by Lender in writing, Borrower represents and warrants that: Borrower has no knowledge of, or reason to believe that there has been (a) any material breach or violation of any Environmental Laws by Borrower; (b) any actual or threatened litigation or claims of any kind by any person (i) relating to non-compliance by or liability of Borrower under any Environmental Laws or (ii) that alleges than Borrower has liability or potential liability with respect to any Hazardous Substance or any Environmental Laws.

Litigation and Claims. No material litigation, claim, investigation, administrative proceeding or similar action (including those for unpaid taxes) against Borrower is pending or threatened, and no other event has occurred which may materially adversely affect Borrower's financial condition or properties, other than litigation, claims, or other events, if any, that have been disclosed in Borrower’s public filings.

Taxes. To the best of Borrower's knowledge, all of Borrower's tax returns and reports that are or were required to be filed, have been filed, and all taxes, assessments and other governmental charges have been paid in full, except those presently being or to be contested by Borrower in good faith in the ordinary course of business and for which adequate reserves have been provided.

Lien Priority. Unless otherwise previously disclosed to Lender in writing, and other than with respect to liens permitted or provided for under this Agreement or the Related Documents, Borrower has not entered into or granted any security agreements, or permitted the filing or attachment of any Security Interests on or affecting any of the Collateral directly or indirectly securing repayment of Borrower's Loan and Note, that, as of the date of this Agreement, are in existence and are superior to Lender's Security Interests and rights in and to such Collateral.

Binding Effect. This Agreement, the Note, all Security Agreements (if any), and all Related Documents are binding upon the signers thereof, as well as upon their successors and assigns, and are legally enforceable in accordance with their respective terms, subject to the effect of any applicable bankruptcy, moratorium, insolvency, reorganization or other similar law affecting the enforceability of creditors’ rights generally and to the effect of general principles of equity which may limit the availability of equitable remedies.

AFFIRMATIVE COVENANTS. Borrower covenants and agrees with Lender that, so long as this Agreement remains in effect, Borrower will:

Notices of Claims and Litigation. Promptly inform Lender in writing of (1) all material adverse changes in Borrower's financial condition, and (2) all existing and all threatened litigation, claims, investigations, administrative proceedings or similar actions affecting Borrower or any Guarantor which could materially affect the financial condition of Borrower or the financial condition of any Guarantor.

Financial Records. Maintain its books and records in accordance with GAAP, applied on a consistent basis (except for the omission of footnotes and year-end adjustments in interim financial statements), and permit Lender to examine and audit Borrower's books and records at all reasonable times.

Financial Statements. Furnish Lender with the following:

(i) Financial Statements:

Annual Financial Statements. Borrower shall provide to Lender, as soon as available, but in no event later than ninety (90) days after the end of each fiscal year, a consolidated and consolidating balance sheet and income statement for the period ended in form satisfactory to Lender, audited by a CPA acceptable to Lender or an independent public accountant of recognized national standing; provided that the requirements set forth in this paragraph may be fulfilled by providing to Lender the report of the Borrower to the Securities and Exchange Commission (“SEC”) on Form 10-K for the applicable fiscal year.

 

   
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Interim Financial Statements. Borrower shall provide to Lender, as soon as available, but in no event later than forty-five (45) days after the end of each of the first three fiscal quarters of each fiscal year of Borrower, a consolidated and consolidating balance sheet and income statement for the period ended in form satisfactory to Lender; provided that the requirements set forth in this paragraph may be fulfilled by providing to Lender the report of the Borrower to the SEC on Form 10-Q for the applicable quarterly period.

(ii) Financial Ratios/Covenants:

Minimum Tangible Net Asset Value. Borrower shall maintain a minimum Net Asset Value in the amount of $100,000,000.00. The term “Net Asset Value" is defined as the total assets less goodwill/other intangible less the total liabilities on a consolidated basis. This required value must be maintained at all times and may be evaluated quarterly.

Statutory Asset Coverage Test. Statutory Asset Coverage Test shall not be less than 200%. The term "Statutory Asset Coverage Test" is defined as the ratio which the value of total assets, less all liabilities and indebtedness not represented by “Senior Securities” (as such term is defined and determined pursuant to the Investment Company Act of 1940, as amended, and any orders of the SEC issued to the Borrower thereunder), bears to the aggregate amount of Senior Securities representing indebtedness. For purposes of this Statutory Asset Coverage Test, any indebtedness of any SBIC shall be excluded from the definition of “Senior Securities.” This required test must be maintained at all times and may be evaluated quarterly.

Minimum Quarterly Net Investment Income. Borrower shall maintain a minimum Quarterly Net Investment Income after the management/incentive fees in the amount of $2,000,000.00. The term "Net Investment Income" is defined as the total investment income less the total expense, as presented in Borrower’s financial statements . This required minimum income must be maintained at all times and may be evaluated quarterly.

(iii) Reports/Schedules/Statements/Certifications:

Borrowing Base Certificate. Borrower shall provide to Lender a Borrowing Base Certificate in the form satisfactory to Lender with each advance request and, at such time as any advance is outstanding, on or before the tenth (10th) day after the end of each calendar month. The aforementioned Borrowing Base Certificate shall set forth a calculation of the Borrowing Base as of the effective date of such Borrowing Base Certificate reasonably acceptable to Lender, and unless Lender notifies Borrower within ten (10) Business Days of Lender's receipt of a Borrowing Base Certificate that Lender does not accept the calculation of the Borrowing Base set forth in such B orrowing Base Certificate, the Borrowing Base set forth shall be deemed to be the applicable Borrowing Base for Advances of Loans until delivery to Lender of the next succeeding Borrowing Base Certificate.

Additional Information. Furnish such additional information and statements, as Lender may request from time to time.

Insurance. Maintain, with financially sound and reputable insurance companies, insurance in such amounts and against such risks as are customarily maintained by companies engaged in the same or similar business, operating in the same or similar locations. Borrower, upon request of Lender, will deliver to Lender from time to time the policies or certificates of insurance in form satisfactory to Lender. Each insurance policy also shall include an endorsement providing that coverage in favor of Lender will not be impaired in any way by any act, omission or default of Borrower or any other person. In connection with all policies covering assets in which Lender holds or is offered a security interest for the Loans, Borrower will provide Lender with such lender's loss payable or other endorsements as Lender may require.

Insurance Reports. Furnish to Lender, upon request of Lender, evidence of each existing insurance policy showing such information as Lender may reasonably request, including without limitation the following: (1) the name of the insurer; (2) the risks insured; (3) the amount of the policy; (4) the properties insured; (5) the then current property values on the basis of which insurance has been obtained; and (6) the expiration date of the policy. To the extent there is a change in the information provided by Borrower with respect to items (1), (2), (3), (4), or (6) of the preceding sentence, Borrower shall notify Lender and provide such changed information.

Guaranties. Prior to disbursement of any Loan proceeds, furnish executed guaranties of the Loans in favor of Lender, executed by the guarantor named below, on Lender's forms, and in the amount and under the conditions set forth in those guaranties.

Name of Guarantor Amount
OFS Capital WM, LLC, a Delaware limited liability company Unlimited

Other Agreements. Comply with all terms and conditions of all other material agreements, whether now or hereafter existing, between Borrower and any other party and notify Lender immediately in writing of any default in connection with any other such agreements, except, in each case, where the failure to comply or such default could not reasonably be expected to be, have, or result in a material adverse effect on Borrower’s business or financial condition.

Loan Proceeds. Use all Loan Proceeds solely for Borrower's or Guarantor’s general corporate purposes and business operations, including, but not limited to, acquiring and funding investments, for working capital purposes, and the paying of dividends.

Taxes, Charges and Liens. Pay and discharge when due all of its material indebtedness and obligations, including without limitation all assessments, taxes, governmental charges, levies and liens, of every kind and nature, imposed upon Borrower or its properties, income, or profits, prior to the date on which penalties would attach, and all lawful claims that, if unpaid, might become a lien or charge upon any of Borrower's properties, income, or profits. Provided however, Borrower will not be required to pay and discharge any such assessment, tax, charge, levy, lien or claim so long as (1) the legality of the same shall be contested in good faith by appropriate proceedings, and (2) Borrower shall have established on Borrower's books adequate reserves with respect to such contested assessment, tax, charge, levy, lien, or claim in accordance with GAAP.

Performance. Perform and comply, in a timely manner, with all terms, conditions, and provisions set forth in this Agreement, in the Related Documents, and in all other instruments and agreements between Borrower and Lender. Borrower shall notify Lender promptly in writing of any default in connection with any such agreement.

Operations. Maintain executive and management personnel with substantially the same qualifications and experience as the present executive and management personnel; provide written notice to Lender of any change in executive and management personnel; engage principally in the same or similar lines of business substantially as heretofore conducted.

 

   
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BUSINESS LOAN

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Compliance with Governmental Requirements. Comply with all material laws, ordinances, and regulations, now or hereafter in effect, of all governmental authorities applicable to the conduct of Borrower's properties, businesses and operations, and to the use or occupancy of the Collateral, except where the failure to comply could not reasonably be expected to be, have, or result in a material adverse effect on Borrower’s business or financial condition.

Inspection. Upon reasonable notice from Lender, permit employees or agents of Lender at any reasonable time to inspect any and all Collateral for the Loan or Loans and Borrower's other properties and to examine or audit Borrower's books, accounts, and records and to make copies and memoranda of Borrower's books, accounts, and records. If Borrower now or at any time hereafter maintains any records (including without limitation computer generated records and computer software programs for the generation of such records) in the possession of a third party, Borrower, upon reasonable notice and request of Lender, shall request that the third party permit Lender free access to such records, to the extent permitted by the third party, at all reasonable times and to provide Lender with copies of any records it may request, all at Borrower's expense.

Environmental Compliance and Reports. Borrower shall comply in all material respects with any and all Environmental Laws, except where the failure to comply could not reasonably be expected to be, have, or result in a material adverse effect on Borrower’s business or financial condition;; shall furnish to Lender promptly and in any event within thirty (30) days after receipt thereof a copy of any notice, summons, lien, citation, directive, letter or other communication from any governmental agency or instrumentality concerning any intentional or unintentional action or omission on Borrower's part in connection with any environmental activity in violation of any Environmental Laws or with regard to any Hazardous Substances, whether or not there is damage to the environment and/or other natural resources.

Additional Assurances. Make, execute and deliver to Lender such promissory notes, mortgages, deeds of trust, security agreements, assignments, financing statements, instruments, documents and other agreements as Lender or its attorneys may reasonably request to evidence and secure the Loans and to perfect all Security Interests.

RECOVERY OF ADDITIONAL COSTS. If the imposition of or any change in any law, rule, regulation or guideline, or the interpretation or application of any thereof by any court or administrative or governmental authority (including any request or policy not having the force of law) shall impose, modify or make applicable any taxes (except federal, state or local income or franchise taxes imposed on Lender), reserve requirements, capital adequacy requirements or other obligations which would (A) increase the cost to Lender for extending or maintaining the credit facilities to which this Agreement relates, (B) reduce the amounts payable to Lender under this Agreement or the Related Documents, or (C) reduce the rate of return on Lender's capital as a consequence of Lender's obligations with respect to the credit facilities to which this Agreement relates, then Borrower agrees to pay Lender such additional amounts as will compensate Lender therefor (“Additional Amounts”), within ten (10) days after Lender's written demand for such payment, which demand shall be accompanied by an explanation of such imposition or charge and a calculation in reasonable detail of the additional amounts payable by Borrower, which explanation and calculations shall be conclusive in the absence of manifest error.

LENDER'S EXPENDITURES. If Borrower fails to comply with any provision of this Agreement or any Related Documents, including but not limited to Borrower's failure to discharge or pay when due any amounts Borrower is required to discharge or pay under this Agreement or any Related Documents, Lender on Borrower's behalf m ay (but shall not be obligated to) pay any such amounts and take any action that Lender deems appropriate to discharge or pay all taxes, liens, security interests, encumbrances and other claims, at any time levied or placed on any Collateral and pay all costs for insuring, maintaining and preserving any Collateral. All such expenditures incurred or paid by Lender for such purposes will then bear interest at the rate charged under the Note from the date incurred or paid by Lender to the date of repayment by Borrower. All such expenses will become a part of the Indebtedness and, at Lender's option, will (A) be payable on demand; (B) be added to the balance of the Note and be apportioned among and be payable with any installment payments to become due during either (1) the term of any applicable insurance policy; or (2) the remaining term of the Note; or (C) be treated as a balloon payment which will be due and payable at the Note's maturity.

NEGATIVE COVENANTS. Borrower covenants and agrees with Lender that while this Agreement is in effect, Borrower shall not, without the prior written consent of Lender:

Indebtedness and Liens. (1) create, incur, assume, or guarantee indebtedness for borrowed money, including capital leases, other than (A) for trade debt incurred in the normal course of business and indebtedness to Lender contemplated by this Agreement, (B) unsecured indebtedness with a maturity date that is after the maturity date of the Indebtedness under this Agreement, (C) indebtedness incurred hereunder and pursuant to this Agreement and the Related Documents, (D) obligations payable to clearing agencies, brokers or dealers in connection with the purchase or sale of securities in the ordinary course of business, (E) any indebtedness that is expressly subordinated to the indebtedness incurred hereunder and pursuant to this Agreement, (F) any guarantee by the Borrower of indebtedness of an SBIC subsidiary of the Borrower on the SBA’s then applicable form, (G) repurchase obligations arising in the ordinary course of business with respect to U.S. government obligations; and (H) any guarantee in the ordinary course of business;

(2) mortgage, pledge, grant a security interest in, or encumber any of Borrower's assets, except that the Borrower may do and incur the following: (A) Permitted Liens; (B) liens on equity interests in any SBIC subsidiary of the Borrower created in favor of the SBA; (C) liens securing repurchase obligations arising in the ordinary course of business with respect to U.S. government obligations; (D) liens of clearing agencies, broker-dealers and similar liens incurred in the ordinary course of business; (E) liens securing the performance of, or payment in respect of, bids, insurance premiums, deductibles or co-insured amounts, tenders, government or utility contracts (other than for the repayment of borrowed money), surety, stay, customs and appeal bonds and other obligations of a similar nature incurred in the ordinary course of business; (F) liens arising out of judgments or awards that have been in force for less than the applicable period for taking an appeal so long as such judgments or awards do not either constitute an Event of Default or exceed $1,000,000 individually or in the aggregate; and (G) any right of set-off granted in favor of any financial institution in respect of deposit accounts opened and maintained in the ordinary course of business or pursuant to the requirements of this Agreement; or

(3) sell, transfer, lease, assign, or otherwise dispose of its assets, or acquire assets, other than in the ordinary course of its business or otherwise in accordance with the investment objectives and policies of Borrower as set forth in the Registration Statement on Form N-2 as filed with the SEC in December 2014 and as such investment objectives and policies may be amended, changed, supplemented or modified from time to time.

Continuity of Operations. (1) Engage in any business activities substantially different than those in which Borrower is presently engaged, (2) cease operations, liquidate, merge, consolidate with any other entity, or dissolve, except that (A) Borrower may engage in such actions in the ordinary course of its business and (B) Borrower may merge or consolidate with any other person so long as Borrower is the continuing or surviving entity in such transaction; or (3) pay any dividends on Borrower's stock (other than dividends payable in its stock), provided, however that notwithstanding the foregoing, Borrower may declare, pay, or make any distribution or dividend necessary to maintain its eligibility to qualify as a “regulated investment company” (as defined in the Internal Revenue Code of 1986, as amended (the “Code”)) and to avoid the imposition of U.S. federal income taxes and excise taxes on undistributed earnings under Section 4982 of the Code or any successor provisions thereto.

Loans and Acquisitions. (1) Loan, invest in or advance money or assets to any other person, enterprise or entity, except for loans, investments, and advances made in accordance with the investment objectives and policies of Borrower as set forth in the Registration Statement on Form N-2 as filed with the SEC in December 2014 and as such investment objectives and policies may be amended, changed, supplemented or modified from time to time, and (2) purchase, create or acquire any equity interest in any other enterprise or entity, other than (A) in an existing subsidiary of Borrower as of the date of this Agreement or (B) in a financing subsidiary or tax blocker.

 

   
Loan No. 4061100374

BUSINESS LOAN

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Agreements. Enter into any material agreement containing any provisions which would be violated or breached by the performance of Borrower's obligations under this Agreement or in connection herewith, except where such violation or breach could not reasonably be expected to be, have, or result in a material adverse effect on Borrower’s business or financial condition.

CESSATION OF ADVANCES. If Lender has made any commitment to make any Loan to Borrower, whether under this Agreement or under any other agreement, Lender shall have no obligation to make Loan Advances or to disburse Loan proceeds if: (A) Borrower or any Guarantor is in default under the terms of this Agreement or any of the Related Documents or any other agreement that Borrower or any Guarantor has with Lender; (B) Borrower or any Guarantor becomes insolvent, files a petition in bankruptcy or similar proceedings, or is adjudged a bankrupt; (C) there occurs a material adverse change in Borrower's financial condition, in the financial condition of any Guarantor, or in the value of any Collateral securing any Loan; or (D) any Guarantor seeks, claims or otherwise attempts to limit, modify or revoke such Guarantor's guaranty of the Loan or any other loan with Lender; or (E) Lender in good faith deems itself insecure, even though no Event of Default shall have occurred.

RIGHT OF SETOFF. To the extent permitted by applicable law, Lender reserves a right of setoff in all Borrower's accounts with Lender (whether checking, savings, or some other account). This includes all accounts Borrower holds jointly with someone else and all accounts Borrower may open in the future. However, this does not include any trust accounts for which setoff would be prohibited by law. Borrower authorizes Lender, to the extent permitted by applicable law, to charge or setoff all sums owing on the Indebtedness against any and all such accounts.

DEFAULT. Each of the following shall constitute an Event of Default under this Agreement:

Payment Default. Borrower fails to make any payment when due under the Loan.

Other Defaults. Borrower fails to comply with or to perform any other term, obligation, covenant or condition contained in this Agreement or in any of the Related Documents to which it is a party or to comply with or to perform any term, obligation, covenant or condition contained in any other agreement between Lender and Borrower.

Default in Favor of Third Parties. Borrower or any Grantor defaults under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that could reasonably be expected to be, have, or result in a material adverse effect on Borrower's assets and property as a whole or Grantor's assets and property as a whole (it being understood that a default by Borrower or any Grantor for an amount equal to or exceeding $1,000,000, individually or in the aggregate, shall be deemed to have a material adverse effect on Borrower or such Grantor, respectively) or Borrower's or Grantor's ability to repay the Loans or perform their respective obligations under this Agreement or any of the Related Documents.

False Statements. Any warranty, representation or statement made or furnished to Lender by Borrower or on Borrower's behalf under this Agreement or the Related Documents is false or misleading in any material respect, either now or at the time made or furnished or becomes false or misleading at any time thereafter.

Insolvency. The dissolution or termination of Borrower's existence as a going business, the insolvency of Borrower, the appointment of a receiver for any part of Borrower's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Borrower.

Defective Collateralization. This Agreement or any of the Related Documents ceases to be in full force and effect (including failure of any collateral document to create a valid and perfected security interest or lien) at any time and for any reason (other than as a result of termination in accordance with such agreement’s or document’s terms).

Creditor or Forfeiture Proceedings. Commencement of foreclosure or forfeiture proceedings by any creditor of Borrower or by any governmental agency against a substantial part of the Collateral securing the Loan and, in any such case, such proceeding shall continue undismissed and unstayed for a period of 60 or more days or an order or decree approving or ordering any of the foregoing shall be entered. However, this Event of Default shall not apply if there is a good faith dispute by Borrower as to the validity or reasonableness of the claim which is the basis of the creditor or forfeiture proceeding and if Borrower gives Lender written notice of the creditor or forfeiture proceeding and deposits with Lender monies or a surety bond for the creditor or forfeiture proceeding, in an amount determined by Lender, in its sole discretion, as being an adequate reserve or bond for the dispute.

Events Affecting Guarantor. Any of the preceding events occurs with respect to any Guarantor of any of the Indebtedness or any Guarantor revokes or disputes the validity of, or liability under, any Guaranty of the Indebtedness.

Change in Advisor. OFS Capital Management, LLC, ceases to serve as Borrower’s investment advisor without the prior written consent of Lender.

Adverse Change. A material adverse change occurs in Borrower's or any Grantor’s financial condition.

Right to Cure. If any one of the above Events of default, other than under the heading “Payment Default,” is curable and if Borrower or Grantor, as the case may be, has not been given a notice of a similar default within the preceding twelve (12) months, it may be cured if Borrower or Grantor, as the case may be, after Lender sends written notice to Borrower or Grantor, as the case may be, demanding cure of such default: (1) cure the default within fifteen (15) days; or (2) if the cure requires more than fifteen (15) days, immediately initiate steps which Lender deems in Lender's sole discretion to be sufficient to cure the default and thereafter continue and complete all reasonable and necessary steps sufficient to produce compliance as soon as reasonably practical.

EFFECT OF AN EVENT OF DEFAULT. If any Event of Default shall occur, except where otherwise provided in this Agreement or the Related Documents, Lender may by notice to Borrower, and at any time during the continuance of such event, take either or both of the following actions: (1) terminate all commitments and obligations of Lender under this Agreement or the Related Documents or any other agreement between Borrower and Lender (including any obligation to make further Loan Advances or disbursements), and (ii) declare all Indebtedness to be due and payable, except that in the case of an Event of Default of the type described in the "Insolvency" subsection above, such acceleration shall be automatic and not require presentment, demand, or notice. In addition, Lender shall have all the rights and remedies provided in the Related Documents or available at law, in equity, or otherwise. Except as may be prohibited by applicable law, all of Lender's rights and remedies shall be cumulative and may be exercised singularly or concurrently. Election by Lender to pursue any remedy shall not exclude pursuit of any other remedy, and an election to make expenditures or to take action to perform an obligation of Borrower or of any Grantor shall not affect Lender's right to declare a default and to exercise its rights and remedies.

INTEGRATION. The parties agree that (a) this Agreement, together with all of the Related Documents, represents the final agreement between the parties, and therefore incorporates all negotiations of the parties hereto (b) there are no unwritten oral agreements between the parties, and (c) this Agreement may not be contradicted by evidence of any prior, contemporaneous, or subsequent oral agreements or understandings of the parties.

MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of this Agreement:

Amendments. This Agreement, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Agreement. No alteration of or amendment to this Agreement shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment.

Attorneys' Fees; Expenses. Borrower agrees to pay upon demand all of Lender's costs and expenses, including Lender's attorneys' fees and Lender's legal expenses, incurred in connection with the enforcement of this Agreement. Lender may hire or pay someone else to help enforce this Agreement, and Borrower shall pay the costs and expenses of such enforcement. Costs and expenses include Lender's attorneys' fees and legal expenses whether or not there is a lawsuit, including attorneys' fees and legal expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Borrower also shall pay all court costs and such additional fees as may be directed by the court.

 

   
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BUSINESS LOAN

AGREEMENT

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Caption Headings. Caption headings in this Agreement are for convenience purposes only and are not to be used to interpret or define the provisions of this Agreement.

Consent to Loan Participation. Borrower agrees and consents to Lender's sale or transfer, whether now or later, of one or more participation interests in the Loan to one or more purchasers, whether related or unrelated to Lender. Borrower additionally waives any and all notices of sale of participation interests, as well as all notices of any repurchase of such participation interests. Borrower also agrees that the purchasers of any such participation interests will be considered as the absolute owners of such interests in the Loan and will have all the rights granted under the participation agreement or agreements governing the sale of such participation interests. Borrower further waives all rights of offset or counterclaim that it may have now or later against Lender or against any purchaser of such a participation interest and unconditionally agrees that either Lender or such purchaser may enforce Borrower's obligation under the Loan irrespective of the failure or insolvency of any holder of any interest in the Loan. Borrower further agrees that the purchaser of any such participation interests may enforce its interests irrespective of any personal claims or defenses that Borrower may have against Lender.

Confidentiality. Lender agrees to maintain the confidentiality of the information received in connection with this Agreement relating to Borrower or Guarantor or any of their respective businesses (other than any such information that is available to the Lender on a nonconfidential basis prior to disclosure by the Borrower or Guarantor), except that information may be disclosed (a) to its affiliates and to its and its affiliates’ respective partners, directors, officers, employees, agents, advisors and other representatives (it being understood that the Persons to whom such disclosure is made will be informed of the confidential nature of such Information and instructed to keep such Information confidential), (b) to the extent requested by any regulatory authority purporting to have jurisdiction over it (including any self-regulatory authority), (c) to the extent required by applicable laws or regulations or by any subpoena or similar legal process, (d) in connection with the exercise of any remedies hereunder or any action or proceeding relating to this Agreement or the enforcement of rights hereunder or thereunder, (e) subject to an agreement containing provisions substantially the same as those of this paragraph, to any assignee of or participant in, or any prospective assignee of or participant in, any of its rights or obligations under this Agreement, and (f) with the consent of the Borrower, (i) to the extent such information (x) becomes publicly available other than as a result of a breach of this paragraph or (y) becomes available to Lender or any of its respective affiliates on a nonconfidential basis from a source other than Borrower. In addition, Lender hereby acknowledges that United States securities laws prohibit any person with material, non-public information about a registered security from buying or selling such securities or, subject to certain limited exceptions, from communicating such information to any other person. Lender hereby agrees that the information provided in connection with this Agreement may contain material, non-public information and further agrees to comply, and to insure compliance by its representatives, with applicable securities laws concerning such information, so long as any such disclosure comports with all applicable laws.

Governing Law. This Agreement will be governed by federal law applicable to Lender and, to the extent not preempted by federal law, the laws of the State of California without regard to its conflicts of law provisions. This Agreement has been accepted by Lender in the State of California.

Choice of Venue. If there is a lawsuit, Borrower agrees upon Lender's request to submit to the jurisdiction of the courts of Los Angeles County, State of California.

No Waiver by Lender. Lender shall not be deemed to have waived any rights under this Agreement unless such waiver is given in writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of a provision of this Agreement shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Agreement. No prior waiver by Lender, nor any course of dealing between Lender and Borrower, or between Lender and any Grantor, shall constitute a waiver of any of Lender's rights or of any of Borrower's or any Grantor's obligations as to any future transactions. Whenever the consent of Lender is required under this Agreement, the granting of such consent by Lender in any instance shall not constitute continuing consent to subsequent instances where such consent is required and in all cases such consent may be granted or withheld in the sole discretion of Lender.

Notices. Any notice required to be given under this Agreement shall be given in writing, and shall be effective when actually delivered, when actually received by e-mail or telefacsimile (unless otherwise required by law), when deposited with a nationally recognized overnight courier, or, if mailed, when deposited in the United States mail, as first class, certified or registered mail postage prepaid, directed to the addresses shown near the beginning of this Agreement. Any party may change its address for notices under this Agreement by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. For notice purposes, Borrower agrees to keep Lender informed at all times of Borrower's current address. Unless otherwise provided or required by law, if there is more than one Borrower, any notice given by Lender to any Borrower is deemed to be notice given to all Borrowers.

Severability. If a court of competent jurisdiction finds any provision of this Agreement to be illegal, invalid, or unenforceable as to any circumstance, that finding shall not make the offending provision illegal, invalid, or unenforceable as to any other circumstance. If feasible, the offending provision shall be considered modified so that it becomes legal, valid and enforceable. If the offending provision cannot be so modified, it shall be considered deleted from this Agreement. Unless otherwise required by law, the illegality, invalidity, or unenforceability of any provision of this Agreement shall not affect the legality, validity or enforceability of any other provision of this Agreement.

Successors and Assigns. All covenants and agreements by or on behalf of Borrower contained in this Agreement or any Related Documents shall bind Borrower's successors and assigns and shall inure to the benefit of Lender and its successors and assigns. Borrower shall not, however, have the right to assign Borrower's rights under this Agreement or any interest therein, without the prior written consent of Lender. Notwithstanding anything herein to the contrary, where Lender assigns or otherwise transfers any of its rights or obligations under this Agreement, (i) Borrower shall only be obligated to pay Additional Amounts to the transferee of Lender to the extent Borrower would have been obligated to pay such Additional Amounts had such transfer not occurred and (ii) such transferee shall provide Borrower with any forms, documents, or certifications as may be required for Borrower to satisfy any information reporting or withholding tax obligations with respect to any payments under this Agreement.

Survival of Representations and Warranties. Borrower understands and agrees that in extending Loan Advances, Lender is relying on all representations, warranties, and covenants made by Borrower in this Agreement or in any certificate or other instrument delivered by Borrower to Lender under this Agreement or the Related Documents. Borrower further agrees that regardless of any investigation made by Lender, all such representations, warranties and covenants will survive the extension of Loan Advances and delivery to Lender of the Related Documents, shall be continuing in nature, shall be deemed made and redated by Borrower at the time each Loan Advance is made (except where reference is made to a specific date), and shall remain in full force and effect until such time as Borrower's Indebtedness shall be paid in full, or until this Agreement shall be terminated in the manner provided above, whichever is the last to occur.

   
Loan No. 4061100374

BUSINESS LOAN

AGREEMENT

Page 7

WAIVER OF JURY TRIAL. TO THE EXTENT PERMITTED BY APPLICABLE LAW, LENDER AND BORROWER, AND EACH OF THEM, HEREBY IRREVOCABLY WAIVE ANY RIGHT WHICH THEY MAY HAVE TO A JURY TRIAL IN ANY ACTION OR PROCEEDING BASED UPON, OR RELATED TO, THE SUBJECT MATTER OF THIS AGREEMENT OR THE INDEBTEDNESS. THE FOREGOING WAIVER OF TRIAL BY JURY IS KNOWINGLY, INTENTIONALLY AND VOLUNTARILY MADE BY THE LENDER AND BORROWER AND BORROWER ACKNOWLEDGES THAT NEITHER LENDER, NOR ANY PERSON ACTING ON BEHALF OF LENDER, HAS MADE ANY REPRESENTATION OF FACT TO INDUCE THIS WAIVER OF TRIAL BY JURY OR IN ANY WAY TO MODIFY OR NULLIFY ITS EFFECT. BORROWER ACKNOWLEDGES THAT IT HAS HAD THE OPPORTUNITY TO CONSULT INDEPENDENT LEGAL COUNSEL, SELECTED OF ITS OWN FREE WILL, IN THE SIGNING OF THIS AGREEMENT AND IN THE MAKING OF THIS WAIVER, AND THAT BORROWER HAS HAD THE OPPORTUNITY TO DISCUSS THIS WAIVER WITH ITS COUNSEL.

Judicial Reference. (a) The parties prefer that any dispute between them be resolved in litigation subject to a jury trial waiver as set forth above, but the California Supreme Court has held that such pre-dispute jury trial waivers are unenforceable. This Section will be applicable until: (i) the California Supreme Court holds that a pre-dispute jury trial waiver provision similar to that contained above is valid or enforceable; or (ii) the California Legislature passes legislation and the governor of the State of California signs into law a statute authorizing pre-dispute jury trial waivers and as a result such waivers become enforceable.

(b) Other than the exercise of provisional remedies (any of which may be initiated pursuant to applicable law), any controversy, dispute or claim (each, a “Claim”) between the parties arising out of or relating to this Agreement and/or any of the other Related Documents will be resolved by a reference proceeding in California in accordance with the provisions of Section 638 et seq. of the California Code of Civil Procedure (“CCP”), or their successor sections, which shall constitute the exclusive remedy for the resolution of any Claim, including whether the Claim is subject to the reference proceeding. Venue for the reference proceeding will be in the Superior Court or Federal District Court in Los Angeles County, California (the “Court”).

(c) The referee shall be a retired Judge or Justice selected by mutual written agreement of the parties. If the parties do not agree, the referee shall be selected by the Presiding Judge of the Court (or his or her representative). A request for appointment of a referee may be heard on an ex parte or expedited basis, and the parties agree that irreparable harm would result if ex parte relief is not granted. The referee shall be appointed to sit with all the powers provided by law. Pending appointment of the referee, the Court has power to issue temporary or provisional remedies.

(d) The parties agree that time is of the essence in conducting the reference proceedings. Accordingly, the referee shall be requested, subject to change in the time periods specified herein for good cause shown, to (a) set the matter for a status and trial-setting conference within fifteen (15) days after the date of selection of the referee, (b) if practicable, try all issues of law or fact within ninety (90) days after the date of the conference and (c) report a statement of decision within twenty (20) days after the matter has been submitted for decision.

(e) The referee will have power to expand or limit the amount and duration of discovery. The referee may set or extend discovery deadlines or cutoffs for good cause, including a party’s failure to provide requested discovery for any reason whatsoever. Unless otherwise ordered based upon good cause shown, no party shall be entitled to “priority” in conducting discovery, depositions may be taken by either party upon seven (7) days written notice, and all other discovery shall be responded to within fifteen (15) days after service. All disputes relating to discovery which cannot be resolved by the parties shall be submitted to the referee whose decision shall be final and binding.

(f) Except as expressly set forth in this Agreement, the referee shall determine the manner in which the reference proceeding is conducted including the time and place of hearings, the order of presentation of evidence, and all other questions that arise with respect to the course of the reference proceeding. All proceedings and hearings conducted before the referee, except for trial, shall be conducted without a court reporter, except that when any party so requests, a court reporter will be used at any hearing conducted before the referee, and the referee will be provided a courtesy copy of the transcript. The party making such a request shall have the obligation to arrange for and pay the court reporter. Subject to the referee’s power to award costs to the prevailing party, the parties will equally share the cost of the referee and the court reporter at trial.

(g) The referee shall be required to determine all issues in accordance with existing case law and the statutory laws of the State of California. The rules of evidence applicable to proceedings at law in the State of California will be applicable to the reference proceeding. The referee shall be empowered to enter equitable as well as legal relief, provide all temporary or provisional remedies, enter equitable orders that will be binding on the parties and rule on any motion which would be authorized in a trial, including without limitation motions for summary judgment or summary adjudication . The referee shall issue a decision pursuant to CCP Section 644 the referee’s decision shall be entered by the Court as a judgment or an order in the same manner as if the action had been tried by the Court. The final judgment or order or from any appealable decision or order entered by the referee shall be fully appealable as provided by law. The parties reserve the right to findings of fact, conclusions of laws, a written statement of decision, and the right to move for a new trial or a different judgment, which new trial, if granted, is also to be a reference proceeding under this provision.

(h) If the enabling legislation which provides for appointment of a referee is repealed (and no successor statute is enacted), any dispute between the parties that would otherwise be determined by reference procedure will be resolved and determined by arbitration. The arbitration will be conducted by a retired judge or Justice, in accordance with the California Arbitration Act Section 1280 through Section 1294.2 of the CCP as amended from time to time. The limitations with respect to discovery set forth above shall apply to any such arbitration proceeding.

(i) THE PARTIES RECOGNIZE AND AGREE THAT ALL DISPUTES RESOLVED UNDER THIS REFERENCE PROVISION WILL BE DECIDED BY A REFEREE AND NOT BY A JURY. AFTER CONSULTING (OR HAVING HAD THE OPPORTUNITY TO CONSULT) WITH COUNSEL OF THEIR OWN CHOICE, EACH PARTY KNOWINGLY AND VOLUNTARILY AND FOR THEIR MUTUAL BENEFIT AGREES THAT THIS REFERENCE PROVISION WILL APPLY TO ANY DISPUTE BETWEEN THEM WHICH ARISES OUT OF OR IS RELATED TO THIS AGREEMENT.

 

DEFINITIONS. The following capitalized words and terms shall have the following meanings when used in this Agreement. Unless specifically stated to the contrary, all references to dollar amounts shall mean amounts in lawful money of the United States of America. Words and terms used in the singular shall include the plural, and the plural shall include the singular, as the context may require. Words and terms not otherwise defined in this Agreement shall have the meanings attributed to such terms in the Uniform Commercial Code. Accounting words and terms not otherwise defined in this Agreement shall have the meanings assigned to them in accordance with generally accepted accounting principles as in effect on the date of this Agreement:

 

   
Loan No. 4061100374

BUSINESS LOAN

AGREEMENT

Page 8

Advance. The word "Advance" means a disbursement of Loan funds made, or to be made, to Borrower or on Borrower's behalf on a line of credit or multiple advance basis under the terms and conditions of this Agreement.

Agreement. The word "Agreement" means this Business Loan Agreement, as this Business Loan Agreement may be amended or modified from time to time, together with all exhibits and schedules attached to this Business Loan Agreement from time to time.

Borrower. The word "Borrower" means OFS Capital Corporation, a Delaware corporation and its successors and assigns.

Collateral. The word "Collateral" means, collectively, the collateral described and defined in both Security Agreements.

Environmental Laws. The words "Environmental Laws" mean any and all state, federal and local statutes, regulations and ordinances relating to the protection of human health or the environment, including without limitation the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, 42 U.S.C. Section 9601, et seq. ("CERCLA"), the Superfund Amendments and Reauthorization Act of 1986, Pub. L. No. 99-499 ("SARA"), the Hazardous Materials Transportation Act, 49 U.S.C. Section 1801, et seq., the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, et seq., Chapters 6.5 through 7.7 of Division 20 of the California Health and Safety Code, Section 25100, et seq., or other applicable state or federal laws, rules, or regulations adopted pursuant thereto.

Event of Default. The words "Event of Default" mean any of the events of default set forth in this Agreement in the default section of this Agreement.

GAAP. The word "GAAP" means generally accepted accounting principles.

Grantor. The word "Grantor" means each and all of the persons or entities granting a Security Interest in any Collateral for the Loan, including without limitation Borrower and Guarantor granting such a Security Interest.

Guarantor. The word "Guarantor" means OFS Capital WM, LLC, a Delaware limited liability company and its successors and assigns.

Guaranty. The word "Guaranty" means the guaranty from Guarantor to Lender, including without limitation a guaranty of all or part of the Note.

Hazardous Substances. The words "Hazardous Substances" mean materials that, because of their quantity, concentration or physical, chemical or infectious characteristics, may cause or pose a present or potential hazard to human health or the environment when improperly used, treated, stored, disposed of, generated, manufactured, transported or otherwise handled. The words "Hazardous Substances" are used in their very broadest sense and include without limitation any and all hazardous or toxic substances, materials or waste as defined by or listed under the Environmental Laws. The term "Hazardous Substances" also includes, without limitation, petroleum and petroleum by-products or any fraction thereof and asbestos.

Indebtedness. The word "Indebtedness" means the indebtedness evidenced by the Note or Related Documents, including all principal and interest together with all other indebtedness and costs and expenses for which Borrower is responsible under this Agreement or under any of the Related Documents.

Lender. The word "Lender" means Pacific Western Bank and its successors and assigns.

Loan. The word "Loan" means any and all loans and financial accommodations from Lender to Borrower whether now or hereafter existing, and however evidenced, including without limitation those loans and financial accommodations described herein or described on any exhibit or schedule attached to this Agreement from time to time.

Note. The word "Note" means the Note executed by Borrower in the principal amount of $15,000,000.00 dated November 5, 2015, together with all renewals of, extensions of, modifications of, refinancings of, consolidations of and substitutions for the note or credit agreement.

Permitted Liens. The words "Permitted Liens" mean (1) liens and security interests securing Indebtedness owed by Borrower to Lender; (2) liens for taxes, assessments, or similar charges either not yet due or being contested in good faith; (3) liens of materialmen, mechanics, warehousemen, carriers, or custodians, or other liens arising in the ordinary course of business and securing obligations which are not yet delinquent; (4) purchase money liens or purchase money security interests upon or in any property acquired or held by Borrower in the ordinary course of business to secure indebtedness outstanding on the date of this Agreement or permitted to be incurred under the paragraph of this Agreement titled "Indebtedness and Liens"; (5) liens and security interests which, as of the date of this Agreement, have been disclosed to and approved by the Lender in writing; and (6) those liens and security interests which in the aggregate constitute an immaterial and insignificant monetary amount with respect to Borrower's total assets.

Related Documents. The words "Related Documents" mean all promissory notes, credit agreements, loan agreements, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, security deeds, collateral mortgages, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the Loan with Pacific Western Bank or its successors and assigns.

Security Agreements. The words "Security Agreement" mean, collectively, (i) that certain Commercial Security Agreement, dated as of the date hereof, between Borrower and Lender, as the same shall be amended from time to time and (ii) that certain Commercial Security Agreement, dated as of the date hereof, between Guarantor, Borrower, and Lender, as the same shall be amended from time to time.

Security Interest. The words "Security Interest" mean, without limitation, any and all types of collateral security, present and future, whether in the form of a lien, charge, encumbrance, mortgage, deed of trust, security deed, assignment, pledge, crop pledge, chattel mortgage, collateral chattel mortgage, chattel trust, factor's lien, equipment trust, conditional sale, trust receipt, lien or title retention contract, lease or consignment intended as a security device, or any other security or lien interest whatsoever whether created by law, contract, or otherwise.

 

   
Loan No. 4061100374

BUSINESS LOAN

AGREEMENT

Page 9

 

BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS BUSINESS LOAN AGREEMENT AND BORROWER AGREES TO ITS TERMS. THIS BUSINESS LOAN AGREEMENT IS DATED NOVEMBER 5, 2015.

 

BORROWER:  
   
OFS CAPITAL CORPORATION, A DELAWARE CORPORATION  
   
By:      
Bilal Rashid, Chief Executive Officer of OFS Capital Corporation, a Delaware corporation  
     
   
LENDER:  
   
PACIFIC WESTERN BANK  
   
By:       
 

Authorized Signer

 

 

 

 

  

 

 

 

 

 

 

Exhibit 10.2

PROMISSORY NOTE

Principal

$15,000,000.00

Loan Date

11-5-2015

Maturity

11-6-2017

Loan No Call / Coll

Account

Port #618529

Officer

825

Initials
4061100374  

References in the boxes above are for Lender's use only and do not limit the applicability of this document to any particular loan or item.

Any item above containing "***" has been omitted due to text length limitations.

Borrower:

OFS Capital Corporation, a Delaware corporation

10 South Wacker Drive, Suite 2500

Chicago, IL 60606

 

Lender:

Pacific Western Bank

Los Angeles Real Estate and Construction

1880 Century Park East, Suite #800

Los Angeles, CA 90067

Principal Amount:   $15,000,000.00 Date of Note:   November 5, 2015

PROMISE TO PAY. OFS Capital Corporation, a Delaware corporation ("Borrower"), promises to pay to Pacific Western Bank ("Lender"), or order, in lawful money of the United States of America, the principal amount of Fifteen Million & 00/100 Dollars ($15,000,000.00) or so much as may be outstanding in relation to that certain loan made to Borrower pursuant to that certain Business Loan Agreement, dated as of the date hereof, between Borrower and Lender (as amended, restated, supplemented, or otherwise modified from time to time, the “Loan Agreement”), together with interest on the unpaid outstanding principal balance of each advance, calculated as described in the "INTEREST CALCULATION METHOD" paragraph using an interest rate of 4.750%. Interest shall be calculated from the date of each advance until repayment of each advance. The interest rate may change under the terms and conditions of the "INTEREST AFTER DEFAULT" section.

Capitalized terms not otherwise defined herein shall have the meanings ascribed to them in the Loan Agreement.

PAYMENT. Borrower will pay this loan in one payment of all outstanding principal plus all accrued unpaid interest on November 6, 2017. In addition, Borrower will pay regular monthly payments of all accrued unpaid interest due as of each payment date, beginning November 30, 2015, with all subsequent interest payments to be due on the last business day of each month after that. Unless otherwise agreed or required by applicable law, payments will be applied first to any accrued unpaid interest; then to principal; then to any unpaid collection costs; and then to any late charges. Borrower will pay Lender at Lender's address shown above or at such other place as Lender may designate in writing.

INTEREST CALCULATION METHOD. Interest on this Note is computed on the basis of a year consisting of 360 days; that is, by applying the ratio of the interest rate over a year of 360 days, multiplied by the outstanding principal balance, multiplied by the actual number of days the principal balance is outstanding. All interest payable under this Note is computed using this method.

PREPAYMENT. Borrower agrees that all loan fees and other prepaid finance charges are earned fully as of the date of the loan and will not be subject to refund upon early payment (whether voluntary or as a result of an Event of Default), except as otherwise required by law. Except for the foregoing, Borrower may pay without penalty all or a portion of the amount owed earlier than it is due. Early payments will not, unless agreed to by Lender in writing, relieve Borrower of Borrower's obligation to continue to make payments of accrued unpaid interest. Rather, early payments will reduce the principal balance due. Borrower agrees not to send Lender payments marked "paid in full", "without recourse", or similar language. If Borrower sends such a payment, Lender may accept it without losing any of Lender's rights under this Note, and Borrower will remain obligated to pay any further amount owed to Lender. All written communications concerning disputed amounts, including any check or other payment instrument that indicates that the payment constitutes "payment in full" of the amount owed or that is tendered with other conditions or limitations or as full satisfaction of a disputed amount must be mailed or delivered to: Pacific Western Bank, Los Angeles Real Estate and Construction, 1880 Century Park East, Suite #800, Los Angeles, CA 90067.

LATE CHARGE. If a payment is 10 days or more late, Borrower will be charged 5.000% of the regularly scheduled payment or $10.00, whichever is greater.

INTEREST AFTER DEFAULT. Upon the occurrence, and solely during the continuance, of an Event of Default, the interest rate on this Note shall, if permitted under applicable law, immediately increase by 5.000 percentage points; provided that in the case of an Event of Default with respect to the payment of interest, such increase in the interest rate shall not apply until such payment of interest is 10 days or more late.

LENDER'S RIGHTS. Upon the occurrence, and during the continuance, of an Event of Default, Lender may, in accordance with the Loan Agreement and the Security Agreements, declare the entire unpaid principal balance under this Note and all accrued unpaid interest immediately due, and then, subject to the terms of the Loan Agreement and the Security Agreements, Borrower will pay that amount.

ATTORNEYS' FEES; EXPENSES. Lender may hire or pay someone else to help collect this Note if Borrower does not pay. Borrower will pay Lender that amount. This includes, subject to any limits under applicable law, Lender's attorneys' fees and Lender's legal expenses , whether or not there is a lawsuit, including attorneys' fees, expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), and appeals. Borrower also will pay any court costs, in addition to all other sums provided by law.

GOVERNING LAW. This Note will be governed by federal law applicable to Lender and, to the extent not preempted by federal law, the laws of the State of California without regard to its conflicts of law provisions. This Note has been accepted by Lender in the State of California.

WAIVER OF JURY TRIAL AND JUDICIAL REFERENCE. This Note shall be subject to the Waiver of Jury Trial and Judicial Reference provisions of the Loan Agreement which are incorporated herein by this reference.

CHOICE OF VENUE. If there is a lawsuit, Borrower agrees upon Lender's request to submit to the jurisdiction of the courts of Los Angeles County, State of California.

RIGHT OF SETOFF. To the extent permitted by applicable law, Lender reserves a right of setoff in all Borrower's accounts with Lender (whether checking, savings, or some other account). This includes all accounts Borrower holds jointly with someone else and all accounts Borrower may open in the future. However, this does not include any trust accounts for which setoff would be prohibited by law. Borrower authorizes Lender, to the extent permitted by applicable law, to charge or setoff all sums owing on the indebtedness against any and all such accounts.

COLLATERAL. Borrower acknowledges this Note is secured by the Collateral.

   

Loan No. 4061100374

PROMISSORY NOTE

(Continued)

Page 2

LINE OF CREDIT. This Note evidences a revolving line of credit under the Loan Agreement. Advances under this Note may be requested orally by Borrower or as provided in this paragraph or the Loan Agreement. All oral requests shall be confirmed in writing on the day of the request. All communications, instructions, or directions by telephone or otherwise to Lender are to be directed to Lender's office shown above. The following person or persons are authorized to request advances and authorize payments under the line of credit until Lender receives from Borrower, at Lender's address shown above, written notice of revocation of such authority: Bilal Rashid, Jeff Cerny, and Eric Rubenfeld. Borrower agrees to be liable for all sums either: (A) advanced in accordance with the instructions of an authorized person or (B) credited to any of Borrower's accounts with Lender. The unpaid principal balance owing on this Note at any time may be evidenced by endorsements on this Note or by Lender's internal records, including daily computer print-outs.

INTEGRATION. The parties agree that (a) this Note, together with all of the Related Documents, represents the final agreement between the parties, and therefore incorporates all negotiations of the parties hereto (b) there are no unwritten oral agreements between the parties, and (c) this Agreement may not be contradicted by evidence of any prior, contemporaneous, or subsequent oral agreements or understandings of the parties.

SUCCESSOR INTERESTS. The terms of this Note shall be binding upon Borrower, and upon Borrower's heirs, personal representatives, successors and assigns, and shall inure to the benefit of Lender and its successors and assigns.

GENERAL PROVISIONS. If any part of this Note cannot be enforced, this fact will not affect the rest of the Note. Lender may delay or forgo enforcing any of its rights or remedies under this Note without losing them. Borrower and any other person who signs, guarantees or endorses this Note, to the extent allowed by law, waive any applicable statute of limitations, presentment, demand for payment, and notice of dishonor. Upon any change in the terms of this Note in accordance with the Loan Agreement, and unless otherwise expressly stated in writing, no party who signs this Note, whether as maker, guarantor, accommodation maker or endorser, shall be released from liability solely as a result of such change. All such parties agree that, except to the extent otherwise provided in the Loan Agreement, the Security Agreements, or the Guaranty, Lender may renew or extend (repeatedly and for any length of time) this loan or release any party or guarantor or collateral; or impair, fail to realize upon or perfect Lender's security interest in the collateral; and take any other action deemed necessary by Lender without the consent of or notice to anyone. All such parties also agree that Lender may modify this loan in accordance with the Loan Agreement. The obligations under this Note are joint and several.

PRIOR TO SIGNING THIS NOTE, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF THIS NOTE. BORROWER AGREES TO THE TERMS OF THE NOTE.

BORROWER ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THIS PROMISSORY NOTE.

BORROWER:  
   
   
   
OFS CAPITAL CORPORATION, A DELAWARE CORPORATION  
   
   
By:        
Bilal Rashid, Chief Executive Officer of OFS Capital Corporation, a Delaware corporation  
     

 

 

 

 

 

 

Exhibit 10.3

 

COMMERCIAL GUARANTY

Principal Loan Date Maturity Loan No Call / Coll Account Officer Initials
$15,000,000 11-5-2015 11-6-2017 4061100374   Port #618529 825  
References in the boxes above are for Lender's use only and do not limit the applicability of this document to any particular loan or item.
Any item above containing "***" has been omitted due to text length limitations.

 

Borrower: OFS Capital Corporation, a Delaware corporation
10 South Wacker Drive, Suite 2500
Chicago, IL 60606

Lender: Pacific Western Bank
Los Angeles Real Estate and Construction
1880 Century Park East, Suite #800
Los Angeles, CA 90067
Guarantor:

OFS Capital WM, LLC, a Delaware limited liability company
10 South Wacker Drive, Suite 2500
Chicago, IL 60606

 

   

 

CONTINUING GUARANTEE OF PAYMENT AND PERFORMANCE. For good and valuable consideration, Guarantor absolutely and unconditionally guarantees full and punctual payment and satisfaction of the Indebtedness of Borrower to Lender, and the performance and discharge of all Borrower's obligations under the Note and the Related Documents. This is a guaranty of payment and performance and not of collection, so Lender can enforce this Guaranty against Guarantor even when Lender has not exhausted Lender's remedies against anyone else obligated to pay the Indebtedness or against any collateral securing the Indebtedness, this Guaranty or any other guaranty of the Indebtedness. Guarantor will make any payments to Lender or its order, on demand, in legal tender of the United States of America, in same-day funds, without set-off or deduction or counterclaim, and will otherwise perform Borrower's obligations under the Note and Related Documents. Neither Borrower nor Guarantor is entering into any swap obligations with Lender or otherwise in connection with this Agreement, the Loan Agreement, or the other Related Documents, and as a result, Guarantor does not guarantee any obligations of Borrower under or in respect of any of Borrower’s existing or future swap obligations.

INDEBTEDNESS. The word "Indebtedness" as used in this Guaranty has the meaning assigned to such term in the Loan Agreement.

If Lender presently holds one or more guaranties, or hereafter receives additional guaranties from Guarantor, Lender's rights under all guaranties shall be cumulative. This Guaranty shall not (unless specifically provided below to the contrary) affect or invalidate any such other guaranties. Guarantor's liability will be Guarantor's aggregate liability under the terms of this Guaranty and any such other unterminated guaranties.

CONTINUING GUARANTY. THIS IS A "CONTINUING GUARANTY" UNDER WHICH GUARANTOR AGREES TO GUARANTEE THE FULL AND PUNCTUAL PAYMENT, PERFORMANCE AND SATISFACTION OF THE INDEBTEDNESS OF BORROWER TO LENDER, NOW EXISTING OR HEREAFTER ARISING OR ACQUIRED, ON AN OPEN AND CONTINUING BASIS. ACCORDINGLY, ANY PAYMENTS MADE ON THE INDEBTEDNESS WILL NOT DISCHARGE OR DIMINISH GUARANTOR'S OBLIGATIONS AND LIABILITY UNDER THIS GUARANTY FOR ANY REMAINING AND SUCCEEDING INDEBTEDNESS EVEN WHEN ALL OR PART OF THE OUTSTANDING INDEBTEDNESS MAY BE A ZERO BALANCE FROM TIME TO TIME.

DURATION OF GUARANTY. This Guaranty will take effect when received by Lender without the necessity of any acceptance by Lender, or any notice to Guarantor or to Borrower, and will continue in full force until all the Indebtedness incurred or contracted before receipt by Lender of any notice of revocation shall have been fully and finally paid and satisfied and all of Guarantor's other obligations under this Guaranty shall have been performed in full. If Guarantor elects to revoke this Guaranty, Guarantor may only do so in writing. Guarantor's written notice of revocation must be mailed to Lender, by certified mail, at Lender's address listed above or such other place as Lender may designate in writing. Written revocation of this Guaranty will apply only to new Indebtedness created after actual receipt by Lender of Guarantor's written revocation. For this purpose and without limitation, the term "new Indebtedness" does not include the Indebtedness which at the time of notice of revocation is contingent, unliquidated, undetermined or not due and which later becomes absolute, liquidated, determined or due. For this purpose and without limitation, "new Indebtedness" does not include all or part of the Indebtedness that is: incurred by Borrower prior to revocation; incurred under a commitment that became binding before revocation; any renewals, extensions, substitutions, and modifications of the Indebtedness. Release of any other guarantor or termination of any other guaranty of the Indebtedness shall not affect the liability of Guarantor under this Guaranty. A revocation Lender receives from any one or more Guarantors shall not affect the liability of any remaining Guarantors under this Guaranty. Guarantor's obligations under this Guaranty shall be in addition to any of Guarantor's obligations, or any of them, under any other guaranties of the Indebtedness or any other person heretofore or hereafter given to Lender unless such other guaranties are modified or revoked in writing; and this Guarantor shall not, unless provided in this Guaranty, affect, invalidate, or supersede any such other guaranty. It is anticipated that fluctuations may occur in the aggregate amount of the Indebtedness covered by this Guaranty, and Guarantor specifically acknowledges and agrees that reductions in the amount of the Indebtedness, even to zero dollars ($0.00), shall not constitute a termination of this Guaranty. This Guaranty is binding upon Guarantor so long as any of the Indebtedness remains unpaid and even though the Indebtedness may from time to time be zero dollars ($0.00). Notwithstanding the foregoing, this Guaranty shall terminate upon payment in full of the Indebtedness, termination of any commitments by Lender to extend additional credit under the Loan Agreement and termination of the Loan Agreement (in accordance with the terms of the Loan Agreement).

GUARANTOR'S AUTHORIZATION TO LENDER. Guarantor authorizes Lender, either before or after any revocation hereof, without notice or demand and without lessening Guarantor's liability under this Guaranty, from time to time: (A) to take such actions as are permitted to be taken by Lender under the Loan Agreement and the Security Agreements and under applicable law; (B) to alter, compromise, renew, extend, accelerate, or otherwise change one or more times the time for payment or other terms of the Indebtedness or any part of the Indebtedness, including increases and decreases of the rate of interest on the Indebtedness; extensions may be repeated and may be for longer than the original loan term; (C) to take and hold security for the payment of this Guaranty or the Indebtedness, and exchange, enforce, waive, subordinate, fail or decide not to perfect, and release any such security, with or without the substitution of new collateral; (D) to release, substitute, agree not to sue, or deal with any one or more of Borrower's sureties, endorsers, or other guarantors on any terms or in any manner Lender may choose; (E) to determine how, when and what application of payments and credits shall be made on the Indebtedness; and (F) to assign or transfer this Guaranty in whole or in part.

GUARANTOR'S REPRESENTATIONS AND WARRANTIES. Guarantor represents and warrants to Lender that (A) no representations or agreements of any kind have been made to Guarantor which would limit or qualify in any way the terms of this Guaranty; (B) this Guaranty is executed at Borrower's request and not at the request of Lender; (C) Guarantor has full power, right and authority to enter into this Guaranty; (D) the provisions of this Guaranty do not result in a default under any agreement or other instrument binding upon Guarantor and do not result in a violation of any law, regulation, court decree or order applicable to Guarantor, the effect of which, in each case, could reasonably be expected to be, have, or result in a material adverse effect on Guarantor’s business or financial condition; (E) Guarantor has not and will not, without the prior written consent of Lender, sell, lease, assign, transfer, encumber (except for liens otherwise permitted or provided for under the Loan Agreement or the Security Agreement between Guarantor and Lender) or otherwise dispose of all or substantially all of Guarantor's assets, provided, however, that consent of Lender shall not be required if the proceeds from such sale, lease, assignment, transfer, or disposition are distributed to Borrower for purposes of reinvestment; (F) upon Lender's request, Guarantor will provide to Lender financial and credit information in form acceptable to Lender, and all such financial information which currently has been, and all future financial information which will be provided to Lender is and will be true and correct in all material respects and fairly present Guarantor's financial condition as of the dates the financial information is provided; (G) no material adverse change has occurred in Guarantor's financial condition since the date of the most recent financial statements provided to Lender and no event has occurred which may materially adversely affect Guarantor's financial condition; (H) no material litigation, claim, investigation, administrative proceeding or similar action (including those for unpaid taxes) against Guarantor is pending or threatened; (I) Lender has made no representation to Guarantor as to the creditworthiness of Borrower; and (J) Guarantor has established adequate means of obtaining from Borrower on a continuing basis information regarding Borrower's financial condition. Guarantor agrees to keep adequately informed from such means of any facts, events, or circumstances which might in any way affect Guarantor's risks under this Guaranty, and Guarantor further agrees that, absent a request for information, Lender shall have no obligation to disclose to Guarantor any information or documents acquired by Lender in the course of its relationship with Borrower.

   

Loan No. 4061100374

COMMERCIAL GUARANTY

(Continued)

Page 2

GUARANTOR'S WAIVERS. Except as prohibited by applicable law, Guarantor waives any right to require Lender to (A) make any presentment, protest, demand, or notice of any kind, including notice of change of any terms of repayment of the Indebtedness, default by Borrower or any other guarantor or surety, any action or nonaction taken by Borrower, Lender, or any other guarantor or surety of Borrower, or the creation of new or additional Indebtedness; (B) proceed against any person, including Borrower, before proceeding against Guarantor; (C) proceed against any collateral for the Indebtedness, including Borrower's collateral, before proceeding against Guarantor; (D) apply any payments or proceeds received against the Indebtedness in any order; (E) disclose any information about the Indebtedness, the Borrower, the collateral, or any other guarantor or surety, or about any action or nonaction of Lender; or (F) pursue any remedy or course of action in Lender's power whatsoever.

Guarantor also waives any and all rights or defenses arising by reason of (G) any disability or other defense of Borrower, any other guarantor or surety or any other person; (H) the cessation from any cause whatsoever, other than payment in full, of the Indebtedness; (I) the application of proceeds of the Indebtedness by Borrower for purposes other than the purposes understood and intended by Guarantor and Lender; (J) any act of omission or commission by Lender which directly or indirectly results in or contributes to the discharge of Borrower or any other guarantor or surety, or the Indebtedness, or the loss or release of any collateral by operation of law or otherwise; (K) any statute of limitations in any action under this Guaranty or on the Indebtedness; or (L) any modification or change in terms of the Indebtedness, whatsoever, including without limitation, the renewal, extension, acceleration, or other change in the time payment of the Indebtedness is due and any change in the interest rate, and including any such modification or change in terms after revocation of this Guaranty on the Indebtedness incurred prior to such revocation.

Guarantor waives all rights of subrogation, reimbursement, indemnification, and contribution and any other rights and defenses that are or may become available to Guarantor by reason of California Civil Code Sections 2787 to 2855, inclusive.

Guarantor waives all rights and any defenses arising out of an election of remedies by Lender even though that the election of remedies, such as a non-judicial foreclosure with respect to security for a guaranteed obligation, has destroyed Guarantor's rights of subrogation and reimbursement against Borrower by operation of Section 580d of the California Code of Civil Procedure or otherwise.

Guarantor waives all rights and defenses that Guarantor may have because Borrower's obligation is secured by real property. This means among other things: (M) Lender may collect from Guarantor without first foreclosing on any real or personal property collateral pledged by Borrower. (N) If Lender forecloses on any real property collateral pledged by Borrower: (1) the amount of Borrower's obligation may be reduced only by the price for which the collateral is sold at the foreclosure sale, even if the collateral is worth more than the sale price. (2) Lender may collect from Guarantor even if Lender, by foreclosing on the real property collateral, has destroyed any right Guarantor may have to collect from Borrower. This is an unconditional and irrevocable waiver of any rights and defenses Guarantor may have because Borrower's obligation is secured by real property. These rights and defenses include, but are not limited to, any rights and defenses based upon Section 580a, 580b, 580d, or 726 of the Code of Civil Procedure.

Guarantor understands and agrees that the foregoing waivers are unconditional and irrevocable waivers of substantive rights and defenses to which Guarantor might otherwise be entitled under state and federal law. The rights and defenses waived include, without limitation, those provided by California laws of suretyship and guaranty, anti-deficiency laws, and the Uniform Commercial Code. Guarantor acknowledges that Guarantor has provided these waivers of rights and defenses with the intention that they be fully relied upon by Lender. Guarantor further understands and agrees that this Guaranty is a separate and independent contract between Guarantor and Lender, given for full and ample consideration, and is enforceable on its own terms. Until all of the Indebtedness is paid in full, Guarantor waives any right to enforce any remedy Guarantor may have against the Borrower or any other guarantor, surety, or other person, and further, Guarantor waives any right to participate in any collateral for the Indebtedness now or hereafter held by Lender.

Guarantor's Understanding With Respect To Waivers. Guarantor warrants and agrees that each of the waivers set forth above is made with Guarantor's full knowledge of its significance and consequences and that, under the circumstances, the waivers are reasonable and not contrary to public policy or law. If any such waiver is determined to be contrary to any applicable law or public policy, such waiver shall be effective only to the extent permitted by law or public policy.

Subordination of Borrower's Debts to Guarantor. Guarantor agrees that the Indebtedness, whether now existing or hereafter created, shall be superior to any claim that Guarantor may now have or hereafter acquire against Borrower, whether or not Borrower becomes insolvent. Guarantor hereby expressly subordinates any claim Guarantor may have against Borrower, upon any account whatsoever, to any claim that Lender may now or hereafter have against Borrower with respect to the Indebtedness. In the event of insolvency and consequent liquidation of the assets of Borrower, through bankruptcy, by an assignment for the benefit of creditors, by voluntary liquidation, or otherwise, the assets of Borrower applicable to the payment of the claims of both Lender and Guarantor shall be paid to Lender and shall be first applied by Lender to the Indebtedness. Guarantor does hereby assign to Lender all claims which it may have or acquire against Borrower or against any assignee or trustee in bankruptcy of Borrower; provided however, that such assignment shall be effective only for the purpose of assuring to Lender full payment in legal tender of the Indebtedness. Guarantor agrees, and Lender is hereby authorized, in the name of Guarantor, from time to time to file financing statements and continuation statements and to execute documents and to take such other actions as Lender deems necessary or appropriate to perfect, preserve and enforce its rights under this Guaranty.

Miscellaneous Provisions. The following miscellaneous provisions are a part of this Guaranty:

   

Loan No. 4061100374

COMMERCIAL GUARANTY

(Continued)

Page 3

AMENDMENTS. This Guaranty, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Guaranty. No alteration of or amendment to this Guaranty shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment.

ATTORNEYS' FEES; EXPENSES. Guarantor agrees to pay upon demand all of Lender's costs and expenses, including Lender's attorneys' fees and Lender's legal expenses, incurred in connection with the enforcement of this Guaranty. Lender may hire or pay someone else to help enforce this Guaranty, and Guarantor shall pay the costs and expenses of such enforcement. Costs and expenses include Lender's attorneys' fees and legal expenses whether or not there is a lawsuit, including attorneys' fees and legal expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Guarantor also shall pay all court costs and such additional fees as may be directed by the court.

CAPTION HEADINGS. Caption headings in this Guaranty are for convenience purposes only and are not to be used to interpret or define the provisions of this Guaranty.

GOVERNING LAW. This Guaranty will be governed by federal law applicable to Lender and, to the extent not preempted by federal law, the laws of the State of California without regard to its conflicts of law provisions.

CHOICE OF VENUE. If there is a lawsuit, Guarantor agrees upon Lender's request to submit to the jurisdiction of the courts of Los Angeles County, State of California.

INTEGRATION. Guarantor further agrees that Guarantor has read and fully understands the terms of this Guaranty. Guarantor has had the opportunity to be advised by Guarantor's attorney with respect to entering into this Guaranty. Guarantor further agrees that the Guaranty represents the final agreement between Guarantor and Lender regarding the matters addressed therein and therefore: (a) incorporates all negotiations of the parties relating to the Guaranty; (b) there are no unwritten oral agreements between Lender and Guarantor, and (c) this Guaranty may not be contradicted by evidence of any prior, contemporaneous, or subsequent oral agreements or understandings of Lender and Guarantor. Guarantor hereby indemnifies and holds Lender harmless from all losses, claims, damages, and costs (including Lender's attorney's fees) suffered by Lender as a result of any breach by Guarantor of the warranties, representations and agreements of this Paragraph.

INTERPRETATION. If a court finds that any provision of this Guaranty is not valid or should not be enforced, that fact by itself will not mean that the rest of this Guaranty will not be valid or enforced. Therefore, a court will enforce the rest of the provisions of this Guaranty even if a provision of this Guaranty may be found to be invalid or unenforceable. If any one or more of Borrower or Guarantor are corporations, partnerships, limited liability companies, or similar entities, it is not necessary for Lender to inquire into the powers of Borrower or Guarantor or of the officers, directors, partners, managers, or other agents acting or purporting to act on their behalf, and any indebtedness made or created in reliance upon the professed exercise of such powers shall be guaranteed under this Guaranty.

NOTICES. Any notice required to be given under this Guaranty shall be given in writing, and, except for revocation notices by Guarantor, shall be effective when actually delivered, when actually received by e-mail or telefacsimile (unless otherwise required by law), when deposited with a nationally recognized overnight courier, or, if mailed, when deposited in the United States mail, as first class, certified or registered mail postage prepaid, directed to the addresses shown near the beginning of this Guaranty. All revocation notices by Guarantor shall be in writing and shall be effective upon delivery to Lender as provided in the section of this Guaranty entitled "DURATION OF GUARANTY." Any party may change its address for notices under this Guaranty by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. For notice purposes , Guarantor agrees to keep Lender informed at all times of Guarantor's current address. .

NO WAIVER BY LENDER. Lender shall not be deemed to have waived any rights under this Guaranty unless such waiver is given in writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of a provision of this Guaranty shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Guaranty. No prior waiver by Lender, nor any course of dealing between Lender and Guarantor, shall constitute a waiver of any of Lender's rights or of any of Guarantor's obligations as to any future transactions. Whenever the consent of Lender is required under this Guaranty, the granting of such consent by Lender in any instance shall not constitute continuing consent to subsequent instances where such consent is required and in all cases such consent may be granted or withheld in the sole discretion of Lender.

SUCCESSORS AND ASSIGNS. Subject to any limitations stated in this Guaranty on transfer of Guarantor's interest, this Guaranty shall be binding upon and inure to the benefit of the parties, their successors and assigns.

Waiver of Jury Trial and Judicial Reference. This Guaranty shall be subject to the Waiver of Jury Trial and Judicial Reference provisions of the Loan Agreement which are incorporated herein by this reference.

Definitions. The following capitalized words and terms shall have the following meanings when used in this Guaranty. Unless specifically stated to the contrary, all references to dollar amounts shall mean amounts in lawful money of the United States of America. Words and terms used in the singular shall include the plural, and the plural shall include the singular, as the context may require. Words and terms not otherwise defined in this Guaranty shall have the meanings attributed to such terms in the Uniform Commercial Code:

BORROWER. The word "Borrower" means OFS Capital Corporation, a Delaware corporation, and its successors and assigns.

GUARANTOR. The word "Guarantor" means OFS Capital WM, LLC, a Delaware limited liability company, and its successors and assigns.

GUARANTY. The word "Guaranty" means this guaranty from Guarantor to Lender.

INDEBTEDNESS. The word "Indebtedness" means Borrower's indebtedness to Lender as more particularly described in this Guaranty.

LENDER. The word "Lender" means Pacific Western Bank and its successors and assigns.

LOAN AGREEMENT. The words “Loan Agreement” mean that certain Business Loan Agreement, dated the date hereof, between Borrower and Lender, as the same may be amended from time to time.

NOTE. The word "Note" means the Note executed by Borrower in the principal amount of $15,000,000 dated November 5, 2015, together with all renewals of, extensions of, modifications of, refinancings of, consolidations of and substitutions for the note or credit agreement.

   

Loan No. 4061100374

COMMERCIAL GUARANTY

(Continued)

Page 4

 

RELATED DOCUMENTS. The words "Related Documents" mean all promissory notes, credit agreements, loan agreements, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, security deeds, collateral mortgages, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the Indebtedness.

SECURITY AGREEMENTS. The words "Security Agreements" mean, collectively, (i) that certain Commercial Security Agreement, dated as of the date hereof, between Borrower and Lender, as the same shall be amended from time to time and (ii) that certain Commercial Security Agreement, dated as of the date hereof, between Guarantor, Borrower, and Lender, as the same shall be amended from time to time.

EACH UNDERSIGNED GUARANTOR ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS GUARANTY AND AGREES TO ITS TERMS. IN ADDITION, EACH GUARANTOR UNDERSTANDS THAT THIS GUARANTY IS EFFECTIVE UPON GUARANTOR'S EXECUTION AND DELIVERY OF THIS GUARANTY TO LENDER AND THAT THE GUARANTY WILL CONTINUE UNTIL TERMINATED IN THE MANNER SET FORTH IN THE SECTION TITLED "DURATION OF GUARANTY". NO FORMAL ACCEPTANCE BY LENDER IS NECESSARY TO MAKE THIS GUARANTY EFFECTIVE. THIS GUARANTY IS DATED NOVEMBER 5, 2015.

 

GUARANTOR:  
   
   
OFS CAPITAL WM, LLC, A DELAWARE LIMITED LIABILITY COMPANY  
   
By: OFS CAPITAL CORPORATION, its Administrative Manager  
     
     
By:    
  Bilal Rashid, Chief Executive Officer of OFS Capital Corporation  

 

 

 

 

 

 

 

 

Exhibit 31.1

 

Certification of Chief Executive Officer

 

I, Bilal Rashid, Chief Executive Officer of OFS Capital Corporation certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of OFS Capital Corporation;

 

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 provided 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 6th day of November 2015.

 

By: /s/ Bilal Rashid  
 

Bilal Rashid

Chief Executive Officer

 

 

 

 

 

Exhibit 31.2

 

Certification of Chief Financial Officer

 

I, Jeffrey A. Cerny, Chief Financial Officer of OFS Capital Corporation certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of OFS Capital Corporation;

 

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 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 provided 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 6th day of November 2015.

 

By: /s/ Jeffrey A. Cerny  
 

Jeffrey A. Cerny

Chief Financial Officer

 

  

 

 

 

Exhibit 32.1

 

Certification of Chief Executive Officer

Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

In connection with the Quarterly Report on Form 10-Q for the period ended September 30, 2015 (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, that:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

 

    /s/ Bilal Rashid
  Name: Bilal Rashid
  Date: November 6, 2015

 

 

 

 

Exhibit 32.2

 

Certification of Chief Financial Officer

Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

In connection with the Quarterly Report on Form 10-Q for the period ended September 30, 2015 (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, that:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

 

    /s/ Jeffrey A. Cerny
  Name: Jeffrey A. Cerny
  Date: November 6, 2015