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OFS CAPITAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[August 08, 2014]

OFS CAPITAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements This quarterly report on Form 10-Q 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 limited experience operating a business development company, or BDC, or a small business investment company, or SBIC, or maintaining our status as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"); • our dependence on key personnel; • our ability to maintain or develop referral relationships; • the administration of OFS Capital WM, LLC's, or OFS Capital WM's, portfolio by an unaffiliated loan manager; • our ability to replicate historical results; • the ability of OFS Capital Management, LLC, or OFS Advisor, to identify, invest in and monitor companies that meet our investment criteria; • actual and potential conflicts of interest with OFS Advisor and other affiliates of Orchard First Source Asset Management, LLC, or OFSAM, which is the holding company of OFS Advisor and OFS Services and owns approximately 31% of our outstanding shares of common stock; • constraints on investment due to access to material nonpublic information; • restrictions on our ability to enter into transactions with our affiliates; • limitations on the amount of debentures guaranteed by the Small Business Administration, or SBA, that may be issued by an SBIC; • Our ability to comply with SBA regulations and requirements; • the use of borrowed money to finance a portion of our investments; • competition for investment opportunities; • our ability to qualify and maintain our qualification as a RIC and as a BDC; • the ability of OFS SBIC I LP, or SBIC I LP, OFS Capital WM and any other portfolio companies to make distributions enabling us to meet RIC requirements; • our ability to raise capital as a BDC; • the timing, form and amount of any distributions from our portfolio companies; • the impact of a protracted decline in the liquidity of credit markets on our business; • the general economy and its impact on the industries in which we invest; • uncertain valuations of our portfolio investments; and • the effect of new or modified laws or regulations governing our operations.

35 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 quarterly report on Form 10-Q 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 our annual report on Form 10-K for our year ended December 31, 2013. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this quarterly report on Form 10-Q.

We have based the forward-looking statements on information available to us on the date of this quarterly report on Form 10-Q. 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 may file with the SEC in the future, 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 quarterly report on Form 10-Q are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto contained elsewhere in this quarterly report on Form 10-Q.

Overview We are an externally managed, closed-end, non-diversified management investment company. Our investment objective is to provide our shareholders with both current income and capital appreciation primarily through debt investments and, to a lesser extent, equity investments. Our investment strategy focuses primarily on investments in middle-market companies in the United States. We use the term "middle-market" to refer to companies that may exhibit one or more of the following characteristics: number of employees between 150 and 2,000; revenues between $15 million and $300 million; annual earnings before interest, taxes, depreciation and amortization, or EBITDA, between $3 million and $50 million; generally, private companies owned by private equity firms or owners/operators; and enterprise value between $10 million and $500 million.

As of June 30, 2014, our investment portfolio consisted of outstanding loans of approximately $231.2 million in aggregate principal amount in 57 portfolio companies, of which $69.4 million in aggregate principal amount was held by SBIC I LP, our wholly-owned SBIC subsidiary, in twelve portfolio companies. As of June 30, 2014, 93% of our investment portfolio was comprised of senior secured loans, 4% of subordinated loans and 3% of equity investments, at fair value.

Our investment strategy focuses primarily on middle-market companies in the United States, including senior secured loans, which includes first-lien, second-lien and unitranche loans, as well as subordinated loans, and, to a lesser extent, warrants and other minority equity securities. We also may invest up to 30% of our portfolio in opportunistic investments of non-eligible portfolio companies. Specifically, as part of this 30% basket, we may consider investments in investment funds that are operating pursuant to certain exceptions to the Investment Company Act of 1940, as amended, or the 1940 Act, and in advisers to similar investment funds, as well as in debt of middle-market companies located outside of the United States and debt and equity of public companies that do not meet the definition of eligible portfolio companies because their market capitalization of publicly traded equity securities exceeds the levels provided for in the 1940 Act.

Our investment strategy includes SBIC I LP, which received an SBIC license from the SBA in May 2012. On December 4, 2013, we received approval from the SBA to acquire all of the limited partnership interests in SBIC I LP and all of the ownership interests of its general partner, OFS SBIC I GP, LLC, or SBIC I GP, that were owned or subscribed for by other persons. We acquired the interests on December 4, 2013, which resulted in SBIC I LP becoming a wholly-owned subsidiary. The transaction was finalized in January 2014. The SBIC license allows SBIC I LP to receive SBA-guaranteed debenture funding, subject to the issuance of a leverage commitment by the SBA and other customary procedures. SBA leverage funding is subject to SBIC I LP's payment of certain fees to the SBA, and the ability of SBIC I LP to draw on the commitment is subject to its compliance with SBA regulations and policies, including an audit by the SBA.

On November 26, 2013, we received an exemptive order from the SEC to permit us to exclude the debt of SBIC I LP guaranteed by the SBA from the definition of senior securities in the statutory 200% asset coverage ratio under the 1940 Act, allowing for greater capital deployment.

36 Our investment activities are managed by OFS Advisor, and supervised by our board of directors, a majority of whom are independent of us, OFS Advisor and its affiliates. Under the Investment Advisory and Management Agreement between us and OFS Advisor, or the 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), adjusted for any share issuances or repurchases during the quarter, as well as an incentive fee based on our investment performance. We have elected to exclude from the base management fee calculation any base management fee that would be owed in respect of the intangible asset and goodwill resulting from our acquisitions of the remaining ownership interests in SBIC I LP and SBIC I GP on December 4, 2013. We have also entered into an administration agreement, or the Administration Agreement, with OFS Capital Services, LLC, or OFS Services, our Administrator. Under our Administration Agreement, we have agreed to reimburse OFS Services for our allocable portion (subject to policies reviewed and approved by our independent directors) of overhead and other expenses incurred by OFS Services in performing its obligations under the Administration Agreement.

As a BDC, we must not acquire any assets other than "qualifying assets" specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets (with certain limited exceptions).

Qualifying assets include investments in "eligible portfolio companies." Under the relevant SEC rules, the term "eligible portfolio company" includes all private companies, companies whose securities are not listed on a national securities exchange, and certain public companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized in the United States.

We are permitted to borrow money from time to time within the levels permitted by the 1940 Act (which generally allows us to incur leverage for up to 50% of our asset base). We may borrow money when the terms and conditions available are favorable to do so and are aligned with our investment strategy and portfolio composition. The use of borrowed funds or the proceeds of preferred stock to make investments would have its own specific benefits and risks, and all of the costs of borrowing funds or issuing preferred stock would be borne by holders of our common stock.

We have elected to be treated for tax purposes as a RIC, under Subchapter M of the Code. To qualify as a RIC, we must, among other things, meet certain source-of-income and assets diversification requirements. Pursuant to these elections, we generally will not have to pay corporate-level taxes on any income we distribute to our shareholders.

Recent Developments and Other Factors Affecting Comparability Transactions with SBIC I LP prior to our Initial Public Offering ("IPO"). Prior to May 10, 2012, we were deemed to be the primary beneficiary of SBIC I LP (formerly Tamarix Capital Partners, L.P.) and, therefore, in accordance with Accounting Standards Codification Topic 810, or ASC Topic 810, the financial statements of SBIC I LP were consolidated with ours. On May 10, 2012, as a result of SBIC I LP's receipt of an SBIC license, we became a 68.4% limited partner in SBIC I LP and were deemed, under the applicable accounting literature, to continue to hold a controlling financial interest in SBIC I LP, as described more fully in our consolidated financial statements. Accordingly, we continued to consolidate the financial statements of SBIC I LP with ours at June 30, 2012. On July 27, 2012, however, SBIC I LP repaid its loans together with accrued interest due to us in an aggregate amount of approximately $16.6 million, and the three investment professionals of SBIC I GP, (formerly Tamarix Capital G.P. LLC) resigned from our affiliated entity. As a result, effective as of July 27, 2012, we deconsolidated SBIC I LP's financial statements from our own, and accounted for our investment in SBIC I LP under the equity method of accounting ("Tamarix Deconsolidation"). From November 8, 2012, upon the completion of our IPO, until our acquisitions of the remaining ownership interests in SBIC I LP and SBIC I GP on December 4, 2013, we accounted for our equity investment in SBIC I LP at fair value.

Acquisition of SBIC I LP & SBIC I GP Interests. On December 4, 2013, we purchased the remaining limited partnership interests in SBIC I LP (the "Tamarix LP Acquisition"), making SBIC I LP a wholly owned subsidiary of OFS Capital. On December 4, 2013, OFS Capital also acquired all of the remaining membership interests in SBIC I GP (the "Tamarix GP Acquisition"). The Tamarix LP Acquisition and Tamarix GP Acquisition are referred to collectively as the "Tamarix Acquisitions" (see Note 3 of our June 30, 2014 unaudited consolidated financial statements for more details). The transaction was finalized in January 2014. Upon the Tamarix Acquisitions, on December 4, 2013, we again consolidated the financial statements of both SBIC I LP and SBIC I GP into our financial statements.

2013 and 2014 OFS Capital WM Credit Facility Amendments. On January 22, 2013, the OFS Capital WM Credit Facility, which is defined under the Financial Condition, Liquidity and Capital Resources section below, was amended, pursuant to which the Class B Facility, which had no outstanding borrowings, was terminated. As a result, the OFS Capital WM Credit Facility commitment was reduced from $180 million to $135 million.

On November 22, 2013, the OFS Capital WM Credit Facility was further amended.

Pursuant to the amendment, (1) the Class A loans with Wells Fargo Bank, N.A., or Wells Fargo, were extended to December 31, 2018; (2) the reinvestment period for the Wells Fargo loan was extended to December 31, 2015; (3) the accrued interest rate on outstanding Class A loans was amended to London Interbank Offered Rate ("LIBOR") plus 2.50% per annum, and (4) the advance rate on borrowing was increased from 65% to 70%. In connection with the amendment, OFS Capital WM incurred financing costs of approximately $1.2 million.

37 On January 17, 2014, the OFS Capital WM Credit Facility was amended again, pursuant to which the calculation of the borrowing base was adjusted and the minimum equity requirement was lowered from $65 million to $50 million, resulting in additional liquidity for the Company. No financing costs were incurred in connection with this amendment.

See "-Recent Developments" for information regarding another amendment to the OFS Capital WM Credit Facility in July 2014.

Critical Accounting Policies The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and disclosure of revenues and expenses during the periods reported. Actual results could materially differ from those estimates. We have identified the following items as critical accounting policies: Valuation of Portfolio Investments.

The most significant estimate inherent in the preparation of our consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded.

Our investments are carried at fair value in accordance with the 1940 Act and ASC Topic 820. At June 30, 2014, approximately 89% of our total assets represented investments in portfolio companies that are valued at fair value by our board of directors. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value as determined in good faith by the board of directors. Our debt and equity securities are primarily comprised of investments in middle market companies whose securities are not publicly traded. Our investments in these portfolio companies are generally considered Level 3 assets under ASC Topic 820 because the inputs used to value the investments are generally unobservable. As such, we value substantially all of our investments at fair value as determined in good faith by our board of directors pursuant to a consistent valuation policy in accordance with the provisions of ASC Topic 820 and the 1940 Act. Due to the inherent uncertainty in determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by our board of directors may differ significantly from the value that would have been used had a readily available market existed for such investments, and the differences could be material.

Our policies relating to the valuation of our portfolio investments are as follows: Investments for which sufficient market quotations are readily available are valued at such market quotations. We may also obtain indicative prices with respect to certain of our investments from pricing services or brokers or dealers in order to value such investments. There is not a readily available market value for many of our investments; those debt and equity securities that are not publicly traded or whose market prices are not readily available are valued at fair value as determined in good faith by the board of directors. We value such investments at fair value as determined in good faith by our board of directors using a documented valuation policy and a consistently applied valuation process. Our valuation of each of our assets for which sufficient market quotations are not readily available is reviewed by one or more independent third-party valuation firms at least once every 12 months.

Our board of directors is ultimately and solely responsible for determining the fair value of the portfolio investments that are not publicly traded, whose market prices are not readily available on a quarterly basis or in any other situation where portfolio investments require a fair value determination.

With respect to investments for which sufficient market quotations are not readily available or for which no or an insufficient number of indicative prices from pricing services or brokers or dealers have been received, our board of directors undertakes, on a quarterly basis, unless otherwise noted, a multi-step valuation process, as described below: • For each debt investment, a basic credit rating review process is completed. The risk rating on every credit facility is reviewed and either reaffirmed or revised by the Investment Committee of OFS Advisor, or the Advisor Investment Committee. This process establishes base information for the quarterly valuation process.

• Each portfolio company or investment is valued by an investment professional.

• Preliminary valuation conclusions are then documented and discussed with individual members of the Advisor Investment Committee.

• The preliminary valuations are then submitted to the Advisor Investment Committee for ratification.

38 • Third-party valuation firm(s) are engaged to provide valuation services as requested, by reviewing the preliminary valuations of the Advisor Investment Committee. The Advisor Investment Committee's preliminary fair value conclusions on each of our assets for which sufficient market quotations are not readily available are reviewed and assessed by a third-party valuation firm at least once in every 12-month period, and more often as determined by our board of directors or required by our valuation policy. Such valuation assessment may be in the form of positive assurance, range of values or other valuation methods based on the discretion of our board of directors.

• Our board of directors will discuss valuations and determine the fair value of each investment in the portfolio in good faith based on the input of OFS Advisor and, where appropriate, the respective independent valuation firms.

The types of factors that we may take into account in fair value pricing our investments include, as relevant, the nature and realizable value of any collateral, the portfolio company's ability to make payments and its earnings and cash flows, the markets in which the portfolio company does business, comparison to publicly traded securities and other relevant factors.

Determination of fair value involves subjective judgments and estimates.

Accordingly, the notes to our financial statements will express the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our financial statements.

Revenue Recognition. Our revenue recognition policies are as follows: Investments and Related Investment Income:Investments are recorded at fair value. Our board of directors determines the fair value of its portfolio investments. Interest income is accrued based upon the outstanding principal amount and contractual interest terms of debt investments. We accrue interest income until certain events take place that may place a loan into a non-accrual status. In addition, we may generate revenue in the form of commitment, origination, amendment, structuring or due diligence fees, fees for providing managerial assistance and consulting fees. Loan origination fees, original issue discount, or OID, market discount or premium, and loan amendment fees (collectively, "net loan origination fee income") are capitalized, and we accrete or amortize such amounts on a straight-line basis over the life of the loan as interest income. When we receive a loan principal payment, the OID related to the paid principal is accelerated and recognized in interest income.

This method is not materially different than the effective interest rate method.

All other income is recorded into income when earned. Further, in connection with our debt investments, we will sometimes receive warrants or similar no-cost equity-related securities ("Warrants"). We determine the cost basis of Warrants based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and Warrants received. Any resulting difference between the face amount of the debt and its recorded fair value resulting from the assignment of value to the Warrants is treated as OID, and accreted into interest income over the life of the debt security. Dividend income is recorded at the time dividends are declared or at the point an obligation exists for the portfolio company to make a distribution. Distribution of earnings from portfolio companies are evaluated to determine if the distribution is income or return of capital.

As of June 30, 2014 and December 31, 2013, unamortized discounts and origination fees on debt investments amounted to approximately $1.9 million and $2.1 million, respectively. For the three and six months ended June 30, 2014, we recognized net loan origination fee income of $264 thousand and $606 thousand, respectively. For the three and six months ended June 30, 2013, we recognized net loan origination fee income of $359 thousand and $725 thousand, respectively.

For investments with contractual paid-in-kind, or PIK interest which represents contractual interest accrued and added to the principal balance that generally becomes due at maturity (or at some other stipulated date), we will not accrue PIK interest if the portfolio company valuation indicates that the PIK interest is not collectible. For the three and six months ended June 30, 2014, we recognized PIK interest in the amount of $112 thousand and $238 thousand, respectively. For the three and six months ended June 30, 2013, we did not recognize any PIK interest.

Investment transactions are accounted for on a trade-date basis. Realized gains or losses on investments are measured by the difference between the net proceeds from the disposition and the cost basis of investment, without regard to unrealized gains or losses previously recognized. The Company reports changes in fair value of investments that are measured at fair value as a component of the net changes in unrealized appreciation (depreciation) on investments in the consolidated statement of operations.

Non-accrual. Loans on which the accrual of interest income has been discontinued are designated as non-accrual loans, and non-accrual loans are further designated to be accounted for under either a non-accrual cash method or a non-accrual cost recovery method. Loans are generally placed on non-accrual when a loan either: (i) is delinquent for 90 days or more on principal or interest based on contractual terms of the loan (unless well secured and in the process of collection), or (ii) in the opinion of our management, there is reasonable doubt about the collectability. When loans are placed on non-accrual status, all interest previously accrued but not collected, other than PIK that has already been contractually added to the principal balance, is reversed against current period interest income. Interest payments received on non-accrual loans may be recognized as income or applied to principal, depending upon management's judgment. Interest accruals are resumed on non-accrual loans only when they are brought current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to all principal and interest. We had two non-accrual loans at June 30, 2014 and one at December 31, 2013, all of which were accounted for as of June 30, 2014 as non-accrual cash method loans. These loans had a fair value of approximately $6.7 million and $1.1 million at June 30, 2014 and December 31, 2013, respectively.

39 Principles of consolidation.

Our June 30, 2014 consolidated financial statements include the accounts of OFS Capital Corporation, or OFS Capital, and our wholly owned subsidiaries, OFS Capital WM, OFS Funding, LLC, SBIC I LP and SBIC I GP. We consolidate an affiliated subsidiary if we own more than 50 percent of the subsidiary's equity and hold the controlling financial interest in such subsidiary. We also consolidate a variable interest entity ("VIE") if we are the primary beneficiary in the VIE. Effective July 27, 2012, we deconsolidated the financial statements of SBIC I LP from our own. Effective December 4, 2013, we consolidated the financial statements of SBIC I LP and SBIC I GP into our own. See "Financial Statements - Note 3" for more detailed information.

Portfolio Composition and Investment Activity Portfolio Composition The total fair value of our investments was approximately $230.7 million at June 30, 2014 and approximately $237.9 million at December 31, 2013. Our investment portfolio as of June 30, 2014 consisted of outstanding loans to 57 portfolio companies, totaling approximately $231.2 million in aggregate principal amount (including SBIC I LP's $69.4 million in loans to twelve portfolio companies), of which 96% were senior secured loans and 4% were subordinated loans, as well as SBIC I LP's approximately $8.2 million in equity investments, at fair value, in eight portfolio companies in which it also holds debt investments. Our investment portfolio encompassed a broad range of geographical regions and industries. As of June 30, 2014, we had unfunded commitments of $5.8 million for four portfolio companies, including $4.3 million for three portfolio companies of SBIC I LP. Set forth in the tables and charts below is selected information with respect to our portfolio as of June 30, 2014.

The following table summarizes the composition of our investment portfolio.

As of June 30, 2014 Outstanding Commitment Principal (Dollar amounts in thousands) Senior secured term loan $ 225,539 $ 222,289 Subordinated term loan 8,928 8,928 Senior secured revolver 2,594 - Equity investments (at fair value) 8,212 8,212 $ 245,273 $ 239,429 Total # of Obligors 57 57 40 The following chart provides a regional breakdown of our investment portfolio commitment as of June 30, 2014.

[[Image Removed]] Our investment portfolio's three largest industries are Healthcare & Pharmaceuticals, Services: Business, and Beverage, Food, & Tobacco, totaling approximately 50% of the investment portfolio. The following table summarizes our investment portfolio by industry as of June 30, 2014.

As of June 30, 2014 Industry Commitment Percent (Dollar amounts in thousands) Aerospace & Defense $ 15,941 6.5 % Automotive 7,086 2.9 Beverage, Food & Tobacco 23,629 9.6Banking, Finance, Insurance & Real Estate 7,000 2.9 Capital Equipment 7,887 3.2 Chemicals, Plastics & Rubber 19,085 7.8 Construction & Building 1,707 0.7 Consumer goods: Non-durable 6,708 2.7 Containers, Packaging & Glass 4,138 1.7 Energy: Oil & Gas 7,016 2.9 Environmental Industries 7,696 3.1 Healthcare & Pharmaceuticals 51,903 21.2 High Tech Industries 7,830 3.2 Media: Advertising, Printing & Publishing 10,098 4.1 Media: Broadcasting & Subscription 3,782 1.5 Retail 3,819 1.6 Services: Business 46,415 18.9 Services: Consumer 6,336 2.6 Telecommunications 7,197 2.9 $ 245,273 100.0 % 41 The following table summarizes our debt investment portfolio by size of exposure.

As of June 30, 2014 Commitment NumberDebt Investment Size (in millions) (Dollar amounts in thousands) $0- $3 $ 35,361 14 $3- $4 53,245 15 $4- $5 90,542 20 $5- $10 57,913 8 >$10 - 0 $ 237,061 57 The following chart provides a breakdown of our debt investment portfolio by investment commitment size as of June 30, 2014.

[[Image Removed]] The following chart provides a breakdown of our debt investment portfolio by yield to fair value as of June 30, 2014.

[[Image Removed]] 42 Investment Activity For the six months ended June 30, 2014, we closed four new debt investments with an aggregate face value of $23.0 million and made an add-on investment of approximately $0.8 million in an existing portfolio company. In addition, for the six months ended June 30, 2014, we participated in a refinancing transaction with an existing portfolio company in the amount of approximately $2.1 million.

For the six months ended June 30, 2014, we received approximately $29.7 million in proceeds from principal payments on debt investments, and approximately $7.5 million in proceeds from debt investments we sold, of which approximately $4.5 million pertained to a debt investment we sold in December 2013.

For the year ended December 31, 2013, we closed debt investments with eight companies with an aggregate face value of approximately $41.2 million and made equity investments totaling approximately $2.5 million in one portfolio company.

Prior to the December 4, 2013 Tamarix Acquisitions, SBIC I LP closed nine investments with five portfolio companies during the period January 1, 2013 through December 4, 2013. SBIC I LP's nine new investments during that period consisted of four debt investments with total principal balance of $19.4 million and unfunded commitments of $3.3 million as well as five equity investments purchased for a total of $0.9 million. For the year ended December 31, 2013, we received approximately $63.1 million in proceeds from principal payments on debt investments and sold three debt investments for approximately $13.9 million, of which approximately $4.5 million was settled in January 2014.

Portfolio Credit Ratings We categorize debt investments into seven risk categories based on relevant information about the ability of borrowers to service their debt.

1 (Low Risk) - A risk rated 1, or Low Risk, credit is a credit that has the most satisfactory asset quality and liquidity, as well as good leverage capacity. It maintains predictable and strong cash flows from operations. The trends and outlook for the credit's operations, balance sheet, and industry are neutral to favorable. Collateral, if appropriate, has maintained value and would be capable of being liquidated on a timely basis. Overall, a 1 rated credit would be considered to be of investment grade quality.

2 (Below Average Risk) - A risk rated 2, or Below Average Risk, credit is a credit that has acceptable asset quality, moderate excess liquidity, and modest leverage capacity. It could have some financial/non-financial weaknesses that are offset by strengths; however, the credit demonstrates an ample current cash flow from operations. The trends and outlook for the credit's operations, balance sheet, and industry are generally positive or neutral to somewhat negative. Collateral, if appropriate, has maintained value and would be capable of being liquidated successfully on a timely basis.

3 (Average) - A risk rated 3, or Average, credit is a credit that has acceptable asset quality, somewhat strained liquidity, and minimal leverage capacity. It is at times characterized by just acceptable cash flows from operations. Under adverse market conditions, carrying the current debt service could pose difficulties for the borrower. The trends and conditions of the credit's operations and balance sheet are neutral to slightly negative.

4 (Special Mention) - A risk rated 4, or Special Mention, credit is a credit with no apparent loss of principal or interest envisioned. Nonetheless, it possesses credit deficiencies or potential weaknesses that deserve management's close and continued attention. The credit's operations and/or balance sheet have demonstrated an adverse trend or deterioration that, while serious, has not reached the point where the liquidation of debt is jeopardized. These weaknesses are generally considered correctable by the borrower in the normal course of business but may, if not checked or corrected, weaken the asset or inadequately protect our credit position.

5 (Substandard) - A risk rated 5, or Substandard, credit is a credit inadequately protected by the current enterprise value or paying capacity of the obligor or of the collateral, if any. These credits have well-defined weaknesses based upon objective evidence, such as recurring or significant decreases in revenues and cash flows. These assets are characterized by the possibility that we may sustain loss if the deficiencies are not corrected. The possibility that liquidation would not be timely (e.g. bankruptcy or foreclosure) requires a Substandard classification even if there is little likelihood of loss.

6 (Doubtful) - A risk rated 6, or Doubtful, credit is a credit with all the weaknesses inherent in those classified as Substandard, with the additional factor that the weaknesses are pronounced to the point that collection or liquidation in full, on the basis of currently existing facts, conditions and values is deemed uncertain. The possibility of loss on a Doubtful asset is high but, because of certain important and reasonably specific pending factors that may strengthen the asset, its classification as an estimated loss is deferred until its more exact status can be determined.

7 (Loss) - A risk rated 7, or Loss, credit is a credit considered almost fully uncollectible and of such little value that its continuance as an asset is not warranted. It is generally a credit that is no longer supported by an operating company, a credit where the majority of our assets have been liquidated or sold and a few assets remain to be sold over many months or even years, or a credit where the remaining collections are expected to be minimal.

The following table shows the classification of our debt investments portfolio by credit rating as of June 30, 2014 and December 31, 2013: June 30, 2014 December 31, 2013 Debt Debt Investments, at % of Debt Investments, at % of Debt Fair Value Investments Fair Value Investments Credit Rating (Dollar amounts in thousands) 1 $ - 0.0 % $ - 0.0 % 2 - 0.0 % - 0.0 % 3 202,262 90.9 % 204,273 88.6 % 4 13,538 6.1 % 17,384 7.5 % 5 - 0.0 % 7,846 3.4 % 6 6,712 3.0 % 1,051 0.5 % 7 - 0.0 % - 0.0 % $ 222,511 100.0 % $ 230,554 100.0 % 43 The following table shows the cost and fair value of our portfolio of investments by asset class as of June 30, 2014 and December 31, 2013.

As of June 30, As of December 31, 2014 2013 Cost Fair Value Cost Fair Value (Dollar amounts in thousands) Senior Secured Performing $ 207,874 $ 206,712 $ 222,564 $ 220,495 Non-Accrual 12,307 6,712 3,988 1,051 Subordinated Performing 9,113 9,087 9,009 9,008 Non-Accrual - - - - Equity Investments 7,851 8,212 7,862 7,365 Total $ 237,145 $ 230,723 $ 243,423 $ 237,919 As of June 30, 2014, the weighted average yield to fair value of our debt investments was approximately 8.08%. Throughout this document, the weighted average yield on debt investments at fair value is computed as (a) total annual stated interest on accruing loans plus the annualized amortization of deferred loan origination fees and accretion of OID divided by (b) total debt investments at fair value excluding assets on non-accrual basis. The weighted average yield on debt investments at fair value is computed as of the balance sheet date.

As of June 30, 2014, floating rate loans comprised 84% of our debt investment portfolio and fixed rate loans comprised 16% of our debt investment portfolio, as a percent of fair value.

Our level of investment activity may vary substantially from period to period depending on various factors, including, but not limited to, the amount of debt and equity capital available to middle market companies, the level of merger and acquisition activity, the general economic environment and the competitive environment for the types of investments we make.

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.

Revenues. We generate revenue in the form of interest income on debt investments and capital gains and distributions, if any, from our investment securities in portfolio companies. Our debt investments typically have a term of three to eight years and bear interest at fixed and floating rates. As of June 30, 2014, floating rate and fixed rate loans comprised 84% and 16%, respectively, of our current debt investment portfolio; however, in accordance with our investment strategy, we expect that over time the proportion of fixed rate loans will increase. In some instances, we receive payments on our debt investments based on scheduled amortization of the outstanding balances. In addition, we anticipate receiving repayments of some of our debt investments prior to their scheduled maturity date. The frequency or volume of these repayments may fluctuate significantly from period to period. On occasion, our portfolio activity may also reflect the proceeds of sales of securities. In some cases, our investments will provide for deferred interest payments or PIK interest (meaning interest paid in the form of additional principal amount of the loan instead of in cash). In addition, we may generate revenue in the form of commitment, origination and sourcing, structuring or due diligence fees, fees for providing managerial assistance and consulting fees. Loan origination fees, OID, market discount or premium, and loan amendment fees are capitalized, and the Company accretes or amortizes such amounts over the life of the loan as interest income. When we receive principal payments on a loan in an amount that exceeds its carrying value, we will also record the excess principal payment as income. Dividend income, if any, will be recognized on an accrual basis to the extent that we expect to collect such amounts.

Expenses. Our primary operating expenses include interest expense due under our outstanding borrowings (both the OFS Capital WM Credit Facility and the SBA debentures), the payment of fees to OFS Advisor under the Advisory Agreement, our allocable portion of overhead expenses under the Administration Agreement and other operating costs described below. Additionally, we will pay interest expense on any outstanding debt under any new credit facility or other debt instrument we may enter into. We will bear all other out-of-pocket costs and expenses of our operations and transactions, whether incurred by us directly or on our behalf by a third party, including: • the cost of calculating our net asset value, including the cost of any third-party valuation services; • the cost of effecting sales and repurchases of shares of our common stock and other securities; 44 • fees payable to third parties relating to making investments, including out-of-pocket fees and expenses associated with performing due diligence and reviews of prospective investments; • transfer agent and custodial fees; • out-of-pocket fees and expenses associated with marketing efforts; • federal and state registration fees and any stock exchange listing fees; • U.S. federal, state and local taxes; • independent directors' fees and expenses; • brokerage commissions; • fidelity bond, directors' and officers' liability insurance and other insurance premiums; • direct costs, such as printing, mailing and long-distance telephone; • fees and expenses associated with independent audits and outside legal costs; • costs associated with our reporting and compliance obligations under the 1940 Act and other applicable U.S. federal and state securities laws; and • other expenses incurred by either OFS Services or us in connection with administering our business, including payments under the Administration Agreement that will be based upon our allocable portion (subject to policies reviewed and approved by our board of directors) of overhead.

We do not believe that our historical operating performance is necessarily indicative of our future results of operations that we expect to report in future periods. We are primarily focused on investments in middle-market companies in the United States, including debt investments and, to a lesser extent, equity investments, including warrants and other minority equity securities, which differs to some degree from our historical investment concentration, in senior secured loans to middle-market companies in the United States. Moreover, as a BDC and a RIC, we will also be subject to certain constraints on our operations, including, but not limited to, limitations imposed by the 1940 Act and the Code. In addition, SBIC I LP is subject to regulation and oversight by the SBA. For the reasons described above, the results of operations described below may not necessarily be indicative of the results we expect to report in future periods.

Comparison of the three and six month periods ended June 30, 2014 (unaudited) and June 30, 2013 (unaudited) Consolidated operating results for the three and six month periods ended June 30, 2014 and June 30, 2013, are as follows: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (Amounts in thousands) (Amounts in thousands) Total investment income $ 4,658 $ 4,236 $ 9,670 $ 8,601 Total expenses 2,559 2,770 6,171 5,693 Net investment income 2,099 1,466 3,499 2,908 Net realized and unrealized gain (loss) on investments (1,542 ) 1,791 (891 ) 3,220 Net increase in net assets resulting from operations $ 557 $ 3,257 $ 2,608 $ 6,128 Net income can vary substantially from period to period for various reasons, including the recognition of realized gains and losses and unrealized appreciation and depreciation. As a result, comparisons of net income may not be meaningful.

45 Investment Income Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (Amounts in thousands) (Amounts in thousands) Interest incomeNon-control/non-affiliate investments $ 3,524 $ 4,236 $ 7,310 $ 8,601 Affiliate investments 792 - 1,619 - Control investment 264 - 566 - Total interest income 4,580 4,236 9,495 8,601 Dividend and fee income Non-control/non-affiliate investments - - 8 - Affiliate investments 53 - 117 - Control investment 25 - 50 -Total dividend and fee income 78 - 175 - Total investment income $ 4,658 $ 4,236 $ 9,670 $ 8,601 Comparison of Investment Income for the Three Months Ended June 30, 2014 and 2013: Total investment income increased by approximately $0.4 million, or 10%, for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013. The $0.4 million increase in total investment income was primarily due to the increase in interest income, which was attributable to the higher yielding debt investments held by SBIC I LP, as a result of our consolidation of SBIC I LP upon closing of the Tamarix Acquisitions on December 4, 2013. For the three months ended June 30, 2014, we generated total interest income from non-control/non-affiliate investments in the amount of approximately $3.5 million, of which approximately $2.8 million was generated by OFS Capital WM investments and $0.7 million by SBIC I LP investments. For the three months ended June 30, 2013, the entire interest income from non-control/non-affiliate investments of approximately $4.2 million was generated by OFS Capital WM investments. The decrease in interest income of approximately $1.4 million generated by OFS Capital WM investments for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was primarily due to the decrease in portfolio investments held by OFS Capital WM in 2014 as compared with 2013 (at June 30, 2014 and March 31, 2014, the aggregate principal of investments held by OFS Capital WM was approximately $161.8 million and $174.5 million, respectively, while at June 30, 2013 and March 2013, the aggregate principal of investments held by OS Capital WM was approximately $224.6 million and $227.0 million, respectively). SBIC I LP holds all of our affiliate investments and our only control investment. In addition, during the three months ended June 30, 2014, SBIC I LP generated dividend and fee income of approximately $78 thousand. While not consolidated with us during the quarter ended June 30, 2013, SBIC I LP had interest income and dividend and fee income of approximately $0.9 million and $91 thousand, respectively, during the quarter.

Comparison of Investment Income for the Six Months Ended June 30, 2014 and 2013: Total investment income increased by approximately $1.1 million, or 12%, for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013. The $1.1 million increase in total investment income was primarily due to the increase in interest income, which was attributable to the higher yielding debt investments held by SBIC I LP, as a result of our consolidation of SBIC I LP upon closing of the Tamarix Acquisitions on December 4, 2013. For the six months ended June 30, 2014, we generated total interest income from non-control/non-affiliate investments in the amount of approximately $7.3 million, of which approximately $6.1 million was generated by OFS Capital WM investments and $1.2 million by SBIC I LP investments. For the six months ended June 30, 2013, the entire interest income from non-control/non-affiliate investments of approximately $8.6 million was generated by OFS Capital WM investments. The decrease in interest income of approximately $2.5 million generated by OFS Capital WM investments for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 was primarily due to the decrease in portfolio investments held by OFS Capital WM in 2014 as compared with 2013. In addition, during the six months ended June 30, 2014, SBIC I LP generated dividend and fee income of approximately $175 thousand. While not consolidated with us during the six months ended June 30, 2013, SBIC I LP had interest income and dividend and fee income of approximately $1.6 million and $137 thousand, respectively, during such period.

46 Expenses Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (Amounts in thousands) (Amounts in thousands) Interest expense $ 997 $ 862 $ 1,988 $ 1,709 Amortization and write-off ofdeferred financing closing costs 152 166 302 635 Amortization of intangible asset 49 - 112 - Management fees 534 794 1,798 1,601 Professional fees 276 509 730 759 Administrative fee 285 177 760 457General and administrative expenses 266 262 481 532 Total expenses $ 2,559 $ 2,770 $ 6,171 $ 5,693 Comparison of Expenses for the Three Months Ended June 30, 2014 and 2013: Total expenses decreased by approximately $0.2 million, or 8%, for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013.

Interest expense increased by approximately $0.1 million for the three months ended June 30, 2014, compared to the three months ended June 30, 2013, primarily due to $0.2 million of 2014 interest expense incurred on our SBA debentures (which we assumed in the December 2013 Tamarix Acquisitions), offset by a 2014 decrease of approximately $0.1 million in interest expense on the OFS Capital WM Credit Facility, due to reduction in the interest rate on the facility pursuant to the November 2013 amendment to the OFS Capital WM Credit Facility).

For the three months ended June 30, 2014, we recorded $49 thousand of amortization expense of intangible asset related to the SBIC license, which intangible asset was recognized by SBIC I LP upon closing of the Tamarix Acquisitions.

Management fees expense decreased by approximately $0.3 million for the three months ended June 30, 2014 compared to the three months ended June 30, 2013, which was primarily attributable to a reduced quarterly base management fee of 0.145833% for the remainder of 2014 effective April 1, 2014, compared with the quarterly base management fee of 0.21875% for 2013. On May 5, 2014, we were notified by OFS Advisor that, effective as of April 1, 2014, it would reduce its base management fee by two-thirds for the balance of the 2014 fiscal year.

Specifically, OFS Advisor agreed to reduce its base management fee from 0.4375% per quarter to 0.145833% per quarter for the second, third, and fourth quarters of 2014. Accordingly, the effective annual base management fee for the 2014 fiscal year will be equal to 50% of the 1.75% required by our Advisory Agreement with OFS Advisor, or not greater than 0.875%. OFS Advisor informed us that this reduction was being made for the benefit of our shareholders to take into account unforeseen delays in completing the Tamarix Acquisitions.

Professional fees decreased by approximately $0.2 million for the three month period ended June 30, 2014 compared to the three month period ended June 30, 2013, largely due to decreased legal fees. A substantial amount of legal fees incurred during the three months ended June 30, 2013 were related to the Tamarix Acquisitions.

Administrative fee expense increased by approximately $0.1 million for the three months ended June 30, 2014 compared to the three months ended June 30, 2013, primarily due to an increase in the allocable amount of the salary of our officers and their respective staffs, which OFS Services passed along to us during the three months ended June 30, 2014 and 2013.

Comparison of Expenses for the Six Months Ended June 30, 2014 and 2013: Total expenses increased by approximately $0.5 million, or 8%, for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013.

Interest expense increased by approximately $0.3 million for the six months ended June 30, 2014, compared to the six months ended June 30, 2013, primarily due to $0.4 million of 2014 interest expense incurred on our SBA debentures (which we assumed in the December 2013 Tamarix Acquisitions), offset by a 2014 decrease of approximately $0.1 million in interest expense on the OFS Capital WM Credit Facility, due to reduction in the interest rate on the facility pursuant to the November 2013 amendment to the OFS Capital WM Credit Facility).

For the six months ended June 30, 2014, we recorded $112 thousand of amortization expense of intangible asset related to the SBIC license, which intangible asset was recognized by SBIC I LP upon closing of the Tamarix Acquisitions.

Management fees expense increased by approximately $0.2 million for the six months ended June 30, 2014 compared to the six months ended June 30, 2013, which was primarily attributable to a higher combined quarterly base management fee rate of 0.583333% (0.4375% for the first quarter of 2014 and 0.145833% for the second quarter of 2014) for the six months ended June 30, 2014, compared with the combined quarterly base management fee rate of 0.4375% for the six months ended June 30, 2013. This was a result of the base management fee reduction effective April 1, 2014, as described above.

47 Administrative fee expense increased by approximately $0.3 million for the six months ended June 30, 2014 compared to the six months ended June 30, 2013, primarily due to an increase in the allocable amount of the salary and bonus of our officers and their respective staffs, which OFS Services passed along to us during the six months ended June 30, 2014 and 2013.

Net Realized and Unrealized Gain (Loss) on Investments Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (Amounts in thousands) (Amounts in thousands) Net realized gain on non-control/non-affiliate investments $ - $ - $ - $ 5 Net realized gain on affiliate investment 28 - 28 - Net change in unrealized depreciation on non-control/non-affiliate investments (1,247 ) 882 (321 ) 2,055 Net change in unrealized appreciation/depreciation on affiliate investments 108 909 627 1,160 Net change in unrealizeddepreciation on control investment (431 ) - (1,225 ) - Net realized and unrealized gain on investments $ (1,542 ) $ 1,791 $ (891 ) $ 3,220 Comparison of Net Realized and Unrealized Gain (loss) on Investments for the Three Months Ended June 30, 2014 and 2013: For the three months ended June 30, 2014, we recorded approximately $(1.2) million of net change in unrealized depreciation on non-control/non-affiliate investments, consisting of approximately $(1.3) million of net change in unrealized depreciation on non-control/non-affiliate investments held by OFS Capital WM, and approximately $0.1 million of net change in unrealized depreciation on non-control/non-affiliate investments held by SBIC I LP. In addition, for the three months ended June 30, 2014, we recorded approximately $0.1 million of net change in unrealized appreciation on affiliate investments held by SBIC I LP, as well as approximately $(0.4) million of net change in unrealized depreciation on a control investment held by SBIC I LP (Tangible Software, Inc). For the three months ended June 30, 2013, we recorded approximately $0.9 million of net change in unrealized depreciation on non-control/non-affiliate investments held by OFS Capital WM, as well as approximately $0.9 million of net change in unrealized depreciation on affiliate investment, consisting solely of our equity investment in SBIC I LP, which we accounted for at fair value at June 30, 2013.

Comparison of Net Realized and Unrealized Gain (loss) on Investments for the Six Months Ended June 30, 2014 and 2013: For the six months ended June 30, 2014, we recorded approximately $(0.3) million of net change in unrealized depreciation on non-control/non-affiliate investments, consisting of approximately $(1.1) million of net change in unrealized depreciation on non-control/non-affiliate investments held by OFS Capital WM, and approximately $0.8 million of net change in unrealized depreciation on non-control/non-affiliate investments held by SBIC I LP. In addition, for the six months ended June 30, 2014, we recorded approximately $0.6 million of net change in unrealized appreciation on affiliate investments held by SBIC I LP, as well as approximately $(1.2) million of net change in unrealized depreciation on a control investment held by SBIC I LP (Tangible Software, Inc). For the six months ended June 30, 2013, we recorded approximately $2.1 million of net change in unrealized depreciation on non-control/non-affiliate investments held by OFS Capital WM, as well as approximately $1.2 million of net change in unrealized depreciation on affiliate investment, consisting solely of our equity investment in SBIC I LP, which we accounted for at fair value at June 30, 2013.

Financial Condition, Liquidity and Capital Resources Cash and Cash Equivalents At June 30, 2014 and December 31, 2013, we had cash and cash equivalents of $21.4 million and $28.6 million, respectively. As of June 30, 2014 and December 31, 2013, $16.5 million and $21.5 million of cash and cash equivalents, respectively, were capital commitments funded by OFS Capital into SBIC I LP.

During the six months ended June 30, 2014, we had net cash provided by operating activities of $15.9 million, primarily due to our $2.6 million net increase in net assets resulting from operations, net proceeds of $29.7 million we received from principal payments on our portfolio investments, as well as cash collections of $7.5 million from sale of our portfolio investments, offset by $25.6 million of cash we used to purchase portfolio investments.

Net cash used in financing activities was $23.1 million for the six months ended June 30, 2014, primarily attributable to the $16.6 million of net repayments on the OFS Capital WM Credit Facility as well as $6.5 million of cash we paid in dividends and distributions.

At June 30, 2013 and December 31, 2012, we had cash and cash equivalents of $10.0 million and $8.3 million, respectively. During the six months ended June 30, 2013, we had net cash provided by operating activities of $11.0 million, primarily due to our $6.1 million net increase in net assets resulting from operations, net proceeds of $26.6 million we received from principal payments on our portfolio investments, as well as cash collections of $4.7 million from sale of our portfolio investments, offset by $21.1 million of cash we used to purchase portfolio investments, our additional investment in SBIC I LP of $2.6 million, and net change in unrealized depreciation in our investments in the aggregate amount of $3.2 million.

48 Net cash used in financing activities was $9.3 million for the six months ended June 30, 2013, primarily attributable to the $5.1 million of net repayments on the OFS Capital WM Credit Facility as well as $4.2 million of cash we paidin dividends and distributions.

We intend to generate additional cash flows from our operations, distributions from equity investments, future borrowings, including borrowings by OFS Capital WM pursuant to the OFS Capital WM Credit Facility as well as by SBIC I LP under the SBA debentures, and through any future offerings of securities. Our primary uses of funds are investments in debt and equity investments, interest payments on indebtedness, payment of other expenses, and cash distributions to our shareholders.

The OFS Capital WM Credit Facility On September 28, 2010, OFS Capital WM entered into a $180.0 million secured revolving credit facility (as amended from time to time, the "OFS Capital WM Credit Facility") with Wells Fargo and Madison Capital Funding, LLC ("Madison Capital"), with the Class A lenders (initially Wells Fargo) providing up to $135.0 million in Class A loans ("Class A Facility") and the Class B lenders (initially Madison Capital) providing up to $45.0 million in Class B loans ("Class B Facility"). The OFS Capital WM Credit Facility is secured by all current and future eligible loans acquired by OFS Capital WM. The loan facilities with Wells Fargo and Madison Capital had five- and six-year terms, respectively, and both facilities provided a one-year option for extension upon the approval of the Class A and Class B lenders, respectively. The loan facilities had a reinvestment period of two years after the closing date of the OFS Capital WM Credit Facility, which could be extended by one year with the consent of each lender. Outstanding borrowings on the loan facilities were limited to the lesser of (1) $180.0 million and (2) the borrowing base as defined by the OFS Capital WM Credit Facility loan documents. OFS Capital WM is obligated to pay interest on outstanding Class A loans (and on the Class B loans until the termination of the Class B Facility in January 2013) on each quarterly payment date.

As of June 30, 2014 and December 31, 2013, we had $92.4 million and $109.0 million, respectively, in indebtedness outstanding under the OFS Capital WM Credit Facility.

If at any time the amount of Class A loans outstanding exceeds the borrowing base, a borrowing base deficiency will exist. In that event, OFS Capital WM will have three business days to eliminate the deficiency by, among other things, (a) depositing additional cash into the relevant collection account, (b) repaying Class A loans, or (c) pledging additional eligible loan assets. In the case of such a deficiency, we may determine it is in our best interests to make additional capital contributions to OFS Capital WM in the form of cash or additional eligible loan assets to protect the value of our equity investment in OFS Capital WM, and our additional contributions could be material.

Under the OFS Capital WM Credit Facility, MCF Capital Management, LLC, which is the loan manager and an affiliated entity of Madison Capital, or the Loan Manager, charges both a senior and subordinated management fee to OFS Capital WM for its services, each at 0.25% per annum of the assigned value of the underlying portfolio investments, plus an accrued fee that is deferred until after the end of the investment period of the portfolio investments. For the three and six months ended June 30, 2014, we incurred management fee expense of approximately $193 thousand and $418 thousand, respectively, to the Loan Manager. For the three and six months ended June 30, 2013, we incurred management fee expense of approximately $287 thousand and $582 thousand, respectively, to the Loan Manager.

Subject to certain amendments through July 24, 2014, the OFS Capital WM Credit Facility's borrowing base was adjusted and the minimum equity requirement was lowered from $65.0 million to $35.0 million, resulting in additional liquidity for the Company. In addition, the maximum facility was reduced from $180.0million to $125.0 million.

49 SBA Debentures As a result of the Tamarix Acquisitions, SBIC I LP became our wholly-owned subsidiary effective December 4, 2013. SBIC I LP has an SBIC license that allows it to obtain leverage by issuing SBA-guaranteed debentures, subject to issuance of a capital commitment by the SBA and customary procedures. These debentures are non-recourse to OFS Capital, and bear interest payable semi-annually, and each debenture has a maturity date that is ten years following issuance. The interest rate is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with ten-year maturities.

Under present SBIC regulations, the maximum amount of SBA-guaranteed debt that may be issued by a single SBIC licensee is $150.0 million. An SBIC fund may borrow up to two times the amount of its regulatory capital, subject to customary regulatory requirements. In connection with the Tamarix Acquisitions, OFS Capital increased its commitments to SBIC I LP to $75.0 million. As of June 30, 2014, OFS Capital had funded $61.4 million of the $75.0 million commitment.

As of June 30, 2014, SBIC I LP had leverage commitments of $61.4 million from the SBA and $26.0 million of outstanding SBA-guaranteed debentures, leaving incremental borrowing capacity of $35.4 million under present SBIC regulations.

As of December 31, 2013, SBIC I LP had leverage commitments of $49.4 million from the SBA and $26.0 million of outstanding SBA-guaranteed debentures, leaving incremental borrowing capacity of $23.4 million.

In July 2014, the Company funded the remaining $13.6 million to SBIC I LP.

Accordingly, SBIC I LP now has access to the full $150.0 million in SBA-guaranteed debentures, subject to proper approval and the customary procedures of the SBA. This also results in an increase in SBIC I LP's incremental borrowing capacity to $112.0 million (taking into consideration SBIC I LP's draw of an additional $12.0 million under the SBA debentures on July 10, 2014) upon SBIC I LP's receipt of the SBA's approval to access the full $150.0 million in SBA-guaranteed debentures.

SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $19.56 million and have average annual fully taxed net income not exceeding $6.5 million for the two most recent fiscal years. In addition, an SBIC must devote 25.0% of its investment activity to "smaller" enterprises as defined by the SBA. A smaller enterprise is one that has a tangible net worth not exceeding $6.0 million and has average annual fully taxed net income not exceeding $2.0 million for the two most recent fiscal years. SBA regulations also provide alternative criteria to determine eligibility, which may include, among other things, the industry in which the business is engaged, the number of employees of the business, its gross sales, and the extent to which the SBIC is proposing to participate in a change of ownership of the business. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services.

SBIC I LP is periodically examined and audited by the SBA's staff to determine its compliance with SBA regulations. If SBIC I LP fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit SBIC I LP's use of debentures, declare outstanding debentures immediately due and payable, and/or limit SBIC I LP from making new investments. In addition, SBIC I LP may also be limited in its ability to make distributions to OFS Capital if it does not have sufficient capital in accordance with SBA regulations. Such actions by the SBA would in turn, negatively affect OFS Capital.

Other Liquidity Matters We expect to fund the growth of our investment portfolio utilizing borrowings under the OFS Capital WM Credit Facility, SBA debentures, future equity offerings, including our dividend reinvestment plan, and issuances of senior securities or future borrowings, to the extent permitted by the 1940 Act. We cannot assure shareholders that our plans to raise capital will be successful.

In addition, we intend to distribute to our shareholders 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 to fund our unfunded commitments to portfolio companies. The illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.

In addition, as a BDC, we generally will be required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities (including SBIC I LP's SBA-guaranteed debt), to total senior securities, which include all of our borrowings (excluding SBA-guaranteed debt) and any outstanding preferred stock (of which we had none at June 30, 2014), of at least 200%. 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.

50 Off-Balance Sheet Arrangements We may be a party to financial instruments with off-balance sheet risk in the normal course of our business to meet the financial needs of our portfolio companies. As of June 30, 2014, we had $5.8 million of total unfunded commitments to four portfolio companies. Unfunded commitments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet and are not reflected on our balance sheet. In addition, as of June 30, 2014, OFS Capital had approximately $13.6 million of unfunded commitments to SBIC I LP, which was subsequently funded to SBIC I LP in July 2014.

Contractual Obligations The following table shows our contractual obligations as of June 30, 2014: Payments due by period Contractual Obligations Less than After 5 (1) Total 1 year 1-3 years 3-5 years (2) years (2) (Amounts in thousands) OFS Capital WM Credit Facility $ 92,389 $ - $ - $ 92,389 $ - SBA Debentures 26,000 - - - 26,000 Total $ 118,389 $ - $ - $ 92,389 $ 26,000 (1) Excludes commitments to extend credit to our portfolio companies.

(2) The OFS Capital WM Facility is scheduled to mature on December 31, 2018. The SBA debentures are scheduled to mature between September 2022 and March 2024.

We have entered into contracts with third parties under which we have material future commitments-the Advisory Agreement, pursuant to which OFS Advisor has agreed to serve as our investment adviser, and the Administration Agreement, pursuant to which OFS Services has agreed to furnish us with the facilities and administrative services necessary to conduct our day-to-day operations.

We have subscribed for $75.0 million of total capital commitments to SBIC I LP, of which $61.4 million was funded as of June 30, 2014, and $13.6 million was funded subsequently in July 2014.

Commitments and Contingencies At June 30, 2014 and December 31, 2013, we had $5.8 million and $4.8 million of total unfunded commitments to four and three portfolio companies, respectively.

Upon completion of the Tamarix Acquisitions on December 4, 2013, OFS Capital increased its commitment to SBIC I LP to $75.0 million. As of June 30, 2014, OFS Capital had funded $61.4 million of the $75.0 million commitment. In July 2014, OFS Capital funded the remaining $13.6 million to SBIC I LP.

From time to time, we are involved in legal proceedings in the normal course of its business. Although the outcome of such litigation cannot be predicted with any certainty, management is of the opinion, based on the advice of legal counsel, that final disposition of any litigation should not have a material adverse effect on our financial position.

Additionally, we are subject to periodic inspection by regulators to assess compliance with applicable regulations related to being a BDC and a RIC, and SBIC I LP is subject to periodic inspections by the SBA. Management believes that the Company is in material compliance with such regulations and inspection results do not indicate otherwise.

In the normal course of business, we enter into contracts and agreements that contain a variety of representations and warranties that provide general indemnifications. Our maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against us that have not occurred. We believe the risk of any material obligation under these indemnifications to be low.

Distributions We are taxed as a RIC under the Code. Generally, a RIC is entitled to deduct dividends it pays to its shareholders from its income to determine "taxable income." Taxable income includes our taxable interest, dividend and fee income, and taxable net capital gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash. Taxable income includes non-cash income, such as changes in accrued and reinvested interest and dividends, which includes contractual PIK interest, and the amortization of discounts and fees.

Cash collections of income resulting from contractual PIK interest 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, andamortization expense.

51 Our board of directors maintains a variable dividend policy with the objective of distributing four quarterly distributions in an amount not less than 90-100% of our taxable quarterly income or potential annual income for a particular year. In addition, at the end of the year, we may also pay an additional special dividend, or fifth dividend, such that we may distribute approximately all of our annual taxable income in the year it was earned, while maintaining the option to spill over our excess taxable income to a following year.

The following table summarizes our distributions declared and paid to date on all shares subsequent to our IPO (dollar amounts in thousands except per share data): Amount Date Declared Record Date Payment Date Per Share (2) Total Amount Fiscal 2014 May 7, 2014 June 16, 2014 June 30, 2014 $ 0.34 $ 3,275 January 21, 2014 January 31, 2014 February 14, 2014 $ 0.34 $ 3,274 Fiscal 2013 September 25, 2013 October 17, 2013 October 31, 2013 $ 0.34 $ 3,273 June 25, 2013 July 17, 2013 July 31, 2013 0.34 3,272 March 26, 2013 April 17, 2013 April 30, 2013 0.34 3,269 Fiscal 2012 November 26, 2012 (1) January 17, 2013 January 31, 2013 $ 0.17 $ 1,628 (1) Represents the distribution declared in the specified period, which, if prorated for the number of days remaining in the fourth quarter after our IPO in November 2012, would be $0.34 per share.

(2) - The determination of the tax attributes of our distributions is made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. If the tax characteristics of these distributions were determined as of June 30, 2014, March 31, 2014, December 31, 2013, September 30, 2013, June 30, 2013, March 31, 2013, and December 31, 2012 (for the period November 8, 2012 through December 31, 2012), the Company estimated that approximately $0.12, $0.19, zero, $0.18, $0.19, $0.18 and zero, respectively, would have represented a return of capital.

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a regulated investment company. We cannot assure shareholders that they will receive any distributions at a particular level.

Distributions in excess of our current and accumulated earnings and profits generally are treated first as a return of capital to the extent of the shareholder's tax basis, and any remaining distributions are treated as a capital gain. The determination of the tax attributes of our distributions is made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year; therefore, a determination made on a quarterly basis may not be representative of the tax attributes of our annual distributions to shareholders. For the distribution paid during the six months ended June 30, 2014, out of the approximately $6.5 million distribution, approximately 45% represented a return of capital and 55% represented ordinary income.

Each year a statement on Form 1099-DIV identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gains on the sale of securities, and/or a return of paid-in-capital surplus, which is a nontaxable distribution) is mailed to our U.S. shareholders. To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a portion of those distributions may be deemed a taxable return of capital to our shareholders.

We maintain an "opt-out" dividend reinvestment plan for our common shareholders.

As a result, if we declare a dividend, cash dividends are automatically reinvested in additional shares of our common stock unless the shareholder specifically "opts out" of the dividend reinvestment plan and chooses to receive cash dividends.

Related Party Transactions Investment Advisory Agreement We have entered into the Advisory Agreement with OFS Advisor and will pay OFS Advisor a management fee and incentive fee. Pursuant to the Advisory Agreement with OFS Advisor and subject to the overall supervision of our board of directors and in accordance with the 1940 Act, OFS Advisor provides investment advisory services to us. For providing these services, OFS Advisor receives a fee from us consisting of two components-a base management fee and an incentive fee. From the completion of our IPO through October 31, 2013, the base management fee was calculated at an annual rate of 0.875% 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) at the end of the two most recently completed calendar quarters, adjusted for any share issuances or repurchases during the quarter.

Beginning on November 1, 2013 and through June 30, 2014, pursuant to the Advisory Agreement, the base management fee was calculated at an annual rate of 1.75% based on the average value of our total assets (other than cash and cash equivalents but including assets purchased with borrowed amounts and including assets owned by any consolidated entity) at the end of the two most recently completed calendar quarters. OFS Advisor has elected to exclude from the base management fee calculation any base management fee that would be owed in respect of the intangible asset and goodwill resulting from our acquisitions of the remaining ownership interests in SBIC I LP and SBIC I GP on December 4, 2013.

52 On May 5, 2014, we were notified by OFS Advisor that, effective as of April 1, 2014, it would reduce its base management fee by two-thirds for the balance of the 2014 fiscal year. Specifically, OFS Advisor agreed to reduce its base management fee from 0.4375% per quarter to 0.145833% per quarter for the second, third, and fourth quarters of 2014. Accordingly, the effective annual base management fee for the 2014 fiscal year will be equal to 50% of the 1.75% required by our Advisory Agreement with OFS Advisor, or not greater than 0.875%.

OFS Advisor informed us that this reduction was being made for the benefit of our shareholders to take into account unforeseen delays in completing the Tamarix Acquisitions.

The base management fee is payable quarterly in arrears. The base management fee expense was approximately $341 thousand and $1.4 million for the three and six months ended June 30, 2014, respectively. The base management fee expense was approximately $507 thousand and $1.0 million for the three and six months ended June 30, 2013, respectively.

On June 30, 2014, OFS Advisor decided to defer the receipt of the first quarter of 2014 base management fee in the amount of approximately $1.0 million, that would otherwise have been due from us by June 30, 2014, until further determination by OFS Advisor. In addition, on June 30, 2014, OFS Advisor decided to defer the receipt of the second quarter of 2014 base management fee in the amount of $341 thousand, that would otherwise have been due from us by September 30, 2014, until further determination by OFS Advisor. The Investment Advisor informed the Company that the deferral of the fee was being made for the benefit of the Company's shareholders to take into account unforeseen delays in completing the Tamarix Acquisitions.

The incentive fee has two parts. One part is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the quarter.

"Pre-incentive fee net investment income" means interest income, dividend income and any other income (including any other fees such as commitment, origination and sourcing, structuring, diligence and consulting fees or other fees that we receive from portfolio companies but excluding fees for providing managerial assistance) accrued during the calendar quarter, minus operating expenses for the quarter (including the base management fee, any expenses payable under the Administration Agreement and any interest expense and dividends paid on any outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as OID, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash.

Pre-incentive fee net investment income does not include any realized gains, realized losses, unrealized capital appreciation or unrealized capital depreciation. Because of the structure of the incentive fee, it is possible that we may pay an incentive fee in a quarter where we incur a loss. For example, if we receive pre-incentive fee net investment income in excess of the hurdle rate (as defined below) for a quarter, we will pay the applicable incentive fee even if we have incurred a loss in that quarter due to realized capital losses and unrealized capital depreciation.

Pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets (defined as total assets less indebtedness and before taking into account any incentive fees payable during the period) at the end of the immediately preceding calendar quarter, is compared to a fixed "hurdle rate" of 2.0% per quarter. If market interest rates rise, we may be able to invest our funds in debt instruments that provide for a higher return, which would increase our pre-incentive fee net investment income and make it easier for OFS Advisor to surpass the fixed hurdle rate and receive an incentive fee based on such net investment income. There is no accumulation of amounts on the hurdle rate from quarter to quarter and accordingly there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle rate, and there is no delay of payment if prior quarters are below the quarterly hurdle rate.

We pay OFS Advisor an incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows: • no incentive fee in any calendar quarter in which the pre-incentive fee net investment income does not exceed the hurdle rate; • 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5% in any calendar quarter. We refer to this portion of our pre-incentive fee net investment income (which exceeds the hurdle rate but is less than 2.5%) as the "catch-up" provision. The catch-up is meant to provide OFS Advisor with 20.0% of the pre-incentive fee net investment income as if a hurdle rate did not apply if this pre-incentive fee net investment income exceeds 2.5% in any calendar quarter; and • 20.0% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.5% in any calendar quarter.

The second part of the incentive fee (the "Capital Gains Fee") is determined and payable in arrears as of the end of each calendar year (or upon termination of the Advisory Agreement, as of the termination date) and is calculated at the end of each applicable year by subtracting (a) the sum of our cumulative aggregate realized capital losses and our aggregate unrealized capital depreciation from (b) our cumulative aggregate realized capital gains. If such amount is positive at the end of such year, then the Capital Gains Fee for such year is equal to 20.0% of such amount, less the aggregate amount of Capital Gains Fees paid in all prior years. If such amount is negative, then there is no Capital GainsFee for such year.

53 The cumulative aggregate realized capital gains are calculated as the sum of the differences, if positive, between (a) the net sales price of each investment in our portfolio when sold and (b) the accreted or amortized cost basis of such investment.

The cumulative aggregate realized capital losses are calculated as the sum of the amounts by which (a) the net sales price of each investment in our portfolio when sold is less than (b) the accreted or amortized cost basis of such investment.

The aggregate unrealized capital depreciation is calculated as the sum of the differences, if negative, between (a) the valuation of each investment in our portfolio as of the applicable Capital Gains Fee calculation date and (b) the accreted or amortized cost basis of such investment. Unrealized capital appreciation is accrued, but not paid until said appreciation is realized.

We accrue the Capital Gains Fee if, on a cumulative basis, the sum of net realized capital gains and (losses) plus net unrealized appreciation and (depreciation) is positive. OFS Advisor has elected to exclude from the Capital Gains Fee calculation any incentive fee that would be owed in respect of the realized gain on step acquisition resulting from the Tamarix Acquisitions.We did not incur any incentive fee expenses for the three and six months ended June 30, 2014 and 2013.

License Agreement We have entered into a license agreement with OFSAM under which OFSAM has agreed to grant us a non-exclusive, royalty-free license to use the name "OFS." Administration Agreement Pursuant to an Administration Agreement, OFS Services furnishes us with office facilities and equipment, necessary software licenses and subscriptions and clerical, bookkeeping and record keeping services at such facilities. Under the Administration Agreement, OFS Services performs, or oversees the performance of, our required administrative services, which include being responsible for the financial records that we are required to maintain and preparing reports to our shareholders and all other reports and materials required to be filed with the SEC or any other regulatory authority. In addition, OFS Services assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our shareholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. Under the Administration Agreement, OFS Services would provide managerial assistance on our behalf to certain portfolio companies that accept our offer to provide such assistance. Payments under the Administration Agreement are equal to an amount based upon our allocable portion (subject to the review and approval of our board of directors) of OFS Services' overhead in performing its obligations under the Administration Agreement, including rent and our allocable portion of the cost of our officers, including our chief executive officer, chief financial officer, chief compliance officer, chief accounting officer, and corporate secretary, and their respective staffs. The administrative fee is payable quarterly in arrears. For the three and six months ended June 30, 2014, we incurred $285 thousand and $760 thousand, respectively, of administrative fees. For the three and six months ended June 30, 2013, we incurred $177 thousand and $457 thousand, respectively, of administrative fees.

On June 30, 2014, OFS Services decided to defer the receipt of the first quarter of 2014 administrative fee in the amount of approximately $475 thousand, that would otherwise have been due from us by June 30, 2014, until further determination by OFS Services. In addition, on June 30, 2014, OFS Services decided to defer the receipt of the second quarter of 2014 administrative fee in the amount of $285 thousand, that would otherwise have been due from us by September 30, 2014, until further determination by OFS Services. The Administrator informed the Company that the deferral of the fee was being made for the benefit of the Company's shareholders to take into account unforeseen delays in completing the Tamarix Acquisitions.

Staffing Agreement OFS Advisor has entered into a Staffing Agreement with Orchard First Source Capital, Inc., or OFSC, which is a wholly owned subsidiary of OFSAM. Under this agreement, OFSC makes available to OFS Advisor experienced investment professionals and access to the senior investment personnel and other resources of OFSC and its affiliates. The Staffing Agreement provides OFS Advisor with access to deal flow generated by the professionals of OFSC and its affiliates and commits the members of the Advisor Investment Committee to serve in that capacity. OFS Advisor capitalizes on the significant deal origination and sourcing, credit underwriting, due diligence, investment structuring, execution, portfolio management and monitoring experience of OFSC's investment professionals.

OFSC also has entered into a staffing and corporate services agreement with OFS Services. Under this agreement, OFSC makes available to OFS Services experienced investment professionals and access to the administrative resources of OFSC.

54 Recent Developments On July 8, 2014, we accepted the resignation of Glenn Pittson from his positions as Chief Executive Officer of the Company and Chairman of the our board of directors. Mr. Pittson's resignation is not the result of any disagreement with the Company. Mr. Pittson will continue to serve as a member of our board of directors. On the same date, we appointed Bilal Rashid to the positions of Chief Executive Officer of the Company and Chairman of our board of directors.

On July 8, 2014, we accepted the resignation of Robert Palmer from his positions as Chief Financial Officer and Treasurer of the Company. Mr. Palmer's resignation is not the result of any disagreement with the Company. On the same date, we appointed Jeffrey A. Cerny to the positions of Chief Financial Officer and Treasurer of the Company.

On July 24, 2014, the OFS Capital WM Credit Facility was further amended, pursuant to which the calculation of the borrowing base was adjusted and the minimum equity requirement was lowered from $50.0 million to $35.0 million, resulting in additional liquidity for the Company. In addition, the maximum facility was reduced from $135.0 million to $125.0 million. No financing costs were incurred in connection with this amendment.

In July 2014, the Company funded the remaining $13.6 million of its $75.0 million commitments to SBIC I LP. Accordingly, SBIC I LP now has access to the full $150.0 million in SBA-guaranteed debentures, subject to proper approval and the customary procedures of the SBA. This also results in an increase in SBIC I LP's incremental borrowing capacity to $112.0 million (taking into consideration SBIC I LP's draw of an additional $12.0 million under the SBA debentures on July 10, 2014) upon SBIC I LP's receipt of the SBA's approval to access the full $150.0 million in SBA-guaranteed debentures.

On August 7, 2014, our board of directors declared a distribution of $0.34 per share for the 2014 third quarter, payable on September 30, 2014 to shareholders of record as of September 16, 2014.

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