OFS Capital(OFS) - 2020 Q4 - Annual Report

Part I Business The company operates as a BDC investing in U.S middle-market companies to generate income and capital appreciation, with a portfolio valued at $442.3 million at year-end 2020 - The company's investment objective is to provide stockholders with both current income and capital appreciation primarily through debt investments in U.S. middle-market companies[12] - A significant portion of the company's investment strategy is executed through its SBIC subsidiary, SBIC I LP, which held approximately 46% of the company's total consolidated assets at year-end 2020[13][131] Portfolio Composition at Fair Value (December 31, 2020) | Investment Type | Fair Value (in millions) | Number of Portfolio Companies/Notes | | :--- | :--- | :--- | | Debt Investments | $321.4 | 49 | | Equity Investments | $64.5 | 23 | | Structured Finance Notes | $56.4 | 12 | - The company's asset coverage ratio was 176% as of December 31, 2020, above the required minimum of 150% which became effective May 3, 2019[16][17] - OFS Advisor manages the company's investment activities for a base management fee of 1.75% of total assets and a two-part incentive fee based on net investment income and capital gains[19][71][72] Risk Factors The company faces substantial risks from the COVID-19 pandemic, its dependence on an external manager, leverage, and the speculative nature of its investments in private companies and CLOs - The COVID-19 pandemic has adversely affected and may continue to affect the business, results, and financial condition of the company and its portfolio companies, potentially leading to reduced dividends[175][180] - The company is dependent on the senior professionals of its external advisor, OFS Advisor, and its affiliates for its success[183] - The use of leverage magnifies potential gains and losses, and the company's required asset coverage ratio was reduced from 200% to 150%, allowing for increased leverage and associated risk[197][205] - Significant potential conflicts of interest exist, as OFS Advisor manages other funds with similar or overlapping investment strategies[239][240] - Investments in private and middle-market companies are inherently risky, speculative, and illiquid, and investments in Structured Finance Notes (CLOs) carry additional risks including subordination and the potential for total loss[286][292][309] - The company's common stock may trade below its net asset value per share, which limits its ability to raise additional equity capital without stockholder approval[334] Unresolved Staff Comments The company reports no unresolved staff comments from the Securities and Exchange Commission - Not applicable[361] Properties The company does not own any material real estate, as its office facilities are provided by its administrator, OFS Services - The company does not own any real estate, as its office facilities are provided by OFS Services pursuant to the Administration Agreement[362] Legal Proceedings The company and its affiliates were not subject to any material pending legal proceedings as of December 31, 2020 - The company is not currently subject to any material pending legal proceedings[363] Mine Safety Disclosures This section is not applicable to the company's operations - Not applicable[365] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's stock trades on Nasdaq and experienced significant volatility in 2020, trading at a substantial discount to NAV, while a $10 million repurchase program remains unused Quarterly Stock Price and Distribution Data (Fiscal 2020) | Quarter | NAV Per Share | High Price | Low Price | Premium/(Discount) to NAV (Low) | Cash Distribution Per Share | | :--- | :--- | :--- | :--- | :--- | :--- | | Q1 | $9.71 | $11.97 | $3.70 | -61.9% | $0.34 | | Q2 | $10.10 | $5.70 | $3.52 | -65.1% | $0.17 | | Q3 | $11.18 | $5.08 | $4.04 | -63.9% | $0.17 | | Q4 | $11.85 | $7.58 | $3.97 | -66.5% | $0.18 | - A stock repurchase program is authorized to acquire up to $10.0 million of common stock through May 22, 2022, though no shares were repurchased during 2020 or 2019[371][374] - Total annual expenses are estimated to be 19.06% of net assets attributable to common stock after a base management fee reduction from the advisor[381] Selected Consolidated Financial Data Key financial data for the past five years shows declines in investment income, net investment income per share, and net asset value per share in 2020 compared to prior years Key Financial Metrics (2018-2020) | Metric (Per Share) | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Net Asset Value (Year-End) | $11.85 | $12.46 | $13.10 | | Net Investment Income | $0.92 | $1.43 | $1.38 | | Net Increase in Net Assets | $0.28 | $0.71 | $0.72 | | Distributions Declared | $0.86 | $1.36 | $1.73 | Statement of Operations Data (in thousands) | Line Item | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Total Investment Income | $45,475 | $52,521 | $42,834 | | Total Expenses, Net | $33,180 | $33,470 | $24,449 | | Net Investment Income | $12,295 | $19,098 | $18,385 | | Net Increase in Net Assets | $3,694 | $9,553 | $9,572 | - The weighted average yield on total investments decreased year-over-year, from 10.49% in 2018 to 9.59% in 2019, and further to 8.56% in 2020[397] Management's Discussion and Analysis of Financial Condition and Results of Operations Management attributes the 2020 performance decline to the COVID-19 pandemic, which led to lower net investment income, portfolio losses, and a shift to lower-yielding assets - Net investment income per share decreased by $0.51 in 2020 compared to 2019, primarily due to a decline in the net interest margin and placing loans on non-accrual status[404] - The portfolio experienced net losses of $6.7 million in 2020, driven by unrealized losses in two debt investments, partially offset by an unrealized gain in an equity investment[405][406] - As of December 31, 2020, the company had $37.7 million in cash and could access an additional $111 million from its credit facilities[513][516] - Subsequent to year-end, the company issued $100.0 million of 4.75% notes due 2026 to redeem higher-coupon notes, reducing interest costs[559][561] Debt Investment Risk Category Breakdown (Fair Value) | Risk Category | Dec 31, 2020 (%) | Dec 31, 2019 (%) | | :--- | :--- | :--- | | 1 (Low Risk) | 0.0% | 0.0% | | 2 (Below Average) | 0.0% | 4.0% | | 3 (Average) | 82.2% | 85.8% | | 4 (Special Mention) | 14.1% | 10.1% | | 5 (Substandard) | 3.6% | 0.0% | | 6 (Doubtful) | 0.1% | 0.1% | | 7 (Loss) | 0.0% | 0.0% | Quantitative and Qualitative Disclosures about Market Risk The company's primary market risk is interest rate volatility, as 96% of its debt investments are floating-rate while most of its borrowings are fixed-rate - The company is primarily exposed to interest rate risk, as 96% of its debt investments were floating-rate as of December 31, 2020, while its SBA debentures and Unsecured Notes were fixed-rate[565][566] Annualized Impact of Hypothetical Interest Rate Changes | Basis Point Change | Net Change in Income (in thousands) | | :--- | :--- | | +100 | $505 | | +50 | $43 | | -25 | $(40) | Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements for 2020 and 2019, with the auditor highlighting the valuation of Level 3 investments as a critical audit matter - The financial statements for the two-year period ended December 31, 2020, were audited by KPMG LLP, which issued an opinion that they are presented fairly in all material respects[572] - The auditor identified the valuation of portfolio company investments using unobservable inputs as a critical audit matter due to the high degree of judgment required for Level 3 assets[577][578] Consolidated Balance Sheet Summary (in thousands) | | Dec 31, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | Total Investments, at Fair Value | $442,323 | $516,931 | | Total Assets | $483,813 | $538,188 | | Total Liabilities | $324,857 | $371,561 | | Total Net Assets | $158,956 | $166,627 | - The Consolidated Schedule of Investments provides a detailed listing of each investment, including its industry, interest rate, maturity, principal, amortized cost, and fair value[593] Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants - Not applicable[778] Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2020 - Management concluded that the company's disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2020[780] - Based on an assessment using the COSO 2013 framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2020[782][783] Other Information There is no other information to report in this section - None[785] Part III Directors, Executive Officers and Corporate Governance Information regarding directors, executive compensation, and corporate governance is incorporated by reference from the company's 2021 Proxy Statement - Information required by Items 10, 11, 12, 13, and 14 is incorporated by reference from the company's definitive Proxy Statement for the 2021 Annual Meeting of Stockholders[788][789][790] Part IV Exhibits and Financial Statement Schedules This section lists all financial statements, schedules, and exhibits filed as part of the Form 10-K report, including key corporate and financing agreements - This item lists all documents filed as part of the report, including financial statements, schedules, and exhibits required by Regulation S-K[795] - Exhibits filed include key corporate governance documents, indentures for multiple note offerings, management and administration agreements, and required CEO/CFO certifications[796][797][798] Form 10-K Summary There is no Form 10-K summary provided in this report - None[800]