UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
(Mark One)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2017
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
COMMISSION FILE NUMBER: 814-00813
OFS Capital Corporation
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware | 46-1339639 |
(State or jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
10 S. Wacker Drive, Suite 2500 Chicago, Illinois | 60606 |
(Address of principal executive offices) | (Zip Code) |
REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:
(847) 734-2000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of Each Class | Name of Each Exchange on Which Registered | |
Common Stock, par value $0.01 per share | The Nasdaq Global Select Market | |
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically 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 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | x |
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Emerging growth company | ¨ | ||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) YES ¨ NO x
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
The aggregate market value of the registrant's voting shares of common stock held by non-affiliates of the registrant as of June 30, 2017, was $148.6 million based on $14.31 per share, the last reported sale price of the shares of common stock on the Nasdaq Global Select Market. For the purpose of calculating this amount only, shares held by certain stockholders and by directors and executive officers of the registrant have been excluded. On March 5, 2018, there were 13,340,217 shares outstanding of the Registrant’s common stock, $0.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement relating to the registrant’s 2018 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission, are incorporated by reference in Part III of this Annual Report on Form 10-K as indicated herein.
TABLE OF CONTENTS
Page | ||
Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
Item 15. | ||
Item 16. | ||
OFS Capital Corporation, our logo and other trademarks of OFS Capital Corporation are the property of OFS Capital Corporation. All other trademarks or trade names referred to in this Annual Report on Form 10-K are the property of their respective owners.
2
Defined Terms
We have used "we," "us," "our," "our company," and "the Company" to refer to OFS Capital Corporation in this report. We also have used several other terms in this report, which are explained or defined below:
1940 Act | Investment Company Act of 1940, as amended |
Administration Agreement | Administration agreement between the Company and OFS Services dated November 7, 2012 |
Advisers Act | Investment Advisers Act of 1940 |
Annual Distribution Requirement | Distributions to our stockholders, for each taxable year, of at least 90% of our ICTI |
ASC | Accounting Standards Codification, as issued by the FASB |
ASC Topic 606 | ASC Topic 606, "Revenue From Contracts With Customers" |
ASC Topic 820 | ASC Topic 820, "Fair Value Measurements and Disclosures" |
ASC Topic 946 | ASC Topic 946, "Financial Services-Investment Companies" |
ASU | Accounting Standards Updates, as issued by the FASB |
BDC | Business Development Company under the 1940 Act |
BLA | Business Loan Agreement, as amended, with Pacific Western Bank, as lender, which provides the Company with a senior secured revolving credit facility |
Board | The Company's board of directors |
Code | Internal Revenue Code of 1986, as amended |
DRIP | Distribution reinvestment plan |
EBITDA | Earnings before interest, taxes, depreciation, and amortization |
Exchange Act | Securities Exchange Act of 1934 |
FASB | Financial Accounting Standards Board |
FDIC | Federal Deposit Insurance Corporation |
GAAP | Accounting principles generally accepted in the United States |
HPCI | Hancock Park Corporate Income, Inc., a non-traded BDC with an investment strategy similar to the Company for whom OFS Advisor serves as investment adviser |
ICTI | Investment company taxable income, as defined in the Code, which is generally net ordinary income plus net short-term capital gains in excess of net long-term capital losses |
Investment Advisory Agreement | Investment advisory agreement between the Company and OFS Advisor dated November 7, 2012 |
IPO | Initial Public Offering |
LIBOR | London Interbank Offered Rate |
OFS Advisor | OFS Capital Management, LLC, a wholly owned subsidiary of OFSAM and registered investment advisor under the 1940 Act |
OFSC | Orchard First Source Capital, Inc., a wholly owned subsidiary of OFSAM |
OFS Capital WM | OFS Capital WM, LLC, a wholly owned investment-company subsidiary |
OFS Services | OFS Capital Services, LLC, a wholly owned subsidiary of OFSAM and affiliate of OFS Advisor |
OFSAM | Orchard First Source Asset Management, LLC, a full-service provider of capital and leveraged finance solutions to U.S. Corporations |
Prime Rate | United States Prime interest rate |
PWB Credit Facility | Senior secured revolving credit facility between the Company and Pacific Western Bank, as lender |
RIC | Regulated investment company under Subchapter M of Code |
SBA | U.S. Small Business Administration |
SBIC | A fund licensed under the SBA small business investment company program |
SBIC Acquisition | The Company's acquisition of the remaining ownership interests in SBIC I LP and SBIC I GP, LLC on December 4, 2013, making SBIC I LP a wholly owned subsidiary of the Company |
SBIC Act | Small Business Investment Act of 1958 |
SBIC I LP | OFS SBIC I, LP, a wholly owned SBIC subsidiary of the Company |
SEC | U.S. Securities and Exchange Commission |
WM Credit Facility | Secured revolving line of credit with Wells Fargo Bank, N.A, terminated on May 28, 2015 |
3
PART I
As used in this annual report on Form 10-K, except as otherwise indicated, the terms “OFS Capital,” “the Company,” “we,” “us,” and “our” refer to OFS Capital Corporation and its consolidated subsidiaries.
Item 1. Business
GENERAL
We are an externally managed, closed-end, non-diversified management investment company and have elected to be treated as a BDC under the 1940 Act, which imposes certain investment restrictions on our portfolio. Our investment objective is to provide our stockholders with both current income and capital appreciation primarily through debt investments and, to a lesser extent, equity investments. Our investment strategy focuses primarily on investments in middle-market companies in the United States. We use the term “middle-market” to refer to companies that may exhibit one or more of the following characteristics: number of employees between 150 and 2,000; revenues between $15 million and $300 million; annual EBITDA between $3 million and $50 million; generally, private companies owned by private equity firms or owners/operators; and enterprise value between $10 million and $500 million. For additional information about how we define the middle-market, see “—Investment Criteria/Guidelines.”
As of December 31, 2017, we held debt and equity investments in 37 portfolio companies with an aggregate fair value of $277.5 million. As of December 31, 2017, 70% of our investment portfolio was comprised of senior secured loans, 18% of subordinated loans and 11% of equity investments, at fair value.
Our investment strategy focuses primarily on middle-market companies in the United States, including senior secured loans, which includes first-lien, second-lien and unitranche loans, as well as subordinated loans and, to a lesser extent, warrants and other equity securities. We also may invest up to 30% of our portfolio in opportunistic investments of portfolio companies not otherwise eligible under BDC regulations. Specifically, as part of this 30% basket, we may consider investments in investment funds that are operating pursuant to certain exceptions to the 1940 Act and in advisers to similar investment funds, as well as in debt 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.
We execute our investment strategy, in part, through SBIC I LP, a licensee under the SBA's SBIC program. 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 leverage commitment is subject to its compliance with SBA regulations and policies, including an audit by the SBA. For additional information regarding the regulation of SBIC I LP, see “Regulation—Small Business Investment Company Regulation”.
On a stand-alone basis, SBIC I LP held approximately $251.6 million and $247.5 million in assets, or approximately 70% and 81% of our total consolidated assets, at December 31, 2017 and 2016, respectively.
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 we have agreed to pay OFS Advisor an annual base management fee based on the average value of our total assets (other than cash and cash equivalents but including assets purchased with borrowed funds and including assets owned by any consolidated entity) as well as an incentive fee based on our investment performance. We have elected to exclude from the base management fee calculation any base management fee that would be owed in respect of the intangible asset and goodwill resulting from the SBIC Acquisition. OFS Advisor also serves as the investment adviser to CLO funds and other assets, including Hancock Park Corporate Income, Inc., a non-traded BDC with an investment strategy similar to the Company's. OFS Advisor will seek to allocate investment opportunities among eligible accounts in a manner that is fair and equitable over time and consistent with its allocation policy.
We have also entered into an Administration Agreement with OFS Services. Under our Administration Agreement, we have agreed to reimburse OFS Services for our allocable portion (subject to the review and approval of our independent directors) of overhead and other expenses incurred by OFS Services in performing its obligations under the Administration Agreement. See “—Management and Other Agreements–Administration Agreement.”
As a BDC, we must not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our assets, as defined by the 1940 Act, are qualifying assets (with certain limited exceptions). Qualifying assets include investments in “eligible portfolio companies.” Under the relevant SEC rules, the term “eligible portfolio company” includes all private companies, companies whose securities are not listed on a national securities exchange, and certain public companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized in the United States.
4
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 continue to qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. Pursuant to this election, we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders.
About OFS and Our Advisor
OFS (which refers to the collective activities and operations of OFSAM, its subsidiaries, and certain affiliates) is a full-service provider of capital and leveraged finance solutions to U.S. companies.
As of December 31, 2017, OFS had 45 full-time employees. OFS is headquartered in Chicago, Illinois and also has offices in New York, New York and Los Angeles, California.
Our investment activities are managed by OFS Advisor, our investment adviser. OFS Advisor is responsible for sourcing potential investments, conducting research and diligence on potential investments and equity sponsors, analyzing investment opportunities, structuring our investments and monitoring our investments and portfolio companies on an ongoing basis. OFS Advisor is a registered investment adviser under the Advisers Act and a wholly-owned subsidiary of OFSAM.
Our relationship with OFS Advisor is governed by and dependent on the Investment Advisory Agreement and may be subject to conflicts of interest. OFS Advisor provides us with advisory services in exchange for a base management fee and incentive fee; see “Management and Other Agreements—Investment Advisory Agreement”. The base management fee is based on our total assets (other than cash and cash equivalents, and the intangible asset and goodwill resulting from the SBIC Acquisition, but including assets purchased with borrowed amounts and assets owned by any consolidated entity) and, therefore, OFS Advisor will benefit when we incur debt or use leverage. Our board of directors is charged with protecting our interests by monitoring how OFS Advisor addresses these and other conflicts of interest associated with its management services and compensation. While our board of directors is not expected to review or approve each borrowing or incurrence of leverage, our independent directors periodically review OFS Advisor’s services and fees as well as its portfolio management decisions and portfolio performance.
OFS Advisor has entered into a Staffing Agreement (the "Staffing Agreement") with OFSC, a wholly-owned subsidiary of OFSAM. Under the Staffing Agreement, OFSC makes experienced investment professionals available to OFS Advisor and provides access to the senior investment personnel of OFS and its affiliates. The Staffing Agreement provides OFS Advisor with access to deal flow generated by OFS and its affiliates in the ordinary course of their businesses and commits the members of OFS Advisor’s investment committee to serve in that capacity. As our investment adviser, OFS Advisor is obligated to allocate investment opportunities among us and any other clients fairly and equitably over time in accordance with its allocation policy.
OFS Advisor capitalizes on the deal origination and sourcing, credit underwriting, due diligence, investment structuring, execution, portfolio management and monitoring experience of OFS’s professionals. The senior management team of OFS, including Bilal Rashid, Jeff Cerny and Mark Hauser, provides services to OFS Advisor. These managers have developed a broad network of contacts within the investment community, and possess an average of over 20 years of experience investing in debt and equity securities of middle-market companies. In addition, these managers have extensive experience investing in assets that constitute our primary focus and have expertise in investing across all levels of the capital structure of middle-market companies.
Competitive Strengths and Core Competencies
Deep Management Team Experienced in All Phases of Investment Cycle and Across All Levels of the Capital Structure. We are managed by OFS Advisor, which has access through the Staffing Agreement with OFSC to the resources and expertise of OFS’s investment professionals. As of December 31, 2017, OFS’s credit and investment professionals (including all investment committee members) employed by OFSC had an average of over 15 years of investment experience with strong institutional backgrounds.
Significant Investment Capacity. The net proceeds of equity and debt offerings and borrowing capacity under our credit facilities will provide us with a substantial amount of capital available for deployment into new investment opportunities in our targeted asset class.
Scalable Infrastructure Supporting the Entire Investment Cycle. We believe that our loan acquisition, origination and sourcing, underwriting, administration and management platform is highly scalable (that is, it can be expanded on a cost efficient basis within a timeframe that meets the demands of business growth). Our platform extends beyond origination and
5
sourcing and includes a regimented credit monitoring system. We believe that our careful approach, which involves ongoing review and analysis by an experienced team of professionals, should enable us to identify problems early and to assist borrowers before they face difficult liquidity constraints.
Extensive Loan Sourcing Capabilities. OFS Advisor gives us access to the deal flow of OFS. We believe OFS’s 20-year history as a middle-market lending platform and its market position make it a leading lender to many sponsors and other deal sources, especially in the currently under-served lending environment, and we have extensive relationships with potential borrowers and other lenders.
Structuring with a High Level of Service and Operational Orientation. We provide client-specific and creative financing structures to our portfolio companies. Based on our experience in lending to and investing in middle-market companies, we believe that the middle-market companies we target, as well as sponsor groups we may pursue, require a higher level of service, creativity and knowledge than has historically been provided by other service providers more accustomed to participating in commodity-like loan transactions.
Rigorous Credit Analysis and Approval Procedures. OFS Advisor utilizes the established, disciplined investment process of OFS for reviewing lending opportunities, structuring transactions and monitoring investments. Using OFS’s disciplined approach to lending, OFS Advisor seeks to minimize credit losses through effective underwriting, comprehensive due diligence investigations, structuring and, where appropriate, the implementation of restrictive debt covenants.
Our Administrator
We do not have any direct employees, and our day-to-day investment operations are managed by OFS Advisor. We have a chief executive officer, chief financial officer, chief compliance officer, chief accounting officer, corporate secretary and, to the extent necessary, our board of directors may elect to appoint additional officers going forward. Our officers are employees of OFSC, an affiliate of OFS Advisor, and a portion of the compensation paid to our officers are paid by us pursuant to the Administration Agreement. All of our executive officers are also officers of OFS Advisor.
OFS Services, an affiliate of OFS Advisor, provides the administrative services necessary for us to operate. OFS Services furnishes us with office facilities and equipment, necessary software licenses and subscriptions and clerical, bookkeeping and recordkeeping services at such facilities. OFS Services oversees our financial reporting as well as prepares our reports to stockholders and all other reports and materials required to be filed with the SEC or any other regulatory authority. OFS Services also manages the determination and publication of our net asset value and the preparation and filing of our tax returns and generally monitors the payment of our expenses and the performance of administrative and professional services rendered to us by others. OFS Services may retain third parties to assist in providing administrative services to us. To the extent that OFS Services outsources any of its functions, we will pay the fees associated with such functions at cost, on a direct basis.
Market Opportunity
Large Target Market. According to the U.S. Census Bureau in its 2012 economic census, there were approximately 197,000 companies in the United States with annual revenues between $10 million and $2.5 billion, compared with approximately 1,300 companies with revenues greater than $2.5 billion. We believe that these middle-market companies represent a significant growth segment of the U.S. economy and often require substantial capital investments to grow. Middle-market companies have historically constituted the vast bulk of OFS’s portfolio companies since its inception, and constituted the vast bulk of our portfolio as of December 31, 2017. We believe that this market segment will continue to produce significant investment opportunities for us.
Specialized Lending Requirements with High Barriers to Entry. We believe that several factors render many U.S. financial institutions ill-suited to lend to U.S. middle-market companies. For example, based on the experience of our management team, lending to private middle-market companies in the United States (a) is generally more labor-intensive than lending to larger companies due to the smaller size of each investment and the fragmented nature of information for such companies, (b) requires due diligence and underwriting practices consistent with the demands and economic limitations of the middle-market and (c) may also require more extensive ongoing monitoring by the lender. As a result, middle-market companies historically have been served by a limited segment of the lending community. As a result of the unique challenges facing lenders to middle-market companies, we believe that there are high barriers to entry that a new lender must overcome.
Robust Demand for Debt Capital. We believe that private equity firms have significant committed but uncalled capital, a large portion of which is still available for investment in the United States. Subject to market conditions, we expect the large amount of unfunded buyout commitments will drive demand for leveraged buyouts over the next several years, which should, in turn, create leveraged lending opportunities for us.
6
Competition
Our primary competitors include public and private funds, other BDCs, commercial and investment banks, commercial finance companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical, and marketing resources than we do. Some competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Further, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC, or to the distribution and other requirements we must satisfy to maintain our RIC status.
We expect to continue to use the expertise of the investment professionals of OFS and its affiliates to which we have access, to assess investment risks and determine appropriate pricing for our investments in portfolio companies. In addition, we expect that the relationships of the senior members of OFS and its affiliates will enable us to learn about, and compete effectively for, financing opportunities with attractive middle-market companies in the industries in which we seek to invest. For additional information concerning the competitive risks we face,
Investment Criteria/Guidelines
Our investment objective is to generate current income and capital appreciation by investing primarily in middle-market companies in the United States. We focus on investments in senior secured loans, including first lien, second lien, and unitranche loans, as well as subordinated loans and, to a lesser extent, warrants and other equity securities. In particular, we believe that structured equity debt investments (i.e., typically senior secured unitranche loans, often with warrant coverage, and often in companies with no financial sponsor) represent a strong relative value opportunity offering the borrower the convenience of dealing with one lender, which may result in a higher blended rate of interest to us than we might expect to receive under a traditional multi-tranche structure. We expect that our investments in the equity securities of portfolio companies, such as warrants, preferred stock, common stock and other equity interests, will principally be made in conjunction with our debt investments. Generally, we do not expect to make investments in companies or securities that OFS Advisor determines to be distressed investments (such as discounted debt instruments that have either experienced a default or have a significant potential for default), other than follow-on investments in portfolio companies of ours. We intend to continue to generate strong risk-adjusted net returns by assembling a diversified portfolio of investments across a broad range of industries.
We target U.S. middle-market companies through OFS’s access to a network of financial institutions, private equity sponsors, investment banks, consultants and attorneys, and our proprietary database of borrowers developed over OFS’s more than 20 years in lending to middle-market companies. A typical targeted borrower will exhibit certain of the following characteristics:
• | number of employees between 150 and 2,000; |
• | revenues between $15 million and $300 million; |
• | annual EBITDA between $3 million and $50 million; |
• | generally, private companies owned by private equity firms or owners/operators; |
• | enterprise value between $10 million and $500 million; |
• | effective and experienced management teams; |
• | defensible market share; |
• | solid historical financial performance, including a steady stream of cash flow; |
• | high degree of recurring revenue; |
• | diversity of customers, markets, products and geography; and |
• | differentiated products or services. |
While we believe that the characteristics listed above are important in identifying and investing in prospective portfolio companies, not all of these criteria will be met by each prospective portfolio company.
Due Diligence and Investment Process Overview
We employ a thorough and disciplined underwriting and due diligence process that is conducted in accordance with established credit policies and procedures, and that is focused on investment recovery. Our process involves a comprehensive analysis of a prospective portfolio company’s market, operational, financial, and legal position, as well as its future prospects.
7
In addition to our own analysis, we may use the services of third parties for environmental reviews, quality of earnings reports, industry surveys, background checks on key managers, and insurance reviews.
We seek to invest in companies that have experienced and incentivized management teams, that have stable and predictable cash flows, and that have defensible market positions. We underwrite our investments with the expectation that we will hold them for a number of years, and we structure and document our investments accordingly.
Our due diligence and underwriting process typically addresses the following elements (although certain elements may not be included in every due diligence undertaking):
Prospective Portfolio Company Characteristics: focusing on primary drivers of the company’s revenues and cash flows, including its key products and services; customer and supplier concentrations, and contractual relationships; depth, breadth, and quality of company management, as well as the extent to which the management team is appropriately compensated with equity incentives; and any regulatory, labor, or litigation matters impacting the company.
Industry and Competitive Overview: including industry size and the company’s position within it; growth potential and barriers to entry; governmental, regulatory, or technological issues potentially affecting the industry; and cyclicality or seasonality risks associated with the industry.
Financial Analysis: involving an understanding of the company’s historical financial results, focusing on actual operating trends experienced over time, in order to forecast future performance, including in various sensitized performance scenarios; attention to projected cash flows, debt service coverage, and leverage multiples under such scenarios; and an assessment of enterprise valuations and debt repayment/investment recovery prospects given such sensitized performance scenarios.
Investment Documentation: focusing on obtaining the best legal protections available to us given our position within the capital structure, including, as appropriate, financial covenants; collateral liens and stock pledges; review of loan documents of other of the prospective portfolio company’s creditors; and negotiation of inter-creditor agreements.
Portfolio Review/Risk Monitoring
We view active portfolio monitoring as a vital part of our investment process, and we benefit from a portfolio management system developed by OFS that includes daily, weekly, monthly, and quarterly components, and that involves comprehensive review of the performance of each of our portfolio companies. As part of the portfolio management process, OFS Advisor performs ongoing risk assessments on each of our investments and assigns each debt investment a credit rating based on OFS’s internal ratings scale.
We categorize debt investments into the following risk categories based on relevant information about the ability of borrowers to service their debt:
1 (Low Risk) – The debt investment has mostly satisfactory asset quality and liquidity, as well as good leverage capacity. It maintains predictable and strong cash flows from operations. The trends and outlook for the portfolio company's operations, balance sheet, and industry are neutral to favorable. Collateral, if appropriate, has maintained value and would be capable of being liquidated on a timely basis. Overall a debt investment with a 1 risk rating is considered to be of investment grade quality.
2 (Below Average Risk) – The debt investment has acceptable asset quality, moderate excess liquidity, and modest leverage capacity. It could have some financial/non-financial weaknesses which are offset by strengths; however, the credit demonstrates an ample current cash flow from operations. The trends and outlook for the portfolio company's operations, balance sheet, and industry are generally positive or neutral to somewhat negative. Collateral, if appropriate, has maintained value and would be capable of being liquidated successfully on a timely basis.
3 (Average) – The debt investment has acceptable asset quality, somewhat strained liquidity, and minimal leverage capacity. It is at times characterized by acceptable cash flows from operations. Under adverse market conditions, the debt service could pose difficulties for the borrower. The trends and conditions of the portfolio company's operations and balance sheet are neutral to slightly negative.
4 (Special Mention) – The debt investment has not lost, and is not expected to lose, principal or interest but it possesses credit deficiencies or potential weaknesses which deserve management’s close and continued attention. The portfolio company’s operations and/or balance sheet have demonstrated an adverse trend or deterioration which, while serious, has not reached the point where the liquidation of debt is jeopardized. These weaknesses are generally considered correctable by the borrower in the normal course of business but may weaken the asset or inadequately protect our credit position if not checked or corrected.
5 (Substandard) – The debt investment is protected inadequately by the current enterprise value or paying capacity of the obligor or of the collateral, if any. The portfolio company has well-defined weaknesses based upon objective evidence, such
8
as recurring or significant decreases in revenues and cash flows. These assets are characterized by the possibility that we may sustain loss if the deficiencies are not corrected. The possibility that liquidation would not be timely (e.g., bankruptcy or foreclosure) requires a Substandard classification even if there is little likelihood of loss.
6 (Doubtful) – The debt investment has all the weaknesses inherent in those classified as Substandard, with the additional factor that the weaknesses are pronounced to the point that collection or liquidation in full, on the basis of currently existing facts, conditions and values, is deemed uncertain. The possibility of loss on a Doubtful asset is high but, because of certain important and reasonably specific pending factors which may strengthen the asset, its classification as an estimated loss is deferred until its more exact status can be determined.
7 (Loss) – The debt investment is considered almost fully uncollectible and of such little value that its continuance as an asset is not warranted. It is generally a credit that is no longer supported by an operating company, a credit where the majority of our assets have been liquidated or sold and a few assets remain to be sold over many months or even years, or a credit where the remaining collections are expected to be minimal.
As of December 31, 2017, we had debt investments in 35 portfolio companies, totaling $246.3 million at fair value, of which $3.8 million, $222.0 million, $16.5 million, and $2.9 million, and $1.2 million were rated 2, 3, 4, 5, and 6, respectively.
Investment Committees
OFS Advisor’s Pre-Allocation Investment Committee, CLO Investment Committee and Middle-Market Investment Committee, (the “Middle-Market Investment Committee”, and collectively, the “Advisor Investment Committees”), are responsible for the overall asset allocation decisions and the evaluation and approval of investments of OFS Advisor’s advisory clients.
The Middle-Market Investment Committee, which is comprised of Richard Ressler (Chairman), Jeffrey Cerny, Mark Hauser and Bilal Rashid, along with the investment committee for SBIC I LP (the “SBIC Investment Committee”), which is comprised of Mark Hauser, Bilal Rashid, Jeffrey Cerny and Tod Reichert, is responsible for the evaluation and approval of all the investments made by us directly or through our wholly-owned subsidiaries, as appropriate.
The process employed by the Advisor Investment Committees, including the Middle-Market Investment Committee, and the SBIC Investment Committee is intended to bring the diverse experience and perspectives of the committees’ members to the investment process. The Middle-Market Investment Committee and SBIC Investment Committee serve to provide investment consistency and adherence to our core investment philosophy and policies. The Middle-Market Investment Committee and SBIC Investment Committee also determine appropriate investment sizing and implement ongoing monitoring requirements of our investments.
In certain instances, management may seek the approval of our board of directors prior to the making of an investment. In addition to reviewing investments, the meetings of the Middle-Market Investment Committee and SBIC Investment Committee, where applicable, serve as a forum to discuss credit views and outlooks. Potential transactions and deal flow are reviewed on a regular basis. Members of the investment team are encouraged to share information and views on credits with members of the Middle-Market Investment Committee and SBIC Investment Committee, where applicable, early in their analysis. We believe this process improves the quality of the analysis and assists the deal team members in working efficiently.
Investments
We pursue an investment strategy focused primarily on investments in middle-market companies in the United States. We focus on investments in loans, in which OFS Advisor’s investment professionals have expertise, including investments in first-lien, unitranche, second-lien, and mezzanine loans and, to a lesser extent, on warrants and other equity securities. We seek to create a diverse portfolio by making investments in the securities of middle-market companies that we expect to range generally from $3.0 million to $25.0 million each, although we expect this investment size will vary proportionately with the size of our capital base.
Structure of Investments
We anticipate that our loan portfolio will continue to contain investments of the following types with the following typical characteristics:
Senior Secured First-Lien Loans. First-lien senior secured loans comprise, and will continue to comprise, a significant portion of our investment portfolio. First-lien senior secured loans obtain security interests in the assets of these portfolio companies as collateral in support of the repayment of these loans (in certain cases, subject to a payment waterfall). The collateral takes the form of first-priority liens on specified assets of the portfolio company borrower and, typically, first-priority pledges of the ownership interests in the borrower. Our first lien loans may provide for moderate loan amortization in the early years of the loan, with the majority of the amortization deferred until loan maturity. These loans are categorized as
9
Senior Secured Loans in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and Supplementary Data."
Senior Secured Unitranche Loans. Unitranche loans are loans that combine both senior and subordinated debt into one loan under which the borrower pays a single blended interest rate that is intended to reflect the relative risk of the secured and unsecured components. We typically structure our unitranche loans as senior secured loans. We obtain security interests in the assets of these portfolio companies as collateral in support of the repayment of these loans. This collateral takes the form of first-priority liens on the assets of a portfolio company and, typically, first-priority pledges of the ownership interests in the company. We believe that unitranche lending represents a significant growth opportunity for us, offering the borrower the convenience of dealing with one lender, which may result in a higher blended rate of interest to us than we might realize in a traditional multi-tranche structure. Unitranche loans typically provide for moderate loan amortization in the initial years of the facility, with the majority of the amortization deferred until loan maturity. Unitranche loans generally allow the borrower to make a large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity. In many cases, we will be the sole lender, or we, together with our affiliates, will be the sole lender, of unitranche loans, which can afford us additional influence with a borrower in terms of monitoring and, if necessary, remediation in the event of underperformance. These loans are categorized as Senior Secured Loans in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and Supplementary Data."
Senior Secured Second-lien Loans. Second-lien senior secured loans obtain security interests in the assets of these portfolio companies as collateral in support of the repayment of such loans. This collateral typically takes the form of second-priority liens on the assets of a portfolio company, and we may enter into an inter-creditor agreement with the holders of the portfolio company’s first-lien senior secured debt. These loans typically provide for no contractual loan amortization in the initial years of the facility, with all amortization deferred until loan maturity. These loans are categorized as Senior Secured Loans in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and Supplementary Data."
Subordinated (“Mezzanine”) Loans. These investments are typically structured as unsecured, subordinated loans that typically provide for relatively high, fixed interest rates that provide us with significant current interest income. These loans typically will have interest-only payments (often representing a combination of cash pay and payment-in-kind (“PIK”) interest) in the early years, with amortization of principal deferred to maturity. Mezzanine loans generally allow the borrower to make a large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity. Mezzanine investments are generally more volatile than secured loans and may involve a greater risk of loss of principal. Mezzanine loans often include a PIK feature (meaning a feature allowing for the payment of interest in the form of additional principal amount of the loan instead of in cash), which effectively operates as negative amortization of loan principal, thereby increasing credit risk exposure over the life of the loan. These loans are categorized as Subordinated Loans in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and Supplementary Data."
Equity Securities. Equity securities typically consist of either a direct minority equity investment in common or membership/partnership interests or preferred stock of a portfolio company, and are typically not control-oriented investments. Our preferred equity investments typically contain a fixed dividend yield based on the par value of the equity security. Preferred equity dividends may be paid in cash at a stipulated date, usually quarterly, and are participating and/or cumulative. We may structure such equity investments to include provisions protecting our rights as a minority-interest holder, as well as a “put,” or right to sell such securities back to the issuer, upon the occurrence of specified events. In many cases, we may also seek to obtain registration rights in connection with these equity interests, which may include demand and “piggyback” registration rights, which grants us the right to register our equity interest when either the portfolio company or another investor in the portfolio company files a registration statement with the SEC to issue securities. Our equity investments typically are made in connection with debt investments to the same portfolio companies. These securities are categorized as a Preferred Equity or Common Equity in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and Supplementary Data."
Warrants. In some cases, we may receive nominally priced warrants to buy a minority equity interest in the portfolio company in connection with a loan. As a result, as a portfolio company appreciates in value, we may achieve additional investment return from this equity interest. We may structure such warrants to include provisions protecting our rights as a minority-interest holder, as well as a put to sell such securities back to the issuer, upon the occurrence of specified events. In many cases, we may also seek to obtain registration rights in connection with these equity interests, which may include demand and “piggyback” registration rights. These securities are categorized as Warrants in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and Supplementary Data."
10
General Structuring Considerations. We tailor the terms of each investment to the facts and circumstances of the transaction and the prospective portfolio company, negotiating a structure that protects our rights and manages our risk while creating incentives for the portfolio company to achieve its business plan and improve its operating results. We seek to limit the downside potential of our investments by:
• | selecting investments that we believe have a very low probability of loss; |
• | requiring a total return on our investments (including both interest and potential equity appreciation) that we believe will compensate us appropriately for credit risk; and |
• | negotiating covenants in connection with our investments that afford our portfolio companies as much flexibility in managing their businesses as possible, consistent with the preservation of our capital. Such restrictions may include affirmative and negative covenants, default penalties, lien protection, change of control provisions and board rights, including either observation or rights to a seat on the board of directors under some circumstances. |
We expect to hold most of our investments to maturity or repayment, but we may sell some of our investments earlier if a liquidity event occurs, such as a sale, recapitalization or worsening of the credit quality of the portfolio company.
MANAGEMENT AND OTHER AGREEMENTS
Investment Advisory Agreement
OFS Advisor is registered as an investment adviser under the Advisers Act. OFS Advisor is a wholly owned subsidiary of OFSAM. Pursuant to the Investment Advisory Agreement with and subject to the overall supervision of our board of directors and in accordance with the 1940 Act, OFS Advisor provides investment advisory services to us. Under the terms of the Investment Advisory Agreement, OFS Advisor:
• | determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes; |
• | assists us in determining what securities we purchase, retain or sell; |
• | identifies, evaluates and negotiates the structure of the investments we make (including performing due diligence on our prospective portfolio companies); and |
• | executes, closes, services and monitors the investments we make. |
Management and Incentive Fee.
For providing these services, OFS Advisor receives a fee from us, consisting of two components—a base management fee and an incentive fee. The base management fee is calculated at an annual rate of 1.75% based on the average value of our total assets (other than cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity), adjusted for stock issuances and stock purchases, at the end of the two most recently completed calendar quarters. We have excluded from the base management fee calculation any base management fee that would be owed in respect of the intangible asset and goodwill resulting from the SBIC Acquisition. The base management fee is payable quarterly in arrears. Base management fees for any partial quarter are prorated based on the number of days in the quarter.
The incentive fee has two parts. One part ("Part One") is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the immediately preceding calendar quarter. “Pre-incentive fee net investment income” means interest income, dividend income and any other income (including any other fees such as commitment, origination and sourcing, structuring, diligence and consulting fees or other fees that we receive from portfolio companies but excluding fees for providing managerial assistance) accrued during the calendar quarter, minus operating expenses for the quarter (including the base management fee, any expenses payable under the Administration Agreement and any interest expense and dividends paid on any outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest or dividend feature (such as original issue discount, or "OID", debt instruments with PIK interest, equity investments with accruing or PIK dividend, and zero coupon securities), accrued income that we have not yet received in cash.
Pre-incentive fee net investment income does not include any realized gains, realized losses, unrealized capital appreciation or unrealized capital depreciation. Because of the structure of the incentive fee, it is possible that we may pay an incentive fee in a quarter where we incur a loss. For example, if we receive pre-incentive fee net investment income in excess of the hurdle rate (as defined below) for a quarter, we will pay the applicable incentive fee even if we have incurred a loss in that quarter due to realized capital losses and unrealized capital depreciation.
11
Pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets (defined as total assets less indebtedness and before taking into account any incentive fees payable during the period) at the end of the immediately preceding calendar quarter, is compared to a fixed “hurdle rate” of 2.0% per quarter. If market interest rates rise, we may be able to invest our funds in debt instruments that provide for a higher return, which would increase our pre-incentive fee net investment income and make it easier for OFS Advisor to surpass the fixed hurdle rate and receive an incentive fee based on such net investment income. There is no accumulation of amounts on the hurdle rate from quarter to quarter and, accordingly, there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle rate, and there is no delay of payment if prior quarters are below the quarterly hurdle rate. Pre-incentive fee net investment income fees are prorated for any partial quarter based on the number of days in such quarter.
We pay OFS Advisor an incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows:
• | no incentive fee in any calendar quarter in which the pre-incentive fee net investment income does not exceed the hurdle rate; |
• | 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5% in any calendar quarter. We refer to this portion of our pre-incentive fee net investment income (which exceeds the hurdle rate but is less than 2.5%) as the “catch-up” provision. The catch-up is meant to provide OFS Advisor with 20.0% of the pre-incentive fee net investment income as if a hurdle rate did not apply if this pre-incentive fee net investment income exceeds 2.5% in any calendar quarter; and |
• | 20.0% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.5% in any calendar quarter. |
The following is a graphical representation of the calculation of the income-related portion of the incentive fee:
Quarterly Incentive Fee Based on Net Investment Income
The second part ("Part Two") of the incentive fee (the “Capital Gains Fee”) is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement, as of the termination date) and is calculated at the end of each applicable year by subtracting (a) the sum of our cumulative aggregate realized capital losses and our aggregate unrealized capital depreciation from (b) our cumulative aggregate realized capital gains. If such amount is positive at the end of such year, then the Capital Gains Fee for such year is equal to 20.0% of such amount, less the aggregate amount of Capital Gains Fees paid in all prior years. If such amount is negative, then there is no Capital Gains Fee for such year. The Company accrues the Capital Gains Fee if, on a cumulative basis, the sum of net realized capital gains and (losses) plus net unrealized appreciation and (depreciation) is positive.
The cumulative aggregate realized capital gains are calculated as the sum of the differences, if positive, between (a) the net sales price of each investment in our portfolio when sold and (b) the accreted or amortized cost basis of such investment.
The cumulative aggregate realized capital losses are calculated as the sum of the amounts by which (a) the net sales price of each investment in our portfolio when sold is less than (b) the accreted or amortized cost basis of such investment.
The aggregate unrealized capital depreciation is calculated as the sum of the differences, if negative, between (a) the valuation of each investment in our portfolio as of the applicable Capital Gains Fee calculation date and (b) the accreted or amortized cost basis of such investments. Unrealized capital appreciation is accrued, but not paid until said appreciation is realized. We accrue the Capital Gains Fee if, on a cumulative basis, the sum of the net realized capital gains (and losses) plus net unrealized appreciation (and depreciation) is positive. OFS Advisor has excluded from the Capital Gains Fee calculation the realized gain with respect to the step acquisitions resulting from the SBIC Acquisition. The Capital Gains Fee for any partial year is prorated based on the number of days in such year.
The base management fee is payable quarterly in arrears and was $5.0 million, $4.5 million, and $4.9 million, for the years ended December 31, 2017, 2016, and 2015, respectively.
12
Examples of Incentive Fee Calculation
Example 1—Income Related Portion of Incentive Fee:
Assumptions
• | Hurdle rate(1) = 2.0% |
• | Management fee(2) = 0.44% |
• | Other estimated expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.20% |
(1) Represents a quarter of the 8.0% annualized hurdle rate.
(2) Represents a quarter of the 1.75% annualized management fee, which became effective October 31, 2013.
(3) Excludes estimated offering expenses.
Alternative 1
Additional Assumptions
• | Investment income (including interest, dividends, fees, etc.) = 1.25% |
• | Pre-incentive fee net investment income (investment income – (management fee + other expenses)) = 0.61% |
Pre-incentive fee net investment income does not exceed the hurdle rate, therefore there is no incentive fee.
Alternative 2
Additional Assumptions
• | Investment income (including interest, dividends, fees, etc.) = 2.80% |
• | Pre-incentive fee net investment income (investment income – (management fee + other expenses)) = 2.16% |
Pre-incentive fee net investment income exceeds hurdle rate, therefore there is an incentive fee.
Incentive Fee | = | 100% × “Catch-Up” + the greater of 0% AND (20% × (pre-incentive fee net investment income – 2.5%)) |
= | (100% ×(2.16% – 2.0%)) + 0% | |
= | 100% × 0.16% | |
= | 0.16% | |
Alternative 3
Additional Assumptions
• | Investment income (including interest, dividends, fees, etc.) = 3.50% |
• | Pre-incentive fee net investment income (investment income – (management fee + other expenses)) = 2.86% |
Pre-incentive fee net investment income exceeds hurdle rate, therefore there is an incentive fee.
Incentive Fee | = | 100% × “Catch-Up” + the greater of 0% AND (20% × (pre-incentive fee net investment income – 2.5%)) |
= | (100% × (2.5% – 2.0%)) + (20% × (2.86% – 2.5%)) | |
= | 0.5% + (20% × 0.36%) | |
= | 0.5% + 0.07% | |
= | 0.57% | |
13
Example 2—Capital Gains Portion of Incentive Fee:
Alternative 1
Assumptions
• | Year 1: $20 million investment made in Company A (“Investment A”), and $30 million investment made in Company B (“Investment B”) |
• | Year 2: Investment A is sold for $50 million and fair market value (“FMV”) of Investment B determined to be $32 million |
• | Year 3: FMV of Investment B determined to be $25 million |
• | Year 4: Investment B sold for $31 million |
The capital gains portion of the incentive fee, if any, would be:
• | Year 1: None (no sales transactions) |
• | Year 2: $6 million (20% multiplied by $30 million realized capital gains on sale of Investment A) |
• | Year 3: None; $5 million (20% multiplied by $30 million cumulative realized capital gains less $5 million cumulative unrealized capital depreciation) less $6 million (Capital Gains Fee paid in Year 2) |
• | Year 4: $200,000; $6.2 million (20% multiplied by $31 million cumulative realized capital gains) less $6 million (Capital Gains Fee paid in Year 2) |
Alternative 2
Assumptions
• | Year 1: $20 million investment made in Company A (“Investment A”), $30 million investment made in Company B (“Investment B”) and $25 million investment made in Company C (“Investment C”) |
• | Year 2: Investment A sold for $50 million, FMV of Investment B determined to be $25 million and FMV of Investment C determined to be $25 million |
• | Year 3: FMV of Investment B determined to be $27 million and Investment C sold for $30 million |
• | Year 4: FMV of Investment B determined to be $35 million |
• | Year 5: Investment B sold for $20 million |
The capital gains portion of the incentive fee, if any, would be:
• | Year 1: None (no sales transactions) |
• | Year 2: $5 million (20% multiplied by $30 million realized capital gains on Investment A less $5 million unrealized capital depreciation on Investment B) |
• | Year 3: $1.4 million; $6.4 million (20% multiplied by $32 million ($35 million cumulative realized capital gains on Investment A and Investment C less $3 million cumulative unrealized capital depreciation on Investment B)) less $5 million (Capital Gains Fee paid in Year 2) |
• | Year 4: $0.6 million; $7 million (20% multiplied by $35 million (cumulative realized capital gains on Investment A and Investment C)) less $6.4 million (cumulative Capital Gains Fee paid in all prior years) |
• | Year 5: None; $5 million (20% multiplied by $25 million ($35 million cumulative realized capital gains on Investments A and C less $10 million realized capital losses on Investment B)) less $7 million (cumulative Capital Gains Fee paid in all prior years)) |
Payment of Our Expenses.
All investment professionals of OFS Advisor and/or its affiliates, when and to the extent engaged in providing investment advisory and management services to us, and the compensation and routine overhead expenses of personnel allocable to these services to us, are provided and paid for by OFS Advisor and not by us. We bear all other out-of-pocket costs and expenses of our operations and transactions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Key Financial Measures—Expenses.”
14
Duration and Termination
Unless terminated earlier as described below, the Investment Advisory Agreement will remain in effect from year to year if approved annually by our board of directors or by the affirmative vote of the holders of a majority of our outstanding voting securities, and, in either case, if also approved by a majority of our directors who are not “interested persons” as defined in the 1940 Act. The Investment Advisory Agreement automatically terminates in the event of its assignment, as defined in the 1940 Act, by OFS Advisor and may be terminated by either party without penalty upon not less than 60 days’ written notice to the other. The holders of a majority of our outstanding voting securities may also terminate the Investment Advisory Agreement without penalty upon not less than 60 days’ written notice. See “Item 1A. Risk Factors—Risks Related to our Business and Structure—We are dependent upon the OFS senior professionals for our future success and upon their access to the investment professionals and partners of OFS and its affiliates.”
Administration Agreement
Pursuant to the Administration Agreement, OFS Services, an affiliate of OFS Advisor, provides the administrative services necessary for us to operate. OFS Services furnishes us with office facilities and equipment, necessary software licenses and subscriptions and clerical, and bookkeeping and record keeping services at such facilities. Under the Administration Agreement, OFS Services performs, or oversees the performance of, our required administrative services, which include being responsible for the financial records that we are required to maintain and preparing reports to our stockholders and all other reports and materials required to be filed with the SEC or any other regulatory authority. In addition, OFS Services assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. Under the Administration Agreement, OFS Services 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, information technology, and our allocable portion of the cost of our officers, including our chief executive officer, chief financial officer, chief compliance officer, chief accounting officer, and their respective staffs. The Administration Agreement may be renewed annually with the approval of our board of directors, including a majority of our directors who are not “interested persons.” The Administration Agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party. To the extent that OFS Services outsources any of its functions we pay the fees associated with such functions at cost without incremental profit to OFS Services.
Indemnification
The Investment Advisory Agreement and the Administration Agreement both provide that OFS Advisor, OFS Services and their affiliates’ respective officers, directors, members, managers, stockholders and employees are entitled to indemnification from us from and against any claims or liabilities, including reasonable legal fees and other expenses reasonably incurred, arising out of or in connection with our business and operations or any action taken or omitted on our behalf pursuant to authority granted by the Investment Advisory Agreement or the Administration Agreement, except where attributable to willful misfeasance, bad faith or gross negligence in the performance of such person’s duties or reckless disregard of such person’s obligations and duties under the Investment Advisory Agreement or the Administration Agreement.
Board Approval of the Investment Advisory and Administrative Agreements
Our board, including our independent directors, approved the Investment Advisory Agreement at a meeting held on April 7, 2017. In reaching a decision to approve the investment advisory agreement, the board of directors reviewed a significant amount of information and considered, among other things:
• | the nature, quality and extent of the advisory and other services to be provided to us by OFS Advisor; |
• | the fee structures of comparable externally managed BDCs that engage in similar investing activities; |
• | our projected operating expenses and expense ratio compared to BDCs with similar investment objectives; |
• | any existing and potential sources of indirect income to OFS Advisor from its relationship with us and the profitability of that relationship, including through the Investment Advisory Agreement; |
• | information about the services to be performed and the personnel performing such services under the Investment Advisory Agreement; and |
• | the organizational capability and financial condition of OFS Advisor and its affiliates. |
Based on the information reviewed and the discussion thereof, the board of directors, including a majority of the non-interested directors, concluded that the investment advisory fee rates are reasonable in relation to the services to be provided and approved the Investment Advisory Agreement as being in the best interests of our stockholders.
15
Our board also reviewed services provided under the Administrative Agreement, and approved its renewal at the April 7, 2017 meeting.
License Agreement
We have entered into a license agreement with OFSAM under which OFSAM has agreed to grant us a non-exclusive, royalty-free license to use the name “OFS.” Under this agreement, we have a right to use the “OFS” name for so long as OFS Advisor or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we have no legal right to the “OFS” name. This license agreement will remain in effect for so long as the Investment Advisory Agreement with OFS Advisor is in effect.
REGULATION
General
We have elected to be regulated as a BDC under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates (including any investment advisers or sub-advisers), principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act.
In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by “a majority of our outstanding voting securities” as defined in the 1940 Act. A majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of: (a) 67% or more of such company’s voting securities present at a meeting if more than 50% of the outstanding voting securities of such company are present or represented by proxy, or (b) more than 50% of the outstanding voting securities of such company. We do not anticipate any substantial change in the nature of our business.
We generally cannot issue and sell our common stock at a price below net asset value per share. We may, however, issue and sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value of our common stock if (1) our board of directors determines that such sale is in our best interests and the best interests of our stockholders, and (2) our stockholders have approved our policy and practice of making such sales within the preceding 12 months. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our board of directors, closely approximates the market value of such securities.
As a BDC, we are required to meet a coverage ratio of the value of total assets to senior securities, which include all of our borrowings and any preferred stock we may issue in the future, of at least 200%. The Company received exemptive relief from the SEC effective November 26, 2013, which allows us to exclude our SBA guaranteed debentures from the definition of senior securities in the statutory 200% asset coverage ratio under the 1940 Act.
The 1940 Act generally prohibits BDCs from making certain negotiated co-investments with certain affiliates absent an order from the SEC permitting the BDC to do so. On October 12, 2016, we received exemptive relief from the SEC to permit us to co-invest in portfolio companies with certain funds managed by OFS Advisor ("Affiliated Funds") in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors, subject to compliance with certain conditions (the "Order"). Pursuant to the Order, we are generally permitted to co-invest with Affiliated Funds if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transactions, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching by us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies.
Legislation has been introduced in the U.S. House of Representatives and Senate intended to revise certain regulations applicable to BDCs. The legislation provides for (i) modifying the asset coverage ratio from 200% to 150%, (ii) permitting BDCs to file registration statements with the U.S. Securities and Exchange Commission that incorporate information from already-filed reports by reference, (iii) utilizing other streamlined registration processes afforded to operating companies, and (iv) allowing BDCs to own investment adviser subsidiaries. There are no assurances as to when the legislation will be enacted by Congress, if at all, or, if enacted, what final form the legislation would take.
We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities Act. Our intention is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies, except that we may enter into hedging transactions to manage the risks associated with interest rate fluctuations. However, we may purchase or otherwise receive warrants to purchase the common stock of our portfolio companies in connection with acquisition financing or other investments. Similarly, in connection with an acquisition, we may acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under
16
certain circumstances. We also do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, except for registered money market funds, we generally cannot acquire more than 3% of the voting stock of any registered investment company, invest more than 5% of the value of our total assets in the securities of one investment company, or invest more than 10% of the value of our total assets in the securities of more than one investment company. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such investments might subject our stockholders to additional expenses as they will be indirectly responsible for the costs and expenses of such companies. None of our investment policies are fundamental and may be changed without stockholder approval.
Qualifying Assets
Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in section 55(a) of the 1940 Act, which are referred to as “qualifying assets,” unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s assets, as defined by the 1940 Act. The principal categories of qualifying assets relevant to our business are the following:
(a) | Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is defined in the 1940 Act as any issuer that: |
• | is organized under the laws of, and has its principal place of business in, the United States; |
• | is not an investment company (other than a small business investment company wholly-owned by the BDC) or a company that would be an investment company but for certain exclusions under the 1940 Act; and |
• | satisfies either of the following: |
• | does not have any class of securities listed on a national securities exchange or has any class of securities listed on a national securities exchange subject to a $250 million market capitalization maximum; or |
• | is controlled by a BDC or a group of companies including a BDC, the BDC actually exercises a controlling influence over the management or policies of the eligible portfolio company, and, as a result, the BDC has an affiliated person who is a director of the eligible portfolio company. |
(b) | Securities of any eligible portfolio company which we control. |
(c) | Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident to such a private transaction, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities, was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements. |
(d) | Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company. |
(e) | Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the exercise of warrants or rights relating to such securities. |
(f) | Cash, cash equivalents, U.S. government securities or high-quality debt securities that mature in one year or less from the date of investment. |
Control, as defined by the 1940 Act, is presumed to exist where a BDC beneficially owns more than 25% of the outstanding voting securities of the portfolio company.
The regulations defining qualifying assets may change over time. We may adjust our investment focus as needed to comply with and/or take advantage of any regulatory, legislative, administrative or judicial actions in this area.
Managerial Assistance to Portfolio Companies
A BDC must have been organized and have its principal place of business in the United States and must be operated for the purpose of making investments in the types of securities described in (a), (b) or (c) above. However, in order to count portfolio securities as qualifying assets for the purpose of the 70% test, the BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance. Where the BDC purchases such securities in conjunction with one or more other persons acting together, the BDC will satisfy this test if one of the other persons in the group makes available such managerial assistance, although this may not be the sole method by which the BDC satisfies the requirement to make available managerial
17
assistance. Making available managerial assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company. With respect to an SBIC, making available managerial assistance means the making of loans to a portfolio company.
Temporary Investments
Pending investment in other types of qualifying assets, as described above, our investments may consist of cash, cash equivalents, U.S. government securities, repurchase agreements and high-quality debt investments that mature in one year or less from the date of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets, as defined by the 1940 Act, are qualifying assets or temporary investments. We may invest in highly rated commercial paper, U.S. Government agency notes, and U.S. Treasury bills or repurchase agreements relating to such securities that are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest rate. Consequently, repurchase agreements are functionally similar to loans. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, the 1940 Act and certain diversification tests in order to qualify as a RIC for federal income tax purposes typically require us to limit the amount we invest with any one counterparty. Accordingly, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. OFS Advisor monitors the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
Warrants and Options
Under the 1940 Act, a BDC is subject to restrictions on the amount of warrants, options, restricted stock or rights to purchase shares of capital stock that it may have outstanding at any time. Under the 1940 Act, we may generally only offer warrants provided that (i) the warrants expire by their terms within ten years, (ii) the exercise or conversion price is not less than the current market value at the date of issuance, (iii) our stockholders authorize the proposal to issue such warrants, and our board of directors approves such issuance on the basis that the issuance is in the best interests of OFS Capital and its stockholders and (iv) if the warrants are accompanied by other securities, the warrants are not separately transferable unless no class of such warrants and the securities accompanying them has been publicly distributed. The 1940 Act also provides that the amount of our voting securities that would result from the exercise of all outstanding warrants, as well as options and rights, at the time of issuance may not exceed 25% of our outstanding voting securities. In particular, the amount of capital stock that would result from the conversion or exercise of all outstanding warrants, options or rights to purchase capital stock cannot exceed 25% of the BDC’s total outstanding shares of capital stock.
Senior Securities
We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any senior securities remain outstanding, we must make provisions to prohibit any distribution to our stockholders or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset coverage. For a discussion of the risks associated with leverage, see “Item 1A. Risk Factors—Risks Related to BDCs—Regulations governing our operation as a BDC affect our ability to and the way in which we raise additional capital. As a BDC, we will need to raise additional capital, which will expose us to risks, including the typical risks associated with leverage.”
Compliance with the Sarbanes-Oxley Act of 2002 and the Nasdaq Global Select Market Corporate Governance Regulations
The Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) imposes a wide variety of regulatory requirements on publicly held companies and their insiders. Many of these requirements affect us. The Sarbanes-Oxley Act has required us to review our policies and procedures to determine whether we comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We will continue to monitor our compliance with all future regulations that are adopted under the Sarbanes-Oxley Act and will take actions necessary to ensure that we are in compliance therewith.
In addition, The Nasdaq Global Select Market has adopted various corporate governance requirements as part of its listing standards. We believe we are in compliance with such corporate governance listing standards. We will continue to monitor our compliance with all future listing standards and will take actions necessary to ensure that we are in compliance therewith.
18
Exemptive Relief
We are generally prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our board of directors who are not interested persons and, in some cases, prior approval by the SEC. The SEC has interpreted the BDC prohibition on transactions with affiliates to prohibit all “joint transactions” between entities that share a common investment adviser. Further, the 1940 Act generally prohibits BDCs from making certain negotiated co-investments with certain affiliates absent an order from the SEC permitting the BDC to do so. On October 12, 2016, we received exemptive relief from the SEC to permit us to co-invest in portfolio companies with certain Affiliated Funds in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors, subject to compliance with the Order. Pursuant to the Order, we are generally permitted to co-invest with Affiliated Funds if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transactions, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching by us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies.
The staff of the SEC has granted no-action relief permitting purchases of a single class of privately placed securities provided that the adviser negotiates no term other than price and certain other conditions are met. As a result, unless under the Order, we only expect to co-invest on a concurrent basis with certain funds advised by OFS Advisor when each of us will own the same securities of the issuer and when no term is negotiated other than price. Any such investment would be made, subject to compliance with existing regulatory guidance, applicable regulations and OFS Advisor’s allocation policy. If opportunities arise that would otherwise be appropriate for us and for another fund advised by OFS Advisor to invest in different securities of the same issuer, OFS Advisor will need to decide which fund will proceed with the investment. The decision by OFS Advisor to allocate an opportunity to another entity could cause us to forego an investment opportunity that we otherwise would have made. Moreover, except in certain circumstances, we will be unable to invest in any issuer in which another fund advised by OFS Advisor has previously invested.
Small Business Investment Company Regulations
Our wholly owned subsidiary, SBIC I LP is an SBIC and must maintain compliance with SBA regulations.
SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses. The SBIC license 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-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid without penalty twice each year on certain dates. The interest rate of SBA-guaranteed debentures is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.
SBA regulations currently limit the amount that an SBIC may borrow to up to a maximum of $150 million when it has at least $75 million in regulatory capital, receives a leverage commitment from the SBA and has been through an examination by the SBA subsequent to licensing. For two or more SBICs under common control, the maximum amount of outstanding SBA debentures cannot exceed $350 million.
The investments of an SBIC are limited to loans to and equity securities of eligible small businesses. Under present SBA regulations, eligible small businesses generally include businesses that (together with their affiliates) have a tangible net worth not exceeding $19.5 million and have average annual net income after U.S. federal income taxes not exceeding $6.5 million (average net income to be computed without benefit of any carryover loss) for the two most recent fiscal years. In addition, an SBIC must devote 25% of its investment activity to “smaller concerns,” as defined by the SBA. A smaller concern generally includes businesses that have a tangible net worth not exceeding $6 million and have average annual net income after U.S. federal income taxes not exceeding $2 million (average net income to be computed without benefit of any net carryover loss) for the two most recent fiscal years. SBA regulations also provide alternative criteria to determine eligibility, which may include, among other things, the industry in which the business is engaged, the number of employees of the business, its gross sales, and the extent to which the SBIC is proposing to participate in a change of ownership of the business. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services.
The SBA prohibits an SBIC from providing funds to small businesses for certain purposes, such as relending, real estate or investing in companies outside of the United States, and from providing funds to businesses engaged in a few prohibited industries and to certain “passive” (i.e., non-operating) companies. In addition, without prior SBA approval, an SBIC may not invest an amount equal to more than approximately 30% of the SBIC’s regulatory capital in any one company and its affiliates.
19
SBICs must invest idle funds that are not being used to make investments permitted under SBA regulations in the following limited types of securities: (i) direct obligations of, or obligations guaranteed as to principal and interest by, the U.S. government, which mature within 15 months from the date of the investment; (ii) repurchase agreements with federally insured institutions with a maturity of seven days or less (and the securities underlying the repurchase obligations must be direct obligations of or guaranteed by the federal government); (iii) certificates of deposit with a maturity of one year or less, issued by a federally insured institution; (iv) a deposit account in a federally insured institution that is subject to a withdrawal restriction of one year or less; (v) a checking account in a federally insured institution; or (vi) a reasonable petty cash fund.
SBA regulations include restrictions on a “change of control” or other transfers of limited partnership interests in an SBIC. In addition, SBIC I LP may also be limited in its ability to make distributions to us if it does not have sufficient accumulated net profit, in accordance with SBA regulations.
SBIC I LP is subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. Receipt of the SBIC license and an SBA leverage commitment does not ensure that SBIC I LP will receive SBA guaranteed debenture funding, and such funding is dependent upon SBIC I LP’s continued compliance with SBA regulations and policies.
The SBA, as a creditor, will have a superior claim to the SBIC I LP’s assets over our stockholders in the event that SBIC I LP is liquidated or the SBA exercises its remedies under the SBA debentures issued by SBIC I LP in the event of a default.
Other
We are subject to periodic examination by the SEC for compliance with the Exchange Act, and the 1940 Act.
We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any director or officer against any liability to OFS Capital or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.
We and OFS Advisor each have adopted and implemented written policies and procedures reasonably designed to prevent violation of relevant federal securities laws, will review these policies and procedures annually for their adequacy and the effectiveness of their implementation, and have designated a chief compliance officer to be responsible for administering the policies and procedures.
Our internet address is www.ofscapital.com. We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statement and amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Codes of Ethics
We and OFS Advisor have each adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act that establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to either code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code’s requirements. Our code of ethics is available, free of charge, on our website at www.ofscapital.com. You may also read and copy the code of ethics at the SEC’s Public Reference Room in Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 942-8090. In addition, the code of ethics is available on the EDGAR Database on the SEC’s website at http://www.sec.gov. You may also obtain copies of the code of ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to OFS Advisor. The proxy voting policies and procedures of OFS Advisor are set out below. The guidelines are reviewed periodically by OFS Advisor and our directors who are not “interested persons,” and, accordingly, are subject to change. For purposes of these proxy voting policies and procedures described below, “we,” “our” and “us” refer to OFS Advisor.
Introduction
As an investment adviser registered under the Advisers Act, we have a fiduciary duty to act solely in the best interests of our clients. As part of this duty, we recognize that we must vote client securities in a timely manner free of conflicts of interest and in the best interests of our clients.
20
These policies and procedures for voting proxies for our investment advisory clients are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.
Proxy Policies
We vote proxies relating to our portfolio securities in what we perceive to be the best interest of our clients. We review on a case-by-case basis each proposal submitted to a stockholder vote to determine its effect on the portfolio securities held by our clients. In most cases we will vote in favor of proposals that we believe are likely to increase the economic value of the underlying portfolio securities held by our clients. Although we will generally vote against proposals that may have a negative effect on our clients’ portfolio securities, we may vote for such a proposal if there exist compelling long-term reasons to do so.
Our proxy voting decisions are made by those senior officers who are responsible for monitoring each of our clients’ investments. To ensure that our vote is not the product of a conflict of interest, we require that (1) anyone involved in the decision-making process disclose to our chief compliance officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (2) employees involved in the decision-making process or vote administration are prohibited from revealing how we intend to vote on a proposal in order to reduce any attempted influence from interested parties. Where conflicts of interest may be present, we will disclose such conflicts to our client, including with respect to OFS Capital, those directors who are not interested persons and we may request guidance from such persons on how to vote such proxies for their account.
Proxy Voting Records
You may obtain information about how we voted proxies for OFS Capital, free of charge, by making a written request for proxy voting information to: OFS Capital Corporation, 10 S. Wacker Drive, Suite 2500, Chicago, Illinois 60606, Attention: Investor Relations, or by calling OFS Capital Corporation at (847) 734-2000. The SEC also maintains a website at http://www.sec.gov that contains such information.
Privacy Principles
We are committed to maintaining the privacy of our stockholders and to safeguarding their nonpublic personal information. The following information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties.
Generally, we do not receive any nonpublic personal information relating to our stockholders, although certain nonpublic personal information of our stockholders may become available to us. We do not disclose any nonpublic personal information about our stockholders or former stockholders to anyone, except as permitted by law or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third-party administrator).
We restrict access to nonpublic personal information about our stockholders to employees of OFS Advisor and its affiliates with a legitimate business need for the information. We maintain physical, electronic and procedural safeguards designed to protect the nonpublic personal information of our stockholders.
Material U.S. Federal Income Tax Considerations
Election to be Taxed as a RIC
We have elected to be taxed as a RIC under Subchapter M of the Code. As a RIC, we are not required to pay corporate-level federal income taxes on any income that we distribute to our stockholders from our otherwise taxable earnings and profits. To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements, as described below. In addition, to receive RIC tax treatment, we must distribute to our stockholders, for each taxable year, the Annual Distribution Requirement. The excess of net long-term capital gains over net short-term capital losses, if any ("Net Capital Gains"), are not a component of the Annual Distribution Requirement, but impacts taxable income if not distributed as discussed below.
Taxation as a RIC
If we:
• | maintain our qualification as a RIC; and |
• | satisfy the Annual Distribution Requirement; |
then we will not be subject to U.S. federal income tax on the portion of our ICTI or Net Capital Gains we distribute to stockholders. We will be subject to U.S. federal income tax at the regular corporate rates on any ICTI or Net Capital Gain not distributed (or deemed distributed) to our stockholders.
We are also subject to a 4% nondeductible federal excise tax on certain undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98.2% of
21
our capital gain net income (both long-term and short-term) for the one-year period ending October 31 in that calendar year (or, if we so elect, for that calendar year) and (3) any income recognized, but not distributed, in preceding years and on which we paid no federal income tax (the “Excise Tax Avoidance Requirement”). We may choose to retain a portion of our ordinary income and/or capital gain net income in any year and pay the 4% U.S. federal excise tax on the retained amounts.
In order to maintain our qualification as a RIC for federal income tax purposes, we must, among other things:
• | continue to qualify as a BDC under the 1940 Act at all times during each taxable year; |
• | derive in each taxable year at least 90% of our gross income from dividends, interest, certain payments with respect to loans of stock and securities, gains from the sale or other disposition of stock, securities, or foreign currencies and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to our business of investing in such stock, securities or currencies, and net income derived from interests in “qualified publicly traded partnerships,” as such term is defined in the Code (the "90% Income Test"); and |
• | diversify our holdings so that at the end of each quarter of the taxable year: |
• | at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities, with such other securities limited, in respect of any one issuer, to an amount not greater than 5% of the value of our assets and 10% of the outstanding voting securities of such issuer; and |
• | no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that we control (as determined under applicable tax rules) and that are engaged in the same, similar or related trades or businesses or of one or more qualified publicly traded partnerships (the “Diversification Tests”). |
We may invest in partnerships, including qualified publicly traded partnerships, which may result in our being subject to state, local or foreign income taxes, franchise taxes, or withholding liabilities.
We are required to recognize ICTI in circumstances in which we have not received a corresponding payment in cash. For example, we hold debt obligations that are treated under applicable tax rules as issued with OID and debt instruments with PIK interest, and we must include in ICTI each year the portion of the OID and PIK interest that accrues for that year (as it accrues over the life of the obligation), irrespective of whether the cash representing such income is received by us in that taxable year. The continued recognition of non-cash ICTI may cause difficulty in meeting the Annual Distribution Requirement. We may be required to sell investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital, or forgo new investment opportunities to meet this requirement. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.
We are authorized to borrow funds and to sell assets in order to satisfy distribution requirements. However, under the 1940 Act, we are not permitted to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. Moreover, our ability to dispose of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous. See “Regulation—Senior Securities.”
Certain of our investment practices may be subject to special and complex federal income tax provisions that may, among other things, (1) treat dividends that would otherwise qualify for the dividends received deduction or constitute qualified dividend income as ineligible for such treatment, (2) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (3) convert lower-taxed long-term capital gain into higher-taxed short-term capital gain or ordinary income, (4) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (5) cause us to recognize income or gain without receipt of a corresponding distribution of cash, (6) adversely affect the time as to when a purchase or sale of stock or securities is deemed to occur, (7) adversely alter the characterization of certain complex financial transactions and (8) produce income that will not be considered "qualifying income" for purposes of the 90% Income Test. We will monitor our transactions and may make certain tax elections to mitigate the potential adverse effect of these provisions, but there can be no assurance that any adverse effects of these provisions will be mitigated.
If we purchase shares in a “passive foreign investment company” (a “PFIC”), we may be subject to federal income tax on our allocable share of a portion of any “excess distribution” received on, or any gain from the disposition of, such shares even if our allocable share of such income is distributed as a taxable dividend to our stockholders. Additional charges in the nature of interest generally will be imposed on us in respect of deferred taxes arising from any such excess distribution or gain. If we invest in a PFIC and elect to treat the PFIC as a “qualified electing fund” under the Code (a “QEF”), in lieu of the foregoing requirements, we will be required to include in income each year our proportionate share of the ordinary earnings and
22
net capital gain of the QEF, even if such income is not distributed by the QEF. Alternatively, we may be able to elect to mark-to-market at the end of each taxable year our shares in a PFIC; in this case, we will recognize as ordinary income our allocable share of any increase in the value of such shares, and as ordinary loss our allocable share of any decrease in such value to the extent that any such decrease does not exceed prior increases included in its income. Under either election, we may be required to recognize in a year income in excess of distributions from PFICs and proceeds from dispositions of PFIC stock during that year, and such income will nevertheless be subject to the Annual Distribution Requirement and will be taken into account for purposes of the 4% excise tax.
Some of the income and fees that we recognize may result in ICTI that will not be "qualifying income" for the 90% Income Test. In order to ensure that such income and fees do not disqualify us as a RIC for a failure to satisfy the 90% Income Test, we may recognize such income and fees directly or indirectly through one or more entities taxed as corporations for U.S. federal income tax purposes. Such corporations are required to pay U.S. corporate income tax on their earnings, which ultimately reduces our return on such income and fees.
Failure to Qualify as a RIC
If we are unable to maintain our qualification as a RIC, we will be subject to tax on all of our ICTI and Net Capital Gains at regular corporate rates; we will not receive a dividend deduction for any distributions to our stockholders. Distributions would not be required, and any distributions would be taxable to our stockholders as ordinary dividend income that would, for qualifying non-corporate U.S. stockholders, be eligible for the current 20% maximum rate to the extent of our current and accumulated earnings and profits (subject to limitations under the Code). Subject to certain limitations under the Code, corporate distributions would be eligible for the dividends-received deduction. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis (reducing that basis accordingly), and any remaining distributions would be treated as a capital gain. To qualify again to be taxed as a RIC in a subsequent year, we would be required to distribute to our stockholders our earnings and profits attributable to non-RIC years. In addition, if we failed to qualify as a RIC for a period greater than two taxable years, then we would be required to elect to recognize and pay tax on any net built-in gain (the excess of aggregate gain, including items of income, over aggregate loss that would have been realized if we had been liquidated) or, alternatively, be subject to taxation on such built-in gain recognized for a period of ten years, in order to qualify as a RIC in a subsequent year.
23
Item 1A. | Risk Factors |
RISK FACTORS
Investing in our common stock involves a number of significant risks. In addition to the other information contained in this Annual Report on Form 10-K, you should consider carefully the following information before making an investment in our common stock. The risks set out below are not the only risks we face. Additional risks and uncertainties not presently known to us or not presently deemed material by us might also impair our operations and performance. If any of the following events occur, our business, financial condition and results of operations could be materially and adversely affected. In such case, our net asset value and the trading price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business and Structure
Global capital markets could enter a period of severe disruption and instability. These conditions have historically affected and could again materially and adversely affect debt and equity capital markets in the United States and around the world and our business.
The current worldwide financial market situation, as well as various social and political tensions in the U.S. and around the world, may contribute to increased market volatility, may have long-term effects on the U.S. and worldwide financial markets, and may cause economic uncertainties or deterioration in the United States and worldwide. The U.S. and global capital markets experienced extreme volatility and disruption during the economic downturn that began in mid-2007, and the U.S. economy was in a recession for several consecutive calendar quarters during the same period. In 2010, a financial crisis emerged in Europe, triggered by high budget deficits and rising direct and contingent sovereign debt, which created concerns about the ability of certain nations to continue to service their sovereign debt obligations. Risks resulting from such debt crisis, including any austerity measures taken in exchange for bailout of certain nations, and any future debt crisis in Europe or any similar crisis elsewhere could have a detrimental impact on the global economic recovery, sovereign and non-sovereign debt in certain countries and the financial condition of financial institutions generally. In June 2016, the United Kingdom held a referendum in which voters approved an exit from the European Union (“Brexit”), and, accordingly, on February 1, 2017, the U.K. Parliament voted in favor of allowing the U.K. government to begin the formal process of Brexit. Brexit created political and economic uncertainty and instability in the global markets (including currency and credit markets), and especially in the United Kingdom and the European Union, and this uncertainty and instability may last indefinitely. There is continued concern about national-level support for the Euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member countries. In addition, the fiscal and monetary policies of foreign nations, such as Russia and China, may have a severe impact on the worldwide and U.S. financial markets.
Additionally, as a result of the 2016 U.S. election, the Republican Party currently controls both the executive and legislative branches of government, which increases the likelihood that legislation may be adopted that could significantly affect the regulation of U.S. financial markets. Areas subject to potential change, amendment or repeal include the Dodd-Frank Act and the authority of the Federal Reserve and the Financial Stability Oversight Council. The United States may also potentially withdraw from or renegotiate various trade agreements and take other actions that would change current trade policies of the United States. We cannot predict which, if any, of these actions will be taken or, if taken, their effect on the financial stability of the United States. Such actions could have a significant adverse effect on our business, financial condition and results of operations. We cannot predict the effects of these or similar events in the future on the U.S. economy and securities markets or on our investments. We monitor developments and seek to manage our investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
We are dependent upon the OFS senior professionals for our future success and upon their access to the investment professionals and partners of OFS and its affiliates.
We do not have any internal management capacity or employees. We will depend on the diligence, skill and network of business contacts of the OFS senior professionals to achieve our investment objective. Our future success will depend, to a significant extent, on the continued service and coordination of the OFS senior management team, particularly Bilal Rashid, Senior Managing Director and President of OFSC, Jeffrey Cerny, Senior Managing Director and Treasurer of OFSC, and Mark Hauser, Senior Managing Director of OFSC. Each of these individuals is an employee at will of OFSC. In addition, we rely on the services of Richard Ressler, Chairman of the executive committee of OFSAM and Chairman of the Advisor Investment Committees, pursuant to a consulting agreement with Orchard Capital Corporation. The departure of Mr. Ressler or any of the senior managers of OFSC, or of a significant number of its other investment professionals, could have a material adverse effect on our ability to achieve our investment objective.
We expect that OFS Advisor will continue to evaluate, negotiate, structure, close and monitor our investments in accordance with the terms of the Investment Advisory Agreement. We can offer no assurance, however, that OFS senior professionals will continue to provide investment advice to us. If these individuals do not maintain their existing relationships
24
with OFS and its affiliates and do not develop new relationships with other sources of investment opportunities, we may not be able to grow our investment portfolio or achieve our investment objective. In addition, individuals with whom the OFS senior professionals have relationships are not obligated to provide us with investment opportunities. Therefore, we can offer no assurance that such relationships will generate investment opportunities for us.
OFS Advisor is a subsidiary of OFSAM that has no employees and depends upon access to the investment professionals and other resources of OFS and its affiliates to fulfill its obligations to us under the Investment Advisory Agreement. OFS Advisor also depends upon OFS to obtain access to deal flow generated by the professionals of OFS and its affiliates. Under a Staffing Agreement between OFSC, a subsidiary of OFSAM that employs OFS’s personnel, and OFS Advisor, OFSC has agreed to provide OFS Advisor with the resources necessary to fulfill these obligations. The Staffing Agreement provides that OFSC will make available to OFS Advisor experienced investment professionals and access to the senior investment personnel of OFSC for purposes of evaluating, negotiating, structuring, closing and monitoring our investments. We are not a party to this Staffing Agreement and cannot assure stockholders that OFSC will fulfill its obligations under the agreement. If OFSC fails to perform, we cannot assure stockholders that OFS Advisor will enforce the Staffing Agreement or that such agreement will not be terminated by either party or that we will continue to have access to the investment professionals of OFSC and its affiliates or their information and deal flow.
The investment committees that oversee our investment activities are provided by OFS Advisor under the Investment Advisory Agreement. The loss of any member of the Advisor Investment Committees or of other OFS senior professionals could limit our ability to achieve our investment objective and operate as we anticipate. This could have a material adverse effect on our financial condition and results of operation.
Our business model depends to a significant extent upon strong referral relationships with financial institutions, sponsors and investment professionals. Any inability of OFS Advisor to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
We depend upon OFS Advisor to maintain relationships with financial institutions, sponsors and investment professionals, and we will continue to rely to a significant extent upon these relationships to provide us with potential investment opportunities. If OFS Advisor fails to maintain such relationships, or to develop new relationships with other sources of investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals with whom the principals of OFS Advisor have relationships are not obligated to provide us with investment opportunities, and, therefore, we can offer no assurance that these relationships will generate investment opportunities for us in the future.
Our financial condition and results of operation will depend on our ability to manage our business effectively.
Our ability to achieve our investment objective and grow will depend on our ability to manage our business. This will depend, in turn, on the ability of the Advisor Investment Committees to identify, invest in and monitor companies that meet our investment criteria. The achievement of our investment objectives on a cost-effective basis will depend upon the Advisor Investment Committees' ability to execute our investment process, their ability to provide competent, attentive and efficient services to us and, to a lesser extent, our access to financing on acceptable terms. OFS Advisor has substantial responsibilities under the Investment Advisory Agreement. The OFS Advisor's senior professionals and other personnel of OFS Advisor's affiliates, including OFSC, may be called upon to provide managerial assistance to our portfolio companies. These activities may distract them or slow our rate of investment. Any failure to manage our business and our future growth effectively could have a material adverse effect on our business, financial condition and results of operations.
We have potential conflicts of interest related to obligations that OFS Advisor or its affiliates may have to other clients.
OFS Advisor and its affiliates manage other assets, including those of other BDCs and CLO funds, and may manage other entities in the future, and these other funds and entities may have similar or overlapping investment strategies. Our executive officers, directors and members of the Advisor Investment Committees serve as officers, directors or principals of entities that operate in the same or a related line of business as we do, or of investment funds or other investment vehicles managed by OFS Advisor or its affiliates. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in our or our stockholders’ best interests or may require them to devote time to services for other entities, which could interfere with the time available to provide services to us. For example, OFS Advisor currently serves as the investment adviser to HPCI, a non-traded BDC, that invests in senior secured loans of middle-market companies in the United States, similar to those we target for investment, including first-lien, second-lien and unitranche loans as well as subordinated loans and, to a lesser extent, warrants and other equity securities. Therefore, many investment opportunities will satisfy the investment criteria for both HPCI and us. HPCI operates as a distinct and separate entity and any investment in our common stock will not be an investment in HPCI. In addition, our executive officers and certain of our independent directors serve in substantially similar capacities for HPCI. Similarly, OFS Advisor and/or its affiliates may have other clients with, similar, different or competing investment objectives. In serving in these multiple capacities, our executive officers and directors, OFS
25
Advisor and/or its affiliates, and members of the Advisor Investment Committees may have obligations to other clients or investors in those entities, the fulfillment of which may not be in the best interests of us or our stockholders.
OFS Advisor will seek to allocate investment opportunities among eligible accounts in a manner that is fair and equitable over time and consistent with its allocation policy. Under this allocation policy, if OFS Advisor is actively seeking investments for two or more investment vehicles with similar or overlapping investment strategies, an available opportunity will be allocated based on the provisions governing allocations of such investment opportunities under law or in the relevant organizational, offering or similar documents, if any, for such investment vehicles. In the absence of any such provisions, OFS Advisor will consider the following factors and the weight that should be given with respect to each of these factors:
• | investment guidelines and/or restrictions, if any, under law or set forth in the applicable organizational, offering or similar documents for the investment vehicles; |
• | risk and return profile of the investment vehicles; |
• | suitability/priority of a particular investment for the investment vehicles; |
• | if applicable, the targeted position size of the investment for the investment vehicles; |
• | level of available cash for investment with respect to the investment vehicles; |
• | total amount of funds committed to the investment vehicles; and |
• | the age of the investment vehicles and the remaining term of their respective investment periods, if any. |
Application of one or more of the factors listed above may result in the allocation of an investment opportunity to HPCI or any other investment vehicle advised by OFS Advisor over us.
OFS Advisor and OFSAM have both subjective and objective procedures and policies in place designed to manage the potential conflicts of interest between OFS Advisor’s fiduciary obligations to us and its fiduciary obligations to other clients. For example, such policies and procedures are designed to ensure that investment opportunities are allocated in a fair and equitable manner among us and other clients of OFS Advisor. An investment opportunity that is suitable for clients of OFS Advisor may not be capable of being shared among some or all of such clients due to the limited scale of the opportunity or other factors, including regulatory restrictions imposed by the 1940 Act.
There can be no assurance that we will be able to participate in all investment opportunities that are suitable to us.
Our independent directors may face conflicts of interest related to their obligations to the affiliated BDC for which they also serve as independent directors.
The independent directors of our board of directors also comprise the independent directors of the board of directors of HPCI, an affiliated BDC that is also managed by OFS Advisor. In their capacities as directors for a BDC board, the independent directors have a duty to make decisions on behalf of that BDC that are in the best interests of that BDC and its stockholders. Accordingly, our independent directors may face conflicts of interest when making a decision on behalf of one BDC that may not be in the best interest of the other BDC. For example, the SEC has granted exemptive relief to us, OFS Advisor, HPCI, and certain other of our affiliates to co-invest in certain transactions that would otherwise be prohibited by the 1940 Act. In accordance with that relief, the independent directors must make certain findings on behalf of each BDC with respect to initial co-investment transactions, including that the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to the BDC and its stockholders and do not involve overreaching in respect of the BDC or its stockholders on the part of any of the other participants in the proposed transaction. Under such circumstances, the independent directors may face conflicts of interest when making these determinations on behalf of us and HPCI.
Members of the Advisor Investment Committees, OFS Advisor or its affiliates may, from time to time, possess material non-public information, limiting our investment discretion.
OFS senior professionals and members of the Advisor Investment Committees may serve as directors of, or in a similar capacity with, companies in which we invest, the securities of which are purchased or sold on our behalf. In the event that material nonpublic information is obtained with respect to such companies, or we become subject to trading restrictions under the internal trading policies of those companies or as a result of applicable law or regulations, we could be prohibited for a period of time from purchasing or selling the securities of such companies, and this prohibition may have an adverse effect on us and our stockholders.
To the extent PIK interest and PIK dividends constitute a portion of our income, we will be exposed to typical risks associated with such income being required to be included in taxable and accounting income prior to receipt of cash representing such income.
26
Our investments may include contractual PIK interest or PIK dividends, which represents contractual interest or dividends added to a loan balance or equity security and due at the end of such loan’s or equity security’s term. To the extent PIK interest and PIK dividends constitute a portion of our income, we will be exposed to typical risks associated with such income being required to be included in taxable and accounting income prior to receipt of cash. Such risks include:
• | The higher interest or dividend rates of PIK instruments reflect the payment deferral and increased risk associated with these instruments, and PIK instruments often represent a significantly higher risk than non-PIK instruments. |
• | Even if the accounting conditions for income accrual are met, the borrower could still default when our actual collection is supposed to occur at the maturity of the obligation. |
• | PIK instruments may have unreliable valuations because their continuing accruals require continuing judgments about the collectability of the deferred payments and the value of any associated collateral. PIK income may also create uncertainty about the source of our cash distributions. |
• | For accounting purposes, any cash distributions to stockholders representing PIK income are not treated as coming from paid-in capital, even though the cash to pay them comes from the offering proceeds. As a result, despite the fact that a distribution representing PIK income could be paid out of amounts invested by our stockholders, the 1940 Act does not require that stockholders be given notice of this fact by reporting it as a return of capital. |
• | PIK interest or dividends have the effect of generating investment income at a compounding rate, thereby further increasing the incentive fees payable to OFS Advisor. Similarly, all things being equal, the deferral associated with PIK interest or dividends also decreases the investment principal-to-value ratio at a compounding rate. |
The valuation process for certain of our portfolio holdings may create a conflict of interest.
Many of our portfolio investments are made in the form of securities that are not publicly traded. As a result, our board of directors will determine the fair value of these securities in good faith as described below in “Many of our portfolio investments are recorded at fair value as determined in good faith by our board of directors and, as a result, there may be uncertainty as to the value of our portfolio investments.” In connection with that determination, investment professionals from OFS Advisor may provide our board of directors with portfolio company valuations based upon the most recent portfolio company financial statements available and projected financial results of each portfolio company. In addition, the members of our board of directors who are not independent directors have a substantial indirect pecuniary interest in OFS Advisor. The participation of the OFS Advisor’s investment professionals in our valuation process, and the indirect pecuniary interest in OFS Advisor by those members of our board of directors, could result in a conflict of interest since OFS Advisor’s management fee is based, in part, on our total assets (other than cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity).
We may have additional conflicts related to other arrangements with OFS Advisor or its affiliates.
We have entered into a license agreement with OFSAM under which OFSAM has granted us a non-exclusive, royalty-free license to use the name “OFS.” See “Item 1. Business—License Agreement.” In addition, we rent office space from a subsidiary of OFSAM and pay to that subsidiary our allocable portion of overhead and other expenses incurred in performing its obligations under the Administration Agreement, such as rent and our allocable portion of the cost of our officers, including our chief executive officer, chief financial officer, chief compliance officer and chief accounting officer. This will create conflicts of interest that our board of directors must monitor.
The Investment Advisory Agreement with the OFS Advisor and the Administration Agreement with OFS Services were not negotiated on an arm’s length basis and may not be as favorable to us as if they had been negotiated with an unaffiliated third party.
The Investment Advisory Agreement and the Administration Agreement were negotiated between related parties. Consequently, their terms, including fees payable to OFS Advisor, may not be as favorable to us as if they had been negotiated with an unaffiliated third party. In addition, we could choose not to enforce, or to enforce less vigorously, our rights and remedies under these agreements because of our desire to maintain our ongoing relationship with OFS Advisor, OFS Services and their respective affiliates. Any such decision, however, would breach our fiduciary obligations to our stockholders.
Our ability to enter into transactions with our affiliates is restricted, which may limit the scope of investments available to us.
BDCs generally are prohibited under the 1940 Act from knowingly participating in certain transactions with their affiliates without the prior approval of their independent directors and, in some cases, of the SEC. Those transactions include purchases and sales, and so-called “joint” transactions, in which a BDC and one or more of its affiliates engage in certain types of profit-making activities. Any person that owns, directly or indirectly, five percent or more of a BDC’s outstanding voting securities will be considered an affiliate of the BDC for purposes of the 1940 Act, and a BDC generally is prohibited from
27
engaging in purchases or sales of assets or joint transactions with such affiliates, absent the prior approval of the BDC’s independent directors. Additionally, without the approval of the SEC, a BDC is prohibited from engaging in purchases or sales of assets or joint transactions with the BDC’s officers, directors, and employees, and advisor (and its affiliates).
BDCs may, however, invest alongside certain related parties or their respective other clients in certain circumstances where doing so is consistent with current law and SEC staff interpretations. For example, a BDC may invest alongside such accounts consistent with guidance promulgated by the SEC staff permitting us and such other accounts to purchase interests in a single class of privately placed securities so long as certain conditions are met, including that the BDC’s advisor, acting on the BDC’s behalf and on behalf of other clients, negotiates no term other than price. Co-investment with such other accounts is not permitted or appropriate under this guidance when there is an opportunity to invest in different securities of the same issuer or where the different investments could be expected to result in a conflict between the BDC’s interests and those of other accounts. Moreover, except in certain circumstances, this guidance does not permit a BDC to invest in any issuer in which the advisor or other affiliates has previously invested.
On October 12, 2016, we received exemptive relief from the SEC to permit us to co-invest in portfolio companies with certain Affiliated Funds, provided we comply with the Order. Pursuant to the Order, we are generally permitted to co-invest with Affiliated Funds if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transactions, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching by us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies.
When we invest alongside OFSAM and its affiliates or their respective other clients, OFS Advisor will, to the extent consistent with applicable law, regulatory guidance, or the Order, allocate investment opportunities in accordance with its allocation policy. Under this allocation policy, if two or more investment vehicles with similar or overlapping investment strategies are in their investment periods, an available opportunity will be allocated based on the provisions governing allocations of such investment opportunities in the relevant organizational, offering or similar documents, if any, for such investment vehicles. In the absence of any such provisions, OFS Advisor will consider the following factors and the weight that should be given with respect to each of these factors:
• | investment guidelines and/or restrictions, if any, set forth in the applicable organizational, offering or similar documents for the investment vehicles; |
• | risk and return profile of the investment vehicles; |
• | suitability/priority of a particular investment for the investment vehicles; |
• | if applicable, the targeted position size of the investment for the investment vehicles |
• | level of available cash for investment with respect to the investment vehicles; |
• | total amount of funds committed to the investment vehicles; and |
• | the age of the investment vehicles and the remaining term of their respective investment periods, if any. |
In situations where co-investment with other accounts is not permitted or appropriate, OFS Advisor will need to decide which account will proceed with the investment. The decision by OFS Advisor to allocate an opportunity to another entity could cause us to forego an investment opportunity that we otherwise would have made. These restrictions, and similar restrictions that limit our ability to transact business with our officers or directors or their affiliates, may limit the scope of investment opportunities that would otherwise be available to us.
SBA regulations limit the outstanding dollar amount of SBA guaranteed debenture funding that may be received by an SBIC or group of SBICs under common control.
SBA regulations currently limit the amount that an SBIC may borrow to up to a maximum of $150 million when it has at least $75 million in regulatory capital, receives a leverage commitment from the SBA and has been through an examination by the SBA subsequent to licensing. For two or more SBICs under common control, the maximum amount of outstanding SBA debentures cannot exceed $350 million.
We cannot presently predict whether or not we will borrow the maximum permitted amount; if we reach the maximum dollar amount of SBA guaranteed debentures permitted, and thereafter require additional capital, our cost of capital may increase, and there is no assurance that we will be able to obtain additional financing on acceptable terms.
Moreover, SBIC I LP’s status as an SBIC does not automatically assure that it will receive SBA guaranteed debenture funding. Receipt of SBA leverage funding is dependent upon whether SBIC I LP is and continues to be in compliance with SBA regulations and policies and whether funding is available. The amount of SBA leverage funding available to SBICs is
28
dependent upon annual Congressional authorizations and in the future may be subject to annual Congressional appropriations. There can be no assurance that there will be sufficient debenture funding available at the times desired by SBIC I LP. As of December 31, 2017, the Company had fully funded its $75.0 million commitment to SBIC I LP. As of December 31, 2017, SBIC I LP had leverage commitments of approximately $149.9 million from the SBA, and $149.9 million of outstanding SBA-guaranteed debentures, leaving no incremental borrowing capacity under present SBA regulations. 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 other customary procedures. There can be no assurance as to whether or when this application will be approved by the SBA.
SBIC I LP is subject to SBA regulations.
Our investment strategy includes SBIC I LP, which is regulated by the SBA. The SBA regulations require that a licensed SBIC be periodically examined and audited by the SBA to determine its compliance with the relevant SBA regulations. If SBIC I LP fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or limit its ability to make new investments. The SBA, as a creditor, will have a superior claim to SBIC I LP’s assets over SBIC I LP’s limited partners and our stockholders in the event SBIC I LP is liquidated or the SBA exercises its remedies under the SBA debentures issued by SBIC I LP in the event of a default. In addition, the SBA can revoke or suspend a license for willful or repeated violation of, or willful or repeated failure to observe, any provision of the Small Business Investment Act of 1958 or any rule or regulation promulgated thereunder. These actions by the SBA would, in turn, negatively affect us because of our ownership interest in SBIC I LP.
The SBA places certain limitations on the financing terms of investments by SBICs in portfolio companies and prohibits an SBIC from providing funds to small businesses for certain purposes, such as relending, real estate or investing in companies outside of the United States, and providing funds to businesses engaged in a few prohibited industries and to certain “passive” (i.e., non-operating) companies. In addition, without prior SBA approval, an SBIC may not invest an amount equal to more than approximately 30% of the SBIC’s regulatory capital in any one company and its affiliates. Compliance with SBIC requirements may cause SBIC I LP to forego attractive investment opportunities that are not permitted under SBA regulations.
SBIC I LP is subject to ongoing regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. In addition, SBIC I LP may also be limited in its ability to make distributions to us if it does not have sufficient accumulated net profit, in accordance with SBA regulations. These requirements may make it more difficult for us to achieve our investment objectives.
We finance our investments with borrowed money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us.
The use of leverage magnifies the potential for gain or loss on amounts invested. The use of leverage is generally considered a speculative investment technique and increases the risks associated with investing in our securities. We may pledge up to 100% of our assets and may grant a security interest in all of our assets, other than assets held in SBIC I LP and our ownership interest in SBIC I LP and SBIC I GP, under the terms of any debt instruments we may enter into with lenders. In addition, under the terms of any credit facility or other debt instrument we enter into, we are likely to be required by its terms to use the net proceeds of any investments that we sell to repay a portion of the amount borrowed under such facility or instrument before applying such net proceeds to any other uses. If the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged, thereby magnifying losses or eliminating our equity stake in a leveraged investment. Similarly, any decrease in our revenue or income will cause our net income to decline more sharply than it would have had we not borrowed. Such a decline would also negatively affect our ability to make dividend payments on our common stock or preferred stock. Our ability to service our debt will depend largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures. Moreover, because the management fee payable to OFS Advisor is payable based on our total assets (other than cash and cash equivalents and goodwill and intangible assets related to the SBIC Acquisition but including assets purchased with borrowed amounts and including assets owned by any consolidated entity), OFS Advisor has a financial incentive to incur leverage which may not be consistent with our stockholders’ interests. In addition, our common stockholders will bear the burden of any increase in our expenses as a result of our use of leverage, including interest expenses and any increase in the management fee payable to OFS Advisor.
As a BDC, generally we are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage ratio for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). In addition, we may not be permitted to declare any cash dividend or other distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have asset coverage of at least 200% after deducting the amount of such dividend, distribution, or purchase price. If this ratio declines below 200%, we may not be
29
able to incur additional debt and may need to sell a portion of our investments to repay some debt when it is disadvantageous to do so, and we may not be able to make distributions. As of December 31, 2017, our asset coverage ratio was greater than 1,000%.
The following table illustrates the effect of leverage on returns from an investment in our common stock assuming various annual returns, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing in the table below.
Assumed Return on Our Portfolio (Net of Expenses) | |||||||||
(10)% | (5)% | —% | 5% | 10% | |||||
Corresponding return to common stockholder (1) | (18.00)% | (10.63)% | (3.27)% | 4.10% | 11.47% | ||||
(1) Assumes $277.5 million in investments at fair value, $167.5 million in debt outstanding, $188.3 million in net assets, and an average cost of funds of 3.7%. Assumptions are based on our financial condition and our average cost of funds at December 31, 2017.
Based on our outstanding indebtedness of $167.5 million as of December 31, 2017 and the average cost of funds of 3.7% as of that date, our investment portfolio must experience an annual return of at least 2.2% to cover interest payments on the outstanding debt.
This example is for illustrative purposes only, and actual interest rates on our borrowings are likely to fluctuate. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources— Borrowings” for additional information.
Changes in interest rates will affect our cost of capital and net investment income.
To the extent we borrow money or issue preferred stock to make investments, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds or pay dividends on preferred stock and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income in the event we use debt to finance our investments. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act.
A rise in the general level of interest rates typically leads to higher interest rates applicable to our debt investments. Accordingly, an increase in interest rates may result in an increase of the amount of incentive fees payable to OFS Advisor.
We may enter into reverse repurchase agreements, which are another form of leverage.
We may enter into reverse repurchase agreements as part of our management of our temporary investment portfolio. Under a reverse repurchase agreement, we will effectively pledge our assets as collateral to secure a short-term loan. Generally, the other party to the agreement makes the loan in an amount equal to a percentage of the fair value of the pledged collateral. At the maturity of the reverse repurchase agreement, we will be required to repay the loan and correspondingly receive back our collateral. While used as collateral, the assets continue to pay principal and interest which are for the benefit of us.
Our use of reverse repurchase agreements, if any, involves many of the same risks involved in our use of leverage, as the proceeds from reverse repurchase agreements generally will be invested in additional securities. There is a risk that the market value of the securities acquired in the reverse repurchase agreement may decline below the price of the securities that we have sold but remain obligated to purchase. In addition, there is a risk that the market value of the securities retained by us may decline. If a buyer of securities under a reverse repurchase agreement were to file for bankruptcy or experience insolvency, we may be adversely affected. Also, in entering into reverse repurchase agreements, we would bear the risk of loss to the extent that the proceeds of such agreements at settlement are less than the fair value of the underlying securities being pledged. In addition, due to the interest costs associated with reverse repurchase agreements transactions, our net asset value would decline, and, in some cases, we may be worse off than if we had not used such instruments.
We may in the future determine to fund a portion of our investments with preferred stock, which would magnify the potential for gain or loss and the risks of investing in us in the same way as our borrowings.
Preferred stock, which is another form of leverage, has the same risks to our common stockholders as borrowings because the dividends on any preferred stock we issue must be cumulative. Payment of such dividends and repayment of the liquidation preference of such preferred stock must take preference over any dividends or other payments to our common stockholders, and preferred stockholders are not subject to any of our expenses or losses and are not entitled to participate in any income or appreciation in excess of their stated preference.
30
We operate in a highly competitive market for investment opportunities, which could reduce returns and result in losses.
A number of entities compete with us to make the types of investments that we plan to make. We compete with public and private funds, other BDCs, commercial and investment banks, commercial finance companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some of our competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC or the source of income, asset diversification and distribution requirements we must satisfy to maintain our RIC tax treatment. These characteristics could allow our competitors to consider a wider variety of instruments, establish more relationships and offer better pricing and more flexible structuring than we are able to. The competitive pressures we face may have a material adverse effect on our business, financial condition and results of operations. As a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we may not be able to identify and make investments that are consistent with our investment objective.
With respect to the investments we make, we will not seek to compete based primarily on the interest rates we will offer, and we believe that some of our competitors may make loans with interest rates that will be lower than the rates we offer. In the secondary market for acquiring existing loans, we expect to compete generally on the basis of pricing terms. With respect to all investments, we may lose some investment opportunities if we do not match our competitors’ pricing, terms and structure. However, if we match our competitors’ pricing, terms and structure, we may experience decreased net interest income, lower yields and increased risk of credit loss. We may also compete for investment opportunities with OFSAM and its other affiliates or accounts managed by OFSAM or one of its other affiliates. Although OFS Advisor will allocate opportunities in accordance with its policies and procedures, allocations to such other accounts will reduce the amount and frequency of opportunities available to us and may not be in the best interests of us and our stockholders. Moreover, the performance of investments will not be known at the time of allocation.
We may suffer credit losses.
Investment in middle-market companies is highly speculative and involves a high degree of risk of credit loss, and therefore our securities may not be suitable for someone with a low tolerance for risk. These risks are likely to increase during volatile economic periods, such as the U.S. and many other economies have recently been experiencing.
We will be subject to corporate-level federal income tax if we are unable to maintain our qualification as a RIC.
We have elected to be treated as a RIC under Subchapter M of the Code, but no assurance can be given that we will be able to maintain RIC status. As a RIC, we are not required to pay corporate-level federal income taxes on our income and capital gains distributed (or deemed distributed) to our stockholders, provided that we satisfy certain distribution and other requirements. To continue to qualify for tax treatment as a RIC under the Code and to be relieved of federal taxes on income and gains distributed to our stockholders, we must meet certain source-of-income, asset diversification and distribution requirements. The distribution requirement for a RIC is satisfied if we distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our stockholders on an annual basis. Because we use debt financing, and may, in the future, issue preferred stock, we are subject to certain asset coverage ratio requirements under the 1940 Act and financial covenants under loan and credit agreements or preferred stock that could, under certain circumstances, restrict us from making distributions necessary to qualify for tax treatment as a RIC. If we are unable to obtain cash from other sources, we may fail to maintain our qualification for the tax benefits available to RICs and, thus, may be subject to corporate-level federal income tax. To maintain our qualification as a RIC, we must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these tests may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments are in private or thinly traded public companies, any such dispositions could be made at disadvantageous prices and may result in substantial losses. If we fail to continue to qualify for tax treatment as a RIC for any reason and become subject to corporate-level federal income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distributions to stockholders and the amount of our distributions and the amount of funds available for new investments. Such a failure would have a material adverse effect on us and our stockholders.
Our subsidiaries and portfolio companies may be unable to make distributions to us that will enable us to meet RIC requirements, which could result in the imposition of an entity-level tax.
In order for us to maintain our tax treatment as a RIC and to minimize corporate-level taxes, we are required to distribute on an annual basis substantially all of our taxable income, which includes income from our subsidiaries and portfolio companies. As a substantial portion of our investments are made through SBIC I LP, we are significantly dependent on that entity for cash distributions to enable us to meet the RIC distribution requirements. SBIC I LP may be limited by the Small Business Investment Act of 1958 and SBA regulations governing SBICs from making certain distributions to us that may be
31
necessary to enable us to continue to qualify as a RIC. We may have to request a waiver of the SBA’s restrictions for SBIC I LP to make certain distributions to maintain our tax treatment as a RIC and we cannot assure stockholders that the SBA will grant such waiver. If our subsidiaries and portfolio companies are unable to make distributions to us, this may result in loss of RIC tax treatment and a consequent imposition of a corporate-level federal income tax on us.
We may have difficulty paying our required distributions if we recognize income before, or without, receiving cash representing such income.
For U.S. federal income tax purposes, we will include in income certain amounts that we have not yet received in cash, such as the accretion of OID. This may arise if we purchase assets at a discount, receive warrants in connection with the making of a loan or in other circumstances, or through contracted PIK interest or dividends (meaning interest or dividends paid in the form of additional principal amount of the loan or equity security instead of in cash), which represents contractual interest or dividends added to the loan balance or equity security and due at the end of the investment term. Such OID, which could be significant relative to our overall investment activities, or increases in loan or equity investment balances as a result of contracted PIK arrangements, will be included in income before we receive any corresponding cash payments. We also may be required to include in income certain other amounts that we will not receive in cash.
Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to maintain the tax benefits available to RICs. In such a case, we may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or reduce new investment originations and sourcings to meet these distribution requirements. If we sell built-in-gain assets, we may be required to recognize taxable income in respect of the built-in-gain on such assets. In such a case, we would have to distribute all of our taxable gain (including the built-in-gain) in respect of such sale to avoid the imposition of entity-level tax on such gain. If we are not able to obtain such cash from other sources, we may fail to maintain the tax benefits available to RICs and thus be subject to corporate-level income tax.
We may in the future choose to pay distributions in our own stock, in which case stockholders may be required to pay tax in excess of the cash they receive.
We distribute taxable distributions that are payable in cash or shares of our common stock at the election of each stockholder. In accordance with guidance issued by the Internal Revenue Service, a publicly traded RIC should generally be eligible to treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder is permitted to elect to receive his or her distribution in either cash or stock of the RIC (even where there is a limitation on the percentage of the distribution payable in cash, provided that the limitation is at least 20%), subject to the satisfaction of certain guidelines. If too many stockholders elect to receive their distributions in cash, each such stockholder would receive a pro rata share of the total cash to be distributed and would receive the remainder of their distribution in shares of stock. If this and certain other requirements are met, for U.S. federal income tax purposes, the amount of the distribution paid in stock generally will be a taxable distribution in an amount equal to the amount of cash that could have been received instead of stock. If we decide to make any distributions consistent with this guidance that are payable in part in our stock, stockholders receiving such distribution would be required to include the full amount of the distribution (whether received in cash, our stock, or a combination thereof) as ordinary income (or as long-term capital gain to the extent such distribution is properly designated as a capital gain dividend) to the extent of our current and accumulated earnings and profits for United States federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with respect to such dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, it may be subject to transaction fees (e.g., broker fees or transfer agent fees) and the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our stock.
Because we expect to distribute substantially all of our net investment income and net realized capital gains to our stockholders, we may need additional capital to finance our growth and such capital may not be available on favorable terms or at all.
We have elected to be taxed for federal income tax purposes as a RIC under Subchapter M of the Code. If we meet certain requirements, including source of income, asset diversification and distribution requirements, and if we continue to qualify as a BDC, we will continue to qualify for tax treatment as RIC under the Code and will not have to pay corporate-level taxes on income we distribute to our stockholders as dividends, allowing us to substantially reduce or eliminate our corporate-level tax liability. As a BDC, we are generally required to meet a coverage ratio of total assets to total senior securities, which includes all of our borrowings and any preferred stock we may issue in the future, of at least 200% at the time we issue any debt or preferred stock. This requirement limits the amount that we may borrow. Because we will continue to need capital to grow
32
our investment portfolio, this limitation may prevent us from incurring debt or preferred stock and require us to raise additional equity at a time when it may be disadvantageous to do so. We cannot assure investors that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by the terms of any of our outstanding borrowings. In addition, as a BDC, we are generally not permitted to issue common stock priced below net asset value without stockholder approval. If additional funds are not available to us, we could be forced to curtail or cease new lending and investment activities, and our net asset value could decline.
Our PWB Credit Facility contains various covenants and restrictions which, if not complied with, could accelerate our repayment obligations under the credit facility or limit its use, thereby materially and adversely affecting our liquidity, financial condition, results of operations and ability to pay distributions.
The PWB Credit Facility provides us with a senior secured revolving line of credit of up to $50.0 million, with maximum availability equal to 50% of the aggregate outstanding principal amount of eligible loans included in the borrowing base and otherwise specified in the PWB Credit Facility. The PWB Credit Facility is guaranteed by our subsidiary 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 PWB Credit Facility contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting requirements, a minimum tangible net asset value, a minimum quarterly net investment income after incentive fees, and a statutory asset coverage test. The PWB Credit Facility also contains customary events of default, including, without limitation, nonpayment, misrepresentation of representations and warranties in a material respect, breach of covenant, cross-default to other indebtedness, bankruptcy, change in investment advisor, and the occurrence of a material adverse change in our financial condition. The PWB Credit Facility permits us to fund additional investments as long as we are within the conditions set out in the PWB Credit Facility. Our continued compliance with these covenants depends on many factors, some of which are beyond our control, and there are no assurances that we will continue to comply with these covenants. Our failure to satisfy these covenants could result in foreclosure by our lender, which would accelerate our repayment obligations under the PWB Credit Facility and thereby have a material adverse effect on our business, liquidity, financial condition, results of operations and ability to pay distributions to our stockholders. We had $17.6 million outstanding under the PWB Credit Facility as of December 31, 2017. Availability under the PWB Credit Facility as of December 31, 2017 was $17.4 million based on the stated advance rate of 50% under the borrowing base.
Adverse developments in the credit markets may impair our ability to secure debt financing.
During the economic downturn in the United States that began in mid-2007, many commercial banks and other financial institutions stopped lending or significantly curtailed their lending activity. In addition, in an effort to stem losses and reduce their exposure to segments of the economy deemed to be high risk, some financial institutions limited routine refinancing and loan modification transactions and even reviewed the terms of existing facilities to identify bases for accelerating the maturity of existing lending facilities. As a result, it may be difficult for us to obtain desired financing to finance the growth of our investments on acceptable economic terms, or at all.
If we are unable to consummate credit facilities on commercially reasonable terms, our liquidity may be reduced significantly. If we are unable to repay amounts outstanding under any facility we may enter into and are declared in default or are unable to renew or refinance any such facility, it would limit our ability to initiate significant originations or to operate our business in the normal course. These situations may arise due to circumstances that we may be unable to control, such as inaccessibility of the credit markets, a severe decline in the value of the U.S. dollar, a further economic downturn or an operational problem that affects third parties or us, and could materially damage our business. Moreover, we are unable to predict when economic and market conditions may become more favorable. Even if such conditions improve broadly and significantly over the long term, adverse conditions in particular sectors of the financial markets could adversely impact our business.
Terrorist attacks, acts of war or natural disasters may impact the businesses in which we invest and harm our business, operating results and financial condition.
Terrorist acts, acts of war or natural disasters may disrupt our operations, as well as the operations of the businesses in which we invest. Such acts have created, and continue to create, economic and political uncertainties and have contributed to global economic instability. Future terrorist activities, military or security operations, or natural disasters could further weaken the domestic/global economies and create additional uncertainties, which may negatively impact the businesses in which we invest directly or indirectly and, in turn, could have a material adverse impact on our business, operating results and financial condition. Losses from terrorist attacks and natural disasters are generally uninsurable.
The failure in cybersecurity systems, as well as the occurrence of events unanticipated in our disaster recovery systems and management continuity planning could impair our ability to conduct business effectively.
The occurrence of a disaster such as a cyberattack, a natural catastrophe, an industrial accident, events unanticipated in our disaster recovery systems, or a support failure from external providers, could have an adverse effect on our ability to
33
conduct business and on our results of operations and financial condition, particularly if those events affect our computer-based data processing, transmission, storage, and retrieval systems or destroy data. If a significant number of our managers were unavailable in the event of a disaster, our ability to effectively conduct our business could be severely compromised.
We depend heavily upon computer systems to perform necessary business functions. Despite our implementation of a variety of security measures, our computer systems could be subject to cyberattacks and unauthorized access, such as physical and electronic break-ins or unauthorized tampering. Like other companies, we may experience threats to our data and systems, including malware and computer virus attacks, unauthorized access, system failures and disruptions. If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations, which could result in damage to our reputation, financial losses, litigation, increased costs, regulatory penalties and/or customer dissatisfaction or loss.
Third parties with whom we do business may also be sources of cybersecurity or other technological risks. We outsource certain functions and these relationships allow for the storage and processing of our information, as well as customer, counterparty, employee and borrower information. While we engage in actions to reduce our exposure resulting from outsourcing, ongoing threats may result in unauthorized access, loss, exposure or destruction of data, or other cybersecurity incidents, with increased costs and other consequences, including those described above.
Many of our portfolio investments are recorded at fair value as determined in good faith by our board of directors and, as a result, there may be uncertainty as to the value of our portfolio investments.
Many of our portfolio investments take the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded may not be readily determinable. We value these securities at fair value as determined in good faith by our board of directors, including to reflect significant events affecting the value of our securities. All of our investments (other than cash and cash equivalents) are classified as Level 3 under Accounting Standards Codification Topic 820, Fair Value Measurement and Disclosures (ASC Topic 820). This means that our portfolio valuations are based on unobservable inputs and our own assumptions about how market participants would price the asset or liability in question. Inputs into the determination of fair value of our portfolio investments require significant management judgment or estimation. Even if observable market data are available, such information may be the result of consensus pricing information or broker quotes, which include a disclaimer that the broker would not be held to such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by disclaimers materially reduces the reliability of such information. We presently retain the services of two independent service providers to review the valuation of these securities.
The types of factors that the board of directors takes into account in determining the fair value of our investments generally include, as appropriate, comparison to third-party yield benchmarks and comparison to publicly traded securities including such factors as yield, maturity and measures of credit quality, the enterprise value of a portfolio company, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and cash flow, the markets in which the portfolio company does business and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such securities.
We adjust quarterly the valuation of our portfolio to reflect our board of directors’ determination of the fair value of each investment in our portfolio. Any changes in fair value are recorded in our statement of income as net change in unrealized appreciation or depreciation.
We may experience fluctuations in our quarterly operating results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including the interest rate payable on the debt securities we acquire, the default rate on such securities, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, distributions from our subsidiaries and portfolio companies, the degree to which we encounter competition in our markets and general economic conditions. In light of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
Changes in the laws or regulations governing our business, or changes in the interpretations thereof, and any failure by us to comply with these laws or regulations, could have a material adverse effect on our, and our portfolio companies’, business, results of operations or financial condition.
We and our portfolio companies are subject to regulation by laws at the U.S. federal, state and local levels, including those that govern BDCs, SBICs, RICs, or non-depository commercial lenders. These laws and regulations, including applicable
34
accounting standards, as well as their interpretation, may change from time to time, and new laws, regulations, accounting standards and interpretations may also come into effect. Any such new or changed laws or regulations could have a material adverse effect on our business.
We are also subject to judicial and administrative decisions that affect our operations, including our loan originations, maximum interest rates, fees and other charges, disclosures to portfolio companies, the terms of secured transactions, collection and foreclosure procedures and other trade practices. If these laws, regulations or decisions change, or if we expand our business into jurisdictions that have adopted more stringent requirements than those in which we currently conduct business, we may have to incur significant expenses in order to comply, or we might have to restrict our operations. If we do not comply with applicable laws, regulations and decisions, we may lose licenses needed for the conduct of our business and may be subject to civil fines and criminal penalties.
In addition, changes to the laws and regulations governing our operations related to permitted investments may cause us to alter our investment strategy, including making investments in entities such as OFS Capital WM and SBIC I LP, in order to avail ourselves of new or different opportunities. Such changes could result in material differences to the strategies and plans set forth in this Annual Report on Form 10-K and our accounting practices described in this Annual Report on Form 10-K, and may shift our investment focus from the areas of expertise of OFS Advisor to other types of investments in which OFS Advisor may have little or no expertise or experience. Any such changes, if they occur, could have a material adverse effect on our results of operations and the value of a stockholder’s investment.
Over the last several years, there has been an increase in regulatory attention to the extension of credit outside of the traditional banking sector, raising the possibility that some portion of the non-bank financial sector will be subject to new or different regulation. While it cannot be known at this time whether these regulations will be implemented or what form they will take, increased regulation of non-bank credit extension could negatively impact our operations, cash flows or financial condition, impose additional costs on us, intensify the regulatory supervision of us or otherwise adversely affect our business.
Legislative or other actions relating to taxes could have a negative effect on us.
Significant U.S. federal tax reform legislation was recently enacted that, among other things, permanently reduces the maximum federal corporate income tax rate, reduces the maximum individual income tax rate (effective for taxable years 2018 through 2025), restricts the deductibility of business interest expense, changes the rules regarding the calculation of net operating loss deductions that may be used to offset taxable income, expands the circumstances in which a foreign corporation will be treated as a “controlled foreign corporation” and, under certain circumstances, requires accrual method taxpayers to recognize income for U.S. federal income tax purposes no later than the income is taken into account as revenue in an applicable financial statement. The impact of this new legislation on us, our stockholders and the entities in which we may invest is uncertain. Prospective investors are urged to consult their tax advisors regarding the effects of the new legislation on an investment in us.
We cannot predict with certainty how any future changes in the tax laws might affect us, our investors or our portfolio investments. New legislation and any U.S. Treasury regulations, administrative interpretations or court decisions interpreting such legislation could significantly and negatively affect our ability to qualify for tax treatment as a RIC or the U.S. federal income tax consequences to us and our investors of such qualification, or could have other adverse consequences. Investors are urged to consult with their tax advisor regarding tax legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our securities.
The effect of global climate change may impact the operations of our portfolio companies.
There may be evidence of global climate change. Climate change creates physical and financial risk and some of our portfolio companies may be adversely affected by climate change. For example, the needs of customers of energy companies vary with weather conditions, primarily temperature and humidity. To the extent weather conditions are affected by climate change, energy use could increase or decrease depending on the duration and magnitude of any changes. Increases in the cost of energy could adversely affect the cost of operations of our portfolio companies if the use of energy products or services is material to their business. A decrease in energy use due to weather changes may affect some of our portfolio companies’ financial condition, through decreased revenues. Extreme weather conditions in general require more systems backup, adding to costs, and can contribute to increased system stresses, including service interruptions. In December 2015, the United Nations, of which the U.S. is a member, adopted a climate accord (the “Paris Agreement”) with the long-term goal of limiting global warming and the short-term goal of significantly reducing greenhouse gas emissions. The U.S. subsequently ratified the Paris Agreement, and it entered into force on November 4, 2016. As a result, some of our portfolio companies may become subject to new or strengthened regulations or legislation which could increase their operating costs and/or decrease their revenues.
Pending legislation may allow us to incur additional leverage.
35
As a BDC, under the 1940 Act we generally are not permitted to incur borrowings, issue debt securities or issue preferred stock unless immediately after the borrowing or issuance the ratio of total assets (less total liabilities other than indebtedness) to total indebtedness plus preferred stock, is at least 200%. Recent legislation introduced in the U.S. House of Representatives and Senate, if passed, would modify this section of the 1940 Act and increase the amount of debt that BDCs may incur by modifying the asset coverage percentage from 200% to 150%. As a result, we may be able to incur additional indebtedness in the future and you may face increased investment risk. In addition, since our base management fee is calculated as a percentage of the value of our gross assets, including assets acquired through the incurrence of debt but excluding cash and cash equivalents, our base management fee expenses will increase if we incur additional indebtedness.
Loss of status as a RIC would reduce our net asset value and distributable income.
We have qualified as a RIC under the Code. As a RIC we do not have to pay federal income taxes on our income (including realized gains) that we distribute to our stockholders, provided that we satisfy certain distribution and other requirements. Accordingly, we are not permitted under accounting rules to establish reserves for taxes on our unrealized capital gains. If we fail to qualify for RIC status in any year, to the extent that we had unrealized gains, we would have to establish reserves for taxes, which would reduce our net asset value and the amount potentially available for distribution. In addition, if we, as a RIC, were to decide to make a deemed distribution of net realized capital gains and retain the net realized capital gains, we would have to establish appropriate reserves for taxes that we would have to pay on behalf of stockholders. It is possible that establishing reserves for taxes could have a material adverse effect on the value of our common stock.
Our board of directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval.
Our board of directors has the authority, except as otherwise provided in the 1940 Act, to modify or waive certain of our operating policies and strategies without prior notice and without stockholder approval. However, absent stockholder approval, we may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC. Under Delaware law, we also cannot be dissolved without prior stockholder approval except by judicial action. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and the price value of our common stock. Nevertheless, any such changes could adversely affect our business and impair our ability to make distributions.
OFS Advisor can resign on 60 days’ notice, and we may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.
OFS Advisor has the right, under the Investment Advisory Agreement, to resign at any time upon not less than 60 days’ written notice, whether we have found a replacement or not. If OFS Advisor resigns, we may not be able to find a new investment advisor or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are likely to be adversely affected and the value of our shares may decline. In addition, the coordination of our internal management and investment activities is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by the OFS Advisor and its affiliates. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our investment objectives may result in additional costs and time delays that may adversely affect our financial condition, business and results of operations.
OFS Services can resign from its role as our Administrator under the Administration Agreement, and we may not be able to find a suitable replacement, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.
OFS Services has the right to resign under the Administration Agreement, whether we have found a replacement or not. If OFS Services resigns, we may not be able to find a new administrator or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are likely to be adversely affected and the value of our shares may decline. In addition, the coordination of our internal management and administrative activities is likely to suffer if we are unable to identify and reach an agreement with a service provider or individuals with the expertise possessed by OFS Services. Even if we are able to retain a comparable service provider or individuals to perform such services, whether internal or external, their integration into our business and lack of familiarity with our investment objectives may result in additional costs and time delays that may adversely affect our financial condition, business and results of operations.
We incur significant costs as a result of being a publicly traded company.
36
As a publicly traded company, we incur legal, accounting and other expenses, including costs associated with the periodic reporting requirements applicable to a company whose securities are registered under the Exchange Act, as well as additional corporate governance requirements, including requirements under the Sarbanes-Oxley Act and other rules implemented by the SEC.
Efforts to comply with the Sarbanes-Oxley Act involve significant expenditures, and non-compliance with Section 404 of the Sarbanes-Oxley Act may adversely affect us and the market price of our securities.
Under current SEC rules, we are required to report on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act and related rules and regulations of the SEC. We are required to review our internal control over financial reporting on an annual basis, and evaluate and disclose changes in our internal control over financial reporting on a quarterly and annual basis.
As a result, we expect to continue to incur additional expenses that may negatively impact our financial performance and our ability to make distributions. This process also results in a diversion of management’s time and attention. In the event that we are unable to maintain compliance with Section 404 of the Sarbanes-Oxley Act and related rules, we and the market price of our securities may be adversely affected.
We have identified a material weakness in our internal control over financial reporting and our business and stock price may be adversely affected if we have not adequately addressed the weakness.
Effective internal controls over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure controls and procedures, are designed to prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered in their implementation could cause us to fail to meet our reporting obligations.
As a result of our evaluation of our internal control over financial reporting for the year ended December 31, 2017, management identified a material weakness related to the design and operating effectiveness of controls over the reliability of financial information reported by portfolio companies that is used as financial inputs in the Company’s investment valuations.
The identification of the material weakness did not require a fourth quarter 2017 adjustment or impact any of our consolidated financial statements for any prior annual or interim periods and we are developing a remediation plan for this material weakness. Accordingly, management believes that the financial statements included in this Annual Report on Form 10-K present fairly in all material respects the Company’s financial condition, results of operations and cash flows for the periods presented. We believe that the audited consolidated financial statements included in this Annual Report on Form 10-K are accurate. If we cannot produce reliable financial reports, investors could lose confidence in our reported financial information, the market price of our stock could decline significantly, we may be unable to obtain additional financing to operate and expand our business, and our business and financial condition could be harmed.
Capital markets may experience periods of disruption and instability and we cannot predict when these conditions will occur. Such market conditions could materially and adversely affect debt and equity capital markets in the United States and abroad, which could have a negative impact on our business, financial condition and results of operations.
The global capital markets have experienced a period of disruption as evidenced by a lack of liquidity in the debt capital markets, write-offs in the financial services sector, the re-pricing of credit risk and the failure of certain major financial institutions. While the capital markets have improved, these conditions could deteriorate again in the future. During such market disruptions, we may have difficulty raising debt or equity capital, especially as a result of regulatory constraints.
Market conditions may in the future make it difficult to extend the maturity of or refinance our existing indebtedness and any failure to do so could have a material adverse effect on our business. The illiquidity of our investments may make it difficult for us to sell such investments if required. As a result, we may realize significantly less than the value at which we have recorded our investments. In addition, significant changes in the capital markets, including the disruption and volatility, have had, and may in the future have, a negative effect on the valuations of our investments and on the potential for liquidity events involving our investments. An inability to raise capital, and any required sale of our investments for liquidity purposes, could have a material adverse impact on our business, financial condition and results of operations.
Various social and political tensions in the United States and around the world, including in the Middle East, Eastern Europe and Russia, may continue to contribute to increased market volatility, may have long-term effects on the United States and worldwide financial markets, and may cause further economic uncertainties or deterioration in the United States and worldwide. Several European Union (“EU”) countries, including Greece, Ireland, Italy, Spain, and Portugal, continue to face budget issues, some of which may have negative long-term effects for the economies of those countries and other EU countries. There is also continued concern about national-level support for the euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member countries. The recent United States and global economic downturn, or a return to the recessionary period in the United States, could adversely impact our investments. We cannot predict
37
the duration of the effects related to these or similar events in the future on the United States economy and securities markets or on our investments. We monitor developments and seek to manage our investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
Risks Related to BDCs
Regulations governing our operation as a BDC affect our ability to and the way in which we raise additional capital. As a BDC, we will need to raise additional capital, which will expose us to risks, including the typical risks associated with leverage.
We may issue debt securities or preferred stock and/or borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act, we are permitted as a BDC to issue senior securities in amounts such that our asset coverage ratio, as defined in the 1940 Act, equals at least 200% of gross assets less all liabilities and indebtedness not represented by senior securities, after each issuance of senior securities. If the value of our assets decline, we may be unable to satisfy this test. If that happens, we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be disadvantageous. Also, any amounts that we use to service our indebtedness would not be available for distributions to our common stockholders. If we issue senior securities, we will be exposed to typical risks associated with leverage, including an increased risk of loss.
As of December 31, 2017, we had $167.5 million of debt outstanding. Our ability to incur additional debt and remain in compliance with the asset coverage test will be limited. We may seek an additional credit facility to finance investments or for working capital requirements. There can be no assurance that we will be able to obtain such financing on favorable terms or at all. We have received an exemptive order from the SEC to permit us to exclude the debt of SBIC I LP guaranteed by the SBA from our definition of senior securities in our statutory 200% asset coverage ratio under the 1940 Act.
If we issue preferred stock, the preferred stock would rank “senior” to common stock in our capital structure, preferred stockholders would have separate voting rights on certain matters and might have other rights, preferences or privileges more favorable than those of our common stockholders, and the issuance of preferred stock could have the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium price for holders of our common stock or otherwise be in our stockholders’ best interest. Holders of our common stock will directly or indirectly bear all of the costs associated with offering and servicing any preferred stock that we issue. In addition, any interests of preferred stockholders may not necessarily align with the interests of holders of our common stock and the rights of holders of shares of preferred stock to receive dividends would be senior to those of holders of shares of our common stock. We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value per share of our common stock if our board of directors determines that such sale is in the best interests of us and our stockholders, and if our stockholders approve any such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price that, in the determination of our board of directors, closely approximates the market value of such securities (less any distributing commission or discount). If we raise additional funds by issuing common stock or senior securities convertible into, or exchangeable for, our common stock, then the percentage ownership of our stockholders at that time will decrease, and our stockholders might experience dilution.
Our ability to invest in public companies may be limited in certain circumstances.
To maintain our status as a BDC, we are not permitted to acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our assets, as defined by the 1940 Act, are qualifying assets (with certain limited exceptions). Subject to certain exceptions for follow-on investments and distressed companies, an investment in an issuer that has outstanding securities listed on a national securities exchange may be treated as a qualifying asset only if such issuer has a common equity market capitalization that is less than $250 million at the time of such investment and meets the other specified requirements.
If we do not invest a sufficient portion of our assets in qualifying assets, we could fail to continue to qualify as a BDC or be precluded from investing according to our current business strategy.
As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our assets, as defined by the 1940 Act, are qualifying assets.
We believe that most of the investments that we may acquire in the future will constitute qualifying assets. However, we may be precluded from investing in what we believe are attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If a sufficient portion of our assets are not qualifying assets, we could violate the 1940 Act provisions applicable to BDCs. As a result of such violation, specific rules under the 1940 Act could prevent us, for example, from making follow-on investments in existing portfolio companies (which could result in the dilution of our position) or could
38
require us to dispose of investments at inappropriate times in order to come into compliance with the 1940 Act. If we need to dispose of such investments quickly, it could be difficult to dispose of such investments on favorable terms. We may not be able to find a buyer for such investments and, even if we do find a buyer, we may have to sell the investments at a substantial loss. Any such outcomes would have a material adverse effect on our business, financial condition and results of operations
If we do not maintain our status as a BDC, we would be subject to regulation as a registered closed-end investment company under the 1940 Act. As a registered closed-end fund, we would be subject to substantially more regulatory restrictions under the 1940 Act which would significantly decrease our operating flexibility.
Risks Related to Our Investments
Economic recessions or downturns could impair our portfolio companies and harm our operating results.
Many of our portfolio companies are susceptible to economic slowdowns or recessions and may be unable to repay our loans during these periods. Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during these periods. Adverse economic conditions may decrease the value of collateral securing some of our loans and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing our investments and harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its assets, which could trigger cross-defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, lenders in certain cases can be subject to lender liability claims for actions taken by them when they become too involved in the borrower’s business or exercise control over a borrower. It is possible that we could become subject to a lender liability claim, including as a result of actions taken if we render significant managerial assistance to the borrower. Furthermore, if one of our portfolio companies were to file for bankruptcy protection, even though we may have structured our investment as senior secured debt, depending on the facts and circumstances, including the extent to which we provided managerial assistance to that portfolio company, a bankruptcy court might re-characterize our debt holding and subordinate all or a portion of our claim to claims of other creditors.
Our investments in the debt instruments of leveraged portfolio companies may be risky and, due to the significant volatility of such companies, we could lose all or part of our investment in bankruptcy proceedings or otherwise.
Investment in leveraged companies involves a number of significant risks. Leveraged companies in which we invest may have limited financial resources and may be unable to meet their obligations under their debt securities that we hold due to the significant volatility of such companies. Negative developments may be accompanied by deterioration of the value of any collateral and a reduction in the likelihood of our realizing any guarantees that we may have obtained in connection with our investment. Such developments may ultimately result in the leveraged companies in which we invest entering into bankruptcy proceedings, which have a number of inherent risks. Many events in a bankruptcy proceeding are the product of contested matters and adversary proceedings and are beyond the control of the creditors. A bankruptcy filing by an issuer may adversely and permanently affect the issuer. If the proceeding is converted to a liquidation, the value of the issuer may not equal the liquidation value that was believed to exist at the time of the investment. The duration of a bankruptcy proceeding is also difficult to predict, and a creditor’s return on investment can be adversely affected by delays until the plan of reorganization or liquidation ultimately becomes effective. The administrative costs in connection with a bankruptcy proceeding are frequently high and would be paid out of the debtor’s estate prior to any return to creditors. Because the standards for classification of claims under bankruptcy law are vague, our influence with respect to the class of securities or other obligations we own may be lost by increases in the number and amount of claims in the same class or by different classification and treatment. In the early stages of the bankruptcy process, it is often difficult to estimate the extent of, or even to identify, any contingent claims that might be made. In addition, certain claims that have priority by law (for example, claims for taxes) may be substantial. In addition, since our mezzanine loans are generally subordinated to senior loans and are generally unsecured, other creditors may rank senior to us in the event of a bankruptcy proceeding.
Our investments in private and middle-market portfolio companies are generally considered lower credit quality obligations, are risky, and we could lose all or part of our investment.
Investment in private and middle-market companies involves a number of significant risks. Generally, little public information exists about these companies, and we rely on the ability of OFS Advisor’s investment professionals to obtain adequate information to evaluate the potential returns from investing in these companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money
39
on our investments. Middle-market companies may have limited financial resources and may be unable to meet their obligations under their debt securities that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of our realizing any guarantees we may have obtained in connection with our investment. Such companies typically have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns.
Middle-market companies are more likely to be considered lower grade investments, commonly called “junk bonds,” which are either rated below investment grade by one or more nationally-recognized statistical rating agencies at the time of investment, or may be unrated but determined by the OFS Advisor to be of comparable quality. Lower grade securities or comparable unrated securities are considered predominantly speculative regarding the issuer’s ability to pay interest and principal, and are susceptible to default or decline in market value due to adverse economic and business developments. The market values for lower grade debt tend to be very volatile and are less liquid than investment grade securities. For these reasons, an investment in our company is subject to the following specific risks: increased price sensitivity to a deteriorating economic environment; greater risk of loss due to default or declining credit quality; adverse company specific events are more likely to render the issuer unable to make interest and/or principal payments; and if a negative perception of the lower grade debt market develops, the price and liquidity of lower grade securities may be depressed. This negative perception could last for a significant period of time.
Additionally, middle-market companies are more likely to depend on the management talents and efforts of a small group of persons. Therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us. Middle-market companies also may be parties to litigation and may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence. In addition, our executive officers, directors and OFS Advisor may, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies.
Investments in equity securities involve a substantial degree of risk.
We have purchased, and may purchase in the future, common stock and other equity securities, including warrants, in various portfolio companies. Although equity securities historically have generated higher average total returns than debt securities over the long term, equity securities may experience more volatility in those returns than debt securities. The equity securities we acquire may fail to appreciate, decline in value or lose all value, and our ability to recover our investment will depend on our portfolio company's success. Investments in equity securities involve a number of significant risks, including the risk of further dilution in the event the portfolio company issues additional securities. Investments in preferred securities involve special risks, such as the risk of deferred distributions, illiquidity and limited voting rights.
Our equity ownership in a portfolio company may represent a control investment. Our ability to exit a control investment in a timely manner could result in a realized loss on the investment.
If we obtain a control investment in a portfolio company, our ability to divest ourselves from a debt or equity investment could be restricted due to illiquidity in a private stock, limited trading volume on a public company’s stock, inside information on a company’s performance, insider blackout periods, or other factors that could prohibit us from disposing of the investment as we would if it were not a control investment. Additionally, we may choose not to take certain actions to protect a debt investment in a control investment portfolio company. As a result, we could experience a decrease in the value of our portfolio company holdings and potentially incur a realized loss on the investment.
We may suffer a loss if a portfolio company defaults on a loan and the underlying collateral is not sufficient.
We will at times take a security interest in the available assets of our portfolio companies, including the equity interests of their subsidiaries and, in some cases, the equity interests of our portfolio companies held by their stockholders. In the event of a default by a portfolio company on a secured loan, we will only have recourse to the assets collateralizing the loan. There is a risk that the collateral securing our loans may decrease in value over time, may be difficult to sell in a timely manner, may be difficult to appraise, and may fluctuate in value based upon the success or deterioration of the business and market conditions, including as a result of the inability of a portfolio company to raise additional capital. Additionally, in the case of certain of our investments, we do not have a first lien position on the collateral and may not receive the full value of the collateral upon liquidation. If the underlying collateral value is less than the loan amount, we will suffer a loss.
In the event of bankruptcy of a portfolio company, we may not have full recourse to its assets in order to satisfy our loan, or our loan may be subject to equitable subordination. In addition, certain of our loans are subordinate to other debt of the portfolio company. If a portfolio company defaults on our loan or on debt senior to our loan, or in the event of a portfolio company bankruptcy, our loan will be satisfied only after the senior debt receives payment. Where debt senior to our loan exists, the presence of inter-creditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies (through “standstill” periods) and control decisions made in bankruptcy proceedings
40
relating to the portfolio company. Bankruptcy and portfolio company litigation can significantly increase collection losses and the time needed for us to acquire the underlying collateral in the event of a default, during which time the collateral may decline in value, causing us to suffer losses.
If the value of collateral underlying our loan declines or interest rates increase during the term of our loan, a portfolio company may not be able to obtain the necessary funds to repay our loan at maturity through refinancing. Decreasing collateral value and/or increasing interest rates may hinder a portfolio company’s ability to refinance our loan because the underlying collateral cannot satisfy the debt service coverage requirements necessary to obtain new financing. If a borrower is unable to repay our loan at maturity, we could suffer a loss which may adversely impact our financial performance.
The lack of liquidity in our investments may adversely affect our business.
All of our assets are presently invested in illiquid securities, and a substantial portion of our investments in leveraged companies is subject to legal and other restrictions on resale or is otherwise less liquid than more broadly traded public securities. The illiquidity of these investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded these investments. We may also face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we, OFS Advisor, OFSAM or any of its other affiliates have material nonpublic information regarding such portfolio company.
Price declines and illiquidity in the corporate debt markets may adversely affect the fair value of our portfolio investments, reducing our net asset value through increased net unrealized depreciation.
As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good faith by our board of directors. As part of the valuation process, we may take into account the following types of factors, if relevant, in determining the fair value of our investments:
• | a comparison of the portfolio company’s securities to publicly traded securities; |
• | the enterprise value of a portfolio company; |
• | the nature and realizable value of any collateral; |
• | the portfolio company’s ability to make payments and its earnings and discounted cash flow; |
• | the markets in which the portfolio company does business; and |
• | changes in the interest rate environment and the credit markets generally that may affect the price at which similar investments may be made in the future and other relevant factors. |
When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we will use the pricing indicated by the external event to corroborate our valuation. We will record decreases in the market values or fair values of our investments as unrealized depreciation. Declines in prices and liquidity in the corporate debt markets may result in significant net unrealized depreciation in our portfolio. The effect of all of these factors on our portfolio may reduce our net asset value by increasing net unrealized depreciation in our portfolio. Depending on market conditions, we could incur substantial realized losses and may suffer additional unrealized losses in future periods, which could have a material adverse effect on our business, financial condition and results of operations.
We are a non-diversified management investment company within the meaning of the 1940 Act, and therefore we are not limited with respect to the proportion of our assets that may be invested in securities of a single issuer.
We are classified as a non-diversified management investment company within the meaning of the 1940 Act, which means that we are not limited by the 1940 Act with respect to the proportion of our assets that we may invest in securities of a single issuer. To the extent that we assume large positions in the securities of a small number of issuers, our net asset value may fluctuate to a greater extent than that of a diversified investment company as a result of changes in the financial condition or the market’s assessment of the issuer. We may also be more susceptible to any single economic or regulatory occurrence than a diversified investment company. Beyond our asset diversification requirements as a RIC under the Code, we do not have fixed guidelines for diversification, and our investments could be concentrated in relatively few portfolio companies.
Our portfolio may be concentrated in a limited number of portfolio companies and industries, which will subject us to a risk of significant loss if any of these companies defaults on its obligations under any of its debt instruments or if there is a downturn in a particular industry.
Although we believe our portfolio is well-diversified across companies and industries, our portfolio is and may in the future be concentrated in a limited number of portfolio companies and industries. Beyond the asset diversification requirements associated with our qualification as a RIC under the Code, we do not have fixed guidelines for diversification. As a result, the
41
aggregate returns we realize may be significantly adversely affected if a small number of investments perform poorly or if we need to write down the value of any one investment. Additionally, while we are not targeting any specific industries, our investments may be concentrated in relatively few industries. As a result, a downturn in any particular industry in which we are invested could also significantly impact the aggregate returns we realize.
Our failure to make follow-on investments in our portfolio companies could impair the value of our portfolio.
Following an initial investment in a portfolio company, we may make additional investments in that portfolio company as “follow-on” investments, in seeking to:
• | increase or maintain in whole or in part our position as a creditor or equity ownership percentage in a portfolio company; |
• | exercise warrants, options or convertible securities that were acquired in the original or subsequent financing; or |
• | preserve or enhance the value of our investment. |
We have discretion to make follow-on investments, subject to the availability of capital resources. Failure on our part to make follow-on investments may, in some circumstances, jeopardize the continued viability of a portfolio company and our initial investment, or may result in a missed opportunity for us to increase our participation in a successful operation. Even if we have sufficient capital to make a desired follow-on investment, we may elect not to make a follow-on investment because we may not want to increase our level of risk, because we prefer other opportunities or because we are inhibited by compliance with BDC requirements or the desire to maintain our RIC status. Our ability to make follow-on investments may also be limited by OFS Advisor’s allocation policy.
Because we generally do not hold controlling equity interests in our portfolio companies, we may not be able to exercise control over our portfolio companies or to prevent decisions by management of our portfolio companies that could decrease the value of our investments.
We generally do not hold controlling equity positions in our portfolio companies. For portfolio companies in which we do not hold a controlling equity interest, we are subject to the risk that a portfolio company may make business decisions with which we disagree, and that the management and/or stockholders of a portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due to the lack of liquidity of the debt and equity investments that we typically hold in our portfolio companies, we may not be able to dispose of our investments in the event we disagree with the actions of a portfolio company and may therefore suffer a decrease in the value of our investments.
Defaults by our portfolio companies will harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its assets. This could trigger cross-defaults under other agreements and jeopardize such portfolio company’s ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
We have invested a substantial portion of our capital in senior secured, unitranche, second-lien and mezzanine loans issued by our portfolio companies. The portfolio companies may be permitted to incur, other debt that ranks equally with, or senior to, the debt securities in which we invest. By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the debt securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying senior creditors, the portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt securities in which we invest, we would have to share any distributions on an equal and ratable basis with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
Additionally, certain loans that we make to portfolio companies may be secured on a second-priority basis by the same collateral securing first-priority debt of such companies. The senior-secured liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by the portfolio company under the agreements governing the loans. The holders of obligations secured by first-priority liens on the collateral will generally control the liquidation of, and be entitled to receive proceeds from, any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the
42
proceeds, if any, from sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second-priority liens after payment in full of all obligations secured by the first-priority liens on the collateral. If such proceeds were not sufficient to repay amounts outstanding under the loan obligations secured by the second-priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, would only have an unsecured claim against the portfolio company’s remaining assets, if any.
The rights we may have with respect to the collateral securing the loans we make to our portfolio companies with more senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of such senior debt. Under a typical intercreditor agreement, at any time that obligations that have the benefit of the first-priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first-priority liens:
• | the ability to cause the commencement of enforcement proceedings against the collateral; |
• | the ability to control the conduct of such proceedings; |
• | the approval of amendments to collateral documents; |
• | releases of liens on the collateral; and |
• | waivers of past defaults under collateral documents. |
We may not have the ability to control or direct such actions, even if our rights are adversely affected.
We may also make unsecured loans to portfolio companies, meaning that such loans will not benefit from any interest in collateral of such companies. Liens on such portfolio companies’ collateral, if any, will secure the portfolio company’s obligations under its outstanding secured debt and may secure certain future debt that is permitted to be incurred by the portfolio company under its secured loan agreements. The holders of obligations secured by such liens will generally control the liquidation of, and be entitled to receive proceeds from, any realization of such collateral to repay their obligations in full before us. In addition, the value of such collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of such collateral would be sufficient to satisfy our unsecured loan obligations after payment in full of all secured loan obligations. If such proceeds were not sufficient to repay the outstanding secured loan obligations, then our unsecured claims would rank equally with the unpaid portion of such secured creditors’ claims against the portfolio company’s remaining assets, if any.
If we make subordinated investments, the obligors or the portfolio companies may not generate sufficient cash flow to service their debt obligations to us.
We make subordinated investments that rank below other obligations of the obligor in right of payment. Subordinated investments are subject to greater risk of default than senior obligations as a result of adverse changes in the financial condition of the obligor or in general economic conditions. If we make a subordinated investment in a portfolio company, the portfolio company may be highly leveraged, and its relatively high debt-to-equity ratio may create increased risks that its operations might not generate sufficient cash flow to service all of its debt obligations.
The disposition of our investments may result in contingent liabilities.
A significant portion of our investments involve private securities. In connection with the disposition of an investment in private securities, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate, or with respect to potential liabilities. These arrangements may result in contingent liabilities that ultimately result in funding obligations that we must satisfy through our return of distributions previously made to us.
Our base management fee may induce OFS Advisor to cause us to incur leverage.
Our base management fee is payable based upon our total assets, other than cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity. This fee structure may encourage OFS Advisor to cause us to borrow money to finance additional investments. Under certain circumstances, the use of borrowed money may increase the likelihood of default, which would disfavor holders of our common stock. Given the subjective nature of the investment decisions made by OFS Advisor on our behalf, our board of directors may not be able to monitor this potential conflict of interest effectively.
Our incentive fee may induce OFS Advisor to make certain investments, including speculative investments.
The incentive fee payable by us to OFS Advisor may create an incentive for OFS Advisor to make investments on our behalf that are riskier or more speculative than would be the case in the absence of such compensation arrangement. The way in
43
which the incentive fee payable to OFS Advisor is determined may encourage OFS Advisor to use leverage to increase the return on our investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which would disfavor our stockholders.
OFS Advisor receives an incentive fee based, in part, upon net capital gains realized on our investments. Unlike that portion of the incentive fee based on income, there is no hurdle rate applicable to the portion of the incentive fee based on net capital gains. As a result, OFS Advisor may have a tendency to invest more capital in investments that are likely to result in capital gains as compared to income producing securities. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.
We may invest, to the extent permitted by law, in the securities and instruments of other investment companies, including private funds, and, to the extent we so invest, will bear our ratable share of any such investment company’s expenses, including management and performance fees. We remain obligated to pay management and incentive fees to OFS Advisor with respect to the assets invested in the securities and instruments of other investment companies. With respect to each of these investments, each of our stockholders will bear his or her share of the management and incentive fee of OFS Advisor as well as indirectly bearing the management and performance fees and other expenses of any investment companies in which we invest.
Our board of directors is charged with protecting our interests by monitoring how OFS Advisor addresses these and other conflicts of interests associated with its management services and compensation. While our board of directors is not expected to review or approve each borrowing or incurrence of leverage, our independent directors will periodically review OFS Advisor’s services and fees. In connection with these reviews, our independent directors will consider whether our fees and expenses (including those related to leverage) remain appropriate.
Our incentive fee structure may create incentives for OFS Advisor that are not fully aligned with the interests of our stockholders.
In the course of our investing activities, we will pay management and incentive fees to OFS Advisor. The base management fee is based on our total assets (other than cash and cash equivalents and the intangible asset and goodwill resulting from the SBIC Acquisition, but including assets purchased with borrowed amounts and including assets owned by any consolidated entity). As a result, investors in our common stock will invest on a “gross” basis and receive distributions on a “net” basis after expenses, resulting in a lower rate of return than one might achieve through direct investments. Because these fees are based on our total assets, other than cash and cash equivalents but including assets purchased with borrowed amounts and including any assets owned by any consolidated entity, OFS Advisor will benefit when we incur debt or use leverage. Our board of directors is charged with protecting our interests by monitoring how OFS Advisor addresses these and other conflicts of interests associated with its management services and compensation. While our board of directors is not expected to review or approve each borrowing or incurrence of leverage, our independent directors will periodically review OFS Advisor’s services and fees as well as its portfolio management decisions and portfolio performance. In connection with these reviews, our independent directors will consider whether our fees and expenses (including those related to leverage) remain appropriate. As a result of this arrangement, OFS Advisor or its affiliates may from time to time have interests that differ from those of our stockholders, giving rise to a conflict.
We may pay an incentive fee on income we do not receive in cash.
The part of the incentive fee payable to OFS Advisor that relates to our pre-incentive fee net investment income is computed and paid on income that may include interest income that has been accrued but not yet received in cash. This fee structure may be considered to involve a conflict of interest for OFS Advisor to the extent that it may encourage OFS Advisor to favor debt financings that provide for deferred interest, rather than current cash payments of interest. OFS Advisor may have an incentive to invest in deferred interest securities in circumstances where it would not have done so but for the opportunity to continue to earn the incentive fee even when the issuers of the deferred interest securities would not be able to make actual cash payments to us on such securities. This risk could be increased because OFS Advisor is not obligated to reimburse us for any incentive fees received even if we subsequently incur losses or never receive in cash the deferred income that was previously accrued.
OFS Advisor’s liability is limited under the Investment Advisory Agreement, and we have agreed to indemnify OFS Advisor against certain liabilities, which may lead OFS Advisor to act in a riskier manner on our behalf than it would when acting for its own account.
Under the Investment Advisory Agreement, OFS Advisor will not assume any responsibility to us other than to render the services called for under that agreement, and it will not be responsible for any action of our board of directors in following or declining to follow OFS Advisor’s advice or recommendations. Under the terms of the Investment Advisory Agreement, OFS Advisor and its affiliates’ respective officers, directors, members, managers, stockholders and employees will not be liable to us, any subsidiary of ours, our directors, our stockholders or any subsidiary’s stockholders or partners for acts or omissions
44
performed in accordance with and pursuant to the Investment Advisory Agreement, except those resulting from acts constituting gross negligence, willful misconduct, bad faith or reckless disregard of such person’s duties under the Investment Advisory Agreement. In addition, we have agreed to indemnify OFS Advisor and its affiliates’ respective officers, directors, members, managers, stockholders and employees from and against any claims or liabilities, including reasonable legal fees and other expenses reasonably incurred, arising out of or in connection with our business and operations or any action taken or omitted on our behalf pursuant to authority granted by the Investment Advisory Agreement, except where attributable to gross negligence, willful misconduct, bad faith or reckless disregard of such person’s duties under the Investment Advisory Agreement. These protections may lead OFS Advisor to act in a riskier manner when acting on our behalf than it would when acting for its own account.
We may be subject to additional risks if we engage in hedging transactions and/or invest in foreign securities.
The 1940 Act generally requires that 70% of our investments be in issuers each of whom is organized under the laws of, and has its principal place of business in, any state of the United States, the District of Columbia, Puerto Rico, the Virgin Islands or any other possession of the United States. Our investment strategy does not presently contemplate investments in securities of non-U.S. companies. We expect that these investments would focus on the same debt investments that we make in U.S. middle-market companies and accordingly would be complementary to our overall strategy and enhance the diversity of our holdings. Investing in securities of emerging market issuers involves many risks, including economic, social, political, financial, tax and security conditions in the emerging market, potential inflationary economic environments, regulation by foreign governments, different accounting standards and political uncertainties. Economic, social, political, financial, tax and security conditions also could negatively affect the value of emerging market companies. These factors could include changes in the emerging market government’s economic and fiscal policies, the possible imposition of, or changes in, currency exchange laws or other laws or restrictions applicable to the emerging market companies or investments in their securities and the possibility of fluctuations in the rate of exchange between currencies.
Engaging in either hedging transactions or investing in foreign securities would entail additional risks to our stockholders. We could, for example, use instruments such as interest rate swaps, caps, collars and floors and, if we were to invest in foreign securities, we could use instruments such as forward contracts or currency options and borrow under a credit facility in currencies selected to minimize our foreign currency exposure. In each such case, we generally would seek to hedge against fluctuations of the relative values of our portfolio positions from changes in market interest rates or currency exchange rates. Hedging against a decline in the values of our portfolio positions would not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of the positions declined. However, such hedging could establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions could also limit the opportunity for gain if the values of the underlying portfolio positions increased. Moreover, it might not be possible to hedge against an exchange rate or interest rate fluctuation that was so generally anticipated that we would not be able to enter into a hedging transaction at an acceptable price.
While we may enter into such transactions to seek to reduce currency exchange rate and interest rate risks, unanticipated changes in currency exchange rates or interest rates could result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged could vary. Moreover, for a variety of reasons, we might not seek to establish a perfect correlation between the hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation could prevent us from achieving the intended hedge and expose us to risk of loss. In addition, it might not be possible to hedge fully or perfectly against currency fluctuations affecting the value of securities denominated in non-U.S. currencies because the value of those securities would likely fluctuate as a result of factors not related to currency fluctuations.
We may not realize gains from our equity investments.
When we invest in senior secured, unitranche, second-lien and mezzanine loans, we may acquire warrants or other equity securities of portfolio companies as well. We may also invest in equity securities directly. To the extent we hold equity investments, except as described below, we will attempt to dispose of them and realize gains upon our disposition of them. However, the equity interests we receive may not appreciate in value and may decline in value. As a result, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience. In the case of SBIC I LP, our wholly-owned subsidiary, we will not receive direct benefits from the sale of assets in their portfolios. Rather, our return on our investment in such assets will depend on the ability of SBIC I LP’s portfolio to generate cash flow in excess of payments required, as appropriate, to be made to other parties under the terms of the SBA debentures, and distribution, subject to SBA regulation, of the excess to us.
45
Uncertainty relating to the LIBOR calculation process may adversely affect the value of any portfolio of LIBOR-indexed, floating-rate debt securities.
Concerns have been publicized that some of the member banks surveyed by the British Bankers' Association (“BBA”) in connection with the calculation of LIBOR across a range of maturities and currencies may have been under-reporting or otherwise manipulating the inter-bank lending rate applicable to them in order to profit on their derivatives positions or to avoid an appearance of capital insufficiency or adverse reputational or other consequences that may have resulted from reporting inter-bank lending rates higher than those they actually submitted. A number of BBA member banks have entered into settlements with their regulators and law enforcement agencies with respect to alleged manipulation of LIBOR, and investigations by regulators and governmental authorities in various jurisdictions are ongoing.
Actions by the BBA, regulators or law enforcement agencies may result in changes to the manner in which LIBOR is determined. Uncertainty as to the nature of such potential changes may adversely affect the market for LIBOR-based securities, including our potential portfolio of LIBOR-indexed, floating-rate debt securities. In addition, any further changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse impact on the market for LIBOR-based securities or the value of our potential portfolio of LIBOR-indexed, floating-rate debt securities.
On July 27, 2017, the United Kingdom's Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time whether or not LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large US financial institutions, is considering replacing U.S. dollar LIBOR with a new index calculated by short term repurchase agreements, backed by Treasury securities. The future of LIBOR at this time is uncertain. If LIBOR ceases to exist, we may need to renegotiate the credit agreements extending beyond 2021 with our portfolio companies that utilize LIBOR as a factor in determining the interest rate to replace LIBOR with the new standard that is established. Any such renegotiated agreements or methodology of the new standard may not be as favorable to us as the current agreements and LIBOR, which may adversely affect our net investment income.
Risks Related to Our Securities
There is a risk that stockholders may not receive distributions or that our distributions may not grow over time and a portion of our distributions may be a return of capital.
We have made distributions on a quarterly basis to our stockholders out of assets legally available for distribution. We cannot assure stockholders that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. Our ability to pay distributions might be adversely affected by the impact of one or more of the risk factors described in this annual report on Form 10-K. Due to the asset coverage test applicable to us under the 1940 Act as a BDC, we may be limited in our ability to make distributions. Our ability to make distributions may also be affected by our ability to receive distributions from SBIC I LP, which is governed by SBA regulations.
When we make distributions, we will be required to determine the extent to which such distributions are paid out of current or accumulated earnings and profits. Distributions in excess of current and accumulated earnings and profits will be treated as a non-taxable return of capital to the extent of an investor’s basis in our stock and, assuming that an investor holds our stock as a capital asset, thereafter as a capital gain. A return of capital is a return to stockholders of a portion of their original investment in us rather than income or capital gains.
The market price of our common stock may fluctuate significantly.
As with any stock, the market price of our common stock will fluctuate with market conditions and other factors. Our common stock is intended for long-term investors and should not be treated as a trading vehicle. Shares of BDCs frequently trade at a discount from their net asset value. The market price and liquidity of the market for shares of our common stock may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:
• | significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which is not necessarily related to the operating performance of these companies; |
• | exclusion of our common stock from certain market indices, such as the Russell 2000 Financial Services Index, which could reduce the ability of certain investment funds to own our common stock and put short-term selling pressure on our common stock; |
• | changes in regulatory policies or tax guidelines, particularly with respect to RICs, SBICs or BDCs; |
46
• | loss of RIC or BDC status; |
• | failure of SBIC I LP to maintain its status as an SBIC; |
• | our origination activity, including the pace of, and competition for, new investment opportunities; |
• | changes or perceived changes in earnings or variations in operating results; |
• | changes or perceived changes in the value of our portfolio of investments; |
• | changes in accounting guidelines governing valuation of our investments; |
• | any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts; |
• | the inability to secure additional debt or equity capital; |
• | potential future sales of common stock or debt securities convertible into or exchangeable or exercisable for our common stock or the conversion of such securities; |
• | departure of OFS Advisor’s, OFSC’s or any of their affiliates’ key personnel; |
• | operating performance of companies comparable to us; |
• | general economic trends and other external factors; and |
• | loss of a major funding source. |
Sales of substantial amounts of our common stock in the public market may have an adverse effect on the market price of our common stock.
The shares of our common stock beneficially owned by our principal stockholders, including OFSAM, are generally available for resale, subject to the provisions of Rule 144 promulgated under the Securities Act unless registered for sale under the Securities Act. We have entered into a registration rights agreement granting OFSAM the right to require us to register its shares for resale. Sales of substantial amounts of our common stock, or the availability of such common stock for sale, could adversely affect the prevailing market prices for our common stock. If this occurs and continues, it could impair our ability to raise additional capital through the sale of securities should we desire to do so.
Certain provisions of the Delaware General Corporation Law and our certificate of incorporation and bylaws could deter takeover attempts and have an adverse impact on the price of our common stock.
The Delaware General Corporation Law, our certificate of incorporation and our bylaws contain provisions that may have the effect of discouraging a third party from making an acquisition proposal for us. We have also adopted measures that may make it difficult for a third party to obtain control of us, including provisions of our certificate of incorporation dividing our board of directors into three classes with the term of one class expiring at each annual meeting of stockholders. These anti-takeover provisions may inhibit a change in control in circumstances that could give the holders of our common stock the opportunity to realize a premium over the market price of our common stock.
Our common stock may trade below its net asset value per share, which limits our ability to raise additional equity capital.
If our common stock is trading below its net asset value per share, we will generally not be able to issue additional shares of our common stock at its market price without first obtaining the approval for such issuance from our stockholders and our independent directors. Shares of BDCs, including shares of our common stock, have traded at discounts to their net asset values. As of December 31, 2017, our net asset value per share was $14.12. The daily average closing price of our shares on the Nasdaq Global Select Market for the year ended December 31, 2017 was $13.69. If our common stock trades below net asset value, the higher the cost of equity capital may result in it being unattractive to raise new equity, which may limit our ability to grow. The risk of trading below net asset value is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether shares of our common stock will trade above, at or below our net asset value.
Item 1B. | Unresolved Staff Comments |
Not applicable.
Item 2. | Properties |
We do not own or lease any real estate or other physical properties material to our operation. Our headquarters are located at 10 S. Wacker Drive, Suite 2500, Chicago, IL, 60606, and are provided by OFS Services pursuant to the Administration Agreement. Additional operations are conducted from offices in New York, New York and Los Angeles,
47
California, which are also provided by OFS Services pursuant to the Administration Agreement. We believe that our office facilities are suitable and adequate for our business as we contemplate continuing to conduct it.
Item 3. | Legal Proceedings |
We, OFS Advisor and OFS Services, are not currently subject to any material pending legal proceedings threatened against us as of December 31, 2017. From time to time, we may be a party to certain legal proceedings incidental to the normal course of our business including the enforcement of our rights under contracts with our portfolio companies. Furthermore, third parties may try to seek to impose liability on us in connection with the activities of our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our business, financial condition, results of operations or cash flows.
Item 4. | Mine Safety Disclosures |
Not applicable.
48
PART II
Item 5. | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Price Range of Common Stock, Holders and Distributions
Our common stock is traded on the Nasdaq Global Select Market under the symbol "OFS". The following table lists the high and low sale price for our common stock, net asset value per share, and the cash distributions per share that we have declared on our common stock for each fiscal quarter during the last two most recently completed fiscal years.
2017 | 2016 | ||||||||||||||||||||||||||||||
Price Range | Distributions | Price Range | Distributions | ||||||||||||||||||||||||||||
NAV (1) | High | Low | Per Share (2) | NAV (1) | High | Low | Per Share (2) | ||||||||||||||||||||||||
For the quarter ended: | |||||||||||||||||||||||||||||||
March 31 | $ | 14.98 | $ | 15.24 | $ | 13.55 | $ | 0.34 | $ | 14.65 | $ | 13.07 | $ | 9.98 | $ | 0.34 | |||||||||||||||
June 30 | $ | 14.40 | $ | 14.58 | $ | 13.50 | $ | 0.34 | $ | 14.76 | $ | 13.75 | $ | 11.83 | $ | 0.34 | |||||||||||||||
September 30 | $ | 14.15 | $ | 14.34 | $ | 12.67 | $ | 0.34 | $ | 14.67 | $ | 14.25 | $ | 12.78 | $ | 0.34 | |||||||||||||||
December 31 | $ | 14.12 | $ | 13.20 | $ | 11.80 | $ | 0.34 | $ | 14.82 | $ | 14.09 | $ | 12.25 | $ | 0.34 | |||||||||||||||
(1) | Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect the net asset value per share on the date of the high and low sales prices. The net asset values shown are based on outstanding shares at the end of each period. |
(2) | Represents distributions declared in the specified quarter. We maintain an “opt-out” distribution reinvestment plan, or DRIP, for our common stockholders. As a result, if we declare a distribution, cash distributions are automatically reinvested in additional shares of our common stock unless the stockholder specifically “opts out” of the dividend reinvestment plan and chooses to receive cash distributions. The determination of the tax attributes of distributions is made annually as of the end of each fiscal year based upon taxable income for the full year and distributions paid for the full year. The return of capital portion of each distribution for the years ended December 31, 2017 and 2016 was $0 and $0.09, respectively. |
The last reported sale price for our common stock on the NASDAQ Global Select Market on March 5, 2018 was $11.51 per share. As of March 5, 2018, there were two holders of record of the common stock, one of which was OFSAM. The other holder of record does not identify stockholders for whom shares are held beneficially in “nominee” or “street name.”
Our board of directors maintains a variable distribution 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 distribution, or fifth distribution, such that we may distribute approximately all of our ICTI in the year it was earned, while maintaining the option to spill over our excess ICTI to a following year.
Distributions directly affect our taxable income. See "Item 1. Business–Material U.S. Federal Income Tax Considerations–Taxation as a RIC".
Distributions in excess of our current and accumulated ICTI are reported as returns of capital; the tax treatment to the stockholder will depend on a variety of factors including the stockholder’s tax basis in our shares. The determination of the tax attributes of our distributions is made annually as of the end of the year, and is based on our taxable income for the full year and distributions paid for the full year; therefore, a determinations made on a quarterly basis may not be representative of the tax attributes of our distributions to stockholders. 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. stockholders. For the year ended December 31, 2017, approximately $1.14 per share, $0.22 per share, and $0 per share of the Company’s distributions represented ordinary income, long-term capital gain, and a return of capital to its stockholders, respectively.
Cash available to make distributions could be impacted by, among other things, SBA regulations. Furthermore, 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 regulated investment company. We cannot assure stockholders that they will receive any distributions at a particular level.
49
Issuer Purchases of Equity Securities
For the years ended December 31, 2017, 2016, and 2015, we did not purchase any shares of our common stock in the open market.
Stock Performance Graph
This graph compares the return on our common stock with that of the Standard & Poor’s 500 Stock Index, the Russell 1000 Index and the SNL U.S. RICs Index, for the last five fiscal years. The graph assumes that, on December 31, 2012, a person invested $100 in our common stock, the Standard & Poor’s 500 Stock Index, the Russell 1000 Index and the SNL U.S. RICs Index. The graph measures total stockholder return, which takes into account changes in stock price and assumes reinvestment of all dividends and distributions prior to any tax effect.
The graph and other information under the heading "Stock Performance Graph" in Part II Item 5 of this Form 10-K is "furnished" and shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Exchange Act and shall not be deemed incorporated by reference in any filing under the Exchange Act. The stock price performance included in the above graph is not necessarily indicative of future stock price performance.
Sales of Unregistered Securities
There was $0.2 million of distributions reinvested during the year ended December 31, 2017 under the DRIP.
50
Item 6. | Selected Consolidated Financial Data |
The following selected financial and other data should be read in conjunction with our consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included in this annual report on Form 10-K (amounts in thousands, except per share data and number of portfolio companies at period end):
For the Years Ended December 31, | |||||||||||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Statement of Operations Data: | |||||||||||||||||||
Investment income | |||||||||||||||||||
Interest income | $ | 28,124 | $ | 26,400 | $ | 27,764 | $ | 20,653 | $ | 16,838 | |||||||||
PIK interest income | 1,508 | 1,194 | 1,206 | 683 | 89 | ||||||||||||||
Dividend income | 482 | 475 | 245 | 124 | 9 | ||||||||||||||
Preferred equity PIK dividend income | 1,399 | 1,433 | 1,116 | 446 | — | ||||||||||||||
Fee income | 1,913 | 1,592 | 1,933 | 914 | 134 | ||||||||||||||
Total investment income | 33,426 | 31,094 | 32,264 | 22,820 | 17,070 | ||||||||||||||
Expenses | |||||||||||||||||||
Management fees | 4,999 | 4,516 | 5,225 | 2,916 | 3,435 | ||||||||||||||
Incentive fees | 2,962 | 3,333 | 2,627 | 1,253 | — | ||||||||||||||
Other expenses | 9,588 | 9,100 | 11,001 | 9,516 | 7,917 | ||||||||||||||
Total expenses | 17,549 | 16,949 | 18,853 | 13,685 | 11,352 | ||||||||||||||
Net investment income | 15,877 | 14,145 | 13,411 | 9,135 | 5,718 | ||||||||||||||
Net realized gain (loss) on investments | 6,833 | 2,404 | (1,562 | ) | (3,359 | ) | 87 | ||||||||||||
Realized gain from SBIC Acquisition | — | — | — | — | 2,742 | ||||||||||||||
Net unrealized appreciation (depreciation on investments | (14,800 | ) | (2,721 | ) | 6,382 | 4,164 | (872 | ) | |||||||||||
Net increase in net assets resulting from operations | 7,910 | 13,828 | 18,231 | 9,940 | 7,675 | ||||||||||||||
Per share data: | |||||||||||||||||||
Net asset value | $ | 14.12 | $ | 14.82 | $ | 14.76 | $ | 14.24 | $ | 14.58 | |||||||||
Net investment income | 1.28 | 1.46 | 1.39 | 0.95 | 0.59 | ||||||||||||||
Net realized gain (loss) on investments | 0.55 | 0.25 | (0.17 | ) | (0.35 | ) | 0.01 | ||||||||||||
Realized gain from SBIC Acquisition | — | — | — | — | 0.29 | ||||||||||||||
Net unrealized appreciation (depreciation) on investments | (1.19 | ) | (0.29 | ) | 0.66 | 0.42 | (0.09 | ) | |||||||||||
Net increase in net assets resulting from operations | 0.64 | 1.43 | 1.89 | 1.03 | 0.80 | ||||||||||||||
Distributions declared (1) | 1.36 | 1.36 | 1.36 | 1.36 | 1.02 | ||||||||||||||
Balance sheet data at period end: | |||||||||||||||||||
Investments, at fair value | $ | 277,499 | $ | 281,627 | $ | 257,296 | $ | 312,234 | $ | 237,919 | |||||||||
Cash and cash equivalents | 72,952 | 17,659 | 32,714 | 12,447 | 28,569 | ||||||||||||||
Restricted cash and cash equivalents | — | — | — | — | 450 | ||||||||||||||
Other assets | 7,327 | 5,744 | 4,666 (2) | 11,823 (2) | 9,106 (2) | ||||||||||||||
Total assets | 357,778 | 305,030 | 294,676 (2) | 336,504 (2) | 276,044 (2) | ||||||||||||||
Debt | 164,823 | 156,343 | 146,460 (2) | 194,935 (2) | 131,912 (2) | ||||||||||||||
Total liabilities | 169,442 | 161,252 | 151,664 (2) | 199,033 (2) | 135,666 (2) | ||||||||||||||
Total net assets | 188,336 | 143,778 | 143,012 | 137,471 | 140,378 | ||||||||||||||
Other data (unaudited): | |||||||||||||||||||
Weighted average yield on performing debt investments (3) (6) | 12.11 | % | 12.08 | % | 11.89 | % | 9.53 | % | 8.49 | % | |||||||||
Weighted average yield on total debt investments (4) (6) | 11.59 | % | 11.72 | % | 11.84 | % | 9.41 | % | 8.35 | % | |||||||||
Weighted average yield on total investments (5) (6) | 10.35 | % | 10.88 | % | 10.79 | % | 8.99 | % | 8.13 | % | |||||||||
Number of portfolio companies at period end | 37 | 41 | 39 | 62 | 58 | ||||||||||||||
(1) | 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 actual tax attributes of our distributions for a full year. The return of capital portion of these distributions for the years ended December 31, 2017, 2016, 2015, 2014, and 2013, was $0, $0.09, $0.23, $0.72, and $0.40, respectively. |
51
(2) | On January 1, 2016, we adopted ASU 2015-03 which requires that debt issuance costs related to a recognized debt liability to be presented on the balance sheet as a direct deduction from the carrying amount of the debt liability rather than as an asset. Adoption of ASU 2015-03 requires the changes to be applied retrospectively. |
(3) | The weighted average yield on our performing debt investments is computed as (a) the annual stated accruing interest on our debt investments at the balance sheet date, plus the annualized accretion of loan origination fees, original issue discount, market discount or premium, and loan amendment fees divided by (b) amortized cost of our debt investments, excluding assets in non-accrual status as of the balance sheet date. |
(4) | The weighted average yield on our performing debt investments is computed as (a) the annual stated accruing interest on our debt investments at the balance sheet date, plus the annualized accretion of loan origination fees, original issue discount, market discount or premium, and loan amendment fees divided by (b) amortized cost of our debt investments, including debt investments in non-accrual status as of the balance sheet date. |
(5) | The weighted average yield on total investments is computed as (a) the annual stated accruing interest on our debt investments at the balance sheet date, plus the annualized accretion of loan origination fees, original issue discount, market discount or premium, and loan amendment fees, plus the cash effective yield on our performing preferred equity investments divided by (b) amortized cost of our total investment portfolio, including debt investments in non-accrual status basis as of the balance sheet date. |
(6) | The weighted average yield of our investments is not the same as a return on investment for our stockholders but, rather, the gross investment income from our investment portfolio before the payment of all of our fees and expenses. There can be no assurance that the weighted average yield will remain at its current level. |
52
Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about us, our current and prospective portfolio investments, our industry, our beliefs, and our assumptions. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “would,” “should,” “targets,” “projects,” and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements, including without limitation:
• | our ability and experience operating a BDC or an SBIC, or maintaining our tax treatment as a RIC under Subchapter M of the Code; |
• | our dependence on key personnel; |
• | our ability to maintain or develop referral relationships; |
• | our ability to replicate historical results; |
• | the ability of OFS Advisor to identify, invest in and monitor companies that meet our investment criteria; |
• | actual and potential conflicts of interest with OFS Advisor and other affiliates of OFSAM; |
• | constraint on investment due to access to material nonpublic information; |
• | restrictions on our ability to enter into transactions with our affiliates; |
• | limitations on the amount of SBA-guaranteed debentures that may be issued by an SBIC; |
• | Our ability to comply with SBA regulations and requirements; |
• | the use of borrowed money to finance a portion of our investments; |
• | competition for investment opportunities; |
• | the ability of SBIC I LP to make distributions enabling us to meet RIC requirements; |
• | our ability to raise debt or equity capital as a BDC; |
• | the timing, form and amount of any distributions from our portfolio companies; |
• | the impact of a protracted decline in the liquidity of credit markets on our business; |
• | the general economy and its impact on the industries in which we invest; |
• | uncertain valuations of our portfolio investments; and |
• | the effect of new or modified laws or regulations governing our operations. |
Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Annual Report on Form 10-K should not be regarded as a representation by us that our plans and objectives will be achieved. These risks and uncertainties include, among others, those described or identified in “Item 1A. Risk Factors” in this Annual Report on Form 10-K. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report on Form 10-K.
We have based the forward-looking statements on information available to us on the date of this Annual Report on Form 10-K. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. The forward-looking statements and projections contained in this annual report on Form 10-K are excluded from the safe harbor protection provided by Section 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 Annual Report on Form 10-K.
53
Critical Accounting Policies and Significant Estimates
The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the periods reported. Actual results could materially differ from those estimates. Critical accounting policies are those that require management to make subjective or complex judgments about the effect of matters that are inherently uncertain and may change in subsequent periods. Changes that may be required in the underlying assumptions or estimates in these areas could have a material impact on our current and future financial condition and results of operations.
Our critical accounting policies and estimates are those relating to revenue recognition and fair value estimates. Management has discussed the development and selection of each critical accounting policy and estimate with the Audit Committee of the Board of Directors. For a descriptions of our revenue recognition and fair value policies, see Note 2 to the consolidated financial statements included in "Item 8.–Financial Statements" of this report.
Revenue recognition
Our investment activities frequently involve the acquisition of multiple financial instruments or rights either in an initial transaction, or in subsequent or "follow-on" transactions, including amendments to existing securities. These financial instruments can include loans, preferred and common stock, warrants, or membership interests in limited liability companies. Acquired rights can include fixed or variable fees that can be either guaranteed or contingent upon operating performance of the underlying portfolio companies. Moreover, these fees may be payable in cash or additional securities. Acquired rights and financial instruments together, referred to as Instruments.
The revenue recognized on these Instruments is a function of the fee or other consideration allocated to them, including amounts allocated to capital structuring fees, at the time of acquisition. Additionally, subsequent amendments to these Instruments can involve both:
• | a determination as to whether the amendment is |
◦ | of such significance to deem it the consummation of the initial investment transaction and the acquisition of new Instruments (i.e., a "significant modification"), or |
◦ | a modification of those Instruments to be recognized over their remaining lives, and |
• | an additional allocation of consideration among newly acquired Instruments. |
These allocations are generally based on the relative fair value of the Instruments at the time of the transaction, a process involving fair value estimates which is also a critical accounting policy and significant estimate. Moreover, these allocations and determinations can differ between GAAP and federal income tax bases. Once determined, these allocations directly affect the discount/premium and yield on debt securities, the cost and net gains/losses on equity securities, and capital structuring fees recognized in the statements of operations; and ICTI. These allocations require an understanding of the terms and conditions of the underlying agreements and requires significant management judgment. The table below presents the impact to the initial cost bases of allocated consideration to acquired Instruments for the years ended December 31, 2017, 2016, and 2015, (in thousands):
2017 | 2016 | 2015 | |||||||||
Loans: | |||||||||||
Net Loan Fees (1) (excluding equity securities and cash amendment fees) | $ | (1,376 | ) | $ | (983 | ) | $ | (922 | ) | ||
Equity securities (including performance-contingent fees) | — | (822 | ) | — | |||||||
Equity securities (including performance-contingent fees) | — | 822 | — | ||||||||
Capital structuring fees | 531 | 369 | 653 | ||||||||
(1) Loan origination fees, OID, market discount or premium, and loan amendment fees.
On January 1, 2018, we adopted ASC Topic 606, which will result in the re-characterization of capital structuring fees received from portfolio companies, which are recognized as earned upon the closing of an investment, to a component of Net Loan Fees, which are recorded as an adjustment to the amortized cost of the investment and amortized as an adjustment to interest income over the life of the respective debt investment. The adoption of new revenue guidance will not have a material impact on our consolidated financial statements, including the presentation of revenues in our consolidated statements of operations.
54
Fair value estimates
As of December 31, 2017, approximately 78% of our total assets were carried on the consolidated balance sheet at fair value. As discussed more fully in “Item 8.–Financial Statements–Note 2” GAAP requires us to categorize financial assets and liabilities carried at fair value according to a three-level valuation hierarchy. The hierarchy gives the highest priority to quoted, active market prices for identical assets and liabilities (Level 1) and the lowest priority to valuation techniques that require significant management judgment because one or more of the significant inputs are unobservable in the market place (Level 3). All of our assets carried at fair value are classified as Level 3; we typically do not hold equity securities or other instruments that are actively traded on an exchange.
As described in “Item 8.–Financial Statements–Note 6”, we follow a process, under the supervision and review of the Board, to determine these unobservable inputs used to calculate the fair values of our investments. The most significant unobservable inputs in these fair value measurements are the discount rates, EBITDA multiples and projected cash flows contractually due from the investment.
We consider a variety of factors in our determination of the discount rate to be applied to an investment including, among other things, investment type, LIBOR swap rate, indicative yields from independent third-party sources and the yield on our investment relative to indicative yields at the time of our investment (initial and subsequent investments) in the portfolio company.
We also consider a variety of factors in our determination of the EBITDA multiple to be applied to an investment including, among other things, the actual EBITDA multiple for the last arms-length transaction, and the ratio of the portfolio company’s EBITDA multiple to the average of EBITDA multiples on comparable public companies.
For both the discount rate and the EBITDA multiple we also consider developments at the portfolio company since our investment including, but not limited to, trends in the portfolio company’s earnings and leverage multiple, and input from our independent third-party valuation firms. This process typically results in a single selected discount rate and/or EBITDA multiple for each investment.
The following table illustrates the sensitivity of our fair value measures to reasonably likely changes to the estimated discount rate and EBITDA multiple inputs used in our investment valuations at December 31, 2017 (dollar amounts in thousands):
Fair Value at December 31, 2017 | Weighted average discount rate/EBITDA multiple at December 31, 2017 | Discount rate sensitivity | EBITDA multiple sensitivity | |||||||||||||||||||
Valuation Method / Investment Type | -10% Weighted average | +10% Weighted average | +0.5x | -0.5x | ||||||||||||||||||
Discounted cash flow | ||||||||||||||||||||||
Debt investments: | ||||||||||||||||||||||
Senior Secured | $ | 152,231 | 12.24% | $ | 155,136 | $ | 147,782 | N/A | N/A | |||||||||||||
Subordinated | $ | 47,117 | 14.69% | $ | 48,261 | $ | 45,641 | N/A | N/A | |||||||||||||
Enterprise value | ||||||||||||||||||||||
Debt investments: | ||||||||||||||||||||||
Senior Secured | $ | 12,910 | 7.50x | N/A | N/A | $ | 13,712 | $ | 12,108 | |||||||||||||
Subordinated | $ | 4,074 | 6.37x | N/A | N/A | $ | 4,752 | $ | 3,397 | |||||||||||||
Equity investments: | ||||||||||||||||||||||
Preferred equity | $ | 19,200 | 7.80x | N/A | N/A | $ | 19,737 | $ | 17,038 | |||||||||||||
Common equity and warrants | $ | 11,489 | 6.27x | N/A | N/A | $ | 13,673 | $ | 10,491 | |||||||||||||
The table above presents the impact to our debt and equity investment fair value accounting measures by uniformly modifying our discount rate and EBITDA valuation inputs, as applicable. This discount rate sensitivity measures included in the table do not present the estimated effect of hypothetical changes in actual, observed interest rates, which would affect the cash flows from many of the underlying investments as they are indexed to LIBOR or the Prime Rate of interest, the operating environment of many of our portfolio companies, and other factors, as well as our estimates of the discount rate valuation input. The effect of hypothetical changes in actual, observed interest rates on our fair value measures is not subject to reasonable estimation.
55
Related Party Transactions
We have entered into a number of business relationships with affiliated or related parties, including the following:
• | The Investment Advisory Agreement with OFS Advisor to manage our operating and investment activities. Under the Investment Advisory Agreement we have agreed to pay OFS Advisor an annual base management fee based on the average value of our total assets (other than cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity) as well as an incentive fee based on our investment performance. See “Item 1—Management and Other Agreements” and “Item 8–Financial Statements and Supplementary Data–Note 4”. |
• | The Administration Agreement with OFS Capital Services, an affiliate of OFS Advisor, to provide us with the office facilities and administrative services necessary to conduct our operations. See “Item 1–Management and Other Agreements” and “Item 8–Financial Statements and Supplementary Data–Note 4”. |
• | A license agreement with OFSAM, the parent company of OFS Advisor, under which OFSAM has agreed to grant us a non-exclusive, royalty-free license to use the name “OFS.” Under this agreement, we have a right to use the “OFS” name for so long as OFS Advisor or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we have no legal right to the “OFS” name. This license agreement will remain in effect for so long as the Investment Advisory Agreement with OFS Advisor is in effect. |
OFS Advisor’s services under the Investment Advisory Agreement are not exclusive to us and OFS Advisor is free to furnish similar services to other entities, including other BDCs affiliated with OFS Advisor, so long as its services to us are not impaired. OFS Advisor also serves as the investment adviser to CLO funds and other assets, including HPCI, a non-traded BDC with an investment strategy similar to ours.
56
Portfolio Composition and Investment Activity
Portfolio Composition
As of December 31, 2017, the fair value of our debt investment portfolio totaled $246.3 million in 35 portfolio companies, of which 79% and 21% were senior secured loans and subordinated loans, respectively, and approximately $31.2 million in equity investments, at fair value, in 17 portfolio companies in which we also held debt investments and two portfolio companies in which we solely held an equity investment. We had unfunded commitments of $9.9 million to three portfolio companies at December 31, 2017. Set forth in the tables and charts below is selected information with respect to our portfolio as of December 31, 2017 and 2016.
The following table summarizes the composition of our investment portfolio as of December 31, 2017 and 2016 (dollar amounts in thousands):
December 31, 2017 | December 31, 2016 | ||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
Senior secured debt investments (1) | $ | 196,020 | $ | 195,112 | $ | 182,315 | $ | 180,955 | |||||||
Subordinated debt investments | 63,031 | 51,198 | 66,591 | 63,410 | |||||||||||
Preferred equity | 24,103 | 19,200 | 23,293 | 23,721 | |||||||||||
Common equity and warrants | 6,821 | 11,989 | 7,108 | 13,541 | |||||||||||
$ | 289,975 | $ | 277,499 | $ | 279,307 | $ | 281,627 | ||||||||
Total number of portfolio companies | 37 | 37 | 41 | 41 | |||||||||||
(1) | Includes debt investments in which we have entered into a contractual arrangement with co‑lenders whereby, subject to certain conditions, we have agreed to receive our principal payments after the repayment of certain co–lenders pursuant to a payment waterfall. The aggregate amortized cost and fair value of these investments was $21,709 and $21,919 at December 31, 2017, respectively, and $28,945 and $29,276, at December 31, 2016, respectively. |
The following table shows the portfolio composition by geographic region at amortized cost and fair value, and as a percentage of total investments. The geographic composition is determined by the location of the portfolio companies' corporate headquarters (dollar amounts in thousands):
Amortized Cost | Fair Value | ||||||||||||||||||||||||||
December 31, 2017 | December 31, 2016 | December 31, 2017 | December 31, 2016 | ||||||||||||||||||||||||
South - US | $ | 126,123 | 43.5 | % | $ | 120,005 | 42.9 | % | $ | 124,699 | 44.9 | % | $ | 122,511 | 43.5 | % | |||||||||||
Northeast - US | 106,506 | 36.7 | 85,693 | 30.7 | 91,012 | 32.8 | 78,186 | 27.8 | |||||||||||||||||||
West - US | 32,976 | 11.4 | 59,120 | 21.2 | 33,097 | 11.9 | 61,219 | 21.7 | |||||||||||||||||||
Midwest - US | 20,431 | 7.0 | 10,566 | 3.8 | 24,621 | 8.9 | 15,788 | 5.6 | |||||||||||||||||||
Canada | 3,939 | 1.4 | 3,923 | 1.4 | 4,070 | 1.5 | 3,923 | 1.4 | |||||||||||||||||||
Total | $ | 289,975 | 100.0 | % | $ | 279,307 | 100.0 | % | $ | 277,499 | 100.0 | % | $ | 281,627 | 100.0 | % | |||||||||||
As of December 31, 2017, our investment portfolio’s three largest industries by fair value, were (1) Manufacturing, (2) Professional, Scientific, and Technical Services, and (3) Other Services (except Public Administration), totaling approximately 44.5% of the investment portfolio. For a full summary of our investment portfolio by industry, see "Note 5, Investments" to the consolidated financial statements included in "Part II, Item 8. Financial Statements and Supplementary Data" of this report.
57
The following table presents our debt investment portfolio by investment size as of December 31, 2017 and 2016 (dollar amounts in thousands):
Amortized Cost | Fair Value | ||||||||||||||||||||||||||
December 31, 2017 | December 31, 2016 | December 31, 2017 | December 31, 2016 | ||||||||||||||||||||||||
Up to $4,000 | $ | 28,403 | 10.9 | % | $ | 34,547 | 13.9 | % | $ | 24,745 | 10.1 | % | $ | 41,419 | 17.0 | % | |||||||||||
$4,001 to $7,000 | 53,271 | 20.5 | 57,996 | 23.3 | 45,765 | 18.6 | 55,342 | 22.6 | |||||||||||||||||||
$7,001 to $10,000 | 84,596 | 32.7 | 78,446 | 31.5 | 84,026 | 34.1 | 80,735 | 33.0 | |||||||||||||||||||
$10,001 to $13,000 | 37,706 | 14.6 | 34,549 | 13.9 | 38,033 | 15.4 | 37,593 | 15.4 | |||||||||||||||||||
Greater than $13,000 | 55,075 | 21.3 | 43,368 | 17.4 | 53,741 | 21.8 | 29,276 | 12.0 | |||||||||||||||||||
Total | $ | 259,051 | 100.0 | % | $ | 248,906 | 100.0 | % | $ | 246,310 | 100.0 | % | $ | 244,365 | 100.0 | % | |||||||||||
The following table displays the composition of our performing debt investment portfolio by weighted average yield as of December 31, 2017 and 2016:
December 31, | ||||||||||||||||||
2017 | 2016 | |||||||||||||||||
Weighted Average Yield - Performing Debt Investments (1) | Senior Secured Debt | SubordinatedDebt | Total Debt | Senior Secured Debt | SubordinatedDebt | Total Debt | ||||||||||||
Less than 8% | 2.0 | % | — | % | 1.6 | % | 8.7 | % | 11.4 | % | 9.5 | % | ||||||
8% - 10% | 26.7 | — | 21.1 | 7.7 | — | 5.6 | ||||||||||||
10% - 12% | 38.4 | 11.5 | 32.7 | 32.6 | 11.9 | 27.0 | ||||||||||||
12% - 14% | 10.1 | 50.8 | 18.6 | 30.9 | 58.1 | 38.2 | ||||||||||||
Greater than 14% | 22.8 | 37.7 | 26.0 | 20.1 | 18.6 | 19.7 | ||||||||||||
Total | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
Weighted average yield - performing debt investments (1) | 11.76 | % | 13.40 | % | 12.11 | % | 11.95 | % | 12.44 | % | 12.08 | % | ||||||
Weighted average yield - total debt investments (2) | 11.76 | % | 11.05 | % | 11.59 | % | 11.52 | % | 12.35 | % | 11.72 | % | ||||||
(1) The weighted average yield on our performing debt investments is computed as (a) the annual stated accruing interest plus the annualized accretion of Net Loan Fees divided by (b) amortized cost of our debt investments, excluding debt investments in non-accrual status as of the balance sheet date.
(2) | The weighted average yield on our total debt investments is computed as (a) the annual stated accruing interest plus the annualized accretion of Net Loan Fees divided by (b) amortized cost of our debt investments, including debt investments in non-accrual status as of the balance sheet date. |
The weighted average yield on total investments was 10.35% and 10.88%, at December 31, 2017 and 2016, respectively. Weighted average yield on total investments is computed as (a) the annual stated accruing interest on our debt investments at the balance sheet date, plus the annualized accretion of Net Loan Fees, plus the effective yield on our performing preferred equity investments, divided by (b) amortized cost of our total investment portfolio, including assets in non-accrual status as of the balance sheet date. The weighted average yield of our investments is not the same as a return on investment for our stockholders but, rather, the gross investment income from our investment portfolio before the payment of all of our fees and expenses. There can be no assurance that the weighted average yield will remain at its current level.
The weighted average yield on our performing debt increased from 12.08% at December 31, 2016 to 12.11% at December 31, 2017, primarily due to an increase in the applicable LIBOR rates which are indexed to our variable rate debt investments, offset by approximately $64.8 million in sales and repayments of debt investments with a weighted average yield of 10.91%, and the deployment of cash during the nine months ended December 31, 2017, including partial deployment of proceeds received from our April 2017 follow–on public offering (the "Offering"), into $107.4 million of debt investments with a weighted average yield of 10.85% at December 31, 2017.
As of December 31, 2017 and 2016, floating rate loans at fair value were 76% and 66% of our debt investment portfolio, respectively, and fixed rate loans at fair value were 24% and 34% of our debt investment portfolio, respectively.
58
Non-Accrual Loans
At December 31, 2017, we had two loans (Community Intervention Services, Inc. and Southern Technical Institute, LLC) on non-accrual status with respect to all interest and Net Loan Fee amortization, with an amortized cost and fair value of $11.1 million and $1.2 million, respectively. Our loan investment in My Alarm Center, LLC, which was on non-accrual status at June 30, 2017, was restructured and exchanged for a new class of preferred equity securities and common equity securities in July 2017. See "Item 1.–Financial Statements–Note 5" for further information. At December 31, 2016, we had one loan (Community Intervention Services, Inc.) on non-accrual status with respect to PIK interest and unamortized Net Loan Fees with an amortized cost and fair value of $7.6 milion and $5.4 million, respectively.
PIK and Cash Dividend Accruals
Payment-in-kind dividends on preferred equity securities are recognized at fair value when earned. At December 31, 2017, we owned four preferred equity securities (Master Cutlery, LLC, Stancor, L.P., Southern Technical Institute, LLC, and TRS Services, LLC), with an aggregate amortized cost and fair value of $10.5 million and $3.7 million, respectively, for which the fair value of the most-recently recognized PIK dividend as of December 31, 2017, was $0. In addition, beginning June 30, 2017, the Company discontinued recognition of the cash preferred dividend from its investment in Master Cutlery, LLC. At December 31, 2016, the Company owned one preferred equity security (Master Cutlery, LLC) with an amortized cost and fair value of $3.5 million, and $1.0 million, respectively, for which the fair value of the most-recently recognized PIK dividend as of December 31, 2016 was $0.
Investment Activity
The following is a summary of our cash investment activity for the years ended December 31, 2017 and 2016 (dollar amounts in millions):
Year Ended December 31, 2017 | Year Ended December 31, 2016 | ||||||||||||||
Debt Investments | Equity Investments | Debt Investments | Equity Investments | ||||||||||||
Investments in new portfolio companies | $ | 114.5 | $ | 4.4 | $ | 48.7 | $ | 0.7 | |||||||
Investments in existing portfolio companies: | |||||||||||||||
Follow-on investments | 19.0 | 1.4 | 13.9 | 0.8 | |||||||||||
Refinanced investments | — | — | 3.2 | — | |||||||||||
Delayed draw funding | 3.6 | — | 0.9 | — | |||||||||||
Total investments in existing portfolio companies | 22.6 | 1.4 | 18.0 | 0.8 | |||||||||||
Total investments in new and existing portfolio companies | $ | 137.1 | $ | 5.8 | $ | 66.7 | $ | 1.5 | |||||||
Number of new portfolio company investments | 17 | 4 | 8 | 1 | |||||||||||
Number of existing portfolio company investments | 17 | 2 | 10 | 1 | |||||||||||
Proceeds/distributions from principal payments/equity investments | $ | 105.1 | $ | — | $ | 41.4 | $ | — | |||||||
Proceeds from investments sold or redeemed | 17.8 | 19.2 | 2.8 | 2.5 | |||||||||||
Total proceeds from principal payments, equity distributions and investments sold | $ | 122.9 | $ | 19.2 | $ | 44.2 | $ | 2.5 | |||||||
Non-cash Investment Activity
In December 2017, our investment in Jobson Healthcare Information, LLC ("Jobson") was restructured, whereby the lender group, including us, purchased all the outstanding equity of Jobson for a nominal purchase price. Immediately after the restructuring, and as of December 31, 2017, we owned approximately 12.6% of the common equity of Jobson. In February 2018, in connection with the restructuring, the Company sold its warrant investment, on a pro-rata basis, to the other members of the lender group for a nominal amount. As of December 31, 2017, the amortized cost and fair value of our common equity investment in Jobson was $0; the amortized cost and fair value of our warrant investment in Jobson was $0.5 million and $0, respectively; and the amortized cost and fair value of our debt investment in Jobson was $15.2 million and $12.9 million, respectively.
In July 2017, our senior secured debt investment with a cost basis of $6.7 million, and preferred equity investments, with an aggregate cost basis of $0.3 million, in My Alarm Center, LLC ("My Alarm"), were restructured and exchanged for common equity and a new class of preferred equity securities with a fair value of $0 and $1.8 million, respectively. As of June
59
30, 2017, we had recognized cumulative unrealized losses of $5.2 million on our pre-restructured securities of My Alarm Center, LLC, which upon restructuring, were recognized as realized losses during the quarter ended September 30, 2017.
During the year ended December 31, 2016, we converted $1.8 million in principal of our subordinated debt investment in Southern Technical Institute, LLC into preferred equity units and warrants valued at $1.8 million, converted $0.3 million in principal of our senior secured debt investment in TRS Services, LLC, into preferred equity units valued at $0.3 million, and converted $0.8 million in principal of our subordinated debt investment in All Metals, LLC, into a senior secured debt investment in the same portfolio company. In addition, we received additional preferred equity units with nominal value in connection with a $1.3 million follow on investment in My Alarm, LLC and also amended our My Alarm, LLC senior secured debt investment for which we received preferred equity units valued at $0.2 million.
Our level of investment activity may vary substantially from period to period depending on various factors, including, but not limited to, the amount of debt and equity capital available to middle-market companies, the level of merger and acquisition activity, the general economic environment and the competitive environment for the types of investments we make.
We categorize debt investments into seven risk categories based on relevant information about the ability of borrowers to service their debt. For additional information regarding our risk categories, see “Item 1. Business—Portfolio Review/Risk Monitoring.” The following table shows the classification of our debt investments portfolio by risk category as of December 31, 2017 and 2016 (dollar amounts in thousands):
As of December 31, | ||||||||||||||
2017 | 2016 | |||||||||||||
Risk Category | Debt Investments, at Fair Value | % of Debt Investments | Debt Investments, at Fair Value | % of Debt Investments | ||||||||||
1 (Low Risk) | $ | — | — | % | $ | — | — | % | ||||||
2 (Below Average Risk) | 3,755 | 1.5 | 3,810 | 1.6 | ||||||||||
3 (Average) | 222,027 | 90.1 | 192,078 | 78.6 | ||||||||||
4 (Special Mention) | 16,454 | 6.7 | 43,084 | 17.6 | ||||||||||
5 (Substandard) | 2,873 | 1.2 | 5,393 | 2.2 | ||||||||||
6 (Doubtful) | 1,201 | 0.5 | — | — | ||||||||||
7 (Loss) | — | — | — | — | ||||||||||
$ | 246,310 | 100.0 | % | $ | 244,365 | 100.0 | % | |||||||
During the year ended December 31, 2017, we reclassified three debt investments from risk category 4 to risk category 3, with an aggregate fair value of $17.2 million at December 31, 2016, primarily due to improvement in the underlying businesses of the portfolio companies. In addition, we reclassified our debt investment in Community Intervention Services, Inc. with a fair value of $5.4 million at December 31, 2016, from risk category 5 to risk category 6 (our non-accrual debt investment with respect to PIK interest and Net Loan Fees described above), our debt investment in Southern Technical Institute, LLC from a risk category 4 to risk category 6 with a fair value of $3.2 million at December 31, 2016, and our debt investment in Master Cutlery, LLC from risk category 4 to risk category 5 with a fair value of $4.4 million at December 31, 2016, primarily due to a degradation in the underlying businesses of the portfolio companies. Further, our loan investment in My Alarm with a fair value and risk rating of $6.2 million and 3, respectively, at December 31, 2016 was restructured and exchanged for a new class of preferred and common equity securities. All other year over year changes in the fair value of our debt investments within each category, were a result of new debt investments, the receipt of amortization payments on existing debt investments, repayment of certain debt investments in full, changes in the fair value of our existing debt investments within the categories, and other investment activity.
Results of Operations
Key Financial Measures
The following is a discussion of the key financial measures that management employs in reviewing the performance of our operations.
Total Investment Income. We generate revenue primarily in the form of interest income on debt investments, and dividend income from our equity investments. Our debt investments typically have a term of three to eight years and bear interest at fixed and floating rates. As of December 31, 2017, floating rate and fixed rate loans comprised 76% and 24%, respectively, of our current debt investment portfolio at fair value; however, in accordance with our investment strategy, we
60
expect that over time the proportion of fixed rate loans will continue to increase. In some cases, our investments provide for PIK interest, or PIK dividends (meaning interest or dividends paid in the form of additional principal amount of the loan or equity security instead of in cash). We also generate revenue in the form of management, valuation, and other contractual fees, which is recognized as the related services are rendered. In the general course of business, we receive certain fees from portfolio companies which are non-recurring in nature. Such non-recurring fees include prepayment fees on certain loans repaid prior to their scheduled due date, which are recognized as earned when received, and fees for capital structuring services from certain portfolio companies, which are recognized as earned upon closing of the investment. Net Loan Fees are capitalized, and accreted or amortized over the life of the loan as interest income. When we receive principal payments on a loan in an amount that exceeds its amortized cost, we recognize the excess principal payment as income in the period it is received.
Expenses. Our primary operating expenses include interest expense due under our outstanding borrowings, the payment of fees to OFS Advisor under the Investment Advisory Agreement, our allocable portion of overhead expenses under the Administration Agreement and other operating costs described below. Additionally, we will pay interest expense on any outstanding debt under any new credit facility or other debt instrument we may enter into. We will bear all other out-of-pocket costs and expenses of our operations and transactions, whether incurred by us directly, OFS Services or its affiliates, or on our behalf by a third party, including:
• | the cost of calculating our net asset value, including the cost of any third-party valuation services; |
• | the cost of effecting sales and repurchases of shares of our common stock and other securities; |
• | fees payable to third parties relating to making investments, including out-of-pocket fees and expenses associated with performing due diligence and reviews of prospective investments; |
• | transfer agent and custodial fees; |
• | out-of-pocket fees and expenses associated with marketing efforts; |
• | federal and state registration fees and any stock exchange listing fees; |
• | U.S. federal, state and local taxes; |
• | independent directors’ fees and expenses; |
• | brokerage commissions; |
• | fidelity bond, directors’ and officers’ liability insurance and other insurance premiums; |
• | direct costs, such as printing, mailing and long-distance telephone; |
• | fees and expenses associated with independent audits and outside legal costs; |
• | costs associated with our reporting and compliance obligations under the 1940 Act and other applicable U.S. federal and state securities laws; and |
• | other expenses incurred by either OFS Services or us in connection with administering our business. |
Net Gain (Loss) on Investments. Net gain (loss) on investments consists of the sum of: (a) realized gains and losses from the sale of debt or equity securities, or the redemption of equity securities; and (b) net unrealized appreciation or depreciation on debt and equity investments, net of applicable taxes to the extent the investments are held through taxable wholly owned subsidiaries. In the period in which a realized gain or loss is recognized, such gain or loss will generally be offset by the reversal of previously recognized unrealized appreciation or depreciation, and the net gain recognized in that period will generally be smaller. The unrealized appreciation or depreciation on debt securities is also reversed when those investments are redeemed or paid off prior to maturity. In such instances, the reversal of accumulated unrealized appreciation or depreciation will be reported as a net loss or gain, respectively, and may be partially offset by the acceleration of any premium or discount on the debt security, which is reported in interest income, and any prepayment fees on the debt security, which is reported in fee income.
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 are also subject to certain constraints on our operations, including, but not limited to, limitations imposed by the 1940 Act and the Code. In addition, SBIC I L.P. is subject to regulation and oversight by they SBA. For the reasons described above, the results of operations described below may not necessarily be indicative of the results we expect to report in future periods.
61
Net increase in net assets resulting from operations can vary substantially from period to period for various reasons, including the recognition of realized gains and losses and unrealized appreciation and depreciation. As a result, annual comparisons of net increase in net assets resulting from operations may not be meaningful.
We changed the primary method used to value certain of our investments as of December 31, 2016, from the income approach to the market approach ("Valuation Methodology Change"), primarily due to the nature of evidence available under the discounted cash flow method, and to better align with industry practice. The methodology change resulted in a fourth quarter 2016 net increase to the carrying value of the investments and corresponding net increase in unrealized appreciation/depreciation on investments in the consolidated statement of operations of approximately $1.6 million.
Comparison of years ended December 31, 2017, 2016, and 2015.
Consolidated operating results for the years ended December 31, 2017, 2016, and 2015 are as follows (in thousands):
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Investment income | |||||||||||
Interest income: | |||||||||||
Cash interest income | $ | 26,444 | $ | 24,901 | $ | 25,464 | |||||
Net Loan Fee amortization | 1,450 | 1,414 | 2,263 | ||||||||
Other interest income | 230 | 85 | 37 | ||||||||
Total interest income | 28,124 | 26,400 | 27,764 | ||||||||
PIK income: | |||||||||||
PIK interest income | 1,508 | 1,194 | 1,206 | ||||||||
Preferred equity PIK dividends | 1,399 | 1,433 | 1,116 | ||||||||
Total PIK income | 2,907 | 2,627 | 2,322 | ||||||||
Dividend income: | |||||||||||
Preferred equity cash dividends | 165 | 168 | 160 | ||||||||
Common equity dividends | 317 | 307 | 85 | ||||||||
Total dividend income | 482 | 475 | 245 | ||||||||
Fee income: | |||||||||||
Management, valuation, and other | 163 | 159 | 159 | ||||||||
Prepayment, structuring, and other fees | 1,750 | 1,433 | 1,774 | ||||||||
Total fee income | 1,913 | 1,592 | 1,933 | ||||||||
Total investment income | 33,426 | 31,094 | 32,264 | ||||||||
Total expenses | 17,549 | 16,949 | 18,853 | ||||||||
Net investment income | 15,877 | 14,145 | 13,411 | ||||||||
Net gain (loss) on investments | (7,967 | ) | (317 | ) | 4,820 | ||||||
Net increase in net assets resulting from operations | $ | 7,910 | $ | 13,828 | $ | 18,231 | |||||
Interest and PIK income by debt investment type for the years ended December 31, 2017, 2016, and 2015 are summarized below (in thousands):
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Interest and PIK interest income: | |||||||||||
Senior secured debt investments | $ | 21,785 | $ | 19,485 | $ | 20,038 | |||||
Subordinated debt investments | 7,847 | 8,109 | 8,932 | ||||||||
Total interest and PIK interest income | $ | 29,632 | $ | 27,594 | $ | 28,970 | |||||
Comparison of investment income for the years ended December 31, 2017 and 2016:
Interest income increased approximately $3.2 million, due to a $3.4 million increase in recurring interest income caused by a 12% increase in the average outstanding loan balance during 2017, offset by a decrease of $1.4 million in recurring interest income resulting from a 63 basis point decrease in the weighted average yield in our portfolio during the year ended December 31, 2017. Acceleration of Net Loan Fees of $0.6 million and $0.6 million were included in interest income for the year ended December 31, 2017 and 2016, respectively, from the repayment of loans prior to their scheduled due dates.
62
Fee income increased $0.3 million primarily due to an increase in prepayment fees and capital structuring fees. We recorded prepayment fees of $1.0 million resulting from $60.2 million of unscheduled principal payments during the year ended December 31, 2017, compared to $0.9 million from $25.0 million of unscheduled principal payments during 2016. We recognized capital structuring fees of $0.5 million and $0.4 million for the years ended December 31, 2017 and 2016, respectively, upon the closing of $55.7 million and $37.3 million of debt and equity investments, respectively.
Comparison of investment income for the years ended December 31, 2016 and 2015:
Interest income decreased $1.4 million primarily due to a $1.0 million decrease in recurring interest income and a $0.4 million decrease in accelerated Net Loan Fees. Acceleration of Net Loan Fees occur and are recognized on certain loans that are repaid prior to their scheduled due date. The $1.0 million decrease in recurring interest income was primarily due to a $3.6 million decrease caused by a 13% decrease in the average outstanding loan balance during 2016, offset by an increase of $2.6 million caused by a 19 basis point increase in the weighted average yield in our portfolio during the year ended December 31, 2016. The 13% decrease in the weighted average principal balance of investments and increase in our average portfolio yield was primarily a result of the sale of a portfolio of 20 senior secured debt investments with an aggregate principal balance of approximately $67.8 million as of May 28, 2015 to Madison (the "WM Asset Sale") which occurred on May 28, 2015 (See "Liquidity and Capital Resources—WM Asset Sale and Related Transactions" for further details), the proceeds of which had only been partially reinvested in higher-yielding assets subsequent to the WM Asset Sale. Acceleration of Net Loan Fees of $0.6 million and $1.0 million were included in interest income for the years ended December 31, 2016 and 2015, respectively.
Preferred equity cash and PIK dividend income increased approximately $0.3 million primarily as a result of additional preferred equity securities purchased during 2015. Common equity dividend income increased by $0.2 million primarily due to an additional common equity security purchased during the fourth quarter of 2015.
Fee income decreased $0.3 million primarily due to a decrease in prepayment fees and capital structuring fees. We recorded prepayment fees of $0.9 million resulting from $25.0 million of unscheduled principal payments during the year ended December 31, 2016, compared to $1.1 million from $47.5 million of unscheduled principal payments during 2015. We recognized capital structuring fees of $0.4 million and $0.7 million for the years ended December 31, 2016 and 2015, respectively, upon the closing of $37.3 million and $89.0 million of debt and equity investments, respectively.
Expenses
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(Amounts in thousands) | |||||||||||
Interest expense | $ | 5,813 | $ | 5,302 | $ | 6,959 | |||||
Management fees | 4,999 | 4,516 | 5,225 | ||||||||
Incentive fee | 2,962 | 3,333 | 2,627 | ||||||||
Professional fees | 1,115 | 1,200 | 1,114 | ||||||||
Administration fee | 1,314 | 1,304 | 1,637 | ||||||||
General and administrative expenses | 1,346 | 1,294 | 1,291 | ||||||||
Total expenses | $ | 17,549 | $ | 16,949 | $ | 18,853 | |||||
Comparison of expenses for the years ended December 31, 2017 and 2016:
Interest expense increased primarily due to an increase in borrowings under our PWB Credit Facility. The average dollar amount of borrowings outstanding under the PWB Credit Facility during the years ended December 31, 2017 and 2016 was $8.5 million and $0.6 million, respectively.
Management fee expense increased by $0.5 million due to an increase in our average total assets, primarily due to an increase in net investment activity, including deployment of funds from our our follow-on public offering of 3,625,000 shares of our common stock in April 2017 (the "Offering").
Incentive fee expense decreased by $0.4 million primarily due to a $0.6 million decrease in Part One incentive fees, due to a share issuance adjustment related to the Offering, which raised the hurdle rate to a level that was not exceeded in the second quarter because the Offering proceeds were not fully deployed, offset by an increase in pre-incentive fee net investment income due to an increase in net investment activity, including additional deployment of funds from the Offering, and an increase in the accrued Capital Gains Fee. During the year ended December 31, 2017, we did not incur a Capital Gains Fee, compared to a Capital Gains Fee of $(0.1) million recorded during the year ended December 31, 2016, which represents the reversal of the accrued Capital Gains Fee at December 31, 2015.
63
Comparison of expenses for the years ended December 31, 2016 and 2015:
Interest expense decreased by $1.7 million, primarily due to a year-over-year decrease of $0.8 million in cash interest expense on the WM Credit Facility and a $1.6 million write-off of deferred debt issuance costs, both related to our permanent reduction of the WM Credit Facility and the termination of the WM Credit Facility on May 28, 2015, offset by an increase of $0.7 million in cash interest expense incurred on our SBA debentures. Interest expense on our SBA debentures increased due to an increase in the weighted average interest rate and the weighted average debentures outstanding during the year ended December 31, 2016, as a result of additional debenture draws of $22.6 million during the nine months ended September 30, 2015, which pooled on September 23, 2015.
Management fee expense decreased by $0.7 million due to a decrease in the average total assets subject to the base management fee.
Incentive fee expense increased by $0.7 million due to an 11% increase in pre-incentive fee net investment income compared to the prior year, which resulted in a $0.8 million increase in the incentive fee catch-up provision (the amount of pre-incentive fee income that exceeds the hurdle rate but is less than 2.5%) and a $0.1 million increase in the incentive fee due to the amount of pre-incentive fee income that exceeded 2.5%, partially offset by a $0.1 million decrease in the Capital Gains Fee, which represents the reversal of the accrued Capital Gains Fee at December 31, 2015.
Administrative fee expense decreased by $0.3 million, primarily due to a decrease in the allocable amount of incentives of our officers and their respective staffs, which OFS Services passed along to us under our administration agreement.
Net gain (loss) on investments
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(Amounts in thousands) | |||||||||||
Senior secured debt | $ | (4,441 | ) | $ | 411 | $ | (1,276 | ) | |||
Subordinated debt | (8,667 | ) | (2,368 | ) | (1,106 | ) | |||||
Preferred equity | 5,373 | (2,584 | ) | 3,351 | |||||||
Common equity and warrants | (232 | ) | 4,224 | 3,851 | |||||||
Net gain (loss) on investments | $ | (7,967 | ) | $ | (317 | ) | $ | 4,820 | |||
Year ended December 31, 2017
We recognized net losses of $4.4 million on senior secured debt during the year ended December 31, 2017, primarily as a result of a realized loss of $5.0 million on our senior secured debt investment in My Alarm recognized upon restructuring in the third quarter of 2017, offset by the positive net impact of portfolio company-specific performance factors on other investments. We held the My Alarm investment from the fourth quarter of 2015 and recognized unrealized appreciation of $0.2 million, and $0 during the years ended December 31, 2016 and 2015, respectively.
We recognized net losses of $8.7 million on subordinated debt during the year ended December 31, 2017, primarily as a result of the net negative impact of portfolio company-specific performance factors, including unrealized depreciation of $5.4 million recognized on our debt investment in Community Intervention Services, Inc., which was placed on non-accrual status during 2016, unrealized depreciation of $2.1 million recognized on our debt investment in Southern Technical Institute, LLC, which was placed on non-accrual status during the fourth quarter of 2017, and $1.6 million of unrealized depreciation on our debt investment in Master Cutlery, LLC.
We recognized net gains of $5.4 million on preferred equity investments for the year ended December 31, 2017, primarily as a result of $7.7 million of net realized gains recognized upon sale of three equity investments, offset by the negative impact from changes to EBITDA multiples used in our valuations and negative impacts of portfolio company-specific performance factors, including a $2.1 million unrealized loss recognized on our equity investment in Southern Technical Institute, LLC. Included in net gains of $7.7 million for the year ended December 31, 2017, were realized gains of $11.0 million we recognized upon sale of the three aforementioned equity investments. We recognized cumulative unrealized appreciation of approximately $3.3 million on these investments through December 31, 2016, which resulted in an aggregate net gain of $7.7 million during the year ended December 31, 2017. In addition, previously recognized cumulative unrealized depreciation of $0.3 million at June 30, 2017, on our preferred equity investments in My Alarm, was realized upon restructuring.
We recognized net losses of $0.2 million on common equity and warrant investments for the year ended December 31, 2017, primarily as a result of the negative impact of portfolio company-specific performance factors, offset by a $0.4 million
64
net gain realized upon sale of a common equity investment, which includes a realized gain of $0.9 million, for which we had recognized cumulative unrealized appreciation of $0.5 million through December 31, 2016.
Year ended December 31, 2016
We recognized net gains of $0.4 million on senior secured debt during the year ended December 31, 2016, primarily as a result of the net positive impact of market based transactions on our fair values, offset by the net impact of portfolio company-specific performance factors, the pay-off of certain senior secured debt investments, and $0.4 million as a result of the Valuation Methodology Change.
We recognized net losses of $2.4 million on subordinated debt during the year ended December 31, 2016, principally due to the net impact of portfolio company-specific performance factors and $0.5 million as a result of the Valuation Methodology Change.
We recognized net losses of $2.6 million on preferred equity investments for the year ended December 31, 2016, primarily due to the net impact of portfolio company-specific performance factors offset by $2.1 million as a result of the Valuation Methodology Change.
We recognized net gains of $4.2 million on common equity and warrant investments for the year ended December 31, 2016, primarily due to the net impact of portfolio company-specific performance factors and $0.4 million as a result of the Valuation Methodology Change. In addition, we realized gains of $2.1 million from the redemption of an equity investment. We held this investment from the first quarter of 2014 and recognized unrealized gains of $2.1 million and $0.5 during the years ended December 31, 2015 and 2014, respectively. The net impact of this transaction was a recognized net loss of $0.5 during the year ended December 31, 2016 due to the reversal of the accumulated unrealized gains in excess of the recognized realized gain.
Year ended December 31, 2015
We recognized net losses of $1.3 million on senior secured debt during the year ended December 31, 2015, primarily as a result of the net impact of changes to certain market loan indices, the impact of portfolio company-specific performance factors, and the settlement of a senior secured debt investment with one of our portfolio companies (Strata Pathology Services, Inc.) ("Strata Settlement") in the fourth quarter of 2015, partially offset by the pay-off of certain senior secured debt investments, including the WM Asset Sale. In connection with the Strata Settlement, we recognized a realized loss of $3.9 million and reversed $3.2 million of previously recognized cumulative unrealized depreciation.
We recognized net losses of $1.1 million on subordinated debt during the year ended December 31, 2015, principally due to the net impact of portfolio company-specific performance factors, and the impact of changes to certain market loan indices.
We recognized net gains of $3.4 million on preferred equity investments for the year ended December 31, 2015, primarily due to the impact of portfolio company-specific performance factors, the impact of certain investments moving closer to their expected exit events, and a net gain of $0.7 million from the sale of an investment. We realized a $1.4 million gain on the sale of the equity investment, offset by the reversal of previously recognized unrealized gains from the date we held this investment, which included recognized unrealized gains of $0.5 at December 31, 2014.
We recognized net gains of $3.9 million on common equity and warrant investments for the year ended December 31, 2015, primarily due to the impact of exit-event assumptions on our valuations, the net impact of portfolio company-specific performance factors, and a gain of $0.7 million from the redemption of a warrant investment.
Liquidity and Capital Resources
At December 31, 2017, we held cash and cash equivalents of $73.0 million, which includes cash and cash equivalents of $72.1 million held by SBIC I LP, our wholly owned SBIC. Our use of cash held by SBIC I LP is restricted by SBA regulation, including limitations on the amount of cash SBIC I LP can distribute to OFS Capital Corporation as parent company (the "Parent"). Any such distributions to the Parent from SBIC I LP are generally restricted to a statutory measure of undistributed accumulated earnings of SBIC I LP under SBA regulation. During the year ended December 31, 2017, the Parent received cash distributions of $5.6 million from SBIC I LP. At December 31, 2017, the Parent had $9.7 million of cash and cash equivalents available for general corporate activities, including $8.8 million held by SBIC I LP that was available for distribution to it. Additionally, the Parent had $17.4 million borrowings available through our PWB Credit Facility at December 31, 2017.
Sources and Uses of Cash and Cash Equivalents
We generate cash through operations from net investment income and the net liquidation of portfolio investments, and use cash in our operations in the net purchase of portfolio investments. Significant variations may exist between net investment income and cash from net investment income, primarily due to the recognition of non-cash investment income, including Net
65
Loan Fee amortization, PIK interest, and PIK dividends, which generally will not be fully realized in cash until we exit the investment. As discussed in "Item 8. Financial Statements—Note 4", we pay OFS Advisor a quarterly incentive fee with respect to our pre-incentive fee net investment income, which includes investment income that has not been received in cash. In addition, we must distribute substantially all our taxable income, which approximates, but will not always equal, the cash we generate from net investment income to maintain our RIC tax treatment. Historically, our distributions have been in excess of taxable income and we have limited history of net taxable gains. We also obtain cash to fund investments or general corporate activities from the issuance of securities and our revolving line of credit. These principal sources and uses of cash and liquidity are presented below (in thousands):
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Cash from net investment income | $ | 11,451 | $ | 10,051 | $ | 12,541 | |||||
Cash received from net realized gains | 11,017 | 2,228 | 2,329 | ||||||||
Net (purchases and originations) repayments of portfolio investments | (11,795 | ) | (23,595 | ) | 68,868 | ||||||
Net cash provided by (used in) operating activities | 10,673 | (11,316 | ) | 83,738 | |||||||
Proceeds from common stock offering, net of expenses | 53,423 | — | — | ||||||||
Cash distributions paid | (16,700 | ) | (13,062 | ) | (12,690 | ) | |||||
Net borrowings (repayment) on debt facilities | 8,100 | 9,500 | (50,027 | ) | |||||||
Payment of debt issuance costs and common stock offering expenses | (203 | ) | (177 | ) | (754 | ) | |||||
Increase (decrease) in cash and cash equivalents | $ | 55,293 | $ | (15,055 | ) | $ | 20,267 | ||||
Comparison of the years ended December 31, 2017 and 2016:
At December 31, 2017, we held cash and cash equivalents of $73.0 million, an increase of $55.3 million from December 31, 2016.
Cash from net investment income
Cash from net investment income increased $1.4 million for the year ended December 31, 2017, compared to the prior year. The increase to cash from net investment income was principally due to an increase in interest income and prepayment and structuring fees collected, and a decrease in cash paid for incentive fees, which primarily resulted from a share issuance adjustment related to the Offering, offset by an increase in cash paid for management fees, primarily due to an increase in net investment activity, including additional deployment of funds from the Offering, and an increase in cash interest paid on our PWB Credit Facility.
Cash received from realized gains
Cash received on realized gains may differ from realized gains in the statement of operations due to delays in the receipt of sale proceeds related to escrow and earn-out provisions in the investment sales transactions.
Net (purchases and originations) repayments of portfolio investments
During the year ended December 31, 2017, net purchases and originations of portfolio investments were primarily due to $142.9 million of cash we used to purchase portfolio investments, offset by $131.1 million of cash we received from amortized cost repayments on our portfolio investments. During the year ended December 31, 2016, net purchases were due to $68.2 million of cash we used to purchase portfolio investments, offset by $44.6 million of cash we received from amortized cost repayments on our portfolio investments.
Proceeds from common stock offering, net of expenses
In April 2017, we issued 3,625,000 shares of our common stock in a follow-on public offering at an offering price of $14.57 per share, including shares purchased by the underwriters pursuant to their exercise of the over-allotment option. OFS Advisor paid all of the underwriting discounts and commissions and an additional supplemental payment of $0.25 per share, representing the difference between the public offering price of $14.57 per share and the net offering proceeds of $14.82 per share, which also represented our NAV per share at the time of the Offering. All payments made by OFS Advisor in connection with the Offering are not subject to reimbursement by us. We received $53.7 million in net proceeds from the Offering.
Comparison of the years ended December 31, 2016 and 2015:
At December 31, 2016, we held cash and cash equivalents of $17.7 million, a decrease of $15.1 million from December 31, 2015.
66
Cash from net investment income
Cash from net investment income decreased $2.5 million for the year ended December 31, 2016, compared to the prior year. The decline was principally due to higher management and incentive fees paid, and cash interest. Cash used to pay incentive fees during the year ended December 31, 2016 were $1.6 million greater than the year ended December 31, 2015, due to an increase in our pre-incentive fee net investment income in the fourth quarter of 2015 and the first, second and third quarter of 2016, which were paid during the year ended December 31, 2016. Cash used to pay base management fees during the year ended December 31, 2016 were $0.2 million greater than the year ended December 31, 2015 primarily due to adjustments in the base management fee rate on January 1, 2015, which lead to a $0.9 million increase in cash paid for management fees during the year ended December 31, 2016, that was offset by a reduction of $0.7 million in management fees paid during the year ended December 31, 2016, due to a decrease in the average fair value of our investment portfolio, primarily as a result of the WM Asset Sale in the second quarter of 2015 and subsequent increase in cash and cash equivalents which are not subject to the management fee. Cash interest paid increased due to higher payments on SBA debentures, partially offset by lower payments on the WM Credit Facility. We are required to make interest payments on our SBA debentures semi-annually in March and September through maturity. The weighted average outstanding balance on our SBA debentures, excluding debt issuance costs, increased from $143.7 million for the year ended December 31, 2015, to $149.9 million for the year ended December 31, 2016. Additionally, during the first and second quarter of 2015, $65.9 million and $22.6 million, respectively, of the weighted average outstanding balance for the year ended December 31, 2015, carried interest at a lower pre-pooling, short-term rate. Consequently, we paid cash interest of $4.7 million on our SBA debentures for the year ended December 31, 2016 compared to $3.2 million for the year ended December 31, 2015. This increase was partially offset by a decline in cash paid for interest on our WM Credit Facility from $1.4 million in the year ended December 31, 2015 to $0 in the year ended December 31, 2016, due to the retirement of that facility.
Net (purchases and originations) repayments of portfolio investments
During the year ended December 31, 2016, net purchases were due to $68.2 million of cash we used to purchase portfolio investments, offset by $44.6 million of cash we received from amortized cost repayments on our portfolio investments. During the year ended December 31, 2015, net repayments were due to $124.0 million of cash we used to purchase portfolio investments, offset by $124.0 million of cash we received from amortized cost repayments on our portfolio investments.
Net borrowings (repayment) on debt facilities
Net borrowings of $9.5 million for the year ended December 31, 2016, were attributable to advances received under the PWB Credit Facility which was used to fund investment purchases and general corporate activities.
Borrowings
SBA Debentures
SBIC I LP has a SBIC license that allowed it to obtain leverage by issuing SBA-guaranteed debentures. These debentures are non-recourse to us, and bear interest payable semi-annually, and each debenture has a maturity date that is ten years following issuance. The interest rate on SBA debentures are fixed at the first pooling date after issuance, which is March and September of each year, at market-driven spreads over U.S. Treasury Notes with ten-year maturities. SBA regulations currently limit the amount that an SBIC may borrow up to a maximum of $150 million when it has at least $75 million in regulatory capital, receives a leverage commitment from the SBA and has been through an examination by the SBA subsequent to licensing. For two or more SBICs under common control, the maximum amount of outstanding SBA-provided leverage cannot exceed $350 million. As of December 31, 2017 and 2016, SBIC I LP had fully drawn the $149.9 million of leverage commitments from the SBA, which bears interest at a weighted-average fixed cash interest rate of 3.18%.
67
The following table shows our outstanding SBA debentures payable as of December 31, 2017 and 2016 (in thousands):
SBA debentures outstanding | |||||||||||||
Pooling Date | Maturity Date | Fixed Interest Rate | December 31, 2017 | December 31, 2016 | |||||||||
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 | 22,585 | |||||||||
SBA debentures outstanding | 149,880 | 149,880 | |||||||||||
Unamortized debt issuance costs | (2,657 | ) | (3,037 | ) | |||||||||
SBA debentures outstanding, net of unamortized debt issuance costs | $ | 147,223 | $ | 146,843 | |||||||||
On a stand-alone basis, SBIC I LP held $251.6 million and $247.5 million in assets at December 31, 2017 and 2016, respectively, which accounted for approximately 70% and 81% of the Company’s total consolidated assets, respectively.
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.
PWB Credit Facility
We are party to a BLA with Pacific Western Bank, as lender, to provide us with a senior secured revolving credit facility, or PWB Credit Facility. The PWB Credit Facility is available for general corporate purposes including investment funding and was scheduled to mature on October 31, 2018. The maximum availability of the PWB Credit Facility is equal to 50% of the aggregate outstanding principal amount of eligible loans included in the borrowing base, which excludes subordinated loan investments (as defined in the BLA) and as otherwise specified in the BLA. The PWB Credit Facility is guaranteed by OFS Capital WM and secured by all of our current and future assets excluding assets held by SBIC I LP and the Company’s partnership interests in SBIC I LP and SBIC I GP. The PWC Credit Facility bore interest at a variable rate of the Prime Rate plus a 0.75% margin, with a 5.00% floor, and includes an unused commitment fee, payable monthly in arrears, equal to 0.50% per annum on any unused portion.
On March 7, 2018 the BLA was amended to, among other things, increase the maximum amount available under the PWB Credit Facility from $35 million to $50 million, extend the maturity date from October 31, 2018 to January 31, 2020, and change the interest rate floor from 5.00% to 5.25%. We incurred deferred debt issuance costs of $0.2 million in connection with the amendment.
As of December 31, 2017, availability under the PWB Credit Facility was $17.4 million, based on the stated advance rate of 50% under the borrowing base.
The BLA contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting requirements, a minimum tangible net asset value, a minimum quarterly net investment income after incentive fees, and a statutory asset coverage test. The BLA also contains customary events of default, including, without limitation, nonpayment, misrepresentation of representations and warranties in a material respect, breach of covenant, cross-default to other indebtedness, bankruptcy, change in investment advisor, and the occurrence of a material adverse change in our financial condition. As of December 31, 2017, the Company was in compliance with the applicable covenants.
WM Asset Sale and Related Transactions
On May 28, 2015, OFS Capital and OFS Capital WM entered into a Loan Portfolio Purchase Agreement with Madison Capital Funding, LLC, a Delaware limited liability company ("Madison"), pursuant to which OFS Capital WM completed the WM Asset Sale. 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
68
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”).
As a result of the WM Asset Sale, we received cash proceeds of approximately $67.3 million. On May 28, 2015, the total fair value of the debt investments sold, applying the March 31, 2015 fair value percentages to the principal balances of the respective investments on the sale date, was approximately $66.7 million. The determination of the fair value of our investments is subject to the good faith determination by our board of directors, which is conducted no less frequently than quarterly, pursuant to our valuation policies and accounting principles generally accepted in the United States.
On May 28, 2015, pursuant to the Loan and Security Agreement, we applied approximately $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 the 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.
Other Liquidity Matters
We expect to fund the growth of our investment portfolio utilizing borrowings under SBA debentures, future equity offerings, and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act. We cannot assure stockholders that our plans to raise capital will be successful. In addition, we intend to distribute to our stockholders substantially all of our taxable income in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. Consequently, we may not have the funds or the ability to fund new investments or make additional investments in our portfolio companies. The illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.
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 December 31, 2017 and 2016), 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 the equity markets and the securitization or other debt-related markets, which may or may not be available on favorable terms, if at all.
Contractual Obligations and Off-Balance Sheet Arrangements
The following table shows our contractual obligations as of December 31, 2017 (in thousands):
Payments due by period (2) | |||||||||||||||||||
Contractual Obligations (1) | Total | Less than 1 year | 1-3 years | 3-5 years | After 5 years | ||||||||||||||
PWB Credit Facility | $ | 17,600 | $ | 17,600 | $ | — | $ | — | $ | — | |||||||||
SBA Debentures | 149,880 | — | — | 14,000 | 135,880 | ||||||||||||||
Total | $ | 167,480 | $ | 17,600 | $ | — | $ | 14,000 | $ | 135,880 | |||||||||
(1) | Excludes commitments to extend credit to our portfolio companies. |
(2) | The PWB Credit Facility was scheduled to mature on October 31, 2018. On March 7, 2018, the BLA was amended to, among other things, extend the maturity date to January 31, 2020. The SBA debentures are scheduled to mature between September 2022 and 2025. |
We have entered into contracts with affiliates under which we will incur material future commitments—the Investment Advisory Agreement, pursuant to which OFS Advisor has agreed to serve as our investment adviser, and the Administration Agreement, pursuant to which OFS Services has agreed to furnish us with the facilities and administrative services necessary to conduct our day-to-day operations.
We may become a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. These instruments may include commitments to extend credit and involve, to varying degrees, elements of liquidity and credit risk in excess of the amount recognized in the balance sheet. We had $9.9 million of total unfunded commitments to three portfolio companies at December 31, 2017.
Distributions
We are taxed as a RIC under the Code. Generally, a RIC is entitled to deduct dividends it pays to its stockholders from its income to determine “taxable income.” Taxable income includes our taxable interest, dividend and fee income, and taxable
69
net capital gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash. Taxable income includes non-cash income, such as changes in accrued and reinvested interest and dividends, which includes contractual PIK interest, and the amortization of discounts and fees. Cash collections of income resulting from contractual PIK interest and dividends or the amortization of discounts and fees generally occur upon the repayment of the loans or debt securities that include such items. Non-cash taxable income is reduced by non-cash expenses, such as realized losses and depreciation, and amortization expense.
Our board of directors maintains a variable dividend policy with the objective of distributing four quarterly distributions in an amount not less than 90-100% of our taxable quarterly income or potential annual income for a particular year. In addition, at the end of the year, we may also pay an additional special dividend, or fifth dividend, such that we may distribute approximately all of our annual taxable income in the year it was earned, while maintaining the option to spill over our excess taxable income to a following year. Each year, a statement on Form 1099-DIV identifying the source of the distribution is mailed to the Company’s stockholders. For the year ended December 31, 2017, approximately $1.14 per share, $0.22 per share, and $0 per share of the Company’s distributions represented ordinary income, long-term capital gain, and a return of capital to its stockholders, respectively. In addition, on February 12, 2018, our Board declared a special distribution of $0.37 per share payable on March 29, 2018 to stockholders of record as of March 22, 2018, which represents undistributed net long-term capital gains as of December 31, 2017.
For a detailed description of our distributions paid for the years ended December 31, 2017, 2016, and 2015, see "Item 1.–Financial Statements–Note 11".
Recent Developments
On February 12, 2018, the Board declared a special distribution of $0.37 per share payable on March 29, 2018 to stockholders of record as of March 22, 2018. In addition, on February 27, 2018, the Company’s Board declared a distribution of $0.34 per share for the first quarter of 2018, payable on March 29, 2018 to stockholders of record as of March 22, 2018.
70
Item 7A. | Quantitative and Qualitative Disclosures about Market Risk |
We are subject to financial market risks, including changes in interest rates. Changes in interest rates affect both our cost of funding and the valuation of our investment portfolio. As of December 31, 2017, 76% of our debt investments bore interest at floating interest rates and 24% of our debt investments bore fixed interest rates, at fair value. The interest rates on our debt investments bearing floating interest rates are usually based on a floating LIBOR, and the debt investments typically contain interest rate re-set provisions that adjust applicable interest rates to current rates on a periodic basis. A significant portion of our loans that are subject to the floating LIBOR rates are also subject to a minimum base rate, or floor, that we charge on our loans if the current market rates are below the respective floors. As of December 31, 2017, 93% of our floating rate loans were based on a floating LIBOR (not subject to a floor).
Our outstanding SBA debentures bear interest at a fixed rate. Our PWB Credit Facility has a floating interest rate provision based on the Prime Rate, with a 5.0% interest rate floor, and was 5.25% as of December 31, 2017.
Assuming that the consolidated balance sheet as of December 31, 2017, were to remain constant and that we took no actions to alter our existing interest rate sensitivity, the following tables show the annualized impact of hypothetical base rate changes in interest rates (in thousands):
Basis point increase | Interest income | Interest expense | Net increase (decrease) | |||||||||
50 | $ | 1,226 | $ | 89 | $ | 1,137 | ||||||
100 | 2,213 | 178 | 2,035 | |||||||||
150 | 3,201 | 268 | 2,933 | |||||||||
200 | 4,188 | 357 | 3,831 | |||||||||
250 | 5,175 | 446 | 4,729 | |||||||||
Basis point decrease | Interest income | Interest expense (1) | Net increase (decrease) | |||||||||
50 | $ | (593 | ) | $ | — | $ | (593 | ) | ||||
100 | (952 | ) | — | (952 | ) | |||||||
150 | (1,022 | ) | — | (1,022 | ) | |||||||
200 | (1,031 | ) | — | (1,031 | ) | |||||||
250 | (1,031 | ) | — | (1,031 | ) | |||||||
(1) Our PWB Credit Facility contains a 5.0% interest rate floor, and therefore a decline in the Prime Rate would not materially impact interest expense.
Although we believe that the foregoing analysis is indicative of our sensitivity to interest rate changes as of December 31, 2017, it does not adjust for potential changes in the credit market, credit quality, size and composition of the assets in our portfolio, and other business developments, including borrowings under our credit facility, that could affect net increase in net assets resulting from operations, or net income. Accordingly, no assurances can be given that actual results would not differ materially from the statement above.
We are subject to financial market risks, including changes in interest rates. Changes in interest rates affect both our cost of funding and the valuation of our investment portfolio. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. Our investment portfolio and investment income may be affected by changes in various interest rates, including LIBOR and the Prime Rate.
71
ITEM 8. FINANCIAL STATEMENTS
Index to Financial Statements
OFS Capital Corporation and Subsidiaries | ||
72
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
OFS Capital Corporation
Chicago, Illinois
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of OFS Capital Corporation (the “Company”), including the consolidated schedules of investments, as of December 31, 2017 and 2016, the related consolidated statements of operations, changes in net assets, cash flows and financial highlights for each of the three years in the period ended December 31, 2017, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 12, 2018 expressed an adverse opinion thereon.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our procedures included confirmation of securities owned as of December 31, 2017 and 2016 by correspondence with the custodian, loan agent, portfolio companies, or by other appropriate auditing procedures where replies were not received. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
Chicago, Illinois
March 12, 2018
We have served as the Company's auditor since 2014
73
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
OFS Capital Corporation
Chicago, Illinois
Opinion on Internal Control over Financial Reporting
We have audited OFS Capital Corporation’s (the “Company’s”) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets, including the consolidated schedule of investments, of the Company as of December 31, 2017 and 2016, the related consolidated statements of operation, changes in net assets, cash flows and financial highlights for each of the three years in the period ended December 31, 2017, and the related notes and our report dated March 12, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Item 9A, Management’s Report on Internal Control over Financial Reporting”. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. A material weakness has been identified and described in management’s assessment and is included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting. The Company did not design and maintain effective internal controls over the reliability of financial information reported by portfolio companies that is used as financial inputs in the Company’s investment valuations. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2017 financial statements, and this report does not affect our report dated March 12, 2018 on those financial statements.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ BDO USA, LLP
Chicago, Illinois
March 12, 2018
74
OFS Capital Corporation and Subsidiaries
Consolidated Balance Sheets
(Dollar amounts in thousands, except per share data)
December 31, | |||||||
2017 | 2016 | ||||||
Assets | |||||||
Investments, at fair value | |||||||
Non-control/non-affiliate investments (amortized cost of $209,360 and $178,279, respectively) | $ | 197,374 | $ | 173,219 | |||
Affiliate investments (amortized cost of $70,402 and $76,306, respectively) | 69,557 | 81,708 | |||||
Control investments (amortized cost of $10,213 and $24,722, respectively) | 10,568 | 26,700 | |||||
Total investments at fair value (amortized cost of $289,975 and $279,307, respectively) | 277,499 | 281,627 | |||||
Cash and cash equivalents | 72,952 | 17,659 | |||||
Interest receivable | 2,734 | 1,770 | |||||
Prepaid expenses and other assets | 4,593 | 3,974 | |||||
Total assets | $ | 357,778 | $ | 305,030 | |||
Liabilities | |||||||
Revolving line of credit | $ | 17,600 | $ | 9,500 | |||
SBA debentures (net of deferred debt issuance costs of $2,657 and $3,037, respectively) | 147,223 | 146,843 | |||||
Interest payable | 1,596 | 1,599 | |||||
Management and incentive fees payable | 1,987 | 2,119 | |||||
Administration fee payable | 476 | 435 | |||||
Accrued professional fees | 433 | 477 | |||||
Other liabilities | 127 | 279 | |||||
Total liabilities | 169,442 | 161,252 | |||||
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 December 31, 2017 and December 31, 2016, respectively | — | — | |||||
Common stock, par value of $0.01 per share, 100,000,000 shares authorized, 13,340,217 and 9,700,297 shares issued and outstanding as of December 31, 2017 and December 31, 2016, respectively | 133 | 97 | |||||
Paid-in capital in excess of par | 187,398 | 134,300 | |||||
Accumulated undistributed net investment income | 9,404 | 6,731 | |||||
Accumulated undistributed net realized gain (loss) | 3,881 | 330 | |||||
Net unrealized appreciation (depreciation) on investments | (12,480 | ) | 2,320 | ||||
Total net assets | 188,336 | 143,778 | |||||
Total liabilities and net assets | $ | 357,778 | $ | 305,030 | |||
Number of shares outstanding | 13,340,217 | 9,700,297 | |||||
Net asset value per share | $ | 14.12 | $ | 14.82 | |||
See Notes to Consolidated Financial Statements.
75
OFS Capital Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollar amounts in thousands, except per share data)
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Investment income | |||||||||||
Interest income: | |||||||||||
Non-control/non-affiliate investments | $ | 20,078 | $ | 17,076 | $ | 22,561 | |||||
Affiliate investments | 6,506 | 7,451 | 5,062 | ||||||||
Control investment | 1,540 | 1,873 | 141 | ||||||||
Total interest income | 28,124 | 26,400 | 27,764 | ||||||||
Payment-in-kind interest and dividend income: | |||||||||||
Non-control/non-affiliate investments | 1,400 | 1,070 | 1,111 | ||||||||
Affiliate investments | 1,375 | 1,437 | 1,211 | ||||||||
Control investment | 132 | 120 | — | ||||||||
Total payment-in-kind interest and dividend income: | 2,907 | 2,627 | 2,322 | ||||||||
Dividend income: | |||||||||||
Non-control/non-affiliate investments | 50 | 36 | — | ||||||||
Affiliate investments | 140 | 170 | 245 | ||||||||
Control investment | 292 | 269 | — | ||||||||
Total dividend income | 482 | 475 | 245 | ||||||||
Fee income: | |||||||||||
Non-control/non-affiliate investments | 1,086 | 1,366 | 1,463 | ||||||||
Affiliate investments | 675 | 110 | 320 | ||||||||
Control investment | 152 | 116 | 150 | ||||||||
Total fee income | 1,913 | 1,592 | 1,933 | ||||||||
Total investment income | 33,426 | 31,094 | 32,264 | ||||||||
Expenses | |||||||||||
Interest expense | 5,813 | 5,302 | 6,959 | ||||||||
Management fees | 4,999 | 4,516 | 5,225 | ||||||||
Incentive fee | 2,962 | 3,333 | 2,627 | ||||||||
Professional fees | 1,115 | 1,200 | 1,114 | ||||||||
Administration fee | 1,314 | 1,304 | 1,637 | ||||||||
General and administrative expenses | 1,346 | 1,294 | 1,291 | ||||||||
Total expenses | 17,549 | 16,949 | 18,853 | ||||||||
Net investment income | 15,877 | 14,145 | 13,411 | ||||||||
Net realized and unrealized gain (loss) on investments | |||||||||||
Net realized gain (loss) on non-control/non-affiliate investments | (3,248 | ) | 2,387 | (3,033 | ) | ||||||
Net realized gain on affiliate investments | 10,081 | 17 | 1,471 | ||||||||
Net unrealized appreciation (depreciation) on non-control/non-affiliate investments | (9,715 | ) | (6,699 | ) | 5,099 | ||||||
Net unrealized appreciation (depreciation) on affiliate investments | (5,088 | ) | 3,341 | 1,283 | |||||||
Net unrealized appreciation on control investments | 3 | 637 | — | ||||||||
Net gain (loss) on investments | (7,967 | ) | (317 | ) | 4,820 | ||||||
Net increase in net assets resulting from operations | $ | 7,910 | $ | 13,828 | $ | 18,231 | |||||
Net investment income per common share - basic and diluted | $ | 1.28 | $ | 1.46 | $ | 1.39 | |||||
Net increase in net assets resulting from operations per common share - basic and diluted | $ | 0.64 | $ | 1.43 | $ | 1.89 | |||||
Distributions declared per common share | $ | 1.36 | $ | 1.36 | $ | 1.36 | |||||
Basic and diluted weighted average shares outstanding | 12,403,706 | 9,692,634 | 9,670,153 | ||||||||
See Notes to Consolidated Financial Statements.
76
OFS Capital Corporation and Subsidiaries
Consolidated Statements of Changes in Net Assets
(Dollar amounts in thousands, except per share data)
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Increase in net assets resulting from operations: | |||||||||||
Net investment income | $ | 15,877 | $ | 14,145 | $ | 13,411 | |||||
Net realized gain (loss) on investments | 6,833 | 2,404 | (1,562 | ) | |||||||
Net unrealized appreciation (depreciation) on investments | (14,800 | ) | (2,721 | ) | 6,382 | ||||||
Net increase in net assets resulting from operations | 7,910 | 13,828 | 18,231 | ||||||||
Distributions to stockholders from: | |||||||||||
Accumulated net investment income | (14,158 | ) | (12,157 | ) | (10,954 | ) | |||||
Accumulated net realized gain | (2,738 | ) | (169 | ) | — | ||||||
Return of capital distributions | — | (858 | ) | (2,197 | ) | ||||||
Total distributions to stockholders | (16,896 | ) | (13,184 | ) | (13,151 | ) | |||||
Common stock transactions: | |||||||||||
Public offering of common stock, net of expenses | 53,348 | — | — | ||||||||
Reinvestment of stockholder distributions | 196 | 122 | 461 | ||||||||
Net increase in net assets resulting from capital transactions | 53,544 | 122 | 461 | ||||||||
Net increase in net assets | 44,558 | 766 | 5,541 | ||||||||
Net assets: | |||||||||||
Beginning of year | 143,778 | 143,012 | 137,471 | ||||||||
End of year | $ | 188,336 | $ | 143,778 | $ | 143,012 | |||||
Accumulated undistributed net investment income | $ | 9,404 | $ | 6,371 | $ | 4,612 | |||||
Common stock activity: | |||||||||||
Public offering of common stock | 3,625,000 | — | — | ||||||||
Common stock issued from reinvestment of stockholder distributions | 14,920 | 9,127 | 40,336 | ||||||||
Common stock issued and outstanding at beginning of year | 9,700,297 | 9,691,170 | 9,650,834 | ||||||||
Common stock issued and outstanding at end of year | 13,340,217 | 9,700,297 | 9,691,170 | ||||||||
See Notes to Consolidated Financial Statements.
77
OFS Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Cash flows from operating activities | |||||||||||
Net increase in net assets resulting from operations | $ | 7,910 | $ | 13,828 | $ | 18,231 | |||||
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by (used in) operating activities: | |||||||||||
Net realized (gain) loss on investments | (6,833 | ) | (2,404 | ) | 1,562 | ||||||
Net change in unrealized appreciation/depreciation on investments | 14,800 | 2,721 | (6,382 | ) | |||||||
Amortization of Net Loan Fees | (1,450 | ) | (1,414 | ) | (2,263 | ) | |||||
Amendment fees collected | 175 | 261 | 112 | ||||||||
Payment-in-kind interest and dividend income | (2,907 | ) | (2,627 | ) | (2,322 | ) | |||||
Amortization and write-off of deferred debt issuance costs | 553 | 490 | 2,117 | ||||||||
Amortization of intangible asset | 195 | 195 | 195 | ||||||||
Purchase and origination of portfolio investments | (142,900 | ) | (68,237 | ) | (123,950 | ) | |||||
Proceeds from principal payments on portfolio investments | 105,078 | 41,404 | 96,069 | ||||||||
Proceeds from sale or redemption of portfolio investments | 37,044 | 5,274 | 98,895 | ||||||||
Distributions received from portfolio investments | — | 192 | 183 | ||||||||
Changes in operating assets and liabilities: | |||||||||||
Interest receivable | (964 | ) | (937 | ) | (113 | ) | |||||
Interest payable | (3 | ) | 51 | 233 | |||||||
Management and incentive fees payable | (132 | ) | (119 | ) | 1,009 | ||||||
Administration fee payable | 41 | (53 | ) | 215 | |||||||
Other assets and liabilities | 66 | 59 | (53 | ) | |||||||
Net cash provided by (used in) operating activities | 10,673 | (11,316 | ) | 83,738 | |||||||
Cash flows from financing activities | |||||||||||
Proceeds from common stock offering, net of expenses | 53,423 | — | — | ||||||||
Distributions paid to stockholders | (16,700 | ) | (13,062 | ) | (12,690 | ) | |||||
Borrowings under revolving line of credit | 44,700 | 9,500 | — | ||||||||
Repayments under revolving line of credit | (36,600 | ) | — | — | |||||||
Borrowings under WM Credit Facility | — | — | 1,217 | ||||||||
Repayments under WM Credit Facility | — | — | (73,829 | ) | |||||||
Draw down on SBA debentures | — | — | 22,585 | ||||||||
Payment of debt issuance costs | (131 | ) | (177 | ) | (750 | ) | |||||
Payment of common stock offering costs | (72 | ) | — | (4 | ) | ||||||
Net cash provided by (used in) financing activities | 44,620 | (3,739 | ) | (63,471 | ) | ||||||
Net increase (decrease) in cash and cash equivalents | 55,293 | (15,055 | ) | 20,267 | |||||||
Cash and cash equivalents — beginning of year | 17,659 | 32,714 | 12,447 | ||||||||
Cash and cash equivalents — end of year | $ | 72,952 | $ | 17,659 | $ | 32,714 | |||||
Supplemental Disclosure of Cash Flow Information: | |||||||||||
Cash paid during the period for interest | $ | 5,263 | $ | 4,762 | $ | 4,609 | |||||
Reinvestment of stockholder distributions | 196 | 122 | 461 | ||||||||
See Notes to Consolidated Financial Statements.
78
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments
December 31, 2017
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Non-control/Non-affiliate Investments | |||||||||||||||||||||||
Aegis Acquisition, Inc. | Testing Laboratories | ||||||||||||||||||||||
Senior Secured Loan | 10.17% | (L +8.50%) | 8/24/2021 | $ | 3,520 | $ | 3,470 | $ | 3,439 | 1.8 | % | ||||||||||||
Armor Holdings II LLC | Other Professional, Scientific, and Technical Services | ||||||||||||||||||||||
Senior Secured Loan | 10.70% | (L +9.00%) | 12/26/2020 | 3,500 | 3,476 | 3,570 | 1.9 | ||||||||||||||||
Avison Young Canada, Inc. | Offices of Real Estate Agents and Brokers | ||||||||||||||||||||||
Senior Secured Loan (5) (6) | 9.50% | N/A | 12/15/2021 | 4,000 | 3,939 | 4,070 | 2.3 | ||||||||||||||||
BJ's Wholesale Club, Inc. | Warehouse Clubs and Supercenters | ||||||||||||||||||||||
Senior Secured Loan | 8.95% | (L +7.50%) | 2/3/2025 | 9,268 | 9,158 | 9,063 | 4.8 | ||||||||||||||||
Carolina Lubes, Inc. (5) (9) | Automotive Oil Change and Lubrication Shops | ||||||||||||||||||||||
Senior Secured Loan | 9.28% | (L +7.25%) | 8/23/2022 | 21,411 | 21,236 | 21,430 | 11.4 | ||||||||||||||||
Senior Secured Loan (Revolver) | 8.59% | (L +7.25%) | 8/23/2022 | 487 | 473 | 489 | 0.3 | ||||||||||||||||
Preferred Equity (973 units) 14% PIK | 3,039 | 3,065 | 1.6 | ||||||||||||||||||||
21,898 | 24,748 | 24,984 | 13.3 | ||||||||||||||||||||
Community Intervention Services, Inc. (5) | Outpatient Mental Health and Substance Abuse Centers | ||||||||||||||||||||||
Subordinated Loan (7) (11) | 7.0% cash / 6.0% PIK | N/A | 1/16/2021 | 8,530 | 7,639 | — | — | ||||||||||||||||
Confie Seguros Holdings II Co. | Insurance Agencies and Brokerages | ||||||||||||||||||||||
Senior Secured Loan | 10.98% | (L +9.50%) | 5/8/2019 | 9,678 | 9,579 | 9,417 | 5.0 | ||||||||||||||||
Constellis Holdings, LLC | Other Justice, Public Order, and Safety Activities | ||||||||||||||||||||||
Senior Secured Loan | 10.69% | (L +9.00%) | 4/21/2025 | 9,950 | 9,813 | 9,919 | 5.3 | ||||||||||||||||
DuPage Medical Group | Offices of Physicians, Mental Health Specialists | ||||||||||||||||||||||
Senior Secured Loan | 8.42% | (L +7.00%) | 8/15/2025 | 5,600 | 5,547 | 5,503 | 2.9 | ||||||||||||||||
79
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2017
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Eblens Holdings, Inc. | Shoe Store | ||||||||||||||||||||||
Subordinated Loan | 12.0% cash / 1.00% PIK | N/A | 1/13/2023 | $ | 8,830 | $ | 8,749 | $ | 8,726 | 4.6 | % | ||||||||||||
Common Equity (71,250 units) | 713 | 771 | 0.4 | ||||||||||||||||||||
8,830 | 9,462 | 9,497 | 5.0 | ||||||||||||||||||||
Elgin Fasteners Group | Bolt, Nut, Screw, Rivet, and Washer Manufacturing | ||||||||||||||||||||||
Senior Secured Loan | 8.44% | (L +6.75%) | 8/27/2018 | 3,888 | 3,873 | 3,544 | 1.9 | ||||||||||||||||
GGC Aerospace Topco L.P. | Other Aircraft Parts and Auxiliary Equipment Manufacturing | ||||||||||||||||||||||
Senior Secured Loan | 10.23% | (L +8.75%) | 9/8/2024 | 5,000 | 4,875 | 4,875 | 2.6 | ||||||||||||||||
Common Equity (368,852 Class A units) | 450 | 450 | 0.2 | ||||||||||||||||||||
Common Equity (40,984 Class B units) | 50 | 50 | — | ||||||||||||||||||||
5,000 | 5,375 | 5,375 | 2.8 | ||||||||||||||||||||
LRI Holding, LLC (5) | Electrical Contractors and Other Wiring Installation Contractors | ||||||||||||||||||||||
Senior Secured Loan | 10.94% | (L +9.25%) | 6/30/2022 | 18,269 | 18,125 | 18,205 | 9.7 | ||||||||||||||||
Preferred Equity (238,095 units) | 300 | 300 | 0.2 | ||||||||||||||||||||
18,269 | 18,425 | 18,505 | 9.9 | ||||||||||||||||||||
Maverick Healthcare Equity, LLC (5) | Home Health Equipment Rental | ||||||||||||||||||||||
Preferred Equity (1,250,000 units) (10) | 900 | 141 | 0.1 | ||||||||||||||||||||
Common Equity (1,250,000 units) (10) | — | — | — | ||||||||||||||||||||
900 | 141 | 0.1 | |||||||||||||||||||||
My Alarm Center, LLC (5) | Security Systems Services (except Locksmiths) | ||||||||||||||||||||||
Preferred Equity (1,485 Class A units), 8% PIK (10) (13) | 1,540 | 1,540 | 0.8 | ||||||||||||||||||||
Preferred Equity (1,198 Class B units) | 1,198 | 1,198 | 0.6 | ||||||||||||||||||||
Common Equity (64,149 units) (13) | — | 43 | — | ||||||||||||||||||||
2,738 | 2,781 | 1.4 | |||||||||||||||||||||
NVA Holdings, Inc. | Veterinary Services | ||||||||||||||||||||||
Senior Secured Loan | 8.69% | (L +7.00%) | 8/14/2022 | 743 | 743 | 748 | 0.4 | ||||||||||||||||
O2 Holdings, LLC (5) | Fitness and Recreational Sports Centers | ||||||||||||||||||||||
Senior Secured Loan | 14.56% | (L +13.00%) | 9/2/2021 | 13,350 | 12,977 | 13,617 | 7.2 | ||||||||||||||||
80
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2017
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Parfums Holding Company, Inc. | Cosmetics, Beauty Supplies, and Perfume Stores | ||||||||||||||||||||||
Senior Secured Loan | 10.45% | (L +8.75%) | 6/30/2025 | $ | 3,520 | $ | 3,492 | $ | 3,472 | 1.8 | % | ||||||||||||
Planet Fitness Midwest LLC (5) | Fitness and Recreational Sports Centers | ||||||||||||||||||||||
Subordinated Loan | 13.00% | N/A | 12/16/2021 | 5,000 | 4,964 | 5,011 | 2.7 | ||||||||||||||||
PM Acquisition LLC | All Other General Merchandise Stores | ||||||||||||||||||||||
Senior Secured Loan | 11.50% cash / 1.00% PIK | N/A | 10/29/2021 | 6,187 | 6,108 | 6,059 | 3.2 | ||||||||||||||||
Common equity (499 units) (10) | 499 | 278 | 0.1 | ||||||||||||||||||||
6,187 | 6,607 | 6,337 | 3.3 | ||||||||||||||||||||
Resource Label Group, LLC | Commercial Printing (except Screen and Books) | ||||||||||||||||||||||
Senior Secured Loan | 10.19% | (L +8.50%) | 11/26/2023 | 4,821 | 4,755 | 4,767 | 2.5 | ||||||||||||||||
Security Alarm Financing Enterprises, L.P. (5) | Security Systems Services (except Locksmiths) | ||||||||||||||||||||||
Subordinated Loan (14) | 14.00% cash / 0.69% PIK | (L +13.00%) | 6/19/2020 | 12,525 | 12,441 | 12,364 | 6.6 | ||||||||||||||||
Sentry Centers Holdings, LLC | Other Professional, Scientific, and Technical Services | ||||||||||||||||||||||
Senior Secured Loan | 13.07% | (L +11.50%) | 7/24/2019 | 4,195 | 4,156 | 4,259 | 2.3 | ||||||||||||||||
Preferred Equity (5,000 units) (10) (13) | 527 | 527 | 0.3 | ||||||||||||||||||||
4,195 | 4,683 | 4,786 | 2.6 | ||||||||||||||||||||
Southern Technical Institute, LLC (5) | Colleges, Universities, and Professional Schools | ||||||||||||||||||||||
Subordinated Loan (10) | 15.00% PIK | N/A | 12/2/2020 | 3,520 | 3,451 | 1,201 | 0.6 | ||||||||||||||||
Preferred Equity (1,764,720 units), 15.75% PIK (8) (10) | 2,094 | — | — | ||||||||||||||||||||
Warrants (2,174,905 units) (10) | 3/30/2026 (12) | 46 | — | — | |||||||||||||||||||
3,520 | 5,591 | 1,201 | 0.6 | ||||||||||||||||||||
81
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2017
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Stancor, L.P. (5) | Pump and Pumping Equipment Manufacturing | ||||||||||||||||||||||
Senior Secured Loan | 9.56% | (L +8.00%) | 8/19/2019 | $ | 7,919 | $ | 7,896 | $ | 7,919 | 4.2 | % | ||||||||||||
Preferred Equity (1,250,000 units), 8% PIK (8) (10) | 1,501 | 1,486 | 0.8 | ||||||||||||||||||||
7,919 | 9,397 | 9,405 | 5.0 | ||||||||||||||||||||
The Escape Game, LLC (5) | |||||||||||||||||||||||
Senior Secured Loan | Other amusement and recreation industries | 10.32% | (L +8.75%) | 12/20/2022 | 7,000 | 6,948 | 6,948 | 3.7 | |||||||||||||||
TravelCLICK, Inc. | Computer Systems Design and Related Services | ||||||||||||||||||||||
Senior Secured Loan | 9.32% | (L +7.75%) | 11/6/2021 | 7,334 | 7,303 | 7,334 | 3.9 | ||||||||||||||||
Truck Hero, Inc. | Truck Trailer Manufacturing | ||||||||||||||||||||||
Senior Secured Loan | 9.89% | (L +8.25%) | 4/21/2025 | 7,014 | 6,971 | 7,064 | 3.8 | ||||||||||||||||
United Biologics Holdings, LLC (5) | Medical Laboratories | ||||||||||||||||||||||
Senior Secured Loan (11) | 12.00% cash / 2.00% PIK | N/A | 4/30/2018 | 4,266 | 4,248 | 4,266 | 2.3 | ||||||||||||||||
Subordinated Loan (10) | 8.00 % PIK | N/A | 4/30/2019 | 7 | 7 | 7 | — | ||||||||||||||||
Preferred Equity (151,787 units) (10) | 9 | 92 | — | ||||||||||||||||||||
Warrants (29,374 units) (10) | 03/05/2022 (12) | 82 | 147 | 0.1 | |||||||||||||||||||
4,273 | 4,346 | 4,512 | 2.4 | ||||||||||||||||||||
Total Non-control/Non-affiliate Investments | 199,332 | 209,360 | 197,374 | 104.9 | |||||||||||||||||||
Affiliate Investments | |||||||||||||||||||||||
All Metals Holding, LLC (5) | Metal Service Centers and Other Metal Merchant Wholesalers | ||||||||||||||||||||||
Senior Secured Loan | 12.00% cash / 1.00% PIK | N/A | 12/28/2021 | 12,869 | 12,288 | 12,759 | 6.8 | ||||||||||||||||
Common Equity (637,954 units) (10) | 565 | 1,785 | 0.9 | ||||||||||||||||||||
12,869 | 12,853 | 14,544 | 7.7 | ||||||||||||||||||||
82
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2017
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Contract Datascan Holdings, Inc. (5) | Office Machinery and Equipment Rental and Leasing | ||||||||||||||||||||||
Subordinated Loan | 12.00% | N/A | 2/5/2021 | $ | 8,000 | $ | 7,985 | $ | 8,000 | 4.2 | % | ||||||||||||
Preferred Equity (3,061 shares), 10% PIK (10) | 4,347 | 5,964 | 3.2 | ||||||||||||||||||||
Common Equity (11,273 shares) (10) | 104 | 260 | 0.1 | ||||||||||||||||||||
8,000 | 12,436 | 14,224 | 7.5 | ||||||||||||||||||||
Jobson Healthcare Information, LLC (5) (9) | Other Professional, Scientific, and Technical Services | ||||||||||||||||||||||
Senior Secured Loan (11) | 10.13% cash / 5.30% PIK | (L +13.43%) | 7/21/2019 | 15,447 | 15,241 | 12,910 | 6.9 | ||||||||||||||||
Common Equity (13 member units) | — | — | — | ||||||||||||||||||||
Warrants (1 member unit) (10) | 7/21/2019 (12) | 454 | — | — | |||||||||||||||||||
15,447 | 15,695 | 12,910 | 6.9 | ||||||||||||||||||||
Master Cutlery, LLC (5) | Sporting and Recreational Goods and Supplies Merchant Wholesalers | ||||||||||||||||||||||
Subordinated Loan | 13.00% | N/A | 4/17/2020 | 4,705 | 4,692 | 2,873 | 1.5 | ||||||||||||||||
Preferred Equity (3,723 units), 8% PIK (8) (10) | 3,483 | — | — | ||||||||||||||||||||
Common Equity (15,564 units) (10) | — | — | — | ||||||||||||||||||||
4,705 | 8,175 | 2,873 | 1.5 | ||||||||||||||||||||
NeoSystems Corp.(5) | Other Accounting Services | ||||||||||||||||||||||
Subordinated Loan | 10.50% cash / 1.25% PIK | N/A | 8/13/2019 | 2,143 | 2,136 | 2,143 | 1.1 | ||||||||||||||||
Preferred Equity (521,962 convertible shares), 10% PIK (10) | 1,390 | 2,248 | 1.2 | ||||||||||||||||||||
2,143 | 3,526 | 4,391 | 2.3 | ||||||||||||||||||||
Pfanstiehl Holdings, Inc. (5) | Pharmaceutical Preparation Manufacturing | ||||||||||||||||||||||
Subordinated Loan | 10.50% | N/A | 9/29/2021 | 3,788 | 3,823 | 3,755 | 2.0 | ||||||||||||||||
Common Equity (400 shares) | 217 | 4,755 | 2.5 | ||||||||||||||||||||
3,788 | 4,040 | 8,510 | 4.5 | ||||||||||||||||||||
83
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2017
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
TRS Services, LLC (5) | Commercial and Industrial Machinery and Equipment (except Automotive and Electronic) Repair and Maintenance | ||||||||||||||||||||||
Senior Secured Loan | 10.07% | (L +8.50%) | 12/10/2019 | $ | 9,466 | $ | 9,330 | $ | 9,466 | 5.0 | % | ||||||||||||
Preferred Equity (329,266 Class AA units), 15% PIK (10) | 401 | 409 | 0.2 | ||||||||||||||||||||
Preferred Equity (3,000,000 Class A units), 11% PIK (8) (10) | 3,374 | 2,230 | 1.2 | ||||||||||||||||||||
Common Equity (3,000,000 units) (10) | 572 | — | — | ||||||||||||||||||||
9,466 | 13,677 | 12,105 | 6.4 | ||||||||||||||||||||
Total Affiliate Investments | 56,418 | 70,402 | 69,557 | 36.8 | |||||||||||||||||||
Control Investments | |||||||||||||||||||||||
MTE Holding Corp. (2) (5) | Travel Trailer and Camper Manufacturing | ||||||||||||||||||||||
Subordinated Loan (to Mirage Trailers, LLC, a controlled, consolidated subsidiary of MTE Holding Corp.) | 13.07% cash / 1.50% PIK | (L +13.50%) | 11/25/2020 | 7,186 | 7,144 | 7,118 | 3.8 | ||||||||||||||||
Common Equity (554 shares) | 3,069 | 3,450 | 1.8 | ||||||||||||||||||||
7,186 | 10,213 | 10,568 | 5.6 | ||||||||||||||||||||
Total Control Investment | 7,186 | 10,213 | 10,568 | 5.6 | |||||||||||||||||||
Total Investments | $ | 262,936 | $ | 289,975 | $ | 277,499 | 147.3 | % | |||||||||||||||
(1) | Equity ownership may be held in shares or units of companies affiliated with the portfolio company. |
(2) | Substantially all of the investments that bear interest at a variable rate are indexed to LIBOR (L), and reset monthly, quarterly, or semi-annually. Approximately 7% of the Company's LIBOR referenced investments are subject to a reference rate floor at December 31, 2017, with a reference rate floor of 2.00%. For each investment, the Company has provided the spread over the reference rate and current interest rate in effect at December 31, 2017. Unless otherwise noted, all investments with a stated PIK rate require interest payments with the issuance of additional securities as payment of the entire PIK provision. |
(3) | Fair value was determined using significant unobservable inputs for all of the Company's investments. See Note 6 for further details. |
(4) | The negative amount represents the excess of the par value of an unfunded commitment in excess of its fair value. |
(5) | Investments (or portion thereof) held by OFS SBIC I, LP. All other investments pledged as collateral under the PWB Credit Facility. |
(6) | Non-qualifying assets under Section 55(a) of the 1940 Act. Qualifying assets must represent at least 70% of the Company's assets, as defined under Section 55 of the 1940 Act, at the time of acquisition of any additional non-qualifying assets. As of December 31, 2017, 97.53% of the Company's assets were qualifying assets. |
(7) | Investment was on non-accrual status as of December 31, 2017, meaning the Company has ceased recognizing all or a portion of income on the investment. See Note 2, Non-accrual loans for further details. |
(8) | The fair value of the most-recently recognized PIK dividend as of December 31, 2017, was $0. |
(9) | The Company has entered into a contractual arrangement with co‑lenders whereby, subject to certain conditions, it has agreed to receive its payment after the repayment of certain co‑lenders pursuant to a payment waterfall. The reported interest rate of 9.28% at December 31, 2017, includes additional interest of 0.69% per annum as specified under the contractual arrangement among the Company and the co‑lenders. |
(10) | Non-income producing. |
84
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2017
(Dollar amounts in thousands)
(11) | The interest rate on these investments contains a PIK provision, whereby the issuer has the option to make interest payments in cash or with the issuance of additional securities as payment of the entire PIK provision. The interest rate in the schedule represents the current interest rate in effect for these investments. The following table provides additional details on these PIK investments, including the maximum annual PIK interest rate allowed as of December 31, 2017: |
Portfolio Company | Investment Type | Range of PIK Option | Range of Cash Option | Maximum PIK Rate Allowed | |||||
Community Intervention Services, Inc. | Subordinated Loan | 0% or 6.00% | 13.00% or 7.00% | 6.00 | % | ||||
Eblens Holdings, Inc. | Subordinated Loan | 0% or 1.00% | 13.00% or 12.00% | 1.00 | % | ||||
Jobson Healthcare Information, LLC | Senior Secured Loan | 1.50% to 5.30% | 13.93% to 10.13% | 5.30 | % | ||||
United Biologics Holdings, LLC | Senior Secured Loan | 0% or 2.00% | 14.00% or 12.00% | 2.00 | % | ||||
(12) | Represents expiration date of the warrants. |
(13) | All or portion of investment held by a wholly-owned subsidiary subject to income tax. See Note 2, Income taxes, for further details. |
(14) | The PIK provision is reset at the beginning of each interest period equal to the excess of reference rate over the reference rate floor of 1.00%. The PIK interest rate in the schedule represents the current PIK interest rate in effect. |
See Notes to Financial Statements.
85
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments
December 31, 2016
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Non-control/Non-affiliate Investments | |||||||||||||||||||||||
Accurate Group Holdings, Inc. (5) | Offices of Real Estate Appraisers | ||||||||||||||||||||||
Subordinated Loan | 13.00% | N/A | 8/23/2018 | $ | 10,000 | $ | 10,032 | $ | 10,000 | 7.0 | % | ||||||||||||
Armor Holdings II LLC | Other Professional, Scientific, and Technical Services | ||||||||||||||||||||||
Senior Secured Loan | 10.25% | (L +9.00%) | 12/26/2020 | 3,500 | 3,469 | 3,496 | 2.4 | ||||||||||||||||
AssuredPartners, Inc | Insurance Agencies and Brokerages | ||||||||||||||||||||||
Senior Secured Loan | 10.00% | (L +9.00%) | 10/20/2023 | 5,000 | 4,854 | 5,013 | 3.5 | ||||||||||||||||
Avison Young Canada, Inc. | Offices of Real Estate Agents and Brokers | ||||||||||||||||||||||
Senior Secured Loan (5) (6) | 9.50% | N/A | 12/15/2021 | 4,000 | 3,923 | 3,923 | 2.7 | ||||||||||||||||
BCC Software, LLC (5) | Custom Computer Programming Services | ||||||||||||||||||||||
Senior Secured Loan | 9.00% | (L +8.00%) | 6/20/2019 | 5,143 | 5,105 | 5,143 | 3.6 | ||||||||||||||||
Senior Secured Loan (Revolver) (11) (4) | N/A | (L +8.00%) | 6/20/2019 | — | (8 | ) | — | — | |||||||||||||||
5,143 | 5,097 | 5,143 | 3.6 | ||||||||||||||||||||
Community Intervention Services, Inc. (5) | Outpatient Mental Health and Substance Abuse Centers | ||||||||||||||||||||||
Subordinated Loan (7) (12) | 7.00% cash / 6.00% PIK | N/A | 1/16/2021 | 8,030 | 7,639 | 5,393 | 3.8 | ||||||||||||||||
Confie Seguros Holdings II Co. | Insurance Agencies and Brokerages | ||||||||||||||||||||||
Senior Secured Loan | 10.25% | (L +9.00%) | 5/8/2019 | 4,000 | 3,976 | 3,973 | 2.8 | ||||||||||||||||
C7 Data Centers, Inc. (5) | Other Computer Related Services | ||||||||||||||||||||||
Senior Secured Loan (10) | 12.47% | (L +8.50%) | 6/22/2020 | 14,850 | 14,738 | 14,883 | 10.4 | ||||||||||||||||
Elgin Fasteners Group | Bolt, Nut, Screw, Rivet, and Washer Manufacturing | ||||||||||||||||||||||
Senior Secured Loan | 8.50% | (L +7.25%) | 8/27/2018 | 4,104 | 4,090 | 3,555 | 2.5 | ||||||||||||||||
86
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2016
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Inhance Technologies Holdings LLC | Other Basic Inorganic Chemical Manufacturing | ||||||||||||||||||||||
Senior Secured Loan | 5.50% | (L +4.50%) | 2/7/2018 | $ | 2,032 | $ | 2,027 | $ | 2,017 | 1.4 | % | ||||||||||||
Intrafusion Holding Corp. (5) | Other Outpatient Care Centers | ||||||||||||||||||||||
Senior Secured Loan (9) | 11.33% | (L +6.75%) | 9/25/2020 | 14,250 | 14,207 | 14,393 | 10.0 | ||||||||||||||||
Jobson Healthcare Information, LLC (5) | Other Professional, Scientific, and Technical Services | ||||||||||||||||||||||
Senior Secured Loan (12) | 10.13% cash / 4.295% PIK | (L +12.425%) | 7/21/2019 | 14,762 | 14,423 | 12,346 | 8.6 | ||||||||||||||||
Warrants (1,056,428 member units) (11) | 7/21/2019 (12) | 454 | — | — | |||||||||||||||||||
14,762 | 14,877 | 12,346 | 8.6 | ||||||||||||||||||||
Maverick Healthcare Equity, LLC (5) | Home Health Equipment Rental | ||||||||||||||||||||||
Preferred Equity (1,250,000 units) (11) | 900 | 1,037 | 0.7 | ||||||||||||||||||||
Common Equity (1,250,000 units) (11) | — | — | — | ||||||||||||||||||||
900 | 1,037 | 0.7 | |||||||||||||||||||||
MN Acquisition, LLC (5) | Software Publishers | ||||||||||||||||||||||
Senior Secured Loan | 10.50% | (L + 9.50%) | 8/24/2021 | 4,989 | 4,896 | 4,949 | 3.4 | ||||||||||||||||
My Alarm Center, LLC (5) | Security Systems Services (except Locksmiths) | ||||||||||||||||||||||
Senior Secured Loan | 12.00% | (L +11.00%) | 7/9/2019 | 6,250 | 6,034 | 6,260 | 4.4 | ||||||||||||||||
Preferred Equity (100 Class A units) (11) | 203 | 205 | 0.1 | ||||||||||||||||||||
Preferred Equity (25 Class A-1 units) (11) | 44 | 36 | — | ||||||||||||||||||||
6,250 | 6,281 | 6,501 | 4.5 | ||||||||||||||||||||
MYI Acquiror Limited (6) | Insurance Agencies and Brokerages | ||||||||||||||||||||||
Senior Secured Loan | 5.75% | (L +4.50%) | 5/28/2019 | 4,686 | 4,680 | 4,613 | 3.2 | ||||||||||||||||
NHR Holdings, LLC | Other Telecommunications | ||||||||||||||||||||||
Senior Secured Loan | 5.50% | (L +4.25%) | 11/30/2018 | 2,666 | 2,652 | 2,630 | 1.8 | ||||||||||||||||
NVA Holdings, Inc. | Veterinary Services | ||||||||||||||||||||||
Senior Secured Loan | 8.00% | (L +7.00%) | 8/14/2022 | 650 | 650 | 651 | 0.5 | ||||||||||||||||
87
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2016
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
O2 Holdings, LLC (5) | Fitness and Recreational Sports Centers | ||||||||||||||||||||||
Senior Secured Loan | 11.77% | (L +11.00%) | 9/2/2021 | $ | 9,500 | $ | 9,417 | $ | 9,430 | 6.6 | % | ||||||||||||
PM Acquisition LLC | All Other General Merchandise Stores | ||||||||||||||||||||||
Senior Secured Loan | 11.50% | N/A | 10/31/2021 | 6,402 | 6,340 | 6,340 | 4.4 | ||||||||||||||||
Common equity (499 units) (11) | 499 | 499 | 0.3 | ||||||||||||||||||||
6,402 | 6,839 | 6,839 | 4.7 | ||||||||||||||||||||
Planet Fitness Midwest LLC (5) | Fitness and Recreational Sports Centers | ||||||||||||||||||||||
Subordinated Loan | 13.00% | N/A | 12/16/2021 | 5,000 | 4,955 | 4,980 | 3.5 | ||||||||||||||||
Quantum Spatial, Inc. (f/k/a Aero-Metric, Inc.) | Other Information Services | ||||||||||||||||||||||
Senior Secured Loan | 6.75% cash / 1.00% PIK | (L +6.50%) | 8/27/2017 | 2,440 | 2,427 | 2,340 | 1.6 | ||||||||||||||||
Ranpak Corp. | Packaging Machinery Manufacturing | ||||||||||||||||||||||
Senior Secured Loan | 8.25% | (L +7.25%) | 10/3/2022 | 2,000 | 1,996 | 1,885 | 1.3 | ||||||||||||||||
Security Alarm Financing Enterprises, L.P. (5) | Security Systems Services (except Locksmiths) | ||||||||||||||||||||||
Subordinated Loan | 14.00% | (L +13.00%) | 6/19/2020 | 12,500 | 12,382 | 12,382 | 8.6 | ||||||||||||||||
Sentry Centers Holdings, LLC | Other Professional, Scientific, and Technical Services | ||||||||||||||||||||||
Senior Secured Loan | 12.40% | (L +11.50%) | 7/24/2019 | 4,209 | 4,145 | 4,171 | 2.9 | ||||||||||||||||
smarTours, LLC (5) | Tour Operators | ||||||||||||||||||||||
Preferred Equity (500,000 units) (11) | 439 | 1,019 | 0.7 | ||||||||||||||||||||
88
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2016
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Southern Technical Institute, LLC (5) | Colleges, Universities, and Professional Schools | ||||||||||||||||||||||
Subordinated Loan | 9.00% cash / 4.00% PIK | (L +12.00%) | 12/2/2020 | $ | 3,398 | $ | 3,330 | $ | 3,158 | 2.2 | % | ||||||||||||
Preferred Equity (1,764,720 units), 15.75% PIK (11) | 1,938 | 1,984 | 1.4 | ||||||||||||||||||||
Warrants (2,174,905 units) (11) | 3/30/2026 (12) | 46 | — | — | |||||||||||||||||||
3,398 | 5,314 | 5,142 | 3.6 | ||||||||||||||||||||
Stancor, L.P. (5) | Pump and Pumping Equipment Manufacturing | ||||||||||||||||||||||
Senior Secured Loan | 9.75% | (L +9.00%) | 8/19/2019 | 9,450 | 9,407 | 9,181 | 6.4 | ||||||||||||||||
Preferred Equity (1,250,000 units), 8% PIK (11) | 1,501 | 835 | 0.6 | ||||||||||||||||||||
9,450 | 10,908 | 10,016 | 7.0 | ||||||||||||||||||||
TravelCLICK, Inc. | Computer Systems Design and Related Services | ||||||||||||||||||||||
Senior Secured Loan | 8.75% | (L +7.75%) | 11/8/2021 | 4,000 | 3,879 | 3,946 | 2.7 | ||||||||||||||||
United Biologics Holdings, LLC (5) | Medical Laboratories | ||||||||||||||||||||||
Senior Secured Loan (12) | 12.00% cash / 2.00% PIK | N/A | 4/30/2018 | 4,181 | 4,106 | 4,034 | 2.8 | ||||||||||||||||
Subordinated Loan (11) | 8.00% PIK | N/A | 4/30/2019 | 7 | 7 | 6 | — | ||||||||||||||||
Preferred Equity (151,787 units) (11) | 9 | 20 | — | ||||||||||||||||||||
Warrants (29,374 units) (11) | 3/5/2022 (12) | 82 | 114 | 0.1 | |||||||||||||||||||
4,188 | 4,204 | 4,174 | 2.9 | ||||||||||||||||||||
VanDeMark Chemical Inc. | Other Basic Inorganic Chemical Manufacturing | ||||||||||||||||||||||
Senior Secured Loan | 6.50% | (L +5.25%) | 11/30/2017 | 2,406 | 2,386 | 2,379 | 1.7 | ||||||||||||||||
Total Non-control/Non-affiliate Investments | 174,405 | 178,279 | 173,219 | 120.6 | |||||||||||||||||||
89
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2016
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Affiliate Investments | |||||||||||||||||||||||
All Metals Holding, LLC (5) | Metal Service Centers and Other Metal Merchant Wholesalers | ||||||||||||||||||||||
Senior Secured Loan | 12.00% cash / 1.00% PIK | N/A | 12/28/2021 | $ | 12,867 | $ | 12,135 | $ | 12,865 | 8.9 | % | ||||||||||||
Common Equity (637,954 units) (11) | 565 | 1,277 | 0.9 | ||||||||||||||||||||
12,867 | 12,700 | 14,142 | 9.8 | ||||||||||||||||||||
Contract Datascan Holdings, Inc. (5) | Office Machinery and Equipment Rental and Leasing | ||||||||||||||||||||||
Subordinated Loan | 12.00% | N/A | 2/5/2021 | 8,000 | 7,980 | 7,902 | 5.5 | ||||||||||||||||
Preferred Equity (3,061 shares), 10% PIK (11) | 3,804 | 5,421 | 3.8 | ||||||||||||||||||||
Common Equity (11,273 shares) (11) | 104 | 187 | 0.1 | ||||||||||||||||||||
8,000 | 11,888 | 13,510 | 9.4 | ||||||||||||||||||||
Intelli-Mark Technologies, Inc.(5) | Other Travel Arrangement and Reservation Services | ||||||||||||||||||||||
Senior Secured Loan (12) | 13.00% | N/A | 11/23/2020 | 8,750 | 8,682 | 8,841 | 6.2 | ||||||||||||||||
Common Equity (2,553,089 shares) (11) | 1,500 | 1,998 | 1.5 | ||||||||||||||||||||
8,750 | 10,182 | 10,839 | 7.7 | ||||||||||||||||||||
Master Cutlery, LLC (5) | Sporting and Recreational Goods and Supplies Merchant Wholesalers | ||||||||||||||||||||||
Subordinated Loan | 13.00% | N/A | 4/17/2020 | 4,741 | 4,722 | 4,440 | 3.1 | ||||||||||||||||
Preferred Equity (3,723 units), 5% cash, 3% PIK (8) (11) | 3,483 | 954 | 0.7 | ||||||||||||||||||||
Common Equity (15,564 units) (11) | — | — | — | ||||||||||||||||||||
4,741 | 8,205 | 5,394 | 3.8 | ||||||||||||||||||||
NeoSystems Corp. (5) | Other Accounting Services | ||||||||||||||||||||||
Subordinated Loan | 10.50% cash / 2.75% PIK | N/A | 8/13/2019 | 4,090 | 4,070 | 3,656 | 2.5 | ||||||||||||||||
Preferred Equity (521,962 convertible shares), 10% PIK (11) | 1,258 | 1,255 | 0.9 | ||||||||||||||||||||
4,090 | 5,328 | 4,911 | 3.4 | ||||||||||||||||||||
Pfanstiehl Holdings, Inc. (5) | Pharmaceutical Preparation Manufacturing | ||||||||||||||||||||||
Subordinated Loan (12) | 10.50% | N/A | 9/29/2021 | 3,788 | 3,832 | 3,810 | 2.6 | ||||||||||||||||
Common Equity (400 shares) | 217 | 6,083 | 4.2 | ||||||||||||||||||||
3,788 | 4,049 | 9,893 | 6.8 | ||||||||||||||||||||
90
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2016
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | |||||||||||||||
Strategic Pharma Solutions, Inc. (5) | Other Professional, Scientific, and Technical Services | ||||||||||||||||||||||
Senior Secured Loan | 11.32% | (L +10.00%) | 12/18/2020 | $ | 8,411 | $ | 8,344 | $ | 8,383 | 5.8 | % | ||||||||||||
Preferred Equity (1,191 units), 6% PIK (11) | 1,915 | 3,026 | 2.1 | ||||||||||||||||||||
8,411 | 10,259 | 11,409 | 7.9 | ||||||||||||||||||||
TRS Services, LLC (5) | Commercial and Industrial Machinery and Equipment (except Automotive and Electronic) Repair and Maintenance | ||||||||||||||||||||||
Senior Secured Loan | 9.75% cash / 1.5% PIK | (L +10.25%) | 12/10/2019 | 9,807 | 9,607 | 9,549 | 6.5 | ||||||||||||||||
Preferred Equity (329,266 Class AA units), 15% PIK (11) | 346 | 354 | 0.2 | ||||||||||||||||||||
Preferred Equity (3,000,000 Class A units), 11% PIK (11) | 3,170 | 1,707 | 1.2 | ||||||||||||||||||||
Common Equity (3,000,000 units) (11) | 572 | — | — | ||||||||||||||||||||
9,807 | 13,695 | 11,610 | 7.9 | ||||||||||||||||||||
Total Affiliate Investments | 60,454 | 76,306 | 81,708 | 56.7 | |||||||||||||||||||
Control Investments | |||||||||||||||||||||||
Malabar International (5) | Other Aircraft Parts and Auxiliary Equipment Manufacturing | ||||||||||||||||||||||
Subordinated Loan | 11.25% cash / 2.00% PIK | N/A | 11/13/2021 | 7,617 | 7,642 | 7,683 | 5.3 | ||||||||||||||||
Preferred Stock (1,644 shares), 6% cash | 4,283 | 5,868 | 4.1 | ||||||||||||||||||||
7,617 | 11,925 | 13,551 | 9.4 | ||||||||||||||||||||
MTE Holding Corp. (5) | Travel Trailer and Camper Manufacturing | ||||||||||||||||||||||
Senior Secured Loan (to Mirage Trailers, LLC, a controlled, consolidated subsidiary of MTE Holding Corp.) | 12.50% | (L +11.50%) | 11/25/2020 | 9,804 | 9,728 | 9,766 | 6.8 | ||||||||||||||||
Common Equity (554 shares) | 3,069 | 3,383 | 2.4 | ||||||||||||||||||||
9,804 | 12,797 | 13,149 | 9.2 | ||||||||||||||||||||
Total Control Investment | 17,421 | 24,722 | 26,700 | 18.6 | |||||||||||||||||||
Total Investments | $ | 252,280 | $ | 279,307 | $ | 281,627 | 195.9 | % | |||||||||||||||
(1) | Equity ownership may be held in shares or units of companies affiliated with the portfolio company. |
(2) | The majority of investments that bear interest at a variable rate are indexed to LIBOR (L) or Prime (P), and reset monthly, quarterly, or semi-annually. Substantially all of the Company's LIBOR referenced investments are subject to a reference rate floor at December 31, 2016, with a weighted average reference rate floor of 1.11%. For each investment, the Company has provided the spread over the reference rate and current interest rate in effect at December 31, 2016. Unless otherwise noted, all investments with a stated PIK rate require interest payments with the issuance of additional securities as payment of the entire PIK provision. |
91
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2016
(Dollar amounts in thousands)
(3) | Fair value was determined using significant unobservable inputs for all of the Company's investments. See Note 6 for further details. |
(4) | The negative fair value is the result of the unfunded commitment being below par. |
(5) | Investments held by OFS SBIC I LP. All other investments pledged as collateral under the PWB Credit Facility. |
(6) | Non-qualifying assets under Section 55(a) of the 1940 Act. Qualifying assets must represent at least 70% of the Company's assets, as defined under Section 55 of the 1940 Act, at the time of acquisition of any additional non-qualifying assets. As of December 31, 2016, 98.4% of the Company's assets were qualifying assets. |
(7) | Investment was on non-accrual status as of December 31, 2016, meaning the Company has ceased recognizing all or a portion of income on the investment. See Note 2, Non-accrual loans for further details. |
(8) | The fair value of the most-recently recognized PIK dividend as of December 31, 2016, was $0. |
(9) | The Company has entered into a contractual arrangement with co‑lenders whereby, subject to certain conditions, it has agreed to receive its payment after the repayment of certain co‑lenders pursuant to a payment waterfall. The reported interest rate of 11.33% at December 31, 2016, includes additional interest of 2.08% per annum as specified under the contractual arrangement among the Company and the co‑lenders. |
(10) | The Company has entered into a contractual arrangement with co‑lenders whereby, subject to certain conditions, it has agreed to receive its payment after the repayment of certain co‑lenders pursuant to a payment waterfall. The reported interest rate of 12.47% at December 31, 2016, includes additional interest of 2.97% per annum as specified under the contractual arrangement among the Company and the co‑lenders. |
(11) | Non-income producing. |
(12) | The interest rate on these investments contains a PIK provision, whereby the issuer has the option to make interest payments in cash or with the issuance of additional securities as payment of the entire PIK provision. The interest rate in the schedule represents the current interest rate in effect for these investments. The following table provides additional details on these PIK investments, including the maximum annual PIK interest rate allowed as of December 31, 2016: |
Portfolio Company | Investment Type | Range of PIK Option | Range of Cash Option | Maximum PIK Rate Allowed | |||||
Community Intervention Services, Inc. | Subordinated Loan | 0% or 6.00% | 13.00% or 7.00% | 6.00 | % | ||||
Intelli-Mark Technologies, Inc. | Senior Secured Loan | 0% or 2.00% | 13.00% or 11.50% | 2.00 | % | ||||
Jobson Healthcare Information, LLC | Senior Secured Loan | 1.50% and 4.295% | 10.13% and 12.925% | 4.295 | % | ||||
Pfanstiehl Holdings, Inc. | Subordinated Loan | 0% or 2.00% | 10.50% or % 8.50% | 2.00 | % | ||||
United Biologics Holdings, LLC | Senior Secured Loan | 0% or 2.00% | 14.00% or 12.00% | 2.00 | % | ||||
(13) | Represents expiration date of the warrants. |
See Notes to Financial Statements.
92
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 1. Organization
OFS Capital Corporation, a Delaware corporation, is an externally managed, closed-end, non-diversified management investment company. The Company has elected to be regulated as a BDC under the 1940 Act. In addition, for income tax purposes, the Company has elected to be treated as a RIC under the Code.
The Company’s objective is to provide stockholders with current income and capital appreciation through its strategic investment focus primarily on debt investments and, to a lesser extent, equity investments primarily in middle-market companies principally in the United States. OFS Advisor manages the day-to-day operations of, and provides investment advisory services to, the Company.
In addition, OFS Advisor also serves as the investment adviser for HPCI a Maryland corporation and a BDC. HPCI’s investment objective is similar to that of the Company.
The Company may make investments directly or through SBIC I LP, its investment company subsidiary licensed under the SBA's SBIC Program. The SBIC Program is designed to stimulate the flow of capital into eligible businesses. SBIC I LP is subject to SBA regulatory requirements, including limitations on the businesses and industries in which it can invest, requirements to invest at least 25% of its regulatory capital in eligible smaller businesses, as defined under the SBIC Act, limitations on the financing terms of investments, and capitalization thresholds that may limit distributions to the Company; and is subject to periodic audits and examinations of its financial statements.
Note 2. Summary of Significant Accounting Policies
Basis of presentation: The Company prepares its consolidated financial statements in accordance with GAAP, including ASC Topic 946, and the requirements for reporting on Form 10-K, the 1940 Act, and Articles 6 or 10 of Regulation S-X. In the opinion of management, the consolidated financial statements include all adjustments, consisting only of normal and recurring accruals and adjustments, necessary for fair presentation in accordance with GAAP. Certain amounts in the prior period financial statements have been reclassified to conform to the current year presentation.
Principles of consolidation: The Company consolidates majority-owned investment company subsidiaries. The Company does not own any controlled operating company whose business consists of providing services to the Company, which would also require consolidation. All intercompany balances and transactions are eliminated upon consolidation.
Investments: The Company applies fair value accounting in accordance with ASC Topic 820, which defines fair value, establishes a framework to measure fair value, and requires disclosures regarding fair value measurements. Fair value is defined as the price to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is determined through the use of models and other valuation techniques, valuation inputs, and assumptions market participants would use to value the investment. Highest priority is given to prices for identical assets quoted in active markets (Level 1) and the lowest priority is given to unobservable valuation inputs (Level 3). The availability of observable inputs can vary significantly and is affected by many factors, including the type of product, whether the product is new to the market, whether the product is traded on an active exchange or in the secondary market, and the current market conditions. To the extent that the valuation is based on less observable or unobservable inputs, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for financial instruments classified as Level 3 (i.e., those instruments valued using non-observable inputs), which comprise the entirety of the Company’s investments.
Changes to the valuation policy are reviewed by management and the Company’s Board. As the Company’s investments change, markets change, new products develop, and valuation inputs become more or less observable, the Company will continue to refine its valuation methodologies.
See Note 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 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in those companies in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of board representation, “Affiliate Investments” are defined as investments in those companies in which the Company owns between 5% and 25% of the voting securities, and “Non-Control/Non-Affiliate Investments” are those that neither qualify as Control Investments nor Affiliate Investments.
93
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Use of estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.
Reportable segments: The Company 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 of three months or less. The Company’s cash and cash equivalents are maintained with a member bank of the FDIC and at times, such balances may be in excess of the FDIC insurance limits. Included in cash and cash equivalents was $72,140 and $17,659 held in a US Bank Money Market Deposit Account as of December 31, 2017 and 2016, respectively. In addition, the Company's use of cash and cash equivalents held by SBIC I LP is limited by SBA regulation, including, but not limited to, investment in eligible portfolio companies and general corporate purposes, subject to a statutory measure of undistributed accumulated earnings.
Revenue recognition:
Interest income: Interest income is recorded on an accrual basis and reported as interest receivable until collected. Interest income is accrued daily based on the outstanding principal amount and the contractual terms of the debt investment. Certain of the Company’s investments contain a payment-in-kind interest income provision (“PIK interest”). The PIK interest, computed at the contractual rate specified in the applicable investment agreement, is added to the principal balance of the investment, rather than being paid in cash, and recorded as interest income, as applicable, on the consolidated statements of operations. The Company discontinues accrual of interest income, including PIK interest, when there is reasonable doubt that the interest income will be collected.
Loan origination fees, original issue discount (“OID”), market discount or premium, and loan amendment fees (collectively, “Net Loan Fees”) are recorded as an adjustment to the amortized cost of the investment, and accreted or amortized as an adjustment to interest income over the life of the respective debt investment using a method that approximates the effective interest method. When the Company receives a loan principal payment, the unamortized Net Loan Fees related to the paid principal is accelerated and recognized in interest income.
Further, the Company may acquire or receive equity, warrants or other equity-related securities (“Equity”) in connection with the Company’s acquisition of, or subsequent amendment to, debt investments. The Company determines the cost basis of Equity based on their fair value, and the fair value of debt investments and other securities or consideration received. Any resulting difference between the face amount of the debt and its recorded cost resulting from the assignment of value to the Equity is treated as OID, and accreted into interest income as described above.
Dividend income: Dividend income on common stock, generally payable in cash, is recorded at the time dividends are declared. Dividend income on preferred equity investments is accrued daily based on the contractual terms of the preferred equity investment. Dividends on preferred equity securities may be payable in cash or in additional preferred securities, and are generally not payable unless declared or upon liquidation. Declared dividends payable in cash are reported as dividend receivables until collected. Non-cash dividends payable in additional preferred securities or contractually earned but not declared (“PIK dividends”) are recognized at fair value and recorded as an adjustment to the cost basis of the investment.
Fee income: The Company generates revenue in the form of management, valuation, and other contractual fees, that is recognized as the related services are rendered. In the general course of its business, the Company receives certain fees from portfolio companies which are non-recurring in nature. Such non-recurring fees include prepayment fees on certain loans repaid prior to their scheduled due date, which are recognized as earned when received, and fees for capital structuring or advisory services from certain portfolio companies, which are recognized as earned upon closing of the investment.
Net realized and unrealized gain or loss on investments: Investment transactions are reported on a trade-date basis. Unsettled trades as of the balance sheet date are included in payable for investments purchased. Realized gains or losses on investments are measured by the difference between the net proceeds from the disposition and the amortized cost basis of the investment. Investments are valued at fair value as determined in good faith by Company management under the supervision and review of the Board. After recording all appropriate interest, dividend, and other income, some of which is recorded as an adjustment to the cost basis of the investment as described above, the Company reports changes in the fair value of investments as net changes in unrealized appreciation/depreciation on investments in the consolidated statements of operations.
94
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Non-accrual loans: When there is reasonable doubt that principal, cash interest, or PIK interest, will be collected, loan investments are placed on non-accrual status and the Company will generally cease recognizing cash interest, PIK interest, or Net Loan Fee amortization, as applicable. When an investment is placed on non-accrual status, all interest previously accrued but not collected , other than PIK interest that has been contractually added to the adjusted cost basis of the investment prior to the designation date, is reversed against current period interest income. Interest payments subsequently received on non-accrual investments may be recognized as income or applied to principal depending upon management’s judgment. Interest accruals and Net Loan Fee amortization are resumed on non-accrual investments only when they are brought current with respect to principal, interest, and when, in the judgment of management, the investments are estimated to be fully collectible as to all principal. At December 31, 2017, the Company had two loans (Community Intervention Services, Inc. and Southern Technical Institute, LLC) on non-accrual status with respect to all interest and Net Loan Fee amortization, with an aggregate amortized cost and fair value of $11,090 and $1,201, respectively. The Company's loan investment in My Alarm Center, LLC, which was on non-accrual status at June 30, 2017, was restructured and exchanged for a new class of preferred equity securities and common equity securities in July 2017. See Note 5 for further information. At December 31, 2016, the Company had one loan (Community Intervention Services, Inc.) on non-accrual status with respect to PIK interest and unamortized Net Loan Fees with an amortized cost and fair value of $7,639 and $5,393, respectively.
Income taxes: The Company has elected to be treated, and intends to qualify annually, as a RIC under Subchapter M of the Code. To qualify as a RIC, the Company must, among other things, meet certain source of income and asset diversification requirements, and timely distribute at least 90% of its ICTI to its stockholders. The Company has made, and intends to continue to make, the requisite distributions to its stockholders, which generally relieves the Company from U.S. federal income taxes.
Depending on the level of ICTI earned in a tax year, the Company may choose to retain ICTI in an amount less than that which would trigger federal income tax liability under Subchapter M of the Code. However, the Company would be liable for a 4% excise tax on such income. Excise tax liability is recognized when the Company determines its estimated current year annual ICTI exceeds estimated current year distributions.
The Company may utilize wholly owned holding companies taxed under Subchapter C of the Code ("Taxable Blockers") when making equity investments in portfolio companies taxed as pass-through entities to meet its source-of-income requirements as a RIC. Taxable Blockers are consolidated in the Company’s GAAP financial statements and may result in current and deferred federal and state income tax expense with respect to income derived from those investments. Such income, net of applicable income taxes, is not included in the Company’s tax-basis net investment income until distributed by the Taxable Blocker, which may result in timing and character differences between the Company’s GAAP and tax-basis net investment income and realized gains and losses. Income tax expense from Taxable Blockers related to net investment income are included in general and administrative expenses, or the applicable net realized or unrealized gain (loss) line item from which the federal or state income tax originated for capital gains and losses.
The Company evaluates tax positions taken in the course of preparing its tax returns to determine whether they are “more-likely-than-not” to be sustained by the applicable tax authority. Tax benefits of positions not deemed to meet the more-likely-than-not threshold could result in greater and undistributed ICTI, income and excise tax expense, and, if involving multiple years, a re-assessment of the Company’s RIC status. GAAP requires recognition of accrued interest and penalties related to uncertain tax benefits as income tax expense. There were no uncertain income tax positions at December 31, 2017 and 2016. The current and prior three tax years remain subject to examination by U.S. federal and most state tax authorities.
Distributions: Distributions to common stockholders are recorded on the declaration date. The timing of distributions as well as the amount to be paid out as a distribution is determined by the Board each quarter. Distributions from net investment income and net realized gains are determined in accordance with the Code. Net realized capital gains, if any, are distributed at least annually, although the Company may decide to retain such capital gains for investment. Distributions paid in excess of taxable net investment income and net realized gains are considered returns of capital to stockholders.
The Company has adopted a DRIP that provides for reinvestment of any distributions the Company declares in cash on behalf of its stockholders, unless stockholder elects to receive cash. As a result, if the Board authorizes and the Company declares a cash distribution, then stockholders who have not “opted out” of the DRIP will have their cash distribution automatically reinvested in additional shares of the Company’s common stock, rather than receiving the cash distribution.
The Company may use newly issued shares under the guidelines of the DRIP, or the Company may purchase shares in the open market in connection with its obligations under the plan.
95
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Deferred debt issuance costs: Deferred debt issuance costs represent fees and other direct incremental costs incurred in connection with the Company’s borrowings. Deferred debt issuance costs are presented as a direct reduction of the related debt liability on the consolidated balance sheets except for deferred debt issuance costs associated with the Company’s line of credit arrangements, which are included in prepaid expenses and other assets on the consolidated balance sheets. Deferred debt issuance costs are amortized to interest expense over the term of the related debt.
Goodwill: On December 4, 2013, in connection with the SBIC Acquisition, the Company recorded goodwill of $1,077, which is included in prepaid expenses and other assets on the consolidated balance sheets. Goodwill is not subject to amortization. Goodwill is evaluated for impairment annually or more frequently if events occur or circumstances change that indicate goodwill may be impaired. There have been no goodwill impairments since the date of the SBIC Acquisition.
Intangible asset: On December 4, 2013, in connection with the SBIC Acquisition, the Company recorded an intangible asset of $2,500 attributable to the SBIC license. The Company amortizes this intangible asset on a straight-line basis over its estimated useful life of 13 years. The Company expects to incur annual amortization expense of $195 in each of the years ending December 31, 2025 and $145 in 2026.
The Company tests its intangible asset for impairment if events or circumstances suggest that the asset carrying value may not be fully recoverable. The intangible asset, net of accumulated amortization of $795 and $600 at December 31, 2017 and 2016, respectively, is included in prepaid expenses and other assets.
Interest expense: Interest expense is recognized on an 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.
New Accounting Standards
The following table discusses recently issued ASUs by the FASB:
Standard | Description | Period of Adoption | Effect of Adoption on the financial statements | |||
Standards that were adopted | ||||||
ASU 2015-02, Consolidation: Amendments to the Consolidation Analysis | Modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. | First Quarter 2016 retrospectively | No material impact to the Company's consolidated financial statements. | |||
96
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Standard | Description | Period of Adoption | Effect of Adoption on the financial statements | |||
Standards that were adopted | ||||||
ASU 2015-03, Interest – Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs | 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. | First Quarter 2016 retrospectively | Resulted in a $3,420 retrospective reduction of both net deferred debt issuance costs and SBA debentures payable in the consolidated balance sheet as of December 31, 2015 and a reduction of amortization and write-off of deferred debt issuance costs and corresponding increase in interest expense in the consolidated statement of operations for the years ended December 31, 2015 and 2014, of $2,100 and $1,354, respectively. Net deferred debt issuance costs of $2,657 and $3,037, are presented as a direct deduction from the SBA debentures payable in the consolidated balance sheet as of December 31, 2017, and 2016, respectively. Amortization and write-off of deferred debt issuance costs associated with the Company's SBA debentures and the OFS Capital WM revolving line of credit is included in interest expense in the consolidated statement of operations. See Note 8 for more details. There was no impact to consolidated earnings as a result of this adoption. | |||
ASU 2015-15, Interest – Imputation of Interest: Presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements - amendments to SEC paragraphs | Response to SEC views on ASU 2015-03. Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line of credit arrangements, the SEC stated it 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. | First Quarter 2016 retrospectively | Net deferred debt issuance costs of $297 and $256 associated with the Company's PWB Credit Facility are presented as an asset and included in prepaid expenses and other assets in the consolidated balance sheet as of December 31, 2017 and 2016, respectively. There was no impact to consolidated earnings as a result of this adoption. | |||
ASU 2015-17, Income Taxes: Balance Sheet Classification of Deferred Taxes | Requires deferred tax liabilities and assets to be classified as noncurrent in the balance sheet. | First Quarter 2017 prospectively | No material impact to the Company's consolidated financial statements. | |||
97
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The following table discusses recently issued ASUs by the FASB yet to be adopted by the Company:
Standard | Description | Effect of Adoption on the financial statements | ||
Standards that are not yet adopted | ||||
ASU 2014-09, Revenue from Contracts with Customers | Supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of the standard is to recognize revenues to depict the transfer of promised goods or services to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The standard defines a five step process to achieve this core principle. The standard must be adopting 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 modified retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The adoption will include updates as provided under ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net); ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing; ASU 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients; ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers; ASU 2017-13, Revenue Recognition (Topic 605), Revenue from Contracts with Customers, Leases (Topic 840), and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to the Staff Announcement at the July 20, 2017 EITF Meeting and Rescission of Prior SEC Staff Announcements and Observer Comments and ASU 2017-14, Income Statement-Reporting Comprehensive Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers. | In August 2015, the FASB issued ASU 2015-14, which defers the effective date of ASU 2014-09, such that the guidance is effective for annual and interim reporting periods beginning after December 15, 2017. Early adoption is not permitted. The Company has completed its evaluation and has determined the adoption of new revenue guidance will not have a material impact to its consolidated financial statements, including the presentation of revenues in its consolidated statements of operations. | ||
ASU 2016-01, Financial Instruments – Overall | Modifies how entities measure equity investments and present changes in the fair value of financial liabilities. Entities will have to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value, and recognize any changes in fair value in net income unless the investments qualify for the new practicality exception. A practicality exception will apply to those equity investments that do not have a readily determinable fair value and do not qualify for the practical expedient to estimate fair value under ASC Topic 820, and as such these investments may be measured at cost. | Annual reporting periods beginning after December 15, 2017, including interim periods within those fiscal years. The Company is required to record its investments at fair value with changes in fair value recognized in net income in accordance with ASC Topic 946. Therefore, the adoption of ASU 2016-01 is not expected to have a material effect on the Company’s consolidated financial statements | ||
98
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Standard | Description | Effect of Adoption on the financial statements | ||
Standards that are not yet adopted | ||||
ASU 2016-15, Statement of Cash Flows | Addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. | Annual reporting periods beginning after December 15, 2017, including interim periods within those fiscal years and early adoption is permitted. The Company is currently evaluating the impact of this ASU will have on the Company's consolidated financial position and disclosures. | ||
ASU 2016-19, Technical Corrections and Improvements | Makes minor corrections and clarifications that affect a wide variety of topics in the Accounting Standards Codification, including an amendment to Topic 820, Fair Value Measurement, which clarifies the difference between a valuation approach and a valuation technique when applying the guidance of that Topic. The amendment also requires an entity to disclose when there has been a change in either or both a valuation approach and/or a valuation technique. The transition guidance for the Topic 820 amendment must be applied prospectively because it could potentially involve the use of hindsight that includes fair value measurements. | Annual reporting periods beginning after December 15, 2017, including interim periods within those years. Early application is permitted for any fiscal year or interim period for which the entity’s financial statements have not yet been issued. The Company is currently evaluating the impact this ASU will have on the Company’s consolidated financial position or disclosures. | ||
ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment | Removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. | Annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early application is permitted. The adoption of ASU 2017-04 is not expected to have a material effect on the Company's consolidated financial statements. | ||
ASU 2017-05, Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 620-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets | Defines "insubstance nonfinancial asset", unifies guidance related to partial sales of nonfinancial assets, eliminates rules specifically addressing sales of real estate, removes exceptions to the financial asset derecognition model, and clarifies the accounting for contributions of nonfinancial assets to joint ventures. | The effective date and transition requirements are the same as the effective date and transition requirements for ASU 2014-09 and is not expected to have a material effect on the Company's consolidated financial statements. | ||
ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities | Shortens the amortization period for certain purchased callable debt securities held at a premium to the earliest call date. Securities held at a discount are to continue to be amortized to maturity. | Annual reporting periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the ASU in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principle. The adoption of ASU 2017-08 is not expected to have a material effect on the Company's consolidated financial statements. | ||
99
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Standard | Description | Effect of Adoption on the financial statements | ||
Standards that are not yet adopted | ||||
ASU 2017-12, Derivatives and Hedging, Targeted Improvements to Accounting for Hedging Activities | Eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires, for qualifying hedges, the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. Additionally, the guidance also expands an entity's ability to apply hedge accounting for nonfinancial and financial risk components, simplifies the hedge documentation and hedge effectiveness assessment requirements, and modifies certain disclosure requirements. | Annual reporting periods beginning after December 15, 2018, including interim periods within those years. Early adoption is permitted. The Company is currently evaluating the impact this ASU will have on the Company’s consolidated financial position or disclosures. | ||
Note 3. OFS Capital WM
OFS Capital WM, a wholly-owned investment company subsidiary, was formed in August 2010 with the limited purpose of holding, acquiring, managing and financing senior secured loan investments to middle-market companies in the United States. These loans were managed and serviced by MCF Capital Management, LLC (“MCF”) under a loan and security agreement among OFS Capital WM, MCF, Wells Fargo Securities, LLC, and Well Fargo Delaware Trust Company, N.A. (the “Loan and Security Agreement”). MCF charged a management fee of 0.25% per annum of the assigned value of the underlying portfolio investments plus an accrued fee that was deferred until termination of the Loan and Security Agreement on May 28, 2015. The Company incurred management fee expense related to this agreement of $0, $0, and $288, for the years ended December 31, 2017, 2016, and 2015, respectively.
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”), an affiliate of MCF, pursuant to which OFS Capital WM sold a portfolio of 20 senior secured debt investments with an aggregate outstanding principal balance of $67,807 to Madison for cash proceeds of $67,309 (the “WM Asset Sale”).On May 28, 2015, the total fair value of the debt investments sold, applying the Company’s March 31, 2015 fair value percentages to the principal balances of the respective investments on the sale date, was approximately $66,703. The determination of the fair value of the Company’s investments is subject to the good faith determination by the Company’s board of directors, which is conducted no less frequently than quarterly, pursuant to the Company’s valuation policies and accounting principles generally accepted in the United States.
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 line of credit with Wells Fargo Bank, N.A. WM Credit Facility. As a result of the termination of the WM Credit Facility, the Company wrote-off related unamortized deferred financing closing costs of $1,216.
Note 4. Related Party Transactions
Investment Advisory and Management Agreement: OFS Advisor manages the day-to-day operations of, and provides investment advisory services to, the Company pursuant to an Investment Advisory Agreement. The Investment Advisory Agreement was most recently re-approved on April 7, 2017. Under the terms of the Investment Advisory Agreement, which are in accordance with the 1940 Act and subject to the overall supervision of the Company’s Board, OFS Advisor is responsible for sourcing potential investments, conducting research and diligence on potential investments and equity sponsors, analyzing investment opportunities, structuring investments, and monitoring investments and portfolio companies on an ongoing basis. OFS Advisor is a subsidiary of OFSAM and a registered investment advisor under the Investment Advisers Act of 1940, as amended.
OFS Advisor’s services under the Investment Advisory Agreement are not exclusive to the Company and OFS Advisor is free to furnish similar services to other entities, including other BDCs affiliated with OFS Advisor, so long as its services to the Company are not impaired. OFS Advisor also serves as the investment adviser to CLO funds and other assets, including HPCI.
100
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
OFS Advisor receives fees for providing services, consisting of two components: a base management fee and an incentive fee. The base management fee is calculated at an annual rate of 1.75% and based on the average value of the Company’s total assets (other than cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity) at the end of the two most recently completed calendar quarters, adjusted for any share issuances or repurchases during the quarter. OFS Advisor has elected to exclude the value of the intangible asset and goodwill resulting from the SBIC Acquisition from the base management fee calculation.
The base management fee is payable quarterly in arrears and was $4,999, $4,516, and $4,937, for the years ended December 31, 2017, 2016, and 2015, respectively.
The incentive fee has two parts. The first part ("Part One") is calculated and payable quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees such as commitment, origination and sourcing, structuring, diligence and consulting fees or other fees that the Company receives from portfolio companies but excluding fees for providing managerial assistance) accrued during the calendar quarter, minus operating expenses for the quarter (including the base management fee, any expenses payable under the Administration Agreement (as defined below) and any interest expense and dividends paid on any outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest or dividend feature (such as OID, debt instruments with PIK interest, equity investments with accruing or PIK dividend and zero coupon securities), accrued income that the Company has not yet received in cash.
Pre-incentive fee net investment income is expressed as a rate of return on the value of the Company’s net assets (defined as total assets less indebtedness and before taking into account any incentive fees payable during the period) at the end of the immediately preceding calendar quarter and adjusted for any share issuances or repurchases during such quarter. Accordingly, as a result of the Offering, the Part One incentive fee was reduced by $593 for the three months ended June 30, 2017, determined by adjusting the value of net assets, as defined above, at March 31, 2017 by the daily weighted average of the Offering proceeds available to the Company during the three months ended June 30, 2017. The incentive fee with respect to pre-incentive fee net income is 20.0% of the amount, if any, by which the pre-incentive fee net investment income for the immediately preceding calendar quarter exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up” provision measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, OFS Advisor receives no incentive fee until the net investment income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100.0% of the pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5%. The effect of this provision is that, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, OFS Advisor will receive 20.0% of the pre-incentive fee net investment income.
Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that the Company may pay an incentive fee in a quarter in which the Company incurs a loss. For example, if the Company receives pre-incentive fee net investment income in excess of the quarterly minimum hurdle rate, the Company will pay the applicable incentive fee even if the Company has incurred a loss in that quarter due to realized and unrealized capital losses. The Company’s net investment income used to calculate this part of the incentive fee is also included in the amount of the Company’s gross assets used to calculate the base management fee. These calculations are appropriately prorated for any period of less than three months.
The second part ("Part Two") of the incentive fee (the “Capital Gain Fee”) is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement, as of the termination date), commencing on December 31, 2012, and equals 20.0% of the Company’s aggregate realized capital gains, if any, on a cumulative basis from the date of the election to be a BDC through the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation through the end of such year, less all previous amounts paid in respect of the Capital Gain Fee; provided that the incentive fee determined as of December 31, 2012, was calculated for a period of shorter than twelve calendar months to take into account any realized capital gains computed net of all realized capital losses and unrealized capital depreciation for the period beginning on the date of the Company’s election to be a BDC and ending December 31, 2012.
The Company accrues the Capital Gain Fee if, on a cumulative basis, the sum of net realized capital gains and (losses) plus net unrealized appreciation and (depreciation) is positive. If, on a cumulative basis, the sum of net realized capital gains (losses) plus net unrealized appreciation (depreciation) decreases during a period, the Company will reverse any excess Capital Gain Fee previously accrued such that the amount of Capital Gains Fee accrued is no more than 20% of the sum of net realized
101
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
capital gains (losses) plus net unrealized appreciation (depreciation). OFS Advisor has excluded from the Capital Gain Fee calculation any realized gain with respect to (1) the SBIC Acquisition, and (2) the WM Asset Sale.
The Company incurred incentive fee expense of $2,962, $3,333, and $2,627 for the years ended December 31, 2017, 2016, and 2015, respectively. Incentive fees for the years ended December 31, 2017, 2016, and 2015, included Part One incentive fees (based on net investment income) of $2,962, which included a share issue adjustment of $(593) related to the Company's Offering, $3,472 and $2,488, respectively, and Part Two incentive fees (based upon net realized and unrealized gains and losses, or capital gains) of $0, $(139) and $139, respectively.
License Agreement: The Company entered into a license agreement with OFSAM under which OFSAM has agreed to grant the Company a non-exclusive, royalty-free license to use the name “OFS.”
Administration Agreement: OFS Services furnishes the Company with office facilities and equipment, necessary software licenses and subscriptions, and clerical, bookkeeping and record keeping services at such facilities pursuant to an Administration Agreement. The Administration Agreement was most recently re-approved on April 7, 2017. Under the Administration Agreement, OFS Services performs, or oversees the performance of, the Company’s required administrative services, which include being responsible for the financial records that the Company is required to maintain and preparing reports to its stockholders and all other reports and materials required to be filed with the SEC or any other regulatory authority. In addition, OFS Services assists the Company in determining and publishing its net asset value, oversees the preparation and filing of its tax returns and the printing and dissemination of reports to its stockholders, and generally oversees the payment of the Company’s expenses and the performance of administrative and professional services rendered to the Company by others. Under the Administration Agreement, OFS Services also provides managerial assistance on the Company’s behalf to those portfolio companies that have accepted the Company’s offer to provide such assistance. Payment under the Administration Agreement is equal to an amount based upon the Company’s allocable portion of OFS Services’s overhead in performing its obligations under the Administration Agreement, including, but not limited to, rent, information technology services and the Company’s allocable portion of the cost of its officers, including its chief executive officer, chief financial officer, chief compliance officer, chief accounting officer, and their respective staffs. To the extent that OFS Services outsources any of its functions, the Company will pay the fees associated with such functions on a direct basis without profit to OFS Services.
Administration fee expense was $1,314, $1,304 and $1,637 for the years ended December 31, 2017, 2016, and 2015, respectively.
Note 5. Investments
As of December 31, 2017, the Company had loans to 35 portfolio companies, of which 79% were senior secured loans and 21% were subordinated loans, at fair value, as well as equity investments in 17 of these portfolio companies. The Company also held an equity investment in two portfolio companies in which it did not hold a debt investment. At December 31, 2017, investments consisted of the following:
Amortized Cost | Percentage of Net Assets | Fair Value | Percentage of Net Assets | ||||||||||
Senior secured debt investments | $ | 196,020 | 104.1 | % | $ | 195,112 | 103.5 | % | |||||
Subordinated debt investments | 63,031 | 33.5 | 51,198 | 27.2 | |||||||||
Preferred equity | 24,103 | 12.8 | 19,200 | 10.2 | |||||||||
Common equity and warrants | 6,821 | 3.6 | 11,989 | 6.4 | |||||||||
Total | 289,975 | 154.0 | % | 277,499 | 147.3 | % | |||||||
In December 2017, the Company's investment in Jobson Healthcare Information, LLC ("Jobson") was restructured, whereby the lender group, including the Company, purchased all the outstanding equity of Jobson for a nominal purchase price. Immediately after the restructuring, and as of December 31, 2017, the Company owned approximately 12.6% of the common equity of Jobson. In February 2018, in connection with the restructuring, the Company sold its warrant investment, on a pro-rata basis, to the other members of the lender group for a nominal amount. As of December 31, 2017, the amortized cost and fair value of the Company's common equity investment was $0; the amortized cost and fair value of the Company's warrant investment was $0.5 million and $0, respectively; and the amortized cost and fair value of the Company's debt investment was $15,241 and $12,910, respectively.
102
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
In July 2017, the Company's senior secured debt investment with a cost basis of $6,701, and preferred equity investments, with an aggregate cost basis of $247, in My Alarm Center, LLC, were restructured and exchanged for common equity and a new class of preferred equity securities with a fair value of $0 and $1,745 respectively. As of June 30, 2017, the Company recognized cumulative unrealized losses of $5,203, which upon restructuring, was realized during the quarter ended September 30, 2017.
At December 31, 2017, all but one (domiciled in Canada) of the Company’s investments, with an amortized cost and fair value of $3,939 and $4,070, respectively, were domiciled in the United States. Geographic composition is determined by the location of the corporate headquarters of the portfolio company. The industry compositions of the Company’s investment portfolio were as follows:
Percentage of Total: | Percentage of Total: | |||||||||||||||||||
Amortized Cost | Amortized Cost | Net Assets | Fair Value | Fair Value | Net Assets | |||||||||||||||
Administrative and Support and Waste Management and Remediation Services | ||||||||||||||||||||
Security Systems Services (except Locksmiths) | $ | 15,179 | 5.2 | % | 8.1 | % | $ | 15,145 | 5.5 | % | 8.0 | % | ||||||||
Arts, Entertainment, and Recreation | ||||||||||||||||||||
Fitness and Recreational Sports Centers | 17,941 | 6.2 | 9.5 | 18,628 | 6.7 | 9.9 | ||||||||||||||
Other Amusement and Recreation Industries | 6,948 | 2.4 | 3.7 | 6,948 | 2.5 | 3.7 | ||||||||||||||
Construction | ||||||||||||||||||||
Electrical Contractors and Other Wiring Installation Contractors | 18,425 | 6.4 | 9.8 | 18,505 | 6.7 | 9.8 | ||||||||||||||
Education Services | ||||||||||||||||||||
Colleges, Universities, and Professional Schools | 5,591 | 1.9 | 3.0 | 1,201 | 0.4 | 0.6 | ||||||||||||||
Finance and Insurance | ||||||||||||||||||||
Insurance Agencies and Brokerages | 9,579 | 3.3 | 5.1 | 9,417 | 3.4 | 5.0 | ||||||||||||||
Offices of Real Estate Agents and Brokers | 3,939 | 1.4 | 2.1 | 4,070 | 1.5 | 2.2 | ||||||||||||||
Health Care and Social Assistance | ||||||||||||||||||||
Medical Laboratories | 4,346 | 1.5 | 2.3 | 4,512 | 1.6 | 2.4 | ||||||||||||||
Offices of Physicians, Mental Health Specialists | 5,547 | 1.9 | 2.9 | 5,503 | 2.0 | 2.9 | ||||||||||||||
Outpatient Mental Health and Substance Abuse Centers | 7,639 | 2.6 | 4.1 | — | — | — | ||||||||||||||
Manufacturing | ||||||||||||||||||||
Bolt, Nut, Screw, Rivet, and Washer Manufacturing | 3,873 | 1.3 | 2.1 | 3,544 | 1.3 | 1.9 | ||||||||||||||
Commercial Printing (except Screen and Books) | 4,755 | 1.6 | 2.5 | 4,767 | 1.7 | 2.5 | ||||||||||||||
Other Aircraft Parts and Auxiliary Equipment Manufacturing | 5,375 | 1.9 | 2.9 | 5,375 | 1.9 | 2.9 | ||||||||||||||
Pharmaceutical Preparation Manufacturing | 4,040 | 1.4 | 2.1 | 8,510 | 3.1 | 4.5 | ||||||||||||||
Pump and Pumping Equipment Manufacturing | 9,397 | 3.2 | 5.0 | 9,405 | 3.4 | 5.0 | ||||||||||||||
Travel Trailer and Camper Manufacturing | 10,213 | 3.5 | 5.5 | 10,568 | 3.7 | 5.5 | ||||||||||||||
Truck Trailer Manufacturing | 6,971 | 2.4 | 3.8 | 7,064 | 2.5 | 3.7 | ||||||||||||||
Other Services (except Public Administration) | ||||||||||||||||||||
Automotive Oil Change and Lubrication Shops | 24,748 | 8.5 | 13.1 | 24,984 | 9.0 | 13.3 | ||||||||||||||
103
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Percentage of Total: | Percentage of Total: | |||||||||||||||||||
Amortized Cost | Amortized Cost | Net Assets | Fair Value | Fair Value | Net Assets | |||||||||||||||
Commercial and Industrial Machinery and Equipment (except Automotive and Electronic) Repair and Maintenance | 13,677 | 4.8 | 7.3 | 12,105 | 4.4 | 6.4 | ||||||||||||||
Professional, Scientific, and Technical Services | ||||||||||||||||||||
Computer Systems Design and Related Services | 7,303 | 2.5 | 3.9 | 7,334 | 2.6 | 3.9 | ||||||||||||||
Other Accounting Services | 3,526 | 1.2 | 1.9 | 4,391 | 1.6 | 2.3 | ||||||||||||||
Other Professional, Scientific, and Technical Services | 23,854 | 8.2 | 12.7 | 21,266 | 7.7 | 11.3 | ||||||||||||||
Testing Laboratories | 3,470 | 1.2 | 1.8 | 3,439 | 1.2 | 1.8 | ||||||||||||||
Veterinary Services | 743 | 0.3 | 0.4 | 748 | 0.3 | 0.4 | ||||||||||||||
Public Administration | ||||||||||||||||||||
Other Justice, Public Order, and Safety Activities | 9,813 | 3.4 | 5.2 | 9,919 | 3.6 | 5.3 | ||||||||||||||
Real Estate and Rental and Leasing | ||||||||||||||||||||
Home Health Equipment Rental | 900 | 0.3 | 0.5 | 141 | 0.1 | 0.1 | ||||||||||||||
Office Machinery and Equipment Rental and Leasing | 12,436 | 4.3 | 6.6 | 14,224 | 5.1 | 7.6 | ||||||||||||||
Retail Trade | ||||||||||||||||||||
Cosmetics, Beauty Supplies, and Perfume Stores | 3,492 | 1.2 | 1.9 | 3,472 | 1.3 | 1.8 | ||||||||||||||
Shoe store | 9,462 | 3.3 | 5.0 | 9,497 | 3.4 | 5.0 | ||||||||||||||
Warehouse Clubs and Supercenters | 9,158 | 3.2 | 4.9 | 9,063 | 3.3 | 4.8 | ||||||||||||||
All Other General Merchandise Stores | 6,607 | 2.3 | 3.5 | 6,337 | 2.3 | 3.4 | ||||||||||||||
Wholesale Trade | ||||||||||||||||||||
Metal Service Centers and Other Metal Merchant Wholesalers | 12,853 | 4.4 | 6.8 | 14,544 | 5.2 | 7.7 | ||||||||||||||
Sporting and Recreational Goods and Supplies Merchant Wholesalers | 8,175 | 2.8 | 4.3 | 2,873 | 1.0 | 1.5 | ||||||||||||||
$ | 289,975 | 100.0 | % | 154.0 | % | $ | 277,499 | 100.0 | % | 147.3 | % | |||||||||
As of December 31, 2016, the Company had loans to 39 portfolio companies, of which 74% were senior secured loans and 26% were subordinated loans, at fair value, as well as equity investments in 17 of these portfolio companies. The Company also held an equity investment in two portfolio companies in which it did not hold a debt interest.
At December 31, 2016, investments consisted of the following:
Amortized Cost | Percentage of Net Assets | Fair Value | Percentage of Net Assets | ||||||||||
Senior secured debt investments | $ | 182,315 | 126.8 | % | $ | 180,955 | 125.9 | % | |||||
Subordinated debt investments | 66,591 | 46.3 | 63,410 | 44.1 | |||||||||
Preferred equity | 23,293 | 16.2 | 23,721 | 16.5 | |||||||||
Common equity and warrants | 7,108 | 4.9 | 13,541 | 9.4 | |||||||||
Total | $ | 279,307 | 194.2 | % | $ | 281,627 | 195.9 | % | |||||
During the year ended December 31, 2016, the Company converted $1,765 in principal of a subordinated debt investment into preferred equity units and warrants valued at $1,765, converted $329 in principal of a senior secured debt investment into
104
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
preferred equity units valued at $335, and converted $800 in principal of a subordinated debt investment into a senior secured debt investment in the same portfolio company. In addition, the Company amended a senior secured debt investment for which it received preferred equity units in the same portfolio company valued at $203 and received additional preferred equity units valued at $44 in connection with a $1,250 follow on investment in the same portfolio company.
At December 31, 2016, all but one (domiciled in Canada) of the Company’s investments, with an amortized cost and fair value of $3,923 and $3,923, respectively, were domiciled in the United States. Geographic composition is determined by the location of the corporate headquarters of the portfolio company. The industry compositions of the Company’s portfolio were as follows:
Percentage of Total: | Percentage of Total: | |||||||||||||||||||
Amortized Cost | Amortized Cost | Net Assets | Fair Value | Fair Value | Net Assets | |||||||||||||||
Administrative and Support and Waste Management and Remediation Services | ||||||||||||||||||||
Other Travel Arrangement and Reservation Services | $ | 10,182 | 3.6 | % | 7.1 | % | $ | 10,839 | 3.8 | % | 7.5 | % | ||||||||
Security Systems Services (except Locksmiths) | 18,663 | 6.7 | 13.0 | 18,883 | 6.7 | 13.1 | ||||||||||||||
Tour Operators | 439 | 0.2 | 0.3 | 1,019 | 0.4 | 0.7 | ||||||||||||||
Arts, Entertainment, and Recreation | ||||||||||||||||||||
Fitness and Recreational Sports Centers | 14,372 | 5.1 | 10.0 | 14,410 | 5.1 | 10.0 | ||||||||||||||
Education Services | ||||||||||||||||||||
Colleges, Universities, and Professional Schools | 5,314 | 1.9 | 3.7 | 5,142 | 1.8 | 3.6 | ||||||||||||||
Finance and Insurance | ||||||||||||||||||||
Insurance Agencies and Brokerages | 13,510 | 4.8 | 9.4 | 13,599 | 4.8 | 9.5 | ||||||||||||||
Health Care and Social Assistance | ||||||||||||||||||||
Medical Laboratories | 4,204 | 1.5 | 2.9 | 4,174 | 1.5 | 2.9 | ||||||||||||||
Other Outpatient Care Centers | 14,207 | 5.2 | 9.9 | 14,393 | 5.1 | 10.0 | ||||||||||||||
Outpatient Mental Health and Substance Abuse Centers | 7,639 | 2.7 | 5.3 | 5,393 | 1.9 | 3.8 | ||||||||||||||
Information | ||||||||||||||||||||
Other Information Services | 2,427 | 0.9 | 1.7 | 2,340 | 0.8 | 1.6 | ||||||||||||||
Other Telecommunications | 2,652 | 0.9 | 1.8 | 2,630 | 0.9 | 1.8 | ||||||||||||||
Software Publishers | 4,896 | 1.8 | 3.4 | 4,949 | 1.8 | 3.4 | ||||||||||||||
Manufacturing | ||||||||||||||||||||
Bolt, Nut, Screw, Rivet, and Washer Manufacturing | 4,090 | 1.5 | 2.8 | 3,555 | 1.3 | 2.5 | ||||||||||||||
Other Aircraft Parts and Auxiliary Equipment Manufacturing | 11,925 | 4.3 | 8.3 | 13,551 | 4.8 | 9.4 | ||||||||||||||
Other Basic Inorganic Chemical Manufacturing | 4,413 | 1.6 | 3.1 | 4,396 | 1.6 | 3.1 | ||||||||||||||
Packaging Machinery Manufacturing | 1,996 | 0.7 | 1.4 | 1,885 | 0.7 | 1.3 | ||||||||||||||
Pharmaceutical Preparation Manufacturing | 4,049 | 1.4 | 2.8 | 9,893 | 3.5 | 6.9 | ||||||||||||||
Pump and Pumping Equipment Manufacturing | 10,908 | 3.9 | 7.6 | 10,016 | 3.6 | 7.0 | ||||||||||||||
Travel Trailer and Camper Manufacturing | 12,797 | 4.6 | 8.9 | 13,149 | 4.7 | 9.1 | ||||||||||||||
Other Services (except Public Administration) | ||||||||||||||||||||
Commercial and Industrial Machinery and Equipment (except Automotive and Electronic) Repair and Maintenance | 13,695 | 4.9 | 9.5 | 11,610 | 4.1 | 8.1 | ||||||||||||||
Professional, Scientific, and Technical Services | ||||||||||||||||||||
105
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Percentage of Total: | Percentage of Total: | |||||||||||||||||||
Amortized Cost | Amortized Cost | Net Assets | Fair Value | Fair Value | Net Assets | |||||||||||||||
Computer Systems Design and Related Services | 3,879 | 1.4 | 2.7 | 3,946 | 1.4 | 2.7 | ||||||||||||||
Custom Computer Programming Services | 5,097 | 1.8 | 3.5 | 5,143 | 1.8 | 3.6 | ||||||||||||||
Other Accounting Services | 5,328 | 1.9 | 3.7 | 4,911 | 1.7 | 3.4 | ||||||||||||||
Other Computer Related Services | 14,738 | 5.3 | 10.3 | 14,883 | 5.3 | 10.4 | ||||||||||||||
Other Professional, Scientific, and Technical Services | 32,750 | 11.7 | 22.7 | 31,422 | 11.2 | 21.8 | ||||||||||||||
Veterinary Services | 650 | 0.2 | 0.5 | 651 | 0.2 | 0.5 | ||||||||||||||
Real Estate and Rental and Leasing | ||||||||||||||||||||
Home Health Equipment Rental | 900 | 0.3 | 0.6 | 1,037 | 0.4 | 0.7 | ||||||||||||||
Office Machinery and Equipment Rental and Leasing | 11,888 | 4.3 | 8.3 | 13,510 | 4.8 | 9.4 | ||||||||||||||
Offices of Real Estate Agents and Brokers | 3,923 | 1.4 | 2.7 | 3,923 | 1.4 | 2.7 | ||||||||||||||
Offices of Real Estate Appraisers | 10,032 | 3.6 | 7.0 | 10,000 | 3.6 | 7.0 | ||||||||||||||
Retail Trade | ||||||||||||||||||||
All Other General Merchandise Stores | 6,839 | 2.4 | 4.8 | 6,839 | 2.4 | 4.8 | ||||||||||||||
Wholesale Trade | ||||||||||||||||||||
Metal Service Centers and Other Metal Merchant Wholesalers | 12,700 | 4.5 | 8.8 | 14,142 | 5.0 | 9.8 | ||||||||||||||
Sporting and Recreational Goods and Supplies Merchant Wholesalers | 8,205 | 3.0 | 5.7 | 5,394 | 1.9 | 3.8 | ||||||||||||||
$ | 279,307 | 100.0 | % | 194.2 | $ | 281,627 | 100.0 | % | 195.9 | % | ||||||||||
106
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Unconsolidated Significant Subsidiaries: In accordance with Regulation S-X and GAAP, the Company is not permitted to consolidate any subsidiary or other entity that is not an investment company, including those in which the Company has a controlling interest unless the business of the controlled operating company consists of providing services to the Company. In accordance with Regulation S-X Rules 3-09 and 4-08(g), the Company evaluates its unconsolidated controlled portfolio companies as significant subsidiaries under the respective rules. As of December 31, 2017 and 2016, MTE Holding Corp. and Subsidiaries was considered a significant unconsolidated subsidiary under Regulation S-X Rule 4-08(g). The Company's voting ownership in MTE Holding Corp. and Subsidiaries is limited to 50% through a substantive participating voting rights agreement with an unaffiliated investor. Based on the requirements under Regulation S-X Rule 4-08(g), the summarized consolidated financial information of MTE Holding Corp. and Subsidiaries is presented below:
December 31, | ||||||||
Balance Sheet: | 2017 | 2016 | ||||||
Current assets | $ | 7,161 | $ | 5,535 | ||||
Noncurrent assets | 25,408 | 24,681 | ||||||
Total Assets | $ | 32,569 | $ | 30,216 | ||||
Current liabilities | $ | 3,116 | $ | 2,401 | ||||
Noncurrent liabilities | 17,276 | 16,889 | ||||||
Total liabilities | 20,392 | 19,290 | ||||||
Non-controlling interest | 5,675 | 4,878 | ||||||
Total equity | 6,502 | 6,048 | ||||||
Years Ended December 31, | ||||||||||||
Summary of Operations: | 2017 | 2016 | 2015 | |||||||||
Net Sales | $ | 31,614 | $ | 27,704 | $ | 1,958 | ||||||
Gross Profit | 9,857 | 7,436 | 508 | |||||||||
Net income (loss) | 2,106 | 2,232 | (967 | ) | ||||||||
Net income (loss) attributable to MTE Holding Corp. | 1,594 | 1,235 | (535 | ) | ||||||||
Note 6. Fair Value of Financial Instruments
Investments
The Company’s investments are valued at fair value as determined in good faith by Company management under the supervision, and review and approval of the Board. These fair values are determined in accordance with a documented valuation policy and a consistently applied valuation process.
• | For each debt investment, a basic credit risk 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. |
• | Each portfolio company or investment is valued by OFS Advisor. |
• | The preliminary valuations are documented and are then submitted to OFS Advisor’s investment committee for ratification. |
• | Third-party valuation firm(s) provide valuation services as requested, by reviewing the investment committee’s preliminary valuations. OFS 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 Board reviews the preliminary valuations of OFS Advisor’s investment committee and independent valuation firms and, if appropriate, recommends the approval of the valuations by the Board. |
107
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
• | 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 OFS Advisor, the audit committee and, where appropriate, the respective independent valuation firm. |
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair values are determined with models or other valuation techniques, valuation inputs, and assumptions market participants would use in pricing an asset or liability. Valuation inputs are organized in a hierarchy that gives the highest priority to prices for identical assets or liabilities quoted in active markets (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of inputs in the fair value hierarchy are described below:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
Level 2: Inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include: (i) quoted prices for similar assets or liabilities in active markets, (ii) quoted prices for identical or similar assets or liabilities in markets that are not active, (iii) inputs other than quoted prices that are observable for the asset or liability, and (iv) inputs that are derived principally from or corroborated by observable market data.
Level 3: Unobservable inputs for the asset or liability, and situations where there is little, if any, market activity for the asset or liability at the measurement date.
The inputs into the determination of fair value are based upon the best information under the circumstances and may require significant management judgment or estimation. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment.
The Company assesses the levels of the investments at each measurement date, and transfers between levels are recognized on the measurement date. All of the Company’s investments, which are measured at fair value, were categorized as Level 3 based upon the lowest level of significant input to the valuations. There were no transfers among Level 1, 2 and 3 for the years ended December 31, 2017, 2016, and 2015.
Each quarter, for investments for which unadjusted quoted prices in active markets are not available, the Company assesses whether market quotations, prices from pricing services or bids from brokers or dealers (collectively, "Indicative Prices") are available, as well as the Company's ability to transact at such Indicative Prices. Investments for which sufficient Indicative Prices exist are generally valued consistent with such Indicative Prices. The Company periodically corroborates observed Indicative Prices with its actual investment purchase prices and/or other valuation techniques, such as the discounted cash flow method described below. Based on the corroborating analysis and the experience of the Company’s management in purchasing and selling these investments, the Company believes that these Indicative Prices may be reasonable indicators of fair value. In certain instances, the Company may partially rely on Indicative Prices when the Company determines such Indicative Prices are not of sufficient strength to rely on as the sole indication of fair value. In such instances, the Company applies a weighting factor to the Indicative Price and an alternative fair value analysis, typically a discounted cash flow analysis. The weighting factor placed on an Indicative Price is applied consistently based upon its relative strength, which considers, among other factors, and when available, the depth and liquidity of the Indicative Price. Weighting factors are not significant to the overall fair value measurement, but rather are applied to incorporate relevant market data when available.
In addition, each quarter, the Company assesses whether an arm’s length transaction occurred in the same security, including the Company's new investments during the quarter, the cost of which (“Transaction Prices”), may be considered a reasonable indication of fair value for up to three months after the transaction date.
Due to the private nature of this marketplace (meaning actual transactions are not publicly reported), and the non-binding nature of the Indicative Prices, and the general inability to observe the input for the full length of the term of an investment, the Company believes that these valuation inputs are classified as Level 3 within the fair value hierarchy.
In the absence of sufficient, actionable Indicative Prices or Transaction Prices, as an indication of fair value, and consistent with the policies and methodologies adopted by the Board, the Company performs detailed valuations of its debt and equity investments, including an analysis on the Company’s unfunded loan commitments, using both the market and income
108
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
approaches as appropriate. There is no one methodology to estimate fair value and, in fact, for any one portfolio company, enterprise value is generally best expressed as a range of values. The Company may also engage one or more independent valuation firms(s) to conduct independent appraisals of its investments to develop the range of values, from which the Company derives a single estimate of value. Under the income approach, the Company typically prepares and analyzes discounted cash flow models to estimate the present value of future cash flows of either an individual debt investment or of the underlying portfolio company itself.
The primary method used to estimate the fair value of the Company's debt investments is the discounted cash flow method. However, if there is deterioration in credit quality or a debt investment is in workout status, the Company may consider other methods in determining the fair value, including the value attributable to the debt investment from the enterprise value of the portfolio company or the proceeds that would be received in a liquidation analysis. The discounted cash flow approach to determining 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, and company performance. The valuation based on the inputs determined to be the most reasonable and probable is used as the fair value of the investment, which may include a weighting factor applied to multiple valuation methods. 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.
The Company changed the primary method used to value certain of its investments, primarily equity investments, as of December 31, 2016, from the income approach to the market approach, principally due to the nature of evidence available under the discounted cash flow method, and to better align with industry practice. The Company may also utilize an income approach when estimating the fair value of its equity securities, either as a primary methodology if consistent with industry practice or if the market approach is otherwise not applicable, or as a supporting methodology to corroborate the fair value ranges determined by the market approach.
Under the market approach, the Company estimates the enterprise value of portfolio companies. Typically, the enterprise value of a private company is based on multiples of EBITDA, net income, revenues, or other relevant basis. The valuation based on the inputs determined to be the most reasonable and probable is used as the fair value of the investment, which may include a weighting factor applied to multiple valuation methods. In estimating the enterprise value of a portfolio company, the Company analyzes various factors consistent with industry practice, 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, the portfolio company’s historical and projected financial results, applicable market trading and transaction comparables, applicable market yields and leverage levels, the nature and realizable value of any collateral, 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.
Due to the inherent uncertainty of determining the fair value of Level 3 investments, the fair value of the investments may differ significantly from the values that would have been used had a ready market or observable inputs existed for such investments and may differ materially from the values that may ultimately be received or settled. Further, such investments are generally subject to legal and other restrictions, or otherwise are less liquid than publicly traded instruments. If the Company were required to liquidate a portfolio investment in a forced or liquidation sale, the Company might realize significantly less than the value at which such investment had previously been recorded. The Company’s investments are subject to market risk. Market risk is the potential for changes in the value due to market changes. Market risk is directly impacted by the volatility and liquidity in the markets in which the investments are traded.
109
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The following tables provide quantitative information about the Company’s significant Level 3 fair value inputs to the Company’s fair value measurements as of December 31, 2017 and 2016. 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 exhaustive, but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements.
Fair Value at December 31, 2017 (1) | Valuation technique | Unobservable inputs | Range (Weighted average) | ||||||
Debt investments: | |||||||||
Senior secured | $ | 152,231 | Discounted cash flow | Discount rates | 10.01% - 16.50% (12.24%) | ||||
12,910 | Enterprise value | EBITDA multiples | 7.50x - 7.50x (7.50x) | ||||||
9,063 | Indicative Prices | Broker-dealers' quotes | N/A | ||||||
Subordinated | 47,117 | Discounted cash flow | Discount rates | 11.24% - 16.90% (14.69%) | |||||
4,074 | Enterprise value | EBITDA multiples | 4.25x - 7.25x (6.37x) | ||||||
Equity investments | |||||||||
Preferred equity | 19,200 | Enterprise value | EBITDA multiples | 4.25x - 13.48x (7.80x) | |||||
Common equity and warrants | 11,489 | Enterprise value | EBITDA multiples | 4.25x - 8.28x (6.27x) | |||||
(1) | Excludes $20,908, $7, and $500 of senior secured debt investments, subordinated debt investments, and equity investments, respectively, valued at a Transaction Price. |
Fair Value at December 31, 2016 (1) | Valuation technique | Unobservable inputs | Range (Weighted average) | ||||||
Debt investments: | |||||||||
Senior secured | $ | 149,128 | Discounted cash flow | Discount rates | 6.70% - 18.71% (12.07%) | ||||
15,901 | Enterprise value | EBITDA multiples | 7.25% - 7.50% (7.31%) | ||||||
Subordinated | 45,635 | Discounted cash flow | Discount rates | 10.75% - 21.24% (14.19%) | |||||
5,393 | Enterprise value | EBITDA multiples | 8.00x - 8.00x (8.00x) | ||||||
Equity investments | |||||||||
Preferred equity | 23,721 | Enterprise value | EBITDA multiples | 4.50x - 8.50x (6.82x) | |||||
Common equity and warrants | 13,042 | Enterprise value | EBITDA multiples | 5.00x - 8.50x (6.07x) | |||||
(1) | Excludes $15,926, $12,382, and $499 of senior secured debt investments, subordinated debt investments, and equity investments, respectively, valued at a Transaction Price. |
Changes in market credit spreads or the credit quality of the underlying portfolio company (both of which could impact the discount rate), as well as changes in EBITDA and/or EBITDA multiples, among other things, could have a significant impact on fair values, with the fair value of a particular debt investment susceptible to change in inverse relation to the changes in the discount rate. Changes in EBITDA and/or EBITDA multiples, as well as changes in the discount rate, could have a significant impact on fair values, with the fair value of an equity investment susceptible to change in tandem with the changes in EBITDA and/or EBITDA multiples, and in inverse relation to changes in the discount rate. Due to 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.
110
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The following tables present changes in investments measured at fair value using Level 3 inputs for the years ended December 31, 2017 and 2016:
Year Ended December 31, 2017 | |||||||||||||||||||
Senior Secured Debt Investments | Subordinated Debt Investments | Preferred Equity | Common Equity and Warrants | Total | |||||||||||||||
Level 3 assets, January 1, 2017 | $ | 180,955 | $ | 63,410 | $ | 23,721 | $ | 13,541 | $ | 281,627 | |||||||||
Net realized gain on investments | (4,908 | ) | — | 10,704 | 1,037 | 6,833 | |||||||||||||
Net unrealized appreciation (depreciation) on investments | 467 | (8,667 | ) | (5,331 | ) | (1,265 | ) | (14,796 | ) | ||||||||||
Amortization of Net Loan Fees | 1,395 | 55 | — | — | 1,450 | ||||||||||||||
Capitalized PIK interest and dividends | 1,042 | 466 | 1,399 | — | 2,907 | ||||||||||||||
Amendment fees | (280 | ) | — | — | — | (280 | ) | ||||||||||||
Purchase and origination of portfolio investments | 127,812 | 9,244 | 4,631 | 1,213 | 142,900 | ||||||||||||||
Proceeds from principal payments on portfolio investments | (82,137 | ) | (22,941 | ) | — | — | (105,078 | ) | |||||||||||
Sale and redemption of portfolio investments | (17,858 | ) | — | (17,669 | ) | (2,537 | ) | (38,064 | ) | ||||||||||
Conversion from debt investment to equity investment (Note 5) | (1,745 | ) | — | 1,745 | — | — | |||||||||||||
Conversion from subordinated to senior secured debt investment (Note 5) | (9,631 | ) | 9,631 | — | — | — | |||||||||||||
Level 3 assets, December 31, 2017 | $ | 195,112 | $ | 51,198 | $ | 19,200 | $ | 11,989 | $ | 277,499 | |||||||||
111
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Year Ended December 31, 2016 | |||||||||||||||||||
Senior Secured Debt Investments | Subordinated Debt Investments | Preferred Equity | Common Equity and Warrants | Total | |||||||||||||||
Level 3 assets, January 1, 2016 | $ | 160,437 | $ | 64,240 | $ | 22,133 | $ | 10,486 | $ | 257,296 | |||||||||
Net realized gain on investments | 83 | 7 | — | 2,137 | 2,227 | ||||||||||||||
Net unrealized appreciation (depreciation) on investments | 329 | (2,376 | ) | (2,584 | ) | 1,910 | (2,721 | ) | |||||||||||
Amortization of Net Loan Fees | 1,012 | 402 | — | — | 1,414 | ||||||||||||||
Capitalized PIK interest and dividends | 547 | 602 | 1,433 | — | 2,582 | ||||||||||||||
Amendment fees | (442 | ) | (97 | ) | — | — | (539 | ) | |||||||||||
Purchase and origination of portfolio investments | 44,671 | 22,101 | 643 | 822 | 68,237 | ||||||||||||||
Proceeds from principal payments on portfolio investments | (26,519 | ) | (14,885 | ) | — | — | (41,404 | ) | |||||||||||
Sale and redemption of portfolio investments | (2,840 | ) | — | — | (2,434 | ) | (5,274 | ) | |||||||||||
Distribution received from equity investment | — | — | (324 | ) | — | (324 | ) | ||||||||||||
Equity received in connection with purchase of portfolio investments and amendments | (743 | ) | (79 | ) | 248 | 574 | — | ||||||||||||
Conversion from debt investment to equity investment (Note 5) | (320 | ) | (1,765 | ) | 2,039 | 46 | — | ||||||||||||
Conversion from subordinated to senior secured debt investment (Note 5) | 800 | (800 | ) | — | — | — | |||||||||||||
Reclassification from Subordinated to Senior Secured debt | 3,940 | (3,940 | ) | — | — | — | |||||||||||||
Other | — | — | 133 | — | 133 | ||||||||||||||
Level 3 assets, December 31, 2016 | $ | 180,955 | $ | 63,410 | $ | 23,721 | $ | 13,541 | $ | 281,627 | |||||||||
The net unrealized appreciation (depreciation) reported in the Company’s consolidated statements of operations for the years ended December 31, 2017, 2016, and 2015, attributable to the Company’s Level 3 assets held at those respective year ends was $(10,496), $254, and $3,243, respectively.
The information presented should not be interpreted as an estimate of the fair value of the entire Company since fair value measurements are 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.
Other Financial Assets and Liabilities
ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. The Company believes that the carrying amounts of its other financial instruments such as cash, receivables and payables approximate the fair value of such items due to the short maturity of such instruments. The Company's SBA-guaranteed debentures are carried at cost and with their longer maturity dates, fair value is estimated by discounting remaining payments using current market rates for similar instruments and considering such factors as the legal maturity date. As of December 31, 2017 and 2016, the fair value of the Company’s SBA debentures using Level 3 inputs is estimated at $155,510 and $159,708, respectively.
112
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 7. Commitments and Contingencies
Unfunded commitments to the Company's portfolio companies as of December 31, 2017, were as follows:
Name of Portfolio Company | Investment Type | Amount | ||||
Carolina Lubes, Inc. | Senior Secured Revolver | $ | 2,433 | |||
The Escape Game, LLC | Senior Secured Loan | 7,000 | ||||
TRS Services, LLC | Senior Secured Loan | 500 | ||||
$ | 9,933 | |||||
From time to time, the Company is involved in legal proceedings in the normal course of its business. Although the outcome of such litigation cannot be predicted with any certainty, management is of the opinion, based on the advice of legal counsel, that final disposition of any litigation should not have a material adverse effect on the financial position of the Company as of December 31, 2017.
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.
In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties that provide general indemnifications. The Company’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Company that have not occurred. The Company believes the risk of any material obligation under these indemnifications to be low.
Note 8 . Borrowings
SBA Debentures: The SBIC Program 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 SBA pooling, which is March and September of each year, at a market-driven spread over U.S. Treasury Notes with ten-year maturities.
Under present regulations of the SBIC Act, the maximum amount of SBA-guaranteed debt that may be issued by a single SBIC licensee is $150,000. An SBIC fund may borrow up to two times the amount of its regulatory capital, subject to customary regulatory requirements. For two or more SBICs under common control, the maximum amount of outstanding SBA-provided leverage cannot exceed $350,000. In connection with the SBIC Acquisition, the Company increased its total commitments to SBIC I LP to $75,000, which became a drop down SBIC fund of the Company on December 4, 2013. During 2014, the Company fully funded its $75,000 commitment to SBIC I LP. As of December 31, 2017 and 2016, SBIC I LP had fully drawn the $149,880 of leverage commitments from the SBA.
On a stand-alone basis, SBIC I LP held $251,601 and $247,512 in assets at December 31, 2017 and 2016, respectively, which accounted for approximately 70% and 81% of the Company’s total consolidated assets, respectively. These assets can not be pledged under any debt obligation of the Company.
113
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The following table shows the Company’s outstanding SBA debentures payable as of December 31, 2017 and 2016:
Fixed Interest Rate | SBA debentures outstanding | ||||||||||||
Pooling Date | Maturity Date | December 31, 2017 | December 31, 2016 | ||||||||||
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 | 22,585 | |||||||||
SBA debentures outstanding | 149,880 | 149,880 | |||||||||||
Unamortized debt issuance costs | (2,657 | ) | (3,037 | ) | |||||||||
SBA debentures outstanding, net of unamortized debt issuance costs | $ | 147,223 | $ | 146,843 | |||||||||
The Company received exemptive relief from the SEC effective November 26, 2013, which permits the Company to exclude SBA guaranteed debentures from the definition of senior securities in the statutory 200% asset coverage ratio under the 1940 Act, allowing for greater capital deployment.
The effective interest rate on the SBA debentures, which includes amortization of deferred debt issuance costs, was 3.43% as of December 31, 2017 and 2016. Interest expense on the SBA debentures was $5,141, $5,156, and $4,352 for the years ended December 31, 2017, 2016, and 2015, respectively, which includes $380, $382, and $297 of debt issuance costs amortization, respectively.
The weighted-average fixed cash interest rate on the SBA debentures as of December 31, 2017 and 2016, was 3.18%.
PWB Credit Facility: The Company is party to the BLA with Pacific Western Bank, as lender, to provide the Company with a $35,000 senior secured revolving credit facility, or PWB Credit Facility. The PWB Credit Facility is available for general corporate purposes including investment funding and is scheduled to mature on October 31, 2018. The maximum availability of the PWB Credit Facility is equal to 50% of the aggregate outstanding principal amount of eligible loans included in the borrowing base, which excludes subordinated loan investments and as otherwise specified in the BLA. The PWB Credit 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 the Company’s partnership interests in SBIC I LP and SBIC I GP. The PWC Credit Facility bears interest at a variable rate of the Prime Rate plus a 0.75% margin, with a 5.00% floor, and includes an unused commitment fee, payable monthly in arrears, equal to 0.50% per annum on any unused portion. As of December 31, 2017, the interest rate on the unpaid principal balance of the PWB Credit Facility was 5.25%.
On March 7, 2018 the BLA was amended to, among other things, increase the maximum amount available under the PWB Credit Facility from $35,000 to $50,000, extend the maturity date from October 31, 2018 to January 31, 2020, and change the interest rate floor from 5.00% to 5.25%. The Company incurred deferred debt issuance costs of $166 in connection with the amendment.
The average dollar amount of borrowings outstanding during the year ended December 31, 2017, was $8,488. The effective interest rate, which includes amortization of deferred debt issuance costs as of December 31, 2017, was 5.74% based on the maximum amount available under the PWB Credit Facility. Deferred debt issuance costs, net of accumulated amortization, was $228 and $256 as of December 31, 2017 and 2016, respectively. Amortization of debt issuance costs was $172, $108 , and $17, for the years ended December 31, 2017, 2016, and 2015, respectively.
Availability under the PWB Credit Facility as of December 31, 2017 was $17,400 based on the stated advance rate of 50% under the borrowing base.
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-
114
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
default to other indebtedness, bankruptcy, change in investment advisor, and the occurrence of a material adverse change in our financial condition. As of December 31, 2017, the Company was in compliance with the applicable covenants.
OFS Capital WM 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 plus 2.50% per annum. The minimum equity requirement was set at $35,000. The unused commitment fee on the WM Credit Facility was (i) 0.5% per annum of the first $25,000 of the unused facility and (ii) 2% per annum of the balance in excess of $25,000, and was included in interest expense on the consolidated statement of operations during 2015. During the three months ended March 31, 2015, the Company recorded a $430 write-off of debt issuance costs due to a permanent reduction in the facility’s commitment from $100,000 to $75,000. During the three months ended June 30, 2015, the Company incurred a $1,216 write-off of debt issuance costs due to the termination of the facility on May 28, 2015.
Note 9. Federal Income Tax
The Company has elected to be taxed as a RIC under Subchapter M of the Code. In order to maintain its status as a RIC, the Company is required to distribute annually to its stockholders at least 90% of its ICTI, as defined by the Code. Additionally, to avoid a 4% excise tax on undistributed earnings the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2% of its net capital gains for the one-year period ending October 31 of that calendar year, and (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no federal income tax. Maintenance of the Company's RIC status also requires adherence to certain source of income and asset diversification requirements.
The Company has met the required distribution, source of income and asset diversification requirements as of December 31, 2017, and intends to continue meeting these requirements. Accordingly, there is no liability for federal income taxes at the Company level. The Company’s ICTI differs from the net increase in net assets resulting from operations primarily due to differences in income recognition on the unrealized appreciation/depreciation of investments, income from Company’s equity investments in pass-through entities, PIK dividends that have not yet been declared and paid by underlying portfolio companies, capital gains and losses and the net creation or utilization of capital loss carryforwards.
The distributions paid to stockholders are reported as ordinary income, long-term capital gains, and returns of capital. The tax character of distributions paid were as follows:
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Ordinary taxable income | $ | 14,158 | $ | 12,157 | $ | 10,954 | |||||
Long-term capital gain | 2,738 | 169 | — | ||||||||
Return of capital | — | 858 | 2,197 | ||||||||
Total distributions to stockholders | $ | 16,896 | $ | 13,184 | $ | 13,151 | |||||
Tax-basis undistributed income as of December 31, 2017 and 2016, was as follows:
December 31, | |||||||
2017 | 2016 | ||||||
Ordinary income | $ | — | $ | — | |||
Net long-term capital gains | 4,936 | — | |||||
115
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The Company records reclassifications to its capital accounts related to permanent differences between GAAP and tax treatment related to goodwill amortization, excise taxes, and other permanent differences; and temporary differences between GAAP and tax treatment of realized gains and losses, income arising from Company’s equity investments in pass-through entities, PIK dividends, and other temporary differences. Reclassifications were as follows:
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Paid-in capital in excess of par | $ | (409 | ) | $ | 592 | $ | (198 | ) | |||
Accumulated undistributed net investment income | 954 | 131 | (304 | ) | |||||||
Accumulated net realized gain (loss) | (545 | ) | (723 | ) | 502 | ||||||
The tax-basis cost of investments and associated tax-basis gross unrealized appreciation (depreciation) inherent in the fair value of investments as of December 31, 2017 and 2016, were as follows:
December 31, | |||||||
2017 | 2016 | ||||||
Tax-basis amortized cost of investments | $ | 282,401 | $ | 273,414 | |||
Tax-basis gross unrealized appreciation on investments | 16,207 | 19,554 | |||||
Tax-basis gross unrealized depreciation on investments | (21,109 | ) | (11,341 | ) | |||
Tax-basis net unrealized appreciation (depreciation) on investments | (4,902 | ) | 8,213 | ||||
Fair value of investments | $ | 277,499 | $ | 281,627 | |||
The Company recognizes deferred taxes on the appreciation of securities held through Taxable Blockers. Net unrealized depreciation on investments reported in net assets on the consolidated balance sheets has been increase by and other liabilities include deferred tax liabilities on appreciated securities of $4 at December 31, 2017. There were no deferred tax assets or liabilities at December 31, 2016.
116
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 10. Financial Highlights
The following is a schedule of financial highlights for the years ended December 31, 2017, 2016, and 2015:
Years Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Per share data: | |||||||||||
Net asset value per share at beginning of period | $ | 14.82 | $ | 14.76 | $ | 14.24 | |||||
Distributions (4) | |||||||||||
From ordinary income | (1.14 | ) | (1.25 | ) | (1.13 | ) | |||||
From capital gains | (0.22 | ) | (0.02 | ) | — | ||||||
Return of capital | — | (0.09 | ) | (0.23 | ) | ||||||
Net investment income | 1.28 | 1.46 | 1.39 | ||||||||
Net realized gain (loss) on non-control/non-affiliate investments | (0.26 | ) | 0.25 | (0.31 | ) | ||||||
Net realized gain on affiliate investments | 0.81 | — | 0.14 | ||||||||
Net unrealized appreciation (depreciation) on non-control/non-affiliate investments | (0.78 | ) | (0.69 | ) | 0.53 | ||||||
Net unrealized appreciation (depreciation) on affiliate investments | (0.41 | ) | 0.33 | 0.13 | |||||||
Net unrealized appreciation on control investment | — | 0.07 | — | ||||||||
Issuance of common stock (5) | (0.03 | ) | — | — | |||||||
Other (6) | 0.05 | — | — | ||||||||
Net asset value per share at end of period | $ | 14.12 | $ | 14.82 | $ | 14.76 | |||||
Per share market value, end of period | $ | 11.90 | $ | 13.76 | $ | 11.48 | |||||
Total return based on market value (1) | (4.7 | )% | 32.3 | % | 9.0 | % | |||||
Total return based on net asset value (2) | 4.3 | % | 9.7 | % | 13.4 | % | |||||
Shares outstanding at end of period | 13,340,217 | 9,700,297 | 9,691,170 | ||||||||
Weighted average shares outstanding | 12,403,706 | 9,693,801 | 9,670,153 | ||||||||
Ratio/Supplemental Data (in thousands except ratios) | |||||||||||
Average net asset value (3) | $ | 171,631 | $ | 142,818 | $ | 140,002 | |||||
Net asset value at end of period | $ | 188,336 | $ | 143,778 | $ | 143,012 | |||||
Net investment income | $ | 15,877 | $ | 14,145 | $ | 13,411 | |||||
Ratio of total expenses to average net assets | 10.2 | % | 11.9 | % | 13.5 | % | |||||
Ratio of net investment income to net assets at end of period | 8.4 | % | 9.8 | % | 9.6 | % | |||||
Portfolio turnover (7) | 50.4 | % | 18.1 | % | 44.6 | % | |||||
(1) | Calculation is ending market value less beginning market value, adjusting for dividends and distributions reinvested at prices obtained in the Company’s dividend reinvestment plan for the respective distributions. |
(2) | Calculation is ending net asset value less beginning net asset value, adjusting for dividends and distributions reinvested at the Company’s quarter-end net asset value for the respective distributions. |
(3) | Based on the average of the net asset value at the beginning of the indicated period and the end of each calendar quarter within the period indicated. |
(4) | The components of the distributions are presented on an income tax basis. |
(5) | The issuance of common stock on a per share basis reflects the incremental net asset value change as a result of the Offering. |
(6) | Represents the impact of different share amounts used in calculating per share data as a result of calculating certain per share data based on a weighted average shares outstanding during the period and certain per share data based on the shares outstanding as of a period end or transaction date. |
(7) | Portfolio turnover rate is calculated using the lesser of period-to-date sales and principal payments or period-to-date purchases over the average of the invested assets at fair value. |
Note 11. Distributions
The Company intends to make distributions to stockholders on a quarterly basis of substantially all of its net investment income. In addition, although the Company intends to make distributions of net realized capital gains, if any, at least annually, out of assets legally available for such distributions, it may in the future decide to retain such capital gains for investment.
117
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The Company may be limited in its ability to make distributions due to the BDC asset coverage requirements of the 1940 Act. The Company’s ability to make distributions may also be affected by its ability to receive distributions from SBIC I LP. SBIC I LP’s ability to make distributions is governed by SBA regulations. Consolidated cash and cash equivalents includes $72,116 held by SBIC I LP, which was not available for distribution at December 31, 2017.
The following table summarizes distributions declared and paid for the years ended December 31, 2017, 2016, and 2015:
Date Declared | Record Date | Payment Date | Amount Per Share | Cash Distribution | DRIP Shares Issued | DRIP Shares Value | |||||||||||||
Year ended December 31, 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 | |||||||||||||
December 2, 2015 | December 17, 2015 | December 31, 2015 | 0.34 | 3,283 | 1,041 | 12 | |||||||||||||
$ | 1.36 | $ | 12,690 | 40,336 | $ | 461 | |||||||||||||
Year ended December 31, 2016 | |||||||||||||||||||
March 7, 2016 | March 17, 2016 | March 31, 2016 | $ | 0.34 | $ | 3,280 | 1,154 | $ | 15 | ||||||||||
May 2, 2016 | June 16, 2016 | June 30, 2016 | 0.34 | 3,269 | 1,998 | 26 | |||||||||||||
August 5, 2016 | September 16, 2016 | September 30, 2016 | 0.34 | 3,258 | 2,888 | 38 | |||||||||||||
October 31, 2016 | December 16, 2016 | December 30, 2016 | 0.34 | 3,255 | 3,087 | 43 | |||||||||||||
$ | 1.36 | $ | 13,062 | 9,127 | $ | 122 | |||||||||||||
Year ended December 31, 2017 | |||||||||||||||||||
March 9, 2017 | March 17, 2017 | March 31, 2017 | $ | 0.34 | $ | 3,257 | 2,919 | $ | 41 | ||||||||||
May 2, 2017 | June 16, 2017 | June 30, 2017 | 0.34 | 4,483 | 3,439 | 49 | |||||||||||||
August 1, 2017 | September 15, 2017 | September 29, 2017 | 0.34 | 4,491 | 3,196 | 42 | |||||||||||||
October 31, 2017 | December 15, 2017 | December 29, 2917 | 0.34 | 4,469 | 5,366 | 64 | |||||||||||||
$ | 1.36 | $ | 16,700 | 14,920 | $ | 196 | |||||||||||||
For the year ended December 31, 2017, $196 of the total $16,896 paid to stockholders represented DRIP participation, during which the Company satisfied the DRIP participation requirements with the issuance of 14,920 shares at an average value of $13.18 per share at the date of issuance. For the year ended December 31, 2016, $122 of the total $13,184 paid to stockholders represented DRIP participation, during which the Company satisfied the DRIP participation requirements with the issuance of 9,127 shares at an average value of $13.23 per share at the date of issuance. For the year ended December 31, 2015, $461 of the total $13,151 paid to stockholders represented DRIP participation, during which the Company satisfied the DRIP participation requirements with the issuance of 40,336 shares at an average value of $11.44 per share at the date of issuance.
Since the Company’s IPO, distributions to stockholders total $67,775, or $6.63 per share on a cumulative basis.
Distributions in excess of the Company’s current and accumulated ICTI would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of the Company’s distributions is made annually as of the end of its fiscal year based upon its ICTI for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of the Company’s distributions for a full year. Each year, a statement on Form 1099-DIV identifying the source of the distribution is mailed to the Company’s stockholders. For the year ended December 31, 2017, approximately $1.14 per share, $0.22 per share, and $0 per share of the Company’s distributions represented ordinary income, long-term capital gain, and a return of capital to its stockholders, respectively.
118
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 12. Selected Quarterly Financial Data (Unaudited)
Quarter Ended | |||||||||||||||
December 31, 2017 | September 30, 2017 | June 30, 2017 | March 31, 2017 | ||||||||||||
Total investment income | $ | 8,292 | $ | 9,122 | $ | 7,978 | $ | 8,034 | |||||||
Net investment income | 3,819 | 4,402 | 4,316 | 3,340 | |||||||||||
Net gain (loss) on investments | 331 | (3,227 | ) | (6,597 | ) | 1,526 | |||||||||
Net increase (decrease) in net assets resulting from operations | 4,150 | 1,175 | (2,281 | ) | 4,866 | ||||||||||
Net increase (decrease) in net assets resulting from operations per share (1) | $ | 0.22 | $ | 0.09 | $ | (0.17 | ) | $ | 0.50 | ||||||
Net asset value per share (2) | $ | 14.12 | $ | 14.15 | $ | 14.40 | $ | 14.98 | |||||||
Quarter Ended | |||||||||||||||
December 31, 2016 | September 30, 2016 | June 30, 2016 | March 31, 2016 | ||||||||||||
Total investment income | $ | 8,209 | $ | 7,359 | $ | 7,683 | $ | 7,843 | |||||||
Net investment income | 3,736 | 3,297 | 3,457 | 3,655 | |||||||||||
Net gain (loss) on investments | 1,087 | (909 | ) | 881 | (1,376 | ) | |||||||||
Net increase in net assets resulting from operations | 4,823 | 2,388 | 4,338 | 2,279 | |||||||||||
Net increase in net assets resulting from operations per share (1) | $ | 0.49 | $ | 0.25 | $ | 0.45 | $ | 0.24 | |||||||
Net asset value per share (2) | $ | 14.82 | $ | 14.67 | $ | 14.76 | $ | 14.65 | |||||||
(1) | Based on weighted average shares outstanding for the respective period. |
(2) | Based on shares outstanding at the end of the respective period. |
119
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 13. Consolidated Schedule of Investments In and Advances To Affiliates
Name of Portfolio Company | Investment Type (1) | Net Realized Gain (Loss) | Net change in unrealized appreciation/depreciation | Interest, Fees and Dividends Credited to Income(2) | December 31, 2016, Fair Value | Gross Additions (3) | Gross Reductions (4) | December 31, 2017, Fair Value (5) | ||||||||||||||||||||||
Control Investments | ||||||||||||||||||||||||||||||
Malabar International | Subordinated Loan | $ | — | $ | — | $ | 536 | $ | 7,683 | $ | 150 | $ | (7,833 | ) | $ | — | ||||||||||||||
Preferred Equity | — | — | 65 | 5,868 | 1,608 | (7,476 | ) | — | ||||||||||||||||||||||
— | — | 601 | 13,551 | 1,758 | (15,309 | ) | — | |||||||||||||||||||||||
MTE Holding Corp. | Senior Secured Loan | — | (64 | ) | 1,288 | 9,766 | 90 | (2,738 | ) | 7,118 | ||||||||||||||||||||
Common Equity | — | 67 | 227 | 3,383 | 67 | — | 3,450 | |||||||||||||||||||||||
— | 3 | 1,515 | 13,149 | 157 | (2,738 | ) | 10,568 | |||||||||||||||||||||||
Total Control Investments | — | 3 | 2,116 | 26,700 | 1,915 | (18,047 | ) | 10,568 | ||||||||||||||||||||||
Affiliate Investments | ||||||||||||||||||||||||||||||
All Metals Holding, LLC | Senior Secured Loan | — | (259 | ) | 1,856 | 12,865 | 283 | (389 | ) | 12,759 | ||||||||||||||||||||
Common Equity(6) | — | 508 | — | 1,277 | 508 | — | 1,785 | |||||||||||||||||||||||
— | 249 | 1,856 | 14,142 | 791 | (389 | ) | 14,544 | |||||||||||||||||||||||
Contract Datascan Holdings, Inc. | Subordinated Loan | — | 93 | 978 | 7,902 | 98 | — | 8,000 | ||||||||||||||||||||||
Preferred Equity(6)(7) | — | — | 542 | 5,421 | 543 | — | 5,964 | |||||||||||||||||||||||
Common Equity(6) | — | 73 | — | 187 | — | 73 | 260 | |||||||||||||||||||||||
— | 166 | 1,520 | 13,510 | 641 | 73 | 14,224 | ||||||||||||||||||||||||
Intelli-Mark Technologies, Inc. | Senior Secured Loan | — | (159 | ) | 613 | 8,841 | 68 | (8,909 | ) | — | ||||||||||||||||||||
Common Equity(6) | 874 | (498 | ) | — | 1,998 | (1,998 | ) | — | ||||||||||||||||||||||
874 | (657 | ) | 613 | 10,839 | 68 | (10,907 | ) | — | ||||||||||||||||||||||
120
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Name of Portfolio Company | Investment Type (1) | Net Realized Gain (Loss) | Net change in unrealized appreciation/depreciation | Interest, Fees and Dividends Credited to Income(2) | December 31, 2016, Fair Value | Gross Additions (3) | Gross Reductions (4) | December 31, 2017, Fair Value (5) | ||||||||||||||||||||||
Jobson Healthcare Information, LLC (8) | Senior Secured Loan | — | — | — | — | 12,910 | 12,910 | |||||||||||||||||||||||
Common Equity | — | — | — | — | — | — | — | |||||||||||||||||||||||
Warrants | — | — | — | — | — | |||||||||||||||||||||||||
— | — | — | — | 12,910 | — | 12,910 | ||||||||||||||||||||||||
Malabar International (9) | Subordinated Loan | — | (41 | ) | 671 | — | 7,833 | (7,833 | ) | — | ||||||||||||||||||||
Preferred Equity | 5,590 | (1,585 | ) | 56 | — | 7,476 | (7,476 | ) | — | |||||||||||||||||||||
5,590 | (1,626 | ) | 727 | — | 15,309 | (15,309 | ) | — | ||||||||||||||||||||||
Master Cutlery, LLC | Subordinated Loan | — | (1,537 | ) | 640 | 4,440 | 653 | (2,220 | ) | 2,873 | ||||||||||||||||||||
Preferred Equity (6)(7) | — | (954 | ) | — | 954 | (954 | ) | — | ||||||||||||||||||||||
Common Equity (6) | — | — | — | — | — | |||||||||||||||||||||||||
— | (2,491 | ) | 640 | 5,394 | 653 | (3,174 | ) | 2,873 | ||||||||||||||||||||||
NeoSystems Corp. | Subordinated Loan | — | 421 | 408 | 3,656 | 487 | (2,000 | ) | 2,143 | |||||||||||||||||||||
Preferred Equity (6)(7) | — | 861 | 133 | 1,255 | 993 | 2,248 | ||||||||||||||||||||||||
— | 1,282 | 541 | 4,911 | 1,480 | (2,000 | ) | 4,391 | |||||||||||||||||||||||
Pfanstiehl Holdings, Inc | Subordinated Loan | — | (46 | ) | 387 | 3,810 | 1 | (56 | ) | 3,755 | ||||||||||||||||||||
Common Equity | — | (1,328 | ) | 84 | 6,083 | (1,328 | ) | 4,755 | ||||||||||||||||||||||
— | (1,374 | ) | 471 | 9,893 | 1 | (1,384 | ) | 8,510 | ||||||||||||||||||||||
Strategic Pharma Solutions, Inc. | Senior Secured Loan | — | (39 | ) | 904 | 8,383 | 67 | (8,450 | ) | — | ||||||||||||||||||||
Preferred Equity(6)(7) | 3,617 | (1,111 | ) | 81 | 3,026 | 81 | (3,107 | ) | — | |||||||||||||||||||||
3,617 | (1,150 | ) | 985 | 11,409 | 148 | (11,557 | ) | — | ||||||||||||||||||||||
121
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Name of Portfolio Company | Investment Type (1) | Net Realized Gain (Loss) | Net change in unrealized appreciation/depreciation | Interest, Fees and Dividends Credited to Income(2) | December 31, 2016, Fair Value | Gross Additions (3) | Gross Reductions (4) | December 31, 2017, Fair Value (5) | ||||||||||||||||||||||
TRS Services, Inc. | Senior Secured Loan | — | 194 | 1,084 | 9,549 | 310 | (393 | ) | 9,466 | |||||||||||||||||||||
Preferred Equity (Class AA units)(6)(7) | — | — | 55 | 354 | 55 | 409 | ||||||||||||||||||||||||
Preferred Equity (Class A units) (6)(7) | — | 319 | 204 | 1,707 | 523 | 2,230 | ||||||||||||||||||||||||
Common Equity (6) | — | — | — | — | — | |||||||||||||||||||||||||
— | 513 | 1,343 | 11,610 | 888 | (393 | ) | 12,105 | |||||||||||||||||||||||
Total Affiliate Investments | 10,081 | (5,088 | ) | 8,696 | 81,708 | 32,889 | (45,040 | ) | 69,557 | |||||||||||||||||||||
Total Control and Affiliate Investments | $ | 10,081 | $ | (5,085 | ) | $ | 10,812 | $ | 108,408 | $ | 34,804 | $ | (63,087 | ) | $ | 80,125 | ||||||||||||||
(1) | Principal balance of debt investments and ownership detail for equity investments are shown in the consolidated schedule of investments. |
(2) | Represents the total amount of interest, fees or dividends included in 2017 income for the portion of the year ended December 31, 2017, that an investment was included in Control or Affiliate Investment categories, respectively. |
(3) | Gross additions include increases in cost basis resulting from a new portfolio investment, PIK interest, fees and dividends, accretion of OID, and net increases in unrealized net appreciation or decreases in net unrealized depreciation. |
(4) | Gross reductions include decreases in the cost basis of investments resulting from principal repayments and sales, if any, and net decreases in net unrealized appreciation or net increases in net unrealized depreciation, and transfers from Affiliate Investment to Control Investment. |
(5) | Fair value was determined using significant unobservable inputs. See Note 6 for further details. |
(6) | Non-income producing. |
(7) | Dividends credited to income include dividends contractually earned but not declared. |
(8) | Jobson became an affiliate investment effective December 31, 2017, due to an increase in voting ownership interest. |
(9) | Malabar was reclassified from a control investment to an affiliate investment due to a decrease in voting interest. |
122
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 14. Subsequent Events Not Disclosed Elsewhere
On February 12, 2018, the Board declared a special distribution of $0.37 per share payable on March 29, 2018 to stockholders of record as of March 22, 2018. In addition, on February 27, 2018, the Company’s Board declared a distribution of $0.34 per share for the first quarter of 2018, payable on March 29, 2018 to stockholders of record as of March 22, 2018.
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
Not applicable.
Item 9A. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2017. The term “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the foregoing evaluation of our disclosure controls and procedures as of December 31, 2017, our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weakness identified in the fourth quarter of 2017 and described below.
The identification of the material weakness did not require a fourth quarter 2017 adjustment or impact any of our consolidated financial statements for any prior annual or interim periods. Accordingly, management believes that the financial statements included in this Annual Report on Form 10-K present fairly in all material respects the Company’s financial condition, results of operations and cash flows for the periods presented. Further, we are developing a remediation plan for this material weakness, which is described below.
Management’s Report on Internal Control Over Financial Reporting
Our management, including our Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external reporting purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that the receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with polices or procedures may deteriorate.
Our management (with the supervision and participation of our Chief Executive Officer and Chief Financial Officer) conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission.
A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis. As a result of our evaluation of our internal control over financial reporting
123
for the year ended December 31, 2017, management identified a material weakness related to the design and operating effectiveness of controls over the reliability of financial information reported by portfolio companies that is used as financial inputs in the Company’s investment valuations.
Remediation Plan
Management is developing a remediation plan to address the control deficiency that led to the material weakness and has begun the process of reviewing the Company's policies and procedures related to the reliability of financial information reported by portfolio companies that is used as financial inputs in the Company’s investment valuations.
Attestation Report of the Registered Public Accounting Firm
Our internal control over financial reporting as of December 31, 2017, has been audited by BDO USA, LLP, an independent registered public accounting firm, which expressed an adverse opinion thereon, which is included in Item 8 of Part II of this Annual Report under the heading Report of Independent Registered Public Accounting Firm.
Changes in Internal Control over Financial Reporting
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act), occurred during the fiscal quarter ended December 31, 2017, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, other than as described above regarding the described material weakness.
Item 9B. | Other Information |
None.
124
PART III
Item 10. | Directors, Executive Officers and Corporate Governance |
The information required by Item 10 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2018 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
Item 11. | Executive Compensation |
The information required by Item 11 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2018 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters |
The information required by Item 12 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2018 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
Item 13. | Certain Relationships and Related Transactions, and Director Independence |
The information required by Item 13 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2018 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
Item 14. Principal Accountant Fees and Services
The information required by Item 14 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2018 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
125
PART IV
Item 15. | Exhibits and Financial Statement Schedules |
a. Documents Filed as Part of this Report
1. Financial Statements: See "Part II, Item 8. Financial Statements and Supplementary Data" of this report for a list of financial statements.
2. Financial Statement Schedules: Schedule 12-14 Investments in and Advances to Affiliates—See "Part II, Item 8. Financial Statements and Supplementary Data—Note 13" of this report.
3. Exhibits required to be filed by Item 601 of Regulation S-K: See Item 15b. below.
b. Exhibits
The following table lists exhibits filed as part of this report, according to the number assigned to them in Item 601 of Regulation S-K. All exhibits listed in the following table are incorporated by reference except for those exhibits denoted in the last column. Please note that the agreements included as exhibits to this Form 10-K are included to provide information regarding their terms and are not intended to provide any other factual or disclosure information about us or the other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable agreement that have been made solely for the benefit of the other parties to the applicable agreement and may not describe the actual state of affairs as of the date they were made or at any other time.
Incorporated by Reference | |||||
Exhibit Number | Description | Form and SEC File No. | Filing Date with SEC | Filed with this 10-K | |
3.1 | N-2 (333-166363) | March 18, 2011 | |||
3.2 | 10-K (814-00813) | March 26, 2013 | |||
3.3 | N-2/A (333-166363) | March 18, 2011 | |||
4.1 | N-2/A (333-166363) | March 18, 2011 | |||
4.2 | N-2 (333-200376) | November 19, 2014 | |||
4.3 | N-2/A (333-200376) | December 24, 2014 | |||
4.4 | N-2/A (333-200376) | December 16, 2014 | |||
4.5 | N-2/A (333-200376) | December 16, 2014 | |||
4.6 | N-2/A (333-200376) | December 16, 2014 | |||
4.7 | N-2/A (333-200376) | December 16, 2014 | |||
10.1 | N-2/A (333-166363) | March 18, 2011 | |||
10.2 | 10-Q (814-00813) | November 7, 2014 | |||
126
Incorporated by Reference | |||||
Exhibit Number | Description | Form and SEC File No. | Filing Date with SEC | Filed with this 10-K | |
10.3 | N-2/A (333-166363) | March 18, 2011 | |||
10.4 | N-2/A (333-166363) | March 18, 2011 | |||
10.5 | N-2/A (333-166363) | March 18, 2011 | |||
10.6 | N-2/A (333-166363) | March 18, 2011 | |||
10.7 | N-2/A (333-166363) | July 24, 2012 | |||
10.8 | 8-K (814-00813) | June 2, 2015 | |||
10.9 | * | ||||
10.10 | 10-Q (814-00813) | November 6, 2015 | |||
10.11 | * | ||||
10.12 | * | ||||
11.1 | Computation of Per Share Earnings | + | |||
14.1 | 10-Q (814-00813) | November 3, 2017 | |||
21.1 | * | ||||
31.1 | * | ||||
31.2 | * | ||||
32.1 | † | ||||
127
Incorporated by Reference | |||||
Exhibit Number | Description | Form and SEC File No. | Filing Date with SEC | Filed with this 10-K | |
32.2 | † | ||||
* | Filed herewith. |
+ | Included in the notes to the financial statements contained in this report |
† | Furnished herewith |
Item 16. | Form 10-K Summary |
None.
128
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.
OFS Capital Corporation | |
Date: March 12, 2018 | /s/ Bilal Rashid |
Bilal Rashid Chief Executive Officer and Chairman of the Board of Directors | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacity and on the dates indicated.
Date: March 12, 2018 | /s/ Bilal Rashid |
Bilal Rashid, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer) | |
Date: March 12, 2018 | /s/ Marc Abrams |
Marc Abrams, Director | |
Date: March 12, 2018 | /s/ Robert J. Cresci |
Robert J. Cresci, Director | |
Date: March 12, 2018 | /s/ Elaine E. Healy |
Elaine E. Healy, Director | |
Date: March 12, 2018 | /s/ Jeffrey A. Cerny |
Jeffrey A. Cerny, Chief Financial Officer, Treasurer (Principal Financial Officer) and Director | |
Date: March 12, 2018 | /s/ Jeff Owen |
Jeff Owen, Chief Accounting Officer (Principal Accounting Officer) | |
129
BUSINESS LOAN AGREEMENT
Principal | Loan Date | Maturity | Loan No | Call / Coll | Account | Officer | Initials |
$50,000,000.00 | 11-05-2015 | 01-31-2020 | 4061100374 | Note #1000 | 823 | ||
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 9701 Wilshire Boulevard, Suite 700 Beverly Hills, CA 90212 |
THIS BUSINESS LOAN AGREEMENT dated March 7, 2018, 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 March 7, 2018, 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 Tod Reichert.
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”).
Unused Commitment Fee. Any unused portion of the $50,000,000.00 commitment, in an amount over $15,000,000.00, shall be subject to a monthly fee of 0.50% (one-half percentage point per annum).
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) (i) All loans where the loan documents (including promissory notes or assignments) evidencing and securing such loans are not being held by Custodian; and (ii) all loans which, together with the loan documents (including promissory notes or assignments) evidencing and securing such loans, are not subject to a Custody Control Agreement that is at all times from and after the date of its delivery in full force and effect;
(b) All loans placed on non-accrual;
(c) All loans that are 61-90 days or more past-due;
(d) All loans to an entity if any loan to such entity is 61-90 days or more past-due;
(e) All foreign loans; and
(f) All subordinated investments (which, for purposes of this Agreement, means all investments identified as subordinated on Borrower’s consolidated Schedule of investments included in any filing with the Securities and Exchange Commission).
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; provided that the Custody Control Agreement shall be delivered by no later than three (3) weeks after the date of this Agreement.
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:
BN 31956266v7
BUSINESS LOAN AGREEMENT | ||
Loan No. 4061100374 | (Continued) | Page 2 |
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.
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 provision 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.
BN 31956266v7
BUSINESS LOAN AGREEMENT | ||
Loan No. 4061100374 | (Continued) | Page 3 |
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 $150,000,000.00. 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 Borrowing 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.
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 i t may request, all at Borrower's expense.
BN 31956266v7
BUSINESS LOAN AGREEMENT | ||
Loan No. 4061100374 | (Continued) | Page 4 |
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, and (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.
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.
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.
BN 31956266v7
BUSINESS LOAN AGREEMENT | ||
Loan No. 4061100374 | (Continued) | Page 5 |
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.
Custody Agreement and Custody Control Agreement. The Custody Agreement is at any time materially amended or terminated without Lender’s prior written consent, the Custodian at any time is removed or resigns without Lender’s prior written consent, or the Custody Control Agreement is not fully executed and delivered by the date that is three (3) weeks after the date of this Agreement or is at any time from and after such delivery date not in full force and effect or not being complied with by Custodian and Borrower.
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.
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.
BN 31956266v7
BUSINESS LOAN AGREEMENT | ||
Loan No. 4061100374 | (Continued) | Page 6 |
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; Judicial Reference. 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. That certain Judicial Reference Agreement among Lender, Borrower and Guarantor, as amended or replaced from time to time, is hereby incorporated into this Agreement 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.
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.
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:
BN 31956266v7
BUSINESS LOAN AGREEMENT | ||
Loan No. 4061100374 | (Continued) | Page 7 |
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.
Custodian. The word “Custodian” means U.S. Bank National Association or any other custodian approved in writing by Lender and a party to a Custody Control Agreement.
Custody Agreement. The words “Custody Agreement” mean that certain custody agreement dated as of November 7, 2012 by and between Borrower and U.S. Bank National Association, as amended from time to time, and any replacement custody agreement with another Custodian from time to time, which custody agreement is subject to a Custody Control Agreement.
Custody Control Agreement. The words “Custody Control Agreement” mean a Custody Control Agreement by and among Lender, Custodian and Borrower, as in existence and amended or replaced from time to time.
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, and including the Custody Control Agreement.
Security Agreements. The words "Security Agreement" mean, collectively, (i) that certain Commercial Security Agreement, dated as of November 5, 2015, between Borrower and Lender, as the same shall be amended from time to time and (ii) that certain Commercial Security Agreement, dated as of November 5, 2015, 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.
BN 31956266v7
BUSINESS LOAN AGREEMENT | ||
Loan No. 4061100374 | (Continued) | Page 8 |
BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS BUSINESS LOAN AGREEMENT AND BORROWER AGREES TO ITS TERMS. THIS BUSINESS LOAN AGREEMENT IS DATED MARCH 7, 2018.
BORROWER:
OFS CAPITAL CORPORATION, A DELAWARE CORPORATION
By: | /s/ Jeffrey A. Cerny | |
Name: | Jeffrey A. Cerny | |
Title: | Chief Financial Officer | |
LENDER:
PACIFIC WESTERN BANK
By: | /s/ Todd Savitz | |
Authorized Signer | ||
BN 31956266v7
CHANGE IN TERMS AGREEMENT
Principal | Loan Date | Maturity | Loan No | Call / Coll | Account | Officer | Initials |
$50,000,000.00 | 11-05-2015 | 01-31-2020 | 4061100374 | Note #1000 | 823 | ||
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 9701 Wilshire Boulevard, Suite 700 Beverly Hills, CA 90212 |
Principal Amount: $50,000,000.00 | Date of Agreement: March 7, 2018 |
DESCRIPTION OF EXISTING INDEBTEDNESS.
Promissory Note dated November 5, 2015 in the original Principal Amount of $15,000,000.00, as modified by Change in Terms Agreements dated October 31, 2016 and August 9, 2017; together with all renewals, extensions and modifications related thereto (the "Note").
DESCRIPTION OF COLLATERAL.
A Commercial Security Agreement dated November 5, 2015 granting Lender a security interest in all business assets of Borrower.
A Commercial Security Agreement dated November 5, 2015 granting Lender a security interest in all business assets of Guarantor.
DESCRIPTION OF CHANGE IN TERMS. This Change In Terms Agreement ("Agreement") is entered into by Borrower and is effective on the latter of (i) its acceptance by Lender, (ii) the satisfaction of all conditions precedent to effectiveness (if any), or (iii) as of the Date of the Agreement set forth above. Borrower agrees that the terms of the Note, the Business Loan Agreement dated March 7, 2018 (the "Business Loan Agreement"), and any other Related Documents described herein, are hereby modified by the terms of this Agreement. To the extent any provision of this Agreement conflicts with the provisions of the Note, or any other Related Documents described herein, then the provisions of this Agreement shall control. Capitalized terms used but not defined herein shall have the meanings ascribed to them in the Business Loan Agreement.
1. The Note is hereby modified as follows:
a) The Principal Amount of the Note is hereby increased from $35,000,000.00 to $50,000,000.00.
b) Effective as of the date of this Agreement, the Variable Interest Rate is modified as further described in this Agreement.
c) Borrower shall make regular payments as further outlined in this Agreement.
2. Borrower shall cause OFS Capital WM, LLC, a Delaware limited liability company to execute a Commercial Guaranty of the loan in favor of Lender, on Lender’s forms and in the amounts and under the conditions set forth in such guaranty.
3. A Business Loan Agreement of even date is hereby executed concurrently with this Agreement.
4. A Judicial Reference Agreement of even date is hereby executed concurrently with this Agreement.
PAYMENT. Borrower will pay this loan in one payment of all outstanding principal plus all accrued unpaid interest, in addition to any unpaid Unused Commitment Fee, which may be due or remain unpaid on January 31, 2020. In addition, Borrower will pay regular monthly payments of all accrued unpaid interest due as of each payment date, beginning March 31, 2018, with all subsequent interest payments to be due on the same day of each month after that.
VARIABLE INTEREST RATE. The interest rate on this loan is subject to change from time to time based on changes in an independent index which is the Wall Street Journal Prime Rate (the "Index"). The Index is not necessarily the lowest rate charged by Lender on its loans. If the Index becomes unavailable during the term of this loan, Lender may designate a substitute index after notifying Borrower. Lender will tell Borrower the current Index rate upon Borrower's request. The interest rate change will not occur more often than each day. Borrower understands that Lender may make loans based on other rates as well. The Index currently is 4.500% per annum. Interest on the unpaid principal balance of this loan will be calculated as described in the "INTEREST CALCULATION METHOD" paragraph using a rate of 0.750 percentage points over the Index, adjusted if necessary for any minimum and maximum rate limitations described below, resulting in an initial rate of 5.250%. NOTICE: Under no circumstances will the interest rate on this loan be less than 5.250% per annum or more than the maximum rate allowed by applicable law.
INTEREST CALCULATION METHOD. Interest on this loan is computed on a 365/360 basis; 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 loan is computed using this method.
CONTINUING VALIDITY. Except as expressly changed by this Agreement, the terms of the original obligation or obligations, including all agreements evidenced or securing the obligation(s), remain unchanged and in full force and effect. Consent by Lender to this Agreement does not waive Lender's right to strict performance of the obligation(s) as changed, nor obligate Lender to make any future change in terms. Nothing in this Agreement will constitute a satisfaction of the obligation(s). It is the intention of Lender to retain as liable parties all makers and endorsers of the original obligation(s), including accommodation parties, unless a party is expressly released by Lender in writing. Any maker or endorser, including accommodation makers, will not be released by virtue of this Agreement. If any person who signed the original obligation does not sign this Agreement below, then all persons signing below acknowledge that this Agreement is given conditionally, based on the representation to Lender that the non-signing party consents to the changes and provisions of this Agreement or otherwise will not be released by it. This waiver applies not only to any initial extension, modification or release, but also to all such subsequent actions.
INTEGRATION. The parties agree that (a) this Agreement and the Business Loan Agreement, as applicable, which governs the 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.
CHANGE IN TERMS AGREEMENT | ||
Loan No.: 4061100374 | (Continued) | Page 2 |
PRIOR TO SIGNING THIS AGREEMENT, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF THIS AGREEMENT. BORROWER AGREES TO THE TERMS OF THE AGREEMENT.
BORROWER:
OFS CAPITAL CORPORATION, A DELAWARE CORPORATION
By: | /s/ Jeffrey A. Cerny | |
Name: | Jeffrey A. Cerny | |
Title: | Chief Financial Officer | |
COMMERCIAL GUARANTY
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 9701 Wilshire Boulevard, Suite 700 Beverly Hills, CA 90212 |
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
BN 19444101v4
COMMERCIAL GUARANTY | ||
Loan No. 4061100374 | (Continued) | Page 2 |
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.
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.
Right of Setoff. To the extent permitted by applicable law, Lender reserves a right of setoff in all Guarantor's accounts with Lender (whether checking, savings, or some other account). This includes all accounts Guarantor holds jointly with someone else and all accounts Guarantor may open in the future. However, this does not include any IRA or Keogh accounts, or any trust accounts for which setoff would be prohibited by law. Guarantor authorizes Lender, to the extent permitted by applicable law, to hold these funds if there is a default, and Lender may apply the funds in these accounts to pay what Guarantor owes under the terms of this Guaranty.
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.
NEGATIVE COVENANT. Guarantor covenants and agrees with Lender that while this Agreement is in effect, Guarantor shall not, without the prior written consent of Lender, become a surety or guarantor of any unsecured debt owed by Borrower or any other person or entity to any creditor other than Lender.
Miscellaneous Provisions. The following miscellaneous provisions are a part of this Guaranty:
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.
2
BN 19444101v4
COMMERCIAL GUARANTY | ||
Loan No. 4061100374 | (Continued) | Page 3 |
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.
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 MARCH 7, 2018.
GUARANTOR:
3
BN 19444101v4
COMMERCIAL GUARANTY | ||
Loan No. 4061100374 | (Continued) | Page 4 |
OFS CAPITAL WM, LLC, A DELAWARE LIMIATED LIABILITY COMPANY | ||
By: | OFS CAPITAL CORPORATION, its Administrative Manager | |
By: | /s/ Jeffrey A. Cerny | |
Name: | Jeffrey A. Cerny | |
Title: | Chief Financial Officer | |
4
BN 19444101v4
Exhibit 21.1
LIST OF SUBSIDIARIES
OFS Capital WM, LLC, a Delaware limited liability company.
OFS SBIC I GP, LLC, a Delaware limited liability company.
OFS SBIC I, LP, a Delaware limited liability company.
Exhibit 31.1
Certification of Chief Executive Officer
I, Bilal Rashid, Chief Executive Officer of OFS Capital Corporation certify that:
1.I have reviewed this annual report on Form 10-K of OFS Capital Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated this 12th day of March 2018.
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 annual report on Form 10-K 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 provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated this 12th day of March 2018.
By: | /s/ Jeffrey A. Cerny | |
Jeffrey A. Cerny | ||
Chief Financial Officer | ||
Exhibit 32.1
Certification of Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350 , as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Annual Report on Form 10-K for the year ended December 31, 2017 (the “Report”) of OFS Capital Corporation (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Bilal Rashid, the Chief Executive Officer of the Registrant, hereby certify, to the best of my knowledge, pursuant to 18 U.S.C. Section 1350, that:
(1)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: | March 12, 2018 | |
Exhibit 32.2
Certification of Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350 , as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Annual Report on Form 10-K for the year ended December 31, 2017 (the “Report”) of OFS Capital Corporation (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Jeffrey A. Cerny, the Chief Financial Officer of the Registrant, hereby certify, to the best of my knowledge, pursuant to 18 U.S.C. Section 1350, that:
(1)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: | March 12, 2018 | |