OFS Capital Corp 10-K

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 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; • the belief that the carrying amounts of our financial instruments, such as cash, receivables and payables approximate the fair value of such items due to the short maturity of such instruments and that such financial instruments are held with high credit quality institutions to mitigate the risk of loss due to credit risk; • actual and potential conflicts of interest with OFS Advisor and other affiliates of OFSAM Holdings; • constraint on investment due to access to material nonpublic information; • restrictions on our ability to enter into transactions with our affiliates; • the use of borrowed money to finance a portion of our investments; • the creation of leveraged lending opportunities as a result of the large amount of unfunded buyout commitments driving demand for leveraged buyouts over the next several years; • our ability to incur additional leverage pursuant to Section 61(a)(2) of the 1940 Act and the impact of such leverage on our net investment income and results of operations; • competition for investment opportunities; • our plans to focus on providing first lien senior secured loans to larger borrowers and the impact of these plans on our risk profile, including our belief that the seniority of such loans in a borrower’s capital structure may provide greater downside protection against adverse economic changes, including those caused by the impacts of elevated interest and inflation rates, the ongoing war between Russia and Ukraine, the escalated armed conflict in the Middle East, instability in the U.S. and international banking systems, the risk of recession or a shutdown of U.S. government services and related market volatility on our business, our portfolio companies, our industry and the global economy; • the percentage of investments that will bear interest on a floating rate or fixed rate basis; • the holding period of our investments; • the impact of alternative reference rates on our business, including a reduction in the value of certain of our investments; • 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 impact of current political, economic and industry conditions, including changes in the interest rate environment, inflation, significant market volatility, supply chain and labor market disruptions, including those as a result of strikes, work stoppages or accidents, resource shortages and other conditions affecting the financial and capital markets, which, in turn, impacts our business prospects and the prospects of our portfolio companies; 74 • the impact of the ongoing war between Russia and Ukraine, the escalated armed conflict in the Middle East and general uncertainty surrounding the financial and political stability of the United States, the United Kingdom, the European Union and China; • the general economy and its impact on the industries in which we invest; • the belief that some of our outstanding debt has favorable financing rates compared to today’s rates; • the belief that we have sufficient levels of liquidity to support our existing portfolio companies; • the effect of laws or regulations, including accounting pronouncements and rule issuances, on our business; • the ability to continue generating strong risk-adjusted net returns by assembling a diversified portfolio of investments across a broad range of industries; • the impact of information technology system failures, data security breaches, data privacy compliance, network disruptions, cybersecurity attacks and the increasing use of artificial intelligence and machine learning technology; • the need and availability of additional capital on favorable terms to finance growth given our expectation to distribute substantially all of our net ordinary income and net realized capital gains to our stockholders; • the impact of our ESG activities; and • the ability to secure financial maintenance covenants in the loans we invest. 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. 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. Overview Key performance metrics per common share are presented below: December 31, 2023 December 31, 2022 Net asset value $ 12.09 $ 13.47 Year Ended December 31, 2023 2022 2021 Net investment income $ 1.50 $ 1.37 $ 1.00 Net increase (decrease) in net assets resulting from operations (0.04) (0.57) 4.24 Distributions declared 1.34 1.16 0.91 Our NAV per common share decreased to $12.09 at December 31, 2023, from $13.47 at December 31, 2022, primarily due to net losses on our investment portfolio of $20.4 million, or $1.52 per common share. For the year ended December 31, 2023, net investment income of $1.50 per common share exceeded our aggregate distributions of $1.34 per common share during such period. During the year ended December 31, 2023, net investment income increased $1.8 million compared to the prior year. The increase in net investment income was primarily due to an increase in total investment income of $8.2 million, partially 75 offset by increases in interest expense and incentive fees (including the Income Incentive Fee and the Capital Gains Fee) of $2.5 million and $4.7 million, respectively. See “—Results of Operations” for additional details. For the year ended December 31, 2023, the weighted-average performing income yield on interest-bearing investments increased to 13.9%, compared to 10.7% during the year ended December 31, 2022. The increase in our investment yield was primarily due to elevated interest rates as our loan portfolio predominately consisted of floating rate loans throughout the year. Our weighted-average debt interest costs increased to 6.0% for the year ended December 31, 2023, from 4.8% during the year ended December 31, 2022, primarily due to the increase in SOFR of approximately 70 bps during the year. The increase in our debt interest costs was primarily due to an increase in the cost of debt on our BNP Facility resulting from SOFR rate increases. As of December 31, 2023, we had $302.4 million of outstanding debt with a weighted-average effective interest rate of 6.1%, which we believe is a favorable financing rate compared to today’s rates. As of December 31, 2023, 70% of our outstanding debt was fixed rate and 89% of our outstanding debt matures in 2026 and beyond. See “—Recent Developments” for additional information regarding our outstanding debt. During the year ended December 31, 2023, our portfolio experienced net losses of $20.4 million, comprised of net realized losses of $11.4 million and net unrealized depreciation of $9.0 million. During the year ended December 31, 2023, our net loss of $20.4 million was primarily related to net unrealized depreciation of $14.5 million on our common equity of Pfanstiehl Holdings, Inc, and net unrealized depreciation of $4.3 million on our non-accrual loans. As of December 31, 2023, our portfolio had non-accrual loans with an aggregate fair value of $12.1 million, or 4.8% of our total loan portfolio at fair value, compared to non-accrual loans with an aggregate fair value of $11.2 million, or 3.6% of our total loan portfolio at fair value, at December 31, 2022. As of December 31, 2023, our common equity investment in Pfanstiehl Holdings, Inc., a global manufacturer of high-purity pharmaceutical ingredients, accounted for 16.9% of our portfolio at fair value and 43.8% of our consolidated net assets, respectively. Primarily due to a decline in financial operating performance during the year ended December 31, 2023, the fair value of our investment in the common equity of Pfanstiehl Holdings, Inc. decreased by $14.5 million to $70.9 million, or $1.08 per share. The value of this investment is substantially comprised of unrealized appreciation of $70.7 million. A deterioration or improvement in the operating performance of the company or other factors underlying the valuation of this investment could have a material impact on our NAV. At December 31, 2023, our asset coverage ratio of 160% exceeded the minimum asset coverage requirement of 150% under the 1940 Act, and we remained in compliance with all applicable covenants under our outstanding debt facilities. As of December 31, 2023, we had unused commitments of $25.0 million under our Banc of California Credit Facility and $59.5 million under our BNP Facility, respectively, each of which are subject to a borrowing base and other covenants. As of December 31, 2023, we had unfunded commitments of $13.8 million to 10 portfolio companies. On February 28, 2024, the Board declared a distribution of $0.34 per share for the first quarter of 2024, payable on March 28, 2024, to stockholders of record as of March 18, 2024. 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, and 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 description of our revenue recognition and fair value policies, see “Item 8. Financial Statements and Supplementary Data—Note 2” of this report. Revenue recognition. Interest Income : Our recognition of interest income from our loan and CLO debt investments is recognized on an accrual basis based upon the outstanding principal amount and contractual interest terms of the debt investment. Net Loan Fees are amortized or accreted into interest income over the life, or estimated life in the case of CLO debt securities, of the respective debt investment. Upon the prepayment of a debt investment, we accelerate the remaining Net Loan Fees into interest income. PIK Income: Our recognition of PIK interest and dividends includes ongoing assessment of collectibility. We discontinue accrual of PIK income when there is reasonable doubt that the income will ultimately be collected. This includes assessments of the fair value of the investment relative to par or cost and other judgments of management. PIK income is 76 included in our ICTI and, therefore, affects the amount we are required to pay to our stockholders in the form of distributions in order to maintain our tax treatment as a RIC, even though we may have not yet collected the cash. CLO Subordinated Notes and Loan Accumulation Facilities: Interest income on our CLO subordinated note securities is recognized in accordance with ASC Subtopic 325-40, Beneficial Interests in Securitized Financial Assets (“ASC 325-40”), which contemplates estimating an effective yield to expected redemption utilizing estimated future cash flows from the investment. The estimated cash flows of the underlying portfolio and to our security are developed utilizing a number of assumptions, including, among others, estimates of default rates, prepayment rates, redemption timing, reinvestment prices, and liquidation-redemption price. These assumptions, and correspondingly the estimated cash flows and accretable yields, are reviewed and updated at each payment date, generally quarterly. The valuation of our Structured Finance Securities makes use of similar assumptions, plus a discount rate assumption, to develop estimated cash flows that are discounted to estimated net present value. Interest income from our investments in Loan Accumulation Facilities is recognized on an accrual basis based on an estimated yield. Income notes associated with our Loan Accumulation Facility investments generally pay returns equal to the actual income earned on facility assets less costs of senior financing and manager costs. We periodically evaluate the realizability of such amounts and, if necessary, subsequently adjust the estimated yield. Non-accrual Loans : We review, for placement on non-accrual status, all loans and CLO mezzanine debt investments that become past due on principal and interest, and/or when there is reasonable doubt that principal or interest will be collected. When a loan is placed on non-accrual status, accrued and unpaid cash interest is reversed. Interest income and Net Loan Fees are no longer recognized as of the date the loan is placed on non-accrual status. Interest payments subsequently received on non-accrual investments may be recognized as income or applied to amortized cost 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 and interest payments and, in management’s judgment, it is probable that we will collect all principal and interest from the investment. Acquisition Cost of Investments : Our middle-market lending activities may 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. The revenue recognized on these instruments is a function of the fee or other consideration allocated to them, including amounts allocated to loan syndication fees at the time of acquisition. 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. Once determined, these allocations directly affect the discount/premium and yield on debt securities, the cost and net gains/losses on equity securities, 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, 2023, total investments of $420.3 million, representing approximately 89% of our total assets, were carried on the consolidated statement of assets and liabilities at fair value. As discussed more fully in “Item 8. Financial Statements and Supplementary Data—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 2 and Level 3, with 96% of our investments classified as Level 3 as of December 31, 2023. In accordance with our investment strategy, we typically do not hold equity securities or other instruments that are actively traded on an exchange (Level 1). On September 7, 2022, pursuant to Rule 2a-5, our Board designated OFS Advisor as the valuation designee to perform fair value determinations relating to our investments for which market quotations are not readily available, and, as prescribed in Rule 2a-5, the Board maintains oversight of OFS Advisor in its capacity as valuation designee. As described in “Item 8. Financial Statements and Supplementary Data—Note 5 ”, under the oversight of the Board, we follow a process to determine these unobservable inputs used in the fair value estimates of our investments. The most significant unobservable inputs in the Level 3 fair value measurements are the discount rates (discounted cash flows approach) and EBITDA or revenue multiples (market approach). Investments classified as Level 2 are measured on the basis of Indicative Prices provided by pricing services. Our discounted cash flow valuations involve a determination of discount rate commensurate with the risk inherent in each investment. OFS Advisor, with the assistance of independent third-party valuation firms, uses two primary methods to 77 estimate discount rates on Portfolio Company Investments, as applicable: a method based upon a hypothetical recapitalization of the entity given its current operating performance and current market conditions; and a synthetic debt rating method, which assigns a surrogate debt rating to the entity based on known industry standards for assigning such ratings and then estimates the discount rate based on observed market yields for actual rated debt. OFS Advisor may also use a relative value method to estimate yields, which involves estimating the discount rate of non-traded subject debt investments based on an expected or assumed relationship between Indicative Prices on traded debt and the subject debt for a portfolio company. All methods for estimating the discount rate generally involve calibration of unobservable inputs utilized in estimating the discount rate on the subject investment to its internal rate of return at close or purchase date. These methods generally produce a range of discount rates, and we generally select the midpoint of the range for use in fair value measures, subject to considerations of any prepayment fees associated with the debt. Our market approach valuations, generally applied to equity investments and investments in impaired debt, involve a determination of an enterprise value multiple to a financial performance metric of the portfolio company, generally trailing historical EBITDA or revenue. These determinations are based on identification of a comparable set of publicly traded companies and determination of a public-to-private liquidity adjustment factor, generally through calibration to transaction prices in the subject investment instrument. We may also utilize other portfolio-company earnings metrics to determine enterprise value, such as forecast EBITDA or revenue, or a weighting of multiple factors. At times, we may also use a discounted cash flow technique in valuing our equity securities or a combination of multiple valuation approaches. These methods generally produce 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, 2023 (in thousands): Fair Value at December 31, 2023 Range of Fair Value Investment Type Low-end High-end Debt investments: First lien $ 202,792 $ 199,466 $ 206,155 Second lien 48,521 46,665 50,375 Subordinated (1) — — — Structured Finance Securities: Subordinated notes 49,985 47,455 52,512 Mezzanine debt 29,060 28,559 29,567 Equity investments: Preferred equity 13,240 11,450 13,752 Common equity, warrants and other 76,689 70,141 83,238 $ 420,287 $ 403,736 $ 435,599 (1) As of December 31, 2023, the fair value of our subordinated debt investment was $0. 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 78 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. For the years ending December 31, 2023, 2022 and 2021, OFS Advisor agreed to reduce its base management fee attributable to all of the OFSCC-FS Assets to 0.25% per quarter (1.00% annualized) of the average value of the OFSCC-FS Assets (other than cash and cash equivalents but including assets purchased with borrowed amounts) at the end of the two most recently completed calendar quarters. OFS Advisor’s base management fee reduction is renewable on an annual basis and OFS Advisor is not entitled to recoup the amount of the base management fee reduced with respect to the OFSCC-FS Assets. OFS Advisor most recently renewed the agreement to reduce its base management fee for the 2024 calendar year on January 8, 2024. 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 funds advised or sub-advised by OFS Advisor, so long as its services to us are not impaired. OFS Advisor also serves as the investment adviser to other funds, including HPCI and OCCI. Additionally, OFS Advisor provides sub-advisory services to: (i) CMFT Securities Investments, LLC, a wholly owned subsidiary of CIM Real Estate Finance Trust, Inc., a corporation that qualifies as a real estate investment trust; and (ii) CIM Real Assets & Credit Fund, an externally managed registered investment company that operates as an interval fund that invests primarily in a combination of real estate, credit and related investments. The 1940 Act generally prohibits BDCs 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 from, sales of assets to, 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 from, sales of assets to, or joint transactions with, the BDC’s officers, directors, and employees, and advisor (and its control affiliates). BDCs may, however, invest alongside certain related parties or their respective other clients in certain circumstances where doing so is consistent with current law and SEC staff interpretations. For example, a BDC may invest alongside such accounts consistent with guidance promulgated by the SEC staff permitting the BDC 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. 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 August 4, 2020, we received our existing Order, which superseded a previous order that we received on October 12, 2016, and provides us with greater flexibility to enter into co-investment transactions with certain Affiliated Funds in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors, subject to compliance with certain conditions. We are generally permitted to co-invest with Affiliated Funds if, under the terms of the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors make certain conclusions in connection with a co-investment transaction, including that: (1) the terms of the transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching in respect 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. In addition, we may file an application for an amendment to our existing Order to permit us to participate in follow-on investments in our existing portfolio companies with private funds that do not hold any investments in such existing portfolio companies. However, if filed, there is no guarantee that such application will be granted. Conflicts may arise when we make an investment in conjunction with an investment being made by an Affiliated Account, or in a transaction where an Affiliated Account has already made an investment. Investment opportunities are, from time to time, appropriate for more than one account in the same, different or overlapping securities of a portfolio company’s capital structure. Conflicts arise in determining the terms of investments, particularly where these accounts may invest in different types of securities in a single portfolio company. Potential conflicts arise when addressing, among other things, questions as to whether payment obligations and covenants should be enforced, modified or waived, or whether debt should be restructured, modified or refinanced. See “ Item 1. Business—Regulations—Conflicts of Interest” and “Item 1A. Risk Factors—Risks Related to OFS Advisor and its Affiliates—We have potential conflicts of interest related to the purchases and sales that OFS Advisor makes on our behalf and/or on behalf of Affiliated Accounts .” 79 Portfolio Composition and Investment Activity Our portfolio consists of debt and equity investments, as well as indirect investments in such securities through investment in other investment companies including Structured Finance Securities. Portfolio Composition. As of December 31, 2023, the fair value of our debt investment portfolio totaled $251.3 million in 44 portfolio companies, of which 81% and 19% were first lien and second lien loans, respectively. We also held equity investments in 15 portfolio companies with a fair value of $89.9 million and 21 investments in Structured Finance Securities with a fair value of $79.0 million. The following table presents our investment portfolio by each wholly owned legal entity within the consolidated group as of December 31, 2023 and 2022 (in thousands): December 31, 2023 December 31, 2022 Amortized Cost Fair Value Amortized Cost Fair Value OFS Capital Corporation (Parent) $ 175,146 $ 143,750 $ 195,823 $ 162,308 SBIC I LP 60,385 121,167 97,214 167,211 OFSCC-FS 165,109 152,582 178,460 168,050 OFSCC-MB 2,890 2,788 3,383 3,007 Total investments $ 403,530 $ 420,287 $ 474,880 $ 500,576 Portfolio Yields . The following table presents weighted-average yield metrics for our portfolio: Year Ended December 31, 2023 2022 Weighted-average performing income yield (1) : Debt investments 13.2 % 9.5 % Structured Finance Securities 16.1 % 15.4 % Interest-bearing investments 13.9 % 10.7 % Weighted-average realized yield : Interest-bearing investments (2) 12.7 % 10.0 % (1) Performing income yield is calculated as (a) the actual amount earned on performing interest-bearing investments, including interest, prepayment fees and amortization of Net Loan Fees, divided by (b) the weighted-average of total performing interest-bearing investments at amortized cost . (2) Realized yield is calculated as ( a) the actual amount earned on interest-bearing investments, including interest, prepayment fees and amortization of Net Loan Fees, divided by (b) the weighted-average of total interest-bearing investments at amortized cost , in each case, including debt investments on non-accrual status and non-income producing Structured Finance Securities. For the year ended December 31, 2023, the increase in our weighted-average realized yields was primarily due to elevated interest rates as our loan portfolio predominantly consisted of floating rate loans throughout the year. 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. 80 Debt and Equity Investments . The following table summarizes the composition of our debt and equity investments by type as of December 31, 2023 and 2022 (dollar amounts in thousands): December 31, 2023 December 31, 2022 Amortized Cost Fair Value Amortized Cost Fair Value First lien debt investments (1) $ 220,941 $ 202,792 $ 269,206 $ 253,617 Second lien debt investments 57,848 48,521 66,352 58,019 Subordinated debt investments 4,680 — 13,890 1,226 Preferred equity 11,403 13,240 9,966 8,196 Common equity, warrants and other 11,537 76,689 12,989 91,000 Total debt and equity investments $ 306,409 $ 341,242 $ 372,403 $ 412,058 Number of portfolio companies 55 55 63 63 (1) Includes unitranche investments (which are loans that combine both senior and subordinated debt, in a first lien position), as of December 31, 2023, with an amortized cost and fair value of $141.3 million and $131.3 million, respectively. As of December 31, 2022, the amortized cost and fair value of unitranche investments was $156.4 million and $146.4 million, respectively. As of December 31, 2023, approximately 100% of our loan portfolio and 60% of our total portfolio consisted of first lien and second lien loans, based on fair value. We believe the seniority of our debt investments in the borrowers’ capital structures may provide greater downside protection against adverse economic changes, including those caused by the impacts of the ongoing war between Russia and Ukraine, the escalated armed conflict in the Middle East, elevated interest and inflation rates, instability in the U.S. and international banking systems, the risk of recession or a shutdown of U.S. government services and related market volatility. As of December 31, 2023, our common equity investment in Pfanstiehl Holdings, Inc., a global manufacturer of high-purity pharmaceutical ingredients, accounted for 16.9% and 43.8% of our total portfolio at fair value and our total net assets, respectively. Primarily due to a decline in financial operating performance during the year ended December 31, 2023, the fair value of our investment in the common equity of Pfanstiehl Holdings, Inc. decreased by $14.5 million to $70.9 million, or $1.08 per share. The value of this investment is substantially comprised of unrealized appreciation of $70.7 million. A deterioration or improvement in the operating performance of the company or other factors underlying the valuation of this investment could have a material impact on our NAV. As of December 31, 2023, the three largest industries of our debt and equity investments by fair value, were (1) Manufacturing (28.7%), (2) Health Care and Social Assistance (20.2%) and (3) Wholesale Trade (15.1%) totaling approximately 64.0% 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 ten largest investments by portfolio company based on fair value as of December 31, 2023 (dollar amounts in thousands): Portfolio Company Type Amortized Cost Fair Value % of Total Portfolio, at Fair Value Pfanstiehl Holdings, Inc. Equity $ 217 $ 70,927 16.9 % All Star Auto Lights, Inc. Debt 27,591 27,776 6.6 % Inergex Holdings, LLC Debt 17,095 17,212 4.1 % Kreg LLC Debt 17,060 15,900 3.8 % Tolemar Acquisition, Inc. Debt 15,889 14,756 3.5 % Honor HN Buyer Inc Debt 13,181 13,356 3.2 % SSJA Bariatric Management LLC Debt 13,395 12,852 3.1 % Boca Home Care Holdings, Inc. Debt and Equity 12,499 11,724 2.8 % One GI LLC Debt 11,219 10,718 2.6 % Contract Datascan Holdings, Inc. Equity 7,412 10,583 2.5 % Total $ 135,558 $ 205,804 49.1 % 81 Structured Finance Securities . The following table summarizes our Structured Finance Securities as of December 31, 2023 and December 31, 2022 (dollar amounts in thousands): December 31, 2023 December 31, 2022 Amortized Cost Fair Value Amortized Cost Fair Value Subordinated notes $ 69,592 $ 52,800 $ 65,870 $ 53,807 Mezzanine debt 27,529 26,245 28,107 26,412 Loan accumulation facility — — 8,500 8,299 Total Structured Finance Securities $ 97,121 $ 79,045 $ 102,477 $ 88,518 Number of Structured Finance Securities 21 21 23 23 As of December 31, 2023, we had no non-performing Structured Finance Securities. Non-performing Structured Finance Securities are securities that have not been optionally redeemed and have an effective yield of 0.0%, as remaining residual distributions are anticipated to be recognized as a return of capital. During the year ended December 31, 2023, we recognized a realized loss of $1.3 million on an optionally redeemed subordinated note after it made its final distribution payment. Investment Activity. The following is a summary of our cash investment activity for the years ended December 31, 2023 and 2022 (dollar amounts in millions): Year Ended December 31, 2023 2022 Investments in debt and equity securities $ 34.1 $ 111.0 Investments in Structured Finance Securities 7.6 43.2 Total investment purchases and originations $ 41.7 $ 154.2 Proceeds from principal payments on portfolio investments $ 83.0 $ 88.7 Proceeds from sales or redemptions of portfolio investments 18.9 46.6 Distributions received from portfolio investments 14.5 12.2 Total proceeds from principal payments, sales or redemptions, and distributions received from portfolio investments $ 116.4 $ 147.5 Risk Monitoring 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, 2023 and 2022 (dollar amounts in thousands): Debt Investments as of December 31, 2023 2022 Risk Category Amortized Cost Fair Value % of Debt Investments, at Fair Value Amortized Cost Fair Value % of Debt Investments, at Fair Value 1 (Low Risk) $ — $ — — % $ — $ — — % 2 (Below Average Risk) — — — — — — 3 (Average) 230,338 223,394 88.9 298,414 288,170 92.2 4 (Special Mention) 25,147 19,581 7.8 30,060 17,218 5.5 5 (Substandard) 18,772 8,136 3.2 16,294 7,352 2.3 6 (Doubtful) 9,212 202 0.1 4,680 122 — 7 (Loss) — — — — — — $ 283,469 $ 251,313 100.0 % $ 349,448 $ 312,862 100.0 % Non-Accrual Loans As of December 31, 2023 The following table shows the classification of our debt investments on non-accrual status (dollar amounts in thousands): 82 December 31, 2023 Amortized Cost Fair Value First lien debt $ 18,772 $ 8,136 Second lien debt 11,116 4,003 Subordinated debt 4,680 — Total $ 34,568 $ 12,139 As of December 31, 2022 The following table shows the classification of our debt investments on non-accrual status (dollar amounts in thousands): December 31, 2022 Amortized Cost Fair Value First lien debt $ 14,113 $ 6,864 Second lien debt 8,520 3,136 Subordinated debt 13,890 1,226 Total $ 36,523 $ 11,226 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. Net Investment Income . Total investment income less total expenses (“NII”) is a key performance metric in obtaining part of our investment objective of providing current income to stockholders. NII can be a general indicator of ICTI and the amount of distributions that will be required to be made due to RIC requirements. One of our main objectives is to increase NII, and, in turn, increase distributions to stockholders. Net Gain (Loss) on Investments. Net gain (loss) on investments consists of the sum of: (a) realized gains and losses from the sale, redemption or write-off of portfolio investments, net of taxes; and (b) net unrealized appreciation or depreciation on portfolio investments, net of deferred taxes. In the period in which a realized gain or loss is recognized, such gain or loss will be offset by the reversal of previously recognized unrealized appreciation or depreciation, and the net gain (loss) recognized in that period will generally be smaller. The net unrealized appreciation or depreciation on debt securities is also reversed when those investments are redeemed or paid off prior to maturity. Net Asset Value : NAV is a key performance metric related to our investment objective to provide our stockholders with both current income and capital appreciation primarily through debt investments and, to a lesser extent, equity investments. NAV per share is increased (decreased) by our net increase (decrease) in net assets resulting from operations, decreased by distributions paid to common stockholders, and increased (decreased) by any capital share transactions depending on if the price transacted is accretive or dilutive to NAV, as applicable. As a result, annual comparisons of net increase (decrease) in net assets resulting from operations may not be meaningful. Portfolio Yield : Portfolio yield is a key financial metric of our investment portfolio in order to achieve our investment objective of providing current income to stockholders. Portfolio yield is a gross figure and does not contemplate changes in our costs, including on our debt and other expenses. See “Portfolio Composition and Investment Activity—Portfolio Yields” for additional information. 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. Our investment strategy is to maintain a leveraged credit investment portfolio, 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. 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. 83 Comparison of years ended December 31, 2023, 2022 and 2021. Consolidated operating results for the years ended December 31, 2023, 2022 and 2021 are as follows (in thousands): Year Ended December 31, 2023 2022 2021 Investment income Interest income: Cash interest income $ 39,915 $ 33,270 $ 28,321 PIK interest income 1,461 523 1,526 Net Loan Fee amortization 1,730 1,726 2,665 Accretion of interest income on CLO subordinated notes 10,857 10,656 9,861 Other interest income 706 83 11 Total interest income 54,669 46,258 42,384 Dividend income: Cash dividends 659 947 2,024 PIK dividends 1,136 466 143 Total dividend income 1,795 1,413 2,167 Fee income: Prepayment and other fees 383 680 977 Management and syndication 96 393 2,235 Total fee income 479 1,073 3,212 Total investment income 56,943 48,744 47,763 Total expenses 36,783 30,392 34,313 Net investment income 20,160 18,352 13,450 Net gain (loss) on investments (20,412) (25,794) 48,005 Loss on extinguishment of debt (213) (144) (4,591) Net increase (decrease) in net assets resulting from operations $ (465) $ (7,586) $ 56,864 Comparison of investment income for the years ended December 31, 2023 and 2022 . Total interest income increased $8.4 million during the year ended December 31, 2023 compared to the prior year, primarily due to an increase in cash interest income of $6.6 million. The increase in cash interest income was primarily due to elevated reference interest rates as our loan portfolio predominately consisted of floating rate loans throughout the year. During the year ended December 31, 2023, total PIK interest income increased $0.9 million compared to the prior year. The increase in PIK interest income primarily related to two credit agreement amendments that increased the contractual PIK interest or converted cash interest to PIK interest. During the year ended December 31, 2023, dividend income increased $0.4 million compared to the prior year, primarily due to an increase of $0.7 million in preferred equity PIK dividends. During the year ended December 31, 2023, we recognized total PIK income of $2.6 million, which represented 4.6% of total investment income. During the year ended December 31, 2022, we recognized total PIK income of $1.0 million, which represented 2.0% of total investment income. Fee income is primarily comprised of unused loan commitment fees, prepayment fees and syndication fees generally result from periodic transactions rather than from holding portfolio investments and are considered non-recurring. During the years ended December 31, 2023, total fee income decreased $0.6 million compared to the prior year, primarily due to a decrease in syndication and prepayment fees. We may receive syndication fees on investments where OFS Advisor sources, structures and arranges the lending group, resulting in incremental economics relative to the other loan participants. Comparison of investment income for the years ended December 31, 2022 and 2021 . Total interest income increased approximately $3.9 million during the year ended December 31, 2022 compared to the prior year, primarily due to an increase in our portfolios’ weighted-average realized yield from 9.7% to 10.0%. Due to the rising interest environment during 2022, our debt investments’ effective yield continually increased throughout 2022. During the year ended December 31, 2022, interest income on Structured Finance Securities increased $3.5 million compared to the prior year, primarily due to additional investments of $43.2 million during the year. 84 During the year ended December 31, 2022, we recognized total PIK income of $1.0 million, which represented only 2.0% of total investment income. During the year ended December 31, 2022, total PIK income decreased $0.7 million compared to the prior year. During the year ended December 31, 2022, dividend income decreased $0.8 million compared to the prior year, primarily due to a $1.1 million decrease in cash dividends. The decrease in cash dividends was primarily due to a reduction in dividends received from Pfanstiehl Holdings, Inc. During the years ended December 31, 2022, total fee income decreased $2.1 million compared to the prior year, primarily due to a decrease of $1.8 million in syndication fees. Expenses. Operating expenses for the years ended December 31, 2023, 2022 and 2021, are presented below (in thousands): Year Ended December 31, 2023 2022 2021 Interest and financing expense $ 19,482 $ 17,025 $ 17,515 Base management fees 7,218 7,979 7,669 Income Incentive Fee 5,040 2,276 2,352 Capital Gains Fee — (1,916) 1,916 Professional fees 1,681 1,608 1,670 Administration fees 1,680 1,742 1,758 Other expenses 1,682 1,678 1,433 Total expenses $ 36,783 $ 30,392 $ 34,313 Comparison of expenses for the years ended December 31, 2023 and 2022 . Interest expense increased by $2.5 million during the year ended December 31, 2023 compared to the year ended December 31, 2022, primarily due to an increase in our weighted-average debt interest costs from 4.8% to 6.0%. The increase in our debt interest costs was primarily due to an increase in the cost of debt on our BNP Facility resulting from variable SOFR rate increases. The BNP Facility’s effective interest rate increased to 8.3% during the year ended December 31, 2023, from 4.4% during the year ended December 31, 2022. Base management fee expense decreased by $0.8 million during the year ended December 31, 2023, due to a decrease in our average total assets, primarily due to our average investment portfolio at fair value decreasing to $474.5 million during the year ended December 31, 2023 from $525.8 million during the year ended December 31, 2022. The decrease in the average investment portfolio at fair value during the year ended December 31, 2023 primarily related to net repayments on portfolio investments of $63.8 million and net losses on portfolio investments of $20.4 million, respectively. The Income Incentive Fee increased by $2.8 million during the year ended December 31, 2023 compared to the year ended December 31, 2022, primarily due to an increase in our net interest margin of $6.0 million. During the year ended December 31, 2023, we did not incur a Capital Gains Fee as compared to 2022, when we fully reversed the Capital Gains Fee of $1.9 million that was accrued in 2021. The Capital Gains Fee previously accrued during the year ended December 31, 2021 was neither contractually due nor payable under the terms of the Investment Advisory Agreement. During the year ended December 31, 2023, professional fees, administration fees and other expenses remained stable compared to the prior year at $5.0 million. Comparison of expenses for the years ended December 31, 2022 and 2021 . Interest expense decreased by $0.5 million during the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to a decrease in the weighted-average interest costs from 5.1% to 4.8%. The decrease in our weighted-average interest costs was primarily due to the refinancing of certain Unsecured Notes during 2021. During the year ended December 31, 2021, we issued $180.0 million in Unsecured Notes with a weighted-average effective yield of 5.4%, and redeemed $177.9 million in Unsecured Notes with a weighted-average effective yield of 6.9%. Base management fee expense increased by $0.3 million due to an increase in our average total assets, primarily due to our average investment portfolio at fair value increasing to $525.8 million during the year ended December 31, 2022, from $485.2 million during the year ended December 31, 2021. 85 During the year ended December 31, 2021, the Income Incentive Fee expense increased $0.8 million, or $0.4 million prior to the waiver in the first quarter of 2020, compared to the year ended December 31, 2020 due to an increase in net investment income. During the year ended December 31, 2021, net investment income increased, primarily due to additional dividend and syndication fee income, as well as a decrease in interest expense. During the year ended December 31, 2022, the Capital Gains Fee decreased $3.8 million compared to the prior year due to the full reversal of the prior years’ accrued Capital Gains Fee. The Capital Gains Fee previously accrued during the year ended December 31, 2021 was neither contractually due nor payable under the terms of the Investment Advisory Agreement. During the year ended December 31, 2022, professional fees, administration fees and other expenses remained relatively steady compared to the prior year, increasing approximately $0.2 million. Net realized and unrealized gain (loss) on investments. Net realized and unrealized gain (loss) on investments, by investment type, for the years ended December 31, 2023, 2022 and 2021, are presented below (in thousands): Year Ended December 31, 2023 2022 2021 Debt investments $ (5,174) $ (24,954) $ 12,236 Equity investments (9,744) 13,187 36,996 Structured Finance Securities (5,374) (14,209) (314) Current/deferred income tax expense (benefit) (120) 182 (913) Net gain (loss) on investments $ (20,412) $ (25,794) $ 48,005 Year ended December 31, 2023 During the year ended December 31, 2023, our portfolio experienced net losses of $20.4 million, comprised of net realized losses of $11.4 million and net unrealized depreciation of $9.0 million. During the year ended December 31, 2023, our net loss of $20.4 million primarily related to net unrealized depreciation of $14.5 million in the common equity of Pfanstiehl Holdings, Inc. During the year ended December 31, 2023, our loan portfolio experienced net losses of $5.2 million, primarily related to net unrealized depreciation of $4.3 million on our non-accrual loans. During the year ended December 31, 2023, we recognized net realized losses of $11.4 million, primarily due to the write-off our non-accrual loan and equity investment in Eblens Holdings, Inc., resulting in a realized loss of $10.5 million, of which $9.0 million was recognized in prior fiscal years. Year ended December 31, 2022 During the year ended December 31, 2022, our portfolio experienced net losses of $25.8 million, primarily related to unrealized depreciation of $23.0 million and $14.2 million on our debt investments and Structured Finance Securities, respectively, offset by unrealized appreciation of $13.1 million on our equity investments. The unrealized depreciation on our debt investments and Structured Finance Securities was primarily due to the widening of liquid credit market spreads. Company specific performance factors on a few non-accrual investments also contributed to the unrealized depreciation on our debt investments. Our common equity investment in Pfanstiehl Holdings, Inc. experienced unrealized gains of $19.7 million during the year ended December 31, 2022. During the year ended December 31, 2022, we recognized realized losses of $1.9 million, primarily on the sale of $44.3 million of Broadly Syndicated Loans. Year ended December 31, 2021 During the year ended December 31, 2021, our portfolio experienced net gains of $48.0 million, primarily due to unrealized appreciation of $32.7 million on our equity investments. Our common equity investment in Pfanstiehl Holdings, Inc. experienced unrealized gains of $29.5 million during the year ended December 31, 2021. Losses on Extinguishment of Debt Year ended December 31, 2023 During the year ended December 31, 2023, we redeemed $19.0 million of SBA debentures and, as a result, we recognized a loss on extinguishment of debt of $0.2 million related to the acceleration of unamortized deferred borrowing costs and prepaid (or breakage) interest on the redeemed debentures. 86 Year ended December 31, 2022 During the year ended December 31, 2022, we redeemed $19.0 million of SBA debentures and, as a result, we recognized a loss on extinguishment of debt of $0.1 million related to the acceleration of unamortized deferred borrowing costs on the redeemed debentures. Year ended December 31, 2021 During the year ended December 31, 2021, we redeemed $35.4 million of SBA debentures that were contractually due September 1, 2022, September 1, 2024 and September 1, 2025. We recognized a loss on extinguishment of debt of $0.3 million related to the charge-off of deferred borrowing costs on the redeemed debentures. During the year ended December 31, 2021, we redeemed $177.9 million of Unsecured Notes that were contractually due in 2023, 2025 and 2026. We recognized a loss on extinguishment of debt of $4.3 million related to the charge-off of deferred borrowing costs on the redeemed notes. Non-GAAP Financial Measure – Adjusted Net Investment Income On a supplemental basis, we disclose Adjusted NII (including on a per share basis), which is a financial measure calculated and presented on basis other than in accordance with GAAP. Adjusted NII represents net investment income, excluding the capital gains incentive fee, in periods in which such expense occurs. GAAP requires recognition of a capital gains incentive fee in our financial statements when aggregate net realized and unrealized capital gains, if any, on a cumulative basis is positive from the date of the election to be a BDC through the reporting date. Such fees are subject to further conditions specified in the Investment Advisory Agreement, principally related to the realization of such net gains, before OFS Advisor is entitled to payment, and such recognized fees are subject to the risk of reversal should unrealized gains diminish to become losses. Management believes that Adjusted NII is a useful indicator of operations exclusive of any net capital gains incentive fee, as net investment income does not include the net gains, realized or unrealized, associated with the capital gains incentive fee. Management believes Adjusted NII facilitates the analysis of our results of operations and provides greater transparency into the determination of incentive fees. Adjusted NII is not meant as a substitute for net investment income determined in accordance with GAAP and should be considered in the context of the entirety of our reported results of operations, financial position and cash flows determined in accordance with GAAP. The following table provides a reconciliation from net investment income (the most comparable GAAP measure) to Adjusted NII for the years ended December 31, 2023, 2022 and 2021 (dollar amounts in thousands, except per share data): Year Ended December 31, 2023 2022 2021 (000's) Per Share (000's) Per Share (000's) Per Share Net investment income $ 20,160 $ 1.50 $ 18,352 $ 1.37 $ 13,450 $ 1.00 Capital Gains Fee — — (1,916) (0.14) 1,916 0.14 Adjusted NII $ 20,160 $ 1.50 $ 16,436 $ 1.23 $ 15,366 $ 1.14 For the year ended December 31, 2021, the Capital Gains Fee of $1.9 million was primarily due to net unrealized appreciation of $49.8 million on the investment portfolio at December 31, 2021, partially offset by cumulative net realized losses of $40.2 million. During the year ended December 31, 2022, we reversed the previously accrued Capital Gains Fees of $1.9 million due to a reduction in net unrealized appreciation on the investment portfolio. Although these non-GAAP financial measures are intended to enhance investors’ understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. 87 Comparison of the three months ended December 31, 2023 and September 30, 2023. Consolidated operating results for the three months ended December 31, 2023 and September 30, 2023, are as follows (in thousands): Three Months Ended December 31, 2023 September 30, 2023 Investment income Interest income: Cash interest income $ 8,742 $ 10,962 PIK interest income 851 170 Net Loan Fee amortization 493 420 Accretion of interest income on CLO subordinated notes 2,323 2,653 Other interest income 475 86 Total interest income 12,884 14,291 Dividend income: Preferred equity PIK dividends 332 323 Cash dividends 10 11 Total dividend income 342 334 Fee income: Prepayment and other fees 257 26 Total fee income 257 26 Total investment income 13,483 14,651 Total expenses 8,787 9,261 Net investment income 4,696 5,390 Net loss on investments (8,805) (3,395) Loss on extinguishment of debt — (194) Net increase (decrease) in net assets resulting from operations $ (4,109) $ 1,801 During the three months ended December 31, 2023, cash interest income decreased $2.2 million compared to the three months ended September 30, 2023, primarily due to total debt investments at cost declining 8% compared to the prior quarter, as well as the recognition of non-recurring interest on a realized Structured Finance Security during the prior quarter. During the three months ended December 31, 2023, PIK interest income increased $0.7 million compared to the three months ended September 30, 2023, primarily due to the placement of a non-accrual loan back on accrual status and the recognition of previously reserved past-due interest. Expenses. Operating expenses for the three months ended December 31, 2023 and September 30, 2023 are presented below (in thousands): Three Months Ended December 31, 2023 September 30, 2023 Interest and financing expense $ 4,684 $ 4,913 Base management fees 1,645 1,796 Income Incentive Fee 1,174 1,348 Professional fees 419 397 Administration fees 379 380 Other expenses 486 427 Total expenses $ 8,787 $ 9,261 During the three months ended December 31, 2023, total expenses decreased $0.5 million compared to the prior quarter, primarily due to decreases in interest expense and base management and Income Incentive fees incurred under the Investment Advisory and Management Agreement. 88 Net realized and unrealized gain (loss) on investments. Net gain (loss) by investment type for the three months ended December 31, 2023 and September 30, 2023 were as follows (in thousands): Three Months Ended December 31, 2023 September 30, 2023 Debt investments $ (2,089) $ (1,570) Equity investments (4,694) (5,196) Structured Finance Securities (1,956) 3,253 Current/deferred income tax expense (benefit) (66) 118 Net loss on investments $ (8,805) $ (3,395) Net gain (loss) on investments for the three months ended December 31, 2023 During the three months ended December 31, 2023, our portfolio experienced net losses of $8.8 million, primarily due to net unrealized depreciation of $5.1 million on our equity investments. During the three months ended December 31, 2023, our common equity investment in Pfanstiehl Holdings, Inc. experienced net unrealized depreciation of $6.2 million. Net gain (loss) on investments for the three months ended September 30, 2023 For the three months ended September 30, 2023, we recognized a net loss on investments of $3.4 million, primarily due to net unrealized depreciation of $6.8 million on our debt and equity investments, partially offset by net unrealized appreciation of $3.3 million on our Structured Finance Securities. During the three months ended September 30, 2023, our common equity investment in Pfanstiehl Holdings, Inc. experienced unrealized depreciation of $5.7 million. Portfolio Yields . The following table presents weighted-average yield metrics for our portfolio: Three Months Ended December 31, 2023 September 30, 2023 Weighted-average performing income yield (1) : Debt investments 14.2 % 13.1 % Structured Finance Securities 13.9 % 19.3 % Interest-bearing investments 14.1 % 14.6 % Weighted-average realized yield : Interest-bearing investments (2) 12.8 % 13.3 % (1) Performing income yield is calculated as (a) the actual amount earned on performing interest-bearing investments, including interest, prepayment fees and amortization of Net Loan Fees, divided by (b) the weighted-average of total performing interest-bearing investments at amortized cost . (2) Realized yield is calculated as ( a) the actual amount earned on interest-bearing investments, including interest, prepayment fees and amortization of Net Loan Fees, divided by (b) the weighted-average of total interest-bearing investments at amortized cost , in each case, including debt investments on non-accrual status and non-income producing Structured Finance Securities. For the three months ended December 31, 2023, the weighted average performing income yield on interest-bearing investments decreased primarily due to non-recurring interest income recognized during the prior quarter on the repayment of a loan accumulation facility. Non-GAAP Financial Measure – Adjusted Net Investment Income During the three months ended December 31, 2023 and September 30, 2023, we did not recognize a Capital Gains Fee that would require the disclosure of Adjusted Net Investment Income for these periods. Liquidity and Capital Resources At December 31, 2023, we held cash of $45.3 million, which includes cash of $28.0 million held by SBIC I LP and $4.0 million held by OFSCC-FS. Our use of cash held by SBIC I LP was restricted by SBA regulation, including limitations on 89 the amount of cash SBIC I LP could distribute to the Parent. During the year ended December 31, 2023, the Parent received income distributions of $4.5 million and a return of capital distribution of $2.5 million related to the redemption of debentures. Distributions from OFSCC-FS to the Parent are restricted by the terms and conditions of the BNP Facility. During the year ended December 31, 2023, the Parent received $11.7 million in cash distributions from OFSCC-FS. At December 31, 2023, the Parent had $26.2 million of cash available for general corporate activities, including approximately $12.8 million and $0 million held by SBIC I LP and OFSCC-FS, respectively, that was available for distribution to the Parent. The Parent was permitted to make unsecured loans to SBIC I LP, the aggregate of which could not exceed $35 million at any given time, and no interest could be charged on the unpaid principal balance. There were no intercompany loans between the Parent and SBIC I LP at December 31, 2023. On February 28, 2024, the Parent made a $3.5 million unsecured loan to SBIC I LP in order for SBIC I LP to have sufficient cash to fully redeem its outstanding SBA debentures totaling $31.9 million. Additionally, at December 31, 2023, we had an unused commitment of $25.0 million under our Banc of California Credit Facility, as well as an unused commitment of $59.5 million under the BNP Facility, both of which are subject to borrowing base requirements and other covenants. As of December 31, 2023, the aggregate amount outstanding of the senior securities issued by us was $302.4 million, for which our asset coverage was 160%. The SBA debentures were not subject to the asset coverage requirements of the 1940 Act as a result of exemptive relief granted to us by the SEC effective November 26, 2013. The asset coverage ratio for a class of senior securities representing indebtedness is calculated as our consolidated total assets, less all liabilities and indebtedness not represented by senior securities, divided by total senior securities representing indebtedness. Sources and Uses of Cash and Cash Equivalents. We generate cash through operations from net investment income and the net proceeds from 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 well as accreted interest income on Structured Finance Securities, which may not coincide with cash distributions from these investments. As discussed in “Item 8. Financial Statements and Supplementary Data—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. We also obtain cash to fund investments or general corporate activities from the issuance of securities and our revolving lines of credit. These principal sources and uses of cash and liquidity are presented below (in thousands): Year Ended December 31, 2023 2022 2021 Cash from net investment income (1) $ 17,742 $ 14,201 $ 15,111 Net (purchases and originations) repayments of portfolio investments (1) 63,824 (11,255) (27,120) Net cash provided by (used in) operating activities 81,566 2,946 (12,009) Proceeds from issuance of the Unsecured Notes, net of discounts — — 175,506 Redemptions of Unsecured Notes — — (177,850) Distributions paid to stockholders (17,954) (15,385) (12,071) Net borrowings (repayments) under revolving line of credits (14,200) 4,700 67,950 Repayments of SBA debentures (19,000) (19,000) (35,350) Payment of deferred debt issuance costs and other financing costs — (1,372) (836) Net cash provided (used) by financing activities (51,154) (31,057) 17,349 Net increase (decrease) in cash $ 30,412 $ (28,111) $ 5,340 (1) Net purchases and originations/repayments and sales of portfolio investments include purchase and origination of portfolio investments, proceeds from principal payments on portfolio investments, proceeds from sale or redemption of portfolio investments, changes in receivable for investments sold, payable form investments purchased as reported in our statements of cash flows, as well as differences in proceeds from distributions received from Structured Finance Securities relative to 90 accretion of interest income on Structured Finance Securities. Cash from net investment income includes all other cash flows from operating activities reported in our statements of cash flows. During the year ended December 31, 2023, cash increased $30.4 million, primarily due to $63.8 million of net repayments on portfolio investments, partially offset by aggregate net repayments on our outstanding debt of $33.2 million. During the year ended December 31, 2022, cash decreased $28.1 million, primarily due to the use of $31.1 million in financing activities. Our net cash used by financing activities primarily related to the redemption of $19.0 million in SBA debentures and $15.4 million of distributions paid to stockholders, respectively. During the year ended December 31, 2021, cash increased $5.3 million, primarily due to additional debt borrowings, partially offset by an increase in purchases of portfolio investments. Borrowings SBA Debentures . SBIC I LP had an SBIC license that allowed it to obtain leverage by issuing SBA-guaranteed debentures. On March 1, 2024, SBIC I LP fully repaid its outstanding SBA debentures totaling $31.9 million and requested the approval of the SBA to surrender its license to operate as a SBIC. See “—Recent Developments.” The following table shows our outstanding SBA debentures payable as of December 31, 2023 and 2022 (dollar amounts in thousands): SBA debentures outstanding Pooling Date Maturity Date Fixed Interest Rate December 31, 2023 December 31, 2022 March 25, 2015 March 1, 2025 2.872 % $ 31,920 $ 50,920 SBA debentures outstanding 31,920 50,920 Unamortized deferred debt issuance costs (20) (223) SBA debentures outstanding, net of unamortized deferred debt issuance costs $ 31,900 $ 50,697 During the year ended December 31, 2023, SBIC I LP redeemed $19.0 million of SBA debentures that were contractually due March 1, 2025. We recognized a loss on extinguishment of debt of $0.2 million related to the charge-off of deferred borrowing costs and prepaid (or breakage) interest on the redeemed debentures. Banc of California Credit Facility . We are party to the BLA with Banc of California, as lender, to provide us with a senior secured revolving credit facility, or the Banc of California Credit Facility. The Banc of California Credit Facility is available for general corporate purposes including investment funding. The maximum availability of the Banc of California 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 Banc of California Credit Facility is guaranteed by OFSCC-MB and secured by all of our and OFSCC-MB’s current and future assets, excluding assets held by OFSCC-FS and SBIC I LP and the our partnership interests in SBIC I LP. As of December 31, 2023, the BLA contained customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting requirements, a minimum tangible NAV, a minimum quarterly net investment income after incentive fees, and a maximum ratio of total liabilities divided by NAV. The BLA also contained 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, 2023, we were in compliance in all material respects with the applicable covenants. As of December 31, 2023, the terms of the Banc of California Credit Facility were as follows (dollar amounts in thousands): Principal Outstanding Unused Commitment Floor Rate Interest Rate Annual Commitment Fee Maturity Date Banc of California Credit Facility $0 $25,000 5.00% Prime + 0.25% 0.50% February 28, 2026 As of December 31, 2023, availability under the Banc of California Credit Facility was $25.0 million, based on the stated advance rate of 50% under the borrowing base, and a $0 outstanding balance. 91 On February 17, 2021, we executed an amendment to the BLA with Banc of California. The amendment, among other things: (i) increased the maximum amount available under the Banc of California Credit Facility from $20.0 million to $25.0 million; (ii) decreased the interest rate floor from 5.25% per annum to 5.00% per annum; (iii) modified certain financial performance covenants; and (iv) extended the maturity date from February 28, 2021 to February 28, 2023. On November 15, 2021, we executed an amendment to the BLA with Banc of California to decrease the interest rate floor from 5.0% to 4.0%, effective as of November 1, 2021. On April 22, 2022, we amended the Banc of California Credit Facility to: (i) increase the maximum amount available under the Banc of California Credit Facility from $25.0 million to $35.0 million; and (ii) extend the maturity date of the Banc of California Credit Facility from February 28, 2023 to February 28, 2024. On December 15, 2022, we amended the Banc of California Credit Facility to: (i) reduce the maximum amount available under the Banc of California Credit Facility from $35.0 million to $25.0 million; and (ii) eliminate the No Net Losses covenant, which restricted net losses (defined as income after adjustments to the investment portfolio for gains and losses, realized and unrealized, also shown as net increase (decrease) in net assets resulting from operations) in more than two quarters during the prior four quarters then ended. On December 15, 2023, we amended the Banc of California Credit Facility to: (i) extend the maturity date from February 28, 2024 to February 28, 2026; (ii) increase the interest rate floor from 4.00% to 5.00%; and (iii) eliminate the 0.50% unused line fee and replace it with an annual commitment fee of 0.50%. BNP Facility . On June 20, 2019, we entered into the a revolving credit and security agreement by and among OFSCC-FS, the lenders from time to time parties thereto, BNP Paribas, as administrative agent, OFSCC-FS Holdings, LLC, a wholly owned subsidiary of the Company, as equityholder, the Company, as servicer, Citibank, N.A., as collateral agent and Virtus Group, LP, as collateral administrator, which provides for borrowings in an aggregate principal amount up to $150.0 million. Borrowings under the BNP Facility bear interest of SOFR plus an applicable spread, which is determined on the basis of industry-recognized portfolio company metrics at the time of funding. The BNP Facility also contains customary events of default, including, without limitation, nonpayment, failure to maintain valid ownership interest in all of the collateral and bankruptcy. Borrowings under the BNP Facility are secured by substantially all of the assets held by OFSCC-FS. On June 24, 2022, OFSCC-FS amended the BNP Facility to, among other things: (i) extend the reinvestment period under the BNP Facility for three years from June 20, 2022 to June 20, 2025; (ii) extend the maturity date under the BNP Facility from June 20, 2024 to June 20, 2027; (iii) convert the benchmark interest rate from LIBOR to SOFR; (iv) increase the applicable margin by 0.40% on all classes of loans; and (v) increase the applicable margin floor from 1.925% to 2.65%. As of December 31, 2023, the BNP Facility had the following terms and balances (dollar amounts in thousands): Principal Outstanding Unused Commitment Interest Rate Maturity BNP Facility $90,500 $59,500 SOFR + 2.65% June 20, 2027 Unsecured Notes . At December 31, 2023 and 2022, the outstanding Unsecured Notes totaled $180.0 million and $180.0 million in aggregate principal debt, respectively. During the years ended December 31, 2023 and 2022, we did not issue, redeem or repurchase any Unsecured Notes. Issuances On February 10, 2021, we closed the public offering of $100.0 million aggregate principal amount of our Unsecured Notes Due February 2026, and on March 18, 2021, we closed an additional public offering of $25.0 million aggregate principal amount of our Unsecured Notes Due February 2026. The total net proceeds to us from the Unsecured Notes Due February 2026, after deducting underwriting discounts and offering expenses of $3.9 million, was approximately $121.1 million. On October 28, 2021 and November 1, 2021, we closed the public offering of $55.0 aggregate principal amount of our Unsecured Notes Due October 2028, which included a full exercise of the underwriters overallotment option. The total net proceeds to us, after deducting underwriting discounts and offering expenses of $1.4 million, was approximately $53.6 million. Redemptions On March 12, 2021, we redeemed all of our $50.0 million aggregate principal amount of Unsecured Notes Due April 2025 and $48.5 million aggregate principal amount of Unsecured Notes Due October 2025. On November 1, 2021, we redeemed all of our $25.0 million aggregate principal amount of Unsecured Notes Due September 2023. 92 On November 22, 2021, we redeemed all of our $54.3 million aggregate principal amount of Unsecured Notes Due October 2026. During the year ended December 31, 2021, we recognized a loss on extinguishment of $4.3 million related to the charge-off of deferred borrowing costs on the redemption of Unsecured Notes. The outstanding Unsecured Notes are direct unsecured obligations and rank equal in right of payment with all of our current and future unsecured indebtedness. Because the outstanding 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 Banc of California Credit Facility and BNP Facility. In order to, among other things, reduce future cash interest payments, as well as future amounts due at maturity or upon redemption, we may, from time to time, purchase the outstanding Unsecured Notes for cash in open market purchases and/or privately negotiated transactions. We will evaluate any such transactions in light of then-existing market conditions, taking into account our current liquidity, prospects for future access to capital, contractual restrictions and other factors. The amounts involved in any such transactions, individually or in the aggregate, may be material. No outstanding Unsecured Notes were repurchased during the years ended December 31, 2023 and 2022. As of December 31, 2023, the outstanding Unsecured Notes had the following terms and balances (dollar amounts in thousands): Unsecured Notes Principal Stated Interest Rate (1) Effective Interest Rate (2) Maturity (3) Unsecured Notes Due February 2026 $ 125,000 4.75 % 5.39 % February 10, 2026 Unsecured Notes Due October 2028 55,000 4.95 5.32 October 31, 2028 Total $ 180,000 (1) The weighted-average fixed cash interest rate on the Unsecured Notes as of December 31, 2023 was 4.81%. (2) The effective interest rate on the Unsecured Notes includes deferred debt issuance cost amortization. (3) We may redeem the Unsecured Notes Due February 2026 in whole or in part at any time, or from time to time, at our option at par plus a “make-whole” premium, if applicable. We may redeem the Unsecured Notes Due October 2028 in whole or in part at any time, or from time to time. The average dollar borrowings and average interest rate related to our debt for the years ended December 31, 2023, 2022 and 2021, were as follows (dollar amounts in thousands): Year Ended Average Dollar Borrowings Weighted-Average Interest Rate December 31, 2023 $ 324,357 6.01 % December 31, 2022 358,337 4.75 December 31, 2021 344,241 5.09 As of December 31, 2023, we had $302.4 million of outstanding debt with a weighted-average effective interest rate of 6.1%, which we believe is a favorable financing rate compared to today’s rates. As of December 31, 2023, 70% of our outstanding debt was fixed rate and 89% of our outstanding debt matures in 2026 and beyond. Other Liquidity Matters. We expect to fund the growth of our investment portfolio utilizing future equity offerings, and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act. On July 19, 2023, our stockholders approved a proposal to authorize us, with approval of our Board, to sell or otherwise issue shares of our common stock (during a twelve-month period) at a price below our then-current NAV per share in one or more offerings, subject to certain limitations (including that the cumulative number of shares sold pursuant to such authority does not exceed 25% of our then outstanding common stock immediately prior to each such sale). 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 certain 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 and incur a capital loss. A BDC generally is not permitted to incur indebtedness unless immediately after such borrowing it has 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). However, Section 61(a)(2) of the 1940 Act provides that a BDC may reduce its asset coverage ratio, provided that certain 93 conditions are met. Specifically, Section 61(a)(2) 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, our Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) thereof, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, effective May 3, 2019, our minimum required asset coverage ratio decreased from 200% to 150%. See “Item 1A. Risk Factors—Risks Related to our Business and Structure—Because we received the approval of our Board, we became subject to 150% asset coverage effective May 3, 2019.” Additionally, effective November 26, 2013, we received exemptive relief from the SEC 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. We continue to monitor the current banking environment arising from recent bank failures. If the banks and financial institutions with whom we have credit facilities enter into receivership, undergo consolidation or become insolvent in the future, our liquidity may be reduced significantly. At various times, our cash balances at third-party financial institutions exceed the federally insured limit. Our cash balances are retained in custodian accounts with U.S. Bank N.A and Citibank N.A., and we do not believe they are exposed to any significant credit risk. Contractual Obligations and Off-Balance Sheet Arrangements At December 31, 2023, we had $45.3 million of cash, as well as access to $25.0 million under our Banc of California Credit Facility and $59.5 million under our BNP Facility, to meet our short-term contractual obligations. At December 31, 2023, we had $13.8 million of outstanding commitments to fund portfolio investments that can be funded with our current cash or credit facilities. Long-term contractual obligations, such as our BNP Facility that matures in 2027 and has $90.5 million outstanding at December 31, 2023, can be repaid by selling OFSCC-FS portfolio investments that have a fair value of $152.6 million at December 31, 2023. The OFSCC-FS portfolio includes Broadly Syndicated Loans in larger portfolio companies that generally can be sold over a relatively short period to generate cash. We cannot, however, be certain that this source of funds will be available and upon terms acceptable to us in sufficient amounts in the future. If we were required to liquidate a portfolio investment in a forced or liquidation sale, we could realize significantly less than its current fair value and incur significant realized losses on our invested capital. At December 31, 2023, we had $31.9 million of outstanding SBA debentures that matured on March 1, 2025. On March 1, 2024, we fully repaid our outstanding SBA debentures totaling $31.9 million and requested the approval of the SBA to surrender our license to operate as a SBIC. See “—Recent Developments . ” We have entered into contracts with affiliates under which we will incur material future commitments: (i) the Investment Advisory Agreement, pursuant to which OFS Advisor has agreed to serve as our investment adviser; and (ii) 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 on the balance sheet. There is no guarantee that these amounts will be funded to the borrowing party now or in the future. We continue to believe that we have sufficient levels of liquidity to support our existing portfolio companies and will meet these unfunded commitments by using our cash on hand or utilizing our available borrowings under the Banc of California Credit Facility and BNP Facility. 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. 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. 94 Our Board maintains a variable dividend policy with the objective of distributing quarterly distributions in an amount not less than 90% of our taxable quarterly income or potential annual income for a particular year. In addition, during the year, we may pay a special dividend, such that we may make additional, non-recurring, distributions of accumulated taxable income, while maintaining the option to spill over our excess taxable income to a following year. We may choose to retain a portion of our taxable income in any year and pay the 4% U.S. federal excise tax on the retained amounts. For the years ended December 31, 2023, 2022 and 2021, we accrued U.S. federal excise taxes of $0, $0.1 million and $0, respectively. Each year, a statement on Form 1099-DIV identifying the source of our distributions is provided to the Company’s stockholders, as required. For a detailed description of our distributions paid for the years ended December 31, 2023, 2022 and 2021, see “Item 8. Financial Statements and Supplementary Data—Note 10.” Recent Developments On February 28, 2024, our Board declared a distribution of $0.34 per share for the first quarter of 2024, payable on March 28, 2024 to stockholders of record as of March 18, 2024. On March 1, 2024, SBIC I LP fully repaid its outstanding SBA debentures totaling $31.9 million that were contractually due March 1, 2025, and requested the approval of the SBA to surrender its license to operate as a SBIC. 95