OFS Capital(OFS) - 2024 Q4 - Annual Report

Investment Strategy - The company targets U.S. middle-market companies with annual revenues between $10 million and$1 billion, representing approximately 200,000 potential companies[32]. - The investment strategy focuses on senior secured loans, including first lien, second lien, and unitranche loans, as well as subordinated loans[38]. - The company aims to generate strong risk-adjusted net returns by assembling a diversified portfolio across various industries[38]. - The company focuses on investments in middle-market companies in the U.S., targeting individual investments generally ranging from $3.0 million to$25.0 million[65]. - The loan portfolio is expected to continue comprising a significant portion of Senior Secured First Lien Loans, which provide security interests in the assets of portfolio companies[66]. - Unitranche loans represent a significant growth opportunity, combining senior and subordinated debt into one loan, typically structured as senior secured loans[67]. - The company anticipates that Senior Secured Second Lien Loans will continue to be part of its investment strategy, with no contractual loan amortization in the initial years[68]. - Broadly Syndicated Loans are utilized for leveraged buyouts, mergers, acquisitions, and refinancings, with the company relying on agents for monitoring compliance and payment collection[69]. - Subordinated Loans are typically unsecured and provide high fixed interest rates, but carry a greater risk of loss compared to secured loans[70]. - The company invests in Structured Finance Securities, including mezzanine and subordinated note securities of CLOs, which are leveraged 9 to 13 times[74]. - The investment strategy includes tailoring terms to protect rights and manage risks while incentivizing portfolio companies to improve operating results[76]. - The company expects to hold most middle-market debt investments to maturity, but may sell some earlier based on relative value decisions and liquidity needs[77]. Risk Management - The company employs a rigorous credit analysis and approval process to minimize credit losses through effective underwriting and comprehensive due diligence[29]. - The company utilizes a disciplined investment process that includes ongoing risk assessments and assigns credit ratings to debt investments[46][47]. - The company has access to a proprietary database of borrowers developed over 25 years, aiding in identifying investment opportunities[39]. - The company anticipates that the unique challenges of lending to middle-market companies create high barriers to entry for new lenders[34]. - The investment committees are responsible for reviewing and evaluating potential investments, ensuring adherence to the company's core investment philosophy[61]. - The company monitors the creditworthiness of counterparties involved in repurchase agreement transactions[114]. - The classification of debt investments by risk category showed that 70.5% were rated as average risk, while 25.4% were under special mention[489]. - Non-accrual loans totaled $39.1 million in amortized cost, with a fair value of$20.8 million as of December 31, 2024[490]. Financial Performance - For the year ended December 31, 2024, total investment income decreased by $8,979,000 to$47,964,000 compared to $56,943,000 in 2023[499]. - Net investment income for the year ended December 31, 2024 was$16,712,000, down from $20,160,000 in 2023, reflecting a decrease of 22.1$11,730,000, a significant recovery from a loss of $20,412,000 in 2023[516]. - Total expenses for the year ended December 31, 2024 decreased to$31,252,000 from $36,783,000 in 2023, a reduction of 15.1$2,834,000 to $16,648,000, primarily due to a reduction in average outstanding debt balances[508]. - The company recognized total PIK income of$2.7 million for the year ended December 31, 2024, representing 5.7% of total investment income[502]. - The average investment portfolio at fair value decreased from $474.5 million in 2023 to$404.7 million in 2024[509]. - Net unrealized appreciation for the year ended December 31, 2024 was $28.9 million, primarily related to common equity investments[518]. - The company fully repaid outstanding SBA debentures totaling$31.9 million during the year ended December 31, 2024[508]. - For the year ended December 31, 2023, the company reported net losses of $20.4 million, including net realized losses of$11.4 million and net unrealized depreciation of $9.0 million[520]. - The net loss of$20.4 million was primarily due to net unrealized depreciation of $14.5 million in the common equity of Pfanstiehl Holdings, Inc.[521]. - The company recognized net realized losses of$11.4 million, mainly from the write-off of a non-accrual loan and equity investment in Eblens Holdings, Inc.[522]. - For the year ended December 31, 2022, the company experienced net losses of $25.8 million, primarily due to unrealized depreciation of$23.0 million on debt investments and Structured Finance Securities[523]. Management Fees and Incentives - OFS Advisor's base management fee is set at an annual rate of 1.75%, calculated based on the average value of total assets, excluding cash and cash equivalents[79]. - For the years ended December 31, 2024, 2023, and 2022, the base management fee was reduced to 0.25% per quarter (1.00% annualized) for OFSCC-FS Assets, resulting in reductions of $1.1 million,$1.2 million, and $1.4 million respectively[80]. - The incentive fee consists of two parts: the Income Incentive Fee, based on pre-incentive fee net investment income, and the Capital Gains Fee, calculated at 20$5.993 million, while the Income Incentive Fee was $4.178 million[89]. - The Capital Gains Fee for the year ended December 31, 2022, was reversed, resulting in a reduction of$1.9 million due to decreased net unrealized appreciation[89]. - The structure of the incentive fee allows for the possibility of paying an incentive fee in a quarter where a loss is incurred, provided pre-incentive fee net investment income exceeds the hurdle rate[82]. - The cumulative aggregate realized capital gains and losses are calculated based on the net sales price of investments when sold, impacting the Capital Gains Fee calculation[86]. Regulatory Compliance - The company is regulated as a Business Development Company (BDC) under the 1940 Act, which imposes restrictions on transactions with affiliates and requires a majority of independent directors[104]. - The company has modified its asset coverage requirements, reducing the minimum required asset coverage ratio from 200% to 150% effective May 3, 2019[117]. - The company is subject to periodic examination by the SEC for compliance with the Exchange Act and the 1940 Act[125]. - The company has adopted a code of ethics to establish procedures for personal investments and restrict certain personal securities transactions[129]. - The company has received an existing Order from the SEC allowing greater flexibility to enter into co-investment transactions with certain Affiliated Funds[122]. - The company must meet certain source-of-income and asset diversification requirements to maintain its qualification as a RIC under Subchapter M of the Code[139]. - The company is required to diversify its holdings such that at least 50% of its assets consist of cash and government securities, and no more than 25% is invested in the securities of any one issuer[144]. - Failure to qualify as a RIC would subject the company to corporate-level U.S. federal income tax on all ICTI and Net Capital Gains[149]. - The company may be required to recognize income in excess of distributions from PFICs, which will be subject to the Annual Distribution Requirement[147]. - The company is authorized to borrow funds and sell assets to satisfy distribution requirements, but must meet certain asset coverage tests[146]. - The company may face conflicts of interest when investing alongside affiliated accounts, particularly in distressed situations[153]. Portfolio Composition - As of December 31, 2024, total debt and equity investments amounted to $332.8 million, with a fair value of$274.6 million, compared to $341.2 million and$306.4 million respectively as of December 31, 2023[477]. - The portfolio consisted of 100% first lien and second lien loans based on fair value, with first lien debt investments valued at $189.9 million and second lien debt investments at$34.3 million as of December 31, 2024[478]. - The three largest industries by fair value in the investment portfolio were Manufacturing (36.7%), Health Care and Social Assistance (20.1%), and Administrative and Support and Waste Management (6.5%), totaling approximately 63.3% of the portfolio[479]. - The ten largest investments by issuer accounted for 52.8% of the total portfolio at fair value, with Pfanstiehl Holdings, Inc. being the largest equity investment at a fair value of $89.3 million[480]. - As of December 31, 2024, the company had no Structured Finance Securities that had been optionally redeemed, and sold Structured Finance Securities for net proceeds of$20.1 million during the year[483]. - Total investment purchases and originations for the year ended December 31, 2024, were $93.4 million, significantly up from$41.7 million in 2023[483]. - The company recognized a realized loss of $3.5 million from the write-off of preferred and common equity investments in Master Cutlery, LLC during the year ended December 31, 2024[484]. - As of December 31, 2023, total debt investments on non-accrual status amounted to$34,568,000, with a fair value of $12,139,000[491]. - For the three months ended December 31, 2024, total investment income was$11.6 million, an increase from $10.9 million in the previous quarter[530]. - The company reported net gains of$21.4 million for the three months ended December 31, 2024, primarily due to net unrealized appreciation of $15.6 million on the common equity investment in Pfanstiehl Holdings, Inc.[533]. - As of December 31, 2024, the company held cash of$6.1 million, including $4.8 million held by OFSCC-FS, and received$11.4 million in cash distributions from OFSCC-FS during the year[535]. - The company had an unused commitment of $24.0 million under its Banc of California Credit Facility and$82.7 million under the BNP Facility as of December 31, 2024[536]. - The aggregate amount outstanding of senior securities issued by the company was $248.4 million, with an asset coverage of 169%, exceeding the minimum requirement of 150%[537].