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, 2018
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 | |
6.375% Notes due 2025 | The Nasdaq Global Select Market | |
6.50% Notes due 2025 | The Nasdaq Global Select Market | |
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ¨ No ¨
Indicate by check mark 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 | ¨ | 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, 2018, was $149.2 million based on $11.46 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, 2019, there were 13,357,337 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 2019 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
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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.
Defined Terms
We have used "we," "us," "our," "our company," and "the Company" to refer to OFS Capital Corporation in this report. We also have used several other terms in this report, which are explained or defined below:
1940 Act | Investment Company Act of 1940, as amended |
Administration Agreement | Administration agreement between the Company and OFS Services dated November 7, 2012 |
Advisers Act | Investment Advisers Act of 1940, as amended |
Annual Distribution Requirement | Distributions to our stockholders, for each taxable year, of at least 90% of our ICTI |
ASC | 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 |
CLO | Collateralized loan obligation |
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, as amended |
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 |
Net Loan Fees | The cumulative amount of fees, such as discounts, premiums and amendment fees that are deferred and recognized as income over the life of the loan. |
OCCI | OFS Credit Company, Inc., a closed-end management investment company that has registered as an investment company under the 1940 Act that primarily invests in CLO debt and subordinated (i.e., residual or equity) securities |
Offering | Follow-on public offering of 3,625,000 shares of our common stock in April 2017 |
OFS Advisor | OFS Capital Management, LLC, a wholly owned subsidiary of OFSAM and registered investment adviser under the Advisers 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 of the Company |
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 |
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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, as amended |
SBIC I LP | OFS SBIC I, LP, a wholly owned SBIC subsidiary of the Company |
SEC | U.S. Securities and Exchange Commission |
The Order | We received exemptive relief from the SEC to permit us to co-invest in portfolio companies with certain funds managed by 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. |
Transaction Price | The cost of an arm's length transaction occurring in the same security |
Unsecured Notes | The combination of the Unsecured Notes Due April 2025 and the Unsecured Notes Due October 2025 |
Unsecured Notes Due April 2025 | The Company's $50.0 million aggregate principal amount of 6.375% notes due April 30, 2025 |
Unsecured Notes Due October 2025 | The Company's $48.5 million aggregate principal amount of 6.5% notes due October 30, 2025 |
Valuation Methodology Change | 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 |
WM Credit Facility | Secured revolving line of credit with Wells Fargo Bank, N.A, terminated on May 28, 2015 |
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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, 2018, the fair value of our debt investment portfolio totaled $363.6 million in 44 portfolio companies, of which 88% was comprised of senior secured loans and 12% of subordinated loans. Additionally, as of December 31, 2018, we held approximately $33.2 million in equity investments, at fair value, in 13 portfolio companies in which we also held debt investments and six portfolio companies in which we solely held an equity investment.
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 $251.1 million and $251.6 million in assets, or approximately 57% and 70% of our total consolidated assets, at December 31, 2018 and 2017, respectively.
Our investment activities are managed by OFS Advisor and supervised by our Board a majority of whom are independent of us, OFS Advisor and its affiliates. Under the Investment Advisory Agreement we have agreed to pay OFS Advisor an annual base management fee based on the average value of our total assets (other than cash and cash equivalents but including assets purchased with borrowed funds and including assets owned by any consolidated entity) as well as an incentive fee based on our investment performance. We have elected to exclude from the base management fee calculation any base management fee that would be owed in respect of the intangible asset and goodwill resulting from the SBIC Acquisition. OFS Advisor also serves as the investment adviser or collateral manager to CLOs and other assets, including HPCI, a non-traded BDC with an investment strategy similar to the Company's, and OCCI, a newly organized, non-diversified, externally managed, closed-end management investment company that has registered as an investment company under the 1940 Act that primarily invests, in the CLO debt and subordinated (i.e., residual or equity) securities. 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
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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.
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). Provisions of the Small Business Credit Availability Act (the "SBCAA"), permit BDCs to be subject to a minimum asset coverage ratio of 150%, if specific conditions are satisfied, when issuing senior securities (i.e., the amount of debt may not exceed 66 2/3% of the value of our assets). As an approximation, prior to the enactment of the SBCAA, the most that a BDC could borrow for investment purposes was $1 for every $1 of investor equity. Now, for those BDCs that satisfy the SBCAA’s approval and disclosure requirements and become subject to the reduced asset coverage ratio, the BDC can borrow $2 for investment purposes for every $1 of investor equity.
The SBCAA provides that in order for a BDC whose common stock is traded on a national securities exchange to be subject to 150% asset coverage, the BDC must either obtain: (i) approval of the required majority of its non-interested directors who have no financial interest in the proposal, which would become effective one year after the date of such approval, or (ii) obtain stockholder approval (of more than 50% of the votes cast for the proposal at a meeting in which quorum is present), which would become effective on the first day after the date of such stockholder approval.
On May 3, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements and, as a result, the asset coverage ratio test applicable to us will be decreased from 200% to 150%, effective May 3, 2019. Additionally, we received exemptive relief from the SEC effective November 26, 2013, which allows us to exclude our SBA guaranteed debentures from the definition of senior securities in the statutory asset coverage ratio under the 1940 Act.
We may borrow money when the terms and conditions available are favorable to do so and are aligned with our investment strategy and portfolio composition. The use of borrowed funds or the proceeds of preferred stock to make investments would have its own specific benefits and risks, and all of the costs of borrowing funds or issuing preferred stock would be borne by holders of our common stock.
We have elected to be treated for tax purposes as a RIC under Subchapter M of the Code. To continue to qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. Pursuant to this election, we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders.
About OFS and Our Advisor
OFS (which refers to the collective activities and operations of OFSAM, its subsidiaries, and certain affiliates) is a full-service provider of capital and leveraged finance solutions to U.S. companies.
As of December 31, 2018, OFS had 46 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 funds and assets owned by any consolidated entity) and, therefore, OFS Advisor will benefit when we incur debt or use leverage. Our board of directors is charged with protecting our interests by monitoring how OFS Advisor addresses these and other conflicts of interest associated with its management services and compensation. While our board of directors is not expected to review or approve each borrowing or incurrence of leverage, our independent directors periodically review OFS Advisor’s services and fees as well as its portfolio management decisions and portfolio performance.
OFS Advisor has entered into a Staffing Agreement (the "Staffing Agreement") with OFSC, a wholly-owned subsidiary of OFSAM. Under the Staffing Agreement, OFSC makes experienced investment professionals available to OFS 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.
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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 to the resources and expertise of OFS’s investment professionals through the Staffing Agreement with OFSC. As of December 31, 2018, OFS’s credit and investment professionals (including all investment committee members) employed by OFSC had an average of over 15 years of investment experience with strong institutional backgrounds.
Significant Investment Capacity. The net proceeds of equity and debt offerings and borrowing capacity under our credit facilities will provide us with a substantial amount of capital available for deployment into new investment opportunities in our targeted asset class.
Scalable Infrastructure Supporting the Entire Investment Cycle. We believe that our loan acquisition, origination and sourcing, underwriting, administration and management platform is highly scalable (that is, it can be expanded on a cost-efficient basis within a timeframe that meets the demands of business growth). Our platform extends beyond origination and sourcing and includes a regimented credit monitoring system. We believe that our careful approach, which involves ongoing review and analysis by an experienced team of professionals, should enable us to identify problems early and to assist borrowers before they face difficult liquidity constraints.
Extensive Loan Sourcing Capabilities. OFS Advisor gives us access to the deal flow of OFS. We believe OFS’s 20-year history as a middle-market lending platform, extensive relationships with potential borrowers and other lenders, and its market position make it a leading lender to many sponsors and other deal sources, especially in the currently under-served lending environment.
Structuring with a High Level of Service and Operational Orientation. We provide client-specific and creative financing structures to our portfolio companies. Based on our experience in lending to and investing in middle-market companies, we believe that the middle-market companies we target, as well as sponsor groups we may pursue, require a higher level of service, creativity and knowledge than has historically been provided by other service providers more accustomed to participating in commodity-like loan transactions.
Rigorous Credit Analysis and Approval Procedures. OFS Advisor utilizes an established, disciplined investment process of OFS for reviewing lending opportunities, structuring transactions and monitoring investments. Using a disciplined approach to lending, OFS Advisor seeks to minimize credit losses through effective underwriting, comprehensive due diligence investigations, structuring and, where appropriate, the implementation of restrictive debt covenants.
Our Administrator
We do not have any direct employees, and our day-to-day investment operations are managed by OFS Advisor. We have a chief executive officer, chief financial officer, chief compliance officer, chief accounting officer, corporate secretary and, to the extent necessary, our board of directors may elect to appoint additional officers going forward. Our officers are employees of OFSC, an affiliate of OFS Advisor, and a portion of the compensation paid to our officers is paid by us pursuant to the Administration Agreement. All of our executive officers are also officers of OFS Advisor.
OFS Services, an affiliate of OFS Advisor, provides the administrative services necessary for us to operate. OFS Services furnishes us with office facilities and equipment, necessary software licenses and subscriptions and clerical, bookkeeping and recordkeeping services at such facilities. OFS Services oversees our financial reporting as well as prepares our reports to stockholders and all other reports and materials required to be filed with the SEC or any other regulatory authority. OFS Services also manages the determination and publication of our net asset value and the preparation and filing of our tax returns and generally monitors the payment of our expenses and the performance of administrative and professional services rendered to us by others. OFS Services may retain third parties to assist in providing administrative services to us. To the extent that OFS Services outsources any of its functions, we will pay the fees associated with such functions at cost, on a direct basis.
Market Opportunity
Our investment strategy is focused primarily on investments in middle-market companies in the United States. We find the middle-market attractive for the following reasons:
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Large Target Market. According to the National Center for the Middle Market, there were approximately 200,000 companies in the United States with annual revenues between $10 million and $1.0 billion, 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 majority of our portfolio as of December 31, 2018. We believe that this market segment will continue to produce significant investment opportunities for us.
Specialized Lending Requirements with High Barriers to Entry. We believe that several factors render many U.S. financial institutions ill-suited to lend to U.S. middle-market companies. For example, based on the experience of our management team, lending to private middle-market companies in the United States (a) is generally more labor-intensive than lending to larger companies due to the smaller size of each investment and the fragmented nature of information for such companies, (b) requires due diligence and underwriting practices consistent with the demands and economic limitations of the middle-market and (c) may also require more extensive ongoing monitoring by the lender. As a result, middle-market companies historically have been served by a limited segment of the lending community. As a result of the unique challenges facing lenders to middle-market companies, we believe that there are high barriers to entry that a new lender must overcome.
Robust Demand for Debt Capital. We believe that private equity firms have significant committed but uncalled capital, a large portion of which is still available for investment in the United States. Subject to market conditions, we expect the large amount of unfunded buyout commitments will drive demand for leveraged buyouts over the next several years, which should, in turn, create leveraged lending opportunities for us.
Competition
Our primary competitors include public and private funds, other BDCs, commercial and investment banks, commercial finance companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical, and marketing resources than we do. Some competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Further, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC, or to the distribution and other requirements we must satisfy to maintain our RIC status.
We expect to continue to use the expertise of the investment professionals of OFS to which we have access, to assess investment risks and determine appropriate pricing for our investments in portfolio companies. In addition, we expect that the relationships of the senior members of OFS and its affiliates will enable us to learn about, and compete effectively for, financing opportunities with attractive middle-market companies in the industries in which we seek to invest. For additional information concerning the competitive risks we face,
Investment Criteria/Guidelines
Our investment objective is to generate current income and capital appreciation by investing primarily in middle-market companies in the United States. We focus on investments in senior secured loans, including first lien, second lien, and unitranche loans, as well as subordinated loans and, to a lesser extent, warrants and other equity securities. 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; |
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• | generally, private companies owned by private equity firms or owners/operators; |
• | enterprise value between $10 million and $500 million; |
• | effective and experienced management teams; |
• | defensible market share; |
• | solid historical financial performance, including a steady stream of cash flow; |
• | high degree of recurring revenue; |
• | diversity of customers, markets, products and geography; and |
• | differentiated products or services. |
While we believe that the characteristics listed above are important in identifying and investing in prospective portfolio companies, not all of these criteria will be met by each prospective portfolio company.
Due Diligence and Investment Process Overview
We employ a thorough and disciplined underwriting and due diligence process that is conducted in accordance with established credit policies and procedures, and that is focused on investment recovery. Our process involves a comprehensive analysis of a prospective portfolio company’s market, operational, financial, and legal position, as well as its future prospects. In addition to our own analysis, we may use the services of third parties for environmental reviews, quality of earnings reports, industry surveys, background checks on key managers, and insurance reviews.
We seek to invest in companies that have experienced and incentivized management teams, that have stable and predictable cash flows, and that have defensible market positions. We underwrite our investments with the expectation that we will hold them for a number of years, and we structure and document our investments accordingly.
Our due diligence and underwriting process typically addresses the following elements (although certain elements may not be included in every due diligence undertaking):
Prospective Portfolio Company Characteristics - focusing on primary drivers of the company’s revenues and cash flows, including its key products and services; customer and supplier concentrations, and contractual relationships; depth, breadth, and quality of company management, as well as the extent to which the management team is appropriately compensated with equity incentives; and any regulatory, labor, or litigation matters impacting the company.
Industry and Competitive Overview - including industry size and the company’s position within it; growth potential and barriers to entry; governmental, regulatory, or technological issues potentially affecting the industry; and cyclicality or seasonality risks associated with the industry.
Financial Analysis - involving an understanding of the company’s historical financial results, focusing on actual operating trends experienced over time, in order to forecast future performance, including in various sensitized performance scenarios; attention to projected cash flows, debt service coverage, and leverage multiples under such scenarios; and an assessment of enterprise valuations and debt repayment/investment recovery prospects given such sensitized performance scenarios.
Investment Documentation - focusing on obtaining the best legal protections available to us given our position within the capital structure, including, as appropriate, financial covenants; collateral liens and stock pledges; review of loan documents of other of the prospective portfolio company’s creditors; and negotiation of inter-creditor agreements.
Portfolio Review/Risk Monitoring
We view active portfolio monitoring as a vital part of our investment process, and we benefit from a portfolio management system developed by OFS that includes daily, weekly, monthly, and quarterly components, and that involves comprehensive review of the performance of each of our portfolio companies. As part of the portfolio management process, OFS Advisor performs ongoing risk assessments on each of our investments and assigns each debt investment a credit rating based on OFS’s internal ratings scale.
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.
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2 (Below Average Risk) – The debt investment has acceptable asset quality, moderate excess liquidity, and modest leverage capacity. It could have some financial/non-financial weaknesses which are offset by strengths; however, the credit demonstrates an ample current cash flow from operations. The trends and outlook for the portfolio company's operations, balance sheet, and industry are generally positive or neutral to somewhat negative. Collateral, if appropriate, has maintained value and would be capable of being liquidated successfully on a timely basis.
3 (Average) – The debt investment has acceptable asset quality, somewhat strained liquidity, and minimal leverage capacity. It is at times characterized by acceptable cash flows from operations. Under adverse market conditions, the debt service could pose difficulties for the borrower. The trends and conditions of the portfolio company's operations and balance sheet are neutral to slightly negative.
4 (Special Mention) – The debt investment has not lost, and is not expected to lose, principal or interest but it possesses credit deficiencies or potential weaknesses which deserve management’s close and continued attention. The portfolio company’s operations and/or balance sheet have demonstrated an adverse trend or deterioration which, while serious, has not reached the point where the liquidation of debt is jeopardized. These weaknesses are generally considered correctable by the borrower in the normal course of business but may weaken the asset or inadequately protect our credit position if not checked or corrected.
5 (Substandard) – The debt investment is protected inadequately by the current enterprise value or paying capacity of the obligor or of the collateral, if any. The portfolio company has well-defined weaknesses based upon objective evidence, such as recurring or significant decreases in revenues and cash flows. These assets are characterized by the possibility that we may sustain loss if the deficiencies are not corrected. The possibility that liquidation would not be timely (e.g., bankruptcy or foreclosure) requires a Substandard classification even if there is little likelihood of loss.
6 (Doubtful) – The debt investment has all the weaknesses inherent in those classified as Substandard, with the additional factor that the weaknesses are pronounced to the point that collection or liquidation in full, on the basis of currently existing facts, conditions and values, is deemed uncertain. The possibility of loss on a Doubtful asset is high but, because of certain important and reasonably specific pending factors which may strengthen the asset, its classification as an estimated loss is deferred until its more exact status can be determined.
7 (Loss) – The debt investment is considered almost fully uncollectible and of such little value that its continuance as an asset is not warranted. It is generally a credit that is no longer supported by an operating company, a credit where the majority of our assets have been liquidated or sold and a few assets remain to be sold over many months or even years, or a credit where the remaining collections are expected to be minimal.
As of December 31, 2018, we had debt investments in 44 portfolio companies, totaling $363.6 million at fair value, of which $3.8 million, $329.6 million, $29.3 million, and $0.0 million, and $0.9 million were rated 2, 3, 4, 5, and 6, respectively.
Investment Committees
OFS Advisor’s Pre-Allocation Investment Committee, CLO Investment Committee, Structured Credit Investment Committee and Middle-Market Investment Committee, (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, Kyde Sharp 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, are responsible for the evaluation and approval of all the investments made by us directly or through our wholly-owned subsidiaries, as appropriate.
The process employed by the Advisor Investment Committees, including the Middle-Market Investment Committee, and the SBIC Investment Committee is intended to bring the diverse experience and perspectives of the committees’ members to the investment process. The Middle-Market Investment Committee and SBIC Investment Committee serve to provide investment consistency and adherence to our core investment philosophy and policies. The Middle-Market Investment Committee and SBIC Investment Committee also determine appropriate investment sizing and implement ongoing monitoring requirements of our investments.
In certain instances, management may seek the approval of our Board prior to the making of an investment. In addition to reviewing investments, the meetings of the Middle-Market Investment Committee and SBIC Investment Committee, where applicable, serve as a forum to discuss credit views and outlooks. Potential transactions and deal flows are reviewed on a regular basis. Members of the investment team are encouraged to share information and views on credits with members of the Middle-Market Investment Committee and SBIC Investment Committee, where applicable, early in their analysis. We believe this process improves the quality of the analysis and assists the deal team members in working efficiently.
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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 characteristics:
Senior Secured First-Lien Loans. First-lien senior secured loans comprise, and will continue to comprise, a significant portion of our investment portfolio. We obtain security interests in the assets of these portfolio companies as collateral in support of the repayment of these loans (in certain cases, subject to a payment waterfall). The collateral takes the form of first-priority liens on specified assets of the portfolio company borrower and, typically, first-priority pledges of the ownership interests in the borrower. Our first lien loans may provide for moderate loan amortization in the early years of the loan, with the majority of the amortization deferred until loan maturity. 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 Unitranche Loans. Unitranche loans are loans that combine both senior and subordinated debt into one loan under which the borrower pays a single blended interest rate that is intended to reflect the relative risk of the secured and unsecured components. We typically structure our unitranche loans as senior secured loans. We obtain security interests in the assets of these portfolio companies as collateral in support of the repayment of these loans. This collateral takes the form of first-priority liens on the assets of a portfolio company and, typically, first-priority pledges of the ownership interests in the company. We believe that unitranche lending represents a significant growth opportunity for us, offering the borrower the convenience of dealing with one lender, which may result in a higher blended rate of interest to us than we might realize in a traditional multi-tranche structure. Unitranche loans typically provide for moderate loan amortization in the initial years of the facility, with the majority of the amortization deferred until loan maturity. Unitranche loans generally allow the borrower to make a large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity. In many cases, we will be the sole lender, or we, together with our affiliates, will be the sole lender, of unitranche loans, which can afford us additional influence with a borrower in terms of monitoring and, if necessary, remediation in the event of under performance. 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 the financial statements included elsewhere in this prospectus supplement.
Broadly Syndicated Loans. Broadly Syndicated Loans (whose features are similar to those described under “Senior Secured First-Lien Loans” and “Senior Secured Second-Lien Loans” above) are typically originated and structured by banks on behalf of large corporate borrowers with employee counts, revenues, EBITDAs and enterprise values larger than the middle-market characteristics described above. The proceeds of Broadly Syndicated Loans are often used for leveraged buyout transactions, mergers and acquisitions, recapitalizations, refinancings, and financing capital expenditures. Broadly Syndicated Loans are typically distributed by the arranging bank to a diverse group of investors primarily consisting of: CLOs; senior secured loan and high yield bond mutual funds; closed-end funds, hedge funds, banks, and insurance companies; and finance companies. A borrower must comply with various covenants contained in a loan agreement or note purchase agreement between the borrower and the holders of the Broadly Syndicated Loan (the “Loan Agreement”). In a typical Broadly Syndicated Loan, an administrative agent (the “Agent”) administers the terms of the Loan Agreement. In such cases, the Agent is normally responsible for the collection of principal and interest payments from the borrower and the apportionment of these payments to the credit of all institutions that are parties to the Loan Agreement. We will generally rely upon the Agent or an intermediate participant to receive and forward to us our portion of the principal and interest payments on the Broadly Syndicated Loan. Additionally, we normally will rely on the Agent and the other loan investors to use appropriate credit remedies against the borrower. The Agent is typically responsible for monitoring compliance with covenants contained in the Loan Agreement based upon reports prepared by the borrower. The Agent may monitor the value of the collateral and, if the value of the collateral declines, may accelerate the Broadly Syndicated Loan, may give the borrower an opportunity to provide additional collateral or
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may seek other protection for the benefit of the participants in the Broadly Syndicated Loan. The Agent is compensated by the borrower for providing these services under a Loan Agreement, and such compensation may include special fees paid upon structuring and funding the Broadly Syndicated Loan and other fees paid on a continuing basis. The Broadly Syndicated Loans in which we invest may include loans that are considered “covenant-lite” loans, because of their lack of a full set of financial maintenance covenants.
Subordinated (“Mezzanine”) Loans. These investments are typically structured as unsecured, subordinated loans that typically provide for relatively high, fixed interest rates that provide us with significant current interest income. These loans typically will have interest-only payments (often representing a combination of cash pay and payment-in-kind ("PIK") interest) in the early years, with amortization of principal deferred to maturity. Mezzanine loans generally allow the borrower to make a large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity. Mezzanine investments are generally more volatile than secured loans and may involve a greater risk of loss of principal. Mezzanine loans often include a PIK feature (meaning a feature allowing for the payment of interest in the form of additional principal amount of the loan instead of in cash), which effectively operates as negative amortization of loan principal, thereby increasing credit risk exposure over the life of the loan. These loans are categorized as Subordinated Loans in our consolidated schedule of investments included in the financial statements included elsewhere in this prospectus supplement.
Equity Securities. Equity securities typically consist of either a direct minority equity investment in common or membership/partnership interests or preferred stock of a portfolio company, and are typically not control-oriented investments. Our preferred equity investments typically contain a fixed dividend yield based on the par value of the equity security. Preferred equity dividends may be paid in cash at a stipulated date, usually quarterly, and are participating and/or cumulative. We may structure such equity investments to include provisions protecting our rights as a minority-interest holder, as well as a “put,” or right to sell such securities back to the issuer, upon the occurrence of specified events. In many cases, we may also seek to obtain registration rights in connection with these equity interests, which may include demand and “piggyback” registration rights, which grants us the right to register our equity interest when either the portfolio company or another investor in the portfolio company files a registration statement with the SEC to issue securities. Our equity investments typically are made in connection with debt investments to the same portfolio companies. These securities are categorized as a Preferred Equity or Common Equity in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and Supplementary Data."
Warrants. In some cases, we may receive nominally priced warrants to buy a minority equity interest in the portfolio company in connection with a loan. As a result, as a portfolio company appreciates in value, we may achieve additional investment return from this equity interest. We may structure such warrants to include provisions protecting our rights as a minority-interest holder, as well as a put to sell such securities back to the issuer, upon the occurrence of specified events. In many cases, we may also seek to obtain registration rights in connection with these equity interests, which may include demand and “piggyback” registration rights. These securities are categorized as Warrants in our consolidated schedule of investments included in "Part II, Item 8. Financial Statements and Supplementary Data."
Structured Finance Notes. We may purchase interests in the equity securities of CLOs collateralized by portfolios consisting primarily of below investment grade U.S. senior secured loans with a large number of distinct underlying borrowers across various industry sectors. The equity of a CLO is unrated and subordinated to the debt tranches and typically represents approximately 8% to 11% of a CLO’s capital structure. A CLO’s equity represents the first loss position in the CLO. The holders of CLO equity interests are typically entitled to any cash reserves that form part of the structure when such reserves are permitted to be released. Structured Finance Notes are considered CLO subordinated debt positions. CLO subordinated debt positions are entitled to recurring distributions which are generally equal to the remaining cash flow of payments made by underlying securities less contractual payments to debt holders and fund expenses. Economically, CLO equity benefits from gains and suffers from losses and generally receive the difference between the interest received from the investment portfolio and the interest paid to the holders of debt tranches of the CLO structure. In addition, the CLO equity securities in which we may invest in the future are highly leveraged (with CLO equity securities typically being leveraged 9 to 13 times), which magnifies our risk of loss on such investments.
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 |
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• | 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.
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.
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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 $6.3 million, $5.0 million, and $4.5 million, for the years ended December 31, 2018, 2017, and 2016, respectively.
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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% | |
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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.”
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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 5, 2018. 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.
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Our board also reviewed services provided under the Administrative Agreement, and approved its renewal at the April 5, 2018 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.
The 1940 Act generally prohibits BDCs from making certain negotiated co-investments with certain affiliates absent an order from the SEC permitting the BDC to do so. On October 12, 2016, we received the Order from the SEC to permit us to co-invest in portfolio companies with certain BDCs, registered investment companies and private funds managed by OFS Advisor, or any adviser that controls, is controlled by, or is under common control with, OFS Adviser and is registered as an investment adviser under the Advisers Act, in a manner consistent with our investment strategy as well as applicable law, including the terms and conditions of the Order. Pursuant to the Order, we are generally permitted to participate in a co-investment transaction if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors makes certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies. We have applied for a new exemptive order (the “New Order”), which, if granted, would supersede the Order and would permit us greater flexibility to enter into co-investment transactions. There can be no assurance that we will obtain such new exemptive relief from the SEC.
We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities Act. Our intention is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies, except that we may enter into hedging transactions to manage the risks associated with interest rate fluctuations. However, we may purchase or otherwise receive warrants to purchase the common stock of our portfolio companies in connection with acquisition financing or other investments. Similarly, in connection with an acquisition, we may acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under certain circumstances. We also do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, except for registered money market funds, we generally cannot acquire more than 3% of the voting stock of any registered investment company, invest more than 5% of the value of our total assets in the securities of one investment company, or invest more than 10% of the value of our total assets in the securities of more than one investment company. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such investments might subject our stockholders to additional expenses as they will be indirectly responsible for the costs and expenses of such companies. None of our investment policies are fundamental and may be changed without stockholder approval.
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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; and |
(f) | Cash, cash equivalents, U.S. government securities or high-quality debt securities that mature in one year or less from the date of investment. |
Control, as defined by the 1940 Act, is presumed to exist where a BDC beneficially owns more than 25% of the outstanding voting securities of the portfolio company.
The regulations defining qualifying assets may change over time. We may adjust our investment focus as needed to comply with and/or take advantage of any regulatory, legislative, administrative or judicial actions in this area.
Managerial Assistance to Portfolio Companies
A BDC must have been organized and have its principal place of business in the United States and must be operated for the purpose of making investments in the types of securities described in (a), (b) or (c) above. However, in order to count portfolio securities as qualifying assets for the purpose of the 70% test, the BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance. Where the BDC purchases such securities in conjunction with one or more other persons acting together, the BDC will satisfy this test if one of the other persons in the group makes available such managerial assistance, although this may not be the sole method by which the BDC satisfies the requirement to make available managerial assistance. Making available managerial assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company. With respect to an SBIC, making available managerial assistance means the making of loans to a portfolio company.
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Temporary Investments
Pending investment in other types of qualifying assets, as described above, our investments may consist of cash, cash equivalents, U.S. government securities, repurchase agreements and high-quality debt investments that mature in one year or less from the date of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets, as defined by the 1940 Act, are qualifying assets or temporary investments. We may invest in highly rated commercial paper, U.S. Government agency notes, and U.S. Treasury bills or repurchase agreements relating to such securities that are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest rate. Consequently, repurchase agreements are functionally similar to loans. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, the 1940 Act and certain diversification tests in order to qualify as a RIC for U.S. federal income tax purposes typically require us to limit the amount we invest with any one counterparty. Accordingly, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. OFS Advisor monitors the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
Warrants and Options
Under the 1940 Act, a BDC is subject to restrictions on the amount of warrants, options, restricted stock or rights to purchase shares of capital stock that it may have outstanding at any time. Under the 1940 Act, we may generally only offer warrants provided that (i) the warrants expire by their terms within ten years, (ii) the exercise or conversion price is not less than the current market value at the date of issuance, (iii) our stockholders authorize the proposal to issue such warrants, and our board of directors approves such issuance on the basis that the issuance is in the best interests of OFS Capital and its stockholders and (iv) if the warrants are accompanied by other securities, the warrants are not separately transferable unless no class of such warrants and the securities accompanying them has been publicly distributed. The 1940 Act also provides that the amount of our voting securities that would result from the exercise of all outstanding warrants, as well as options and rights, at the time of issuance may not exceed 25% of our outstanding voting securities. In particular, the amount of capital stock that 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
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). Provisions of the SBCAA permit BDCs to be subject to a minimum asset coverage ratio of 150%, if specific conditions are satisfied, when issuing senior securities (i.e., the amount of debt may not exceed 66 2/3% of the value of our assets). As an approximation, prior to the enactment of the SBCAA, the most that a BDC could borrow for investment purposes was $1 for every $1 of investor equity. Now, for those BDCs that satisfy the SBCAA’s approval and disclosure requirements and become subject to the reduced asset coverage ratio, the BDC can borrow $2 for investment purposes for every $1 of investor equity.
The SBCAA provides that in order for a BDC whose common stock is traded on a national securities exchange to be subject to 150% asset coverage, the BDC must either obtain: (i) approval of the required majority of its non-interested directors who have no financial interest in the proposal, which would become effective one year after the date of such approval, or (ii) obtain stockholder approval (of more than 50% of the votes cast for the proposal at a meeting in which quorum is present), which would become effective on the first day after the date of such stockholder approval.
On May 3, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements and, as a result, the asset coverage ratio test applicable to us will be decreased from 200% to 150%, effective May 3, 2019. Additionally, we received exemptive relief from the SEC effective November 26, 2013, which allows us to exclude our SBA guaranteed debentures from the definition of senior securities in the statutory asset coverage ratio under the 1940 Act.
We may borrow money when the terms and conditions available are favorable to do so and are aligned with our investment strategy and portfolio composition. The use of borrowed funds or the proceeds of preferred stock to make investments would have its own specific benefits and risks, and all of the costs of borrowing funds or issuing preferred stock would be borne by holders of our common stock.
For a discussion of the risks associated with leverage, see “Item 1A. Risk Factors—Risks Related to BDCs—Regulations governing our operation as a BDC affect our ability to and the way in which we raise additional capital. As a BDC, we will need to raise additional capital, which will expose us to risks, including the typical risks associated with leverage.”
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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.
Exemptive Relief
We are generally prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our board of directors who are not interested persons and, in some cases, prior approval by the SEC. The SEC has interpreted the BDC prohibition on transactions with affiliates to prohibit all “joint transactions” between entities that share a common investment adviser. Further, the 1940 Act generally prohibits BDCs from making certain negotiated co-investments with certain affiliates absent an order from the SEC permitting the BDC to do so.
On October 12, 2016, we received the Order from the SEC to permit us to co-invest in portfolio companies with certain BDCs, registered investment companies and private funds managed by OFS Advisor or any adviser that controls, is controlled by, or is under common control with, OFS Adviser, and is registered as an investment adviser under the Advisers Act, in a manner consistent with our investment strategy as well as applicable law, including the terms and conditions of the Order. Pursuant to the Order, we are generally permitted to participate in a co-investment transaction if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors makes certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies. The Order is subject to additional terms and conditions; there can be no assurance that we will be permitted to co-invest with certain of our affiliates other than in the circumstances currently permitted by regulatory guidance and in compliance with conditions of the Order. We have applied for the New Order which, if granted, would supersede the Order and would permit us greater flexibility to enter into co-investment transactions. There can be no assurance that we will obtain such new exemptive relief from the SEC.
On October 12, 2016, we received the Order from the SEC to permit us to co-invest in portfolio companies with certain BDCs, registered investment companies and private funds managed by OFS Advisor or any adviser that controls, is controlled by, or is under common control with, OFS Adviser, and is registered as an investment adviser under the Advisers Act, in a manner consistent with our investment strategy as well as applicable law, including the terms and conditions of the Order. Pursuant to the Order, we are generally permitted to participate in a co-investment transaction if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors makes certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies. The Order is subject to additional terms and conditions; there can be no assurance that we will be permitted to co-invest with certain of our affiliates other than in the circumstances currently permitted by regulatory guidance and in compliance with conditions of the Order. We have applied for the New Order which, if granted, would supersede the Order and would permit us greater flexibility to enter into co-investment transactions. There can be no assurance that we will obtain such new exemptive relief from the SEC.
The staff of the SEC has granted no-action relief permitting purchases of a single class of privately placed securities provided that the adviser negotiates no term other than price and certain other conditions are met. As a result, unless under the Order, we only expect to co-invest on a concurrent basis with certain funds advised by OFS Advisor when each of us will own the same securities of the issuer and when no term is negotiated other than price. Any such investment would be made, subject to compliance with existing regulatory guidance, applicable regulations and OFS Advisor’s allocation policy. If opportunities arise that would otherwise be appropriate for us and for another fund advised by OFS Advisor to invest in different securities of the same issuer, OFS Advisor will need to decide which fund will proceed with the investment. The decision by OFS Advisor to allocate an opportunity to another entity could cause us to forego an investment opportunity that we otherwise would have made. Moreover, except in certain circumstances, we will be unable to invest in any issuer in which another fund advised by OFS Advisor has previously invested.
Small Business Investment Company Regulations
Our wholly owned subsidiary, SBIC I LP, is an SBIC and must maintain compliance with SBA regulations.
SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses. The SBIC license 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 (or $175 million with SBA approval) when it has at least $75 million in regulatory capital (or $87.5 million with approval to borrow up to $175 million), receives a leverage commitment from the SBA and has been through an examination by the SBA subsequent
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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 (total assets less goodwill less total liabilities) not exceeding $19.5 million and have average annual net income after U.S. federal income taxes not exceeding $6.5 million (average net income to be computed without benefit of any carryover loss) for the two most recent fiscal years. In addition, an SBIC must devote 25% of its investment activity to “smaller concerns,” as defined by the SBA. A smaller concern generally includes businesses that have a tangible net worth not exceeding $6 million and have average annual net income after U.S. federal income taxes not exceeding $2 million (average net income to be computed without benefit of any net carryover loss) for the two most recent fiscal years. SBA regulations also provide alternative criteria to determine eligibility, which may include, among other things, the industry in which the business is engaged, the number of employees of the business, its gross sales, and the extent to which the SBIC is proposing to participate in a change of ownership of the business. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services.
The SBA prohibits an SBIC from providing funds to small businesses for certain purposes, such as relending, real estate or investing in companies outside of the United States, and from providing funds to businesses engaged in a few prohibited industries and to certain “passive” (i.e., non-operating) companies. In addition, without prior SBA approval, an SBIC may not invest an amount equal to more than approximately 30% of the SBIC’s regulatory capital in any one company and its affiliates.
SBICs must invest idle funds that are not being used to make investments permitted under SBA regulations in the following limited types of securities: (i) direct obligations of, or obligations guaranteed as to principal and interest by, the U.S. government, which mature within 15 months from the date of the investment; (ii) repurchase agreements with federally insured institutions with a maturity of seven days or less (and the securities underlying the repurchase obligations must be direct obligations of or guaranteed by the federal government); (iii) certificates of deposit with a maturity of one year or less, issued by a federally insured institution; (iv) a deposit account in a federally insured institution that is subject to a withdrawal restriction of one year or less; (v) a checking account in a federally insured institution; or (vi) a reasonable petty cash fund.
SBA regulations include restrictions on a “change of control” or other transfers of limited partnership interests in an SBIC. In addition, SBIC I LP may also be limited in its ability to make distributions to us if it does not have sufficient accumulated net profit, in accordance with SBA regulations.
SBIC I LP is subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. 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
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invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code’s requirements. Our code of ethics is available, free of charge, on our website at www.ofscapital.com. The code of ethics is available on the EDGAR Database on the SEC’s website at http://www.sec.gov. You may also obtain copies of the code of ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to OFS Advisor. The proxy voting policies and procedures of OFS Advisor are set out below. The guidelines are reviewed periodically by OFS Advisor and our directors who are not “interested persons,” and, accordingly, are subject to change. For purposes of these proxy voting policies and procedures described below, “we,” “our” and “us” refer to OFS Advisor.
Introduction
As an investment adviser registered under the Advisers Act, we have a fiduciary duty to act solely in the best interests of our clients. As part of this duty, we recognize that we must vote client securities in a timely manner free of conflicts of interest and in the best interests of our clients.
These policies and procedures for voting proxies for our investment advisory clients are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.
Proxy Policies
We vote proxies relating to our portfolio securities in what we perceive to be the best interest of our clients. We review on a case-by-case basis each proposal submitted to a stockholder vote to determine its effect on the portfolio securities held by our clients. In most cases we will vote in favor of proposals that we believe are likely to increase the economic value of the underlying portfolio securities held by our clients. Although we will generally vote against proposals that may have a negative effect on our clients’ portfolio securities, we may vote for such a proposal if there exist compelling long-term reasons to do so.
Our proxy voting decisions are made by those senior officers who are responsible for monitoring each of our clients’ investments. To ensure that our vote is not the product of a conflict of interest, we require that (1) anyone involved in the decision-making process disclose to our chief compliance officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (2) employees involved in the decision-making process or vote administration are prohibited from revealing how we intend to vote on a proposal in order to reduce any attempted influence from interested parties. Where conflicts of interest may be present, we will disclose such conflicts to our client, including with respect to OFS Capital, those directors who are not interested persons and we may request guidance from such persons on how to vote such proxies for their account.
Proxy Voting Records
You may obtain information about how we voted proxies for the Company free of charge, by making a written request for proxy voting information to: OFS Capital Corporation, 10 S. Wacker Drive, Suite 2500, Chicago, Illinois 60606, Attention: Investor Relations, or by calling OFS Capital Corporation at (847) 734-2000. The SEC also maintains a website at http://www.sec.gov that contains such information.
Privacy Principles
We are committed to maintaining the privacy of our stockholders and to safeguarding their nonpublic personal information. The following information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties.
Generally, we do not receive any nonpublic personal information relating to our stockholders, although certain nonpublic personal information of our stockholders may become available to us. We do not disclose any nonpublic personal information about our stockholders or former stockholders to anyone, except as permitted by law or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third-party administrator).
We restrict access to nonpublic personal information about our stockholders to employees of OFS Advisor and its affiliates with a legitimate business need for the information. We maintain physical, electronic and procedural safeguards designed to protect the nonpublic personal information of our stockholders.
Material U.S. Federal Income Tax Considerations
Election to be Taxed as a RIC
We have elected to be taxed as a RIC under Subchapter M of the Code. As a RIC, we are not required to pay corporate-level U.S. federal income taxes on any income that we distribute to our stockholders from our otherwise taxable
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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 U.S. federal excise tax on certain undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98.2% of our capital gain net income (both long-term and short-term) for the one-year period ending October 31 in that calendar year (or, if we so elect, for that calendar year) and (3) any income and gains recognized, but not distributed, in preceding years and on which we paid no U.S. federal income tax (the “Excise Tax Avoidance Requirement”). We may choose to retain a portion of our ordinary income and/or capital gain net income in any year and pay the 4% U.S. federal excise tax on the retained amounts.
In order to maintain our qualification as a RIC for U.S. federal income tax purposes, we must, among other things:
• | continue to qualify as a BDC under the 1940 Act at all times during each taxable year; |
• | derive in each taxable year at least 90% of our gross income from dividends, interest, certain payments with respect to loans of stock and securities, gains from the sale or other disposition of stock, securities, or foreign currencies and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to our business of investing in such stock, securities or currencies, and net income derived from interests in “qualified publicly traded partnerships,” as such term is defined in the Code (the "90% Income Test"); and |
• | diversify our holdings so that at the end of each quarter of the taxable year: |
• | at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities, with such other securities limited, in respect of any one issuer, to an amount not greater than 5% of the value of our assets and 10% of the outstanding voting securities of such issuer; and |
• | no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that we control (as determined under applicable tax rules) and that are engaged in the same, similar or related trades or businesses or of one or more qualified publicly traded partnerships (the “Diversification Tests”). |
We may invest in partnerships, including qualified publicly traded partnerships, which may result in our being subject to state, local or foreign income taxes, franchise taxes, or withholding liabilities.
We are required to recognize ICTI in circumstances in which we have not received a corresponding payment in cash. For example, we hold debt obligations that are treated under applicable tax rules as issued with OID and debt instruments with PIK interest, and we must include in ICTI each year the portion of the OID and PIK interest that accrues for that year (as it accrues over the life of the obligation), irrespective of whether the cash representing such income is received by us in that taxable year. The continued recognition of non-cash ICTI may cause difficulty in meeting the Annual Distribution Requirement. We may be required to sell investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital, or forgo new investment opportunities to meet this requirement. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level U.S. federal income tax.
We are authorized to borrow funds and to sell assets in order to satisfy distribution requirements. However, under the 1940 Act, we are not permitted to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. Moreover, our ability to dispose of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous. See “Regulation—Senior Securities.”
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Certain of our investment practices may be subject to special and complex U.S. federal income tax provisions that may, among other things, (1) treat dividends that would otherwise qualify for the dividends received deduction or constitute qualified dividend income as ineligible for such treatment, (2) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (3) convert lower-taxed long-term capital gain into higher-taxed short-term capital gain or ordinary income, (4) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (5) cause us to recognize income or gain without receipt of a corresponding distribution of cash, (6) adversely affect the time as to when a purchase or sale of stock or securities is deemed to occur, (7) adversely alter the characterization of certain complex financial transactions and (8) produce income that will not be considered "qualifying income" for purposes of the 90% Income Test. We will monitor our transactions and may make certain tax elections to mitigate the potential adverse effect of these provisions, but there can be no assurance that any adverse effects of these provisions will be mitigated.
If we purchase shares in a “passive foreign investment company” (a “PFIC”), we may be subject to U.S. federal income tax on our allocable share of a portion of any “excess distribution” received on, or any gain from the disposition of, such shares even if our allocable share of such income is distributed as a taxable dividend to our stockholders. Additional charges in the nature of interest generally will be imposed on us in respect of deferred taxes arising from any such excess distribution or gain. If we invest in a PFIC and elect to treat the PFIC as a “qualified electing fund” under the Code (a “QEF”), in lieu of the foregoing requirements, we will be required to include in income each year our proportionate share of the ordinary earnings and net capital gain of the QEF, even if such income is not distributed by the QEF. Alternatively, we may be able to elect to mark-to-market at the end of each taxable year our shares in a PFIC; in this case, we will recognize as ordinary income our allocable share of any increase in the value of such shares, and as ordinary loss our allocable share of any decrease in such value to the extent that any such decrease does not exceed prior increases included in its income. Under either election, we may be required to recognize in a year income in excess of distributions from PFICs and proceeds from dispositions of PFIC stock during that year, and such income will nevertheless be subject to the Annual Distribution Requirement and will be taken into account for purposes of the 4% U.S. federal excise tax.
Some of the income and fees that we recognize may result in ICTI that will not be "qualifying income" for the 90% Income Test. In order to ensure that such income and fees do not disqualify us as a RIC for a failure to satisfy the 90% Income Test, we may recognize such income and fees directly or indirectly through one or more entities taxed as corporations for U.S. federal income tax purposes. Such corporations are required to pay U.S. corporate income tax on their earnings, which ultimately reduces our return on such income and fees.
Failure to Qualify as a RIC
If we are unable to maintain our qualification as a RIC, we will be subject to tax on all of our ICTI and Net Capital Gains at regular corporate rates; we will not receive a dividend deduction for any distributions to our stockholders. Distributions would not be required, and any distributions would be taxable to our stockholders as ordinary dividend income that would, for qualifying non-corporate U.S. stockholders, be eligible for the current 20% maximum rate to the extent of our current and accumulated earnings and profits (subject to limitations under the Code). Subject to certain limitations under the Code, corporate distributions would be eligible for the dividends-received deduction. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis (reducing that basis accordingly), and any remaining distributions would be treated as a capital gain. To qualify again to be taxed as a RIC in a subsequent year, we would be required to distribute to our stockholders our earnings and profits attributable to non-RIC years. In addition, if we failed to qualify as a RIC for a period greater than two taxable years, then we would be required to elect to recognize and pay tax on any net built-in gain (the excess of aggregate gain, including items of income, over aggregate loss that would have been realized if we had been liquidated) or, alternatively, be subject to taxation on such built-in gain recognized for a period of five years, in order to qualify as a RIC in a subsequent year.
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Item 1A. | Risk Factors |
RISK FACTORS
Investing in our common stock involves a number of significant risks. In addition to the other information contained in this Annual Report on Form 10-K, you should consider carefully the following information before making an investment in our common stock. The risks set out below are not the only risks we face. Additional risks and uncertainties not presently known to us or not presently deemed material by us might also impair our operations and performance. If any of the following events occur, our business, financial condition and results of operations could be materially and adversely affected. In such case, our net asset value and the trading price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business and Structure
We are dependent upon the OFS senior professionals for our future success and upon their access to the investment professionals and partners of OFS and its affiliates.
We do not have any internal management capacity or employees. We will depend on the diligence, skill and network of business contacts of the OFS senior professionals to achieve our investment objective. Our future success will depend, to a significant extent, on the continued service and coordination of the OFS senior management team, particularly Bilal Rashid, Senior Managing Director and President of OFSC, 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 certain of the Advisor Investment Committees, pursuant to a consulting agreement with Orchard Capital Corporation. The departure of Mr. Ressler or any of the senior managers of OFSC, or of a significant number of its other investment professionals, could have a material adverse effect on our ability to achieve our investment objective.
We expect that OFS Advisor will continue to evaluate, negotiate, structure, close and monitor our investments in accordance with the terms of the Investment Advisory Agreement. We can offer no assurance, however, that OFS senior professionals will continue to provide investment advice to us. If these individuals do not maintain their existing relationships with OFS and its affiliates and do not develop new relationships with other sources of investment opportunities, we may not be able to grow our investment portfolio or achieve our investment objective. In addition, individuals with whom the OFS senior professionals have relationships are not obligated to provide us with investment opportunities. Therefore, we can offer no assurance that such relationships will generate investment opportunities for us.
OFS Advisor is a subsidiary of OFSAM that has no employees and depends upon access to the investment professionals and other resources of OFS and its affiliates to fulfill its obligations to us under the Investment Advisory Agreement. OFS Advisor also depends upon OFS to obtain access to deal flow generated by the professionals of OFS and its affiliates. Under a Staffing Agreement between OFSC, a subsidiary of OFSAM that employs OFS’s personnel, and OFS Advisor, OFSC has agreed to provide OFS Advisor with the resources necessary to fulfill these obligations. The Staffing Agreement provides that OFSC will make available to OFS Advisor experienced investment professionals and access to the senior investment personnel of OFSC for purposes of evaluating, negotiating, structuring, closing and monitoring our investments. We are not a party to this Staffing Agreement and cannot assure stockholders that OFSC will fulfill its obligations under the agreement. If OFSC fails to perform, we cannot assure stockholders that OFS Advisor will enforce the Staffing Agreement or that such agreement will not be terminated by either party or that we will continue to have access to the investment professionals of OFSC and its affiliates or their information and deal flow.
The investment committees that oversee our investment activities are provided by OFS Advisor under the Investment Advisory Agreement. The loss of any member of the Advisor Investment Committees or of other OFS senior professionals could limit our ability to achieve our investment objective and operate as we anticipate. This could have a material adverse effect on our financial condition and results of operation.
Our business model depends to a significant extent upon strong referral relationships with financial institutions, sponsors and investment professionals. Any inability of OFS Advisor to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
We depend upon OFS Advisor to maintain relationships with financial institutions, sponsors and investment professionals, and we will continue to rely to a significant extent upon these relationships to provide us with potential investment opportunities. If OFS Advisor fails to maintain such relationships, or to develop new relationships with other sources of investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals with whom the principals of OFS Advisor have relationships are not obligated to provide us with investment opportunities, and, therefore, we can offer no assurance that these relationships will generate investment opportunities for us in the future.
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Our financial condition and results of operation will depend on our ability to manage our business effectively.
Our ability to achieve our investment objective and grow will depend on our ability to manage our business. This will depend, in turn, on the ability of the Advisor Investment Committees to identify, invest in and monitor companies that meet our investment criteria. The achievement of our investment objectives on a cost-effective basis will depend upon the Advisor Investment Committees' ability to execute our investment process, their ability to provide competent, attentive and efficient services to us and, to a lesser extent, our access to financing on acceptable terms. OFS Advisor has substantial responsibilities under the Investment Advisory Agreement. OFS Advisor's senior professionals and other personnel of OFS Advisor's affiliates, including OFSC, may be called upon to provide managerial assistance to our portfolio companies. These activities may distract them or slow our rate of investment. Any failure to manage our business and our future growth effectively could have a material adverse effect on our business, financial condition and results of operations.
To the extent PIK interest and PIK dividends constitute a portion of our income, we will be 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.
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. |
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 an independent service provider to prepare the valuation of these securities.
The types of factors that the board of directors takes into account in determining the fair value of our investments generally include, as appropriate, comparison to third-party yield benchmarks and comparison to publicly traded securities including such factors as yield, maturity and measures of credit quality, the enterprise value of a portfolio company, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and cash flow, the markets in which the portfolio company does business and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. Our net asset value could be adversely affected if our determinations regarding the
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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.
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 (or $175 million with SBA approval) when it has at least $75 million in regulatory capital (or $87.5 million with approval to borrow up to $175 million), receives a leverage commitment from the SBA and has been through an examination by the SBA subsequent to licensing. 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 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, 2018, the Company had fully funded its $75.0 million commitment to SBIC I LP. As of December 31, 2018, 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.
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
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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% (or 150% if certain requirements are met) (i.e., the amount of debt may not exceed 50% or 66 2/3% of the value of our assets). See "Regulation". 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% (or 150% if certain requirements are met) after deducting the amount of such dividend, distribution, or purchase price. If this ratio declines below the applicable threshold, we may not be 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, 2018, our asset coverage ratio was greater than 1,000%, excluding the debt held by SBIC I LP.
On May 3, 2018, the Board, including a "required majority" (as such item is determined in section 57(o) of the 1940 Act) of the Board, approved the application of a reduced 150% asset coverage ratio to us; therefore provided certain conditions are met, we will be subject to the reduced asset coverage ratio as of May 3, 2019.
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) | (30.00)% | (18.67)% | (7.33)% | 4.01% | 15.34% | ||||
(1) Assumes $396.8 million in investments at fair value, $260.4 million in debt outstanding, $175.0 million in net assets, and an average cost of funds of 4.9%. Assumptions are based on our financial condition and our average cost of funds at December 31, 2018.
Based on our outstanding indebtedness of $260.4 million as of December 31, 2018 and the average cost of funds of 4.9% as of that date, our investment portfolio must experience an annual return of at least 3.2% 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.
The amount of our debt outstanding increased due to the issuance of the Unsecured Notes.
Our ability to generate sufficient cash flow in the future is, to some extent, subject to general economic, financial, competitive, legislative and regulatory factors as well as other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations to meet the payment obligations of our debt.
Because we have received the approval of our Board, we will be subject to 150% Asset Coverage beginning on May 3, 2019.
The 1940 Act generally prohibits us from incurring indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). However, the SBCAA has modified the 1940 Act by allowing a BDC to increase the maximum amount of leverage it may incur from an asset coverage ratio of 200% to an asset coverage ratio of 150%, if certain requirements are met. Under the SBCAA, we are allowed to increase our leverage capacity if stockholders representing at least a majority of the votes cast, when quorum is met, approve a proposal to do so. If we receive stockholder approval, we would be allowed to increase our leverage capacity on the first day after such approval. Alternatively, the legislation allows a “required majority” (as defined in Section 57(o) of the 1940 Act) of our directors to approve an increase in our leverage capacity, and such approval would become effective after
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one year from the date of approval. In either case, we would be required to make certain disclosures on our website and in SEC filings regarding, among other things, the receipt of approval to increase our leverage, our leverage capacity and usage, and risks related to leverage.
On May 3, 2018 our Board approved the application of the reduced asset coverage ratio to us. As a result, we will be able to increase our leverage up to an amount that reduces our asset coverage ratio from 200% to 150% (i.e., the amount of debt may not exceed 66 2/3% of the value of our assets) beginning on May 3, 2019, assuming that additional borrowings are available and we are able to amend our PWB Credit Facility to permit additional leverage. Leverage magnifies the potential for loss on investments in our indebtedness and on invested equity capital. As we use leverage to partially finance our investments, you will experience increased risks of investing in our securities. If the value of our assets increases, then the additional leverage would cause the net asset value attributable to our common stock to increase more sharply than it would have had we not increased our leverage. Conversely, if the value of our assets decreases, the additional leverage would cause net asset value to decline more sharply than it otherwise would have had we not increased our leverage. Similarly, any increase in our income in excess of interest payable on the borrowed funds would cause our net investment income to increase more than it would without the additional leverage, while any decrease in our income would cause net investment income to decline more sharply than it would have had we not increased our leverage. Such a decline could negatively affect our ability to pay common stock dividends, scheduled debt payments or other payments related to our securities. Leverage is generally considered a speculative investment technique. See “- Risks Related to Our Business and Structure - We finance our investments with borrowed money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us.”
In addition, the ability of BDCs to increase their leverage will increase the capital available to BDCs and thus competition for the investments that we seek to make. This may negatively impact pricing on the investments that we do make and adversely affect our net investment income and results of operations.
Changes in interest rates will affect our cost of capital and net investment income.
To the extent we borrow money or issue preferred stock to make investments, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds or pay dividends on preferred stock and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income in the event we use debt to finance our investments. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act.
A rise in the general level of interest rates typically leads to higher interest rates applicable to our debt investments. Accordingly, an increase in interest rates may result in an increase of the amount of incentive fees payable to OFS Advisor.
We may enter into reverse repurchase agreements, which are another form of leverage.
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.
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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 U.S. federal income tax if we are unable to maintain our qualification as a RIC.
We have elected to be treated as a RIC under Subchapter M of the Code, but no assurance can be given that we will be able to maintain RIC status. As a RIC, we are not required to pay corporate-level U.S. federal income taxes on our income and capital gains distributed (or deemed distributed) to our stockholders, provided that we satisfy certain distribution and other requirements. To continue to qualify for tax treatment as a RIC under the Code and to be relieved of federal taxes on income and gains distributed to our stockholders, we must meet certain source-of-income, asset diversification and distribution requirements. The distribution requirement for a RIC is satisfied if we distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our stockholders on an annual basis. Because we use debt financing, and may, in the future, issue preferred stock, we are subject to certain asset coverage ratio requirements under the 1940 Act and financial covenants under loan and credit agreements or preferred stock that could, under certain circumstances, restrict us from making distributions necessary to qualify for tax treatment as a RIC. If we are unable to obtain cash from other sources, we may fail to maintain our qualification for the tax benefits available to RICs and, thus, may be subject to corporate-level U.S. federal income tax. To maintain our qualification as a RIC, we must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these tests may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments are in private or thinly traded public companies, any such dispositions could be made at disadvantageous prices and may result in substantial losses. If we fail to continue to qualify for tax treatment as a RIC for any reason and become subject to corporate-level U.S. federal income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distributions to stockholders and the amount of our distributions and the amount of funds available for new investments. Such a failure would have a material adverse effect on us and our stockholders.
Our subsidiaries and portfolio companies may be unable to make distributions to us that will enable us to meet RIC requirements, which could result in the imposition of an entity-level tax.
In order for us to maintain our tax treatment as a RIC and to minimize corporate-level taxes, we are required to distribute on an annual basis substantially all of our taxable income, which includes income from our subsidiaries and portfolio companies. 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 SBIC Act and SBA regulations governing SBICs from making certain distributions to us that may be necessary to enable us to continue to
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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 U.S. federal income tax.
We may in the future choose to pay distributions in our own stock, in which case stockholders may be required to pay tax in excess of the cash they receive.
We distribute taxable distributions that are payable in cash or shares of our common stock at the election of each stockholder. In accordance with guidance issued by the Internal Revenue Service, a publicly traded RIC should generally be eligible to treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder is permitted to elect to receive his or her distribution in either cash or stock of the RIC (even where there is a limitation on the percentage of the distribution payable in cash, provided that the limitation is at least 20%), subject to the satisfaction of certain guidelines. If too many stockholders elect to receive their distributions in cash, each such stockholder would receive a pro rata share of the total cash to be distributed and would receive the remainder of their distribution in shares of stock. If this and certain other requirements are met, for U.S. federal income tax purposes, the amount of the distribution paid in stock generally will be a taxable distribution in an amount equal to the amount of cash that could have been received instead of stock. If we decide to make any distributions consistent with this guidance that are payable in part in our stock, stockholders receiving such distribution would be required to include the full amount of the distribution (whether received in cash, our stock, or a combination thereof) as ordinary income (or as long-term capital gain to the extent such distribution is properly designated as a capital gain dividend) to the extent of our current and accumulated earnings and profits for United States federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with respect to such dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, it may be subject to transaction fees (e.g., broker fees or transfer agent fees) and the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our stock.
Because we expect to distribute substantially all of our net investment income and net realized capital gains to our stockholders, we may need additional capital to finance our growth and such capital may not be available on favorable terms or at all.
We have elected to be taxed for U.S. federal income tax purposes as a RIC under Subchapter M of the Code. If we meet certain requirements, including source of income, asset diversification and distribution requirements, and if we continue to qualify as a BDC, we will continue to qualify for tax treatment as RIC under the Code and will not have to pay corporate-level taxes on income we distribute to our stockholders as dividends, allowing us to substantially reduce or eliminate our corporate-level U.S. federal tax liability. 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, or 150%, if certain requirements are met. This requirement limits the amount that we may
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borrow. Because we will continue to need capital to grow our investment portfolio, this limitation may prevent us from incurring debt or preferred stock and require us to raise additional equity at a time when it may be disadvantageous to do so. We cannot assure investors that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by the terms of any of our outstanding borrowings. In addition, as a BDC, we are generally not permitted to issue common stock priced below net asset value without stockholder approval. If additional funds are not available to us, we could be forced to curtail or cease new lending and investment activities, and our net asset value could decline.
Our PWB Credit Facility contains various covenants and restrictions which, if not complied with, could accelerate our repayment obligations under the 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 $12.0 million outstanding under the PWB Credit Facility as of December 31, 2018. Availability under the PWB Credit Facility as of December 31, 2018 was $38.0 million based on the stated advance rate of 50% under the borrowing base.
Global capital markets could enter a period of severe disruption and instability. These conditions have historically affected and could again materially and adversely affect debt and equity capital markets in the United States and around the world and our business.
The current worldwide financial market situation, as well as various social and political tensions in the United States and around the world, may contribute to increased market volatility, may have long-term effects on the United States and worldwide financial markets and may cause economic uncertainties or deterioration in the United States and worldwide. The impact of downgrades by rating agencies to the United States government’s sovereign credit rating or its perceived creditworthiness as well as potential government shutdowns could adversely affect the United States and global financial markets and economic conditions. Since 2010, several European Union, or EU, countries have faced budget issues, some of which may have negative long-term effects for the economies of those countries and other EU countries. There is continued concern about national-level support for the Euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member countries. In addition, the fiscal policy of foreign nations, such as Russia and China, may have a severe impact on the worldwide and United States financial markets. The decision made in the United Kingdom referendum to leave the EU (the so-called “Brexit”) has led to volatility in global financial markets and may lead to weakening in consumer, corporate and financial confidence in the United Kingdom and Europe. While the United Kingdom is currently expected to leave the EU on March 29, 2019, uncertainty remains as to the exact timing and process, which may lead to continued volatility. Additionally, volatility in the Chinese stock markets and global markets for commodities may affect other financial markets worldwide. We cannot predict the effects of these or similar events in the future on the United States and global economies and securities markets or on our investments. We monitor developments in economic, political and market conditions and seek to manage our investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
Adverse developments in the credit markets may impair our ability to secure debt financing.
During the economic downturn in the United States that began in mid-2007, many commercial banks and other financial institutions stopped lending or significantly curtailed their lending activity. In addition, in an effort to stem losses and reduce their exposure to segments of the economy deemed to be high risk, some financial institutions limited routine refinancing and loan modification transactions and even reviewed the terms of existing facilities to identify bases for accelerating the maturity of existing lending facilities. As a result, should we experience another economic downturn in the United States, it may be difficult for us to obtain desired financing to finance the growth of our investments on acceptable economic terms, or at all.
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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 conduct business and on our results of operations and financial condition, particularly if those events affect our computer-based data processing, transmission, storage, and retrieval systems or destroy data. If a significant number of our managers were unavailable in the event of a disaster, our ability to effectively conduct our business could be severely compromised.
We depend heavily upon computer systems to perform necessary business functions. Despite our implementation of a variety of security measures, our computer systems could be subject to cyberattacks and unauthorized access, such as physical and electronic break-ins or unauthorized tampering. Like other companies, we may experience threats to our data and systems, including malware and computer virus attacks, unauthorized access, system failures and disruptions. If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations, which could result in damage to our reputation, financial losses, litigation, increased costs, regulatory penalties and/or customer dissatisfaction or loss.
Third parties with whom we do business may also be sources of cybersecurity or other technological risks. We outsource certain functions and these relationships allow for the storage and processing of our information, as well as customer, counterparty, employee and borrower information. While we engage in actions to reduce our exposure resulting from outsourcing, ongoing threats may result in unauthorized access, loss, exposure or destruction of data, or other cybersecurity incidents, with increased costs and other consequences, including those described above.
We may experience fluctuations in our quarterly operating results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including the interest rate payable on the debt securities we acquire, the default rate on such securities, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, distributions from our subsidiaries and portfolio companies, the degree to which we encounter competition in our markets and general economic conditions. In light of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
Changes in the laws or regulations governing our business, or changes in the interpretations thereof, and any failure by us to comply with these laws or regulations, could have a material adverse effect on our, and our portfolio companies’, business, results of operations or financial condition.
We and our portfolio companies are subject to regulation by laws at the U.S. federal, state and local levels, including those that govern BDCs, SBICs, RICs, or non-depository commercial lenders. These laws and regulations, including applicable accounting standards, as well as their interpretation, may change from time to time, and new laws, regulations, accounting standards and interpretations may also come into effect. Any such new or changed laws or regulations could have a material adverse effect on our business.
We are also subject to judicial and administrative decisions that affect our operations, including our loan originations, maximum interest rates, fees and other charges, disclosures to portfolio companies, the terms of secured transactions, collection
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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 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.
Changes to United States tariff and import/export regulations may have a negative effect on our portfolio companies and, in turn, harm us.
There has been on-going discussion and commentary regarding potential significant changes to United States trade policies, treaties and tariffs. There is significant uncertainty about the future relationship between the United States and other countries with respect to the trade policies, treaties and tariffs. These developments, or the perception that any of them could occur, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global trade and, in particular, trade between the impacted nations and the United States. Any of these factors could depress economic activity and restrict our portfolio companies’ access to suppliers or customers and have a material adverse effect on their business, financial condition and results of operations, which in turn would negatively impact us.
The effect of global climate change may impact the operations of our portfolio companies.
There may be evidence of global climate change. Climate change creates physical and financial risk and some of our portfolio companies may be adversely affected by climate change. For example, the needs of customers of energy companies vary with weather conditions, primarily temperature and humidity. To the extent weather conditions are affected by climate change, energy use could increase or decrease depending on the duration and magnitude of any changes. Increases in the cost of energy could adversely affect the cost of operations of our portfolio companies if the use of energy products or services is material to their business. A decrease in energy use due to weather changes may affect some of our portfolio companies’ financial condition, through decreased revenues. Extreme weather conditions in general require more systems backup, adding to costs, and can contribute to increased system stresses, including service interruptions.
Loss of status as a RIC would reduce our net asset value and distributable income.
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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.
We incur significant costs as a result of being a publicly traded company.
As a publicly traded company, we incur legal, accounting and other expenses, including costs associated with the periodic reporting requirements applicable to a company whose securities are registered under the Exchange Act, as well as additional corporate governance requirements, including requirements under the Sarbanes-Oxley Act and other rules implemented by the SEC.
Efforts to comply with the Sarbanes-Oxley Act involve significant expenditures, and non-compliance with Section 404 of the Sarbanes-Oxley Act may adversely affect us and the market price of our securities.
Under current SEC rules, we are required to report on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act and related rules and regulations of the SEC. We are required to review our internal control over financial reporting on an annual basis, and evaluate and disclose changes in our internal control over financial reporting on a quarterly and annual basis.
As a result, we expect to continue to incur additional expenses that may negatively impact our financial performance and our ability to make distributions. This process also results in a diversion of management’s time and attention. In the event that we are unable to maintain compliance with Section 404 of the Sarbanes-Oxley Act and related rules, we and the market price of our securities may be adversely affected.
We previously identified a material weakness in our internal control over financial reporting, which has since been remediated. Any future failure to establish and maintain effective internal control over financial reporting could have an adverse effect on our business and stock price.
Effective internal controls over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure controls and procedures, are designed to prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered in their implementation could cause us to fail to meet our reporting obligations.
We previously identified a material weakness related to the design and operating effectiveness of controls over the reliability of financial information reported by portfolio companies that is used as financial inputs in the Company’s investment valuations. We addressed the material weakness through, among other things, adding new and/or enhanced existing controls surrounding the valuation process and financial reporting oversight of various controlled/affiliated portfolio companies.
Although we have remediated this material weakness in our internal control over financial reporting, any failure to improve our disclosure controls and procedures or internal control over financial reporting to address any identified weaknesses in the future, if and when they are identified, could prevent us from maintaining accurate accounting records and discovering material accounting errors. Any of these results could adversely affect our business and the value of our common stock.
Capital markets may experience periods of disruption and instability and we cannot predict when these conditions will occur. Such market conditions could materially and adversely affect debt and equity capital markets in the United States and abroad, which could have a negative impact on our business, financial condition and results of operations.
The global capital markets have experienced a period of disruption as evidenced by a lack of liquidity in the debt capital markets, write-offs in the financial services sector, the re-pricing of credit risk and the failure of certain major financial
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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 EU countries, including Greece, Ireland, Italy, Spain, and Portugal, continue to face budget issues, some of which may have negative long-term effects for the economies of those countries and other EU countries. There is also continued concern about national-level support for the euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member countries. The recent United States and global economic downturn, or a return to the recessionary period in the United States, could adversely impact our investments. We cannot predict the duration of the effects related to these or similar events in the future on the United States economy and securities markets or on our investments. We monitor developments and seek to manage our investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
Risks Related to OFS Advisory and its Affiliates
We have potential conflicts of interest related to obligations that OFS Advisor or its affiliates may have to other clients.
OFS Advisor and its affiliates manage other assets, including those of other BDCs, registered investment companies, separately managed accounts, accounts for which OFS Advisor or its affiliates may serve as a subadvisor and CLOs, and may manage other entities in the future, and these other funds and entities may have similar or overlapping investment strategies. Our executive officers, directors and members of the Advisor Investment Committees serve as officers, directors or principals of entities that operate in the same or a related line of business as we do, or of investment funds or other investment vehicles managed by OFS Advisor or its affiliates. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in our or our stockholders’ best interests or may require them to devote time to services for other entities, which could interfere with the time available to provide services to us. For example, OFS Advisor currently serves as the investment adviser to HPCI, a non-traded BDC, that invests in senior secured loans of middle-market companies in the United States, similar to those we target for investment, including first-lien, second-lien and unitranche loans as well as subordinated loans and, to a lesser extent, warrants and other equity securities. OFS Advisor also serves as the investment adviser to OCCI, a closed-end management investment company that primarily invests in CLO debt and subordinated securities.Therefore, many investment opportunities will satisfy the investment criteria for both HPCI and us and, in certain instances, investment opportunities may be appropriate for OCCI and us. HPCI operates as a distinct and separate entity and any investment in our common stock will not be an investment in HPCI. In addition, our executive officers and certain of our independent directors serve in substantially similar capacities for HPCI and OCCI. Similarly, OFS Advisor and/or its affiliates may have other clients with, similar, different or competing investment objectives. In serving in these multiple capacities, our executive officers and directors, OFS Advisor and/or its affiliates, and members of the Advisor Investment Committees may have obligations to other clients or investors in those entities, the fulfillment of which may not be in the best interests of us or our stockholders.
OFS Advisor and OFSAM have procedures and policies in place designed to manage the potential conflicts of interest between OFS Advisor’s fiduciary obligations to us and its fiduciary obligations to other clients. For example, such policies and procedures are designed to ensure that investment opportunities are allocated in a fair and equitable manner among us and other clients of OFS Advisor. An investment opportunity that is suitable for clients of OFS Advisor may not be capable of being shared among some or all of such clients due to the limited scale of the opportunity or other factors, including regulatory restrictions imposed by the 1940 Act.
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
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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.
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 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).
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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.
On October 12, 2016, we received the Order from the SEC that permits us to co-invest in portfolio companies with certain affiliates, provided that we comply with the conditions of the Order. Pursuant to the Order, we are generally permitted to co-invest with BDCs, registered investment companies and private funds managed by OFS Advisor or any adviser that controls, is controlled by, or is under common control with, OFS Advisor, and is registered as an investment adviser under the Advisers Act, in a manner consistent with our investment strategy as well as applicable law, including the terms and conditions of the Order. Under the terms of the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies.
When we invest alongside clients of OFSAM and its affiliates or their respective other clients, OFS Advisor will, to the extent consistent with applicable law, regulatory guidance, or the Order, allocate investment opportunities in accordance with its allocation policy. Under this allocation policy, if two or more investment vehicles with similar or overlapping investment strategies are in their investment periods, an available opportunity will be allocated based on the provisions governing allocations of such investment opportunities in the relevant organizational, offering or similar documents, if any, for such investment vehicles. In the absence of any such provisions, OFS Advisor will consider the following factors and the weight that should be given with respect to each of these factors:
• | investment guidelines and/or restrictions, if any, set forth in the applicable organizational, offering or similar documents for the investment vehicles; |
• | the status of tax restrictions and tests and other regulatory restrictions and tests; |
• | risk and return profile of the investment vehicles; |
• | suitability/priority of a particular investment for the investment vehicles; |
• | if applicable, the targeted position size of the investment for the investment vehicles |
• | level of available cash for investment with respect to the investment vehicles; |
• | total amount of funds committed to the investment vehicles; and |
• | the age of the investment vehicles and the remaining term of their respective investment periods, if any. |
In situations where co-investment with other accounts is not permitted or appropriate, OFS Advisor will need to decide which account will proceed with the investment. The decision by OFS Advisor to allocate an opportunity to another entity could cause us to forego an investment opportunity that we otherwise would have made. These restrictions, and similar restrictions that limit our ability to transact business with our officers or directors or their affiliates, may limit the scope of investment opportunities that would otherwise be available to us.
Our base management fee may induce OFS Advisor to cause us to incur leverage.
Our base management fee is payable based upon our total assets, other than cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity. This fee structure may encourage OFS Advisor to cause us to borrow money to finance additional investments. Under certain circumstances, the use of borrowed money may increase the likelihood of default, which would disfavor holders of our common stock. Given the subjective nature of the investment decisions made by OFS Advisor on our behalf, our board of directors may not be able to monitor this potential conflict of interest effectively.
Our incentive fee may induce OFS Advisor to make certain investments, including speculative investments.
The incentive fee payable by us to OFS Advisor may create an incentive for OFS Advisor to make investments on our behalf that are riskier or more speculative than would be the case in the absence of such compensation arrangement. The way in which the incentive fee payable to OFS Advisor is determined may encourage OFS Advisor to use leverage to increase the
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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 performed in accordance with and pursuant to the Investment Advisory Agreement, except those resulting from acts constituting
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gross negligence, willful misconduct, bad faith or reckless disregard of such person’s duties under the Investment Advisory Agreement. In addition, we have agreed to indemnify OFS Advisor and its affiliates’ respective officers, directors, members, managers, stockholders and employees from and against any claims or liabilities, including reasonable legal fees and other expenses reasonably incurred, arising out of or in connection with our business and operations or any action taken or omitted on our behalf pursuant to authority granted by the Investment Advisory Agreement, except where attributable to gross negligence, willful misconduct, bad faith or reckless disregard of such person’s duties under the Investment Advisory Agreement. These protections may lead OFS Advisor to act in a riskier manner when acting on our behalf than it would when acting for its own account.
OFS Advisor can resign on 60 days’ notice, and we may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.
OFS Advisor has the right, under the Investment Advisory Agreement, to resign at any time upon not less than 60 days’ written notice, whether we have found a replacement or not. If OFS Advisor resigns, we may not be able to find a new investment advisor or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are likely to be adversely affected and the value of our shares may decline. In addition, the coordination of our internal management and investment activities is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by the OFS Advisor and its affiliates. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our investment objectives may result in additional costs and time delays that may adversely affect our financial condition, business and results of operations.
OFS Services can resign from its role as our Administrator under the Administration Agreement, and we may not be able to find a suitable replacement, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.
OFS Services has the right to resign under the Administration Agreement, whether we have found a replacement or not. If OFS Services resigns, we may not be able to find a new administrator or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are likely to be adversely affected and the value of our shares may decline. In addition, the coordination of our internal management and administrative activities is likely to suffer if we are unable to identify and reach an agreement with a service provider or individuals with the expertise possessed by OFS Services. Even if we are able to retain a comparable service provider or individuals to perform such services, whether internal or external, their integration into our business and lack of familiarity with our investment objectives may result in additional costs and time delays that may adversely affect our financial condition, business and results of operations.
Risks Related to BDCs
Regulations governing our operation as a BDC affect our ability to and the way in which we raise additional capital. As a BDC, we will need to raise additional capital, which will expose us to risks, including the typical risks associated with leverage.
We may issue debt securities or preferred stock and/or borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act, 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% (or 150% if certain conditions are satisfied) of gross assets less all liabilities and indebtedness not represented by senior securities, after each issuance of senior securities. If the value of our assets decline, we may be unable to satisfy this test. If that happens, we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be disadvantageous. Also, any amounts that we use to service our indebtedness would not be available for distributions to our common stockholders. If we issue senior securities, we will be exposed to typical risks associated with leverage, including an increased risk of loss.
On May 3, 2018, the Board, including a "required majority" (as such item is determined in section 57(o) of the 1940 Act) of the Board, approved the application of a reduced 150% asset coverage ratio to us; therefore provided certain conditions are met, we will be subject to the reduced asset coverage ratio as of May 3, 2019.
As of December 31, 2018, we had $260.4 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
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at all. We have received an exemptive order from the SEC to permit us to exclude the debt of SBIC I LP guaranteed by the SBA from our definition of senior securities in our statutory asset coverage ratio under the 1940 Act.
If we issue preferred stock, the preferred stock would rank “senior” to common stock in our capital structure, preferred stockholders would have separate voting rights on certain matters and might have other rights, preferences or privileges more favorable than those of our common stockholders, and the issuance of preferred stock could have the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium price for holders of our common stock or otherwise be in our stockholders’ best interest. Holders of our common stock will directly or indirectly bear all of the costs associated with offering and servicing any preferred stock that we issue. In addition, any interests of preferred stockholders may not necessarily align with the interests of holders of our common stock and the rights of holders of shares of preferred stock to receive dividends would be senior to those of holders of shares of our common stock. We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value per share of our common stock if our board of directors determines that such sale is in the best interests of us and our stockholders, and if our stockholders approve any such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price that, in the determination of our board of directors, closely approximates the market value of such securities (less any distributing commission or discount). If we raise additional funds by issuing common stock or senior securities convertible into, or exchangeable for, our common stock, then the percentage ownership of our stockholders at that time will decrease, and our stockholders might experience dilution.
Our ability to invest in public companies may be limited in certain circumstances.
To maintain our status as a BDC, we are not permitted to acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our assets, as defined by the 1940 Act, are qualifying assets (with certain limited exceptions). Subject to certain exceptions for follow-on investments and distressed companies, an investment in an issuer that has outstanding securities listed on a national securities exchange may be treated as a qualifying asset only if such issuer has a common equity market capitalization that is less than $250 million at the time of such investment and meets the other specified requirements.
If we do not invest a sufficient portion of our assets in qualifying assets, we could fail to continue to qualify as a BDC or be precluded from investing according to our current business strategy.
As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our assets, as defined by the 1940 Act, are qualifying assets.
We believe that most of the investments that we may acquire in the future will constitute qualifying assets. However, we may be precluded from investing in what we believe are attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If a sufficient portion of our assets are not qualifying assets, we could violate the 1940 Act provisions applicable to BDCs. As a result of such violation, specific rules under the 1940 Act could prevent us, for example, from making follow-on investments in existing portfolio companies (which could result in the dilution of our position) or could require us to dispose of investments at inappropriate times in order to come into compliance with the 1940 Act. If we need to dispose of such investments quickly, it could be difficult to dispose of such investments on favorable terms. We may not be able to find a buyer for such investments and, even if we do find a buyer, we may have to sell the investments at a substantial loss. Any such outcomes would have a material adverse effect on our business, financial condition and results of operations
If we do not maintain our status as a BDC, we would be subject to regulation as a registered closed-end investment company under the 1940 Act. As a registered closed-end fund, we would be subject to substantially more regulatory restrictions under the 1940 Act which would significantly decrease our operating flexibility.
Risks Related to Our Investments
Economic recessions or downturns could impair our portfolio companies and harm our operating results.
Many of our portfolio companies are susceptible to economic slowdowns or recessions and may be unable to repay our loans during these periods. Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during these periods. Adverse economic conditions may decrease the value of collateral securing some of our loans and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a 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
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agreements and jeopardize our portfolio company’s ability to meet its obligations under the debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, lenders in certain cases can be subject to lender liability claims for actions taken by them when they become too involved in the borrower’s business or exercise control over a borrower. It is possible that we could become subject to a lender liability claim, including as a result of actions taken if we render significant managerial assistance to the borrower. Furthermore, if one of our portfolio companies were to file for bankruptcy protection, even though we may have structured our investment as senior secured debt, depending on the facts and circumstances, including the extent to which we provided managerial assistance to that portfolio company, a bankruptcy court might re-characterize our debt holding and subordinate all or a portion of our claim to claims of other creditors.
Our investments in the debt instruments of leveraged portfolio companies may be risky and, due to the significant volatility of such companies, we could lose all or part of our investment in bankruptcy proceedings or otherwise.
Investment in leveraged companies involves a number of significant risks. Leveraged companies in which we invest may have limited financial resources and may be unable to meet their obligations under their debt securities that we hold due to the significant volatility of such companies. Negative developments may be accompanied by deterioration of the value of any collateral and a reduction in the likelihood of our realizing any guarantees that we may have obtained in connection with our investment. Such developments may ultimately result in the leveraged companies in which we invest entering into bankruptcy proceedings, which have a number of inherent risks. Many events in a bankruptcy proceeding are the product of contested matters and adversary proceedings and are beyond the control of the creditors. A bankruptcy filing by an issuer may adversely and permanently affect the issuer. If the proceeding is converted to a liquidation, the value of the issuer may not equal the liquidation value that was believed to exist at the time of the investment. The duration of a bankruptcy proceeding is also difficult to predict, and a creditor’s return on investment can be adversely affected by delays until the plan of reorganization or liquidation ultimately becomes effective. The administrative costs in connection with a bankruptcy proceeding are frequently high and would be paid out of the debtor’s estate prior to any return to creditors. Because the standards for classification of claims under bankruptcy law are vague, our influence with respect to the class of securities or other obligations we own may be lost by increases in the number and amount of claims in the same class or by different classification and treatment. In the early stages of the bankruptcy process, it is often difficult to estimate the extent of, or even to identify, any contingent claims that might be made. In addition, certain claims that have priority by law (for example, claims for taxes) may be substantial. In addition, since our mezzanine loans are generally subordinated to senior loans and are generally unsecured, other creditors may rank senior to us in the event of a bankruptcy proceeding.
Our investments in debt instruments may include “covenant-lite” loans. Covenants are contractual restrictions that lenders place on companies to limit the corporate actions a company may pursue. Generally, the loans in which we expect to invest will have financial maintenance covenants, which are used to proactively address materially adverse changes in a portfolio company’s financial performance. However, to a lesser extent, we may invest in “covenant-lite” loans. We use the term “covenant-lite” to refer generally to loans that do not have a complete set of financial maintenance covenants. Generally, “covenant-lite” loans provide borrower companies more freedom to negatively impact lenders because their covenants are incurrence-based, which means they are only tested and can only be breached following an affirmative action of the borrower, rather than by a deterioration in the borrower’s financial condition. Accordingly, to the extent we invest in “covenant-lite” loans, we may have fewer rights against a borrower and may have a greater risk of loss on such investments as compared to investments in or exposure to loans with financial maintenance covenants.
Our investments in private and middle-market portfolio companies are generally considered lower credit quality obligations, are risky, and we could lose all or part of our investment.
Investment in private and middle-market companies involves a number of significant risks. Generally, little public information exists about these companies, and we rely on the ability of OFS Advisor’s investment professionals to obtain adequate information to evaluate the potential returns from investing in these companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments. Middle-market companies may have limited financial resources and may be unable to meet their obligations under their debt securities that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of our realizing any guarantees we may have obtained in connection with our investment. Such companies typically have shorter operating histories, narrower product lines and smaller market shares than larger businesses, 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
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principal, and are susceptible to default or decline in market value due to adverse economic and business developments. The market values for lower grade debt tend to be very volatile and are less liquid than investment grade securities. For these reasons, an investment in our company is subject to the following specific risks: increased price sensitivity to a deteriorating economic environment; greater risk of loss due to default or declining credit quality; adverse company specific events are more likely to render the issuer unable to make interest and/or principal payments; and if a negative perception of the lower grade debt market develops, the price and liquidity of lower grade securities may be depressed. This negative perception could last for a significant period of time.
Additionally, middle-market companies are more likely to depend on the management talents and efforts of a small group of persons. Therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us. Middle-market companies also may be parties to litigation and may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence. In addition, our executive officers, directors and OFS Advisor may, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies.
Investments in equity securities involve a substantial degree of risk.
We have purchased, and may purchase in the future, common stock and other equity securities, including warrants, in various portfolio companies. Although equity securities historically have generated higher average total returns than debt securities over the long term, equity securities may experience more volatility in those returns than debt securities. The equity securities we acquire may fail to appreciate, decline in value or lose all value, and our ability to recover our investment will depend on our portfolio company's success. Investments in equity securities involve a number of significant risks, including the risk of further dilution in the event the portfolio company issues additional securities. Investments in preferred securities involve special risks, such as the risk of deferred distributions, illiquidity and limited voting rights.
Our equity ownership in a portfolio company may represent a control investment. Our ability to exit a control investment in a timely manner could result in a realized loss on the investment.
If we obtain a control investment in a portfolio company, our ability to divest ourselves from a debt or equity investment could be restricted due to illiquidity in a private stock, limited trading volume on a public company’s stock, inside information on a company’s performance, insider blackout periods, or other factors that could prohibit us from disposing of the investment as we would if it were not a control investment. Additionally, we may choose not to take certain actions to protect a debt investment in a control investment portfolio company. As a result, we could experience a decrease in the value of our portfolio company holdings and potentially incur a realized loss on the investment.
Our investments in CLOs carry additional risks to the risks associated with investing in private debt.
In addition to the general risks associated with debt securities and structured products discussed herein, CLOs carry additional risks, including, but not limited to (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the quality of the collateral may decline in value or default; (iii) the possibility that the investments in CLOs are subordinate to other classes or tranches thereof, (iv) the potential of spread compression in the underlying loans of the CLO, which could reduce credit enhancement in the CLOs and (v) the complex structure of the security may not be fully understood at the time of investment and may produce disputes with the issuer or unexpected investment results. CLO equity securities that we may acquire are subordinated to more senior tranches of CLO debt. CLO equity securities are subject to increased risks of default relative to the holders of superior priority interests in the same securities. In addition, at the time of issuance, CLO equity securities are under-collateralized in that the liabilities of a CLO at inception exceed its total assets. When we invest in CLOs, we may be in a first loss or subordinated position with respect to realized losses on the assets of the CLOs in which it is invested. We may recognize phantom taxable income from our investments in the subordinated tranches of CLOs.
Between the closing date and the effective date of a CLO, the CLO collateral manager will generally expect to purchase additional collateral obligations for the CLO. During this period, the price and availability of these collateral obligations may be adversely affected by a number of market factors, including price volatility and availability of investments suitable for the CLO, which could hamper the ability of the collateral manager to acquire a portfolio of collateral obligations that will satisfy specified concentration limitations and allow the CLO to reach the initial par amount of collateral prior to the effective date. An inability or delay in reaching the target initial par amount of collateral may adversely affect the timing and amount of interest or principal payments received by the holders of the CLO debt securities and distributions of the CLO on equity securities and could result in early redemptions which may cause CLO debt and equity investors to receive less than the face value of their investment.
In addition, the portfolios of certain CLOs in which we may invest may contain “covenant-lite” loans. Accordingly, to the extent we are exposed to “covenant-lite” loans, we may have a greater risk of loss on such investments as compared to investments in or exposure to loans with financial maintenance covenants.The failure by a CLO in which we invest to satisfy
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financial covenants, including with respect to adequate collateralization and/or interest coverage tests, could lead to a reduction in the payments we receive from the CLO. In the event that a CLO fails certain tests, holders of CLO senior debt may be entitled to additional payments that would, in turn, reduce the payments we would otherwise be entitled to receive. Separately, we may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting CLO or any other investment we may make. If any of these occur, it could adversely affect our operating results and cash flows.
Our CLO investments will be exposed to leveraged credit risk. If a CLO does not meet certain minimum collateral value ratios and/or interest coverage ratios, primarily due to senior secured loan defaults, then cash flow that otherwise would have been available to pay us distributions may instead be used to redeem any senior notes or to purchase additional senior secured loans, until the ratios again exceed the minimum required levels or any senior notes are repaid in full.
We may suffer a loss if a portfolio company defaults on a loan and the underlying collateral is not sufficient.
We will at times take a security interest in the available assets of our portfolio companies, including the equity interests of their subsidiaries and, in some cases, the equity interests of our portfolio companies held by their stockholders. In the event of a default by a portfolio company on a secured loan, we will only have recourse to the assets collateralizing the loan. There is a risk that the collateral securing our loans may decrease in value over time, may be difficult to sell in a timely manner, may be difficult to appraise, and may fluctuate in value based upon the success or deterioration of the business and market conditions, including as a result of the inability of a portfolio company to raise additional capital. Additionally, in the case of certain of our investments, we do not have a first lien position on the collateral and may not receive the full value of the collateral upon liquidation. If the underlying collateral value is less than the loan amount, we will suffer a loss.
In the event of bankruptcy of a portfolio company, we may not have full recourse to its assets in order to satisfy our loan, or our loan may be subject to equitable subordination. In addition, certain of our loans are subordinate to other debt of the portfolio company. If a portfolio company defaults on our loan or on debt senior to our loan, or in the event of a portfolio company bankruptcy, our loan will be satisfied only after the senior debt receives payment. Where debt senior to our loan exists, the presence of inter-creditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies (through “standstill” periods) and control decisions made in bankruptcy proceedings relating to the portfolio company. Bankruptcy and portfolio company litigation can significantly increase collection losses and the time needed for us to acquire the underlying collateral in the event of a default, during which time the collateral may decline in value, causing us to suffer losses.
Borrowers of Broadly Syndicated Loans may be permitted to designate unrestricted subsidiaries under the terms of their financing agreements, which would exclude such unrestricted subsidiaries from restrictive covenants under the financing agreement with the borrower. Without restriction under the financing agreement, the borrower could take various actions with respect to the unrestricted subsidiary including, among other things, incur debt, grant security on its assets, sell assets, pay dividends or distribute shares of the unrestricted subsidiary to the borrower’s shareholders. Any of these actions could increase the amount of leverage that the borrower is able to incur and increase the risk involved in our investments in Broadly Syndicated Loans accordingly.
If the value of collateral underlying our loan declines or interest rates increase during the term of our loan, a portfolio company may not be able to obtain the necessary funds to repay our loan at maturity through refinancing. Decreasing collateral value and/or increasing interest rates may hinder a portfolio company’s ability to refinance our loan because the underlying collateral cannot satisfy the debt service coverage requirements necessary to obtain new financing. If a borrower is unable to repay our loan at maturity, we could suffer a loss which may adversely impact our financial performance.
The lack of liquidity in our investments may adversely affect our business.
All of our assets are presently invested in illiquid securities, and a substantial portion of our investments in leveraged companies is subject to legal and other restrictions on resale or is otherwise less liquid than more broadly traded public securities. The illiquidity of these investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded these investments. We may also face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we, OFS Advisor, OFSAM or any of its other affiliates have material nonpublic information regarding such portfolio company.
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:
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• | 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 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.
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We generally do not hold controlling equity positions in our portfolio companies. For portfolio companies in which we do not hold a controlling equity interest, we are subject to the risk that a portfolio company may make business decisions with which we disagree, and that the management and/or stockholders of a portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due to the lack of liquidity of the debt and equity investments that we typically hold in our portfolio companies, we may not be able to dispose of our investments in the event we disagree with the actions of a portfolio company and may therefore suffer a decrease in the value of our investments.
Defaults by our portfolio companies will harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its assets. This could trigger cross-defaults under other agreements and jeopardize such portfolio company’s ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
We have invested a substantial portion of our capital in senior secured, unitranche, second-lien and mezzanine loans issued by our portfolio companies. The portfolio companies may be permitted to incur, other debt that ranks equally with, or senior to, the debt securities in which we invest. By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the debt securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying senior creditors, the portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt securities in which we invest, we would have to share any distributions on an equal and ratable basis with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
Additionally, certain loans that we make to portfolio companies may be secured on a second-priority basis by the same collateral securing first-priority debt of such companies. The senior-secured liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by the portfolio company under the agreements governing the loans. The holders of obligations secured by first-priority liens on the collateral will generally control the liquidation of, and be entitled to receive proceeds from, any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second-priority liens after payment in full of all obligations secured by the first-priority liens on the collateral. If such proceeds were not sufficient to repay amounts outstanding under the loan obligations secured by the second-priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, would only have an unsecured claim against the portfolio company’s remaining assets, if any.
The rights we may have with respect to the collateral securing the loans we make to our portfolio companies with more senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of such senior debt. Under a typical intercreditor agreement, at any time that obligations that have the benefit of the first-priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first-priority liens:
• | the ability to cause the commencement of enforcement proceedings against the collateral; |
• | the ability to control the conduct of such proceedings; |
• | the approval of amendments to collateral documents; |
• | releases of liens on the collateral; and |
• | waivers of past defaults under collateral documents. |
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
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before us. In addition, the value of such collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of such collateral would be sufficient to satisfy our unsecured loan obligations after payment in full of all secured loan obligations. If such proceeds were not sufficient to repay the outstanding secured loan obligations, then our unsecured claims would rank equally with the unpaid portion of such secured creditors’ claims against the portfolio company’s remaining assets, if any.
Cybersecurity risks and cyber incidents may adversely affect our business or the business of our portfolio companies by causing a disruption to our operations or the operations of our portfolio companies, a compromise or corruption of our confidential information or the confidential information of our portfolio companies and/or damage to our business relationships or the business relationships of our portfolio companies, all of which could negatively impact the business, financial condition and operating results of us or our portfolio companies.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of the information resources of us or our portfolio companies. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our information systems or those of our portfolio companies for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. We and OFS Advisor’s employees have been and expect to continue to be the target of fraudulent calls, emails and other forms of activities. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to business relationships. The costs related to cyber or other security threats or disruptions may not be fully insured or indemnified by other means. As our and our portfolio companies’ reliance on technology has increased, so have the risks posed to our information systems, both internal and those provided by OFS Services and third-party service providers, and the information systems of our portfolio companies. OFS Advisor has implemented processes, procedures and internal controls to help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that a cyber incident will not occur and/or that our financial results, operations or confidential information will not be negatively impacted by such an incident. In addition, cybersecurity has become a top priority for regulators around the world, and some jurisdictions have enacted laws requiring companies to notify individuals of data security breaches involving certain types of personal data. If we fail to comply with the relevant laws and regulations, we could suffer financial losses, a disruption of our businesses, liability to investors, regulatory intervention or reputational damage.
If we make subordinated investments, the obligors or the portfolio companies may not generate sufficient cash flow to service their debt obligations to us.
We make subordinated investments that rank below other obligations of the obligor in right of payment. Subordinated investments are subject to greater risk of default than senior obligations as a result of adverse changes in the financial condition of the obligor or in general economic conditions. If we make a subordinated investment in a portfolio company, the portfolio company may be highly leveraged, and its relatively high debt-to-equity ratio may create increased risks that its operations might not generate sufficient cash flow to service all of its debt obligations.
The disposition of our investments may result in contingent liabilities.
A significant portion of our investments involve private securities. In connection with the disposition of an investment in private securities, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate, or with respect to potential liabilities. These arrangements may result in contingent liabilities that ultimately result in funding obligations that we must satisfy through our return of distributions previously made to us.
We may be subject to additional risks if we engage in hedging transactions and/or invest in foreign securities.
The 1940 Act generally requires that 70% of our investments be in issuers each of whom is organized under the laws of, and has its principal place of business in, any state of the United States, the District of Columbia, Puerto Rico, the Virgin Islands or any other possession of the United States. Our investment strategy does not presently contemplate investments in securities of non-U.S. companies. We expect that these investments would focus on the same debt investments that we make in U.S. middle-market companies and accordingly would be complementary to our overall strategy and enhance the diversity of 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.
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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.
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.
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Risks Related to Our Securities
There is a risk that stockholders may not receive distributions or that our distributions may not grow over time and a portion of our distributions may be a return of capital.
We have made distributions on a quarterly basis to our stockholders out of assets legally available for distribution. We cannot assure stockholders that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. Our ability to pay distributions might be adversely affected by the impact of one or more of the risk factors described in this Annual Report on Form 10-K. Due to the asset coverage test applicable to us under the 1940 Act as a BDC, we may be limited in our ability to make distributions. Our ability to make distributions may also be affected by our ability to receive distributions from SBIC I LP, which is governed by SBA regulations.
When we make distributions, we will be required to determine the extent to which such distributions are paid out of current or accumulated earnings and profits. Distributions in excess of current and accumulated earnings and profits will be treated as a non-taxable return of capital to the extent of an investor’s basis in our stock and, assuming that an investor holds our stock as a capital asset, thereafter as a capital gain. A return of capital is a return to stockholders of a portion of their original investment in us rather than income or capital gains.
The market price of our common stock may fluctuate significantly.
As with any stock, the market price of our common stock will fluctuate with market conditions and other factors. Our common stock is intended for long-term investors and should not be treated as a trading vehicle. Shares of BDCs frequently trade at a discount from their net asset value. The market price and liquidity of the market for shares of our common stock may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:
• | significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which is not necessarily related to the operating performance of these companies; |
• | exclusion of our common stock from certain market indices, such as the Russell 2000 Financial Services Index, which could reduce the ability of certain investment funds to own our common stock and put short-term selling pressure on our common stock; |
• | changes in regulatory policies or tax guidelines, particularly with respect to RICs, SBICs or BDCs; |
• | loss of RIC or BDC status; |
• | 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
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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, 2018, our net asset value per share was $13.10. The daily average closing price of our shares on the Nasdaq Global Select Market for the year ended December 31, 2018 was $11.49. If our common stock trades below net asset value, the higher the cost of equity capital may result in it being unattractive to raise new equity, which may limit our ability to grow. The risk of trading below net asset value is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether shares of our common stock will trade above, at or below our net asset value.
Our Unsecured Notes are effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future and will rank pari passu with, or equal to, all outstanding and future unsecured, unsubordinated indebtedness issued by us and our general liabilities.
Our Unsecured Notes are not secured by any of our assets or any of the assets of any of our subsidiaries. As a result, the Unsecured Notes are effectively subordinated to any secured indebtedness we or our subsidiaries have outstanding (including the PWB Credit Facility) or that we or our subsidiaries may incur in the future (or any indebtedness that is initially unsecured as to which we subsequently grant a security interest) to the extent of the value of the assets securing such indebtedness. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our secured indebtedness or secured indebtedness of our subsidiaries may assert rights against the assets pledged to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used to pay other creditors, including the holders of the Unsecured Notes.
The Unsecured Notes are structurally subordinated to the indebtedness and other liabilities of our subsidiaries.
The Unsecured Notes are obligations exclusively of OFS Capital Corporation, and not of any of our subsidiaries. None of our subsidiaries are a guarantor of the Unsecured Notes, and the Unsecured Notes will not be required to be guaranteed by any subsidiary we may acquire or create in the future. Any assets of our subsidiaries will not be directly available to satisfy the claims of our creditors, including holders of the Unsecured Notes. Except to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors of our subsidiaries will have priority over our equity interests in such entities (and therefore the claims of our creditors, including holders of the Unsecured Notes) with respect to the assets of such entities. Even if we are recognized as a creditor of one or more of these entities, our claims would still be effectively subordinated to any security interests in the assets of any such entity and to any indebtedness or other liabilities of any such entity senior to our claims. Consequently, the Unsecured Notes will be structurally subordinated to all indebtedness and other liabilities, including trade payables, of any of our existing or future subsidiaries, including SBIC I LP. Certain of these entities currently serve as guarantors under the PWB Credit Facility, and in the future our subsidiaries may incur substantial additional indebtedness, all of which is and would be structurally senior to the Unsecured Notes.
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The indenture under which the Unsecured Notes were issued contains limited protection for holders of the unsecured Notes.
The indenture under which the Unsecured Notes were issued offers limited protection to holders of the Unsecured Notes. The terms of the indenture and the Unsecured Notes do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have a material adverse impact on your investment in the Unsecured Notes. In particular, the terms of the indenture and the Unsecured Notes will not place any restrictions on our or our subsidiaries’ ability to:
• | issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be equal in right of payment to the Unsecured Notes, (2) any indebtedness or other obligations that would be secured and therefore rank effectively senior in right of payment to the Unsecured Notes to the extent of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the Unsecured Notes and (4) securities, indebtedness or obligations issued or incurred by our subsidiaries that would be senior to our equity interests in those entities and therefore rank structurally senior to the Unsecured Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by such provisions of Section 61(a) of the 1940 Act as may be applicable to us from time to time or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in each case, to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from making additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 200% (or 150% on and after May 3, 2019) after such borrowings. |
• | pay dividends on, or purchase or redeem or make any payments in respect of, capital stock or other securities ranking junior in right of payment to the Unsecured Notes, including subordinated indebtedness, in each case other than dividends, purchases, redemptions or payments that would cause our asset coverage to fall below the threshold specified in Section 18(a)(1)(B) as modified by such provisions of Section 61(a) of the 1940 Act as may be applicable to us from time to time or any successor provisions, giving effect to (i) any exemptive relief granted to us by the SEC and (ii) no-action relief granted by the SEC to another BDC (or to us if we determine to seek such similar no-action or other relief) permitting the BDC to declare any cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by such provisions of Section 61(a) of the 1940 Act as may be applicable to us from time to time in order to maintain the BDC’s status as a RIC under Subchapter M of the Code. These provisions generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, is below 200% (or 150% on and after May 3, 2019) at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or purchase; |
• | sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or substantially all of our assets); |
• | enter into transactions with affiliates; |
• | create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions; |
• | make investments; or |
• | create restrictions on the payment of dividends or other amounts to us from our subsidiaries. |
In addition, the indenture does not require us to make an offer to purchase the Unsecured Notes in connection with a change of control or any other event.
Furthermore, the terms of the indenture and the Unsecured Notes do not protect holders of the unsecured Notes in the event that we experience changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, if any, as they do not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income, cash flow, or liquidity.
Our ability to recapitalize, incur additional debt (including additional debt that matures prior to the maturity of the Unsecured Notes), and take a number of other actions that are not limited by the terms of the Unsecured Notes may have important consequences for you as a holder of the Unsecured Notes, including making it more difficult for us to satisfy our obligations with respect to the Unsecured Notes or negatively affecting the trading value of the Unsecured Notes.
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Other debt we issue or incur in the future could contain more protections for its holders than the indenture and the Unsecured Notes, including additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for, trading levels, and prices of the Unsecured Notes.
We may choose to redeem the Unsecured Notes when prevailing interest rates are relatively low.
On or after April 30, 2020 for the Unsecured Notes Due April 2025 or October 31, 2020 for the Unsecured Notes Due October 2025, we may choose to redeem the Unsecured Notes from time to time, especially if prevailing interest rates are lower than the rate borne by the Unsecured Notes. If prevailing rates are lower at the time of redemption, and we redeem the Unsecured Notes, you likely would not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as the interest rate on the Unsecured Notes being redeemed. Our redemption right also may adversely impact your ability to sell the Unsecured Notes as the optional redemption date or period approaches.
Item 1B. | Unresolved Staff Comments |
Not applicable.
Item 2. | Properties |
We do not own or lease any real estate or other physical properties material to our operation. Our headquarters are located at 10 S. Wacker Drive, Suite 2500, Chicago, IL, 60606, and are provided by OFS Services pursuant to the Administration Agreement. Additional operations are conducted from offices in New York, New York and Los Angeles, California, which are also provided by OFS Services pursuant to the Administration Agreement. We believe that our office facilities are suitable and adequate for our business as we contemplate continuing to conduct it.
Item 3. | Legal Proceedings |
We, OFS Advisor and OFS Services, are not currently subject to any material pending legal proceedings threatened against us as of December 31, 2018. From time to time, we may be a party to certain legal proceedings incidental to the normal course of our business including the enforcement of our rights under contracts with our portfolio companies. Furthermore, third parties may try to seek to impose liability on us in connection with the activities of our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our business, financial condition, results of operations or cash flows.
Item 4. | Mine Safety Disclosures |
Not applicable.
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PART II
Item 5. | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Common Stock and Holders
Our common stock is traded on the Nasdaq Global Select Market under the symbol "OFS". The last reported sale price for our common stock on the Nasdaq Global Select Market on March 4, 2019 was $12.05 per share. As of March 4, 2019, 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.”
Issuer Purchases of Equity Securities
On May 22, 2018, the Board authorized us to initiate a stock repurchase program under which the we may acquire up to $10.0 million of its outstanding common stock (the "Stock Repurchase Program"). Under the Stock Repurchase Program, we are authorized to repurchase shares in open-market transactions, including through block purchases, depending on prevailing market conditions and other factors. The Stock Repurchase Program may be extended, modified or discontinued at any time for any reason. We expect the Stock Repurchase Program to be in place through May 22, 2020, or until the approved dollar amount has been used to repurchase shares. The Stock Repurchase Program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.
The following table summarizes the shares of common stock that we repurchased under the Stock Repurchase Program during the three months ended December 31, 2018 (amount in thousands except shares).
Period | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Yet be Purchased Under the Plans or Programs | ||||||||||
October 1, 2018 through December 31, 2018 | 300 | $ | 10.29 | 300 | $ | 9,997 | ||||||||
Total | 300 | 10.29 | 300 | 9,997 | ||||||||||
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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, 2013, 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, 2018 under the DRIP.
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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, | |||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||
Statement of Operations Data: | |||||||||||||||||||
Investment income | |||||||||||||||||||
Interest income | $ | 38,607 | $ | 28,124 | $ | 26,400 | $ | 27,764 | $ | 20,653 | |||||||||
PIK interest income | 1,193 | 1,508 | 1,194 | 1,206 | 683 | ||||||||||||||
Dividend income | 315 | 482 | 475 | 245 | 124 | ||||||||||||||
Preferred equity PIK dividend income | 906 | 1,399 | 1,433 | 1,116 | 446 | ||||||||||||||
Fee income | 1,813 | 1,913 | 1,592 | 1,933 | 914 | ||||||||||||||
Total investment income | 42,834 | 33,426 | 31,094 | 32,264 | 22,820 | ||||||||||||||
Expenses | |||||||||||||||||||
Management fees | 6,335 | 4,999 | 4,516 | 5,225 | 2,916 | ||||||||||||||
Incentive fees, net of waiver | 4,387 | 2,962 | 3,333 | 2,627 | 1,253 | ||||||||||||||
Other expenses | 13,727 | 9,588 | 9,100 | 11,001 | 9,516 | ||||||||||||||
Total expenses, net | 24,449 | 17,549 | 16,949 | 18,853 | 13,685 | ||||||||||||||
Net investment income | 18,385 | 15,877 | 14,145 | 13,411 | 9,135 | ||||||||||||||
Net realized gain (loss) on investments | (4,779 | ) | 6,833 | 2,404 | (1,562 | ) | (3,359 | ) | |||||||||||
Net unrealized appreciation (depreciation) on investments | (4,034 | ) | (14,800 | ) | (2,721 | ) | 6,382 | 4,164 | |||||||||||
Net increase in net assets resulting from operations | 9,572 | 7,910 | 13,828 | 18,231 | 9,940 | ||||||||||||||
Per share data: | |||||||||||||||||||
Net asset value | $ | 13.10 | $ | 14.12 | $ | 14.82 | $ | 14.76 | $ | 14.24 | |||||||||
Net investment income | 1.38 | 1.28 | 1.46 | 1.39 | 0.95 | ||||||||||||||
Net realized gain (loss) on investments | (0.36 | ) | 0.55 | 0.25 | (0.17 | ) | (0.35 | ) | |||||||||||
Net unrealized appreciation (depreciation) on investments | (0.30 | ) | (1.19 | ) | (0.29 | ) | 0.66 | 0.42 | |||||||||||
Net increase in net assets resulting from operations | 0.72 | 0.64 | 1.43 | 1.89 | 1.03 | ||||||||||||||
Distributions declared (1) | 1.73 | 1.36 | 1.36 | 1.36 | 1.36 | ||||||||||||||
Total return based on market value (7) | 2.8 | % | (4.7 | )% | 32.3 | % | 9.0 | % | 2.4 | % | |||||||||
Balance sheet data at period end: | |||||||||||||||||||
Investments, at fair value | $ | 396,797 | $ | 277,499 | $ | 281,627 | $ | 257,296 | $ | 312,234 | |||||||||
Cash and cash equivalents | 38,172 | 72,952 | 17,659 | 32,714 | 12,447 | ||||||||||||||
Other assets | 6,452 | 7,327 | 5,744 | 4,666 (2) | 11,823 (2) | ||||||||||||||
Total assets | 441,421 | 357,778 | 305,030 | 294,676 (2) | 336,504 (2) | ||||||||||||||
Debt | 254,826 | 164,823 | 156,343 | 146,460 (2) | 194,935 (2) | ||||||||||||||
Total liabilities | 266,398 | 169,442 | 161,252 | 151,664 (2) | 199,033 (2) | ||||||||||||||
Total net assets | 175,023 | 188,336 | 143,778 | 143,012 | 137,471 | ||||||||||||||
Other data (unaudited): | |||||||||||||||||||
Weighted average yield on performing debt investments (3) (6) | 11.50 | % | 12.11 | % | 12.08 | % | 11.89 | % | 9.53 | % | |||||||||
Weighted average yield on total debt investments (4) (6) | 11.12 | % | 11.59 | % | 11.72 | % | 11.84 | % | 9.41 | % | |||||||||
Weighted average yield on total investments (5) (6) | 10.49 | % | 10.35 | % | 10.88 | % | 10.79 | % | 8.99 | % | |||||||||
Number of portfolio companies at end of year | 50 | 37 | 41 | 39 | 62 | ||||||||||||||
(1) | The return of capital portion of these distributions for the years ended December 31, 2018, 2017, 2016, 2015, and 2014, was $0, $0, $0.09, $0.23, and $0.72, respectively. |
(2) | On January 1, 2016, we adopted ASU 2015-03 which requires that debt issuance costs related to a recognized debt liability to be presented on the balance sheet as a direct deduction from the carrying amount of the debt liability rather than as an asset. Adoption of ASU 2015-03 requires the changes to be applied retrospectively. |
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(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 debt investments 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. |
(7) | 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. |
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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; |
• | our increased ability to incur leverage pursuant to the SBCAA, beginning on May 3, 2019; |
• | 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 21E of the Securities Exchange Act.
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The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto contained elsewhere in this Annual Report on Form 10-K.
Critical Accounting Policies and Significant Estimates
The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the periods reported. Actual results could materially differ from those estimates. Critical accounting policies are those that require management to make subjective or complex judgments about the effect of matters that are inherently uncertain and may change in subsequent periods. Changes that may be required in the underlying assumptions or estimates in these areas could have a material impact on our current and future financial condition and results of operations.
Our critical accounting policies and estimates are those relating to revenue recognition and fair value estimates. Management has discussed the development and selection of each critical accounting policy and estimate with the Audit Committee of the Board. For a descriptions of our revenue recognition and fair value policies, see Note 2 to the consolidated financial statements included in "Item 8.–Financial Statements" of this report.
Revenue recognition
Our investment activities frequently involve the acquisition of multiple financial instruments or rights either in an initial transaction, or in subsequent or "follow-on" transactions, including amendments to existing securities. These financial instruments can include loans, preferred and common stock, 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.
Fair value estimates
As of December 31, 2018, total investments representing approximately 90% of our total assets were carried on the consolidated balance sheet at fair value. As discussed more fully in “Item 8.–Financial Statements–Note 2” GAAP requires us to categorize fair value measurements according to a three-level valuation hierarchy. The hierarchy gives the highest priority to quoted, active market prices for identical assets and liabilities (Level 1) and the lowest priority to valuation techniques that require significant management judgment because one or more of the significant inputs are unobservable in the market place (Level 3). All of our investments carried at fair value are classified as Level 3; we typically do not hold equity securities or other instruments that are actively traded on an exchange.
As described in “Item 8.–Financial Statements–Note 5”, we follow a process, under the supervision and review of the Board, to determine these unobservable inputs used to calculate the fair values of our investments. The most significant unobservable inputs in these fair value measurements are the discount rates, EBITDA multiples and projected cash flows contractually due from the investment.
Our discounted cash flow valuations involve a determination of discount rate commensurate with the risk inherent in the investment. We use two methods to estimate discount rates: the weighted-average cost of capital method, which is a method based upon a hypothetical recapitalization of the entity given its current operating performance and current market conditions; and a hypothetical debt rating method, which assigns a surrogate debt rating to the entity based on known industry standards for
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assigning such ratings and estimates the discount rate based on observed market conditions for similar rated debt. These methods generally produces a range of discount rates, and we generally select the midpoint of the range for use in fair value measures, subject to limitations on the basis of the borrowers' ability to prepay the debt without penalty.
Our market approach valuations, generally applied to equity investments and investments in non-performing debt, involve a determination of an enterprise value multiple to a financial performance metric of the portfolio company, generally EBITDA. These determinations are based on identification of a comparable set of publicly traded companies and determination of a public-to-private liquidity adjustment factor. This method generally produces a range of multiplier values and we generally select the midpoint of the range for fair value measures.
The following table illustrates the impact of our fair value measures if we selected the low or high end of the range for all investments at December 31, 2018 (dollar amounts in thousands):
Fair Value at December 31, 2018 | Range of Fair Value | ||||||||||||
Investment Type | Low-end | High-end | |||||||||||
Debt investments: | |||||||||||||
Senior Secured | $ | 295,087 | $ | 289,637 | $ | 300,772 | |||||||
Subordinated | $ | 44,540 | 43,891 | 45,189 | |||||||||
Equity investments: | |||||||||||||
Preferred equity | $ | 14,613 | 13,528 | 15,057 | |||||||||
Common equity and warrants | $ | 18,627 | 15,113 | 22,540 | |||||||||
The above tables excludes $23,930, $-0-, and $-0-, of senior secured debt investments, subordinated debt investments and equity investments, respectively, valued at Transaction Prices.
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 3.” |
• | The Administration Agreement with OFS Services, an affiliate of OFS Advisor, to provide us with the office facilities and administrative services necessary to conduct our operations. See “Item 1–Management and Other Agreements” and “Item 8–Financial Statements and Supplementary Data–Note 3.” |
• | A license agreement with OFSAM, the parent company of OFS Advisor, under which OFSAM has agreed to grant us a non-exclusive, royalty-free license to use the name “OFS.” Under this agreement, we have a right to use the “OFS” name for so long as OFS Advisor or one of its affiliates remains our investment adviser. Other than with 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 managed by OFS Advisor, so long as its services to us are not impaired. OFS Advisor also serves as the investment adviser or collateral manager to CLOs and other assets, including HPCI, a non-traded BDC with an investment strategy similar to ours, as well as OCCI, a newly organized, non-diversified, externally managed, closed-end management investment company that has registered as an investment company under the 1940 Act that primarily invests in the debt and subordinated securities of CLOs.
Portfolio Composition and Investment Activity
Portfolio Composition
As of December 31, 2018, the fair value of our debt investment portfolio totaled $363.6 million in 44 portfolio companies, of which 88% and 12% were senior secured loans and subordinated loans, respectively, and approximately $33.2 million in equity investments, at fair value, in 13 portfolio companies in which we also held debt investments and six portfolio companies in which we solely held an equity investment. We had unfunded commitments of $8.2 million to four portfolio
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companies at December 31, 2018. Set forth in the tables and charts below is selected information with respect to our portfolio as of December 31, 2018 and 2017.
The following table summarizes the composition of our investment portfolio as of December 31, 2018 and 2017 (dollar amounts in thousands):
December 31, 2018 | December 31, 2017 | ||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
Senior secured debt investments (1) | $ | 325,873 | $ | 319,017 | $ | 196,020 | $ | 195,112 | |||||||
Subordinated debt investments | 56,212 | 44,540 | 63,031 | 51,198 | |||||||||||
Preferred equity | 19,620 | 14,613 | 24,103 | 19,200 | |||||||||||
Common equity and warrants | 11,606 | 18,627 | 6,821 | 11,989 | |||||||||||
Total | $ | 413,311 | $ | 396,797 | $ | 289,975 | $ | 277,499 | |||||||
Total number of portfolio companies | 50 | 50 | 37 | 37 | |||||||||||
(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 $68,207 and $67,480 at December 31, 2018, respectively, and $21,709 and $21,919, at December 31, 2017, 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, 2018 | December 31, 2017 | December 31, 2018 | December 31, 2017 | ||||||||||||||||||||||||
South - US | $ | 124,795 | 30.2 | % | $ | 126,123 | 43.5 | % | $ | 123,344 | 31.1 | % | $ | 124,699 | 44.9 | % | |||||||||||
Northeast - US | 109,899 | 26.6 | 106,506 | 36.7 | 92,570 | 23.4 | 91,012 | 32.8 | |||||||||||||||||||
West - US | 124,991 | 30.2 | 32,976 | 11.4 | 120,788 | 30.4 | 33,097 | 11.9 | |||||||||||||||||||
Midwest - US | 53,626 | 13.0 | 20,431 | 7.0 | 60,095 | 15.1 | 24,621 | 8.9 | |||||||||||||||||||
Canada | — | — | 3,939 | 1.4 | — | — | 4,070 | 1.5 | |||||||||||||||||||
Total | $ | 413,311 | 100.0 | % | $ | 289,975 | 100.0 | % | $ | 396,797 | 100.0 | % | $ | 277,499 | 100.0 | % | |||||||||||
As of December 31, 2018, our investment portfolio’s three largest industries by fair value, were (1) Professional, Scientific, and Technical Services (13.7%), (2) Manufacturing (13.5%), and (3) Information (10.4%), totaling approximately 37.6% of the investment portfolio. For a full summary of our investment portfolio by industry, see "Note 4, Investments" to the consolidated financial statements included in "Part II, Item 8. Financial Statements and Supplementary Data" of this report.
The following table presents our debt investment portfolio by investment size as of December 31, 2018 and 2017 (dollar amounts in thousands):
Amortized Cost | Fair Value | ||||||||||||||||||||||||||
December 31, 2018 | December 31, 2017 | December 31, 2018 | December 31, 2017 | ||||||||||||||||||||||||
Up to $4,000 | $ | 24,785 | 6.4 | % | $ | 28,403 | 10.9 | % | $ | 25,117 | 6.9 | % | $ | 24,745 | 10.1 | % | |||||||||||
$4,001 to $7,000 | 66,756 | 17.5 | 53,271 | 20.5 | 60,151 | 16.5 | 45,765 | 18.6 | |||||||||||||||||||
$7,001 to $10,000 | 92,389 | 24.2 | 84,596 | 32.7 | 92,687 | 25.5 | 84,026 | 34.1 | |||||||||||||||||||
$10,001 to $13,000 | 44,527 | 11.7 | 37,706 | 14.6 | 34,032 | 9.4 | 38,033 | 15.4 | |||||||||||||||||||
Greater than $13,000 | 153,628 | 40.2 | 55,075 | 21.3 | 151,570 | 41.7 | 53,741 | 21.8 | |||||||||||||||||||
Total | $ | 382,085 | 100.0 | % | $ | 259,051 | 100.0 | % | $ | 363,557 | 100.0 | % | $ | 246,310 | 100.0 | % | |||||||||||
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The following table displays the composition of our performing debt investment portfolio by weighted average yield as of December 31, 2018 and 2017:
December 31, | ||||||||||||||||||
2018 | 2017 | |||||||||||||||||
Weighted Average Yield - Performing Debt Investments (1) | Senior Secured Debt | SubordinatedDebt | Total Debt | Senior Secured Debt | SubordinatedDebt | Total Debt | ||||||||||||
Less than 8% | 0.7 | % | — | % | 0.7 | % | 2.0 | % | — | % | 1.6 | % | ||||||
8% – 10% | 22.5 | — | 19.8 | 26.7 | — | 21.1 | ||||||||||||
10% – 12% | 42.9 | 26.9 | 41.0 | 38.4 | 11.5 | 32.7 | ||||||||||||
12% – 14% | 29.5 | 56.5 | 32.7 | 10.1 | 50.8 | 18.6 | ||||||||||||
Greater than 14% | 4.4 | 16.6 | 5.8 | 22.8 | 37.7 | 26.0 | ||||||||||||
Total | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
Weighted average yield – performing debt investments (1) | 11.33 | % | 12.74 | % | 11.50 | % | 11.76 | % | 13.40 | % | 12.11 | % | ||||||
Weighted average yield – total debt investments (2) | 11.33 | % | 9.93 | % | 11.12 | % | 11.76 | % | 11.05 | % | 11.59 | % | ||||||
(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 10.49% and 10.35%, at December 31, 2018 and 2017, 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 decreased from 12.11% at December 31, 2017 to 11.50% at December 31, 2018, primarily due to approximately $138.0 million in sales and repayments of debt investments with a weighted average yield of 12.49%, and the deployment of $247.9 million in new originations with a weighted average yield of 11.19% during the year ended December 31, 2018. This decline was partly offset by increases in weighted average yield due to LIBOR on existing loan investments held at December 31, 2017.
As of December 31, 2018 and 2017, floating rate loans at fair value were 87% and 76% of our debt investment portfolio, respectively, and fixed rate loans at fair value were 13% and 24% of our debt investment portfolio, respectively.
Non-Accrual Loans
At December 31, 2018, we had three loans (Community Intervention Services, Inc., Master Cutlery, LLC and Southern Technical Institute, LLC) on non-accrual status with respect to all interest and Net Loan Fee amortization, with an amortized cost and fair value of $12.4 million and $0.9 million, respectively. In August 2018, the Elgin Fasteners Group senior secured loan became contractually due. The lending group entered into a forbearance agreement with respect to the maturity date through September 26, 2019, subject to other terms and conditions. The investment continues to accrue interest as the borrower has continued to make interest and amortization payments.
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 unamortized Net Loan Fees 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 8.–Financial Statements–Note 4" for further information.
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PIK and Cash Dividend Accruals
Payment-in-kind dividends on preferred equity securities are recognized at fair value when earned. However, at December 31, 2018, we owned four preferred equity securities (Master Cutlery, LLC, Stancor, L.P., My Alarm Center, LLC and TRS Services, LLC), with an aggregate amortized cost and fair value of $9.9 million and $3.8 million, respectively, for which, notwithstanding the fair value on certain of the preferred equity securities, the fair value of the most-recent PIK dividend as of December 31, 2018, was recognized at $0. 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.
Investment Activity
The following is a summary of our cash investment activity for the years ended December 31, 2018 and 2017 (dollar amounts in millions):
Year Ended December 31, 2018 | Year Ended December 31, 2017 | ||||||||||||||
Debt Investments | Equity Investments | Debt Investments | Equity Investments | ||||||||||||
Investments in new portfolio companies | $ | 196.4 | $ | 4.7 | $ | 114.5 | $ | 4.4 | |||||||
Investments in existing portfolio companies: | |||||||||||||||
Follow-on investments | 63.6 | 1.3 | 19.0 | 1.4 | |||||||||||
Delayed draw funding | 6.2 | — | 3.6 | — | |||||||||||
Total investments in existing portfolio companies | 69.8 | 1.3 | 22.6 | 1.4 | |||||||||||
Total investments in new and existing portfolio companies | $ | 266.2 | $ | 6.0 | $ | 137.1 | $ | 5.8 | |||||||
Number of new portfolio company investments | 28 | 4 | 17 | 4 | |||||||||||
Number of existing portfolio company investments | 20 | 4 | 17 | 2 | |||||||||||
Proceeds/distributions from principal payments/equity investments | $ | 100.7 | $ | — | $ | 105.1 | $ | — | |||||||
Proceeds from investments sold or redeemed | 39.1 | 8.3 | 17.8 | 19.2 | |||||||||||
Total proceeds from principal payments, equity distributions and investments sold | $ | 139.8 | $ | 8.3 | $ | 122.9 | $ | 19.2 | |||||||
Non-cash Investment Activity
In June 2018, our investment in Southern Technical Institute, LLC was restructured. We converted our subordinated note, SP-1 preferred shares, and warrants for a $1.5 million subordinated loan and 1,764,720 shares of Class A-1 common units. Subsequent to the conversion, we sold our Class A-1 common units but retained a significant economic interest in the units. The cost and fair value of the subordinated loan and economic interest were $0 and $0 as of December 31, 2018. We recognized a realized loss on the restructuring of $5.6 million for the year ended December 31, 2018, of which $4.4 million was recognized as unrealized losses as of December 31, 2017.
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, we sold our 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 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.
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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, 2018 and 2017 (dollar amounts in thousands):
As of December 31, | ||||||||||||||
2018 | 2017 | |||||||||||||
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) | 3,788 | 1.0 | 3,755 | 1.5 | ||||||||||
3 (Average) | 329,635 | 90.7 | 222,027 | 90.1 | ||||||||||
4 (Special Mention) | 29,284 | 8.1 | 16,454 | 6.7 | ||||||||||
5 (Substandard) | — | — | 2,873 | 1.2 | ||||||||||
6 (Doubtful) | 850 | 0.2 | 1,201 | 0.5 | ||||||||||
7 (Loss) | — | — | — | — | ||||||||||
$ | 363,557 | 100.0 | % | $ | 246,310 | 100.0 | % | |||||||
During the year ended December 31, 2018, we reclassified three debt investments (TRS Services, LLC, GGC Aerospace Topco L.P. and MTE Holdings Corp.) from risk category 3 to risk category 4, with an aggregate fair value of $21.46 million at December 31, 2017, primarily due to declining performance in the underlying businesses of the portfolio companies. We also reclassified our debt investment in Master Cutlery, LLC, with a fair value of $2.87 million at December 31, 2017, from risk category 5 to risk category 6 and classified the investment as non-accrual with respect to PIK interest and Net Loan Fees. All other year over year changes in the fair value of our debt investments within each category, were a result of new debt investments, the receipt of amortization payments on existing debt investments, repayment of certain debt investments in full, changes in the fair value of our existing debt investments within the categories, and other investment activity.
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, 2018, floating rate and fixed rate loans comprised 87% and 13%, respectively, of our current debt investment portfolio at fair value; however, in accordance with our investment strategy, we expect that over time the proportion of fixed rate loans will continue to increase. In some cases, our investments provide for PIK interest, or PIK dividends (meaning interest or dividends paid in the form of additional principal amount of the loan or equity security instead of in cash). We also generate revenue in the form of management, valuation, and other contractual fees, which 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.
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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. Moreover, as a BDC and a RIC, we are also subject to certain constraints on our operations, including, but not limited to, limitations imposed by the 1940 Act and the Code. In addition, SBIC I LP is subject to regulation and oversight by they SBA. For the reasons described above, the results of operations described below may not necessarily be indicative of the results we expect to report in future periods.
Net increase in net assets resulting from operations can vary substantially from period to period for various reasons, including the recognition of realized gains and losses and unrealized appreciation and depreciation. As a result, annual comparisons of net increase in net assets resulting from operations may not be meaningful.
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Comparison of years ended December 31, 2018, 2017, and 2016.
Consolidated operating results for the years ended December 31, 2018, 2017, and 2016 are as follows (in thousands):
Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
Investment income | |||||||||||
Interest income: | |||||||||||
Cash interest income | $ | 36,068 | $ | 26,444 | $ | 24,901 | |||||
Net Loan Fee amortization | 2,288 | 1,450 | 1,414 | ||||||||
Other interest income | 251 | 230 | 85 | ||||||||
Total interest income | 38,607 | 28,124 | 26,400 | ||||||||
PIK income: | |||||||||||
PIK interest income | 1,193 | 1,508 | 1,194 | ||||||||
Preferred equity PIK dividends | 906 | 1,399 | 1,433 | ||||||||
Total PIK income | 2,099 | 2,907 | 2,627 | ||||||||
Dividend income: | |||||||||||
Preferred equity cash dividends | — | 165 | 168 | ||||||||
Common equity dividends | 315 | 317 | 307 | ||||||||
Total dividend income | 315 | 482 | 475 | ||||||||
Fee income: | |||||||||||
Management, valuation, and syndication | 922 | 163 | 159 | ||||||||
Prepayment, structuring, and other fees | 891 | 1,750 | 1,433 | ||||||||
Total fee income | 1,813 | 1,913 | 1,592 | ||||||||
Total investment income | 42,834 | 33,426 | 31,094 | ||||||||
Total expenses, net | 24,449 | 17,549 | 16,949 | ||||||||
Net investment income | 18,385 | 15,877 | 14,145 | ||||||||
Net loss on investments | (8,813 | ) | (7,967 | ) | (317 | ) | |||||
Net increase in net assets resulting from operations | $ | 9,572 | $ | 7,910 | $ | 13,828 | |||||
Interest and PIK income by debt investment type for the years ended December 31, 2018, 2017, and 2016 are summarized below (in thousands):
Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
Interest and PIK interest income: | |||||||||||
Senior secured debt investments | $ | 32,127 | $ | 21,785 | $ | 19,485 | |||||
Subordinated debt investments | 7,673 | 7,847 | 8,109 | ||||||||
Total interest and PIK interest income | $ | 39,800 | $ | 29,632 | $ | 27,594 | |||||
Comparison of investment income for the years ended December 31, 2018 and 2017:
Interest and PIK interest income increased approximately $10.2 million, due to a $8.9 million increase in recurring interest income caused by a $76.8 million increase in the average outstanding loan balance during 2018 along with an increase of $0.7 million in recurring interest income resulting from a 23 basis point increase in the weighted average yield in our debt portfolio during the year ended December 31, 2018. Acceleration of Net Loan Fees of $1.1 million and $0.6 million were included in interest income for the years ended December 31, 2018 and 2017, respectively, from the repayment of loans prior to their scheduled due dates.
We recorded prepayment fees of $0.9 million resulting from $50.0 million of unscheduled principal payments during the year ended December 31, 2018, compared to $1.0 million from $60.2 million of unscheduled principal payments during 2017. We recognized capital structuring fees of $0.0 million and $0.5 million for the years ended December 31, 2018 and 2017, respectively, upon the closing of $0 and $55.7 million of debt and equity investments, respectively. We ceased recognition of such fees with the adoption of ASC 606. We recognized syndication fees of $0.7 million and $0.2 million for the years ended December 31, 2018 and 2017, respectively, resulting from approximately $64 million and $21 million in loan originations during that period in which OFS Advisor sourced, structured, and arranged the lending group, and for which we were additionally compensated.
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Comparison of investment income for the years ended December 31, 2017 and 2016:
Interest and PIK 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 debt 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 years ended December 31, 2017 and 2016, respectively, from the repayment of loans prior to their scheduled due dates.
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.
Expenses
Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
(Amounts in thousands) | |||||||||||
Interest expense | $ | 9,232 | $ | 5,813 | $ | 5,302 | |||||
Management fees | 6,335 | 4,999 | 4,516 | ||||||||
Incentive fee, net of waiver | 4,387 | 2,962 | 3,333 | ||||||||
Professional fees | 1,245 | 1,115 | 1,200 | ||||||||
Administration fee | 1,601 | 1,314 | 1,304 | ||||||||
General and administrative expenses | 1,649 | 1,346 | 1,294 | ||||||||
Total expenses | $ | 24,449 | $ | 17,549 | $ | 16,949 | |||||
Comparison of expenses for the years ended December 31, 2018 and 2017:
Interest expense increased by $3.4 million primarily due to interest expense of $3.1 million associated with the Unsecured Notes issued in April and October of 2018, see "Item 8.–Financial Statements–Note 7" for details.
Management fee expense increased by $1.3 million due to an increase in our average total assets, primarily due to an increase in net investment activity, including deployment of $95.4 million in proceeds from the issuance of the Unsecured Notes.
Incentive fee expense increased by $1.4 million primarily due to a $2.5 million increase in net investment income relating to the deployment of the proceeds from the Unsecured Notes, as well as a decrease in 2017 relating to Part One incentive fees, due to a share issuance adjustment related to the Offering, which raised the hurdle rate to a level that was not exceeded in the second quarter because the Offering proceeds were not fully deployed.
Administration fees increased by $0.3 million primarily due to an increase in allocated accounting labor and software costs.
General and administrative expenses increased $0.3 million primarily due to legal and other offering costs incurred during the first quarter of 2018 in connection with a foreign debt transaction that we elected not to pursue due to regulatory changes and market conditions.
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 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,
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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.
Net gain (loss) on investments
Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
(Amounts in thousands) | |||||||||||
Senior secured debt | $ | (9,020 | ) | $ | (4,441 | ) | $ | 411,000 | |||
Subordinated debt | (3,308 | ) | (8,667 | ) | (2,368 | ) | |||||
Preferred equity | (1,993 | ) | 5,373 | (2,584,000 | ) | ||||||
Common equity and warrants | 5,508 | (232 | ) | 4,224 | |||||||
Net loss on investments | $ | (8,813 | ) | $ | (7,967 | ) | $ | (317,000 | ) | ||
Year ended December 31, 2018
We recognized net losses of $9.0 million on senior secured debt during the year ended December 31, 2018, primarily as a result of a realized loss of $3.5 million on our senior secured debt investment in Jobson recognized upon the sale in the second quarter of 2018, as well as by the negative net impact of mark-to-market adjustments in the fourth quarter relating to our Broadly Syndicated Loan investments resulting in an unrealized loss of $5.5 million.
We recognized net losses of $3.3 million on subordinated debt during the year ended December 31, 2018, primarily as a result of a realized loss of $3.5 million on the restructuring of the Southern Technical Institute, LLC subordinated debt investment, of which $2.3 million was recognized as unrealized losses in prior years, and net unrealized depreciation of $2.1 from the negative impact of specific performance factors, principally related to Master Cutlery LLC.
We recognized net losses of $2.0 million on preferred equity investments for the year ended December 31, 2018, primarily as a result of a $1.4 million unrealized loss on TRS Services, LLC, and other negative net impact of portfolio company-specific performance factors on other investments resulting in an additional unrealized loss of $0.6 million.
We recognized net gains of $5.5 million on common equity and warrant investments for the year ended December 31, 2018, as a result of net realized gains of $3.7 million, primarily driven by a $4.1 million realized gain on the sale of All Metal Holdings, LLC, and the positive impact of portfolio company-specific performance factors resulting in unrealized appreciation of $1.8 million for the year ended December 31, 2018.
Year ended December 31, 2017
We recognized net losses of $4.4 million on senior secured debt during the year ended December 31, 2017, primarily as a result of a realized loss of $5.0 million on our senior secured debt investment in My Alarm recognized upon restructuring in the third quarter of 2017, offset by the positive net impact of portfolio company-specific performance factors on other investments. We held the My Alarm investment from the fourth quarter of 2015 and recognized unrealized appreciation of $0.2 million and $0 during the years ended December 31, 2016 and 2015, respectively.
We recognized net losses of $8.7 million on subordinated debt during the year ended December 31, 2017, primarily as a result of the net negative impact of portfolio company-specific performance factors, including unrealized depreciation of $5.4 million recognized on our debt investment in Community Intervention Services, Inc., which was placed on non-accrual status during 2016, unrealized depreciation of $2.1 million recognized on our debt investment in Southern Technical Institute, LLC, which was placed on non-accrual status during the fourth quarter of 2017, and $1.6 million of unrealized depreciation on our debt investment in Master Cutlery, LLC.
We recognized net gains of $5.4 million on preferred equity investments for the year ended December 31, 2017, primarily as a result of $7.7 million of net realized gains recognized upon sale of three equity investments, offset by the negative impact from changes to EBITDA multiples used in our valuations and negative impacts of portfolio company-specific performance factors, including a $2.1 million unrealized loss recognized on our equity investment in Southern Technical Institute, LLC. Included in net gains of $7.7 million for the year ended December 31, 2017, were realized gains of $11.0 million we recognized upon sale of the three aforementioned equity investments. We recognized cumulative unrealized appreciation of approximately $3.3 million on these investments through December 31, 2016, which resulted in an aggregate net gain of $7.7 million during the year ended December 31, 2017. In addition, previously recognized cumulative unrealized depreciation of $0.3 million at June 30, 2017, on our preferred equity investment in My Alarm, was realized upon restructuring.
We recognized net losses of $0.2 million on common equity and warrant investments for the year ended December 31, 2017, primarily as a result of the negative impact of portfolio company-specific performance factors, offset by a $0.4 million
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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.
Liquidity and Capital Resources
At December 31, 2018, we held cash and cash equivalents of $38.2 million, which includes cash and cash equivalents of $36.0 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, 2018, the Parent received cash distributions of $21.9 million from SBIC I LP. At December 31, 2018, the Parent had $8.4 million of cash and cash equivalents available for general corporate activities, including approximately $6.3 million held by SBIC I LP that was available for distribution to it. Additionally, we had $38.0 million borrowings available through our PWB Credit Facility, $50 million of Unsecured Notes Due April 2025 and $48.5 million of Unsecured Notes Due October 2025 outstanding at December 31, 2018. Our asset coverage as of December 31, 2018 was 254%.
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Sources and Uses of Cash and Cash Equivalents
We generate cash through operations from net investment income and the net liquidation of portfolio investments, and use cash in our operations in the net purchase of portfolio investments. Significant variations may exist between net investment income and cash from net investment income, primarily due to the recognition of non-cash investment income, including Net Loan Fee amortization, PIK interest, and PIK dividends, which generally will not be fully realized in cash until we exit the investment. As discussed in "Item 8. Financial Statements—Note 3", we pay OFS Advisor a quarterly incentive fee with respect to our pre-incentive fee net investment income, which includes investment income that has not been received in cash. In addition, we must distribute substantially all our taxable income, which approximates, but will not always equal, the cash we generate from net investment income to maintain our RIC tax treatment. Historically, our distributions have been in excess of taxable income and we have limited history of net taxable gains. We also obtain cash to fund investments or general corporate activities from the issuance of securities and our revolving line of credit. These principal sources and uses of cash and liquidity are presented below (in thousands):
Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
Cash from net investment income | $ | 18,782 | $ | 11,451 | $ | 10,051 | |||||
Cash received from net realized gains (losses) | 402 | 11,017 | 2,228 | ||||||||
Net (purchases and originations) repayments of portfolio investments | (120,272 | ) | (11,795 | ) | (23,595 | ) | |||||
Net cash provided by (used in) operating activities | (101,088 | ) | 10,673 | (11,316 | ) | ||||||
Proceeds from common stock offering, net of expenses | — | 53,423 | — | ||||||||
Proceeds from issuance of the Unsecured Notes, net of discounts | 95,446 | — | — | ||||||||
Distributions paid to stockholders | (22,895 | ) | (16,700 | ) | (13,062 | ) | |||||
Net borrowings (repayments) under revolving line of credit | (5,600 | ) | 8,100 | 9,500 | |||||||
Payment of debt issuance costs | (643 | ) | (203 | ) | (177 | ) | |||||
Net Increase (decrease) in cash and cash equivalents | $ | (34,780 | ) | $ | 55,293 | $ | (15,055 | ) | |||
Comparison of the years ended December 31, 2018 and 2017:
At December 31, 2018, we held cash and cash equivalents of $38.2 million, a decrease of $34.8 million from December 31, 2017.
Cash from net investment income
Cash from net investment income increased $7.3 million for the year ended December 31, 2018, compared to the prior year. The increase to cash from net investment income was principally due to an increase in interest income resulting from the deployment of the Unsecured Notes proceeds.
Cash received from realized gains (losses)
Cash received on realized gains (losses) 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, 2018, net purchases and originations of portfolio investments were primarily due to $272.2 million of cash we used to purchase portfolio investments, offset by $148.0 million of cash we received from amortized cost repayments and sales on our portfolio investments. During the year ended December 31, 2017, net purchases were due to $142.9 million of cash we used to purchase portfolio investments, offset by $142.1 million of cash we received from amortized cost repayments on our portfolio investments.
Proceeds from issuance of the Unsecured Notes, net of expenses
During the year ended December 31, 2018, we issued $98.5 million in Unsecured Notes, with net proceeds of $95.4 million after deducting underwriting discounts and offering costs.
Cash distributions paid
Cash distributions increased $6.2 million for the year ended December 31, 2018 compared to the prior year, mostly due to the $4.9 million special dividend paid in the first quarter of 2018 for an undistributed net long-term capital gains realized by the Company in 2017.
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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 in 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 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 and originations of portfolio investments 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 the Offering at a 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.
Borrowings
SBA Debentures
SBIC I LP has a SBIC license that allowed it to obtain leverage by issuing SBA-guaranteed debentures. These debentures are non-recourse to us, and bear interest payable semi-annually, and each debenture has a maturity date that is ten years following issuance. The interest rate on SBA debentures are fixed at the first pooling date after issuance, which is March and September of each year, at market-driven spreads over U.S. Treasury Notes with ten-year maturities. SBA regulations currently limit the amount that an SBIC may borrow up to a maximum of $150 million (or $175 million with SBA approval) when it has at least $75 million in regulatory capital (or $87.5 million with approval to borrow up to $175 million), receives a leverage commitment from the SBA and has been through an examination by the SBA subsequent to licensing. For two or more SBICs under common control, the maximum amount of outstanding SBA-provided leverage cannot exceed $350 million. As of December 31, 2018 and 2017, 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%.
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The following table shows our outstanding SBA debentures payable as of December 31, 2018 and 2017 (in thousands):
SBA debentures outstanding | |||||||||||||
Pooling Date | Maturity Date | Fixed Interest Rate | December 31, 2018 | December 31, 2017 | |||||||||
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 | (2,280 | ) | (2,657 | ) | |||||||||
SBA debentures outstanding, net of unamortized debt issuance costs | $ | 147,600 | $ | 147,223 | |||||||||
On a stand-alone basis, SBIC I LP held $251.1 million and $251.6 million in assets at December 31, 2018 and 2017, respectively, which accounted for approximately 57% and 70% 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 the Company if it does not have sufficient capital in accordance with SBA regulations. Such actions by the SBA would in turn, negatively affect the Company.
PWB Credit Facility
We are party to a BLA with Pacific Western Bank, as lender, to provide us with a senior secured revolving credit facility, or PWB Credit Facility. The PWB Credit Facility is available for general corporate purposes including investment funding. The maximum availability of the PWB Credit Facility is equal to 50% of the aggregate outstanding principal amount of eligible loans included in the borrowing base, which excludes subordinated loan investments (as defined in the BLA) and as otherwise specified in the BLA. The PWB Credit Facility is guaranteed by 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 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, 2018, we were in compliance with the applicable covenants.
The terms of the PWB Credit Facility as of December 31, 2018 are as follows (amounts in thousands):
Maximum Availability | Floor Rate | Interest Rate | Unused Fee | Maturity Date | |||||||||
PWB Credit Facility | $ | 50,000 | 5.25 | % | Prime + 0.75% | 0.50 | % | January 31, 2020 | |||||
Availability under the PWB Credit Facility was $38.0 million, based on the stated advance rate of 50% under the borrowing base, and the $12.0 million outstanding as of December 31, 2018.
Unsecured Notes
In April 2018, we publicly offered the Unsecured Notes Due April 2025 with aggregate principal of $50.0 million. The total net proceeds to the Company from the Unsecured Notes Due April 2025, after deducting underwriting discounts and offering costs of $1.8 million were $48.2 million. In October and November 2018, the Company publicly offered the Unsecured Notes Due October 2025 with aggregate principal of $48.5 million, which included a partial exercise of the underwriters overallotment option. The total net proceeds to the Company from the Unsecured Notes Due October 2025, after
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deducting underwriting discounts and offering expenses of $1.7 million, were $46.8 million. The combined Unsecured Notes totaled $98.5 million in aggregate principal debt, with net proceeds of $95.0 million to the Company.
The Unsecured Notes are direct unsecured obligations and rank equal in right of payment with all of our current and future unsecured indebtedness. Because the Unsecured Notes are not secured by any of our assets, they are effectively subordinated to all existing and future secured unsubordinated indebtedness (or any indebtedness that is initially unsecured as to which we subsequently grant a security interest), to the extent of the value of the assets securing such indebtedness, including, without limitation, borrowings under the PWB Credit Facility.
As of December 31, 2018, the Unsecured Notes had the following terms and balances (amounts in thousands):
Unsecured Notes | Principal | Stated Interest Rate (1) | Effective Interest Rate (2) | Maturity (3) | 2018 Interest Expense (4) | ||||||||||
Unsecured Notes Due April 2025 | $ | 50,000 | 6.375 | % | 6.875 | % | 4/30/2025 | $ | 2,439 | ||||||
Unsecured Notes Due October 2025 | 48,525 | 6.50 | % | 7.01 | % | 10/31/2025 | 697 | ||||||||
Total | $ | 98,525 | $ | 3,136 | |||||||||||
(1) | The weighted-average fixed cash interest rate on the Unsecured Notes as of December 31, 2018 was 6.44%. |
(2) | The effective interest rate on the Unsecured Notes includes deferred debt issuance cost amortization. |
(3) | The Unsecured Notes Due April 2025 may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after April 30, 2020. The Unsecured Notes Due October 2025 may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after October 31, 2020. |
(4) | Interest expense includes deferred issuance costs amortization of $228 for the year ended December 31, 2018. |
The average dollar borrowings and average interest rate for all debt the years ended December 31, 2018, 2017, and 2016, were as follows:
Year ended | Average Dollar Borrowings | Average Interest Rate | |||||
December 31, 2018 | $ | 206,936 | 4.37 | % | |||
December 31, 2017 | 158,368 | 3.55 | |||||
December 31, 2016 | 150,458 | 3.44 | |||||
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.
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). Provisions of the SBCAA permit BDCs to be subject to a minimum asset coverage ratio of 150%, if specific conditions are satisfied, when issuing senior securities (i.e., the amount of debt may not exceed 66 2/3% of the value of our assets). As an approximation, prior to the enactment of the SBCAA, the most that a BDC could borrow for investment purposes was $1 for every $1 of investor equity. Now, for those BDCs that satisfy the SBCAA’s approval and disclosure requirements and become subject to the reduced asset coverage ratio, the BDC can borrow $2 for investment purposes for every $1 of investor equity.
The SBCAA provides that in order for a BDC whose common stock is traded on a national securities exchange to be subject to 150% asset coverage, the BDC must either obtain: (i) approval of the required majority of its non-interested directors who have no financial interest in the proposal, which would become effective one year after the date of such approval, or (ii) obtain stockholder approval (of more than 50% of the votes cast for the proposal at a meeting in which quorum is present), which would become effective on the first day after the date of such stockholder approval.
On May 3, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements and, as a result, the asset coverage ratio test
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applicable to us will be decreased from 200% to 150%, effective May 3, 2019. Additionally, we received exemptive relief from the SEC effective November 26, 2013, which allows us to exclude our SBA guaranteed debentures from the definition of senior securities in the statutory asset coverage ratio under the 1940 Act.
This requirement limits the amount that we may borrow. To fund growth in our investment portfolio in the future, we anticipate needing to raise additional capital from various sources, including the equity markets and the securitization or other debt-related markets, which may or may not be available on favorable terms, if at all.
Contractual Obligations and Off-Balance Sheet Arrangements
The following table shows our contractual obligations as of December 31, 2018 (in thousands):
Principal and Interest 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 (3) | $ | 12,812 | $ | 750 | $ | 12,062 | $ | — | $ | — | |||||||||
SBA Debentures | 178,862 | 4,761 | 9,535 | 30,095 | 134,471 | ||||||||||||||
Unsecured Notes | 127,584 | 6,342 | 6,342 | 6,342 | 108,558 | ||||||||||||||
Total | $ | 319,258 | $ | 11,853 | $ | 27,939 | $ | 36,437 | $ | 243,029 | |||||||||
(1) | Excludes commitments to extend credit to our portfolio companies. |
(2) | The PWB Credit Facility is scheduled to mature on January 31, 2020. The SBA debentures are scheduled to mature between September 2022 and 2025. The Unsecured Notes are scheduled to mature between April 2025 and October 2025. |
(3) | Contractual interest is based on LIBOR at December 31, 2018 and assumes no interim additional borrowings or repayments under the revolving line of credit between December 31, 2018 and maturity. |
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 $8.2 million of total unfunded commitments to four portfolio companies at December 31, 2018.
Distributions
We are taxed as a RIC under the Code. Generally, a RIC is entitled to deduct dividends it pays to its stockholders from its income to determine “taxable income.” Taxable income includes our taxable interest, dividend and fee income, and taxable net capital gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash. Taxable income includes non-cash income, such as changes in accrued and reinvested interest and dividends, which includes contractual PIK interest, and the amortization of discounts and fees. Cash collections of income resulting from contractual PIK interest and dividends or the amortization of discounts and fees generally occur upon the repayment of the loans or debt securities that include such items. Non-cash taxable income is reduced by non-cash expenses, such as realized losses and depreciation, and amortization expense.
Our board of directors maintains a variable dividend policy with the objective of distributing four quarterly distributions in an amount not less than 90-100% of our taxable quarterly income or potential annual income for a particular year. In addition, at the end of the year, we may also pay an additional special dividend, or fifth dividend, such that we may distribute approximately all of our annual taxable income in the year it was earned, while maintaining the option to spill over our excess taxable income to a following year. Each year, a statement on Form 1099-DIV identifying the source of the distribution is mailed to the Company’s stockholders. For the year ended December 31, 2018, approximately $1.36 per share, $0.37 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
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$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, 2018, 2017, and 2016, see "Item 8.–Financial Statements–Note 10."
Recent Developments
On March 5, 2019, our Board declared a distribution of $0.34 per share for the first quarter of 2019, payable on March 29, 2019 to stockholders of record as of March 22, 2019.
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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, 2018, 87% of our debt investments bore interest at floating interest rates and 13% 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, 2018, 100% of our floating rate loans were based on a floating LIBOR (not subject to a floor).
Our outstanding SBA debentures and Unsecured Notes bear interest at a fixed rate. Our PWB Credit Facility has a floating interest rate provision based on the Prime Rate, with a 5.25% interest rate floor, and was 6.25% as of December 31, 2018.
Assuming that the consolidated balance sheet as of December 31, 2018, 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 | $ | 1,929 | $ | 61 | $ | 1,868 | ||||||
100 | 3,557 | 122 | 3,435 | |||||||||
150 | 5,185 | 183 | 5,002 | |||||||||
200 | 6,813 | 243 | 6,570 | |||||||||
250 | 8,441 | 304 | 8,137 | |||||||||
Basis point decrease | Interest income | Interest expense (1) | Net increase (decrease) | |||||||||
50 | $ | (1,327 | ) | $ | (61 | ) | $ | (1,266 | ) | |||
100 | (2,947 | ) | (122 | ) | (2,825 | ) | ||||||
150 | (4,518 | ) | (4,518 | ) | ||||||||
200 | (5,241 | ) | — | (5,241 | ) | |||||||
250 | (5,479 | ) | — | (5,479 | ) | |||||||
(1) Our PWB Credit Facility contains a 5.25% interest rate floor, and therefore a decline in the Prime Rate would not materially impact interest expense.
Although we believe that the foregoing analysis is indicative of our sensitivity to interest rate changes as of December 31, 2018, 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.
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ITEM 8. FINANCIAL STATEMENTS
Index to Financial Statements
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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 statements of assets and liabilities of OFS Capital Corporation (the “Company”), including the consolidated schedules of investments, as of December 31, 2018 and 2017, the related consolidated statements of operations, changes in net assets and cash flows for each of the three years in the period ended December 31, 2018, and the related notes, including the financial highlights for each of the five years in the period ended December 31, 2018 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017, and the results of its operations, changes in its net assets, and its cash flows for each of the three years in the period ended December 31, 2018, and its financial highlights for each of the five years in the period ended December 31, 2018, 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, 2018, 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 15, 2019 expressed an unqualified 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 Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our procedures included confirmation of securities owned as of December 31, 2018 and 2017 by correspondence with the custodian, loan agent, portfolio companies, or by other appropriate auditing procedures where replies were not received. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
We have served as the Company’s auditors since 2014.
Chicago, Illinois
March 15, 2019
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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, 2018, 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 maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, 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 statements of assets and liabilities, including the consolidated schedule of investments, of the Company as of December 31, 2018 and 2017, the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes, including the financial highlights for each of the five years in the period ended December 31, 2018 and our report dated March 15, 2019 expressed 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.
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.
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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 15, 2019
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OFS Capital Corporation and Subsidiaries
Consolidated Statements of Assets and Liabilities
(Dollar amounts in thousands, except per share data)
December 31, | |||||||
2018 | 2017 | ||||||
Assets | |||||||
Investments, at fair value | |||||||
Non-control/non-affiliate investments (amortized cost of $312,223 and $209,360, respectively) | $ | 297,749 | $ | 197,374 | |||
Affiliate investments (amortized cost of $90,751 and $70,402, respectively) | 89,103 | 69,557 | |||||
Control investment (amortized cost of $10,337 and $10,213, respectively) | 9,945 | 10,568 | |||||
Total investments at fair value (amortized cost of $413,311 and $289,975, respectively) | 396,797 | 277,499 | |||||
Cash and cash equivalents | 38,172 | 72,952 | |||||
Interest receivable | 2,787 | 2,734 | |||||
Prepaid expenses and other assets | 3,665 | 4,593 | |||||
Total assets | $ | 441,421 | $ | 357,778 | |||
Liabilities | |||||||
Revolving line of credit | $ | 12,000 | $ | 17,600 | |||
SBA debentures (net of deferred debt issuance costs of $2,280 and 2,657, respectively) | 147,600 | 147,223 | |||||
Unsecured notes (net of discounts and deferred debt issuance costs of $3,299 and $0, respectively) | 95,226 | — | |||||
Interest payable | 2,791 | 1,596 | |||||
Payable to investment adviser and affiliates | 3,700 | 2,463 | |||||
Payable for investments purchased | 4,151 | — | |||||
Accrued professional fees | 637 | 433 | |||||
Other liabilities | 293 | 127 | |||||
Total liabilities | $ | 266,398 | $ | 169,442 | |||
Commitments and contingencies (Note 6) | |||||||
Net Assets | |||||||
Preferred stock, par value of $0.01 per share, 2,000,000 shares authorized, 0 shares issued and outstanding as of December 31, 2018 and December 31, 2017, respectively | $ | — | $ | — | |||
Common stock, par value of $0.01 per share, 100,000,000 shares authorized, 13,357,337 and 13,340,217 shares issued and outstanding as of December 31, 2018 and December 31, 2017, respectively | 134 | 133 | |||||
Paid-in capital in excess of par | 187,540 | 187,398 | |||||
Total distributable earning (accumulated loss) | (12,651 | ) | 805 | ||||
Total net assets | $ | 175,023 | $ | 188,336 | |||
Total liabilities and net assets | $ | 441,421 | $ | 357,778 | |||
Number of shares outstanding | 13,357,337 | 13,340,217 | |||||
Net asset value per share | $ | 13.10 | $ | 14.12 | |||
See Notes to Consolidated Financial Statements.
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OFS Capital Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollar amounts in thousands, except per share data)
Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
Investment income | |||||||||||
Interest income: | |||||||||||
Non-control/non-affiliate investments | $ | 27,547 | $ | 20,078 | $ | 17,076 | |||||
Affiliate investments | 10,055 | 6,506 | 7,451 | ||||||||
Control investment | 1,005 | 1,540 | 1,873 | ||||||||
Total interest income | 38,607 | 28,124 | 26,400 | ||||||||
Payment-in-kind interest and dividend income: | |||||||||||
Non-control/non-affiliate investments | 668 | 1,400 | 1,070 | ||||||||
Affiliate investments | 1,321 | 1,375 | 1,437 | ||||||||
Control investment | 110 | 132 | 120 | ||||||||
Total payment-in-kind interest and dividend income: | 2,099 | 2,907 | 2,627 | ||||||||
Dividend income: | |||||||||||
Non-control/non-affiliate investments | — | 50 | 36 | ||||||||
Affiliate investments | 130 | 140 | 170 | ||||||||
Control investment | 185 | 292 | 269 | ||||||||
Total dividend income | 315 | 482 | 475 | ||||||||
Fee income: | |||||||||||
Non-control/non-affiliate investments | 987 | 1,086 | 1,366 | ||||||||
Affiliate investments | 760 | 675 | 110 | ||||||||
Control investment | 66 | 152 | 116 | ||||||||
Total fee income | 1,813 | 1,913 | 1,592 | ||||||||
Total investment income | 42,834 | 33,426 | 31,094 | ||||||||
Expenses | |||||||||||
Interest and financing expense | 9,232 | 5,813 | 5,302 | ||||||||
Management fees | 6,335 | 4,999 | 4,516 | ||||||||
Incentive fee | 4,409 | 2,962 | 3,333 | ||||||||
Professional fees | 1,245 | 1,115 | 1,200 | ||||||||
Administration fee | 1,601 | 1,314 | 1,304 | ||||||||
Other Expenses | 1,649 | 1,346 | 1,294 | ||||||||
Total expenses before incentive fee waiver | 24,471 | 17,549 | 16,949 | ||||||||
Incentive fee waiver (see Note 3) | (22 | ) | — | — | |||||||
Total expenses, net of incentive fee waiver | 24,449 | 17,549 | 16,949 | ||||||||
Net investment income | 18,385 | 15,877 | 14,145 | ||||||||
Net realized and unrealized gain (loss) on investments | |||||||||||
Net realized gain (loss) on non-control/non-affiliate investments | (4,966 | ) | (3,248 | ) | 2,387 | ||||||
Net realized gain on affiliate investments | 187 | 10,081 | 17 | ||||||||
Net unrealized depreciation on non-control/non-affiliate investments | (2,484 | ) | (9,715 | ) | (6,699 | ) | |||||
Net unrealized appreciation (depreciation) on affiliate investments | (803 | ) | (5,088 | ) | 3,341 | ||||||
Net unrealized appreciation (depreciation) on control investments | (747 | ) | 3 | 637 | |||||||
Net loss on investments | (8,813 | ) | (7,967 | ) | (317 | ) | |||||
Net increase in net assets resulting from operations | $ | 9,572 | $ | 7,910 | $ | 13,828 | |||||
Net investment income per common share - basic and diluted | $ | 1.38 | $ | 1.28 | $ | 1.46 | |||||
Net increase in net assets resulting from operations per common share - basic and diluted | $ | 0.72 | $ | 0.64 | $ | 1.43 | |||||
Distributions declared per common share | $ | 1.73 | $ | 1.36 | $ | 1.36 | |||||
Basic and diluted weighted average shares outstanding | 13,348,203 | 12,403,706 | 9,692,634 | ||||||||
See Notes to Consolidated Financial Statements.
80
OFS Capital Corporation and Subsidiaries
Consolidated Statements of Changes in Net Assets
(Dollar amounts in thousands, except per share data)
Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
Common Stock | |||||||||||
Balance at beginning of year | $ | 133 | $ | 97 | $ | 96 | |||||
Common stock issued from reinvestment of stockholder distributions, net of repurchase | 1 | 36 | 1 | ||||||||
Balance at December 31 | 134 | 133 | 97 | ||||||||
Paid-in capital in excess of par | |||||||||||
Balance at beginning of year | 187,398 | 134,300 | 134,446 | ||||||||
Common stock issued from reinvestment of stockholder distributions, net of repurchase | 204 | 53,507 | 120 | ||||||||
Return of capital distributions | — | — | (858 | ) | |||||||
Tax reclassifications of permanent differences | (62 | ) | (409 | ) | 592 | ||||||
Balance at December 31 | 187,540 | 187,398 | 134,300 | ||||||||
Total distributable earnings (accumulated losses) | |||||||||||
Net investment income | 18,385 | 15,877 | 14,145 | ||||||||
Realized net gains (losses) on investments | (4,779 | ) | 6,833 | 2,404 | |||||||
Unrealized depreciation net of taxes | (4,034 | ) | (14,800 | ) | (2,721 | ) | |||||
Net increase in net assets resulting from operations | 9,572 | 7,910 | 13,828 | ||||||||
Balance at beginning of year | 805 | 9,381 | 8,471 | ||||||||
Distributions to stockholders | (23,090 | ) | (16,895 | ) | (12,326 | ) | |||||
Tax reclassifications of net assets in accordance with GAAP | 62 | 409 | (592 | ) | |||||||
Balance at December 31 | (12,651 | ) | 805 | 9,381 | |||||||
Total net assets at December 31 | $ | 175,023 | $ | 188,336 | $ | 143,778 | |||||
Shares outstanding | |||||||||||
Balance at beginning of year | 13,340,217 | 9,700,297 | 9,691,170 | ||||||||
Public offering of common stock | — | 3,625,000 | — | ||||||||
Common stock issued from reinvestment of stockholder distributions | 17,420 | 14,920 | 9,127 | ||||||||
Repurchase of common stock | (300 | ) | — | — | |||||||
Number of shares outstanding at December 31 | 13,357,337 | 13,340,217 | 9,700,297 | ||||||||
See Notes to Consolidated Financial Statements.
81
OFS Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
Cash flows from operating activities | |||||||||||
Net increase in net assets resulting from operations | $ | 9,572 | $ | 7,910 | $ | 13,828 | |||||
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 | 4,779 | (6,833 | ) | (2,404 | ) | ||||||
Net change in unrealized depreciation on investments | 4,034 | 14,800 | 2,721 | ||||||||
Amortization of net loan fees | (2,288 | ) | (1,450 | ) | (1,414 | ) | |||||
Amendment fees collected | 161 | 175 | 261 | ||||||||
Payment-in-kind interest and dividend income | (2,099 | ) | (2,907 | ) | (2,627 | ) | |||||
Amortization and write-off of debt issuance costs | 781 | 553 | 490 | ||||||||
Amortization of intangible asset | 195 | 195 | 195 | ||||||||
Purchase and origination of portfolio investments | (272,155 | ) | (142,900 | ) | (68,237 | ) | |||||
Proceeds from principal payments on portfolio investments | 100,699 | 105,078 | 41,404 | ||||||||
Proceeds from sale or redemption of portfolio investments | 47,435 | 37,044 | 5,274 | ||||||||
Distributions received from portfolio investments | — | — | 192 | ||||||||
Changes in operating assets and liabilities: | |||||||||||
Interest receivable | (53 | ) | (964 | ) | (937 | ) | |||||
Interest payable | 1,195 | (3 | ) | 51 | |||||||
Payable to investment adviser and affiliates | 1,237 | (91 | ) | (172 | ) | ||||||
Other assets and liabilities | 5,419 | 66 | 59 | ||||||||
Net cash provided by (used in) operating activities | (101,088 | ) | 10,673 | (11,316 | ) | ||||||
Cash flows from financing activities | |||||||||||
Proceeds from common stock offering, net of expenses | — | 53,423 | — | ||||||||
Payment of common stock offering costs | — | (72 | ) | — | |||||||
Proceeds from unsecured notes offerings, net of discounts | 95,446 | — | — | ||||||||
Distributions paid to stockholders | (22,895 | ) | (16,700 | ) | (13,062 | ) | |||||
Borrowings under revolving line of credit | 96,500 | 44,700 | 9,500 | ||||||||
Repayments under revolving line of credit | (102,100 | ) | (36,600 | ) | — | ||||||
Payment of debt issuance costs | (643 | ) | (131 | ) | (177 | ) | |||||
Net cash provided by (used in) financing activities | 66,308 | 44,620 | (3,739 | ) | |||||||
Net increase (decrease) in cash and cash equivalents | (34,780 | ) | 55,293 | (15,055 | ) | ||||||
Cash and cash equivalents — beginning of year | 72,952 | 17,659 | 32,714 | ||||||||
Cash and cash equivalents — end of year | $ | 38,172 | $ | 72,952 | $ | 17,659 | |||||
Supplemental Disclosure of Cash Flow Information: | |||||||||||
Cash paid during the period for interest | $ | 7,256 | $ | 5,263 | $ | 4,762 | |||||
Reinvestment of stockholder distributions | 195 | 196 | 122 | ||||||||
See Notes to Consolidated Financial Statements.
82
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value (3) | Percent of Net Assets | ||||||||||||||||
Non-control/Non-affiliate Investments | |||||||||||||||||||||||||
BayMark Health Services | Outpatient Mental Health and Substance Abuse Centers | ||||||||||||||||||||||||
Senior Secured Loan | 10.60% | (L +8.25%) | 3/22/2018 | 3/1/2025 | $ | 4,000 | $ | 3,964 | $ | 3,933 | 2.2 | % | |||||||||||||
Brookfield WEC Holdings Inc., | Business to Business Electronic Markets | ||||||||||||||||||||||||
Senior Secured Loan | 9.27% | (L +6.75%) | 12/6/2018 | 8/3/2026 | 1,959 | 1,959 | 1,914 | 1.1 | |||||||||||||||||
Carolina Lubes, Inc. (4) | Automotive Oil Change and Lubrication Shops | ||||||||||||||||||||||||
Senior Secured Loan (8) | 10.24% | (L +7.82%) | 8/23/2017 | 8/23/2022 | 20,840 | 20,705 | 20,839 | 11.9 | |||||||||||||||||
Senior Secured Loan (Revolver) (7) | 9.65% | (L +7.25%) | 8/23/2017 | 8/23/2022 | — | (11 | ) | — | — | ||||||||||||||||
20,840 | 20,694 | 20,839 | 11.9 | ||||||||||||||||||||||
Cirrus Medical Staffing, Inc. (4) | Temporary Help Services | ||||||||||||||||||||||||
Senior Secured Loan | 11.05% | (L +8.25%) | 3/5/2018 | 10/19/2022 | 12,926 | 12,779 | 12,732 | 7.3 | |||||||||||||||||
Senior Secured Loan (Revolver) (7) | 11.05% | (L +8.25%) | 3/5/2018 | 10/19/2022 | 1,280 | 1,280 | 1,261 | 0.7 | |||||||||||||||||
14,206 | 14,059 | 13,993 | 8.0 | ||||||||||||||||||||||
Community Intervention Services, Inc. (4) (6) (10) (11) | Outpatient Mental Health and Substance Abuse Centers | ||||||||||||||||||||||||
Subordinated Loan | 7.0% cash / 6.0% PIK | N/A | 7/16/2015 | 1/16/2021 | 9,060 | 7,639 | — | — | |||||||||||||||||
Confie Seguros Holdings II Co. | Insurance Agencies and Brokerages | ||||||||||||||||||||||||
Senior Secured Loan | 11.24% | (L +8.50%) | 7/7/2015 | 11/1/2025 | 9,678 | 9,489 | 9,290 | 5.3 | |||||||||||||||||
Constellis Holdings, LLC | Other Justice, Public Order, and Safety Activities | ||||||||||||||||||||||||
Senior Secured Loan | 11.52% | (L +9.00%) | 4/28/2017 | 4/21/2025 | 9,950 | 9,832 | 9,437 | 5.4 | |||||||||||||||||
Convergint Technologies | Security Systems Services (except Locksmiths) | ||||||||||||||||||||||||
Senior Secured Loan | 9.27% | (L +6.75%) | 9/28/2018 | 2/2/2026 | 3,481 | 3,422 | 3,327 | 1.9 | |||||||||||||||||
83
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value (3) | Percent of Net Assets | ||||||||||||||||
Davis Vision, Inc. | Direct Health and Medical Insurance Carriers | ||||||||||||||||||||||||
Senior Secured Loan | 9.28% | (L +6.75%) | 7/17/2018 | 12/1/2025 | $ | 5,854 | $ | 5,700 | $ | 5,570 | 3.2 | % | |||||||||||||
DuPage Medical Group | Offices of Physicians, Mental Health Specialists | ||||||||||||||||||||||||
Senior Secured Loan | 9.50% | (L +7.00%) | 8/22/2017 | 8/15/2025 | 10,098 | 10,185 | 9,771 | 5.6 | |||||||||||||||||
Eblens Holdings, Inc. | Shoe Store | ||||||||||||||||||||||||
Subordinated Loan (11) | 12.0% cash / 1.00% PIK | N/A | 7/13/2017 | 1/13/2023 | 8,920 | 8,855 | 8,821 | 5 | |||||||||||||||||
Common Equity (71,250 Class A units) (10) | 7/13/2017 | 713 | 722 | 0.4 | |||||||||||||||||||||
8,920 | 9,568 | 9,543 | 5.4 | ||||||||||||||||||||||
Elgin Fasteners Group | Bolt, Nut, Screw, Rivet, and Washer Manufacturing | ||||||||||||||||||||||||
Senior Secured Loan | 9.30% | (L +6.50%) | 10/31/2011 | 8/27/18 (5) | 3,645 | 3,645 | 3,509 | 2.0 | |||||||||||||||||
Envocore Holding, LLC (FKA LRI Holding, LLC) (4) | Electrical Contractors and Other Wiring Installation Contractors | ||||||||||||||||||||||||
Senior Secured Loan | 12.05% | (L +9.25%) | 6/30/2017 | 6/30/2022 | 17,344 | 17,212 | 16,821 | 9.6 | |||||||||||||||||
Preferred Equity (238,095 Series B units) (10) | 6/30/2017 | 300 | 300 | 0.2 | |||||||||||||||||||||
Preferred Equity (13,315 Series C units) (10) | 8/13/2018 | 13 | 13 | — | |||||||||||||||||||||
17,344 | 17,525 | 17,134 | 9.8 | ||||||||||||||||||||||
Excelin Home Health, LLC | Home Health Care Services | ||||||||||||||||||||||||
Senior Secured Loan | 12.31% | (L +9.50%) | 10/25/2018 | 4/25/2024 | 4,250 | 4,168 | 4,168 | 2.4 | |||||||||||||||||
GGC Aerospace Topco L.P. | Other Aircraft Parts and Auxiliary Equipment Manufacturing | ||||||||||||||||||||||||
Senior Secured Loan | 11.49% | (L +8.75%) | 12/29/2017 | 9/8/2024 | 5,000 | 4,894 | 4,033 | 2.3 | |||||||||||||||||
Common Equity (368,852 Class A units) (10) | 12/29/2017 | 450 | 104 | 0.1 | |||||||||||||||||||||
Common Equity (40,984 Class B units) (10) | 12/29/2017 | 50 | 4 | — | |||||||||||||||||||||
5,000 | 5,394 | 4,141 | 2.4 | ||||||||||||||||||||||
GOBP Holdings, Inc., | Supermarkets and Other Grocery (except Convenience) Stores | ||||||||||||||||||||||||
Senior Secured Loan | 10.05% | (L +7.25%) | 10/17/2018 | 10/22/2026 | 1,400 | 1,386 | 1,349 | 0.8 | |||||||||||||||||
84
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value (3) | Percent of Net Assets | ||||||||||||||||
Hyland Software, Inc. | Software Publishers | ||||||||||||||||||||||||
Senior Secured Loan | 6.02% | (L +3.50%) | 10/24/2018 | 7/1/2024 | $ | 173 | $ | 173 | $ | 166 | 0.1 | % | |||||||||||||
Senior Secured Loan | 9.52% | (L +7.00%) | 10/24/2018 | 7/7/2025 | 2,601 | 2,620 | 2,534 | 1.4 | |||||||||||||||||
2,774 | 2,793 | 2,700 | 1.5 | ||||||||||||||||||||||
Inergex Holdings | Other Computer Related Services | ||||||||||||||||||||||||
Senior Secured Loan | 9.39% | (L +7.00%) | 10/1/2018 | 10/1/2024 | 13,092 | 12,904 | 12,904 | 7.4 | |||||||||||||||||
Senior Secured Loan (Revolver) (7) | 0.50% | 10/1/2018 | 10/1/2024 | — | (27 | ) | — | — | |||||||||||||||||
13,092 | 12,877 | 12,904 | 7.4 | ||||||||||||||||||||||
JBR Clinical Research, Inc. (4) (8) | Research and Development in the Social Sciences and Humanities | ||||||||||||||||||||||||
Senior Secured Loan | 9.10% | (L +6.71%) | 8/2/2018 | 8/2/2023 | 29,943 | 29,693 | 29,016 | 16.5 | |||||||||||||||||
MAI Holdings, Inc. (4) | Printing Machinery and Equipment Manufacturing | ||||||||||||||||||||||||
Senior Secured Loan | 9.50% | N/A | 6/21/2018 | 6/1/2023 | 5,000 | 5,000 | 4,841 | 2.8 | |||||||||||||||||
My Alarm Center, LLC (4) (10) (13) | Security Systems Services (except Locksmiths) | ||||||||||||||||||||||||
Preferred Equity (1,485 Class A units), 8% PIK | 7/14/2017 | 1,571 | 1,536 | 0.9 | |||||||||||||||||||||
Preferred Equity (1,198 Class B units) | 7/14/2017 | 1,198 | — | — | |||||||||||||||||||||
Preferred Equity (335 Class Z units) 25% PIK | 9/12/2018 | 325 | 1,038 | 0.6 | |||||||||||||||||||||
Common Equity (64,149 units) | 7/14/2017 | — | — | — | |||||||||||||||||||||
3,094 | 2,574 | 1.5 | |||||||||||||||||||||||
Online Tech Stores, LLC (4) | Stationery and Office Supplies Merchant Wholesalers | ||||||||||||||||||||||||
Subordinated Loan | 10.50% cash / 1.0% PIK | N/A | 2/1/2018 | 8/1/2023 | 16,150 | 15,882 | 15,785 | 8.9 | |||||||||||||||||
OnSite Care, PLLC (4) (8) | Home Health Care Services | ||||||||||||||||||||||||
Senior Secured Loan | 10.22% | (L +7.85%) | 8/10/2018 | 8/10/2023 | 7,100 | 7,035 | 7,008 | 4.0 | |||||||||||||||||
Parfums Holding Company, Inc. | Cosmetics, Beauty Supplies, and Perfume Stores | ||||||||||||||||||||||||
Senior Secured Loan | 11.56% | (L +8.75%) | 11/16/2017 | 6/30/2025 | 6,320 | 6,334 | 6,292 | 3.6 | |||||||||||||||||
85
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value (3) | Percent of Net Assets | ||||||||||||||||
Pelican Products, Inc. | Unlaminated Plastics Profile Shape Manufacturing | ||||||||||||||||||||||||
Senior Secured Loan | 10.13% | (L +7.75%) | 9/24/2018 | 5/1/2026 | $ | 6,055 | $ | 6,060 | $ | 5,901 | 3.4 | % | |||||||||||||
Performance Team LLC (4) | General Warehousing and Storage | ||||||||||||||||||||||||
Senior Secured Loan | 12.52% | (L +10.00%) | 5/24/2018 | 11/24/2023 | 20,300 | 20,118 | 20,647 | 11.7 | |||||||||||||||||
PM Acquisition LLC | All Other General Merchandise Stores | ||||||||||||||||||||||||
Senior Secured Loan | 11.50% cash / 2.50% PIK | N/A | 9/30/2017 | 10/29/2021 | 5,512 | 5,431 | 5,217 | 3.0 | |||||||||||||||||
Common Equity (499 units) (10) (13) | 9/30/2017 | 499 | 137 | 0.1 | |||||||||||||||||||||
5,512 | 5,930 | 5,354 | 3.1 | ||||||||||||||||||||||
Resource Label Group, LLC | Commercial Printing (except Screen and Books) | ||||||||||||||||||||||||
Senior Secured Loan | 10.90% | (L +8.50%) | 6/7/2017 | 11/26/2023 | 4,821 | 4,767 | 4,772 | 2.7 | |||||||||||||||||
Rocket Software, Inc. | Software Publishers | ||||||||||||||||||||||||
Senior Secured Loan | 6.77% | (L +4.25%) | 11/20/2018 | 11/19/2025 | 670 | 667 | 645 | 0.4 | |||||||||||||||||
Senior Secured Loan | 10.77% | (L +8.25%) | 11/20/2018 | 11/19/2026 | 5,187 | 5,136 | 5,046 | 2.9 | |||||||||||||||||
5,857 | 5,803 | 5,691 | 3.3 | ||||||||||||||||||||||
RPLF Holdings, LLC (10) (13) | Software Publishers | ||||||||||||||||||||||||
Common Equity (254,110 Class A units) | 1/17/2018 | 254 | 291 | 0.2 | |||||||||||||||||||||
Sentry Centers Holdings, LLC | Other Professional, Scientific, and Technical Services | ||||||||||||||||||||||||
Senior Secured Loan (14) | 13.50% | (L +11.50%) | 1/25/2016 | 7/24/2020 | 8,855 | 8,802 | 8,753 | 5.0 | |||||||||||||||||
Common Equity (5,000 Series C units) (10) (13) | 3/31/2014 | — | 500 | 983 | 0.6 | ||||||||||||||||||||
8,855 | 9,302 | 9,736 | 5.6 | ||||||||||||||||||||||
Southern Technical Institute, LLC (4) (6) (10) | Colleges, Universities, and Professional Schools | ||||||||||||||||||||||||
Subordinated Loan | 6.00% PIK | N/A | 6/27/2018 | 12/31/2021 | 1,517 | — | — | — | |||||||||||||||||
Other | 6/27/2018 | — | — | — | — | ||||||||||||||||||||
1,517 | — | — | — | ||||||||||||||||||||||
86
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value (3) | Percent of Net Assets | ||||||||||||||||
SSH Group Holdings, Inc., | Child Day Care Services | ||||||||||||||||||||||||
Senior Secured Loan | 6.77% | (L +4.25%) | 7/26/2018 | 7/30/2025 | $ | 982 | $ | 979 | $ | 920 | 0.5 | % | |||||||||||||
Senior Secured Loan | 10.77% | (L +8.25%) | 7/26/2018 | 7/30/2026 | 7,216 | 7,147 | 6,839 | 3.9 | |||||||||||||||||
8,198 | 8,126 | 7,759 | 4.4 | ||||||||||||||||||||||
Stancor, L.P. (4) (10) | Pump and Pumping Equipment Manufacturing | ||||||||||||||||||||||||
Preferred Equity (1,250,000 Class A units), 8% PIK | 8/19/2014 | — | 1,501 | 1,416 | 0.8 | ||||||||||||||||||||
STS Operating, Inc. | Industrial Machinery and Equipment Merchant Wholesalers | ||||||||||||||||||||||||
Senior Secured Loan | 6.77% | (L +4.25%) | 5/16/2018 | 12/11/2024 | 638 | 637 | 602 | 0.3 | |||||||||||||||||
Senior Secured Loan | 10.52% | (L +8.00%) | 5/15/2018 | 4/30/2026 | 9,073 | 9,069 | 8,484 | 4.8 | |||||||||||||||||
9,711 | 9,706 | 9,086 | 5.1 | ||||||||||||||||||||||
The Escape Game, LLC (4) | |||||||||||||||||||||||||
Senior Secured Loan | Other amusement and recreation industries | 11.27% | (L +8.75%) | 12/22/2017 | 12/22/2022 | 7,000 | 6,958 | 6,855 | 3.9 | ||||||||||||||||
Senior Secured Loan (Delayed Draw) (7) | 11.22% | (L +8.75%) | 7/20/2018 | 12/22/2022 | 3,733 | 3,733 | 3,656 | 2.1 | |||||||||||||||||
10,733 | 10,691 | 10,511 | 6.0 | ||||||||||||||||||||||
Truck Hero, Inc. | Truck Trailer Manufacturing | ||||||||||||||||||||||||
Senior Secured Loan | 10.76% | (L +8.25%) | 5/30/2017 | 4/21/2025 | 7,014 | 6,977 | 6,808 | 3.9 | |||||||||||||||||
United Biologics Holdings, LLC (4) (10) | Medical Laboratories | ||||||||||||||||||||||||
Preferred Equity (151,787 units) | 7/26/2012 | — | 9 | 20 | — | ||||||||||||||||||||
Warrants (29,374 units) | 7/26/2012 | 3/05/2022 (12) | — | 82 | 25 | — | |||||||||||||||||||
— | 91 | 45 | — | ||||||||||||||||||||||
Wand Intermediate I LP | Automotive Body, Paint, and Interior Repair and Maintenance | ||||||||||||||||||||||||
Senior Secured Loan | 9.84% | (L +7.25%) | 5/14/2018 | 9/19/2022 | 3,770 | 3,802 | 3,747 | 2.1 | |||||||||||||||||
87
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value (3) | Percent of Net Assets | ||||||||||||||||
Wastebuilt Environmental Solutions, LLC. | Industrial Supplies Merchant Wholesalers | ||||||||||||||||||||||||
Senior Secured Loan | 11.27% | (L +8.75%) | 10/11/2018 | 10/11/2024 | $ | 7,000 | $ | 6,858 | $ | 6,858 | 3.9 | % | |||||||||||||
Other | 900 | 89 | 0.1 | ||||||||||||||||||||||
Total Non-control/Non-affiliate Investments | 309,407 | 312,223 | 297,749 | 169.9 | |||||||||||||||||||||
Affiliate Investments | |||||||||||||||||||||||||
3rd Rock Gaming Holdings, LLC | Software Publishers | ||||||||||||||||||||||||
Senior Secured Loan | 10.30% | (L +7.50%) | 3/13/2018 | 3/12/2023 | 21,626 | 21,353 | 20,023 | 11.4 | |||||||||||||||||
Common Equity (2,547,250 units) (10) (13) | 3/13/2018 | — | 2,547 | 1,073 | 0.6 | ||||||||||||||||||||
21,626 | 23,900 | 21,096 | 12.0 | ||||||||||||||||||||||
Contract Datascan Holdings, Inc. (4) | Office Machinery and Equipment Rental and Leasing | ||||||||||||||||||||||||
Subordinated Loan | 11.50% | N/A | 8/5/2015 | 2/5/2021 | 8,000 | 7,990 | 8,000 | 4.6 | |||||||||||||||||
Preferred Equity (3,061 Series A shares), 10% PIK | 8/5/2015 | — | 4,944 | 6,652 | 3.8 | ||||||||||||||||||||
Common Equity (11,273 shares) (10) | 6/28/2016 | — | 104 | 2,313 | 1.3 | ||||||||||||||||||||
8,000 | 13,038 | 16,965 | 9.7 | ||||||||||||||||||||||
DRS Imaging Services, LLC | Data Processing, Hosting, and Related Services | ||||||||||||||||||||||||
Senior Secured Loan (4) (8) | 12.23% | (L +9.42%) | 3/8/2018 | 11/20/2023 | 10,864 | 10,774 | 10,617 | 6.1 | |||||||||||||||||
Common Equity (1,135 units) (10) (13) | 3/8/2018 | — | 1,135 | 1,197 | 0.7 | ||||||||||||||||||||
10,864 | 11,909 | 11,814 | 6.8 | ||||||||||||||||||||||
Master Cutlery, LLC (4) (6) (10) | Sporting and Recreational Goods and Supplies Merchant Wholesalers | ||||||||||||||||||||||||
Subordinated Loan (11) | 13.00% PIK | N/A | 4/17/2015 | 4/17/2020 | 5,229 | 4,764 | 850 | 0.5 | |||||||||||||||||
Preferred Equity (3,723 Series A units), 8% PIK | 4/17/2015 | — | 3,483 | — | — | ||||||||||||||||||||
Common Equity (15,564 units) | 4/17/2015 | — | — | — | — | ||||||||||||||||||||
5,229 | 8,247 | 850 | 0.5 | ||||||||||||||||||||||
88
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
Portfolio Company (1) Investment Type | Industry | Interest Rate (2) | Spread Above Index (2) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value (3) | Percent of Net Assets | ||||||||||||||||
NeoSystems Corp. (4) (10) | Other Accounting Services | ||||||||||||||||||||||||
Preferred Equity (521,962 convertible shares), 10% PIK | 8/14/2014 | $ | — | $ | 1,537 | $ | 2,250 | 1.3 | % | ||||||||||||||||
Pfanstiehl Holdings, Inc. (4) | Pharmaceutical Preparation Manufacturing | ||||||||||||||||||||||||
Subordinated Loan | 10.50% | N/A | 1/1/2014 | 9/29/2022 | 3,788 | 3,814 | 3,788 | 2.2 | |||||||||||||||||
Common Equity (400 Class A shares) | 1/1/2014 | — | 217 | 8,360 | 4.8 | ||||||||||||||||||||
3,788 | 4,031 | 12,148 | 7.0 | ||||||||||||||||||||||
Professional Pipe Holdings, LLC | Plumbing, Heating, and Air-Conditioning Contractors | ||||||||||||||||||||||||
Senior Secured Loan | 12.77% | (L +10.25%) | 3/23/2018 | 3/23/2023 | 7,779 | 7,647 | 7,466 | 4.3 | |||||||||||||||||
Common Equity (1,414 Class A units) (10) | 3/23/2018 | — | 1,414 | 769 | 0.4 | ||||||||||||||||||||
7,779 | 9,061 | 8,235 | 4.7 | ||||||||||||||||||||||
TRS Services, LLC (4) (11) | Commercial and Industrial Machinery and Equipment (except Automotive and Electronic) Repair and Maintenance | ||||||||||||||||||||||||
Senior Secured Loan | 11.27% cash / 1.0% PIK | (L +8.75%) | 12/10/2014 | 12/10/2019 | 14,681 | 14,617 | 14,446 | 8.3 | |||||||||||||||||
Preferred Equity (329,266 Class AA units), 15% PIK | 6/30/2016 | — | 465 | 473 | 0.3 | ||||||||||||||||||||
Preferred Equity (3,000,000 Class A units), 11% PIK (10) | 12/10/2014 | — | 3,374 | 826 | 0.5 | ||||||||||||||||||||
Common Equity (3,000,000 units) (10) | 12/10/2014 | — | 572 | — | — | ||||||||||||||||||||
14,681 | 19,028 | 15,745 | 9.1 | ||||||||||||||||||||||
Total Affiliate Investments | 71,967 | 90,751 | 89,103 | 51.1 | |||||||||||||||||||||
Control Investment | |||||||||||||||||||||||||
MTE Holding Corp. (4) | Travel Trailer and Camper Manufacturing | ||||||||||||||||||||||||
Subordinated Loan (to Mirage Trailers, LLC, a controlled, consolidated subsidiary of MTE Holding Corp.) | 14.00% cash / 1.50% PIK | (L +11.50%) | 11/25/2015 | 11/25/2020 | 7,296 | 7,268 | 7,296 | 4.2 | |||||||||||||||||
Common Equity (554 shares) | 11/25/2015 | — | 3,069 | 2,649 | 1.5 | ||||||||||||||||||||
7,296 | 10,337 | 9,945 | 5.7 | ||||||||||||||||||||||
Total Control Investment | 7,296 | 10,337 | 9,945 | 5.7 | |||||||||||||||||||||
Total Investments | $ | 388,670 | $ | 413,311 | $ | 396,797 | 226.7 | % | |||||||||||||||||
89
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2018
(Dollar amounts in thousands)
(1) | Equity ownership may be held in shares or units of companies affiliated with the portfolio company. The Company's investments are generally classified as "restricted securities" as such term is defined under Regulation S-X Rule 6-03(f) or Securities Act Rule 144. |
(2) | Substantially all of the investments that bear interest at a variable rate are indexed to LIBOR (L), and reset monthly, quarterly, or semi-annually. Variable-rate loans with an aggregate cost of $316,260 include LIBOR reference rate floor provisions of generally 1% to 2%. At December 31, 2018, the reference rate on all such instruments was above the stated floors. For each investment, the Company has provided the spread over the reference rate and current interest rate in effect at December 31, 2018. Unless otherwise noted, all investments with a stated PIK rate require interest payments with the issuance of additional securities as payment of the entire PIK provision. |
(3) | Fair value was determined using significant unobservable inputs for all of the Company's investments. See Note 5 for further details. |
(4) | Investments (or portion thereof) held by SBIC I LP. All other investments pledged as collateral under the PWB Credit Facility. |
(5) | Elgin Fasteners Group became contractually due on August 27, 2018. The lending group entered into a forbearance agreement to extend the maturity through September 26, 2019. The investment shall continue to accrue interest as the borrower has continued to make interest and amortization payments. |
(6) | Investment was on non-accrual status as of December 31, 2018, meaning the Company has ceased recognizing all or a portion of income on the investment. See Note 5 for further details. |
(7) | Subject to unfunded commitments. See Note 6 for further details. |
(8) | The Company has entered into a contractual arrangement with co‑lenders whereby, subject to certain conditions, it has agreed to receive its principal payment after the repayment of certain co‑lenders pursuant to a payment waterfall. The table below provides additional details as of December 31, 2018: |
Portfolio Company | Reported Interest Rate | Interest Rate per Credit Agreement | Additional Interest per Annum | ||
Carolina Lubes, Inc. | 10.24% | 9.65% | 0.59% | ||
DRS Imaging Services, LLC | 12.23% | 10.80% | 1.43% | ||
JBR Clinical Research, Inc. | 9.10% | 8.64% | 0.46% | ||
OnSite Care, PLLC | 10.22% | 8.60% | 1.62% | ||
(9) | Reserved. |
(10) | Non-income producing. |
(11)The interest rate on these investments contains a PIK provision, whereby the issuer has the option to make interest payments in cash or with the issuance of additional securities as payment of the entire PIK provision. The interest rate in the schedule represents the current interest rate in effect for these investments. The following table provides additional details on these PIK investments, including the maximum annual PIK interest rate allowed as of December 31, 2018
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% | 14.00% or 12.00% | 1.50% | ||||
Master Cutlery, LLC | Senior Secured Loan | 0% to 13.00% | 13.00% to 0% | 13.00% | ||||
TRS Services, LLC | Senior Secured Loan | 0% or 1.00% | 11.25% or 1.00% | 1.00% | ||||
(12) | Represents expiration date of the warrants. |
(13) | All or portion of investment held by a wholly-owned subsidiary subject to corporate income tax. See Note 8 for further details. |
(14) | Maximum interest rate allowable under the terms of this investment is 13.50% |
See Notes to Financial Statements.
90
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) | Initial Acquisition Date | 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%) | 10/31/2017 | 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%) | 7/20/2016 | 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 | 12/23/2016 | 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%) | 5/9/2017 | 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%) | 8/23/2017 | 8/23/2022 | 21,411 | 21,236 | 21,430 | 11.4 | |||||||||||||||||
Senior Secured Loan (Revolver) | 8.59% | (L +7.25%) | 8/23/2017 | 8/23/2022 | 487 | 473 | 489 | 0.3 | |||||||||||||||||
Preferred Equity (973 units) 14% PIK | 8/23/2017 | 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 | 7/16/2015 | 1/16/2021 | 8,530 | 7,639 | — | — | |||||||||||||||||
Confie Seguros Holdings II Co. | Insurance Agencies and Brokerages | ||||||||||||||||||||||||
Senior Secured Loan | 10.98% | (L +9.50%) | 7/7/2015 | 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%) | 4/28/2017 | 4/21/2025 | 9,950 | 9,813 | 9,919 | 5.3 | |||||||||||||||||
91
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) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | ||||||||||||||||
DuPage Medical Group | Offices of Physicians, Mental Health Specialists | ||||||||||||||||||||||||
Senior Secured Loan | 8.42% | (L +7.00%) | 8/22/2017 | 8/15/2025 | $ | 5,600 | $ | 5,547 | $ | 5,503 | 2.9 | % | |||||||||||||
Eblens Holdings, Inc. | Shoe Store | ||||||||||||||||||||||||
Subordinated Loan | 12.0% cash / 1.00% PIK | N/A | 7/13/2017 | 1/13/2023 | 8,830 | 8,749 | 8,726 | 4.6 | |||||||||||||||||
Common Equity (71,250 Class A units) | 7/13/2017 | 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%) | 10/31/2011 | 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%) | 12/29/2017 | 9/8/2024 | 5,000 | 4,875 | 4,875 | 2.6 | |||||||||||||||||
Common Equity (368,852 Class A units) | 12/29/2017 | 450 | 450 | 0.2 | |||||||||||||||||||||
Common Equity (40,984 Class B units) | 12/29/2017 | 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%) | 6/30/2017 | 6/30/2022 | 18,269 | 18,125 | 18,205 | 9.7 | |||||||||||||||||
Preferred Equity (238,095 Series B units) | 6/30/2017 | 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) | 12/10/2014 | 900 | 141 | 0.1 | |||||||||||||||||||||
Common Equity (1,250,000 Class A units) (10) | 12/10/2014 | — | — | — | |||||||||||||||||||||
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) | 7/14/2017 | 1,540 | 1,540 | 0.8 | |||||||||||||||||||||
Preferred Equity (1,198 Class B units) | 7/14/2017 | 1,198 | 1,198 | 0.6 | |||||||||||||||||||||
Common Equity (64,149 units) (13) | 7/14/2017 | — | 43 | — | |||||||||||||||||||||
2,738 | 2,781 | 1.4 | |||||||||||||||||||||||
92
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) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | ||||||||||||||||
NVA Holdings, Inc. | Veterinary Services | ||||||||||||||||||||||||
Senior Secured Loan | 8.69% | (L +7.00%) | 5/18/2016 | 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%) | 9/2/2016 | 9/2/2021 | 13,350 | 12,977 | 13,617 | 7.2 | |||||||||||||||||
Parfums Holding Company, Inc. | Cosmetics, Beauty Supplies, and Perfume Stores | ||||||||||||||||||||||||
Senior Secured Loan | 10.45% | (L +8.75%) | 11/16/2017 | 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 | 6/16/2016 | 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 | 9/30/2017 | 10/29/2021 | 6,187 | 6,108 | 6,059 | 3.2 | |||||||||||||||||
Common equity (499 units) (10) | 9/30/2017 | 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%) | 6/7/2017 | 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%) | 10/14/2016 | 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%) | 1/25/2016 | 7/24/2019 | 4,195 | 4,156 | 4,259 | 2.3 | |||||||||||||||||
Preferred Equity (5,000 Series C units), 8% PIK (10) (13) | 3/31/2014 | 527 | 527 | 0.3 | |||||||||||||||||||||
4,195 | 4,683 | 4,786 | 2.6 | ||||||||||||||||||||||
93
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) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | ||||||||||||||||
Southern Technical Institute, LLC (5) | Colleges, Universities, and Professional Schools | ||||||||||||||||||||||||
Subordinated Loan (10) | 15.00% PIK | N/A | 12/2/2014 | 12/2/2020 | $ | 3,520 | $ | 3,451 | $ | 1,201 | 0.6 | % | |||||||||||||
Preferred Equity (1,764,720 Class SP-1 units), 15.75% PIK (8) (10) | 3/30/2016 | 2,094 | — | — | |||||||||||||||||||||
Warrants (2,174,905 Class A units) (10) | 3/30/2016 | 3/30/2026 (12) | 46 | — | — | ||||||||||||||||||||
3,520 | 5,591 | 1,201 | 0.6 | ||||||||||||||||||||||
Stancor, L.P. (5) | Pump and Pumping Equipment Manufacturing | ||||||||||||||||||||||||
Senior Secured Loan | 9.56% | (L +8.00%) | 8/19/2014 | 8/19/2019 | 7,919 | 7,896 | 7,919 | 4.2 | |||||||||||||||||
Preferred Equity (1,250,000 Class A units), 8% PIK (8) (10) | 8/19/2014 | 1,501 | 1,486 | 0.8 | |||||||||||||||||||||
7,919 | 9,397 | 9,405 | 5.0 | ||||||||||||||||||||||
The Escape Game, LLC (5) | Other amusement and recreation industries | ||||||||||||||||||||||||
Senior Secured Loan | 10.32% | (L +8.75%) | 12/22/2017 | 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%) | 10/16/2015 | 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%) | 5/30/2017 | 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 | 7/26/2012 | 4/30/2018 | 4,266 | 4,248 | 4,266 | 2.3 | |||||||||||||||||
Subordinated Loan (10) | 8.00 % PIK | N/A | 7/6/2016 | 4/30/2019 | 7 | 7 | 7 | — | |||||||||||||||||
Preferred Equity (151,787 units) (10) | 4/16/2013 | 9 | 92 | — | |||||||||||||||||||||
Warrants (29,374 units) (10) | 7/26/2012 | 3/5/2022 (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 | |||||||||||||||||||||
94
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) | Initial Acquisition Date | 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 | 12/31/2014 | 12/28/2021 | $ | 12,869 | $ | 12,288 | $ | 12,759 | 6.8 | % | |||||||||||||
Common Equity (637,954 units) (10) | 12/31/2014 | 565 | 1,785 | 0.9 | |||||||||||||||||||||
12,869 | 12,853 | 14,544 | 7.7 | ||||||||||||||||||||||
Contract Datascan Holdings, Inc. (5) | Office Machinery and Equipment Rental and Leasing | ||||||||||||||||||||||||
Subordinated Loan | 12.00% | N/A | 8/5/2015 | 2/5/2021 | 8,000 | 7,985 | 8,000 | 4.2 | |||||||||||||||||
Preferred Equity (3,061 Series A shares), 10% PIK (10) | 8/5/2015 | 4,347 | 5,964 | 3.2 | |||||||||||||||||||||
Common Equity (11,273 shares) (10) | 6/28/2016 | 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%) | 7/23/2014 | 7/21/2019 | 15,447 | 15,241 | 12,910 | 6.9 | |||||||||||||||||
Common Equity (13 member units) | 12/15/2017 | — | — | — | |||||||||||||||||||||
Warrants (1 member unit) (10) | 7/23/2014 | 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 | 4/17/2015 | 4/17/2020 | 4,705 | 4,692 | 2,873 | 1.5 | |||||||||||||||||
Preferred Equity (3,723 Series A units), 8% PIK (8) (10) | 4/17/2015 | 3,483 | — | — | |||||||||||||||||||||
Common Equity (15,564 units) (10) | 4/17/2015 | — | — | — | |||||||||||||||||||||
4,705 | 8,175 | 2,873 | 1.5 | ||||||||||||||||||||||
NeoSystems Corp.(5) | Other Accounting Services | ||||||||||||||||||||||||
Subordinated Loan | 10.50% cash / 1.25% PIK | N/A | 8/29/2014 | 8/13/2019 | 2,143 | 2,136 | 2,143 | 1.1 | |||||||||||||||||
Preferred Equity (521,962 convertible shares), 10% PIK (10) | 8/14/2014 | 1,390 | 2,248 | 1.2 | |||||||||||||||||||||
2,143 | 3,526 | 4,391 | 2.3 | ||||||||||||||||||||||
95
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) | Initial Acquisition Date | Maturity | Principal Amount | Amortized Cost | Fair Value | Percent of Net Assets | ||||||||||||||||
Pfanstiehl Holdings, Inc. (5) | Pharmaceutical Preparation Manufacturing | ||||||||||||||||||||||||
Subordinated Loan | 10.50% | N/A | 1/1/2014 | 9/29/2021 | $ | 3,788 | $ | 3,823 | $ | 3,755 | 2.0 | % | |||||||||||||
Common Equity (400 Class A shares) | 1/1/2014 | 217 | 4,755 | 2.5 | |||||||||||||||||||||
3,788 | 4,040 | 8,510 | 4.5 | ||||||||||||||||||||||
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%) | 12/10/2014 | 12/10/2019 | 9,466 | 9,330 | 9,466 | 5.0 | |||||||||||||||||
Preferred Equity (329,266 Class AA units), 15% PIK (10) | 6/30/2016 | 401 | 409 | 0.2 | |||||||||||||||||||||
Preferred Equity (3,000,000 Class A units), 11% PIK (8) (10) | 12/10/2014 | 3,374 | 2,230 | 1.2 | |||||||||||||||||||||
Common Equity (3,000,000 units) (10) | 12/10/2014 | 572 | — | — | |||||||||||||||||||||
9,466 | 13,677 | 12,105 | 6.4 | ||||||||||||||||||||||
Total Affiliate Investments | 56,418 | 70,402 | 69,557 | 36.8 | |||||||||||||||||||||
Control Investment | |||||||||||||||||||||||||
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%) | 11/25/2015 | 11/25/2020 | 7,186 | 7,144 | 7,118 | 3.8 | |||||||||||||||||
Common Equity (554 shares) | 11/25/2015 | 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. The Company's investments are generally classified as "restricted securities" as such term is defined under Regulation S-X Rule 6-03(f) or Securities Act Rule 144. |
(2) | Substantially all of the investments that bear interest at a variable rate are indexed to LIBOR (L), and reset monthly, quarterly, or semi-annually. Variable-rate loans with an aggregate cost of $189,022 include LIBOR reference rate floor provisions of generally 1% to 2%; at December 31, 2017, approximately 7% of the Company's LIBOR referenced amounts are subject to 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 5 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 SBIC I LP. All other investments pledged as collateral under the PWB Credit Facility. |
96
OFS Capital Corporation and Subsidiaries
Consolidated Schedule of Investments - Continued
December 31, 2017
(Dollar amounts in thousands)
(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 4 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. |
(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. |
(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.
97
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 1. Organization
OFS Capital Corporation (the "Company"), a Delaware corporation, is an externally managed, closed-end, non-diversified management investment company. The Company has elected to be regulated as a business development company ("BDC") under the Investment Company Act of 1940, as amended ("1940 Act"). In addition, for income tax purposes, the Company has elected to be treated as a regulated investment company ("RIC") under Subchapter M of Code under the Internal Revenue Code of 1986, as amended (the "Code").
The Company’s investment objective is to provide stockholders with current income and capital appreciation through its strategic investment focus primarily on debt investments and, to a lesser extent, equity investments primarily in middle-market companies principally in the United States. OFS Capital Management, LLC, a wholly owned subsidiary of OFSAM and registered investment advisor under the Advisers Act ("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 Hancock Park Corporate Income, Inc. ("HPCI"), a Maryland corporation and a BDC. HPCI’s investment objective is similar to that of the Company. OFS Advisor also serves as the investment adviser for OFS Credit Company, Inc. ("OCCI"), a newly organized, non-diversified, externally managed, closed-end management investment company that has registered as an investment company under the 1940 Act that primarily invests in CLO debt and subordinated securities. In addition, Orchard First Source Asset Management, LLC, a full-service provider of capital and leveraged finance solutions to U.S. Corporations ("OFSAM"), owns 2,946,474 shares, or 22%, of the outstanding common stock of the Company.
The Company may make investments directly or through SBIC I LP, its investment company subsidiary licensed under the U.S. Small Business Administration's ("SBA") small business investment company program ("SBIC Program"). The SBIC Program is designed to stimulate the flow of capital into eligible businesses. SBIC I LP is subject to SBA regulatory requirements, including limitations on the businesses and industries in which it can invest, requirements to invest at least 25% of its "regulatory capital" in "eligible smaller businesses", as defined under the Small Business Investment Act of 1958, as amended ("SBIC Act"), limitations on the financing terms of investments, and capitalization thresholds that may limit distributions to the Company; and is subject to periodic audits and examinations of its financial statements.
Note 2. Summary of Significant Accounting Policies
Basis of presentation: The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP"), including ASC Topic 946, Financial Services-Investment Companies, and the requirements for reporting on Form 10-K, the 1940 Act, and Articles 6 and 12 of Regulation S-X. In the opinion of management, the consolidated financial statements include all adjustments, consisting only of normal and recurring accruals and adjustments, necessary for fair presentation in accordance with GAAP. Certain amounts in the prior period financial statements have been reclassified to conform to the current year presentation.
Principles of consolidation: The Company consolidates majority-owned investment company subsidiaries. The Company does not own any controlled operating company whose business consists of providing services to the Company, which would also require consolidation. All intercompany balances and transactions are eliminated upon consolidation.
Investments: The Company applies fair value accounting in accordance with ASC Topic 820, Fair Value Measurements, which defines fair value, establishes a framework to measure fair value, and requires disclosures regarding fair value measurements. 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.
98
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Changes to the valuation policy are reviewed by management and the Company’s board of directors (the "Board"). As the Company’s investments change, markets change, new products develop, and valuation inputs become more or less observable, the Company will continue to refine its valuation methodologies.
See Note 5 for more detailed disclosures of the Company’s fair value measurements of its financial instruments.
Investment classification: The Company classifies its investments in accordance with the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in those companies in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of board representation, “Affiliate Investments” are defined as investments in those companies in which the Company owns between 5% and 25% of the voting securities, and “Non-Control/Non-Affiliate Investments” are those that neither qualify as Control Investments nor Affiliate Investments.
Use of estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of investment income, expenses, gains and losses during the reporting period. Actual results could differ significantly from those estimates.
Cash and cash equivalents:Cash and cash equivalents consist of cash and highly liquid investments not held for resale with original maturities of three months or less. The Company’s cash and cash equivalents are maintained with a member bank of the FDIC and at times, such balances may be in excess of the Federal Deposit Insurance Corporation
("FDIC") insurance limits. Included in cash and cash equivalents was $38,172 and $72,140 held in a US Bank Money Market Deposit Account as of December 31, 2018 and 2017, 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.
("FDIC") insurance limits. Included in cash and cash equivalents was $38,172 and $72,140 held in a US Bank Money Market Deposit Account as of December 31, 2018 and 2017, respectively. In addition, the Company's use of cash and cash equivalents held by SBIC I LP is limited by SBA regulation, including, but not limited to, investment in eligible portfolio companies and general corporate purposes, subject to a statutory measure of undistributed accumulated earnings.
Revenue recognition:
Interest income:Interest income is recorded on an accrual basis and reported as an interest receivable until collected. Interest income is accrued daily based on the outstanding principal amount and the contractual terms of the debt investment. Certain of the Company’s investments contain a payment-in-kind interest income provision (“PIK interest”). The PIK interest, computed at the contractual rate specified in the applicable investment agreement, is added to the principal balance of the investment, rather than being paid in cash, and recorded as interest income at fair value, as applicable, on the consolidated statements of operations. The Company discontinues accrual of interest income, including PIK interest, when there is reasonable doubt that the interest income will be collected.
Loan origination fees, original issue discount (“OID”), market discount or premium, and loan amendment fees (collectively, “Net Loan Fees”) are recorded as an adjustment to the amortized cost of the investment, and accreted or amortized as an adjustment to interest income over the life of the respective debt investment using a method that approximates the effective interest method. When the Company receives a loan principal payment, the unamortized Net Loan Fees related to the paid principal is accelerated and recognized in interest income.
Further, the Company may acquire or receive equity, warrants or other equity-related securities (“Equity”) in connection with the Company’s acquisition of, or subsequent amendment to, debt investments. The Company determines the cost basis of Equity based on its fair value, and the fair value of debt investments and other securities or consideration received. Any resulting difference between the face amount of the debt and its recorded cost resulting from the assignment of value to the Equity is treated as OID, and accreted into interest income as described above.
Dividend income: Dividend income on common equity securities in limited liability companies, partnerships and other private entities, generally payable in cash, is recorded at the time dividends are declared. Dividend income on preferred equity investments is accrued daily based on the contractual terms of the preferred equity investment. Dividends on preferred equity securities may be payable in cash or in additional preferred securities, and are generally not payable unless declared or upon liquidation. Declared dividends payable in cash are reported as dividend receivables until collected. Non-cash dividends payable in additional preferred securities or contractually earned but not declared (“PIK dividends”) are recognized at fair value and recorded as an adjustment to the cost basis of the investment. Distributions in excess of the accumulated net income of the underlying portfolio company are recorded as a reduction in the cost of the common or preferred stock investment.
Fee income:The Company generates revenue in the form of management, valuation, and other contractual fees, that is recognized as the related services are rendered. In the general course of its business, the Company receives certain fees from portfolio companies which are non-recurring in nature. Such non-recurring fees include prepayment fees on certain loans repaid
99
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
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.
Investment Transactions and net realized and unrealized gain or loss on investments: Investment transactions are reported on a trade-date basis. Unsettled trades as of the balance sheet date are included in payable for investments purchased. Realized gains or losses on investments are measured by the difference between the net proceeds from the disposition and the amortized cost basis of the investment. Investments are valued at fair value as determined in good faith by Company management under the supervision and review of the Board. After recording all appropriate interest, dividend, and other income, some of which is recorded as an adjustment to the cost basis of the investment as described above, the Company reports changes in the fair value of investments as net changes in unrealized appreciation (depreciation) on investments in the consolidated statements of operations.
Non-accrual loans: When there is reasonable doubt that principal, cash interest, or PIK interest, will be collected, debt investments are placed on non-accrual status and the Company will cease recognizing cash interest, PIK interest, or Net Loan Fee amortization, as applicable. When an investment is placed on non-accrual status, all interest previously accrued but not collected , other than PIK interest that has been contractually added to the adjusted cost basis of the investment prior to the designation date, is reserved against current period interest income. Interest payments subsequently received on non-accrual investments may be recognized as income or applied to principal depending upon management’s judgment. Interest accruals and Net Loan Fee amortization are resumed on non-accrual investments only when they are brought current with respect to principal, interest, and when, in the judgment of management, the investments are estimated to be fully collectible as to all principal and interest. In the opinion of management, if there is a question as to the ability of the debtor to meet the terms of the loan agreement, or interest or principal is more than 90 days contractually past due, the loan investment will be placed on non-accrual status. Past due status is based on how long after the contractual due date a principal or interest payment is received. See Note 4 for further information.
Income taxes: The Company has elected to be treated, and intends to qualify annually, as a RIC under Subchapter M of the Code. To qualify as a RIC, the Company must, among other things, meet certain source of income and asset diversification requirements, and timely distribute at least 90% of its ICTI to its stockholders. The Company has made, and intends to continue to make, the requisite distributions to its stockholders, which generally relieves the Company from U.S. federal income taxes.
Depending on the level of ICTI earned in a tax year, the Company may choose to retain ICTI in an amount less than that which would trigger U.S. federal income tax liability under Subchapter M of the Code. However, the Company would be liable for a 4% excise tax on such income. Excise tax liability is recognized when the Company determines its estimated current year annual investment company table income ("ICTI"), as defined in the Code, exceeds distributions from current year ICTI. The Company recognized excise tax of $130, $0 and $0 for the years ended December 31, 2018, 2017 and 2016. See Note 8 for further information.
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, which are investment companies under GAAP, and 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. See Note 8 for further information.
The Company evaluates tax positions taken in the course of preparing its tax returns to determine whether they are “more-likely-than-not” to be sustained by the applicable tax authority. Tax benefits of positions not deemed to meet the more-likely-than-not threshold could result in greater and undistributed ICTI, income and excise tax expense, and, if involving multiple years, a re-assessment of the Company’s RIC status. GAAP requires recognition of accrued interest and penalties related to uncertain tax benefits as income tax expense. There were no uncertain income tax positions at December 31, 2018 and 2017. The current and prior three tax years remain subject to examination by U.S. federal and most state tax authorities.
Distributions: Distributions to common stockholders are recognized on the record date. The timing of distributions as well as the amount to be paid out as a distribution is determined by the Board each quarter. Distributions from net investment income
100
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
and net realized gains are determined in accordance with the Code. Net realized capital gains, if any, are distributed at least annually, although the Company may decide to retain such capital gains for investment. Distributions paid in excess of ICTI and not capital gains are considered returns of capital to stockholders.
The Company has adopted a distribution reinvestment plan ("DRIP") that provides for reinvestment of any distributions the Company declares in cash on behalf of its stockholders, unless stockholder elects to receive cash. As a result, if the Board authorizes and the Company declares a cash distribution, then stockholders who have not “opted out” of the DRIP will have their cash distribution automatically reinvested in additional shares of the Company’s common stock, rather than receiving the cash distribution.
The Company may use newly issued shares under the guidelines of the DRIP, or the Company may purchase shares in the open market in connection with its obligations under the plan.
Deferred debt issuance costs: Deferred debt issuance costs represent fees and other direct incremental costs incurred in connection with the Company’s borrowings. Deferred debt issuance costs are presented as a direct reduction of the related debt liability on the consolidated statements of assets and liabilities except for deferred debt issuance costs associated with the Company’s line of credit arrangements, which are included in prepaid expenses and other assets on the consolidated statements of assets and liabilities. Unamortized debt issuance costs included in prepaid expenses and other assets on the consolidated statements of assets and liabilities as of December 31, 2018 and 2017 were $180 and $80, respectively. Deferred debt issuance costs are amortized to interest expense over the term of the related debt.
Goodwill: On December 4, 2013, in connection with the the Company's acquisition of the remaining ownership interests in SBIC I LP and SBIC I GP, LLC on December 4, 2013, making SBIC I LP a wholly owned subsidiary of the Company ("SBIC Acquisition"), the Company recorded goodwill of $1,077, which is included in prepaid expenses and other assets on the consolidated statements of assets and liabilities. Goodwill is not subject to amortization. Goodwill is evaluated for impairment annually or more frequently if events occur or circumstances change that indicate goodwill may be impaired. There have been no goodwill impairments since the date of the SBIC Acquisition.
Intangible asset: On December 4, 2013, in connection with the SBIC Acquisition, the Company recorded an intangible asset of $2,500 attributable to the SBIC license. The Company amortizes this intangible asset on a straight-line basis over its estimated useful life of 13 years. The Company expects to incur annual amortization expense of $195 in each annual period through December 31, 2025 and $145 in 2026.
The Company tests its intangible asset for impairment if events or circumstances suggest that the asset carrying value may not be fully recoverable. The intangible asset, net of accumulated amortization of $991 and $795 at December 31, 2018 and 2017, respectively, is included in prepaid expenses and other assets in the consolidated statements of assets and liabilities.
Interest expense: Interest expense is recognized on an accrual basis as incurred.
Concentration of credit risk: Aside from its debt instruments, financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash deposits at financial institutions. At various times during the year, the Company may exceed the federally insured limits. To mitigate this risk, the Company places cash deposits only with high credit quality institutions. Management believes this risk of loss is minimal. The amount of loss due to credit risk from debt investments if borrowers fail to perform according to the terms of the contracts, and the collateral or other security for those instruments proved to be of no value to the Company, is equal to the Company's recorded investment in debt instruments and the unfunded loan commitments as disclosed in Note 6.
101
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
New Accounting Standards
The following table discusses recently issued ASUs by the FASB:
The following table discusses recently issued ASUs by the FASB yet to be adopted by the Company:
Standard | Description | Period of Adoption | Effect of Adoption on the Financial Statements | |||
Standards that were adopted | ||||||
ASU No. 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement | Eliminates, adds and modifies certain disclosure requirements for fair value measurements | Third Quarter 2018 prospectively | No material impact to the Company's consolidated financial statements. | |||
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. | First Quarter 2018 prospectively | No material impact to the Company's consolidated financial statements. | |||
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. | First Quarter 2018 prospectively | No material impact to the Company's consolidated financial statements. | |||
Standard | Description | Effect of Adoption on the Financial Statements | ||
Standards that are not yet adopted | ||||
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. | ||
102
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 2017-08, 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. | ||
SEC Disclosure Update and Simplification
In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. The amendments are intended to facilitate the disclosure of information to investors and simplify compliance. The Company adopted the final rule under SEC Release No. 33-10532 as of December 31, 2018. The Company has evaluated the impact of the amendments and determined the effect of the adoption of the simplification rules on financial statements will be limited to the modification and removal of certain presentations on the financial statements.
The SEC Release requires presentation changes to the Company's Consolidated Statements of Changes in Net Assets. The changes in presentation have been retrospectively applied to the Consolidated Statements of Assets and Liabilities and Consolidated Statement of Changes in Net Assets for the years ended December 31, 2017. The following tables provide reconciliations of retrospective changes applied to the prior period.
December 31, 2017 | |||
Accumulated undistributed net investment income | $ | 9,404 | |
Accumulated undistributed net realized gains | 3,881 | ||
Net unrealized depreciation on investments | (12,480 | ) | |
Total distributable earnings | $ | 805 | |
For the Year Ended December 31, | ||||||
Distributions to stockholders | 2017 | 2016 | ||||
Accumulated net investment income | $ | 14,158 | $ | 12,157 | ||
Accumulated net realized gains | 2,738 | 169 | ||||
Total distributions from total distributable earnings (accumulated losses) | 16,896 | 12,326 | ||||
Return of capital distributions | — | 858 | ||||
Total distributions to stockholders | 16,896 | 13,184 | ||||
Note 3. 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 agreement dated November 7, 2012 ("Investment Advisory
103
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Agreement"). The Investment Advisory Agreement was most recently re-approved on April 5, 2018. Under the terms of the Investment Advisory Agreement, which are in accordance with the 1940 Act and subject to the overall supervision of the Company’s Board, OFS Advisor is responsible for sourcing potential investments, conducting research and diligence on potential investments and equity sponsors, analyzing investment opportunities, structuring investments, and monitoring investments and portfolio companies on an ongoing basis. OFS Advisor is a subsidiary of OFSAM and a registered investment advisor under the Investment Advisers Act of 1940, as amended.
OFS Advisor’s services under the Investment Advisory Agreement are not exclusive to the Company and OFS Advisor is free to furnish similar services to other entities, including other BDCs affiliated with OFS Advisor, so long as its services to the Company are not impaired. OFS Advisor also serves as the investment adviser or collateral manager to CLOs and other companies, including HPCI and OCCI.
OFS Advisor receives fees for providing services, consisting of two components: a base management fee and an incentive fee. The base management fee is calculated at an annual rate of 1.75% and based on the average value of the Company’s total assets (other than cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity) at the end of the two most recently completed calendar quarters, adjusted for any share issuances or repurchases during the quarter. OFS Advisor has elected to exclude the value of the intangible asset and goodwill resulting from the SBIC Acquisition from the base management fee calculation.
The base management fee is payable quarterly in arrears and was $6,335, $4,999, and $4,516, for the years ended December 31, 2018, 2017, and 2016, respectively. The Company owed the Advisor management fees of $1,749 and $1,273 as of December 31, 2018 and 2017, respectively.
The incentive fee has two parts. The first part ("Part One") is calculated and payable quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees such as commitment, origination and sourcing, structuring, diligence and consulting fees or other fees that the Company receives from portfolio companies but excluding fees for providing managerial assistance) accrued during the calendar quarter, minus operating expenses for the quarter (including the base management fee, any expenses payable under the Administration Agreement (as defined below) and any interest expense and dividends paid on any outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest or dividend feature (such as OID, debt instruments with PIK interest, equity investments with accruing or PIK dividend and zero coupon securities), accrued income that the Company has not yet received in cash.
Pre-incentive fee net investment income is expressed as a rate of return on the value of the Company’s net assets (defined as total assets less indebtedness and before taking into account any incentive fees payable during the period) at the end of the immediately preceding calendar quarter and adjusted for any share issuances or repurchases during such quarter. Accordingly, as a result of the follow-on public offering of 3,625,000 shares of common stock in April 2017 (the "Offering"), the Part One incentive fee was reduced by $593 for the three months ended June 30, 2017, determined by adjusting the value of net assets, as defined above, at March 31, 2017 by the daily weighted average of the Offering proceeds available to the Company during the three months ended June 30, 2017. The incentive fee with respect to pre-incentive fee net income is 20.0% of the amount, if any, by which the pre-incentive fee net investment income for the immediately preceding calendar quarter exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up” provision measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, OFS Advisor receives no incentive fee until the net investment income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100.0% of the pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5%. The effect of this provision is that, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, OFS Advisor will receive 20.0% of the pre-incentive fee net investment income.
Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that the Company may pay an incentive fee in a quarter in which the Company incurs a loss. For example, if the Company receives pre-incentive fee net investment income in excess of the quarterly minimum hurdle rate, the Company will pay the applicable incentive fee even if the Company has incurred a loss in that quarter due to realized and unrealized capital losses. The Company’s net investment income used to calculate this part of the incentive fee is also included in the amount of the Company’s gross assets used to calculate the base management fee. These calculations are appropriately prorated for any period of less than three months.
104
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
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 capital gains (losses) plus net unrealized appreciation (depreciation). OFS Advisor has excluded from the Capital Gain Fee calculation any realized gain with respect to (1) the SBIC Acquisition, and (2) the WM Asset Sale.
The Company incurred incentive fee expense of $4,409, $2,962, and $3,333 for the years ended December 31, 2018, 2017, and 2016, respectively. Incentive fees for the years ended December 31, 2018, 2017, and 2016, included Part One incentive fees (based on net investment income) of $4,409, which included an irrevocably waiver of receipt of $22 by OFS Advisor, $2,962, which included a share issue adjustment of $(593) related to the Company's Offering, and $3,472, respectively, and Part Two incentive fees (based upon net realized and unrealized gains and losses, or capital gains) of $0, $0 and $(139), respectively.
The Company owed the Advisor incentive fees of $1,368 and $714 as of December 31, 2018 and 2017, respectively.
License Agreement: The Company entered into a license agreement with OFSAM under which OFSAM has agreed to grant the Company a non-exclusive, royalty-free license to use the name “OFS.”
Administration Agreement: OFS Services furnishes the Company with office facilities and equipment, necessary software licenses and subscriptions, and clerical, bookkeeping and record keeping services at such facilities pursuant to an Administration Agreement. The Administration Agreement was most recently re-approved by the Board on April 5, 2018. 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 $1,601, $1,314 and $1,304 for the years ended December 31, 2018, 2017, and 2016, respectively. The Company owed OFS Services administration fees of $577 and $476 as of December 31, 2018 and 2017, respectively.
105
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 4. Investments
As of December 31, 2018, the Company had loans to 44 portfolio companies, of which 88% were senior secured loans and 12% were subordinated loans, at fair value, as well as equity investments in 13 of these portfolio companies. The Company also held an equity investment in six portfolio companies in which it did not hold a debt investment. At December 31, 2018, investments consisted of the following:
Percentage of Total | Percentage of Total | ||||||||||||||||||
Amortized Cost | Amortized Cost | Net Assets | Fair Value | Fair Value | Net Assets | ||||||||||||||
Senior secured debt investments | $ | 325,873 | 78.8 | % | 186.2 | % | $ | 319,017 | 80.4 | % | 182.3 | % | |||||||
Subordinated debt investments | 56,212 | 13.6 | 32.1 | 44,540 | 11.2 | 25.4 | |||||||||||||
Preferred equity | 19,620 | 4.7 | 11.2 | 14,613 | 3.7 | 8.4 | |||||||||||||
Common equity and warrants | 11,606 | 2.8 | 6.6 | 18,627 | 4.7 | 10.6 | |||||||||||||
Total | $ | 413,311 | 100.0 | % | 236.1 | % | $ | 396,797 | 100.0 | % | 226.7 | % | |||||||
In June 2018, the Company's investment in Southern Technical Institute, LLC was restructured. The Company converted its subordinated note, SP-1 preferred shares, and warrants for a $1,471 subordinated loan and 1,764,720 shares of Class A-1 common units. The cost and fair value of the securities received were $-0- and $-0- as of December 31, 2018. The Company recognized a realized loss on the restructuring of $5,608 for the year ended December 31, 2018, of which $4,407 was recognized as unrealized losses as of December 31, 2017.
At December 31, 2018, the Company had three loans (Community Intervention Services, Inc., Southern Technical Institute, LLC and Master Cutlery, LLC) on non-accrual status with respect to all interest and Net Loan Fee amortization, with an aggregate amortized cost and fair value of $12,403 and $850 thousand, respectively.
In August 2018, the Elgin Fasteners Group senior secured loan became contractually due. The lending group entered into a forbearance agreement with respect to the maturity date through September 26, 2019, subject to other terms and conditions. The investment continues to accrue interest as the borrower has continued to make interest and amortization payments.
At December 31, 2018, all of the Company’s investments were domiciled in the United States. The industry compositions of the Company’s investment portfolio were as follows:
Percentage of Total | Percentage of Total | |||||||||||||||||||
Amortized Cost | Amortized Cost | Net Assets | Fair Value | Fair Value | Net Assets | |||||||||||||||
Administrative and Support and Waste Management and Remediation Services | ||||||||||||||||||||
Security Systems Services (except Locksmiths) | $ | 6,516 | 1.6 | % | 3.7 | % | $ | 5,901 | 1.5 | % | 3.4 | % | ||||||||
Temporary Help Services | 14,059 | 3.4 | 8.0 | 13,993 | 3.5 | 8.0 | ||||||||||||||
Arts, Entertainment, and Recreation | ||||||||||||||||||||
Other Amusement and Recreation Industries | 10,691 | 2.6 | 6.1 | 10,511 | 2.6 | 6.0 | ||||||||||||||
Construction | ||||||||||||||||||||
Electrical Contractors and Other Wiring Installation Contractors | 17,525 | 4.2 | 10.0 | 17,134 | 4.3 | 9.8 | ||||||||||||||
Plumbing, Heating, and Air-Conditioning Contractors | 9,061 | 2.2 | 5.2 | 8,235 | 2.1 | 4.7 | ||||||||||||||
Education Services | ||||||||||||||||||||
Colleges, Universities, and Professional Schools | — | — | — | — | — | — | ||||||||||||||
Finance and Insurance | ||||||||||||||||||||
Direct Health and Medical Insurance Carriers | 5,700 | 1.4 | 3.3 | 5,570 | 1.4 | 3.2 | ||||||||||||||
Insurance Agencies and Brokerages | 9,489 | 2.3 | 5.4 | 9,290 | 2.3 | 5.3 | ||||||||||||||
106
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 | |||||||||||||||
Health Care and Social Assistance | ||||||||||||||||||||
Child Day Care Services | 8,126 | 2.0 | 4.6 | 7,759 | 2.0 | 4.4 | ||||||||||||||
Home Health Care Services | 11,203 | 2.7 | 6.4 | 11,176 | 2.8 | 6.4 | ||||||||||||||
Medical Laboratories | 91 | — | 0.1 | 45 | — | — | ||||||||||||||
Offices of Physicians, Mental Health Specialists | 10,185 | 2.5 | 5.8 | 9,771 | 2.5 | 5.6 | ||||||||||||||
Outpatient Mental Health and Substance Abuse Centers | 11,603 | 2.8 | 6.6 | 3,933 | 1.0 | 2.2 | ||||||||||||||
Information | ||||||||||||||||||||
Data Processing, Hosting, and Related Services | 11,909 | 2.9 | 6.8 | 11,814 | 3.0 | 6.7 | ||||||||||||||
Software Publishers | 32,750 | 7.9 | 18.6 | 29,778 | 7.5 | 16.9 | ||||||||||||||
Manufacturing | ||||||||||||||||||||
Bolt, Nut, Screw, Rivet, and Washer Manufacturing | 3,645 | 0.9 | 2.1 | 3,509 | 0.9 | 2.0 | ||||||||||||||
Commercial Printing (except Screen and Books) | 4,767 | 1.2 | 2.7 | 4,772 | 1.2 | 2.7 | ||||||||||||||
Other Aircraft Parts and Auxiliary Equipment Manufacturing | 5,394 | 1.3 | 3.1 | 4,141 | 1.0 | 2.4 | ||||||||||||||
Pharmaceutical Preparation Manufacturing | 4,031 | 1.0 | 2.3 | 12,148 | 3.1 | 6.9 | ||||||||||||||
Printing Machinery and Equipment Manufacturing | 5,000 | 1.2 | 2.9 | 4,841 | 1.2 | 2.8 | ||||||||||||||
Pump and Pumping Equipment Manufacturing | 1,501 | 0.4 | 0.9 | 1,416 | 0.4 | 0.8 | ||||||||||||||
Travel Trailer and Camper Manufacturing | 10,337 | 2.5 | 5.9 | 9,945 | 2.5 | 5.7 | ||||||||||||||
Truck Trailer Manufacturing | 6,977 | 1.7 | 4.0 | 6,808 | 1.7 | 3.9 | ||||||||||||||
Unlaminated Plastics Profile Shape Manufacturing | 6,060 | 1.5 | 3.5 | 5,901 | 1.5 | 3.4 | ||||||||||||||
Other Services (except Public Administration) | ||||||||||||||||||||
Automotive Body, Paint, and Interior Repair and Maintenance | 3,802 | 0.9 | 2.2 | 3,747 | 0.9 | 2.1 | ||||||||||||||
Automotive Oil Change and Lubrication Shops | 20,694 | 5.0 | 11.8 | 20,839 | 5.3 | 11.9 | ||||||||||||||
Commercial and Industrial Machinery and Equipment (except Automotive and Electronic) Repair and Maintenance | 19,028 | 4.6 | 10.9 | 15,745 | 4.0 | 9.0 | ||||||||||||||
Professional, Scientific, and Technical Services | ||||||||||||||||||||
Other Accounting Services | 1,537 | 0.4 | 0.9 | 2,250 | 0.6 | 1.3 | ||||||||||||||
Other Computer Related Services | 12,877 | 3.1 | 7.4 | 12,904 | 3.3 | 7.4 | ||||||||||||||
Other Professional, Scientific, and Technical Services | 9,302 | 2.3 | 5.3 | 9,736 | 2.5 | 5.6 | ||||||||||||||
Research and Development in the Social Sciences and Humanities | 29,693 | 7.2 | 17.0 | 29,016 | 7.3 | 16.5 | ||||||||||||||
Public Administration | ||||||||||||||||||||
107
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 | |||||||||||||||
Other Justice, Public Order, and Safety Activities | 9,832 | 2.4 | 5.6 | 9,437 | 2.4 | 5.4 | ||||||||||||||
Real Estate and Rental and Leasing | ||||||||||||||||||||
Home Health Equipment Rental | 900 | 0.2 | 0.5 | 89 | — | 0.1 | ||||||||||||||
Office Machinery and Equipment Rental and Leasing | 13,038 | 3.2 | 7.4 | 16,965 | 4.3 | 9.7 | ||||||||||||||
Retail Trade | ||||||||||||||||||||
Cosmetics, Beauty Supplies, and Perfume Stores | 6,334 | 1.5 | 3.6 | 6,292 | 1.6 | 3.6 | ||||||||||||||
Shoe store | 9,568 | 2.2 | 5.5 | 9,543 | 2.4 | 5.5 | ||||||||||||||
Supermarkets and Other Grocery (except Convenience) Stores | 1,386 | 0.3 | 0.8 | 1,349 | 0.3 | 0.8 | ||||||||||||||
All Other General Merchandise Stores | 5,930 | 1.4 | 3.4 | 5,354 | 1.2 | 3.1 | ||||||||||||||
Transportation and Warehousing | ||||||||||||||||||||
General Warehousing and Storage | 20,118 | 4.9 | 11.5 | 20,647 | 5.2 | 11.8 | ||||||||||||||
Wholesale Trade | ||||||||||||||||||||
Business to Business Electronic Markets | 1,959 | 0.5 | 1.1 | 1,914 | 0.5 | 1.1 | ||||||||||||||
Industrial Machinery and Equipment Merchant Wholesalers | 9,706 | 2.3 | 5.5 | 9,086 | 2.3 | 5.2 | ||||||||||||||
Industrial Supplies Merchant Wholesalers | 6,858 | 1.7 | 3.9 | 6,858 | 1.7 | 3.9 | ||||||||||||||
Sporting and Recreational Goods and Supplies Merchant Wholesalers | 8,247 | 2.0 | 4.7 | 850 | 0.2 | 0.5 | ||||||||||||||
Stationery and Office Supplies Merchant Wholesalers | 15,882 | 3.7 | 9.1 | 15,785 | 4.0 | 9.0 | ||||||||||||||
$ | 413,311 | 100.0 | % | 236.1 | % | $ | 396,797 | 100.0 | % | 226.7 | % | |||||||||
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:
At December 31, 2017, investments consisted of the following:
Percentage of Total | Percentage of Total | ||||||||||||||||||
Amortized Cost | Amor-tized Cost | Net Assets | Fair Value | Fair Value | Net Assets | ||||||||||||||
Senior secured debt investments | $ | 196,020 | 67.6 | % | 104.1 | % | $ | 195,112 | 70.3 | % | 103.5 | % | |||||||
Subordinated debt investments | 63,031 | 21.7 | % | 33.5 | 51,198 | 18.4 | % | 27.2 | |||||||||||
Preferred equity | 24,103 | 8.3 | % | 12.8 | 19,200 | 6.9 | % | 10.2 | |||||||||||
Common equity and warrants | 6,821 | 2.4 | % | 3.6 | 11,989 | 4.3 | % | 6.4 | |||||||||||
Total | $ | 289,975 | 100.0 | % | 154.0 | % | $ | 277,499 | 100.0 | % | 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
108
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
fair value of the Company's common equity investment was $-0-; the amortized cost and fair value of the Company's warrant investment was $453 and $-0-, respectively; and the amortized cost and fair value of the Company's debt investment was $15,241 and $12,910, respectively. The Company recognized realized losses of $3,931 on its senior secured debt investment and warrants upon their sale during the year ended December 31, 2018.
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, the Company had two loans (Community Intervention Services, Inc. and Southern Technical Institute, LLC) on non-accrual status with respect to all interest and unamortized Net Loan Fees with an amortized cost and fair value of $11,100 and $1,200, respectively.
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. 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 | ||||||||||||||
109
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 | |||||||||||||||
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 | 13.0 | 24,984 | 9.0 | 13.5 | ||||||||||||||
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 | 12.5 | 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 | % | |||||||||
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, 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
110
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
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: | 2018 | 2017 | |||||
Current assets | $ | 5,900 | $ | 7,161 | |||
Noncurrent assets | 25,103 | 25,408 | |||||
Total assets | $ | 31,003 | $ | 32,569 | |||
Current liabilities | $ | 979 | $ | 3,116 | |||
Noncurrent liabilities | 19,886 | 17,276 | |||||
Total liabilities | 20,865 | 20,392 | |||||
Non-controlling interest | 4,526 | 5,675 | |||||
Controlling interest | 5,612 | 6,502 | |||||
Total equity | $ | 10,138 | $ | 12,177 | |||
Year Ended December 31 | |||||||||||
Summary of Operations: | 2018 | 2017 | 2016 | ||||||||
Net Sales | $ | 29,902 | $ | 31,614 | $ | 27,704 | |||||
Gross Profit | 3,216 | 9,857 | 7,436 | ||||||||
Net income (loss) | (597 | ) | 2,106 | 2,232 | |||||||
Net income (loss) attributable to MTE Holding Corp. | 191 | 1,594 | 1,235 | ||||||||
Note 5. 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.
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
111
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
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, 2018, 2017, and 2016.
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 not rely on or may only partially rely on the 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.
Investments that are not valued using Indicative Prices or Transaction Prices are typically valued using two different valuation techniques. The Company typically estimates the fair value of debt investments by a discounted cash flows technique in which a current price is imputed for the investment based upon an assessment of the expected market yield (or discount rate) for similarly structured investments with a similar level of risk. The Company considers the current contractual interest rate, the maturity and other terms of the investment relative to risk of the portfolio company and various market indices. A key determinant of portfolio-company risk is the leverage through the investment relative to earnings metrics of the portfolio company. The fair value of Company’s equity investments as well as certain of its non-performing debt investments are estimated through analysis of the portfolio companies’ enterprise value under a market approach. Enterprise value means the entire value of the portfolio company to a market participant, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. The primary method for determining enterprise value under the market approach involves multiple analysis whereby appropriate multiples are applied to an earnings metric of the portfolio company, typically earnings before net interest expense, income tax expense, depreciation and amortization (“EBITDA”). EBITDA multiples are typically determined based upon review of market comparable transactions and publicly traded comparable companies, if any. The Company may also utilize other portfolio-company earnings metrics to determine enterprise value, such as recurring monthly revenue ("RMR”) or a delineated measure of portfolio company EBITDA. Application of these valuation methodologies involves a significant degree of judgment by management.
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.
112
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, 2018 and 2017. 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, 2018 (1) | Valuation technique | Unobservable inputs | Range (Weighted average) | ||||||
Debt investments: | |||||||||
Senior secured | $ | 295,087 | Discounted cash flow | Discount rates | 6.94% - 19.70% (12.49%) | ||||
Subordinated | 36,394 | Discounted cash flow | Discount rates | 7.16% - 15.40% (7.21%) | |||||
8,146 | Market approach | EBITDA multiples | 3.50x - 7.65x (5.10x) | ||||||
Equity investments | |||||||||
Preferred equity | 12,039 | Market approach | EBITDA multiples | 4.50x - 8.50x (7.42x) | |||||
2,574 | Market approach | Reoccurring Monthly Revenue | 38.0x - 42.0x (40.0x) | ||||||
Common equity and warrants | 18,627 | Market approach | EBITDA multiples | 3.50x - 11.00x (8.68x) | |||||
(1) | Excludes $23,930, $-0-, and $-0- of senior secured debt investments, subordinated debt investments, and equity investments, respectively, valued at a Transaction Price. |
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 | Market approach | EBITDA multiples | 4.25x - 7.25x (6.37x) | ||||||
Equity investments | |||||||||
Preferred equity | 19,200 | Market approach | EBITDA multiples | 4.25x - 13.48x (7.80x) | |||||
Common equity and warrants | 11,489 | Market approach | 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. |
Changes in market credit spreads or events impacting the credit quality of the underlying portfolio company (both of which could impact the discount rate), as well as changes in EBITDA and/or EBITDA multiples, among other things, could have a significant impact on fair values, with the fair value of a particular debt investment susceptible to change in inverse relation to the changes in the discount rate. Changes in EBITDA and/or EBITDA multiples, as well as changes in the discount rate, could have a significant impact on fair values, with the fair value of an equity investment susceptible to change in tandem with the changes in EBITDA and/or EBITDA multiples, and in inverse relation to changes in the discount rate. Due to wide range of approaches towards developing input assumptions to these valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.
113
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, 2018 and 2017:
Year Ended December 31, 2018 | |||||||||||||||||||
Senior Secured Debt Investments | Subordinated Debt Investments | Preferred Equity | Common Equity and Warrants | Total | |||||||||||||||
Level 3 assets, January 1, 2018 | $ | 195,112 | $ | 51,198 | $ | 19,200 | $ | 11,989 | $ | 277,499 | |||||||||
Net realized gain (loss) on investments | (3,076 | ) | (3,469 | ) | (1,889 | ) | 3,655 | (4,779 | ) | ||||||||||
Net unrealized appreciation (depreciation) on investments | (5,944 | ) | 161 | (104 | ) | 1,853 | (4,034 | ) | |||||||||||
Amortization of Net Loan Fees | 2,076 | 212 | — | — | 2,288 | ||||||||||||||
Capitalized PIK interest and dividends | 388 | 668 | 907 | — | 1,963 | ||||||||||||||
Amendment fees | (159 | ) | (2 | ) | — | — | (161 | ) | |||||||||||
Purchase and origination of portfolio investments | 245,278 | 20,930 | 338 | 5,609 | 272,155 | ||||||||||||||
Proceeds from principal payments on portfolio investments | (75,541 | ) | (25,158 | ) | — | — | (100,699 | ) | |||||||||||
Sale and redemption of portfolio investments | (39,117 | ) | — | (3,339 | ) | (4,979 | ) | (47,435 | ) | ||||||||||
Reclassification between preferred equity and common equity and warrants | — | — | (500 | ) | 500 | — | |||||||||||||
Level 3 assets, December 31, 2018 | $ | 319,017 | $ | 44,540 | $ | 14,613 | $ | 18,627 | $ | 396,797 | |||||||||
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 4) | (1,745 | ) | — | 1,745 | — | — | |||||||||||||
Conversion from subordinated to senior secured debt investment (Note 4) | (9,631 | ) | 9,631 | — | — | — | |||||||||||||
Level 3 assets, December 31, 2017 | $ | 195,112 | $ | 51,198 | $ | 19,200 | $ | 11,989 | $ | 277,499 | |||||||||
114
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
The net unrealized appreciation (depreciation) reported in the Company’s consolidated statements of operations for the years ended December 31, 2018 and 2017, attributable to the Company’s Level 3 assets still held at those respective year ends was as follows:
Year Ended December 31, | ||||||
2018 | 2017 | |||||
Senior secured debt investments | $ | (6,738 | ) | $ | 1,013 | |
Subordinated debt investments | 138 | (8,681 | ) | |||
Preferred equity | (2,172 | ) | (767 | ) | ||
Common equity and warrants | 2,573 | (2,061 | ) | |||
Net unrealized depreciation on investments held | $ | (6,199 | ) | $ | (10,496 | ) |
Other Financial Assets and Liabilities
GAAP requires disclosure of the fair value of financial instruments not reported at fair value on a recurring basis for which it is practical to estimate such value. The Company believes that the carrying amounts of its other financial instruments such as cash, receivables and payables approximate the fair value of such items due to the short maturity of such instruments. The PWB Facility is a variable rate instrument and fair value is approximately book value.
The following tables present the fair value measurements of the Company's debt and indicate the fair value hierarchy of the significant unobservable inputs utilized by the Company to determine such fair values as of December 31, 2018 and 2017:
December 31, 2018 | |||||||||||||||
Description | Level 1 | Level 2 | Level 3 (1) | Total | |||||||||||
OFS Capital Corporation 6.375% Notes due 2025 | $ | 48,500 | $ | — | $ | — | $ | 48,500 | |||||||
OFS Capital Corporation 6.5% Notes due 2025 | 46,603 | — | — | 46,603 | |||||||||||
SBA-guaranteed debentures | — | — | 147,956 | 147,956 | |||||||||||
Total debt, at fair value | $ | 95,103 | $ | — | $ | 147,956 | $ | 243,059 | |||||||
December 31, 2017 | |||||||||||||||
Description | Level 1 | Level 2 | Level 3 (1) | Total | |||||||||||
SBA-guaranteed debentures | $ | — | $ | — | $ | 155,510 | $ | 155,510 | |||||||
Total debt, at fair value | $ | — | $ | — | $ | 155,510 | $ | 155,510 | |||||||
(1) For Level 3 measurements, fair value is estimated by discounting remaining payments using current market rates for similar instruments at the measurement date and considering such factors as the legal maturity date.
The following are the carrying values and fair values of the Company’s debt as of December 31, 2018 and 2017:
As of December 31, 2018 | As of December 31, 2017 | ||||||||||||||
Description | Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||
OFS Capital Corporation 6.375% Notes due 2025 | $ | 48,377 | $ | 48,500 | $ | — | $ | — | |||||||
OFS Capital Corporation 6.5% Notes due 2025 | 46,849 | 46,603 | — | — | |||||||||||
SBA-guaranteed debentures | 147,600 | 147,956 | 147,223 | 155,510 | |||||||||||
Total debt, at fair value | $ | 242,826 | $ | 243,059 | $ | 147,223 | $ | 155,510 | |||||||
115
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 6. Commitments and Contingencies
The Company has the following unfunded commitments to portfolio companies as of December 31, 2018:
Name of Portfolio Company | Investment Type | Amount | ||||
Carolina Lubes, Inc. | Senior Secured Loan (Revolver) | $ | 2,920 | |||
Cirrus Medical Staffing, Inc. | Senior Secured Loan (Revolver) | 128 | ||||
Inergex Holdings | Senior Secured Loan (Revolver) | 1,875 | ||||
The Escape Game, LLC | Senior Secured Loan (Delayed Draw) | 3,267 | ||||
$ | 8,190 | |||||
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, 2018.
Additionally, the Company is subject to periodic inspection by regulators to assess compliance with applicable BDC regulations and the SBIC I LP is subject to periodic inspections by the SBA.
In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties that provide general indemnifications. The Company’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Company that have not occurred. The Company believes the risk of any material obligation under these indemnifications to be low.
Note 7. Borrowings
SBA Debentures: The SBIC Program 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 (or $175,000 with SBA approval). An SBIC fund may borrow up to two times the amount of its regulatory capital, subject to customary regulatory requirements. 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, 2018 and 2017, SBIC I LP had fully drawn the $149,880 of leverage commitments from the SBA.
On a stand-alone basis, SBIC I LP held $251,060 and $251,601 in assets at December 31, 2018 and 2017, respectively, which accounted for approximately 57% and 70% of the Company’s total consolidated assets, respectively. These assets can not be pledged under any debt obligation of the Company.
116
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, 2018 and 2017:
Fixed Interest Rate | SBA debentures outstanding | ||||||||||||
Pooling Date | Maturity Date | December 31, 2018 | December 31, 2017 | ||||||||||
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 | (2,280 | ) | (2,657 | ) | |||||||||
SBA debentures outstanding, net of unamortized debt issuance costs | $ | 147,600 | $ | 147,223 | |||||||||
The Company received exemptive relief from the SEC effective November 26, 2013, which permits the Company to exclude SBA guaranteed debentures from the definition of senior securities in the statutory asset coverage ratio under the 1940 Act, allowing for greater capital deployment.
The effective interest rate on the SBA debentures, which includes amortization of deferred debt issuance costs, was 3.43% as of December 31, 2018 and 2017. Interest expense on the SBA debentures was $5,137, $5,141, and $5,156 for the years ended December 31, 2018, 2017, and 2016, respectively, which includes $377, $380, and $382 of debt issuance costs amortization, respectively.
The weighted-average fixed cash interest rate on the SBA debentures as of December 31, 2018 and 2017, was 3.18%.
Unsecured Notes: In April 2018, the Company publicly offered the Unsecured Notes Due April 2025 with an aggregate principal of $50,000. The total net proceeds to the Company from the Unsecured Notes Due April 2025, after deducting underwriting discounts and offering costs of $1,753 were $48,247. In October and November 2018, the Company publicly offered the Unsecured Notes Due October 2025 with an aggregate principal of $48,525, which included a partial exercise of the underwriters overallotment option. The total net proceeds to the Company from the Unsecured Notes Due October 2025, after deducting underwriting discounts and offering expenses of $1,723, were $46,802. The Unsecured Notes Due April 2025 and the Unsecured Notes Due October 2025, combined (the “Unsecured Notes”), totaled $98,525 in aggregate principal debt, with net proceeds of $95,049 to the Company.
The Unsecured Notes are direct unsecured obligations and rank equal in right of payment with all current and future unsecured indebtedness of the Company. Because the Unsecured Notes are not secured by any of the Company's assets, they are effectively subordinated to all existing and future secured unsubordinated indebtedness (or any indebtedness that is initially unsecured as to which the Company subsequently grant a security interest), to the extent of the value of the assets securing such indebtedness, including, without limitation, borrowings under the senior secured revolving credit facility between the Company and Pacific Western Bank ("PWB Credit Facility").
The indenture governing the Unsecured Notes contains certain covenants (i) prohibiting additional borrowings, including through the issuance of additional debt securities, unless the Company's asset coverage, as defined in the 1940 Act, after giving effect to any exemptive relief granted to the Company by the SEC, equals at least 200% (or 150% on and after May 3, 2019) after such borrowings; and (ii) prohibiting (a) the declaration of any cash dividend or distribution upon any class of the Company’s capital stock (except to the extent necessary for the Company to maintain its treatment as a RIC under Subchapter M of the Code), or (b) the purchase of any capital stock if the Company’s asset coverage, as defined in the 1940 Act, were below 200% (or 150% on and after May 3, 2019) at the time of such capital transaction and after deducting the amount of such transaction.
117
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
As of December 31, 2018, the Unsecured Notes had the following terms and balances:
Unsecured Notes | Principal | Unamor-tized Discount and Issuance Costs | Stated Interest Rate (1) | Effec-tive Interest Rate (2) | Maturity (3) | 2018 Interest Expense (4) | |||||||||||||
Unsecured Notes Due April 2025 | $ | 50,000 | $ | 1,623 | 6.375 | % | 6.875 | % | 4/30/2025 | $ | 2,439 | ||||||||
Unsecured Notes Due October 2025 | 48,525 | 1,676 | 6.500 | % | 7.007 | % | 10/31/2025 | 697 | |||||||||||
Total | $ | 98,525 | $ | 3,299 | $ | 3,136 | |||||||||||||
(1) The weighted-average fixed cash interest rate on the Unsecured Notes as of December 31, 2018, was 6.44%.
(2) The effective interest rate on the Unsecured Notes includes deferred debt issuance cost amortization.
(3) The Unsecured Notes Due April 2025 and October 2025 may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after April 30, 2020 and on or after October 31, 2020, respectively.
(4) Interest expense includes debt issuance costs amortization of $228 for the year ended December 31, 2018.
PWB Credit Facility: The Company is party to a business loan agreement ("BLA") with Pacific Western Bank, as lender, to provide the Company with a $50,000 senior secured revolving credit facility. The PWB Credit Facility is available for general corporate purposes including investment funding and is scheduled to mature on January 31, 2020. 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 PWB Credit Facility bears interest at a variable rate of the Prime Rate plus a 0.75% margin, with a 5.25% floor, and includes an unused commitment fee, payable monthly in arrears, equal to 0.50% per annum on any unused portion. As of December 31, 2018, the interest rate on the unpaid principal balance of the PWB Credit Facility was 6.25%.
The average dollar amount of borrowings outstanding during the year ended December 31, 2018, was $11,387. The effective interest rate, which includes amortization of deferred debt issuance costs as of December 31, 2018, was 6.61% based on the maximum amount available under the PWB Credit Facility. Interest expense on the PWB Credit Facility was $959, $672, and $146 for the years ended December 31, 2018, 2017, and 2016, respectively, which includes $180, $172, and $108 of deferred financing amortization, respectively Unamortized debt issuance costs included in prepaid expenses and other assets on the consolidated statements of assets and liabilities as of December 31, 2018 and 2017 were $180 and $80, respectively.
Availability under the PWB Credit Facility was $38,000 based on the stated advance rate of 50% under the borrowing base, and the $12,000 outstanding as of December 31, 2018.
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, 2018, the Company was in compliance with the applicable covenants.
The average dollar borrowings and average interest rate for all debt the years ended December 31, 2018, 2017, and 2016, were as follows:
Year ended | Average Dollar Borrowings | Average Interest Rate | |||||
December 31, 2018 | $ | 206,936 | 4.37 | % | |||
December 31, 2017 | 158,368 | 3.55 | |||||
December 31, 2016 | 150,458 | 3.44 | |||||
118
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 8. Federal Income Tax
Filing status: The Company has elected to be taxed as a RIC under Subchapter M of the Code. In order to maintain its status as a RIC, the Company is required to distribute annually to its stockholders at least 90% of its ICTI, as defined by the Code. Additionally, to avoid a 4% U.S. federal excise tax on undistributed earnings the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2% of its net capital gains for the one-year period ending October 31 of that calendar year, and (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no U.S. federal income tax. Maintenance of the Company's RIC status also requires adherence to certain source of income and asset diversification requirements.
Taxable income and distributions: The Company has met the required distribution, source of income and asset diversification requirements as of December 31, 2018, and intends to continue meeting these requirements. Accordingly, there is no liability for federal income taxes at the Company level. The Company’s ICTI differs from the net increase in net assets resulting from operations primarily due to differences in income recognition on the unrealized appreciation/depreciation of investments, income from Company’s equity investments in pass-through entities, PIK dividends that have not yet been declared and paid by underlying portfolio companies, capital gains and losses and the net creation or utilization of capital loss carryforwards. The Company recognized approximately $3,879 of ordinary taxable income in 2018 related to the recapture of passive losses recognized over the four-year period ended December 31, 2017, on its investment in Jobson Healthcare, that was not recognized in the net increase in net assets resulting from operations.
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, | |||||||||||
2018 | 2017 | 2016 | |||||||||
Ordinary taxable income | $ | 18,053 | $ | 14,158 | $ | 12,157 | |||||
Long-term capital gain | 5,036 | 2,738 | 169 | ||||||||
Return of capital | — | — | 858 | ||||||||
Total distributions to stockholders | $ | 23,089 | $ | 16,896 | $ | 13,184 | |||||
Tax-basis components of distributable earnings (accumulated losses) as of December 31, 2018 and 2017, were as follows:
December 31, | |||||||
2018 | 2017 | ||||||
Ordinary income | $ | 3,712 | $ | — | |||
Net long-term capital gains (capital loss carryforward – non-expiring) | (5,176 | ) | 4,936 | ||||
The Company records reclassifications to its capital accounts related to permanent differences between GAAP and tax treatment related to goodwill amortization, excise taxes, and other permanent differences; and temporary differences between GAAP and tax treatment of realized gains and losses, income arising from Company’s equity investments in pass-through entities, PIK dividends, and other temporary differences. The Company recorded reclassifications to increase (decrease) additional paid-in capital against total distributable earnings (accumulated loss) of $(62), $(409) and $592 for the years ended December 31, 2018, 2017, and 2016, respectively.
119
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
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, 2018 and 2017, were as follows:
December 31, | |||||||
2018 | 2017 | ||||||
Tax-basis amortized cost of investments | $ | 408,715 | $ | 282,401 | |||
Tax-basis gross unrealized appreciation on investments | 18,426 | 16,207 | |||||
Tax-basis gross unrealized depreciation on investments | (30,344 | ) | (21,109 | ) | |||
Tax-basis net unrealized appreciation (depreciation) on investments | (11,918 | ) | (4,902 | ) | |||
Fair value of investments | $ | 396,797 | $ | 277,499 | |||
Deferred taxes: The Company recognizes deferred taxes on the unrealized appreciation or depreciation of securities held through Taxable Blockers. Deferred tax assets and liabilities are measured using enacted corporate federal tax rates expected to apply to taxable income in the years in which those unrealized gains and losses are realized. The recoverability of deferred tax assets is assessed and a valuation allowance is recorded to the extent that it is more likely than not that any portion of the deferred tax asset will not be realized on the basis of the projected taxable income or other taxable events in the Taxable Blocker. Deferred tax assets and liabilities, and related valuation allowance, as of December 31, 2018 and 2017, were as follows:
December 31, | |||||||
2018 | 2017 | ||||||
Total deferred tax assets | $ | 310 | $ | — | |||
Total deferred tax liabilities | (225 | ) | (4 | ) | |||
Valuation allowance on net deferred tax assets | (85 | ) | — | ||||
Net unrealized appreciation (depreciation) on investments reported in the consolidated statements of operations includes $(4), $4 and $-0-of net deferred tax (benefit) expense for the year ended December 31, 2018, 2017, and 2016, respectively.
120
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 9. Financial Highlights
The following is a schedule of financial highlights for the years ended December 31, 2018, 2017, 2016, 2015 and 2014:
Years Ended December 31, | |||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||
Per share operating performance: | |||||||||||||||||||
Net asset value per share at beginning of year | $ | 14.12 | $ | 14.82 | $ | 14.76 | $ | 14.24 | $ | 14.58 | |||||||||
Distributions | (1.73 | ) | (1.36 | ) | (1.36 | ) | (1.36 | ) | (1.36 | ) | |||||||||
Net investment income(10) | 1.38 | 1.28 | 1.46 | 1.39 | 0.95 | ||||||||||||||
Net realized gain (loss) on non-control/non-affiliate investments(10) | (0.37 | ) | (0.26 | ) | 0.25 | (0.31 | ) | 0.02 | |||||||||||
Net realized gain on affiliate investments(10) | 0.01 | 0.81 | — | 0.14 | — | ||||||||||||||
Net realized loss on control investment(10) | — | — | — | — | (0.37 | ) | |||||||||||||
Net unrealized appreciation (depreciation) on non-control/non-affiliate investments(10) | (0.19 | ) | (0.78 | ) | (0.69 | ) | 0.53 | 0.05 | |||||||||||
Net unrealized appreciation (depreciation) on affiliate investments(10) | (0.06 | ) | (0.41 | ) | 0.33 | 0.13 | 0.19 | ||||||||||||
Net unrealized appreciation on control investment(10) | (0.06 | ) | — | 0.07 | — | 0.18 | |||||||||||||
Issuance of common stock (5) | — | (0.03 | ) | — | — | — | |||||||||||||
Other (6) | — | 0.05 | — | — | — | ||||||||||||||
Net asset value per share at end of year | $ | 13.10 | $ | 14.12 | $ | 14.82 | $ | 14.76 | $ | 14.24 | |||||||||
Per share market value, end of period | $ | 10.60 | $ | 11.90 | $ | 13.76 | $ | 11.48 | $ | 11.78 | |||||||||
Total return based on market value (1) | 3.5 | % | (4.7 | )% | 32.3 | % | 9.0 | % | 2.4 | % | |||||||||
Total return based on net asset value (2) | 7.8 | % | 5.0 | % | 10.9 | % | 16.0 | % | 7.5 | % | |||||||||
Shares outstanding at end of period | 13,357,337 | 13,340,217 | 9,700,297 | 9,691,170 | 9,650,834 | ||||||||||||||
Weighted average shares outstanding | 13,348,203 | 12,403,706 | 9,693,801 | 9,670,153 | 9,634,471 | ||||||||||||||
Ratio/Supplemental Data (in thousands except ratios) | |||||||||||||||||||
Average net asset value (3) | $ | 182,468 | $ | 171,631 | $ | 142,818 | $ | 140,002 | $ | 138,131 | |||||||||
Net asset value at end of year | $ | 175,023 | $ | 188,336 | $ | 143,778 | $ | 143,012 | $ | 137,471 | |||||||||
Net investment income | $ | 18,385 | $ | 15,877 | $ | 14,145 | $ | 13,411 | $ | 9,135 | |||||||||
Ratio of total expenses, net to average net assets (8) | 13.4 | % | 10.2 | % | 11.9 | % | 13.5 | % | 9.9 | % | |||||||||
Ratio of net investment income to average net assets (9) | 10.5 | % | 8.4 | % | 9.8 | % | 9.6 | % | 6.6 | % | |||||||||
Portfolio turnover (7) | 41.9 | % | 50.4 | % | 18.1 | % | 44.6 | % | 34.9 | % | |||||||||
(1) | Calculation is ending market price less beginning market price, adjusted for distributions reinvested at prices based on 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 dividend reinvestment plan for the respective distributions. |
(3) | Based on the average of the net asset value at the beginning of the indicated period and the end of each calendar quarter within the period indicated. |
(4) | Reserved. |
(5) | The issuance of common stock on a per share basis reflects the incremental net asset value change as a result of the Offering. |
(6) | Represents the impact of different share amounts used in calculating per share data as a result of calculating certain per share data based on a weighted average shares outstanding during the period and certain per share data based on the shares outstanding as of a period end or transaction date. |
(7) | Portfolio turnover rate is calculated using the lesser of year-to-date sales and principal payments or year-to-date purchases over the average of the investments at fair value. |
(8) | Ratio of total expenses before incentive fee waiver to average net assets was 13.4% for the year ended December 31, 2018. |
(9) | Ratio of net investment income before incentive fee waiver to average net assets was 10.5% for the year ended December 31, 2018. |
(10) | Calculated on the average share method. |
121
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 10. Capital Transactions
Distributions: The Company intends to make distributions to stockholders on a quarterly basis of substantially all of its net investment income. In addition, although the Company intends to make distributions of net realized capital gains, if any, at least annually, out of assets legally available for such distributions. The Company may in the future decide to retain such net investment income and capital gains for investment or corporate purposes.
The Company has elected to pay excise tax on undistributed net investment income in the amount of $130, $-0- and $-0- for the years ended December 31, 2018, 2017, and 2016, respectively.
The Company may be limited in its ability to make distributions due to the BDC asset coverage requirements of the 1940 Act. The Company’s ability to make distributions may also be affected by its restrictions imposed by the SBA regulations on the Company's wholly owned SBIC subsidiary. Net assets of SBIC I LP were $101,727 and $102,675, which included consolidated cash and cash equivalents of $36,031 and $72,116, not available for distribution at December 31, 2018 and 2017, respectively.
The following table summarizes distributions declared and paid for the years ended December 31, 2018, 2017, and 2016:
Date Declared | Record Date | Payment Date | Amount Per Share | Cash Distribution | DRIP Shares Issued | DRIP Shares Value | |||||||||||||
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 | |||||||||||||
Year ended December 31, 2018 | |||||||||||||||||||
February 12, 2018 (1) | March 22, 2018 | March 29, 2018 | $ | 0.37 | $ | 4,886 | 4,459 | $ | 50 | ||||||||||
February 27, 2018 | March 22, 2018 | March 29, 2018 | 0.34 | 4,490 | 4,098 | 46 | |||||||||||||
May 1, 2018 | June 22, 2018 | June 29, 2018 | 0.34 | 4,518 | 1,684 | 20 | |||||||||||||
August 3, 2018 | September 14, 2018 | September 28, 2018 | 0.34 | 4,511 | 2,366 | 28 | |||||||||||||
October 30, 2018 | December 17, 2018 | December 31, 2018 | 0.34 | 4,489 | 4,813 | 51 | |||||||||||||
$ | 1.73 | $ | 22,894 | 17,420 | $ | 195 | |||||||||||||
(1) Special distribution representing undistributed net long-term capital gains realized by the Company in 2017.
The following table represents DRIP participation for the years ended December 31, 2018, 2017, and 2016, respectively:
For the Year Ended | DRIP Shares Value | Total Distribution Declared | DRIP Shares Issued | Average Value Per Share | |||||||||||
December 31, 2018 | $ | 195 | $ | 23,089 | 17,420 | $ | 11.16 | ||||||||
December 31, 2017 | 196 | 16,896 | 14,920 | 13.18 | |||||||||||
December 31, 2016 | 122 | 13,184 | 9,127 | 13.23 | |||||||||||
Since the Company’s IPO, distributions to stockholders total $90,864, or $8.36 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
122
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
source of the distribution is mailed to the Company’s stockholders. For the year ended December 31, 2018, approximately $1.36 per share, $0.37 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.
Stock repurchase program: On May 22, 2018, the Board authorized the Company to initiate the Stock Repurchase Program under which the Company may acquire up to $10,000 of its outstanding common stock. Under the Stock Repurchase Program, the Company is authorized to repurchase shares in open-market transactions, including through block purchases, depending on prevailing market conditions and other factors. The Stock Repurchase Program may be extended, modified or discontinued at any time for any reason. The Company expects the Stock Repurchase Program to be in place through May 22, 2020, or until the approved dollar amount has been used to repurchase shares. The Stock Repurchase Program does not obligate the Company to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. The Company repurchased 300 shares for $3 under the Stock Repurchase Program during the year ended December 31, 2018.
Note 11. Selected Quarterly Financial Data (Unaudited)
Three Months Ended | |||||||||||||||
December 31, 2018 | September 30, 2018 | June 30, 2018 | March 31, 2018 | ||||||||||||
Total investment income | $ | 12,571 | $ | 10,982 | $ | 10,278 | $ | 9,003 | |||||||
Net investment income | 5,321 | 4,690 | 4,558 | 3,816 | |||||||||||
Net gain (loss) on investments | (9,416 | ) | 489 | 437 | (323 | ) | |||||||||
Net increase (decrease) in net assets resulting from operations | (4,095 | ) | 5,179 | 4,995 | 3,493 | ||||||||||
Net investment income per share – basic and diluted (1) | $ | 0.40 | $ | 0.35 | $ | 0.34 | $ | 0.29 | |||||||
Net increase (decrease) in net assets resulting from operations per share – basic and diluted (1) | $ | (0.30 | ) | $ | 0.39 | $ | 0.37 | $ | 0.26 | ||||||
Net asset value per share (2) | $ | 13.10 | $ | 13.75 | $ | 13.70 | $ | 13.67 | |||||||
Three Months 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 investment income per share – basic and diluted (1) | $ | 0.28 | $ | 0.33 | $ | 0.33 | $ | 0.34 | |||||||
Net increase (decrease) in net assets resulting from operations per share – basic and diluted (1) | $ | 0.22 | $ | 0.09 | $ | (0.17 | ) | $ | 0.50 | ||||||
Net asset value per share (2) | $ | 14.12 | $ | 14.15 | $ | 14.40 | $ | 14.98 | |||||||
(1) | Based on weighted average shares outstanding for the respective period. |
(2) | Based on shares outstanding at the end of the respective period. |
123
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 12. Consolidated Schedule of Investments In and Advances To Affiliates
Year ended December 31, 2018 | ||||||||||||||||||||||||||||||||||||||||||
Name of Portfolio Company | Investment Type (1) | Net Realized Gain (Loss) | Net change in unrealized appreciation/ (depreciation) | Interest & PIK Interest | Dividends | Fees | Total Income (2) | December 31, 2017, Fair Value | Gross Additions (3) | Gross Reductions (4) | December 31, 2018, Fair Value (5) | |||||||||||||||||||||||||||||||
Control Investment | ||||||||||||||||||||||||||||||||||||||||||
MTE Holding Corp. | Subordinated Secured Loan | $ | — | $ | 54 | $ | 1,115 | $ | — | $ | 66 | $ | 1,181 | $ | 7,118 | $ | 177 | $ | — | $ | 7,296 | |||||||||||||||||||||
Common Equity | — | (801 | ) | — | 185 | — | 185 | 3,450 | — | (801 | ) | 2,649 | ||||||||||||||||||||||||||||||
— | (747 | ) | 1,115 | 185 | 66 | 1,366 | 10,568 | 177 | (801 | ) | 9,945 | |||||||||||||||||||||||||||||||
Total Control Investment | (747 | ) | 1,115 | 185 | 66 | 1,366 | 10,568 | 177 | (801 | ) | 9,945 | |||||||||||||||||||||||||||||||
Affiliate Investments | ||||||||||||||||||||||||||||||||||||||||||
3rd Rock Gaming Holdings, LLC | Senior Secured Loan | — | (1,330 | ) | 1,777 | — | — | 1,777 | — | 21,750 | (1,727 | ) | 20,023 | |||||||||||||||||||||||||||||
Common Equity (6) | — | (1,474 | ) | — | — | — | — | — | 2,560 | (1,487 | ) | 1,073 | ||||||||||||||||||||||||||||||
— | (2,804 | ) | 1,777 | — | — | 1,777 | — | 24,310 | (3,214 | ) | 21,096 | |||||||||||||||||||||||||||||||
All Metals Holding, LLC | Senior Secured Loan | — | (471 | ) | 2,748 | — | 588 | 3,336 | 12,759 | 7,230 | (19,989 | ) | — | |||||||||||||||||||||||||||||
Common Equity (6) | 4,118 | (1,220 | ) | — | — | — | — | 1,785 | 258 | (2,043 | ) | — | ||||||||||||||||||||||||||||||
4,118 | (1,691 | ) | 2,748 | — | 588 | 3,336 | 14,544 | 7,488 | (22,032 | ) | — | |||||||||||||||||||||||||||||||
Contract Datascan Holdings, Inc. | Subordinated Loan | — | (5 | ) | 950 | — | — | 950 | 8,000 | 6 | (6 | ) | 8,000 | |||||||||||||||||||||||||||||
Preferred Equity A (7) | — | 91 | 597 | — | — | 597 | 5,964 | 688 | — | 6,652 | ||||||||||||||||||||||||||||||||
Common Equity (6) | — | 2,053 | — | — | — | — | 260 | 2,053 | — | 2,313 | ||||||||||||||||||||||||||||||||
— | 2,139 | 1,547 | — | — | 1,547 | 14,224 | 2,747 | (6 | ) | 16,965 | ||||||||||||||||||||||||||||||||
124
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Year ended December 31, 2018 | ||||||||||||||||||||||||||||||||||||||||||
Name of Portfolio Company | Investment Type (1) | Net Realized Gain (Loss) | Net change in unrealized appreciation/ (depreciation) | Interest & PIK Interest | Dividends | Fees | Total Income (2) | December 31, 2017, Fair Value | Gross Additions (3) | Gross Reductions (4) | December 31, 2018, Fair Value (5) | |||||||||||||||||||||||||||||||
DRS Imaging Services, LLC | Senior Secured Loan | $ | — | $ | (157 | ) | $ | 659 | $ | — | $ | 163 | $ | 822 | $ | — | $ | 10,802 | $ | (185 | ) | $ | 10,617 | |||||||||||||||||||
Common Equity (6) | — | 62 | — | — | — | — | — | 1,197 | — | 1,197 | ||||||||||||||||||||||||||||||||
— | (95 | ) | 659 | — | 163 | 822 | — | 11,999 | (185 | ) | 11,814 | |||||||||||||||||||||||||||||||
Jobson Healthcare Information (8) | Senior Secured Loan | (3,477 | ) | 2,331 | 905 | — | — | 905 | 12,910 | 2,751 | (15,661 | ) | — | |||||||||||||||||||||||||||||
Common Equity (6) | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||
Warrants (6) | (454 | ) | 454 | — | — | — | — | — | 454 | (454 | ) | — | ||||||||||||||||||||||||||||||
(3,931 | ) | 2,785 | 905 | — | — | 905 | 12,910 | 3,205 | (16,115 | ) | — | |||||||||||||||||||||||||||||||
Master Cutlery, LLC | Subordinated Loan | — | (2,095 | ) | 156 | — | — | 156 | 2,873 | 117 | (2,140 | ) | 850 | |||||||||||||||||||||||||||||
Preferred Equity (6) | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||
Common Equity (6) | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||
— | (2,095 | ) | 156 | — | — | 156 | 2,873 | 117 | (2,140 | ) | 850 | |||||||||||||||||||||||||||||||
NeoSystems Corp. | Subordinated Loan | — | (7 | ) | 283 | — | — | 283 | 2,143 | 47 | (2,190 | ) | — | |||||||||||||||||||||||||||||
Preferred Stock (7) | — | (145 | ) | 146 | — | — | 146 | 2,248 | 147 | (145 | ) | 2,250 | ||||||||||||||||||||||||||||||
— | (152 | ) | 429 | — | — | 429 | 4,391 | 194 | (2,335 | ) | 2,250 | |||||||||||||||||||||||||||||||
Pfanstiehl Holdings, Inc | Subordinated Loan | — | 42 | 392 | — | — | 392 | 3,755 | 42 | (9 | ) | 3,788 | ||||||||||||||||||||||||||||||
Common Equity | — | 3,605 | — | 130 | — | 130 | 4,755 | 3,605 | — | 8,360 | ||||||||||||||||||||||||||||||||
— | 3,647 | 392 | 130 | — | 522 | 8,510 | 3,647 | (9 | ) | 12,148 | ||||||||||||||||||||||||||||||||
125
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Year ended December 31, 2018 | ||||||||||||||||||||||||||||||||||||||||||
Name of Portfolio Company | Investment Type (1) | Net Realized Gain (Loss) | Net change in unrealized appreciation/ (depreciation) | Interest & PIK Interest | Dividends | Fees | Total Income (2) | December 31, 2017, Fair Value | Gross Additions (3) | Gross Reductions (4) | December 31, 2018, Fair Value (5) | |||||||||||||||||||||||||||||||
Professional Pipe Holdings, LLC | Senior Secured Loan | $ | — | $ | (181 | ) | $ | 845 | $ | — | $ | — | $ | 845 | $ | — | $ | 8,355 | $ | (889 | ) | $ | 7,466 | |||||||||||||||||||
Common Equity (6) | — | (645 | ) | — | — | — | — | — | 1,414 | (645 | ) | 769 | ||||||||||||||||||||||||||||||
— | (826 | ) | 845 | — | — | 845 | — | 9,769 | (1,534 | ) | 8,235 | |||||||||||||||||||||||||||||||
TRS Services, Inc. | Senior Secured Loan | — | (307 | ) | 1,856 | — | 9 | 1,865 | 9,466 | 7,942 | (2,962 | ) | 14,446 | |||||||||||||||||||||||||||||
Preferred Equity (Class AA units) (7) | — | — | 62 | — | — | 62 | 409 | 64 | — | 473 | ||||||||||||||||||||||||||||||||
Preferred Equity (Class A units) (6) | — | (1,404 | ) | — | — | — | — | 2,230 | — | (1,404 | ) | 826 | ||||||||||||||||||||||||||||||
Common Equity (6) | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||
— | (1,711 | ) | 1,918 | — | 9 | 1,927 | 12,105 | 8,006 | (4,366 | ) | 15,745 | |||||||||||||||||||||||||||||||
Total Affiliate Investments | 187 | (803 | ) | 11,376 | 130 | 760 | 12,266 | 69,557 | 71,482 | (51,936 | ) | 89,103 | ||||||||||||||||||||||||||||||
Total Control and Affiliate Investments | $ | 187 | $ | (1,550 | ) | $ | 12,491 | $ | 315 | $ | 826 | $ | 13,632 | $ | 80,125 | $ | 71,659 | $ | (52,737 | ) | $ | 99,048 | ||||||||||||||||||||
(1) | Principal balance of debt investments and ownership detail for equity investments are shown in the consolidated schedule of investments. The Company's investments are generally classified as "restricted securities" as such term is defined under Regulation S-X Rule 6-03(f) or Securities Act Rule 144. |
(2) | Represents the total amount of interest, fees or dividends included in 2018 income for the portion of the year ended December 31, 2018, that an investment was included in Control or Affiliate Investment categories, respectively. |
(3) | Gross additions include increases in cost basis resulting from a new portfolio investment, PIK interest, fees and dividends, accretion of OID, and net increases in unrealized net appreciation or decreases in net unrealized depreciation. |
(4) | Gross reductions include decreases in the cost basis of investments resulting from principal repayments and sales, if any, and net decreases in net unrealized appreciation or net increases in net unrealized depreciation. |
(5) | Fair value was determined using significant unobservable inputs. See Note 5 for further details. |
(6) | Non-income producing. |
(7) | Dividends credited to income include dividends contractually earned but not declared. |
(8) | Jobson became an affiliate investment effective December 31, 2017, due to an increase in voting ownership interest. |
126
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Year ended December 31, 2017 | ||||||||||||||||||||||||||||||||||||||||||
Name of Portfolio Company | Investment Type (1) | Net Realized Gain (Loss) | Net change in unrealized appreciation/(depreciation) | Interest & PIK Interest | Dividends | Fees | Total 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 | $ | — | $ | — | $ | 504 | $ | — | $ | 32 | $ | 536 | $ | 7,683 | $ | 150 | $ | (7,833 | ) | $ | — | ||||||||||||||||||||
Preferred Equity | — | — | — | 65 | — | 65 | 5,868 | 1,608 | (7,476 | ) | — | |||||||||||||||||||||||||||||||
— | — | 504 | 65 | 32 | 601 | 13,551 | 1,758 | (15,309 | ) | — | ||||||||||||||||||||||||||||||||
MTE Holding Corp. | Senior Secured Loan | — | (64 | ) | 1,168 | — | 120 | 1,288 | 9,766 | 90 | (2,738 | ) | 7,118 | |||||||||||||||||||||||||||||
Common Equity | — | 67 | — | 227 | — | 227 | 3,383 | 67 | — | 3,450 | ||||||||||||||||||||||||||||||||
— | 3 | 1,168 | 227 | 120 | 1,515 | 13,149 | 157 | (2,738 | ) | 10,568 | ||||||||||||||||||||||||||||||||
Total Control Investments | — | 3 | 1,672 | 292 | 152 | 2,116 | 26,700 | 1,915 | (18,047 | ) | 10,568 | |||||||||||||||||||||||||||||||
Affiliate Investments | ||||||||||||||||||||||||||||||||||||||||||
All Metals Holding, LLC | Senior Secured Loan | — | (259 | ) | 1,830 | — | 26 | 1,856 | 12,865 | 283 | (389 | ) | 12,759 | |||||||||||||||||||||||||||||
Common Equity (6) | — | 508 | — | — | — | — | 1,277 | 508 | — | 1,785 | ||||||||||||||||||||||||||||||||
— | 249 | 1,830 | — | 26 | 1,856 | 14,142 | 791 | (389 | ) | 14,544 | ||||||||||||||||||||||||||||||||
Contract Datascan Holdings, Inc. | Subordinated Loan | — | 93 | 978 | — | — | 978 | 7,902 | 98 | — | 8,000 | |||||||||||||||||||||||||||||||
Preferred Equity (6) (7) | — | — | 542 | — | — | 542 | 5,421 | 543 | — | 5,964 | ||||||||||||||||||||||||||||||||
Common Equity (6) | — | 73 | — | — | — | — | 187 | — | 73 | 260 | ||||||||||||||||||||||||||||||||
— | 166 | 1,520 | — | — | 1,520 | 13,510 | 641 | 73 | 14,224 | |||||||||||||||||||||||||||||||||
127
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Year ended December 31, 2017 | ||||||||||||||||||||||||||||||||||||||||||
Name of Portfolio Company | Investment Type (1) | Net Realized Gain (Loss) | Net change in unrealized appreciation/(depreciation) | Interest & PIK Interest | Dividends | Fees | Total Income (2) | December 31, 2016, Fair Value | Gross Additions (3) | Gross Reductions (4) | December 31, 2017, Fair Value (5) | |||||||||||||||||||||||||||||||
Intelli-Mark Technologies, Inc. | Senior Secured Loan | $ | — | $ | (159 | ) | $ | 438 | $ | — | $ | 175 | $ | 613 | $ | 8,841 | $ | 68 | $ | (8,909 | ) | $ | — | |||||||||||||||||||
Common Equity (6) | 874 | (498 | ) | — | — | — | — | 1,998 | — | (1,998 | ) | — | ||||||||||||||||||||||||||||||
874 | (657 | ) | 438 | — | 175 | 613 | 10,839 | 68 | (10,907 | ) | — | |||||||||||||||||||||||||||||||
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 | ) | 415 | — | 256 | 671 | — | 7,833 | (7,833 | ) | — | |||||||||||||||||||||||||||||
Preferred Equity | 5,590 | (1,585 | ) | — | 56 | — | 56 | — | 7,476 | (7,476 | ) | — | ||||||||||||||||||||||||||||||
5,590 | (1,626 | ) | 415 | 56 | 256 | 727 | — | 15,309 | (15,309 | ) | — | |||||||||||||||||||||||||||||||
Master Cutlery, LLC | Subordinated Loan | — | (1,537 | ) | 640 | — | — | 640 | 4,440 | 653 | (2,220 | ) | 2,873 | |||||||||||||||||||||||||||||
Preferred Equity (6) (7) | — | (954 | ) | — | — | — | — | 954 | — | (954 | ) | — | ||||||||||||||||||||||||||||||
Common Equity (6) | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||
— | (2,491 | ) | 640 | — | — | 640 | 5,394 | 653 | (3,174 | ) | 2,873 | |||||||||||||||||||||||||||||||
NeoSystems Corp. | Subordinated Loan | — | 421 | 408 | — | — | 408 | 3,656 | 487 | (2,000 | ) | 2,143 | ||||||||||||||||||||||||||||||
Preferred Equity (6) (7) | — | 861 | 133 | — | — | 133 | 1,255 | 993 | — | 2,248 | ||||||||||||||||||||||||||||||||
— | 1,282 | 541 | — | — | 541 | 4,911 | 1,480 | (2,000 | ) | 4,391 | ||||||||||||||||||||||||||||||||
128
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Year ended December 31, 2017 | ||||||||||||||||||||||||||||||||||||||||||
Name of Portfolio Company | Investment Type (1) | Net Realized Gain (Loss) | Net change in unrealized appreciation/(depreciation) | Interest & PIK Interest | Dividends | Fees | Total Income (2) | December 31, 2016, Fair Value | Gross Additions (3) | Gross Reductions (4) | December 31, 2017, Fair Value (5) | |||||||||||||||||||||||||||||||
Pfanstiehl Holdings, Inc | Subordinated Loan | $ | — | $ | (46 | ) | $ | 387 | $ | — | $ | — | $ | 387 | $ | 3,810 | $ | 1 | $ | (56 | ) | $ | 3,755 | |||||||||||||||||||
Common Equity | — | (1,328 | ) | — | 84 | — | 84 | 6,083 | — | (1,328 | ) | 4,755 | ||||||||||||||||||||||||||||||
— | (1,374 | ) | 387 | 84 | — | 471 | 9,893 | 1 | (1,384 | ) | 8,510 | |||||||||||||||||||||||||||||||
Strategic Pharma Solutions, Inc. | Senior Secured Loan | — | (39 | ) | 746 | — | 158 | 904 | 8,383 | 67 | (8,450 | ) | — | |||||||||||||||||||||||||||||
Preferred Equity (6) (7) | 3,617 | (1,111 | ) | 81 | — | — | 81 | 3,026 | 81 | (3,107 | ) | — | ||||||||||||||||||||||||||||||
3,617 | (1,150 | ) | 827 | — | 158 | 985 | 11,409 | 148 | (11,557 | ) | — | |||||||||||||||||||||||||||||||
TRS Services, Inc. | Senior Secured Loan | — | 194 | 1,024 | — | 60 | 1,084 | 9,549 | 310 | (393 | ) | 9,466 | ||||||||||||||||||||||||||||||
Preferred Equity (Class AA units)(6)(7) | — | — | 55 | — | — | 55 | 354 | 55 | — | 409 | ||||||||||||||||||||||||||||||||
Preferred Equity (Class A units) (6)(7) | — | 319 | 204 | — | — | 204 | 1,707 | 523 | — | 2,230 | ||||||||||||||||||||||||||||||||
Common Equity (6) | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||
— | 513 | 1,283 | — | 60 | 1,343 | 11,610 | 888 | (393 | ) | 12,105 | ||||||||||||||||||||||||||||||||
Total Affiliate Investments | 10,081 | (5,088 | ) | 7,881 | 140 | 675 | 8,696 | 81,708 | 32,889 | (45,040 | ) | 69,557 | ||||||||||||||||||||||||||||||
Total Control and Affiliate Investments | $ | 10,081 | $ | (5,085 | ) | $ | 9,553 | $ | 432 | $ | 827 | $ | 10,812 | $ | 108,408 | $ | 34,804 | $ | (63,087 | ) | $ | 80,125 | ||||||||||||||||||||
129
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
(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. |
130
OFS Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share data)
Note 13. Subsequent Events Not Disclosed Elsewhere
On March 5, 2019, the Company’s Board declared a distribution of $0.34 per share for the first quarter of 2019, payable on March 29, 2019 to stockholders of record as of March 22, 2019.
131
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, 2018. 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, 2018, our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management, including our Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external reporting purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that the receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with polices or procedures may deteriorate.
Our management (with the supervision and participation of our Chief Executive Officer and Chief Financial Officer) conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2018 based on the framework in Internal Control – Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on our assessment, management concluded that, as of December 31, 2018, our internal control over financial reporting is effective based on those criteria.
Attestation Report of the Registered Public Accounting Firm
Our internal control over financial reporting as of December 31, 2018, has been audited by BDO USA, LLP, an independent registered public accounting firm, as stated in their report, which is included in Item 8 of Part II of this Annual Report under the heading Report of Independent Registered Public Accounting Firm.
Changes in Internal Control over Financial Reporting
As previously disclosed in Item 9A of our Form 10-K for the year ended December 31, 2017, management concluded that there was a material weakness in internal control over financial reporting related 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. In response to the material weakness identified, management developed and implemented a remediation plan to address the underlying causes of the material weakness.
The remediation plan included a tracking system to ensure all portfolio company audited financial statements are received and reviewed to confirm the reliability of financial information reported by portfolio companies.
132
During the twelve months ended December 31, 2018, we implemented the new internal control procedures described above to address the previously identified material weakness as of December 31, 2017. After completing our testing of the design and operating effectiveness of our control enhancements, we concluded that we have remediated the previously identified material weakness.
Other than controls implemented in response to the material weakness described above, no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. | Other Information |
None.
133
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 2019 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 2019 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 2019 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 2019 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 2019 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.
134
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 12" of this report.
3. Exhibits required to be filed by Item 601 of Regulation S-K: See Item 15b. below.
b. Exhibits
The following table lists exhibits filed as part of this report, according to the number assigned to them in Item 601 of Regulation S-K. All exhibits listed in the following table are incorporated by reference except for those exhibits denoted in the last column. Please note that the agreements included as exhibits to this Form 10-K are included to provide information regarding their terms and are not intended to provide any other factual or disclosure information about us or the other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable agreement that have been made solely for the benefit of the other parties to the applicable agreement and may not describe the actual state of affairs as of the date they were made or at any other time.
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 16, 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 | POS EX (333-217302) | April 16, 2018 | |||
4.8 | POS EX (333-217302) | April 16, 2018 | |||
135
Incorporated by Reference | |||||
Exhibit Number | Description | Form and SEC File No. | Filing Date with SEC | Filed with this 10-K | |
4.9 | POS EX (333-222419) | October 16, 2018 | |||
4.10 | POS EX (333-222419) | October 16, 2018 | |||
10.1 | N-2/A (333-166363) | March 18, 2011 | |||
10.2 | 10-Q (814-00813) | November 7, 2014 | |||
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-K (814-00813) | March 12, 2018 | |||
10.10 | 10-Q (814-00813) | November 6, 2015 | |||
10.11 | 10-K (814-00813) | March 12, 2018 | |||
10.12 | 10-K (814-00813) | March 12, 2018 | |||
11.1 | Computation of Per Share Earnings | + | |||
14.1 | * | ||||
136
Incorporated by Reference | |||||
Exhibit Number | Description | Form and SEC File No. | Filing Date with SEC | Filed with this 10-K | |
21.1 | * | ||||
31.1 | * | ||||
31.2 | * | ||||
32.1 | † | ||||
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.
137
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 15, 2019 | /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 15, 2019 | /s/ Bilal Rashid |
Bilal Rashid, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer) | |
Date: March 15, 2019 | /s/ Marc Abrams |
Marc Abrams, Director | |
Date: March 15, 2019 | /s/ Robert J. Cresci |
Robert J. Cresci, Director | |
Date: March 15, 2019 | /s/ Elaine E. Healy |
Elaine E. Healy, Director | |
Date: March 15, 2019 | /s/ Jeffrey A. Cerny |
Jeffrey A. Cerny, Chief Financial Officer, Treasurer (Principal Financial Officer) and Director | |
Date: March 15, 2019 | /s/ Jeff Owen |
Jeff Owen, Chief Accounting Officer (Principal Accounting Officer) | |
138
Exhibit 14.1
OFS Capital Management, LLC
OFS CLO Management, LLC
OFS Capital Corporation
OFS Credit Company, Inc.
Hancock Park Corporate Income, Inc.
Code of Ethics
Restated and Adopted on October 30, 2018
This Code of Ethics is the property of OFS Capital Management, LLC and certain affiliated entities and must be returned to it if an individual’s association with it terminates for any reason.
The content of this Code of Ethics is confidential, and should not be revealed to third parties without the consent of the Chief Compliance Officer (“CCO”). The policies and procedures set forth herein supersede previous versions.
TABLE OF CONTENTS
Page
I. | GENERAL (CODE OF ETHICS) 1 |
A. | INTRODUCTION 3 |
B. | STATEMENT OF STANDARDS OF BUSINESS CONDUCT 3 |
C. | PERIODIC COMPLIANCE AND TRAINING 7 |
D. | ACKNOWLEDGMENT 7 |
E. | REPORTING AND SANCTIONS 7 |
F. | ADDITIONAL RESTRICTIONS AND WAIVERS BY OFS ADVISER AND THE OFS FUNDS 8 |
G. | REVIEW BY THE BOARD OF DIRECTORS OF EACH OFS FUND 8 |
H. | CCO REPORTING 9 |
I. | CONFLICT WITH EMPLOYEE HANDBOOK 9 |
II. | PERSONAL INVESTMENT POLICY 10 |
A. | INTRODUCTION AND DEFINITIONS 10 |
B. | RECORDKEEPING AND REPORTING REQUIREMENTS 12 |
1. | Reports 12 |
2. | Determining Whether an Account is an Affiliated Account 13 |
3. | Managed Accounts 14 |
4. | Non-Transferable Accounts 14 |
5. | Transactions Subject to Review 15 |
C. | STATEMENT OF RESTRICTIONS 15 |
1. | Restricted List 15 |
2. | Private Placements and Initial Public Offerings 17 |
3. | Trades by OFS Fund Directors 17 |
4. | Trades of OFS Fund Securities or CMCT 17 |
5. | Trades by Access Persons Serving on Company Boards 17 |
TABLE OF CONTENTS (cont’d)
Page
6. | No Personal Trades Through OFS Adviser’s Traders 18 |
7. | Use of Brokerage for Personal or Family Benefit 18 |
8. | No “Front Running” 18 |
D. | REQUIREMENTS OF DISINTERESTED DIRECTORS 18 |
III. | INSIDE INFORMATION POLICY 19 |
A. | INTRODUCTION 19 |
B. | KEY TERMS 20 |
1. | What is a “Security”? 20 |
2. | Who is an Insider? 20 |
3. | What is Material Information? 21 |
4. | What is Nonpublic Information? 22 |
5. | Contacts with Companies 22 |
6. | Tender Offers 22 |
7. | Penalties for Insider Trading 22 |
C. | INSIDER TRADING PROCEDURES 23 |
1. | Identifying Inside Information 23 |
2. | Restricting Access to Material and Nonpublic Information 23 |
3. | Review and Dissemination of Certain Investment Related Information 24 |
4. | Determination of Materiality 24 |
5. | Policies and Procedures Relating to Paid Research Consultants and Expert Network Firms Regarding Securities 24 |
IV. | GIFTS, ENTERTAINMENT AND POLITICAL ACTIVITIES 27 |
A. | INTRODUCTION 27 |
B. | GIFTS AND ENTERTAINMENT POLICY 27 |
1. | Business Meals 27 |
TABLE OF CONTENTS (cont’d)
Page
2. | Providing Gifts 28 |
3. | Receiving Gifts 28 |
4. | Entertainment 29 |
5. | Travel and Lodging 29 |
6. | Providing Meals, Gifts and Entertainment to Public Officials and Union Employees 30 |
7. | Receipt of Meals, Gifts or Entertainment by Traders from Brokers/Agent Bank Employees 30 |
C. | POLITICAL ACTIVITY POLICY 30 |
1. | Introduction 30 |
2. | Indirect Violations 32 |
3. | Periodic Disclosure 32 |
V. | OUTSIDE AFFILIATIONS POLICY 33 |
A. | OUTSIDE BUSINESS ACTIVITIES 33 |
B. | DIRECTOR AND OFFICER POSITIONS 33 |
C. | EMPLOYEE RELATIONSHIPS 34 |
VI. ANTI-CORRUPTION POLICY…………………………………………………………35
VII. CIM COMPUTER ACCEPTABLE USE POLICY……………………………………...38
VIII. PERSONAL USE OF FIRMS RESOURCES AND RELATIONSHIPS POLICY……..39
1
I. | GENERAL (CODE OF ETHICS) |
A. | INTRODUCTION |
The Code of Ethics (“Code”) has been jointly adopted by OFS Capital Management and OFS CLO Management, LLC (collectively, “OFS Adviser” or the "Firm”)and certain entities that are controlled by or under common control with OFS Capital Management (“Affiliates”), as determined from time to time by Senior Management, and each of OFS Capital Corporation, Hancock Park Corporate Income, Inc., OFS Credit Company, Inc. and any investment company that OFS Adviser may sponsor and/or manage from time to time (each, an “OFS Fund” and collectively, “OFS Funds”) in order to establish applicable policies, guidelines and procedures that promote ethical practices and conduct by all Supervised Persons of OFS Adviser, including, but not limited to, certain employees, interns, temporary employees, principals and others designated by Compliance, and that prevent violations of applicable laws including the Investment Advisers Act of 1940, as amended (“Advisers Act”) and the Investment Company Act of 1940, as amended (“Company Act”).1 “Supervised Person” is defined as any director, officer, member or employee (or other person occupying similar status or performing similar functions) of OFS Adviser or any other person who provides investment advice on behalf of OFS Adviser and is subject to the supervision and control of OFS Adviser 2 . Unless instructed otherwise or approved by the Compliance Department, temporary employees and consultants will generally be deemed a Supervised Person if the employee’s or consultant’s work assignment or engagement exceeds ninety (90) calendar days. This Code is available to all Supervised Persons on OFS Adviser’s public network drive and Sharepoint site. All Supervised Persons must read it carefully and must verify at least annually (and at such other times that a Compliance Officer may request) that he or she has read, understands, and agrees to abide by the Code.
The Code is designed to address conflicts of interest that may arise in your personal dealings and those in which you engage on behalf of the Firm and its Advisory Clients3. The following policies comprise the Code consists and address certain conflicts:
1 The Code is adopted by OFS Adviser and each OFS Fund pursuant to and in accordance with the requirements of each of Rules 204A-1 and 206(4)-7 under the Advisers Act and Rules 17j-1 and 38a-1under the Company Act.
2 The Chief Compliance Officer or his/her designee may consider any director, officer, member, principal or employee, including, but not limited to, intern and temporary employees, of an Affiliate of OFS Adviser to be a Supervised Person of OFS Adviser if the Chief Compliance Officer determines that such person performs services for OFS Adviser, through any staffing or similar agreement, such that the person would constitute a Supervised Person if such person was a director, officer, member, employee, intern or temporary employee of OFS Adviser. The Compliance Department maintains a list of all such persons and whether each person is (1) a Supervised Person and (2) an Access Person and will notify each person of relevant requirements. The majority of OFS Adviser’s personnel are employees of Orchard First Source Capital, Inc., an Affiliate of OFS Adviser..
3 Advisory Client means any individual, group of individuals, partnership, trust, company or other investment fund entity for whom OFS Adviser acts as investment adviser. For example, any OFS Fund is an Advisory Client. For the avoidance of doubt, Advisory Clients include public and private investment funds, including comingled funds and single investor funds (“Funds”) and managed accounts managed by OFS Adviser, but do not include the underlying individual investors in such Funds (“Investors”), although certain protections afforded to Advisory Clients pursuant to this Code do extend to Investors through Rule 206(4)-8 of the Advisers Act.
• | the Personal Investment Policy, |
• | the Inside Information Policy, |
• | the Gifts and Entertainment Policy, |
• | Political Activity Policy, |
• | Outside Affiliations Policy, and |
• | Anti-Corruption Policy. |
OFS Adviser and each OFS Fund require that all Supervised Persons observe the applicable standards of care set forth in these policies and not seek to evade the provisions of the Code in any way, including through indirect acts by Related Persons or other associates.
All activities involving the OFS Funds are subject to the Company Act and the policies and procedures adopted by each OFS Fund in connection therewith as set forth in the Rule 38a-1 Compliance Manual (“38a-1 Manual”) for each OFS Fund. The obligations set forth in the Code and the 38a-1 Manual are in addition to and not in lieu of the policies and procedures set forth in the Firm’s Employee Handbook and any other Compliance Policies adopted by OFS Adviser in respect of the conduct of its business. |
B. | STATEMENT OF STANDARDS OF BUSINESS CONDUCT |
As a fundamental mandate, OFS Adviser and each OFS Fund demand the highest standards of ethical conduct and care from all Supervised Persons and OFS Fund Directors. Supervised Persons and OFS Fund Directors must abide by this basic business standard and must not take inappropriate advantage of their position with the Firm or OFS Fund. Each Supervised Person and OFS Fund Director is under a duty to exercise his or her authority and responsibility for the primary benefit of our Advisory Clients, including the OFS Funds, and the Firm, and may not have outside interests or engage in activities that inappropriately conflict or appear to conflict with the interests of the Firm or its Advisory Clients, including the OFS Funds. Examples of such conflicts include:
• | engaging a service provider on behalf of Advisory Clients or the Firm in which you or your Related Person has a financial interest. |
• | accepting extravagant gifts or entertainment from a potential service provider to the Firm. |
• | making charitable donations at the request of a prospective Advisory Client when the Advisory Client will directly benefit from such donation. |
• | contributing to the reelection campaign of a Governor who has the authority to appoint pension plan board members who are responsible for selecting investment advisers for such pension plan. |
• | purchasing an interest in a company or property that you know the Firm is targeting for investment. |
• | assuming an outside position with a company that competes directly with the Firm. |
The above list of examples is not exhaustive, and you, as a Supervised Person or OFS Fund Director, are responsible for assessing the unique facts and circumstances of your activities for potential conflicts and consulting with OFS Adviser’s Legal and Compliance Departments prior to engaging in such activities.
Each Supervised Person and OFS Fund Director must avoid circumstances or conduct that adversely affect or that appear to adversely affect OFS Adviser or its Advisory Clients, including the OFS Funds. Every Supervised Person and OFS Fund Director must comply with applicable federal securities laws and must promptly report suspected violations of the Code to a Compliance Officer. OFS Adviser strictly prohibits retaliation against any individual reporting suspected violations, who, in good faith, seeks help or reports known or suspected violations, including Supervised Persons who assist in making a report or who cooperate in an investigation (see Section I.E. Reporting and Sanctions).
GENERAL GUIDELINES
1. | Supervised Persons and OFS Directors may not employ any device, scheme or artifice to defraud an OFS Fund or any Advisory Client, make any untrue statement of a material fact to an OFS Fund or any Advisory Client, or omit to state a material fact necessary in order to make the statements not misleading, engage in any act, practice or course of business that operates or would operate as a fraud or deceit upon an OFS Fund or any other Advisory Client, |
engage in any manipulative practice with respect to an OFS Fund or any other Advisory Client, or engage in any manipulative practice with respect to Securities, including price manipulation.
2. | Except with the prior approval of a Compliance Officer, in consultation with a Supervised Person’s supervisor and/or Senior Management, a Supervised Person may not act as a director, officer, general partner, managing member, principal, proprietor, consultant, agent, representative, trustee or employee of any unaffiliated public or private entity or business other than an OFS Fund, OFS Adviser, or an Affiliate of OFS Adviser. (See Section IV) |
3. | All Supervised Persons must disclose to OFS Adviser and their respective OFS Fund any interests they may have in any entity that is not affiliated with OFS Adviser or any OFS Fund and that has a known business relationship with OFS Adviser, an Affiliate of OFS Adviser or any OFS Fund. |
4. | Except with the prior approval of a Compliance Officer, and as specifically permitted by law, Supervised Persons may not have a material direct or indirect interest (e.g., as principal, co-principal, agent, member, partner, or material shareholder or beneficiary) in any transaction that conflicts with the interests of OFS Adviser or its Advisory Clients. |
5. | Except with the prior approval of a Compliance Officer, Access Persons may not invest in any Initial Public Offering (“IPO”) or Private Placement (including hedge funds and other private investment vehicles). (See Section II.C.2) This requirement also applies to Private Placements that are Advisory Clients of OFS Adviser, such as OFS Credit Income Fund, L.P. |
6. | No Supervised Person, except in the course of the rightful exercise of his or her job responsibilities, shall reveal to any other person, information regarding any Advisory Client or any investment or Security transaction being considered, recommended or executed on behalf of any Advisory Client. (See Section III.) |
7. | No OFS Fund Director, except in the course of the rightful exercise of his or her board responsibilities, shall reveal to any other person information regarding any OFS Fund or any “Portfolio Company”, defined as any legal entity in which an OFS Fund or another Advisory Client holds an investment regardless of whether or not the investment is a Security, or any investment or Security transaction being considered, recommended, or executed on behalf of any other Advisory Client. (See Section III.) |
8. | No Supervised Person shall make any recommendation concerning the purchase or sale of any Security by an Advisory Client without disclosing, to the extent known, the interest of the Firm or any Supervised Person, if any, in such Security or the issuer thereof, including, without limitation (a) any direct or indirect beneficial ownership of any Security of such issuer; (b) any contemplated transaction by such person in such Security; and (c) any present or proposed relationship with respect to such Security, issuer or its affiliates. |
4. Private Placement is defined as an offering that is exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”), pursuant to section 4(2) or section 4(5) or pursuant to rule 504, rule 505 or rule 506 thereunder.
9. | Subject to certain exceptions permitted by applicable law, each OFS Fund shall not, directly or indirectly extend, maintain or arrange for the extension of credit or the renewal of an extension of credit, in the form of a personal loan to any officer or director of the Fund. Any Supervised Person or person who serves as a director on the board of directors of any OFS Fund (“OFS Fund Director”) who becomes aware that their respective OFS Fund may be extending or arranging for the extension of credit to a director or officer, or person serving an equivalent function, should notify and consult with a Compliance Officer to ensure that the proposed extension of credit complies with this Code and the applicable law. |
10. | No Supervised Person shall engage in insider trading (as described in the “Inside Information Policy” in Section III.) whether for his or her own benefit or for the benefit of others. |
11. | No Supervised Person may communicate material, nonpublic information concerning any Security, or its issuer, or Portfolio Company to anyone unless it is properly within his or her duties to do so. No OFS Fund Director may communicate material, nonpublic information concerning any Security of an issuer in which the OFS Fund Director knows, or, in the course of his or her duties as a director, should have known, OFS Fund has a current investment, or with respect to which an investment or Security is Being Considered for Purchase or Sale by any OFS Fund (“OFS Fund Portfolio Security”) or Portfolio Company of their respective OFS Fund to anyone unless it is properly within his or her duties to do so. A Security is “Being Considered for Purchase or Sale” when a recommendation to purchase or sell the Security has been made and communicated and, with respect to the person making the recommendation, when such person seriously considers making such a recommendation. In all cases, a Security which has been recommended for purchase or sale pursuant to an Investment Committee memorandum, presentation, due diligence package or other formal Investment Committee recommendation shall be deemed to be a Security Being Considered for Purchase or Sale. |
12. | Each Supervised Person shall complete a compliance questionnaire (the “Regulatory Compliance Disclosure”) prior to employment and annually thereafter, within the prescribed deadline, as provided by the Compliance Department, (“Compliance Due Date”) through the Firm’s automated compliance system. Each Supervised Person shall supplement the Regulatory Compliance Disclosure, as necessary, to reflect any material changes between annual disclosures, and must immediately notify Compliance if any of the conditions addressed in the Regulatory Compliance Disclosure become applicable to such Supervised Person. |
13. | Every Supervised Person must avoid any activity that might give rise to a question as to whether the Firm’s objectivity as a fiduciary has been compromised. (See Section V) |
14. | Access Persons are required to disclose to a Compliance Officer the existence of any account that has the ability to hold any Reportable Securities (e.g., brokerage or trading accounts and IRAs), as well the account’s holdings (immediately upon commencement of employment (which shall include the accounts and holdings of the Access Person’s Related Persons), and in no case later than ten (10) calendar days beyond Access Person’s start date. Such Accounts must be disclosed even if they contain a zero balance or non-Reportable Securities. Access Persons are required to disclose accounts that are Managed Accounts; however, disclosing the holdings of such Managed Accounts is not required. With limited exceptions provided herein, Access Persons are also required to maintain Non-Managed Accounts capable of |
holding Reportable Securities with Approved Brokers, which have contracted to provide holdings and transaction reporting to the Compliance Department on the Firm’s automated compliance system. Access Persons must confirm the accuracy and completeness of the information so provided to the Firm on a quarterly and annual basis by the Compliance Due Date. Initial and quarterly reports must disclose the existence of all accounts, even if none of those accounts at the time hold a Reportable Security. (See Section II).
15. | The intentional creation, transmission or use of false rumors is inconsistent with the Firm’s commitment to high ethical standards and may violate the antifraud provisions of the Advisers Act, among other securities laws of the United States. Accordingly, no Supervised Person may maliciously create, disseminate or use false rumors. This prohibition covers oral and written communications, including the use of electronic communication media such as e-mail, PIN messages, instant messages, tweets, text messages, blogs and chat rooms. Because of the difficulty identifying “false” rumors, the Firm discourages Supervised Persons from creating, passing or using any rumor. |
C. | PERIODIC COMPLIANCE AND TRAINING |
Each Supervised Person is required to complete all assigned compliance certifications and disclosures by the Compliance Due Date. Absent an exemption granted to you by a Compliance Officer, failure to complete such items by the Compliance Due Date will likely constitute a violation of this Code and may result in the imposition of sanctions.
The Compliance Department also presents and/or coordinates mandatory training on this Code at least annually, and may assign mandatory or voluntary training at such other times as a Compliance Department deems appropriate. Failure to attend or complete mandatory training sessions, unless excused in writing by a Compliance Officer, will likely constitute a violation of this Code and may lead to the imposition of sanctions. The Compliance Department maintains an attendance or completion list, as appropriate, of all Supervised Persons assigned to such training sessions.
D. | ACKNOWLEDGMENT |
Each Supervised Person must certify upon commencement of employment, at least annually thereafter, and at such other times as a Compliance Officer may determine, that he or she has read, understands, is subject to and has complied with the Code. Any Supervised Person who has any questions about the applicability of the Code to a particular situation should promptly consult with a Compliance Officer.
E. | REPORTING AND SANCTIONS |
While compliance with the provisions of the Code is anticipated, Supervised Persons should be aware that, in response to any violations, the Firm (or any OFS Fund, as applicable) shall take any action deemed necessary under the circumstances including, but without limitation, the imposition of appropriate sanctions. These sanctions may include, among others, verbal or written warnings, the reversal of trades, reallocation of trades to client accounts, disgorgement of profits, suspension or termination of personal trading or investment privileges, reduction in bonus or bonus opportunity, payment of a monetary fine payable to a recognized charitable organization of the Supervised Person’s choice or, in more serious cases, suspension or termination of employment and/or the making of any civil or criminal referral to the appropriate governmental authorities.
Moreover, Supervised Persons are required to promptly report any violation(s) of this Code, any other compliance policies adopted by OFS Adviser or the Rule 38a-1 Manual adopted by any OFS Fund (collectively “Compliance Policies”), or any activity that may adversely affect the Firm’s or any OFS Fund’s business or reputation, to a Compliance Officer. The Compliance Department shall maintain a record of all violations of the Code and any corrective actions taken. Supervised Persons are encouraged to identify themselves when reporting such conduct, but they may also report anonymously. Reporting should be made through a letter to a Compliance Officer or via the telephonic and electronic reporting procedures detailed in the Firm’s “Whistleblower Hotline Information” attached hereto as Attachment A. Further, all activities reported by Supervised Persons will be treated anonymously and confidentially (to the extent reasonably practicable) in order to encourage Supervised Persons to come forward with perceived problems. The Firm and each OFS Fund are committed to a full, unbiased review of any matter(s) raised.
The Firm and OFS Fund prohibit retaliation against any such personnel who, in good faith, seeks help or reports known or suspected violations (even if the reported event is determined not to be a violation), including personnel who assist in making a report or who cooperate in an investigation. Any Supervised Person who engages in retaliatory conduct will be subject to disciplinary action, up to and including termination of employment.
F. | ADDITIONAL RESTRICTIONS AND WAIVERS BY OFS ADVISER AND THE OFS FUNDS |
From time to time, a Compliance Officer may determine that it is in the best interests of the Firm to subject certain Supervised Persons or other persons (i.e., consultants and third party service providers) to restrictions or requirements in addition to those set forth in the Code. In such cases, the affected persons will be notified of the additional restrictions or requirements and will be required to abide by them as if they were included in the Code. In addition, under extraordinary circumstances, the Compliance Officer may grant a waiver of certain of these restrictions or requirements contained in the Code on a case by case basis. In order for a Supervised Person to rely on any such waiver, it must be granted in writing.
Any waiver of the requirements of the Code for executive officers of any OFS Fund or any OFS Fund Director may be made only by the respective OFS Fund’s board of directors or a committee of the board, and must be promptly disclosed to shareholders of the OFS Fund as required by law or relevant exchange rule or regulation.
The Compliance Department maintains a log of all requests for exceptions and waivers and the determinations made with respect to such requests.
G. | REVIEW BY THE BOARD OF DIRECTORS OF EACH OFS FUND |
The CCO will prepare a written report to be considered by the board of directors of each OFS Fund (1) quarterly, that identifies any violations of the Code with respect to each OFS Fund requiring significant remedial action during the past quarter and the nature of that remedial action; and (2) annually, that (a) describes any issues arising under the Code since the last written report to the Board, including, but not limited to, information about material violations of the Code and sanctions imposed in response to such violations, and (b) identifies any recommended changes in existing restrictions or procedures based upon each OFS Fund’s and/or OFS Adviser’s experience under the Code, then-prevailing industry practices, or developments in applicable laws or regulations, and (c) certifies that each OFS Fund and OFS Adviser have each adopted procedures reasonably designed to prevent violations of the Code, and of the federal securities laws in accordance with the requirements of the Advisers Act and the Company Act.
The board of directors of each OFS Fund will also be asked to approve any material changes to the Code within six (6) months after the adoption of such change, based on a determination that the Code, as amended, contains policies and procedures reasonably designed to prevent violations of the federal securities laws.
H. | CCO REPORTING |
The CCO will prepare a written report to be considered by Senior Management no less than annually, that (a) describes any issues arising under the Code since the last written report, including, but not limited to, information about material violations of the Code and sanctions imposed in response to such violations, and (b) identifies any recommended changes in existing restrictions or procedures based upon OFS Adviser’s experience under the Code, then-prevailing industry practices, or developments in applicable laws or regulations.
The CCO of each OFS Fund, as applicable, prepares a written report to be considered by the relevant OFS Fund Directors no less than annually, that (a) describes any issues arising under the Compliance Policies since the last written report, including, but not limited to, information about material violations of the Compliance Policies and sanctions imposed in response to such violations, and (b) identifies any recommended changes in existing restrictions or procedures based upon each OFS Fund’s and/or OFS Adviser’s experience under the Compliance Policies, then-prevailing industry practices, or developments in applicable laws or regulations.
I. | CONFIDENTIALITY |
Personnel will be given access to and become acquainted with highly confidential information about the Firm such as its financial information, business plans and strategies, investment strategies and opportunities, affiliated companies and internal policies and practices, as well as information relating to past, current and prospective Advisory Clients and Portfolio Companies. Such information must not be disclosed or discussed with anyone other than the Firm’s employees under any circumstances, and only on a “need to know” basis, unless otherwise permitted by the Legal or Compliance Departments.
J. | CONFLICT WITH EMPLOYEE HANDBOOK |
Where this Code addresses policies that are also addressed in other corporate policies or in the Employee Handbook of Orchard First Source Capital, Inc. or another Affiliate by which a Supervised Person is employed, the policies herein are intended to augment, and not to supersede or replace, the relevant corporate or Employee Handbook policies. In the event of any conflict that would prohibit a Supervised Person from complying with both sets of policies, the Supervised Person should address the conflict to a Compliance Officer.
II. | PERSONAL INVESTMENT POLICY |
A. | INTRODUCTION AND DEFINITIONS |
The Advisers Act, specifically Rule 204A-1, requires “Access Persons” of a registered investment adviser, such as OFS Adviser, to provide periodic reports regarding transactions and holdings in Reportable Securities beneficially owned by Access Persons. Rule 17j-1 under the Company Act requires similar reports for “Access Persons” to a Fund, such as each of the OFS Funds.
The purpose of this Personal Investment Policy and related procedures is to advise Access Persons of their ethical and legal responsibilities with respect to Securities transactions that may involve (i) possible conflicts of interest with Advisory Clients, including the OFS Funds, and (ii) the possession and use of material, nonpublic information (“MNPI”). It is a violation of the Code for any Access Person of OFS Adviser or any OFS Fund to use their knowledge concerning a trade, pending trade, or contemplated trade or investment by an OFS Fund or any other Advisory Client to profit personally, directly or indirectly, as a result of such transaction, including by purchasing or selling such Securities.
The following definitions are utilized within this Personal Investments Policy and more broadly within the rest of the Code.
“Access Person” with respect to OFS Adviser means (a) any Supervised Person who (i) has access to nonpublic information regarding any Advisory Client’s purchase or sale of Securities, or nonpublic information regarding the portfolio holdings of any Advisory Client (including any OFS Fund); or (ii) is involved in making Securities recommendations to Advisory Clients (including any OFS Fund), or has access to such recommendations that are nonpublic; and (b) all directors, officers and partners of OFS Adviser.5
For purposes of the Code, all Supervised Persons are generally considered to be Access Persons of OFS Adviser, and all Access Persons of OFS Adviser are considered to be Access Persons of each OFS Fund. OFS Fund Directors are also considered Access Persons of each OFS Fund but are generally exempt from Recordkeeping, Reporting and Statement of Restrictions requirements of Access Persons included in this Code, except as described in Section II.D below.
“Affiliate Account” means: (i) the personal Securities account of an Access Person or the account of any Related Person in which Reportable Securities may be held or transacted; (ii) any such Securities account for which any Access Person serves as custodian, trustee, or otherwise acts in a fiduciary capacity or with respect to which an Access Person either has authority to make investment decisions or from time to time makes investment recommendations, except with respect to Advisory Clients; (iii) any such Securities account of any person, partnership, joint venture, trust or other entity in which an Access Person or his or her Related Person has Beneficial Ownership or other Beneficial Interest; and (iv) and accounts containing Reportable Funds of which an Access Person or his or her Related Person has Beneficial Ownership or Beneficial Interest.
5 The Chief Compliance Officer or his/her designee may consider any director, officer, principal, member or employee, including, but not limited to, intern and temporary employees, of an Affiliate of OFS Adviser to be a Supervised Person, and Access Person if appropriate, of OFS Adviser if the Chief Compliance Officer determines that such person performs services for OFS Adviser, through any staffing or similar agreement, such that the person would constitute a Supervised Person or Access Person if such person was a director, officer, member, principal or employee, including an intern or temporary employee, of OFS Adviser. The Compliance Department will maintain a list of all such persons and whether each person is (1) a Supervised Person and (2) an Access Person and will notify each person of relevant requirements. The majority of OFS Adviser’s personnel are employees of Orchard First Source Capital, Inc., an Affiliate of OFS Adviser.
“Beneficial Interest” means an interest whereby a person can, directly or indirectly, control the disposition of a Security or a Reportable Fund or derive a monetary, pecuniary or other right or benefit from the purchase, sale or ownership of a Security or a Reportable Fund (e.g., interest payments or dividends).
“Beneficial Ownership” of a Security, Reportable Fund or account means, consistent with Section 16 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 16a-1(a)(2) thereunder, ownership of Securities, Securities accounts, or Reportable Funds by or for the benefit of a person or his or her Related Person. Beneficial Ownership specifically includes any Security or account in which the Access Person or any Related Persons holds a direct or indirect Beneficial Interest or retains voting power (or the ability to direct such a vote) or investment power (which includes the power to acquire or dispose of, or the ability to direct the acquisition or disposition of, a Security, Securities accounts or Reportable Funds), directly or indirectly (e.g., by exercising a power of attorney or otherwise).
“Exempt Security” is any Security that falls into any of the following categories: (i) shares issued by open-end mutual funds (excluding exchange traded funds (“ETFs”), except Reportable Funds, if any; (ii) shares issued by money market funds; (iii) Security purchases or sales that are part of an automatic dividend reinvestment plan (e.g., DRIP accounts, etc.); (iv) College Direct Savings Plans (e.g., 529 College Savings Program, etc.); (v) shares issued by unit investment trusts that are invested exclusively in one or more open-end funds (so long as such funds are not Reportable Funds); (vi) bankers’ acceptances, bank certificates of deposit or time deposits, commercial paper and other short term high quality debt instruments with one year or less to maturity; and (vii) treasury obligations (e.g., T-bills, notes and bonds) or other Securities issued/guaranteed by the U.S. Government, its agencies, or instrumentalities (e.g., FNMA, GNMA).
“Related Person” means the spouse, domestic partner, child or stepchild, parent or stepparent, grandchild, grandparent, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, sister-in-law (including adoptive relationships) of an Access Person, who either resides with, or is financially dependent upon, the Access Person, or whose investments are controlled by the Access Person.
“Reportable Fund” means any Fund for which OFS Advisor or any Affiliate acts as investment adviser, sub-adviser or underwriter.
“Reportable Security” means every Security and Reportable Fund in which an Access Person or a Related Person has a Beneficial Ownership or other Beneficial Interest, except for an Exempt Security.
“Security” means any note, stock, treasury stock, bond, debenture, evidence of indebtedness6, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, reorganization certificate or subscription, transferable share, investment contract, voting trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas or other mineral rights, any put, call, straddle, option or privilege on any security (including a certificate of deposit) or on any group or index of securities (including any interest therein or based on the value thereof), or a put, call, straddle, option or privilege, entered into on a national securities exchange relating to foreign currency, or in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
6 Note that, for most purposes, evidences of indebtedness are treated as “Securities” for securities law purposes; insider trading prohibitions are an exception to this general rule.
Note that Security has a different definition for purposes of the Inside Information Policy of the Code.
B. | RECORDKEEPING AND REPORTING REQUIREMENTS |
Under the Advisers Act and the Company Act, OFS Adviser and each OFS Fund are required to keep records of transactions in Reportable Securities in which Access Persons have Beneficial Ownership or a direct or indirect Beneficial Interest.
1.Reports
The following personal Securities holdings and transaction reporting requirements have been adopted to enable each of OFS Adviser and each OFS Fund to satisfy their legal and regulatory requirements:
In all cases, within ten (10) calendar days from the date of commencement of employment (or other engagement or arrangement) with the Firm, every new Access Person shall submit to the Compliance Department, through the Firm’s automated compliance system, the required information about any Affiliated Accounts (such information must be current as of a date no more than forty-five (45) calendar days prior to the date the person becomes an Access Person);
Within sixty (60) calendar days of becoming an Access Person, every new Access Person must transfer all Affiliated Accounts in which the Access Person or his or her Related Persons have direct influence or control in the investment decisions (“Non-Managed Accounts”) and in which Reportable Securities are held or are capable of being held to a broker-dealer to which the Compliance Department has access via the Firm’s automated compliance system (an “Approved Broker”). Subsequently, any new Non-Managed Accounts opened on behalf of such Access Person or his or her Related Person in which Reportable Securities will be held or transacted must be established with an Approved Broker. The Compliance Department maintains a list of Approved Brokers, which can be found on the Firm’s Sharepoint site. Holdings and transactions in Reportable Securities in these accounts are electronically reported to the Compliance Department by the Approved Brokers through the automated compliance system.
Any exception to the Approved Broker policy above must be approved in writing by a Compliance Officer.
By the Compliance Due Date and no later than thirty (30) calendar days after each quarter end, every Access Person is required to certify all Affiliated Accounts via the Firm’s automated compliance system. Any updates to an Access Person’s accounts must be reported via the Firm’s automated compliance system within thirty (30) calendar days of opening or closing of such Affiliated Account.
By the Compliance Due Date and no later than thirty (30) calendar days after each quarter end, every Access Person is required to certify via the Firm’s automated compliance system, all transactions in Reportable Securities in Non-Managed Accounts, as recorded by the system during the quarter. Any transactions in Reportable Securities in a Non-Managed Account not included within the Firm’s automated compliance system should be reported separately by the Access Person.
• | By the Compliance Due Date and no later than forty-five (45) calendar days following the end of each calendar year (i.e., February 14), every Access Person is required to certify, via the Firm’s automated compliance system, such Access Person’s Affiliated Accounts and Reportable Securities holdings in all Non-Managed Accounts as of year-end. Any holdings in Reportable Securities in a Non-Managed Account not included within the Firm’s automated compliance system should be reported separately by the Access Person. |
2.Determining Whether an Account is an Affiliated Account
In most cases, determining whether an Access Person or his or her Related Person has Beneficial Ownership of or a Beneficial Interest in the Reportable Securities held in an account (which would make such account an Affiliated Account for purposes hereof) is a straight-forward process. It is, however, important to note that, in some cases, an owner of an equity interest in an entity may be considered to have Beneficial Ownership of the assets of that entity. In general, equity holders are not deemed to have Beneficial Ownership of Securities held by an entity that is not “controlled” by the equity holders or in which the equity holders do not have or share investment control over the entity’s portfolio. Because the determination of whether an equity holder controls an entity or its investment decisions can be complicated, Access Persons are encouraged to seek guidance from a Compliance Officer. To the extent such guidance is not sought, any failure by an Access Person to properly identify all Affiliated Accounts will be treated as a violation of the Code.
3.Managed Accounts
The Firm recognizes that it may be impossible or impractical for accounts that are controlled or invested by a third party, such as an investment adviser or broker (“Managed Accounts”), to comply with the Reporting and Restricted List procedures of the Code. Therefore, Managed Accounts are exempted from such procedures, provided that the Access Person cedes any and all control over investment decisions for the account (other than general asset class and objectives guidelines) to such third party and does not communicate with such person with respect to individual transactions for the account. Special rules apply with respect to whether an Access Person “controls” the investment decisions of an entity in which he or she invests; guidance from a Compliance Officer should be sought in such instances.
The Firm requires that general information regarding Managed Accounts, including broker, account title, account number, and the status of the account, be reported through the Firm’s automated compliance system. In order to properly establish a Managed Account, the Access Persons is required to provide to the Compliance Department evidence that full investment discretion has been provided to the third-party investment adviser or broker (e.g., provide the investment management agreement). Upon establishing a Managed Account in the Firm’s automated compliance system and quarterly thereafter, the Access Person is required to certify within the Firm’s automated compliance system that he or she does not participate, directly or indirectly in individual investment decisions in the Managed Account or be made aware of such decisions before transactions are executed.
4.Non-Transferable Accounts
The Firm recognizes that it may be impossible or impracticable for certain types of Non-Managed Accounts (e.g. 401(k) accounts) of Access Persons or their Related Persons with other employers, an account pledged to secure a personal loan, etc. to be transferred to an Approved Broker. A Compliance Officer may exempt any such Non-Managed Account from the Approved Broker procedures set forth above provided that the Access Person shall be responsible for reporting transactions and holdings of Reportable Securities
(e.g. employer shares) in such account as set forth above and complying with the Restricted List procedures with respect to such Non-Managed Accounts.
The Firm requires that all such “non-transferable” Non-Managed Accounts be reported to the Compliance Department so that an exemption may properly be granted. General information regarding such accounts must be reported through the Firm’s automated compliance system. A Compliance Officer may, as a condition to exempting such Affiliated Accounts, require, initially and periodically thereafter, copies of account statements, a certification from the Access Person, or such other information as such Compliance Officer deems prudent.
5.Transactions Subject to Review
Transactions and holding information reported via the Firm’s automated compliance system will be reviewed by a Compliance Officer and compared against the investments made or considered by each of the Advisory Clients. Such review and comparison are designed to evaluate compliance with the Code and further, to determine whether there have been any violations of applicable law. Reporting made by a Compliance Officer is reviewed by a different Compliance Officer so that no Compliance Officer is reviewing his or her own reporting.
C. | STATEMENT OF RESTRICTIONS |
1.Restricted List
No Access Person or Related Person may make a trade Personal Securities Trade in the Securities of an issuer listed on the Firm’s Restricted List. Before an Access Person or his/her Related Person makes a Personal Securities Trade, the Access Person must review the Restricted List and confirm that neither the Security to be traded nor the relevant issuer are listed thereon. The information that a particular issuer or Security has been placed on the Restricted List is itself sensitive and confidential. The contents of the Restricted List should never be communicated to persons outside of the Firm except in the limited circumstances in which a Compliance Officer has determined that it is necessary and appropriate to disclose such information for bona fide business purposes. The Firm may place an issuer on the Restricted List at any time without prior notice to Access Persons. Therefore, Access Persons who obtain Securities of an issuer that is later placed on the Restricted List may be “frozen in,” or prohibited from disposing of such Securities, until the issuer has been removed from the Restricted List. Because Access Persons are already required to obtain pre-approval for the purchase or sale of any Private Placement (see below), the Restricted List is limited to the Securities of issuers with a class of publicly-traded Securities.
(a) | Securities |
The name of an issuer or Security could be placed on the Restricted List for many reasons, including when:
• | the Firm, any investment adviser Affiliate, or an Advisory Client purchases a Security of a particular issuer or such Security is Being Considered for Purchase or Sale; |
• | the Firm or any investment adviser Affiliate executes a confidentiality agreement with or relating to an issuer; |
• | the Firm, any investment adviser Affiliate, or an Advisory Client has declared itself “Private” with respect to an issuer in an electronic workspace; |
• | the Firm becomes bound by a fiduciary obligation or other duty (for example, because an Access Person has become a board member of an issuer); |
• | an Access Person becomes a member of an issuer’s board on behalf of the Firm or a Portfolio Company; |
• | an Access Person becomes aware of (or is likely to become aware of) MNPI about a Security or issuer; or |
• | the Firm, as determined by a Compliance Officer, has determined to include an issuer to avoid the appearance of impropriety and protect the Firm’s reputation for integrity and ethical conduct. |
(b) | Procedures |
The Compliance Department maintains and updates the Firm’s Restricted List. It is the responsibility of Access Persons, however, to ensure that the Firm’s Restricted List is accurate. Please refer to the Confidentiality Policy for further information on the relevant procedures.
• | Additions: Access Persons who become aware of any of the circumstances set forth in subsection 1.a) above, or who for any other reason believe an issuer or Security should be added to the Restricted List, should immediately notify a Compliance Officer in order to ensure that the Restricted List is updated. |
• | Deletions: When the circumstances set forth in subsection 1.a) above no longer exist, or the Firm is no longer bound by the obligations giving rise to the inclusion of an issuer or Security on the Restricted List, Access Persons should notify a Compliance Officer so that the proposed removal can be assessed and the name of the issuer or Security can be promptly removed, as necessary, from the Restricted List. |
• | Changes: From time to time, the Compliance Department will update the Restricted List as contemplated by this Personal Investment Policy and the Confidentiality Policy. Access Persons are responsible for checking the Restricted List in all cases before engaging in any Personal Securities Trade. |
Generally, Securities that are on the Restricted List because OFS Adviser or an investment adviser Affiliate has entered into a confidentiality agreement, declared itself “private” or otherwise accessed MNPI with respect to an issuer, must stay on the list for at least one hundred eighty (180) calendar days after the applicable Advisory Client(s) have liquidated the holding or last accessed MNPI on the relevant Security or issuer of such Security. A Compliance Officer may determine that a longer or shorter “stay” period is appropriate for issuers or Securities in such Compliance Officer’s sole discretion.
2.Private Placements and Initial Public Offerings
No IPO may be purchased and no Private Placement of Securities may be purchased or sold for any Affiliated Account, except with the prior, express written approval of (i) the CCO or designee; or (ii) where such Access Person is the CCO, the prior written approval of a member of Senior Management. Requests to make such investments shall be made through the Firm’s automated compliance system. A record of such approval (or denial), and a brief description of the reasoning supporting such decision will be maintained in accordance with the recordkeeping requirements of the Advisers Act and the Company Act.
3.Trades by OFS Fund Directors
OFS Fund Directors are prohibited from trading any OFS Fund Portfolio Security.
4.Trades of OFS Fund Securities or CMCT
All Access Persons are prohibited from buying or selling shares issued by any OFS Fund or either CIM Commercial Trust Corporation (“CMCT”), an Affiliate of OFS Adviser, except during an open trading window announced by a Compliance Officer. Except with the express written consent of the CCO, all Access Persons are prohibited from buying or selling options on, or futures or other derivatives related to, shares issued by any OFS Fund or CMCT, and are likewise prohibited from selling short, shares of any OFS Fund or CMCT.
5.Trades by Access Persons Serving on Company Boards
Companies for which Access Persons serve on the board of directors may permit members of its board of directors to purchase or sell stock based on a predetermined schedule (such as a Rule 10b5-1 Plan7) that is approved by the company (“Predetermined Schedule”). Personal Securities Trades made in accordance with a Predetermined Schedule by Access Persons who serve on the board of directors of such companies are exempt from the restriction against trading in Securities added to the Restricted List after the adoption of the Predetermined Schedule, however such Predetermined Schedules must be disclosed to a Compliance Officer prior to making the trade and are subject to the reporting requirements set forth in the section above. Further, purchases and sales of Securities by such company’s directors during an established trading window may be permitted with prior notice to, and at the discretion of, a Compliance Officer.
6.No Personal Trades Through OFS Adviser’s Traders
No Personal Securities Trades may be effected through OFS Adviser’s trading personnel.
7.Use of Brokerage for Personal or Family Benefit
No Access Person may, for direct or indirect personal or a Related Person’s benefit, execute a trade with a broker by using the influence (actual or implied) of OFS Adviser or any Access Person’s influence (actual or implied) with OFS Adviser.
8.No “Front Running”
While the Code contains policies and procedures designed to promote ethical conduct with respect to Personal Securities Trades, irrespective of the application of any particular trading policy or restriction, no Personal Securities Trades may be effected by any Access Person who is aware or should be aware that (i) there is a pending buy or sell order in the Securities of that same issuer for any Advisory Client of OFS Adviser, or (ii) a purchase or sale of the Securities of that same issuer can reasonably be anticipated for an OFS Adviser Advisory Client in the next five (5) calendar days. No Personal Securities Trade may be executed with a view toward making a profit from a change in price of such Security resulting from anticipated transactions by or for OFS Adviser’s Advisory Clients.
D. | REQUIREMENTS OF DISINTERESTED DIRECTORS |
The Recordkeeping, Reporting, and Statement of Restrictions provisions listed above (except those in Section II(C)(3-4) do not apply to any OFS Fund Director who is not an interested person of any OFS Fund within the meaning of Section 2(a)(19) of the Company Act (“Disinterested Directors”) of each of the OFS Funds, except as the following describes. A Disinterested Director need only report a transaction if, at the time of a Personal Securities Trade in a Reportable Security, the Disinterested Director knew, or, in the ordinary course of fulfilling his or her duties as a director, should have known that during the fifteen (15)
day period immediately preceding or after the date of the transaction, their OFS Fund purchased or sold the Security or the Security was Being Considered for Purchase or Sale by their OFS Fundor OFS Adviser.
7 A Rule 10b5-1 plan is a written plan for trading Securities that is designed in accordance with Rule 105-1(c). Any person executing pre-planned transactions pursuant to a Rule 10b5-1 plan that was established in good faith at a time when that person was unaware of material nonpublic information has an affirmative defense against accusations of insider trading, even if actual trades made pursuant to the plan are executed at a time when the individual may be aware of material nonpublic information.)
III. | INSIDE INFORMATION POLICY |
A. | INTRODUCTION |
The prohibitions against insider trading set forth in the federal securities laws play an essential role in maintaining the fairness, health and integrity of our markets. These laws also establish fundamental standards of business conduct that govern our daily activities and help to ensure that Advisory Client’s trust and confidence are not compromised in any way. Consistent with these principles, OFS Adviser forbids any Supervised Person from (i) trading Securities for the Firm, any Advisory Client or any account in which a Supervised Person has a Beneficial Interest, if that Supervised Person is “aware” of material and nonpublic information (“MNPI” or “Inside Information”) concerning an issuer; or (ii) communicating MNPI to others in violation of the law. This conduct is frequently referred to as “insider trading.” This policy applies to all Supervised Persons, and extends to activities within and outside of each Supervised Person’s duties at OFS Adviser or with any OFS Fund.
The term “insider trading” is not specifically defined under the federal securities laws (most guidance in this area can be found under case law and related judicial decisions), but generally is used to refer to improper trading in Securities8 on the basis of MNPI (whether or not the person trading is an insider). A person is generally deemed to trade “on the basis of MNPI if that person is aware of MNPI when making the purchase or sale, regardless of whether the person specifically relied on the information in making an investment decision. It is generally understood that the law prohibits trading by an insider on the basis of MNPI about the Security or issuer. To be held liable under the law, the person trading generally must violate a duty of trust or confidence owed directly, indirectly or derivatively to the issuer of that Security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information (e.g., an employer). The law also prohibits the communication of inside information to others and provides for penalties and punitive damages against the “tipper” even if he or she does not gain personally from the improper trading.
8 OFS Adviser often transacts in syndicated or other loan interests on the basis of information that is not available to other members of the syndicate, or to the public in general; however, for the limited purpose of this policy, “Securities” (as defined in the Exchange Act) do not include such loan interests or other “evidences of indebtedness.” If you are uncertain as to whether a particular investment is a “security” for purposes of this policy, contact the Legal/Compliance Department.
B. | KEY TERMS |
1.What is a “Security”?
The Exchange Act, which covers insider trading, defines “Security” very broadly to include most types of financial instruments,9 except bank debt.10 There may be instances where Supervised Persons receive information about such investments that is not generally known by other institutional investors - even those institutional investors who may be similarly situated (e.g., lenders that are privy to nonpublic information and have access to bank-level information or primary lender meetings). Although trading in “non-security” investments on the basis of nonpublic information is not prohibited by federal securities laws, such trading may be prohibited by fiduciary obligations, other federal or state statutes, or contractual obligations such as confidentiality agreements11. In situations where OFS Adviser has access to MNPI to which other potential investors/counterparties may not have access, Supervised Persons should consult with a Compliance Officer or Senior Management, as appropriate, as to whether a proposed purchase or sale of an investment should be made, and, if made, should include the use of a “Big Boy” letter (see the Firm’s Confidentiality Policy), a confidentiality agreement (see the Firm’s Confidentiality Policy), or, if the investment is a syndicated loan, the execution by OFS Adviser of the standard LSTA form, which includes disclosure concerning the possibility of access to such information. In addition, even if trading in a “non-security” investment is permissible because the above standards are met, Supervised Persons are still prohibited from trading in any Securities issued by the relevant borrower, either for an Advisory Client or themselves, if the information obtained would be material with respect to the Securities transaction. This would also include indirect participation in such a transaction; for example, by participating in an Investment Committee meeting in which a decision regarding such Securities was being considered.
2.Who is an Insider?
The concept of an “insider” is broad. It includes officers, directors and employees of a company. In addition, a person can be a “temporary insider” if he or she enters into a special confidential relationship in the conduct of a company’s affairs and as a result is given access to information solely for the company’s purposes. A temporary insider can include, among others, a company’s attorneys, accountants, consultants, bank lending officers, investment advisers (such as OFS Adviser) and the employees of such organizations. OFS Adviser may become a temporary insider by signing a confidentiality agreement or by accessing material nonpublic information on a private electronic workspace.
9 For purposes of the Inside Information Policy, “Security” means any note, stock, treasury stock, security feature, security-based swap, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a “security”; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.
10 Note that, for most purposes, evidences of indebtedness are treated as “securities” for securities law purposes; insider trading prohibitions are an exception to this general rule.
11 The Compliance Department maintains the Private Company List and Advisory Clients may not transact in these investments unless an exception to the prohibition from trading a security on the Private Company List has been granted by the CCO or his or her designee. Please refer to the Confidentiality Policy for more information..
3.What is Material Information?
Trading on inside information is not a basis for liability unless the information is material. “Material” information generally is defined as information with respect to which there is a substantial likelihood that a reasonable investor would consider it important in making his or her investment decisions, or information that is reasonably certain to have a substantial effect on the price of a company’s Securities.
Among other things, the following types of information are generally regarded as “material”:
• | dividend or earnings announcements |
• | write-downs or write-offs of assets |
• | additions to reserves for bad debts or contingent liabilities |
• | expansion or curtailment of company or major division operations |
• | merger, joint venture announcements |
• | new product/service/marketing announcements |
• | new supplier/manufacturing/production announcements |
• | material charge/impairment announcements |
• | senior management changes |
• | changes in control |
• | material restatement of previously issued financial statements |
• | discovery or research developments |
• | criminal indictments and civil and government investigations, litigations and/or settlements |
• | pending labor disputes |
• | debt service or liquidity problems |
• | bankruptcy or insolvency problems |
• | tender offers, stock repurchase plans, etc. |
• | recapitalizations |
Material information does not have to relate to a company’s business. For example, in Carpenter v. U.S., 18 U.S. 316 (1987), the Supreme Court considered as material certain information about the contents of a forthcoming newspaper column that was expected to affect the market price of a Security. In that case, a Wall Street Journal reporter was found criminally liable for disclosing to others the dates that reports on various companies would appear in the Journal and whether those reports would be favorable or not.
4.What is Nonpublic Information?
Information is nonpublic until it has been effectively communicated to the marketplace. One must be able to point to some fact to show that the information is generally public. For example, information found in a report filed with the SEC, or appearing in Dow Jones, Reuters Economic Services, The Wall Street Journal, Bloomberg or other publications of general circulation would be considered public. Supervised Persons should seek specific guidance from a Compliance Officer in situations where information concerning an issuer or its affiliated entities (e.g., subsidiaries) may not have been made available to the investment community generally but was made available to a group of institutional investors.
5.Contacts with Companies
From time to time, Supervised Persons may meet with members of senior management at publicly-traded companies associated with an investment, or a prospective investment. OFS Adviser may make investment decisions on the basis of the Firm’s conclusions formed through such contacts and analysis of publicly-available information regarding foreign and U.S. companies. Difficult legal issues arise when, during these contacts, a Supervised Person becomes aware of MNPI about those companies. This could happen, for example, if a company’s chief financial officer prematurely discloses quarterly results to a Supervised Person, a broker or a securities analyst, or if an investor relations representative makes a selective disclosure of adverse news to a handful of investors. In such situations, Supervised Persons should immediately contact a Compliance Officer if he or she believes that he or she may have received MNPI about a publicly traded company.
6.Tender Offers
Tender offers raise heightened concerns in the law of insider trading for two reasons. First, tender offer activity often produces gyrations in the price of the target company’s Securities. Trading during this period is more likely to attract regulatory attention (and produces a disproportionate percentage of insider trading cases). Second, the SEC has adopted a rule which expressly forbids trading and “tipping” while in possession of MNPI regarding a tender offer received from the tender offeror, the target company or anyone acting on behalf of either. Supervised Persons should exercise caution any time they become aware of nonpublic information relating to a tender offer.
7.Penalties for Insider Trading
Penalties for trading on or inappropriately communicating MNPI are severe, both for the individuals involved and their employers. A person can be subject to some or all of the penalties below, even if he or she does not personally benefit from the violations. Penalties include:
• | civil injunctions; |
• | disgorgement of profits; |
• | punitive damages (i.e., fines for the person who committed the violation of up to three (3) times the profit gained or loss avoided, irrespective of whether the person actually benefited personally); |
• | felony convictions which include possible jail sentences; and |
• | fines and sanctions against the employer or other controlling person. |
C. | INSIDER TRADING PROCEDURES |
The following procedures have been established to assist Supervised Persons in avoiding insider trading, and to aid OFS Adviser in preventing, detecting and imposing sanctions for insider trading. The following procedures should be read in conjunction with other policies set forth in this Code, and in the Compliance Policies.
1.Identifying MNPI
Before trading in the Securities of a company about which they may have potential MNPI, Supervised Persons should ask themselves the following questions:
• | Is the information material? Is this information that an investor would consider important in making his or her investment decisions (e.g., whether the investor should buy, sell or hold a Security)? Is this information that would substantially affect the market price of the Securities if generally disclosed? |
• | Is the information nonpublic? To whom has this information been provided? Has the information been effectively communicated to the marketplace by being published in Reuters, The Wall Street Journal, Bloomberg or other publications of general circulation? Remember that information that has been communicated to a relatively large group of sophisticated investors does not by itself mean that the information is public (e.g., large group of potential bank debt investors during an invitation only meeting). |
2.Restricting Access to MNPI
Care should be taken so that MNPI is secure. For example, files containing MNPI should be sealed or locked; access to computer files containing MNPI should be restricted. As a general matter, materials containing such information should not be removed from the Firm’s premises and, if they are, appropriate measures should be maintained to protect the materials from loss or disclosure. Among other things, Supervised Persons should:
• | distribute materials containing MNPI only on a need-to-know” basis; |
• | take care so that telephone conversations cannot be overheard when discussing matters involving MNPI (e.g., speaker telephones should generally be used in a way so that outsiders who might be in OFS Advisers’ offices are not inadvertently exposed to this information); |
• | limit access to offices and conference rooms when these rooms contain MNPI; and |
• | not leave materials containing MNPI displayed on the computer viewing screen when they leave their computers unattended. |
3.Review and Dissemination of Certain Investment Related Information
As part of its consideration of certain investments, including in certain types of “non-Securities” (e.g., bank debt instruments), the Firm may enter into confidentiality agreements with third parties (e.g., issuers, sponsors, syndicate members or other lenders) that could have implications for the Firm’s compliance with federal securities laws. Those agreements may sometimes contain so-called “stand-still” provisions, which specifically restrict the Firm’s activity in Securities of identified issuers, but more typically simply raise the possibility that nonpublic information may be disclosed to the recipient and seek the receiving party’s acknowledgment of that understanding and agreement not to disclose any MNPI transmitted. The procedures for executing confidentiality agreements are set forth in the Firm’s Confidentiality Policy. Many potential counterparties or their agents specifically require that potential investors sign a confidentiality agreement before they will be provided access to investment-related information. Because of the importance of our policies regarding access to and use of confidential information, confidentiality agreements may only be reviewed, negotiated and executed as set forth in the Firm’s Confidentiality Policy.
4.Determination of Materiality
Given the unique asset classes in which OFS Adviser typically invests, Supervised Persons may receive detailed information about a Security that may not be otherwise readily available to the investing public. The issue of “materiality” and the ultimate determination as to whether the information provided rises to the level of MNPI should not be made independently by a Supervised Person. Rather, the individual
should contact a Compliance Officer so that an analysis may be performed and an informed determination may be made. Unless otherwise determined by a Compliance Officer, in consultation with investment staff and outside legal counsel, as appropriate, information received about a publicly-traded Security that is not readily available to the investing public shall be deemed to be and treated as material.
5.Policies and Procedures Relating to Paid Research Consultants and Expert Network Firms Regarding Securities
While it is permissible to utilize consultants who may provide information relating to Securities as part of the research process, OFS Adviser must be particularly sensitive about the information that these consultants provide. Accordingly, OFS Adviser has adopted the following procedures with which all Supervised Persons must comply in connection with their contact and interaction with paid consultants who provide information relating to Securities or their issuers:
• | The Supervised Person must obtain the prior written approval of a Compliance Officer before engaging a paid consultant if; (1) substantive information related to a Security or its issuer will be discussed as part of the engagement; and/or (2) the consultant is either employed with an issuer of Securities at the time of the engagement or was employed with such an issuer within six months of the engagement. The Compliance Department will maintain a log of all such engagements. |
• | Prior to the commencement of a phone call or meeting with a paid consultant where (i) it is anticipated that substantive information related to a Security or its issuer will be discussed, and/or (ii) the consultant is either employed with an issuer of Securities at the time of the call or was employed with such an issuer within six months of the call, the Supervised Person must inform such consultant that: |
(i) | the Firm may invest in the public and non-public Securities and private debt markets, |
(ii) | the Firm does not wish to receive MNPI, |
(iii) | the purpose of speaking with such consultant is to obtain his/her independent insight as it relates to a particular industry, sector or company, and |
(iv) | such consultant should not share any MNPI or confidential information that he/she may have a duty to keep confidential or that he/she otherwise should not disclose. |
• | The Supervised Person should also confirm with such consultant that he/she will not be violating any agreement, duty or obligation such consultant may have with any employer or other institution. |
• | Supervised Persons must keep and maintain logs of all call or conversations with such consultants, which should include the date/time of the conversation, the name of the consultant and a summary of the information discussed on the call. |
• | In the event that a Supervised Person learns or has reason to suspect that he or she has been provided with confidential or MNPI relating to a Security from a consultant, the Supervised Person must immediately contact a Compliance Officer prior to either communicating such |
confidential or material nonpublic information to anyone else, or making any investment or trading decisions.
Agreements with paid research consultants and expert network firms who provide information relating to Securities must be pre-approved by a Compliance Officer and may be signed only by (i) Bilal Rashid on behalf of Senior Management in the case of Advisory Clients, after consultation with, and approval by, a Compliance Officer. Depending on the facts and circumstances, the CCO may impose other conditions on the engagement of consultants or on the conduct of the engagement, including, but not limited to, the participation of a Compliance Officer on any phone calls or in any correspondence between the consultant and the Firm.
IV. | GIFTS, ENTERTAINMENT AND POLITICAL ACTIVITIES |
A. | INTRODUCTION |
OFS Adviser attempts to minimize any activity that might give rise to a question as to whether the Firm’s objectivity as a fiduciary has been compromised.
B. | GIFTS AND ENTERTAINMENT POLICY |
One possible area of fiduciary concern relates to providing or receiving meals, gifts or entertainment from third parties with which OFS Adviser or its Advisory Clients, including each OFS Fund, joint business partners, service providers and current and prospective clients (collectively “Outside Parties” and each an “Outside Party”), do business.
Supervised Persons are prohibited from soliciting anything of value from Outside Parties. Further, no Supervised Person may give or receive any gift, meal or entertainment that could or is intended to influence decision-making or to make a person beholden, in any way, to another person or company that seeks to do or is currently doing business with the Firm or its Advisory Clients. Lavish or luxurious gifts and entertainment, and gifts and entertainment that are received or provided on a frequent basis, are generally deemed to meet this standard and, unless a Compliance Officer indicates otherwise, are prohibited. In addition, depending upon a Supervised Person’s responsibilities, specific regulatory requirements may dictate the types and extent of gifts and entertainment that Supervised Persons may give or receive. The Firm is committed to competing solely on the merit of its products and services, and Supervised Persons should avoid any actions that create a perception that favorable treatment of Outside Parties by the Firm was sought, received or given in exchange for gifts or entertainment.
1.Business Meals
Generally, Supervised Persons may share meals with Outside Parties in the ordinary course of business. Meals received by Supervised Persons from Outside Parties should not exceed $250 per person per meal. Meals provided by Supervised Persons to Outside Parties are generally permissible and should also not exceed $250 per person per meal, subject to certain pre-approval requirements applicable to providing meals to Public Officials. A “Public Official” means any person who is employed full- or part-time by a government, or by regional subdivisions of governments, including states, provinces, districts, counties, cities, towns and villages or by independent agencies, state-owned businesses, state-controlled businesses or public academic institutions. This would include, for example, employees of sovereign wealth funds, government-sponsored pension plans (i.e. pension plans for the benefit of government employees), heads of state, lower level employees of state-controlled businesses and government-sponsored university endowments. “Public Official” also includes political party officials and candidates for political office.
2.Providing Business Gifts
Any Supervised Person who offers a gift to an Outside Party must be sure that it cannot reasonably be interpreted as an attempt to gain an unfair business advantage or otherwise reflect negatively upon the Firm. In addition, a Supervised Person may never use personal funds or resources to do something that cannot be done with Firm resources. A gift may include any services or merchandise of any kind or discounts on
merchandise or services and other items of value. Supervised Persons are prohibited from giving gifts of cash, cash equivalents (such as gift cards and gift certificates) and securities to Outside Parties. This policy does not prohibit the provision of occasional or nominal non-cash gift items, such as holiday gifts, to Outside Parties so long as the value of the gift(s) provided by a Supervised Person to any one recipient over a calendar year does not exceed $250. Once the aggregate amount proposed to be provided by a Supervised Person to any one recipient during one calendar year exceeds $250, that Supervised Person must obtain pre-approval from a Compliance Officer. Such request should be submitted via the Firm’s automated compliance system. Further, anything of value (e.g., meals, beverages, gifts and entertainment) to be provided to Public Officials requires pre-approval from a Compliance Officer. Such requests should be submitted via the Firm’s automated compliance system.
The Compliance Department shall periodically review gifts provided for compliance with this Code as part of quarterly expense reimbursement review process.
If you are unsure of OFS Adviser’s policy with respect to providing gifts in any circumstance, you should consult with a Compliance Officer.
3.Receiving Gifts
No Supervised Person should obtain any material personal benefits or favors because of his or her position with the Firm. Each Supervised Person’s decisions on behalf of the Firm must be free from undue influence. Soliciting gifts from Outside Parties is strictly prohibited. A gift may include any services or merchandise of any kind or discounts on merchandise or services and other items of value. Supervised Persons are prohibited from receiving gifts of cash, cash equivalents (such as gift cards and gift certificates) and securities from Outside Parties. This policy does not prohibit the receipt of occasional or nominal non-cash gift items, such as holiday gifts, so long as the value of the gift(s) received by a Supervised Person from any one source over a calendar year does not exceed $250. Any gift that will cause the total received by that Supervised Person from a single source to exceed $250 for the calendar year, and any additional gift thereafter received during the calendar year, requires pre-approval by a Compliance Officer. Such requests should be submitted via the Firm’s automated compliance system.
Gifts in any amount received by a Supervised Person from an Outside Party, except for gifts of nominal value (such as logo items, including pens, notepads, coffee mugs and baseball caps) must be disclosed in the Firm’s automated compliance system at the time of receipt.
4.Entertainment
The gift policies above are not intended to prohibit the acceptance or provision of non-extravagant entertainment that facilitates the handling of the Firm’s business. Thus, normal and customary entertainment (e.g., concerts, exhibitions or games featuring local sports teams, where the person providing the entertainment is present), that is not frequent or “lavish” and does not influence the selection of vendors or other Outside Parties, is acceptable. Note, entertainment provided by or to a Supervised Person where the person providing the entertainment does not attend should be treated as a “gift.” Also, if you bring a guest to an entertainment event hosted by an Outside Party, your guest’s ticket is considered as a “gift” for purposes of this policy. Business meals are not considered entertainment for purposes of this Policy (see Section IV.B. 1. “Business Meals” above for additional information).
No Supervised Person may provide or accept extravagant or excessive entertainment to or from an Outside Party. Any entertainment that a Supervised Person reasonably expects to exceed $1,000 in market value per person must be pre-approved by a Compliance Officer. Such requests should be
submitted via the Firm’s automated compliance system. Further, entertainment of any value to be provided to Public Officials requires pre-approval from a Compliance Officer. Such requests should be submitted via the Firm’s automated compliance system.
Entertainment in any amount received by a Supervised Person must be reported via the Firm’s automated compliance system within a reasonable amount of time of participating in such entertainment and no later than 30 calendar days of participation in such event. Entertainment provided to Outside Parties is not required to be reported in the Firm’s automated compliance system, as OFS Adviser shall track all entertainment expenses in the Firm’s corporate accounting records. The Compliance Department periodically reviews entertainment provided by Supervised Persons for compliance with this Code as part of its quarterly expense reimbursement review process.
5. | Travel and Lodging |
You may occasionally be invited to conferences or other events by Outside Parties, which include an offer of travel and/or lodging. In the event that you receive such offers, you must obtain approval from the Compliance Department prior to accepting the travel and/or lodging. Requests to accept travel or lodging that appear to be exorbitant in price and/or luxurious in nature will generally be denied. All travel and lodging received from Outside Parties must be disclosed. Requests and disclosures should be submitted via the Firm’s automated compliance system.
6. | Providing Meals, Gifts and Entertainment to Public Officials and Union Employees |
Specific requirements and restrictions apply regarding the offering of meals, gifts and entertainment to Public Officials and can vary depending on the governmental branch/body, state or other jurisdiction. For example, many government pension plans place strict limits on the value of any meal provided by a service provider, such as the Firm, to the pension plans’ employees. Certain jurisdictions even ban service providers from providing anything of value to their public employees, including promotional items of nominal value. Penalties for violating these gift laws can range from monetary fines to disqualification from RFP participation and rescindment of existing investment mandates. Private unions are subject to Department of Labor gift rules and regulations and service providers, such as the Firm, must comply with prescribed limits and reporting requirements when providing gifts and meals to union employees. Accordingly, it is against Firm policy to offer or give meals, gifts, entertainment or anything of value to Public Officials or union officials or employees unless the regulations applicable to that individual permit acceptance of such items. Further, Supervised Persons are prohibited from offering or giving anything of value, including nominal items or snacks, to Public Officials or union officials or employees without first obtaining the approval of a Compliance Officer. Such requests for prior approval should be submitted via the Firm’s automated compliance system.
If you are unsure of applicable laws, rules and regulations with respect to providing gifts, meals and entertainment to Public Officials and union employees or officials in any circumstance, you should consult with a Compliance Officer.
7. | Receipt of Meals, Gifts or Entertainment by Traders from Brokers/Agent Bank Employees |
Traders or other investment professionals with the ability to influence the selection of brokers/agent banks with respect to trading in Securities and broadly syndicated loans are prohibited from receiving meals, gifts or entertainment in any value from an employee of such broker/agent bank without preapproval from
a Compliance Officer. Such request for pre-approval should be submitted via the Firm’s automated compliance system.
C. | POLITICAL ACTIVITY POLICY |
1.Introduction
The SEC, along with certain states, municipalities and public pension plans, have adopted regulations limiting or completely disqualifying investment advisers from providing services to, or accepting placements from, a government entity if certain political contributions12 are made or solicited13 by the Firm, certain of its Supervised Persons, or, in some instances, a Supervised Person’s Related Persons. Under these “pay to play” regulations, a single prohibited political contribution to a candidate or officeholder, political party, political action committee or other political organization at practically every level of government (including local, state and federal) may preclude the Firm from providing services to, or accepting placements from, the applicable government entity and may compel the firm to repay compensation received by the Firm in connection with such services or placements.
OFS Adviser and its Affiliates (other than natural persons, as provided below) generally do not make or solicit contributions in any amount to any federal, state, county or local political campaign, candidate or officeholder, or any political organization (e.g., political party committee and political action committee (“PAC”)). As such, Supervised Persons are prohibited from making or soliciting contributions in the name of or on behalf of OFS Advisers and/or its Affiliates unless otherwise approved by the Compliance Department and a member of Senior Management.
No Supervised Person of the Firm or his/her Related Persons may engage in any Political Activity for any federal, state, county, or local political campaign, candidate or officeholder, or any political organizations (e.g., political party committee, political action committee), without the prior written approval of a Compliance Officer. Such requests should be submitted via the Firm’s automated compliance system. “Political Activity” is defined as monetary or in-kind campaign contributions to, or for the benefit of, any government official, candidate running for office, political party or legislative leadership, politically active non-profit, ballot measure committee or PAC as well as the solicitation and coordination of campaign contributions. Volunteering for a campaign that does not include solicitation or coordination of campaign contributions does not require pre-approval.
12 Contributions include cash, checks, gifts, subscriptions, loans, advances, deposits of money, “in kind” contributions (e.g., the provision of free professional services) or anything else of value provided for the purpose of influencing an election for a federal, state or local office, including any payments for debts incurred in such an election.
13 Solicitation of contributions encompasses any fundraising activity on behalf of a candidate, campaign or political organization, including direct solicitation, hosting of events and/or aggregating, coordinating or “bundling” the contributions of others.
A Supervised Person must submit a Political Activity pre-approval request on behalf of the Supervised Person (or his or her Related Person) through the Firm’s automated compliance system prior to engaging in Political Activity, and such submission must include all pertinent information related to the proposed activity, including, but not limited to, the individual wishing to contribute, amount of the contribution, the name of the intended recipient, the nature of the recipient’s candidacy, whether the proposed recipient holds an existing political office (whether local, state or federal), and whether the Supervised Person (or his or her Related Person, where applicable) is legally entitled to vote for the proposed recipient. Because of the serious nature of the sanctions applicable to a pay to play violation, requests to engage in Political Activity for candidates seeking election to state and local offices will generally be limited and/or declined, depending on whether a Supervised Person is legally entitled to vote for the candidate. As such, requests to donate to state or local candidates and officials may be approved up to $350, where the Supervised Person is legally entitled to vote for the candidate, and is limited to $150 or less, where a Supervised Person is not legally entitled to vote for the candidate or where the relevant jurisdiction imposes more restrictive limits.
The Firm expects that every Supervised Person will explain the importance of compliance with this policy to his/her Related Persons, and ensure their clear understanding of the obligation to follow these requirements. Moreover, the applicable laws in this area are complex and a trap for the unwary -- no Supervised Person should attempt to decide for himself or herself whether a Political Activity is prohibited or permissible. Supervised Persons are responsible for complying with and tracking their own Political Activity limits.
2.Indirect Violations
The pay to play laws also prohibit actions taken indirectly that the Firm or its Supervised Persons could not take directly without violating the law. For example, it is improper and unlawful to provide funds to a third party (such as a consultant or attorney) with the understanding that the third party will use such funds to make an otherwise prohibited contribution. Such indirect violations may result in a prohibition on the Firm from receiving compensation and result in other sanctions, including possible criminal penalties. If any Supervised Person learns of facts and circumstances suggesting a possible indirect violation, that Supervised Person must report such facts and circumstances to a Compliance Officer immediately.
3.Periodic Disclosure
In order to ensure compliance with this policy, every Supervised Person must submit via the Firm’s automated compliance system, a disclosure and certification setting forth all Political Activity by the Supervised Person and his/her Related Persons for the previous two (2) years or confirming that no such contributions have been made, prior to and at commencement of employment. Supervised Persons are also required to disclose and certify all Political Activity in which they or their Related Persons have engaged on a quarterly basis.
V. | OUTSIDE AFFILIATIONS POLICY |
A. | OUTSIDE BUSINESS ACTIVITIES |
From time to time, Supervised Persons may be asked and/or desire to own, work for or serve as a general partner, managing member, principal, proprietor, consultant, agent, representative, or employees of an outside organization, all of which are considered “Outside Business Activities”. These organizations may include public or private corporations, limited and general partnerships, businesses, family trusts, endowments and foundations.
Outside Business Activities may, however, create potential conflicts of interest and/or provide access to MNPI. So that the Compliance Department can address these potential issues, Supervised Persons must obtain prior approval from their supervisor and a Compliance Officer to engage in Outside Business Activities. Approval should be requested through the Firm’s automated compliance system.
Prior approval is generally not required to assume positions with charitable and other non-profit organizations or civic and trade associations. However, if your responsibilities include the provision of investment advice, such as participation on the investment committee of a non-profit organization, or the organization is a client or business partner of the Firm or its Affiliates, you must obtain pre-approval from a Compliance Officer.
B. | DIRECTOR AND OFFICER POSITIONS |
In other instances, Supervised Persons may be asked or desire to serve as a director, trustee or officer for organizations unaffiliated with the Firm and its Affiliates (“Outside Director and Officer Positions”) or for organizations that are affiliated with the Firm, such as a Portfolio Company (“Affiliated Director and Officer Positions”).
As a prospective board member, trustee or officer, it is critical that you coordinate with the Compliance Department to ensure that potential conflicts of interest are addressed and special measures are taken to handle and maintain the confidentiality of any information that you may obtain in your new position. As such, in the event that you wish to assume an Outside Director and Officer Position, you must obtain prior approval from your supervisor and a Compliance Officer. However, if you are assuming an Affiliated Director and Officer Position, you must only disclose your new position to the Compliance Department and in a timely manner. Such disclosures and requests for pre-approval should be made through the Firm’s automated compliance system.
You are prohibited from engaging in any outside activity previously described, without the prior approval or disclosure required for such activity. Outside Director and Officer Positions will be approved only if any associated conflicts of interest and insider trading risks, actual or apparent, can be satisfactorily mitigated or resolved. Please note, however, you are not required to seek pre-approval or provide disclosure to serve as a board member or officer of a personal residential organization, such as a homeowner’s association or coop board, or an entity formed for personal estate planning purposes.
C. | EMPLOYEE RELATIONSHIPS |
The Firm needs to be aware of relationships maintained by Supervised Persons with third parties that may create the potential for conflicts of interest. The Firm uses this information to assess the need to prohibit certain Supervised Persons from handling matters where such a conflict exists or institute mitigating controls surrounding the levels of business activity or contract negotiations where a relationship posing a conflict has been identified. This may include situations where a Supervised Person’s Related Person or Family Member is: 1) a director, an owner of more than 5% of or a senior management executive of a public company, 2) employed or engaged by a company with which the Firm is conducting or may conduct business, and such Related Person or Family Member is in a position to make decisions with respect to such business or is directly involved with the relationship with the Firm (e.g. a law firm, real estate broker or general contractor), or 3) employed with or serving in an office of a state or local government entity (e.g., city retirement system, state office, public university), in which the Related Person or Family Member has the authority, directly or indirectly, to affect the entity’s current or prospective relationship with the Firm. Such relationships should be disclosed using the Firm’s automated compliance system.
For purposes of this Code, “Family Member” means the parents, children, brothers, sisters, aunts, uncles and in-laws of the Supervised Person regardless of residence, financial dependence or investment control.
VI.ANTI-CORRUPTION POLICY
The purpose of the OFS Adviser’s Anti-Corruption Policy is to ensure compliance by the Firm and its employees with applicable anti-bribery laws. As such, the Policy prohibits OFS Adviser employees from offering, promising, paying or providing, or authorizing the promising, paying or providing (in each case, directly or indirectly, including through third parties) of any amount of money or anything of value to any Public Official or Private Sector Counterparty (defined below), including a person actually known to be an immediate family member of such parties, in order to improperly influence or reward any action or decision by such person for the Firm’s benefit.
Neither funds from the Firm nor funds from any other source may be used to make any such payment or gift on behalf of or for the Firm’s benefit.
(a) | Requirements for Interaction with Public Officials |
The U.S. Foreign Corrupt Practices Act (also referred to as the “FCPA”) is a U.S. federal law that generally prohibits the bribery of foreign officials (also referred to as “Public Officials”), directly or indirectly, by any individual, business entity or employee of any such entity for the purpose of obtaining or retaining business and/or gaining an unfair advantage.
“Public Official”, for purposes of this Policy, includes any person who is employed full- or part-time by a government, or by regional subdivisions of governments, including states, provinces, districts, counties, cities, towns and villages or by independent agencies, state-owned businesses, state-controlled businesses or public academic institutions. This would include, for example, employees of sovereign wealth funds, government-sponsored pension plans (i.e. pension plans for the benefit of government employees), heads of state, lower level employees of state-controlled businesses and government-sponsored university endowments. “Public Official” also includes political party officials and candidates for political office. For example, a campaign contribution is the equivalent of a payment to a Public Official under the FCPA. In certain cases, providing a payment or thing of value to a person actually known to be an immediate family member of a Public Official or a charity associated with a Public Official may be the equivalent of providing a thing of value to the Public Official directly.
Under the FCPA, the employees of public international organizations, such as the African and Asian Development Banks, the European Union, the International Monetary Fund, the United Nations and the Organization of American States, are considered Public Officials.
In April 2010, the United Kingdom, passed its own anti-bribery law, the Bribery Act 2010 (the “Bribery Act”). However, the law went further than the FCPA, prohibiting not only bribery of “foreign public officials” but also the bribery of private parties. Further, the Bribery Act, unlike the FCPA, prohibits “passive” bribery or the acceptance of bribes, in addition to “active” bribery, or giving a bribe.
The OFS Adviser Anti-Corruption Policy is applicable to all OFS Adviser employees, regardless of their country of citizenship or residency. Although the FCPA and the Bribery Act are the principal anti-bribery statutes applicable to OFS Adviser and its employees worldwide, OFS Adviser and its employees are also subject to the applicable anti-bribery laws of all jurisdictions in which they do business and any jurisdictions involved in OFS Adviser’s cross-border transactions. OFS Adviser employees who are not U.S.
or U.K. citizens or residents may also be subject to anti- bribery laws of their countries of citizenship or residency, as applicable.
Prior to transacting business (including merger and acquisition transactions and the retention of certain third parties) outside the U.S. or U.K., you should consult with the CCO or and Legal Department or local counsel to obtain the applicable policies, requirements and procedures pertinent to complying with the applicable anti-bribery laws of such jurisdictions.
(b) | Requirements for Interaction with Private Sector Counterparty Representatives |
OFS employees should be sensitive to anti-corruption issues in their dealings directly or indirectly, with Private Sector Counterparty Representatives. A Private Sector Counterparty Representative is an owner, employee or representative of a private entity, such as a partnership or corporation, with which OFS Adviser is conducting or seeking to conduct business. Individuals affiliated with current and prospective clients, service providers and other third parties in such a capacity are all “Private Sector Counterparty Representatives”.
Bribery concerns may arise in connection with your day-to-day interactions with Private Sector Counterparty Representatives, regarding, for example, the offering of investment opportunities or the solicitation of OFS Adviser business by service providers. It is important to be mindful of the anti-bribery laws and to avoid any action that may give the appearance of bribery in your dealings with such individuals. While you may engage in the exchange of gifts, meals and entertainment with Private Sector Counterparty Representatives in the normal and routine course of business, it is important that you adhere to this Policy and to the Gifts, Meals and Entertainment Policy of this Code to avoid running afoul of the anti-corruption laws.
(c) | Requirements for Retention of Certain Third Parties |
Payments by OFS Adviser to Third Parties raise special concerns under the FCPA, Bribery Act and any other applicable anti-bribery laws. A “Third Party” is defined as any consultant, investor, joint venture partner, local partner, broker, agent or other third party retained or to be retained by OFS Adviser for purposes of dealing with a Public Official or a Private Sector Counterparty Representative on behalf of OFS Adviser or where the contemplated services are likely to involve business-related interactions with a Public Official or Private Sector Counterparty Representative on behalf of OFS Adviser. Because of the risk that a Third Party may seek to secure business for OFS Adviser or its Advisory Clients through violations of the FCPA or Bribery Act and that OFS Adviser or its Advisory Client’s Portfolio Companies may be subject to liability under the FCPA or Bribery Act as a result, any agreement with a Third Party that is engaged to do business with OFS Adviser is subject to specific due diligence and contractual requirements to assure compliance with the Firm’s Anti-Corruption Policy.
(d) | Pre-Approval Reporting, Due Diligence and Contractual Requirements |
Unless otherwise authorized by the CCO or a Compliance Officer, you are required to adhere to the following policies and procedures, designed to facilitate your compliance with applicable anti-bribery laws.
You must obtain pre-approval for the following types of expenses, donations and contributions:
• | gifts, meals, entertainment, travel or lodging provided to a Public Official or a person actually known to be an immediate family member or guest of a Public Official; |
• | charitable donations made on behalf of OFS Adviser at the request of a Private Sector Counterparty Representative; |
• | charitable donations made in an individual capacity or on behalf of OFS Adviser at the request of or for the benefit of a Public Official; and |
• | political contributions made to any Public Official on behalf of OFS Adviser or at the request of an Outside Party. |
Pre-approval requests should be submitted via the Firm’s automated compliance system.
(e) Reporting Obligations
On a quarterly basis, you must certify to all previously approved and/or disclosed political contributions, charitable donations, items to Public Officials and all gifts and entertainment received, as specified above. Certification must be made via the Firm’s automated compliance system.
VII. CIM COMPUTER ACCEPTABLE USE POLICY
The CIM Computer Acceptable Use Policy is hereby incorporated into this Code by reference. Supervised Persons are required to fully comply with all policies and procedures and certification and training requirements associated with the CIM Computer Acceptable Use Policy, and any instance of non-compliance will likely constitute a violation of this Code. The CIM Computer Acceptable Use Policy is available to all Supervised Persons on the Firm’s public network drive and Sharepoint.
VIII. PERSONAL USE OF FIRM RESOURCES AND RELATIONSHIP POLICY
OFS email and other OFS-sponsored communication mediums (e.g., Skype for Business) (collectively, “OFS communication platforms”) should generally only be used for conducting OFS business. While occasional use of OFS email for personal communications is permissible, Supervised Persons are prohibited from using OFS communication platforms to conduct personal outside business activities (including those involving political, civic or charitable solicitations), which may imply OFS’s sponsorship or endorsement of such activities. Use of OFS stationary for personal correspondence or other personal purposes is strictly prohibited. All communications made via OFS communication platforms are the property of OFS and use of such platforms must comply with the OFS Computer Acceptable Use Policy.
Absent an exemption granted by Human Resources or Compliance, Supervised Persons are prohibited from assigning tasks associated with personal business activities to staff or soliciting assistance for such personal endeavors from staff in a junior role to the requestor.
Further, Supervised Persons are prohibited from leveraging relationships with OFS clients, vendors and other business contacts (“OFS Contacts”) gained over the course of their employment for personal purposes. Personal purposes include, but are not limited to, charitable and political activities, including solicitation of donations, and the conduct of personal business activities.
OFS reserves the right to search and monitor the computer files of and OFS communication platforms used by any Supervised Persons, without advance notice, for purposes of monitoring compliance with this policy.
ATTACHMENTS
Whistleblower Information.....................................................................................Attachment A
The listed attachment is also available on OFS Adviser’s public network drive and Sharepoint site, or from the Compliance Department.
ATTACHMENT A
Whistleblower Hotline Information
As part of our Whistleblower Policy, we have established an anonymous hotline where you will be able to report any suspected violation(s) of our various codes of conduct, any activity that may adversely affect the Firm’s business or reputation, or any other inappropriate conduct of which you may become aware. Although we encourage you to report any concerns or problems you may have to your supervisor, there may be times where you may not feel comfortable voicing these concerns or problems to them. Due to this, we have set up an anonymous hotline with Report It Systems. Through Report It, you can report any situations or concerns without having any adverse ramifications for you. If you desire or need to report a violation or misconduct, you can do so by either calling the Report It hotline or by logging into their website. The OFS Report It username and password information is listed below.
Username: OFS Management
Password: OFS Management
1. Toll free hotline number: 1-877-778-5463 (1 -877-RPT-LINE)
2. Website address: www.reportit.net
a. Click on the Report It Online link
b. Click on the Report It Now button
c. Type the Username/Password under the “Create Report” column
d. Click on the Report It Now button
You will be able to anonymously file a wide variety of reports from questionable accounting or auditing matters to harassment or hostile work environment through either the website or the toll free hotline number. Any report that you submit will be handled anonymously by Report It and your name will not be provided by Report It to any OFS contact. We hope that by implementing this hotline service, you will be able to keep our organization free from fraudulent and unethical accounting/auditing activity while achieving our goal to maintain and conduct our business at the utmost level of professional standards and best practices.
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 15th day of March 2019.
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 15th day of March 2019.
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, 2018 (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 15, 2019 | |
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, 2018 (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 15, 2019 | |