UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2018

 

Commission File Number: 000-55767

 

Flat Rock Capital Corp.

 

Maryland		82-0894786
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
1350 6th Avenue, 18th Floor, New York, NY		10019
(Address of principal executive offices)		(Zip Code)

 

(212) 596-3413

(Registrant’s telephone number, including area code)

 

Securities to be registered pursuant to Section 12(b) of the Act:

None

 

Securities to be registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.001 per share

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

☒ Yes ☐ No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

 

☐ Yes ☐ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	☐		Accelerated filer	☐
Non-accelerated filer	☒	(Do not check if a smaller reporting company)	Smaller reporting company	☐
Emerging growth company	☒

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☒

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

☐ Yes ☒ No

 

As of August 8, 2018, the registrant had 1,263,239 shares of common stock, $0.001 par value per share, outstanding.

 

 

 

Table of Contents

 

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	1
	Statements of Assets and Liabilities as of June 30, 2018 (Unaudited) and December 31, 2017	1
	Statements of Operations for the Three and Six Months Ended June 30, 2018 and for the Period May 3, 2017 (commencement of operations) through June 30, 2017 (Unaudited)	2
	Statements of Changes in Net Assets for the Six Months Ended June 30, 2018 and for the Period May 3, 2017 (commencement of operations) through June 30, 2017 (Unaudited)	3
	Statements of Cash Flows for the Six Months Ended June 30, 2018 and for the Period May 3, 2017 (commencement of operations) through June 30, 2017 (Unaudited)	4
	Schedules of Investments as of June 30, 2018 (Unaudited) and December 31, 2017	5-8
	Notes to Financial Statements (Unaudited)	9-21
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
Item 4.	Controls and Procedures	31
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
Item 3.	Defaults Upon Senior Securities	33
Item 4.	Mine Safety Disclosures	33
Item 5.	Other Information	33
Item 6.	Exhibits	34
Signatures		35

 

 

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

Flat Rock Capital Corp.

Statements of Assets and Liabilities

 

		June 30, 2018 (Unaudited)				December 31, 2017
Assets:
Non-controlled investments, at fair value (amortized cost $29,479,640 and $27,416,962, respectively)		$	29,652,802			$	27,717,744
Cash and cash equivalents			1,266,745				1,244,044
Unrealized appreciation on forward foreign currency contracts			188,627				—
Receivables:
Investment securities sold			1,755,000				1,486,885
Paydowns receivable			—				12,658
Subscriptions receivable			1,443,000				100,000
Interest			15,253				60,792
Due from investment adviser			80,392				520,033
Total Assets		$	34,401,819			$	31,142,156
Liabilities:
Payables:
Investment securities purchased		$	9,705,896			$	9,735,166
Distributions payable			122,506				110,965
Unrealized depreciation on forward foreign currency contracts			—				38,141
Incentive fee payable			26,927				—
Accrued other general and administrative expenses			377,288				588,235
Total Liabilities		$	10,232,617			$	10,472,507
Commitments and Contingencies (Note 7)
Net Assets:
Preferred shares, $0.001 par value; 25,000,000 shares authorized; 0 issued and outstanding		$	—			$	—
Common shares, $0.001 par value; 125,000,000 shares authorized; 1,206,355 and 1,032,445 issued and outstanding, respectively			1,206				1,032
Additional paid-in capital			23,971,669				20,488,843
Accumulated undistributed net investment income (loss)			(246,602	)			(83,641	)
Net realized gains (losses) on investments and foreign currency transactions			81,140				—
Net unrealized gains (losses) on investments, foreign currency translations, and foreign currency contracts			361,789				263,415
Total Net Assets		$	24,169,202			$	20,669,649
Total Liabilities and Net Assets		$	34,401,819			$	31,142,156
Net Asset Value Per Share		$	20.03			$	20.02

 

The accompanying notes are an integral part of these financial statements.

 

   

Flat Rock Capital Corp.

Statements of Operations

(Unaudited)

 

		For the Three Months ended June 30, 2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017				For the Six Months ended June 30, 2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Income:
Investment income from non-controlled, non-affiliated investments:
Interest income		$	438,581			$	685			$	850,828			$	685
Other income			218				—				3,714				—
Total investment income from non-controlled, non-affiliated investments			438,799				685				854,542				685
Total Investment Income			438,799				685				854,542				685
Expenses:
Management fee			115,666				24,592				224,536				24,592
Professional fees			89,237				25,480				183,685				25,480
Incentive fees			26,927				—				26,927				—
Other general and administrative expenses			109,113				10,000				193,014				10,000
Total Expenses			340,943				60,072				628,162				60,072
Less: Management fee waiver (Note 3)			(115,666	)			(24,592	)			(224,536	)			(24,592	)
Less: Expense reimbursement (Note 3)			(47,540	)			(35,000	)			(80,392	)			(35,000	)
Net expenses			177,737				480				323,234				480
Net Investment Income			261,062				205				531,308				205
Realized and unrealized gains (losses) on investments
Net realized gains (losses):
Non-controlled, non-affiliated investments			44,003				—				81,546				—
Net realized gains (losses) on foreign currency transactions			302				—				(406	)			—
Total net realized gains (losses)			44,305				—				81,140				—
Net unrealized gains (losses):
Non-controlled, non-affiliated investments			47,285				362				92,490				362
Foreign currency translation			(88,208	)			—				(220,884	)			—
Forward foreign currency contracts (Note 2)			97,427				—				226,768				—
Total net unrealized gains (losses)			56,504				362				98,374				362
Total realized and unrealized gains (losses)			100,809				362				179,514				362
Net Increase in Net Assets Resulting from Operations		$	361,871			$	567			$	710,822			$	567
Earnings Per Share - Basic and Diluted		$	0.33			$	0.04			$	0.66			$	0.04
Weighted Average Shares Outstanding - Basic and Diluted			1,102,254				14,025				1,073,953				14,025

   

The accompanying notes are an integral part of these financial statements.

 

 

Flat Rock Capital Corp.

Statements of Changes in Net Assets

(Unaudited)

 

		For the Six Months ended June 30, 2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Increase in Net Assets Resulting from Operations:
Net investment income		$	531,308			$	205
Net realized gains (losses) on investments and foreign currency transactions			81,140				—
Net unrealized gains (losses) on investments, foreign currency translations, and foreign currency contracts			98,374				362
Net Increase in Net Assets Resulting from Operations			710,822				567
Decrease in Net Assets Resulting from Stockholder Distributions
Distributions declared from net investment income			(694,269	)			—
Net Decrease in Net Assets Resulting from Stockholder Distributions			(694,269	)			—
Increase in Net Assets Resulting from Capital Share Transactions
Issuance of common shares			3,483,000				2,575,000
Net Increase in Net Assets Resulting from Capital Share Transactions			3,483,000				2,575,000
Total Increase (Decrease) in Net Assets			3,499,553				2,575,567
Net Assets, Beginning of Period			20,669,649				—
Net Assets, End of Period		$	24,169,202			$	2,575,567
Undistributed net investment income (loss)		$	(246,602	)		$	205

 

The accompanying notes are an integral part of these financial statements.

 

 

Flat Rock Capital Corp

Statements of Cash Flows

(Unaudited)

 

		For the Six Months Ended				For the Period May 3, 2017 (commencement of operations) through
		June 30, 2018				June 30, 2017
Cash Flows from Operating Activities:
Net increase in net assets resulting from operations		$	710,822			$	567
Adjustments to reconcile net increase in net assets resulting from operations to net cash used in operating activities:
Net change in realized gains/losses on investments and foreign currency transactions			(81,140	)			—
Net change in unrealized gains/losses on investments and foreign currency translations			128,394				(362	)
Net amortization of discount on investments			(13,713	)			(685	)
Purchases of investments			(32,299,708	)			(19,953,068	)
Proceeds from sale of investments			30,331,109				—
Changes in operating assets and liabilities:
Investment securities sold			(268,115	)			—
Dividends and interest receivable			45,539				—
Receivable due from investment adviser			439,641				—
Receivable for paydowns			12,658				—
Payable for investments purchased			(29,270	)			6,954,895
Payable for incentive fee			26,927				—
Payable due to broker			—				12,598,173
Unrealized depreciation on forward foreign currency contracts			(226,768	)			—
Accrued other general and administrative expenses			(210,947	)			480
Net cash used in operating activities			(1,434,571	)			(400,000	)
Cash Flows from Financing Activities:
Distributions paid in cash			(682,728	)			—
Proceeds from issuance of common shares			2,140,000				2,550,000
Net cash provided by financing activities			1,457,272				2,550,000
Net increase in cash and cash equivalents			22,701				2,150,000
Cash and cash equivalents, beginning of period			1,244,044				—
Cash and cash equivalents, end of period		$	1,266,745			$	2,150,000
Non-cash financing activities:
Subscription receivable		$	1,343,000			$	25,000
Supplemental Information:
Interest paid during the period		$	—			$	—

 

The accompanying notes are an integral part of these financial statements.

 

 

Flat Rock Capital Corp.

Schedule of Investments

As of June 30, 2018

(Unaudited)

 

						Acquisition		Maturity		Principal /				Amortized				Fair				Percentage of Net
Company(3)		Industry		Interest		Date		Date		Par				Cost(1)(6)				Value				Assets
Debt Investments
First Lien Senior Secured(2)
AP Gaming I, LLC		Entertainment & Leisure		L + 4.25% (1% Floor)		12/4/2017		2/15/2024		$	248,120			$	248,120			$	250,911				1.0	%
AqGen Ascensus, Inc. Delayed Draw(7)		Insurance		—		6/7/2018		12/5/2022			-				-				-				0.0	%
AqGen Ascensus, Inc. Term Loan		Insurance		L + 3.50% (1% Floor)		6/7/2018		12/5/2022			311,719				310,484				310,471				1.3	%
Big Ass Solutions(5)		Home Furnishings		L + 3.75% (1% Floor)		6/22/2018		5/21/2024			498,747				498,747				498,747				2.1	%
BMC Software Finance, Inc.(5)		Computers & Electronics		L+ 4.25% (1% Floor)		6/28/2018		9/30/2025			1,000,000				990,000				990,000				4.1	%
Bomgar Corporation		Computers & Electronics		L + 4.00% (1% Floor)		4/17/2018		4/17/2025			500,000				498,772				498,750				2.1	%
Deliver Buyer, Inc.(5)		Machinery		L + 5.00% (1% Floor)		6/14/2018		5/1/2024			500,000				498,750				498,750				2.1	%
Genuine Financial Holdings LLC(5)		Business Services		L + 3.75% (1% Floor)		6/29/2018		6/27/2025			1,000,000				995,000				995,000				4.1	%
GI Revelation Acquisition LLC		Business Services		L + 5.00% (1% Floor)		4/11/2018		4/11/2025			500,000				497,560				497,500				2.1	%
Hill International, Inc.		Business Services		L + 5.75% (1% Floor)		9/22/2017		6/21/2023			1,485,000				1,477,948				1,481,287				6.1	%
Idera, Inc.		Computers & Electronics		L + 4.50% (1% Floor)		6/27/2017		6/28/2024			837,000				835,553				841,185				3.5	%
Isagenix International LLC		Direct Selling		L + 5.75% (1% Floor)		4/26/2018		6/14/2025			1,000,000				990,037				990,000				4.1	%
Logibec Inc.(4)		Healthcare IT		CDOR + 6.00% (1% Floor)		6/14/2017		1/15/2020			4,904,679				4,835,924				4,904,679				20.3	%
MND Holdings III Corp.(5)		Consumer Goods		L + 3.50% (1% Floor)		6/8/2018		6/19/2024			997,481				997,481				997,481				4.1	%
MRO Holdings, Inc.		Transportation		L + 5.25% (1% Floor)		10/20/2017		10/25/2023			995,000				985,987				1,004,950				4.2	%
Octave Music Group, Inc.		Broadcasting & Subscription		L + 4.75% (1% Floor)		10/17/2017		5/28/2021			992,327				998,406				999,770				4.1	%
Paradigm Business Solutions, Inc.		Insurance Services		L+ 4.25% (1% Floor)		10/6/2017		10/11/2024			497,500				496,429				496,256				2.1	%
Radiology Partners, Inc. Term Loan A		Healthcare Services		L + 5.75% (1% Floor)		11/28/2017		12/4/2023			3,982,393				3,947,811				3,982,393				16.5	%
Radiology Partners, Inc. Term Loan(5)		Healthcare Services		L+ 4.25% (1% Floor)		6/28/2018		7/4/2025			2,000,000				1,980,000				1,980,000				8.2	%
ThreeBridge Solutions Delayed Draw(7)		IT Implementation		-		12/4/2017		6/30/2018			-				-				-				0.0	%
ThreeBridge Solutions Term Loan		IT Implementation		L+ 9.00% (1% Floor)		12/4/2017		12/4/2022			3,950,000				3,911,835				3,950,000				16.3	%
Zep Inc.		Chemicals & Allied Products		L+ 4.00% (1% Floor)		5/25/2018		8/12/2024			997,487				985,128				985,019				4.1	%
Total First Lien Senior Secured										$	27,197,453			$	26,979,972			$	27,153,149				112.5	%
Total Debt Investments											27,197,453				26,979,972				27,153,149				112.5	%

  

		Yield to				Maturity				Acquisition				Number of				Principal /				Amortized				Fair				Percentage
Company(3)		Maturity				Date				Date				Shares				Par				Cost(6)				Value				of Net Assets
U.S. Government Securities
U.S. Treasury Bill(5)			0.00	%			7/5/2018				6/29/2018				2,500,000				2,500,000				2,499,668				2,499,653				10.2	%
Total U.S. Government Securities																			2,500,000				2,499,668				2,499,653				10.2	%
Total Investments																		$	30,384,953			$	29,479,640			$	29,652,802				122.7	%
Liabilities in Excess of Other Assets																											(5,483,600	)			(22.7	)%
Net assets																										$	24,169,202				100.0	%

  

 

Forward foreign currency contracts outstanding as of June 30, 2018 were as follows:

 

								Unrealized
Currency		Currency				Expiration		Appreciation
Purchased		Sold		Counterparty		Date		(Depreciation)
USD 5,090,981		CAD 6,435,000		Bannockburn Global Forex, LLC		8/1/2018			188,627

 

CAD	Canadian Dollar

USD	United States Dollar

 

(1)	The amortized cost represents the original cost adjusted for the amortization of discounts and premiums, as applicable, on debt investments using the effective interest method.
(2)	Loan contains a variable rate structure, subject to an interest rate floor. Variable rate loans bear interest at a rate that may be determined by reference to either the London Interbank Offered Rate (“LIBOR” or “L”) (which can include one-, two-, three- or six-month LIBOR), Canadian Dollar Offered Rate (“CDOR”), or an alternate base rate (which can include the Federal Funds Effective Rate or the Prime Rate), at the borrower’s option, and which reset periodically based on the terms of the loan agreement. For each such loan, the Company has provided the interest rate in effect on the date presented. As of June 30, 2018, the 1 month, 2 month, and 3 month LIBOR rates were 2.09%, 2.17%, and 2.34% respectively. As of June 30, 2018, CDOR was 1.70%.
(3)	As of June 30, 2018, all investments are non-controlled, non-affiliated investments. Non-controlled, non-affiliated investments are defined as investments in which the Company owns less than 5% of the portfolio company’s outstanding voting securities and does not have the power to exercise control over the management or policies of such portfolio company.
(4)	Non-qualifying investment as defined by Section 55(a) of the Investment Company Act of 1940.
(5)	Investments or a portion of investments are unsettled as of June 30, 2018.
(6)	As of June 30, 2018, the tax cost of the Company’s investments approximates their amortized cost.
(7)	The entire $187,500 commitment to AqGen Ascensus, Inc. Delayed Draw and the entire $500,000 commitment to ThreeBridge Solutions Delayed Draw was unfunded as of June 30, 2018. As such, no interest is being earned on either of these investments. AqGen Ascensus Inc. Delayed Draw is subject to a 0.25% commitment fee and ThreeBridge Solutions Delayed Draw is subject to a 1% commitment fee (see Note 7 to the financial statements).

  

The accompanying notes are an integral part of these financial statements.

  

 

Flat Rock Capital Corp.

Schedule of Investments

As of December 31, 2017

  

Company(3)		Industry		Interest		Acquisition Date		Maturity Date		Principal / Par				Amortized Cost(1)(6)				Fair Value				Percentage of Net Assets
Debt Investments
First Lien Senior Secured(2)
AP Gaming I, LLC(5)		Entertainment & Leisure		L + 5.50% (1% Floor)		6/6/2017		2/15/2024		$	249,373			$	249,373			$	249,373				1.2	%
Hill International, Inc.		Business Services		L + 5.75% (1% Floor)		9/22/2017		6/21/2023			1,492,500				1,485,259				1,485,037				7.2	%
Idera, Inc.		Computers & Electronics		L + 5.00% (1% Floor)		6/27/2017		6/29/2024			841,268				839,933				845,474				4.1	%
KeyPoint Government Solutions, Inc.		Federal Services		L + 6.00% (1% Floor)		8/24/2017		4/30/2022			974,684				965,465				972,247				4.7	%
Logibec Inc.(4)		Healthcare IT		CDOR + 6.00% (1% Floor)		6/14/2017		1/15/2020			5,123,523				4,823,203				5,123,523				24.8	%
MRO Holdings, Inc.		Transportation		L + 5.25% (1% Floor)		10/20/2017		10/25/2023			1,000,000				990,062				990,000				4.8	%
Octave Music Group, Inc.		Broadcasting & Subscription		L + 4.75% (1% Floor)		10/17/2017		5/29/2021			997,442				1,004,712				999,936				4.8	%
Paradigm Business Solutions, Inc.		Insurance Services		L+ 4.25% (1% Floor)		10/6/2017		10/4/2024			500,000				498,805				498,750				2.4	%
PetVet Care Centers, LLC		Consumer Services		L + 6.00% (1% Floor)		8/24/2017		3/31/2023			995,000				990,473				990,025				4.8	%
Radiology Partners, Inc. Term Loan		Healthcare Services		L + 5.75% (1% Floor)		11/28/2017		12/4/2023			3,084,000				3,048,343				3,044,867				14.7	%
Radiology Partners, Inc. Delayed Draw		Healthcare Services		L + 5.75% (1% Floor)		11/28/2017		12/4/2023			564,000				564,000				564,000				2.8	%
Radiology Partners, Inc. Delayed Draw(7)		Healthcare Services		—		11/28/2017		12/4/2023			—				—				—				0.0	%
ThreeBridge Solutions Term Loan		IT Implementation		L+ 9.00% (1% Floor)		12/1/2017		12/1/2022			4,000,000				3,957,791				3,955,000				19.1	%
ThreeBridge Solutions Delayed Draw(7)		IT Implementation		—		12/1/2017		6/30/2018			—				—				—				0.0	%
Total First Lien Senior Secured										$	19,821,790			$	19,417,419			$	19,718,232				95.4	%
Total Debt Investments											19,821,790				19,417,419				19,718,232				95.4	%

  

		Yield to				Maturity		Acquisition		Number  of				Principal/				Amortized				Fair				Percentage
Company(3)		Maturity				Date		Date		Shares				Par				Cost(6)				Value				of Net Assets
U.S. Government Securities
U.S. Treasury Bill(5)			0.00	%		1/4/2018		12/29/2017			8,000,000				8,000,000				7,999,543				7,999,512				38.7	%
Total U.S. Government Securities															8,000,000				7,999,543				7,999,512				38.7	%
Total Investments														$	27,821,790			$	27,416,962			$	27,717,744				134.1	%
Liabilities in Excess of Other Assets																							(7,048,095	)			(34.1	)%
Net assets																						$	20,669,649				100.0	%

 

 

Forward foreign currency contracts outstanding as of December 31, 2017 were as follows:                       

 

Unrealized

Currency

Currency

Expiration

Appreciation

Purchased

Sold

Counterparty

Date

(Depreciation)

USD 5,090,981

CAD 6,435,000

Bannockburn Global Forex, LLC

8/1/2018

(38,141

)

 

CAD	Canadian Dollar

USD	United States Dollar

 

(1)	The amortized cost represents the original cost adjusted for the amortization of discounts and premiums, as applicable, on debt investments using the effective interest method.
(2)	Loan contains a variable rate structure, subject to an interest rate floor. Variable rate loans bear interest at a rate that may be determined by reference to either the London Interbank Offered Rate (“LIBOR” or “L”) (which can include one-, two-, three- or six-month LIBOR), Canadian Dollar Offered Rate (“CDOR”), or an alternate base rate (which can include the Federal Funds Effective Rate or the Prime Rate), at the borrower’s option, and which reset periodically based on the terms of the loan agreement. For each such loan, the Company has provided the interest rate in effect on the date presented. As of December 31, 2017, the 1 month, 2 month, and 3 month LIBOR rates were 1.56%, 1.62%, and 1.69% respectively. As of December 31, 2017, CDOR was 1.48%.
(3)	As of December 31, 2017, all investments are non-controlled, non-affiliated investments. Non-controlled, non-affiliated investments are defined as investments in which the Company owns less than 5% of the portfolio company’s outstanding voting securities and does not have the power to exercise control over the management or policies of such portfolio company.
(4)	Non-qualifying investment as defined by Section 55(a) of the Investment Company Act of 1940.
(5)	Investments or a portion of investments are unsettled as of December 31, 2017.
(6)	As of December 31, 2017, the tax cost of the Company’s investments approximates their amortized cost.
(7)	The entire commitment was unfunded as of December 31, 2017. As such, no interest is being earned on this investment. The investment is subject to a 1% commitment fee (see Note 7 to the financial statements).

 

The accompanying notes are an integral part of these financial statements.

 

 

Flat Rock Capital Corp.

Notes to Financial Statements (Unaudited)

 

Note 1. Organization and Basis of Presentation

 

Organization

 

Flat Rock Capital Corp. (the “Company”) is a Maryland corporation formed on March 20, 2017 that commenced operations on May 3, 2017. The Company was formed to primarily make debt investments in senior secured loans of U.S. middle-market companies (“Senior Loans”). The Company is an externally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the ”1940 Act”). In addition, for tax purposes, the Company intends to qualify and be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). Because the Company has elected to be regulated as a BDC and intends to qualify as a RIC under the Code, the Company’s portfolio is subject to diversification and other requirements. The Company’s investment objective is the preservation of capital while generating current income from its debt investments and seeking to maximize the portfolio’s total return.

 

Flat Rock Global, LLC (the “Adviser” or “Flat Rock Global”), a Delaware limited liability company, serves as the Company’s investment adviser. The Adviser is registered with the Securities and Exchange Commission (“SEC”) as an investment adviser under the Investment Advisers Act of 1940 (the “Advisers Act”). The Adviser oversees the management of the Company’s activities and is responsible for making investment decisions with respect to, and providing day-to-day management and administration of, the Company’s investment portfolio under the terms of an investment advisory agreement between the Company and the Adviser (the “Investment Advisory Agreement”), subject to the supervision of the Company’s Board of Directors (the “Board”). The Board consists of three directors, two of whom are not “interested persons” of the Company or Flat Rock Global, as such term is defined in Section 2(a)(19) of the 1940 Act.

 

The Company is conducting a continuous private offering of shares of common stock to investors in reliance on exemptions from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”). Shares of common stock are offered solely to investors that are “accredited investors” as defined in Rule 501(a) of Regulation D promulgated under the Securities Act. The Company offers shares through its agents and employees without sales commission or other remuneration on a “best efforts” basis. The Company believes that each of its employees and agents qualifies as an “associated person not deemed to be broker” within the meaning of Rule 3a4-1 promulgated pursuant to the Securities Exchange Act of 1934, as amended.

 

Note 2. Significant Accounting Policies

 

Basis of Presentation

 

The accompanying interim financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information. The accompanying interim financial statements of the Company and related financial information have been prepared pursuant to the requirements for reporting on Form 10-Q and Articles 6 or 10 of Regulation S-X. The Company is an investment company, and, therefore, applies the specialized accounting and reporting guidance in Accounting Standards Codification (“ASC”) Topic 946, Financial Services - Investment Companies.

 

Use of Estimates

 

U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reported periods. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.

 

Cash and Cash Equivalents

 

Cash and cash equivalents consist of demand deposits and highly liquid investments (e.g., U.S. treasury notes) with original maturities of three months or less. Cash and cash equivalents are carried at cost, which approximates fair value. The Company deposits its cash and cash equivalents with highly-rated banking corporations and, at times, may exceed the insured limits under applicable law.

 

Income Taxes

 

The Company intends to elect to be treated for U.S. federal income tax purposes as a RIC under the Code for its taxable year ended December 31, 2017. So long as the Company maintains its status as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that it distributes at least annually to its stockholders as dividends. Rather, any tax liability related to income earned by the Company represents obligations of the Company’s investors and will not be reflected in the financial statements of the Company. To qualify as a RIC under Subchapter M of the Code, the Company must, among other things, meet certain source-of-income and asset diversification requirements. In addition, to qualify for RIC tax treatment, the Company must distribute to its stockholders, for each taxable year, at least 90% of its “investment company taxable income” for that year, which is generally its ordinary income plus the excess of its realized net short-term capital gains over its realized net long-term capital losses.

 

 

In order for the Company not to be subject to U.S. federal excise taxes, it must distribute annually an amount at least equal to the sum of (i) 98% of its net ordinary income (taking into account certain deferrals and elections) for the calendar year, (ii) 98.2% of its capital gains in excess of capital losses for the calendar year and (iii) any net ordinary income and capital gains in excess of capital losses for preceding years that were not distributed during such years. The Company, at its discretion, may carry forward taxable income in excess of calendar year dividends and pay a 4% nondeductible U.S. federal excise tax on this income.

 

The Company evaluates tax positions taken or expected to be taken in the course of preparing its financial statements to determine whether the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority. Tax positions not deemed to meet the “more-likely-than-not” threshold are reserved and recorded as a tax benefit or expense in the current year. All penalties and interest associated with income taxes are included in income tax expense. Conclusions regarding tax positions are subject to review and may be adjusted at a later date based on factors including, but not limited to, on-going analyses of tax laws, regulations and interpretations thereof.

 

Although the Company files federal and state tax returns, its major tax jurisdiction is federal. The Company’s inception-to- date federal tax years remain subject to examination by the Internal Revenue Service and the State of Maryland Department of Revenue.

 

Valuation of Portfolio Investments

 

The Board has established procedures for the valuation of the Company’s investment portfolio. The valuation committee, which is comprised of the independent members of the Company’s Board of Directors, is responsible for executing the valuation policy. These procedures are detailed below.

 

Investments for which market quotations are readily available will be valued at such market quotations.

 

Most of the Company’s investments will not be traded on a national securities exchange and will not have the benefit of market quotations or other pricing data from such an exchange. With respect to investments for which pricing data is not readily available or when such pricing data is deemed not to represent fair value, the Board has approved a multi-step valuation process each quarter, as described below:

 

1.

each portfolio company or investment will be valued by Flat Rock Global, potentially with information received from one or more independent valuation firms engaged by the Company;

 

2.

an independent valuation firm will conduct independent valuations and make an independent assessment of the value of each investment on a rotating basis so that each investment is valued at least twice annually;

 

3.

the valuation committee of the Board will review and discuss the preliminary valuation prepared by Flat Rock Global and that of the independent valuation firm; and

 

4.

the Board will discuss the valuations and determine the fair value of each investment in the Company’s portfolio in good faith based on the input of Flat Rock Global, an independent valuation firm and the valuation committee.

 

Investments will be valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted) calculated based on an appropriate discount rate. The measurement is based on the net present value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that may be taken into account in fair value pricing the Company’s investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, M&A comparables, the principal market and enterprise values, among other factors.

 

The Company has adopted Financial Accounting Standards Board, or FASB, ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value measurements.

 

 

ASC Topic 820 clarifies that fair value is defined as the price that the Company would receive upon selling an investment or paying to transfer a liability to a market participant in the principal or most advantageous market for the investment. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. ASC Topic 820 provides a consistent definition of fair value that focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, ASC Topic 820 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date as discussed in Note 5.

 

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

 

The Company measures realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized upfront fees and prepayment penalties. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

 

Organization and Offering Expenses

 

Generally, costs associated with the organization of the Company are expensed as incurred, and costs incurred in connection with a continuous offering are deferred and amortized over twelve months from incurrence. However, the Adviser has agreed to bear all organization expenses and offering costs incurred in connection with the private offering and such expenses will not be subject to reimbursement by the Company.

 

Interest and Dividend Income Recognition

 

Interest income is recorded on the accrual basis and includes amortization of discounts or premiums. Discounts and premiums to par value on securities purchased are amortized into interest income over the contractual life of the respective security using the effective yield method. The amortized cost of investments represents the original cost adjusted for the amortization of discounts or premiums, if any. Upon prepayment of a loan or debt security, any prepayment premiums, unamortized upfront loan origination fees and unamortized discounts are recorded as interest income in the current period.

 

Loans are generally placed on non-accrual status when there is reasonable doubt that principal or interest will be collected in full. Accrued interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability. Non- accrual loans are restored to accrual status when past due principal and interest is paid current and, in management’s judgment, are likely to remain current. Management may make exceptions to this treatment and determine to not place a loan on non-accrual status if the loan has sufficient collateral value and is in the process of collection.

 

Dividend income on preferred equity securities is recorded on the accrual basis to the extent that such amounts are payable by the portfolio company and are expected to be collected. Dividend income on common equity securities is recorded on the record date for private portfolio companies or on the ex-dividend date for publicly-traded portfolio companies.

 

 

Other Income

 

From time to time, the Company may receive fees for services provided to portfolio companies. These fees are generally only available to the Company as a result of closing investments, are normally paid at the closing of the investments, are generally non- recurring and are recognized as revenue when earned upon closing of the investment. The services that the Adviser provides vary by investment, but can include closing, work, diligence or other similar fees and fees for providing managerial assistance to the Company’s portfolio companies. In addition, the Company may generate revenue in the form of commitment, origination, structuring or diligence fees, monitoring fees and possibly consulting and performance-based fees.

 

Debt Issuance Costs

 

The Company records origination and other expenses related to its debt obligations as deferred financing costs. These expenses are deferred and amortized over the life of the related debt instrument. Debt issuance costs are presented on the statement of assets and liabilities as a direct deduction from the debt liability. In circumstances in which there is not an associated debt liability amount recorded in the financial statements when the debt issuance costs are incurred, such debt issuance costs will be reported on the statement of assets and liabilities as an asset until the debt liability is recorded.

 

Distributions to Common Stockholders

 

Distributions to common stockholders are recorded on the record date. The amount to be distributed is determined by the Board and is generally based upon current and estimated net earnings. Net realized long-term capital gains, if any, would be generally distributed at least annually, although the Company may decide to retain such capital gains for investment.

 

Derivatives and Hedging Activities

 

Derivative instruments are defined as financial instruments whose value and performance are based on the value and performance of another security or financial instrument. During the quarter ended June 30, 2018, the Company utilized forward foreign currency contracts to hedge its foreign currency exposure.

 

The following table provides quantitative disclosures about fair values of, and unrealized appreciation (depreciation) on, the Company’s derivative instruments as of and for the quarter ended June 30, 2018, grouped by contract type and risk exposure category.

 

Derivatives
Forward Contracts		Unrealized appreciation (depreciation) on forward foreign currency contracts		$	188,627
Derivative Assets				$	188,627

 

The following table lists the amount of change in unrealized appreciation (depreciation) included in net increase (decrease) in net assets resulting from operations during the quarter ended June 30, 2018, grouped by contract type and risk exposure.

 

Derivative Type		Statement of Operation Location		Foreign Currency Contracts				Total
Forward Contracts		Net change in unrealized gains (losses) from forward foreign currency contracts		$	226,768			$	226,768
				$	226,768			$	226,768

 

During the current fiscal period, the Company’s quarterly average volume of derivatives is as follows:

 

Forward Foreign Currency Contracts - Payable (Value at Trade Date)
$	(5,090,981	)

 

 

Foreign Currency Translation

 

The Company’s books and records are maintained in U.S. dollars. Any foreign currency amounts are translated into U.S. dollars on the following basis:

 

1.

Fair value of investment securities, other assets and liabilities — at the exchange rates prevailing at the end of the applicable period; and

 

2.

Purchases and sales of investment securities, income and expenses — at the exchange rates prevailing on the respective dates of such transactions.

 

Although net assets and fair values are presented based on the applicable foreign exchange rates described above, the Company does not isolate that portion of the results of operations due to changes in foreign exchange rates on investments, other assets and debt from the fluctuations arising from changes in fair values of investments and liabilities held. Such fluctuations are included with the net realized and unrealized gain or loss from investments and liabilities.

 

Foreign security and currency translations may involve certain considerations and risks not typically associated with investing in U.S. companies and U.S. government securities. These risks include, but are not limited to, currency fluctuations and revaluations and future adverse political, social and economic developments, which could cause investments in foreign markets to be less liquid and prices to be more volatile than those of comparable U.S. companies or U.S. government securities.

 

Accounting Standards

 

In February 2016, the FASB issued ASU 2016-02, Amendments to the Leases (“ASU Topic 842”), which will require for all operating leases the recognition of a right-of-use asset and a lease liability, in the statement of financial position. The lease cost will be allocated over the lease term on a straight-line basis. This guidance is effective for annual and interim periods beginning after December 15, 2018. Management is currently evaluating the impact these changes will have on the Company’s financial statements and disclosures.

 

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606) –Principal versus Agent Considerations (Reporting Revenue Gross Versus Net) (“ASU 2016-08”). The amended guidance affects entities that enter into contracts with customers to transfer goods or services in exchange for consideration. Under ASU 2016-08, when another party is involved in providing goods or services to a customer, an entity must determine whether the nature of its promise is to provide the specified good or service itself (that is, the entity is a principal) or to arrange for the good or service to be provided by the other party (that is, the entity is an agent). An entity is a principal if it controls the specified good or service before that good or service is transferred to a customer. The amended guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customer. ASU 2016-08 affects the guidance in the new revenue standard issued in May 2014 and has the same effective date. Adoption of ASU 2016-08 did not have a material impact on the Company’s financial statements and disclosures.

 

In October 2016, the SEC adopted new rules and amended rules (together, “final rules”) intended to modernize the reporting and disclosure of information by registered investment companies. In part, the final rules amend Regulation S-X and require standardized, enhanced disclosure about derivatives in investment company financial statements, as well as other amendments. The compliance date for the amendments to Regulation S-X was August 1, 2017. The Company has evaluated the impact of the adoption of the amendments to Regulation S-X on its financial statements and disclosures and determined that the adoption of the amendments to Regulation S-X has not had a material impact on its financial statements.

 

In November 2016, FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash, a consensus of the FASB’s Emerging Issues Task Force (“ASU 2016-18”). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in ASU 2016-18 do not provide a definition of restricted cash or restricted cash equivalents. ASU 2016-18 is effective for interim and annual reporting periods beginning after December 15, 2017. The Company determined that this adoption did not have a material impact on its financial statements.

 

In March 2017, the FASB issued ASU 2017-08, Receivables— Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities (“ASU 2017-08”) which amends the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date. ASU 2017-08 does not require any accounting change for debt securities held at a discount; the discount continues to be amortized to maturity. ASU 2017-08 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Management has assessed these changes and does not believe they would have a material impact on the Company’s consolidated financial statements and disclosures.

 

 

Note 3. Agreements and Related Party Transactions

 

Investment Advisory Agreement

 

On May 16, 2017, the Company entered into the Investment Advisory Agreement with Flat Rock Global. Pursuant to the Investment Advisory Agreement, the Company pays Flat Rock Global a fee for its services consisting of two components — a management fee and an incentive fee. The management fee is calculated at an annual rate of 1.375% of the Company’s average gross assets as of the end of the two most recently completed quarters and is payable quarterly in arrears. The management fee for any partial month or quarter will be appropriately pro-rated. In order to meet the diversification tests required to qualify as a RIC, the Company, on June 30, 2018, acquired $2,500,000 in face value of short-term U.S. Treasury Bills. This transaction had the effect of increasing management fees payable to Flat Rock Global, all of which were waived by Flat Rock Global. For the three and six months ended June 30, 2018, the Company incurred management fees of $115,666 and $224,536, respectively, all of which were waived by Flat Rock Global. For the period May 3, 2017 (commencement of operations) through June 30, 2017, the Company incurred management fees of $24,592, all of which were waived by Flat Rock Global.

 

The incentive fee consists of two parts. The first part, which is referred to as the subordinated incentive fee on income, is calculated and payable quarterly in arrears based on 15% of the Company’s pre-incentive fee net investment income for the immediately preceding quarter. The payment of the subordinated incentive fee on income is subject to payment of a preferred return to investors each quarter, expressed as a quarterly rate of return on adjusted capital at the beginning of the most recently completed calendar quarter, of 1.5% (6.0% annualized), subject to a “catch up” feature. The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s pre-incentive fee net investment income is payable except to the extent that 15.0% of the cumulative net increase in net assets resulting from operations for the prior twelve quarters exceeds the cumulative incentive fees accrued and/or paid for the prior twelve quarters. In other words, any subordinated incentive fee on income that is payable in a calendar quarter is limited to the lesser of (i) 15.0% of the amount by which the Company’s pre- incentive fee net investment income for such calendar quarter that exceeds the 1.5% hurdle, subject to the “catch-up” provision and (ii) (x) 15.0% of the cumulative net increase in net assets resulting from operations for the prior twelve quarters minus (y) the cumulative incentive fees accrued and/or paid for the prior twelve quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the sum of the Company’s pre-incentive fee net investment income, realized gains and losses and unrealized gains and losses since inception.

 

The total return requirement described above is designed to measure the performance of Flat Rock Global over a longer time horizon than on a quarterly basis and to ensure that Flat Rock Global does not earn fees for exceeding the hurdle rate in selected quarters while under-performing on a longer-term basis. The total return requirement is likewise designed to incentivize Flat Rock Global to not focus solely on quarterly performance, but to seek investments that exhibit strong performance on a long-term basis. The Company believes that the total return requirement is beneficial to investors and has the potential to reduce the fees payable to Flat Rock Global in the event of under-performance on a long-term basis.

 

Under the capital gains component of the incentive fee, the Company pays Flat Rock Global at the end of each calendar year 15.0% of its aggregate cumulative realized capital gains from inception through the end of that year, computed net of the Company’s aggregate cumulative realized capital losses and the Company’s aggregate cumulative unrealized losses through the end of such year, less the aggregate amount of any previously paid capital gain incentive fees. For the foregoing purpose, the Company’s “aggregate cumulative realized capital gains” does not include any unrealized gains. It should be noted that the Company accrues an incentive fee for accounting purposes taking into account any unrealized gains in accordance with U.S. GAAP. The capital gains component of the incentive fee is not subject to any minimum return to stockholders. If such amount is negative, then no capital gains incentive fee is payable for such year. Additionally, if the Investment Advisory Agreement is terminated as of a date that is not a calendar year end, the termination date is treated as though it were a calendar year end for purposes of calculating and paying the capital gains incentive fee.

 

For the three- and six-month periods ended June 30, 2018, the Company did not incur subordinated incentive fees on income.

 

The Company includes unrealized gains in the calculation of the capital gains incentive fee expense and related accrued capital gains incentive fee. This accrual reflects the incentive fees that would be payable to Flat Rock Global if the Company’s entire portfolio was liquidated at its fair value as of the balance sheet date even though Flat Rock Global is not entitled to an incentive fee with respect to unrealized gains unless and until such gains are actually realized. For the three- and six-month periods ended June 30, 2018, the Company accrued capital gains incentive fees of $26,927. On a quarterly basis, the Company accrues for the capital gains incentive fee by calculating such fee as if it were due and payable as of the end of such period.

 

Administration Agreement

 

The Company entered into an administration agreement with Flat Rock Global to serve as its Administrator. Pursuant to the administration agreement, Flat Rock Global provides the Company with services such as accounting, financial reporting, legal and compliance support and investor relations support necessary for the Company to operate or has engaged a third-party firm to perform some or all of these functions. The Company does not pay Flat Rock Global any fees pursuant to the Administration Agreement. The Company reimburses Flat Rock Global for administrative expenses it incurs as a result of providing these services.

 

Beginning on May 3, 2017, Flat Rock Global agreed to reimburse the Company for certain operating expenses. Flat Rock Global has no obligation to reimburse any portion of the Company’s expenses but has indicated that it expects to continue such reimbursements until it deems that the Company has achieved economies of scale sufficient to ensure that the Company bears a reasonable level of expenses in relation to its income. The specific amount of expenses reimbursed by Flat Rock Global, if any, will be determined at the end of each quarter. For the three and six months ended June 30, 2018, the reimbursement totaled $47,540 and $80,392, respectively, which consisted of audit, fund accounting, fund administration, insurance, legal, valuation and other fees. For the period May 3, 2017 (commencement of operations) through June 30, 2017, the reimbursement totaled $35,000. To the extent reimbursements may be needed in the future, there can be no assurance that Flat Rock Global will provide any such reimbursements. In addition, there are no recoupment agreements in place and the aforementioned expenses will not be recouped by Flat Rock Global.

 

 

Note 4. Investments

 

The following table presents the composition of the Company’s investment portfolio at amortized cost and fair value as of June 30, 2018 and December 31, 2017:

		June 30, 2018								December 31, 2017
		Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value
First-lien senior secured debt		$	26,979,972			$	27,153,149			$	19,417,419			$	19,718,232
U.S. Government Securities			2,499,668				2,499,653				7,999,543				7,999,512
			29,479,640				29,652,802				27,416,962				27,717,744
Forward foreign currency contracts			-				188,627				-				(38,141	)
Total Investments		$	29,479,640			$	29,841,429			$	27,416,962			$	27,679,603

 

As of June 30, 2018, approximately 17.9% of the investment portfolio at amortized cost and 18.1% of the investment portfolio measured at fair value, respectively, were invested in portfolio companies with foreign domiciles, specifically Canada. Such investments are not qualifying assets as defined by Section 55(a) of the Investment Company Act of 1940. 

The industry composition of investments based on fair value as of June 30, 2018 and December 31, 2017 was as follows:

		June 30, 2018				December 31, 2017
Healthcare Services			20.0	%			13.0	%
Healthcare IT			16.4	%			18.5	%
IT Implementation			13.2	%			14.3	%
Business Services			10.0	%			5.3	%
U.S. Government Securities			8.4	%			28.9	%
Computers & Electronics			7.8	%			3.0	%
Transportation			3.4	%			3.6	%
Broadcasting & Subscription			3.4	%			3.6	%
Direct Selling			3.3	%			0.0	%
Chemicals & Allied Products			3.3	%			0.0	%
Consumer Goods			3.3	%			0.0	%
Insurance Services			1.7	%			1.8	%
Home Furnishings			1.7	%			0.0	%
Machinery			1.7	%			0.0	%
Insurance			1.0	%			0.0	%
Entertainment & Leisure			0.8	%			0.9	%
Forward Foreign Currency Contracts			0.6	%			0.0	%*
Federal Services			0.0	%			3.5	%
Consumer Services			0.0	%			3.6	%
Total			100.0	%			100.0	%

 

* Less than 0.5%. 

The geographic composition of investments based on fair value as of June 30, 2018 and December 31, 2017 was as follows:

		June 30, 2018				December 31, 2017
United States:
West			27.7	%			17.4	%
Midwest			15.0	%			16.1	%
South			14.5	%			3.0	%
Northeast			14.5	%			12.5	%
Government Securities			8.4	%			28.9	%
Southeast			3.4	%			3.6	%
Canada			16.5	%			18.5	%
Total			100.0	%			100.0	%

 

 

Note 5. Fair Value of Investments

 

Fair value is defined as the price that the Company would receive upon selling an investment or paying to transfer a liability in an orderly transaction to a market participant in the principal or most advantageous market for the investment. Accounting guidance emphasizes that valuation techniques maximize the use of observable market inputs and minimize the use of unobservable inputs.

 

Inputs refer broadly to the assumptions that market participants would use in pricing an asset or liability, including assumptions about risk. Inputs may be observable or unobservable. Observable inputs are inputs that reflect the assumptions market participants would use in pricing an asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the assumptions market participants would use in pricing an asset or liability developed based on the best information available in the circumstances. The valuation hierarchical levels are based upon the transparency of the inputs to the valuation of the investment as of the measurement date. The three levels are defined as follows:

 

Level 1 — Valuations based on quoted prices in active markets for identical assets or liabilities at the measurement date.

 

Level 2 — Valuations based on inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable at the measurement date. This category includes quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in non-active markets including actionable bids from third parties for privately held assets or liabilities, and observable inputs other than quoted prices such as yield curves and forward currency rates that are entered directly into valuation models to determine the value of derivatives or other assets or liabilities.

 

Level 3 — Valuations based on inputs that are unobservable and where there is little, if any, market activity at the measurement date.

 

The inputs for the determination of fair value may require significant management judgment or estimation and are based upon management’s assessment of the assumptions that market participants would use in pricing the assets or liabilities. These investments include debt and equity investments in private companies or assets valued using the market or income approach and may involve pricing models whose inputs require significant judgment or estimation because of the absence of any meaningful current market data for identical or similar investments. The inputs in these valuations may include, but are not limited to, capitalization and discount rates, beta and EBITDA multiples. The information may also include pricing information or broker quotes, which include a disclaimer that the broker would not be held to such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by disclaimer would result in classification as Level 3 information, assuming no additional corroborating evidence.

 

Pricing inputs and weightings applied to determine fair value require subjective determination. Accordingly, valuations do not necessarily represent the amounts that may eventually be realized from sales or other dispositions of investments.

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

There were no transfers between levels during the period.

 

The following table presents the fair value hierarchy of investments as of June 30, 2018 and December 31, 2017:

 

		Fair Value Hierarchy as of June 30, 2018
		Level 1				Level 2				Level 3				Total
First-lien senior secured debt		$	-			$	-			$	27,153,149			$	27,153,149
U.S. Government Securities			2,499,653				-				-				2,499,653
Forward foreign currency contracts			-				188,627				-				188,627
Total Investments		$	2,499,653			$	188,627			$	27,153,149			$	29,841,429

 

		Fair Value Hierarchy as of December 31, 2017
		Level 1				Level 2				Level 3				Total
First-lien senior secured debt		$	-			$	-			$	19,718,232			$	19,718,232
U.S. Government Securities			7,999,512				-				-				7,999,512
Forward foreign currency contracts			-				(38,141	)			-				(38,141	)
Total Investments		$	7,999,512			$	(38,141	)		$	19,718,232			$	27,679,603

 

 

The following table presents changes in the fair value of investments for which Level 3 inputs were used to determine the fair value as of and for the three and six months ended June 30, 2018 and for the period May 3, 2017 (commencement of operations) through June 30, 2017:

 

		First-lien senior secured debt
		For the Three Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Fair value, beginning of period		$	20,951,738			$	-
Purchases of investments, net			13,985,884				6,954,895
Proceeds from investments, net			(7,745,958	)			-
Net change in unrealized gain (loss)			(45,042	)			-
Net amortization of discount on investments			6,527				-
Transfers into (out of) Level 3							-
Fair value, end of period		$	27,153,149			$	6,954,895

 

		For the Six Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Fair value, beginning of period		$	19,718,232			$	-
Purchases of investments, net			21,801,088				6,954,895
Proceeds from investments, net			(14,251,490	)			-
Net change in unrealized gain (loss)			(128,394	)			-
Net amortization of discount on investments			13,713				-
Transfers into (out of) Level 3			-				-
Fair value, end of period		$	27,153,149			$	6,954,895

 

The following table presents the net change in unrealized gains/losses for the period relating to these Level 3 assets that were still held by the Company at the end of the period ended June 30, 2018 and for the period May 3, 2017 (commencement of operations) through June 30, 2017:

 

		Net Change in Unrealized Gain (Loss)
			For the Three Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
First-lien senior secured debt		$	(40,923	)		$	362

 

 

			Net Change in Unrealized Gain (Loss)
			For the Six Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
First-lien senior secured debt		$	(128,394	)		$	362

 

Market Based Approach: The Company may estimate the total enterprise value of each portfolio company by utilizing market value cash flow (EBITDA) multiples of publicly traded comparable companies and comparable transactions. The Company considers numerous factors when selecting the appropriate companies whose trading multiples are used to value its portfolio companies. These factors include, but are not limited to, the type of organization, similarity to the business being valued, and relevant risk factors, as well as size, profitability and growth expectations. The Company may apply an average of various relevant comparable company EBITDA multiples to the portfolio company’s latest twelve–month EBITDA or projected EBITDA to calculate the enterprise value of the portfolio company. Significant increases or decreases in the EBITDA multiple will result in an increase or decrease in enterprise value, which may result in an increase or decrease in the fair value estimate of the investment. In applying the market based approach as of June 30, 2018, the Company used the relevant EBITDA multiple ranges set forth in the table below to determine the enterprise value of its portfolio companies. The Company believes these were reasonable ranges in light of current comparable company trading levels and the specific portfolio companies involved.

 

Income Based Approach: The Company also may use a discounted cash flow analysis to estimate the fair value of an investment. Projected cash flows represent the relevant security’s contractual interest, fee and principal payments plus the assumption of full principal recovery at the investment’s expected maturity date. These cash flows are discounted at a rate established utilizing a yield calibration approach, which incorporates changes in the credit quality (as measured by relevant statistics) of the portfolio company, as compared to changes in the yield associated with comparable credit quality market indices, between the date of origination and the valuation date. Significant increases or decreases in the discount rate would result in a decrease or increase in the fair value measurement. In applying the income based approach as of June 30, 2018, the Company used the discount ranges set forth in the table below to value investments in its portfolio companies.

 

Fair value was also determined in some cases based on transaction pricing or recent acquisition or sale as the best measure of fair value with no material changes in operations of the related portfolio company since the transaction date.

 

The following table presents quantitative information about the significant unobservable inputs of the Company’s Level 3 investments as of June 30, 2018 and December 31, 2017. The table is not intended to be all-inclusive but instead captures the significant unobservable inputs relevant to the Company’s determination of fair value.

 

As of June 30, 2018

Range

Valuation

Unobservable

(Weighted

Fair Value

Technique

Input

Average)

First-lien senior secured debt

$11,009,124

Recent transaction

Transaction price

98.75-100.00 (99.47)

First-lien senior secured debt

16,144,025

Market & income approach

EBITDA multiple

7.3x-11.0x (9.5x)

$

27,153,149

Revenue multiple

0.6x-5.5x (3.3x)

Discount rate

6.75%-11.75% (8.56%)

  

As of December 31, 2017

Range

Valuation

Unobservable

(Weighted

Fair Value

Technique

Input

Average)

First-lien senior secured debt

$

10,301,926

Recent transaction

Transaction price

99.00-100.25 (99.18)

First-lien senior secured debt

9,416,306

Market & income approach

EBITDA multiple

6.5x-12.5x (9.99x)

$

19,718,232

Revenue multiple

1.5x

Discount rate

6.50% - 8.25% (7.41%)

Broker quote

99.75

 

 

Note 6. Share Transactions

 

Offering Proceeds

 

During the six months ended June 30, 2018, the Company issued and sold 173,910 shares of its common stock at an aggregate purchase price of $3,483,000.

 

Distributions

 

The following table reflects the distributions declared on shares of the Company’s common stock during the six months ended June 30, 2018:

 

Declaration

Record

Distribution

Payment

Distribution

Date

Date

Per Share

Date

Payment

1/26/2018

1/26/2018

$

0.108

2/6/2018

$

111,504

2/26/2018

2/26/2018

0.108

3/6/2018

113,258

3/26/2018

3/26/2018

0.108

4/6/2018

113,554

4/26/2018

4/26/2018

0.108

5/6/2018

115,928

5/26/2018

5/26/2018

0.108

6/6/2018

117,519

6/26/2018

6/26/2018

0.108

7/6/2018

122,506

$

694,269

 

Repurchases of Shares

 

The Small Business Credit Availability Act (the “SBCAA”) was signed into law as part of the 2018 omnibus spending bill on March 23, 2018. The SBCAA permits a BDC to incur additional amounts of leverage than previously permitted under the 1940 Act. Specifically, the SBCAA permits a BDC to reduce its asset coverage ratio from 200% to 150% so long as such BDC complies with certain requirements contained within the SBCAA. For BDCs, like the Company, that do not have shares of common stock listed on a national securities exchange, in order to take advantage of the modified asset coverage ratio, they must, among other things, extend, within the next twelve months, to each of the BDC’s stockholders as of the date of approval from the BDC’s board of directors, the opportunity to sell the securities held by that stockholder as of that date.

 

On May 30, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, assuming the Company complies with the requirements set forth in the SBCAA, the asset coverage ratio test applicable to the Company will be decreased from 200% to 150%, effective May 30, 2019. In order to comply with the requirement that the Company extend, within twelve months of May 30, 2018, to each of the Company’s stockholders as of May 30, 2018, the opportunity to sell the securities held by that stockholder as of that date, the Company filed a tender offer on June 27, 2018 offering to repurchase up to 283,529 shares of the Company’s issued and outstanding common stock, at a price equal to the net asset value per share on July 26, 2018. The tender offer represented 25% of the total issued and outstanding shares of common stock as of May 30, 2018. The tender offer expired at 11:59 P.M., Central Time, on July 26, 2018 (the “Expiration Date”). As of the Expiration Date, 20,000 shares of the Company’s common stock were validly tendered and not withdrawn pursuant to the tender offer. In accordance with the terms of the tender offer, the Company purchased all 20,000 shares of its common stock validly tendered and not withdrawn at a price equal to $20.03 per share for an aggregate purchase price of approximately $400,600. 

 

On August 7, 2018, following approval from the Board, the Company filed a second tender offer to repurchase up to 315,818 shares of the Company’s issued and outstanding common stock, which represent 25% of the total issued and outstanding shares of our common stock as of July 31, 2018.

 

Note 7. Commitments and Contingencies

 

The Company had an aggregate of $0.7 million of unfunded commitments to provide debt financing to its portfolio companies or to fund limited partnership interests as of June 30, 2018. Such commitments are generally up to the Company’s discretion to approve, or the satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Company’s statement of assets and liabilities and are not reflected in the Company’s statement of assets and liabilities.

 

A summary of the composition of the unfunded commitments as of June 30, 2018 is shown in the table below:

 

		As of
		June 30, 2018
AqGen Ascensus, Inc.		$	187,500
ThreeBridge Solutions			500,000
		$	687,500

 

From time to time, the Company may become a party to certain legal proceedings incidental to the normal course of its business. As of June 30, 2018, management is not aware of any pending or threatened litigation.

 

Note 8. Earnings Per Share

 

The following table sets forth the computation of basic and diluted earnings per common share for the three and six months ended June 30, 2018 and for the period May 3, 2017 (commencement of operations) through June 30, 2017:

 

		For the Three Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017				For the Six Months ended June 30, 2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Increase in net assets resulting from operations			361,871			$	567			$	710,822			$	567
Weighted average shares of common stock outstanding - basic and diluted			1,102,254				14,025				1,073,953				14,025
Earnings per common share - basic and diluted		$	0.33			$	0.04			$	0.66			$	0.04

  

Note 9. Financial Highlights

 

The following per common share data has been derived from information provided in the unaudited financial statements. The following is a schedule of financial highlights for the six months ended June 30, 2018 and for the period May 3, 2017 (commencement of operations) through June 30, 2017:

 

		For the Six Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Per Common Share Operating Performance
Net Asset Value, Beginning of Period		$	20.02			$	-
Results of Operations:
Net Investment Income(1)			0.49				0.01
Net Realized and Unrealized Gain (Loss) on Investments(1)			0.17				(0.01	)
Net Increase (Decrease) in Net Assets Resulting from Operations			0.66				-
Distributions to Common Stockholders
Distributions from Net Investment Income			(0.65	)			-
Distributions from Realized Gains							-
Net Decrease in Net Assets Resulting from Distributions			(0.65	)			-
Capital Share Transactions
Issuance of Common Stock			-				20.00
Net Increase (Decrease) Resulting from Capital Share Transactions			-				20.00
Net Asset Value, End of Period		$	20.03			$	20.00
Shares Outstanding, End of Period			1,206,355				128,750
Ratio/Supplemental Data
Net assets, end of period		$	24,169,202			$	2,575,567
Weighted-average shares outstanding			1,073,953				14,025
Total Return(3)			3.29	%			0.00	%
Portfolio turnover			63.4	%			0.0	%
Ratio of operating expenses to average net assets without waiver and reimbursement(2)(4)			2.95	%			28.86	%
Ratio of operating expenses to average net assets with waiver and reimbursement(2)(4)			5.73	%			0.23	%
Ratio of net investment income (loss) to average net assets without waiver and reimbursement(2)(4)			4.85	%			(28.53	%)
Ratio of net investment income (loss) to average net assets with waiver and reimbursement(2)(4)			2.07	%			0.10	%

 

  

(1)	The per common share data was derived by using weighted average shares outstanding.
(2)	The ratios reflect an annualized amount.
(3)	Total return is calculated as the change in net asset value (“NAV”) per share during the period, plus distributions per share (if any), divided by the beginning NAV per share. Total return is not annualized.
(4)	Includes interest expense which is not subject to reimbursement by Flat Rock Global LLC.

 

Note 10. Subsequent Events

 

The Company’s management has evaluated subsequent events through the date of issuance of the financial statements included herein.

 

There have been no subsequent events that require recognition or disclosure in these financial statements except for the following:

 

The Company’s initial tender offer expired on July 26, 2018 (the “Expiration Date”). As of the Expiration Date, 20,000 shares of the Company’s common stock were validly tendered and not withdrawn pursuant to the tender offer. In accordance with the terms of the tender offer, the Company purchased all 20,000 shares of our common stock validly tendered and not withdrawn at a price equal to $20.03 per share for an aggregate purchase price of approximately $400,600.

 

On July 13, 2018, the Company issued and sold 47,678 shares of its common stock at an aggregate purchase price of $955,000. The issuance of the shares of common stock was exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) and Rule 506(b) of Regulation D thereof.

 

On July 26, 2018, the Company declared a distribution of $0.108 per share, or $135,436, payable on August 6, 2018.

 

On July 27, 2018, the Company issued and sold 29,206 shares of its common stock at an aggregate purchase price of $585,000. The issuance of the shares of common stock was exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) and Rule 506(b) of Regulation D thereof.

 

On August 8, 2018, following approval from the Board, the Company filed a second tender offer to repurchase up to 315,818 of the total issued and outstanding shares of our common stock as of July 31, 2018.

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion and analysis should be read in conjunction with our financial statements and related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. Except as otherwise specified, references to “we,” “us,” “our,” or the “Company” refer to Flat Rock Capital Corp.

 

Overview

 

We are a recently organized specialty finance company formed as a Maryland corporation on March 20, 2017. We are an externally managed, non-diversified closed-end investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (“1940 Act”), and intends to elect and to be treated for tax purposes as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”).

 

Flat Rock Global, LLC (our “Adviser” or “Flat Rock Global”), a recently-formed Delaware limited liability company, acts as our investment adviser. Flat Rock Global is registered as an investment adviser under the Advisers Act. Flat Rock Global is controlled by Robert K. Grunewald, our Chairman and Chief Executive Officer. Mr. Grunewald has over 25 years of experience in BDCs, middle market finance, private equity and investment banking. Flat Rock Global manages our day-to-day operations and provides investment advisory and management services to us.

 

Our investment objective is the preservation of capital while generating current income from our debt investments and seeking to maximize our portfolio’s total return. We intend to achieve this objective by investing in a portfolio composed primarily of debt investments in senior secured loans of U.S. middle-market companies, which we refer to as Senior Loans. We intend to achieve our investment objective by (i) accessing the established loan origination channels developed by our management team, (ii) selecting investments within our core middle-market focus, (iii) partnering with experienced private equity firms, or sponsors, in many cases with whom our management team has invested alongside in the past, (iv) implementing disciplined underwriting standards and (v) drawing upon the aggregate experience and resources of our management team. We expect that most of our Senior Loans will be made to borrowers with EBITDA of between $10 million and $75 million annually.

 

We plan to hold many of our investments to maturity or repayment, but will sell our investments earlier if a sale or recapitalization of a portfolio company takes place, or if we determine a sale of one or more of our investments is in our best interest. Once we raise significant capital in this or any future offering, we will seek to create a diverse portfolio of Senior Loans by investing approximately $10 to $25 million of capital, on average, in the securities of middle-market companies. Prior to raising significant capital, we intend to make smaller investments primarily in Senior Loans.

 

Additionally, we may from time to time hold or invest in equity securities and other debt or equity securities generally arising from a restructuring of Senior Loan positions previously held by us. Flat Rock Global will also periodically evaluate all investments that are not Senior Loans to determine whether we should dispose of assets that are not Senior Loans. We intend to utilize leverage to enhance stockholder returns, and believe that, when properly financed and hedged, our investment strategy can produce attractive risk- adjusted returns.

 

Characteristics of and Risks Related to Investments in Private Companies

 

A core component of our strategy will be to invest in the corporate debt of privately held companies. Investments in private companies pose certain incremental risks as compared to investments in public companies. First, private companies have reduced access to the capital markets, resulting in diminished capital resources and ability to withstand financial distress. Second, the investments themselves may often be illiquid. As such, we may have difficulty exiting an investment promptly or at a desired price prior to maturity or outside of a normal amortization schedule. In addition, less public information generally exists about private companies. Finally, these companies may often not have third-party debt ratings or audited financial statements. We must therefore rely on the ability of Flat Rock Global to obtain adequate information through its due diligence efforts to evaluate the creditworthiness of and risks involved in investing in these companies. These companies and their financial information will also generally not be subject to the Sarbanes-Oxley Act and other rules that govern public companies that are designed to protect investors.

 

Operating and Regulatory Structure

 

Our investment activities are managed by Flat Rock Global and supervised by our board of directors (the “Board”), a majority of whom are independent. Under the Investment Advisory Agreement, we pay Flat Rock Global a quarterly management fee based on our average gross assets as well as incentive fees based on our performance.

 

We have entered into an administration agreement with Flat Rock Global to serve as our Administrator. Pursuant to the administration agreement, Flat Rock Global will provide us with services such as accounting, financial reporting, legal and compliance support and investor relations support, necessary for us to operate or engage a third-party firm to perform some or all of these functions.

 

Revenues

 

We generate revenue in the form of dividends or interest payable on the debt securities that we hold and capital gains, if any, received prior to the maturity of any debt instruments or other equity interests that we acquire in portfolio companies. In addition, we may generate revenue in the form of commitment, origination, structuring or diligence fees, monitoring fees and possibly consulting and performance-based fees. Any such fees will be generated in connection with our investments and recognized as earned.

 

 

Expenses

 

Our primary operating expenses are the payment of advisory fees and other expenses under the Investment Advisory Agreement. The investment advisory fees compensate Flat Rock Global for its work in identifying, evaluating, negotiating, executing, monitoring and servicing our investments.

 

We bear all other expenses of our operations and transactions, including (without limitation) fees and expenses relating to:

 

●

the cost of calculating our NAV, including the cost of any third-party valuation services;

●

the cost of effecting sales and repurchase of shares of our common stock and other securities;

●

investment advisory fees;

●

transfer agent and custodial fees;

●

fees and expenses associated with marketing efforts;

●

federal and state registration fees;

●

federal, state and local taxes;

●

independent directors’ fees and expenses;

●

costs of proxy statements, stockholders’ reports and notices;

●

fidelity bond, directors and officers/errors and omissions liability insurance and other insurance premiums;

●

fees and expenses associated with independent audits and outside legal costs, including compliance with the Sarbanes-Oxley Act;

●

costs associated with our reporting and compliance obligations under the 1940 Act and applicable federal and state securities laws;

●

brokerage commissions for our investments; and

●

direct costs such as printing, mailing and long distance telephone, incurred by Flat Rock Global and all other expenses incurred by either Flat Rock Global or us in connection with administering our business, including payments under the administration agreement that will be based upon our allocable portion of overhead and other expenses incurred by Flat Rock Global in performing its obligations under the administration agreement, including rent and our allocable portion of the costs of compensation and related expenses of our chief compliance officer and chief financial officer and their respective staffs, subject to limitations included in our Investment Advisory Agreement.

 

Pursuant to the Investment Advisory Agreement, Flat Rock Global is responsible for payment of any and all organization and offering expenses incurred on our behalf in connection with our private offering of shares. We will not reimburse Flat Rock Global for such expenses borne on our behalf.

 

Beginning on May 3, 2017, commencement of our operations, Flat Rock Global agreed to voluntarily reimburse us for certain operating expenses. Flat Rock Global has no obligation to reimburse any portion of our expenses but has indicated that it expects to continue such reimbursements until it deems that we have achieved economies of scale sufficient to ensure that we bear a reasonable level of expenses in relation to our income. The specific amount of expenses reimbursed by Flat Rock Global, if any, will be determined at the end of each quarter. For the three and six months ended June 30, 2018, the reimbursement totaled $47,540 and $80,392, respectively, which consisted of audit, fund accounting, fund administration, insurance, legal, valuation and other fees. For the period May 3, 2017 (commencement of operations) through June 30, 2017, the reimbursement totaled $35,000. To the extent reimbursements may be needed in the future, there can be no assurance that Flat Rock Global will provide any such reimbursements. In addition, there are no recoupment agreements in place and the aforementioned expenses will not be recouped by Flat Rock Global.

 

 

Portfolio and Investment Activity

 

As of June 30, 2018, our weighted average total yield of debt and income producing securities at fair value was 8.28%, and our weighted average total yield of debt and income producing securities at amortized cost was 8.29%.

 

As of June 30, 2018, we had 22 investments in 19 portfolio companies with an aggregate fair value of approximately $27.2 million.

 

Our investment activity for the three months ended June 30, 2018 and for the period ended May 3, 2017 (commencement of operations) through June 30, 2017 is presented below (information presented herein is at amortized cost unless otherwise indicated).

 

		For the Three Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
New investments:
Gross investments		$	14,250,000			$	6,907,141
Less: sold investments			(7,750,000	)			-
Total new investments			6,500,000				6,907,141
Principal amount of investments funded:
First-lien senior secured debt investments		$	6,500,000			$	6,907,141
Second-lien senior secured debt investments			-				-
Total principal amount of investments funded			6,500,000				6,907,141
Principal amount of investments sold:
First-lien senior secured debt investments			7,750,000				-
Second-lien senior secured debt investments			-				-
Total principal amount of investments sold or repaid			7,750,000				-
Number of new investment commitments			7				4
Average new investment commitment amount		$	928,571			$	1,726,785
Weighted average maturity for new investment commitments			6.6 years				3.7 years
Percentage of new debt investment commitments at floating rates			100	%			100	%
Percentage of new debt investment commitments at fixed rates			0	%			0	%
Weighted average interest rate of new investment commitments			6.32	%			6.88	%
Weighted average spread LIBOR of new floating rate investment commitments			3.97	%			5.75	%
Weighted average interest rate on investment sold or paid down			4.04	%			0.00	%

 

As of June 30, 2018 and December 31, 2017, our investments consisted of the following:

 

		June 30, 2018								December 31, 2017
		Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value
First-lien senior secured debt		$	26,979,972			$	27,153,149			$	19,417,419			$	19,718,232
U.S. Government Securities			2,499,668				2,499,653				7,999,543				7,999,512
Forward foreign currency contracts			-				188,627				-				(38,141	)
Total Investments		$	29,479,640			$	29,841,429			$	27,416,962			$	27,679,603

 

 

The table below describes investments by industry composition based on fair value as of June 30, 2018 and December 31, 2017:

 

		June 30, 2018				December 31, 2017
Healthcare Services			20.0	%			13.0	%
Healthcare IT			16.4	%			18.5	%
IT Implementation			13.2	%			14.3	%
Business Services			10.0	%			5.3	%
U.S. Government Securities			8.4	%			28.9	%
Computers & Electronics			7.8	%			3.0	%
Transportation			3.4	%			3.6	%
Broadcasting & Subscription			3.4	%			3.6	%
Direct Selling			3.3	%			0.0	%
Chemicals & Allied Products			3.3	%			0.0	%
Consumer Goods			3.3	%			0.0	%
Insurance Services			1.7	%			1.8	%
Home Furnishings			1.7	%			0.0	%
Machinery			1.7	%			0.0	%
Insurance			1.0	%			0.0	%
Entertainment & Leisure			0.8	%			0.9	%
Forward Foreign Currency Contracts			0.6	%			0.0	%*
Federal Services			0.0	%			3.5	%
Consumer Services			0.0	%			3.6	%
Total			100.0	%			100.0	%

 

* Less than 0.5%.

 

The table below describes investments by geographic composition based on fair value as of June 30, 2018 and December 31, 2017:

 

		June 30, 2018				December 31, 2017
United States:
West			27.7	%			17.4	%
Midwest			15.0	%			16.1	%
South			14.5	%			3.0	%
Northeast			14.5	%			12.5	%
Government Securities			8.4	%			28.9	%
Southeast			3.4	%			3.6	%
Canada			16.5	%			18.5	%
Total			100.0	%			100.0	%

 

The table below shows the weighted average yields and interest rate of our debt investments at fair value as of June 30, 2018 and December 31, 2017:

 

		June 30, 2018				December 31, 2017
Weighted average total yield of debt and income producing securities			8.28	%			7.99	%
Weighted average interest rate of debt and income producing securities			7.98	%			7.82	%
Weighted average spread over LIBOR of all floating rate investments			5.63	%			6.35	%

 

Our Adviser monitors our portfolio companies on an ongoing basis. It monitors the financial trends of each portfolio company to determine if they are meeting their respective business plans and to assess the appropriate course of action with respect to each portfolio company. Our Adviser has a number of methods of evaluating and monitoring the performance and fair value of our investments, which may include the following:

 

●

Assessment of success of the portfolio company in adhering to its business plan and compliance with covenants;

●

Periodic and regular contact with portfolio company management and, if appropriate, the financial or strategic sponsor, to discuss financial position, requirements and accomplishments;

●

Comparisons to other companies in the portfolio company’s industry; and

●

Review of monthly or quarterly financial statements and financial projections for portfolio companies.

 

 

As part of the monitoring process, our Adviser employs an investment rating system to categorize our investments. In addition to various risk management and monitoring tools, our Adviser rates the credit risk of all investments on a scale of 1 to 5. This system is intended primarily to reflect the underlying risk of a portfolio investment relative to our initial cost basis in respect of such portfolio investment (i.e., at the time of origination or acquisition), although it may also take into account the performance of the portfolio company’s business, the collateral coverage of the investment and other relevant factors. The rating system is as follows:

 

Investment Rating			Description
1			Investments with a rating of 1 involve the least amount of risk to our initial cost basis. The borrower is performing above expectations, and the trends and risk factors for this investment since origination or acquisition are generally favorable;
2			Investments rated 2 involve an acceptable level of risk that is similar to the risk at the time of origination or acquisition. The borrower is generally performing as expected and the risk factors are neutral to favorable. All investments or acquired investments in new portfolio companies are initially assessed a rating of 2;
3			Investments rated 3 involve a borrower performing below expectations and indicates that the loan’s risk has increased somewhat since origination or acquisition;
4			Investments rated 4 involve a borrower performing materially below expectations and indicates that the loan’s risk has increased materially since origination or acquisition. In addition to the borrower being generally out of compliance with debt covenants, loan payments may be past due (but generally not more than 120 days past due); and
5			Investments rated 5 involve a borrower performing substantially below expectations and indicates that the loan’s risk has increased substantially since origination or acquisition. Most or all of the debt covenants are out of compliance and payments are substantially delinquent. Loans rated 5 are not anticipated to be repaid in full and we will reduce the fair market value of the loan to the amount we anticipate will be recovered.

 

Our Adviser rates the investments in our portfolio at least quarterly and it is possible that the rating of a portfolio investment may be reduced or increased over time. For investments rated 3, 4 or 5, our Adviser enhances its level of scrutiny over the monitoring of such portfolio company. The following table presents the ratings of our portfolio investments at June 30, 2018 and December 31, 2017.

 

		June 30, 2018								December 31, 2017
		Investments				Percentage				Investments				Percentage
		at				of Total				at				of Total
Investment Rating		Fair Value				Portfolio				Fair Value				Portfolio
2		$	29,841,429				100.0	%		$	27,679,603				100.0	%
Total		$	29,841,429				100.0	%		$	27,679,603				100.0	%

 

Results of Operations

 

We are a recently-formed entity that commenced our principal operations on May 3, 2017. Since we commenced principal operations on May 3, 2017, we therefore have no full prior periods with which to compare our operating results.

 

The following table represents the operating results for the three and six months ended June 30, 2018 and for the period May 3, 2017 (commencement of operations) through June 30, 2017:

 

		For the Three Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017				For the Six Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Total Investment Income		$	438,799			$	685			$	854,542			$	685
Less: Net Expenses			177,737				480				323,234				480
Net Investment Income (Loss) before income taxes			261,062				205				531,308				205
Less: Income taxes, including excise taxes			-				-				-				-
Net Investment Income			261,062				205				531,308				205
Net realized gains (losses) on investments			44,305				-				81,140				-
Net unrealized gains (losses) on investments			56,504				362				98,374				362
Net increase in net assets resulting from operations		$	361,871			$	567			$	710,822			$	567

 

 

Investment Income

 

Investment income for the three and six months ended June 30, 2018 and for the period May 3, 2017 (commencement of operations) through June 30, 2017 was as follows:

 

		For the Three Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017				For the Six Months ended       June 30,       2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Interest from investments		$	438,581			$	685			$	850,828			$	685
Other income			218				-				3,714				-
Total investment income		$	438,799			$	685			$	854,542			$	685

  

Expenses

 

Operating expenses for the three and six months ended June 30, 2018 and for the period May 3, 2017 (commencement of operations) through June 30, 2017 was as follows:

 

		For the Three Months ended June 30, 2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017				For the Six Months ended June 30, 2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Management fees		$	115,666			$	24,592			$	224,536			$	24,592
Incentive fees			26,927				—				26,927				—
Other operating expenses			198,350				35,480				376,699				35,480
Management fee waiver			(115,666	)			(24,592	)			(224,536	)			(24,592	)
Expense Reimbursement			(47,540	)			(35,000	)			(80,392	)			(35,000	)
Net Expenses		$	177,737			$	480			$	323,234			$	480

 

Net expenses for the three months ended June 30, 2018 were $177,737, which consisted of $115,666 in management fees, $26,927 in incentive fees, $89,237 in professional fees, and $109,113 in general and administrative expenses, offset by $115,666 in management fee waiver and $47,540 in expense reimbursement from the Adviser.

 

Net expenses for the six months ended June 30, 2018 were $323,234, which consisted of $224,536 in management fees, $26,927 in incentive fees, $183,685 in professional fees, and $193,014 in general and administrative expenses, offset by $224,536 in management fee waiver and $80,392 in expense reimbursement from the Adviser.

 

In order to meet the diversification tests required to qualify as a RIC, the Company, on June 29, 2018, acquired $2,500,000 in face value of short-term U.S. Treasury Bills. This transaction had the effect of increasing management fees payable to the Adviser. For the six months ended June 30, 2018, the Company incurred management fees of $224,536, all of which were waived by Flat Rock Global.

 

 

Net Unrealized Gains (Losses) on Investments

 

We fair value our portfolio investments quarterly and any changes in fair value are recorded as unrealized gains or losses. During the three and six months ended June 30, 2018 and for the period May 3, 2017 (commencement of operations) through June 30, 2017, net unrealized gains on our investment portfolio were comprised of the following:

 

		For the Three Months ended         June 30,         2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017				For the Six Months ended         June 30,         2018				For the Period May 3, 2017 (commencement of operations) through June 30, 2017
Net unrealized gains (losses) on investments		$	56,504			$	362			$	98,374			$	362
Net unrealized gains (losses)		$	56,504			$	362			$	98,374			$	362

 

Financial Condition, Liquidity and Capital Resources

 

We generate cash primarily from the net proceeds generated from our private offering and from cash flows from fees, interest and dividends earned from our investments and principal repayments and proceeds from sales of our investments. Our primary use of funds is investments in Senior Loans, payments of our expenses and distributions to holders of our common stock. We commenced our private offering of shares on June 29, 2017. As of June 30, 2018, we sold 1,206,355 shares of common stock for gross proceeds of approximately $24.1 million. As of June 30, 2018, we had cash and cash equivalents of $1,266,745.

 

As a BDC, we generally are required to meet a coverage ratio of total assets to total borrowings and other senior securities, which include all of our borrowings and any preferred stock that we may issue in the future, of at least 200%. If this ratio declines below 200%, we cannot incur additional debt and could be required to sell a portion of our investments to repay some debt when it is disadvantageous to do so. On May 30, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, assuming we comply with the requirements set forth in the SBCAA, the asset coverage ratio test applicable to us will be decreased from 200% to 150%, effective May 30, 2019.

 

Flat Rock Global has agreed to pay all of our organization and offering expenses in connection with our private offering, including, but not limited to, expenses incurred in connection with legal, accounting and printing expenses, expenses associated with stockholder relations, transfer agent fees, fulfillment costs, and expenses associated with advertising and sales literature prepared by us. We will not reimburse Flat Rock Global for such organization and offering expenses. Therefore, these fees and expenses will not reduce the net proceeds available to us from the sale of our shares in our private offering.

 

Capital Contributions

 

During the six months ended June 30, 2018, we issued and sold 173,910 shares of our common stock at an aggregate purchase price of $3,483,000. 

 

 

Distribution Policy

 

Subject to our Board’s discretion and applicable legal restrictions, we intend to authorize and declare monthly distributions that will be paid on a monthly basis beginning with our initial monthly distribution of $0.108 per share declared by our Board on August 25, 2017, which was paid to our stockholders on September 6, 2017. We calculate each stockholder’s specific distribution amount for the month based on a distribution amount per share per day of our common stock, which accrues daily for each stockholder from the date we accept their subscription for shares of our common stock. From time to time, we may also pay interim distributions, including capital gains distributions, at the discretion of our Board. Each year a statement on Internal Revenue Service Form 1099-DIV (or successor form) identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gain on the sale of securities, or a return of paid-in capital surplus which is a nontaxable distribution) will be mailed to our stockholders. Our distributions may exceed our earnings, especially during the period before we have substantially invested the proceeds from this offering. As a result, a portion of the distributions we make may represent a return of capital for tax purposes.

 

We intend to elect to be treated for U.S. federal income tax purposes, and intend to qualify annually thereafter, as a RIC under Subchapter M of the Code. To obtain and maintain RIC tax treatment, we must, among other things, distribute at least 90.0% of our ordinary income and net short-term capital gain in excess of net long-term capital loss, if any. In order to avoid certain excise taxes imposed on RICs, we currently intend to distribute, or be deemed to distribute, during each calendar year an amount at least equal to the sum of (1) 98.0% of our ordinary income for the calendar year, (2) 98.2% of our capital gain in excess of capital loss for the one-year period ending on October 31 of such calendar year and (3) any ordinary income and net capital gain for preceding years that were not distributed during such years and on which we paid no U.S. federal income tax. 

 

The following table reflects the cash distributions per share that the Company declared and paid on its common stock during the six months ended June 30, 2018:

 

Declaration

Record

Distribution

Payment

Distribution

Date

Date

Per Share

Date

Payment

1/26/2018

1/26/2018

$

0.108

2/6/2018

$

111,504

2/26/2018

2/26/2018

0.108

3/6/2018

113,258

3/26/2018

3/26/2018

0.108

4/6/2018

113,554

4/26/2018

4/26/2018

0.108

5/6/2018

115,928

5/26/2018

5/26/2018

0.108

6/6/2018

117,519

6/26/2018

6/26/2018

0.108

7/6/2018

122,506

$

694,269

 

Critical Accounting Policies

 

Our financial statements are prepared in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Critical accounting policies are those that require the application of management’s most difficult, subjective, or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. The preparation of these financial statements will require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ. In addition to the discussion below, we have described our critical accounting policies in the notes to our financial statements.

 

Valuation of Portfolio Investments

 

Our Board has established procedures for the valuation of our investment portfolio. These procedures are detailed below.

 

Investments for which market quotations are readily available will be valued at such market quotations.

 

Most of our investments will not be traded on a national securities exchange and we will not have the benefit of market quotations or other pricing data from such an exchange. Certain of our investments will have the benefit of third-party bid-ask quotations. With respect to investments for which pricing data is not readily available or when such pricing data is deemed not to represent fair value, our Board has approved a multi-step valuation process each quarter, as described below:

 

1.

each portfolio company or investment will be valued by Flat Rock Global, potentially with information received from one or more independent valuation firms engaged by the Company;

 

2.

an independent valuation firm will conduct independent valuations and make an independent assessment of the value of each investment on a rotating basis so that each investment is valued at least twice annually;

 

3.

the valuation committee of our Board will review and discuss the preliminary valuation prepared by Flat Rock Global and that of the independent valuation firm; and

 

4.

our Board will discuss the valuations and determine the fair value of each investment in our portfolio in good faith based on the input of Flat Rock Global, an independent valuation firm and the valuation committee.

 

 

Investments will be valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted) calculated based on an appropriate discount rate. The measurement is based on the net present value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, M&A comparables, the principal market and enterprise values, among other factors.

 

The Company applies Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, Topic 820, Fair Value Measurements and Disclosures, as amended, which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements.

 

ASC Topic 820 clarifies that fair value is defined as the price that the Company would receive upon selling an investment or paying to transfer a liability to a market participant in the principal or most advantageous market for the investment. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. ASC Topic 820 provides a consistent definition of fair value that focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, ASC Topic 820 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date as discussed in Note 5.

 

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

 

We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized upfront fees and prepayment penalties. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

 

Contractual Obligations

 

Payments for investment advisory services under the Investment Advisory Agreement are equal to (a) a management fee calculated at an annual rate of 1.375% of the value of our average gross assets as of the end of the two most recently completed quarters and (b) an incentive fee based on our performance. We have entered into an administration agreement with Flat Rock Global to serve as our Administrator. Pursuant to the administration agreement, Flat Rock Global provides us with services such as accounting, financial reporting, legal and compliance support and investor relations support, necessary for us to operate or engage a third-party firm to perform some or all of these functions.

 

Off-Balance Sheet Arrangements

 

Other than contractual commitments and other legal contingencies incurred in the normal course of our business, we do not have any off-balance sheet financings or liabilities.

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

We are principally exposed to three types of market risk: foreign currency risk, valuation risk, and interest rate risk. Our investment guidelines permit, subject to approval, investments in derivative instruments such as futures, options, foreign currency forward contracts and swap agreements, which may be used to assume risks or for hedging purposes.

 

Foreign Currency Risk

 

The Company’s net cash inflows and outflows that are exposed to the risk of adverse changes in exchange rates as related to investments in portfolio companies in countries other than the United States and anticipated foreign currency denominated transaction proceeds. Where possible, the Company utilizes derivative financial instruments to manage foreign currency exchange rate risks, such as forward currency contracts. Forward and option contracts may be further utilized to reduce the impact to the Company’s cash flows from adverse movements in exchange rates. Foreign currency exposures are reviewed periodically and any natural offsets are considered prior to entering into a derivative financial instrument. The Company’s current primary hedged foreign currency exposures include the Canadian Dollar. The Company’s hedge transactions relate to a specific portion of the exposure that does not exceed the aggregate amount of the underlying transaction.

 

In addition to the transactional exposure described above, the Company’s operating results are impacted by the translation of its foreign operating income into U.S. dollars. The Company does not enter into foreign exchange contracts to mitigate this exposure.

 

The hypothetical pre-tax gain or loss in fair value from a 10% favorable or adverse change in quoted currency exchange rates would be approximately $0.5 million and $0.5 million for foreign currency derivative financial instruments as of June 30, 2018 and December 31, 2017, respectively. These estimated changes assume a parallel shift in all currency exchange rates and include the gain or loss on financial instruments used to hedge investments in portfolio companies. Because exchange rates typically do not all move in the same direction, the estimate may overstate the impact of changing exchange rates on the net fair value of the Company’s financial derivatives. It is also important to note that gains and losses indicated in the sensitivity analysis would generally be offset by gains and losses on the underlying exposures being hedged.

 

Valuation Risk

 

Substantially all, if not all, of our investments will not be traded on a national securities exchange, and we will not have the benefit of market quotations or other pricing data from such an exchange. Certain of our investments will have the benefit of third- party bid-ask quotations. With respect to investments for which pricing data is not readily available or when such pricing data is deemed not to represent fair value, our Board has approved a multi-step valuation process each quarter. There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make.

 

Interest Rate Risk

 

Interest rate sensitivity refers to the change in earnings that may result from changes in the level of interest rates. We intend to fund portions of our investments with borrowings, and at such time, our net investment income will be affected by the difference between the rate at which we invest and the rate at which we borrow. As of June 30, 2018, we had not incurred any leverage. Accordingly, we cannot assure you that a significant change in market interest rates will not have a material adverse effect on our net investment income.

 

As of June 30, 2018, all of the investments in our portfolio were at floating rates.

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Our disclosure controls and procedures include internal controls and other procedures designed to provide reasonable assurance that information required to be disclosed in this and other reports filed under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized, and reported within the required time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures. It should be noted that no system of controls can provide complete assurance of achieving a company’s objectives and that future events may impact the effectiveness of a system of controls.

 

Our Chief Executive Officer and Chief Financial Officer, after conducting an evaluation, together with members of our management, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2018, have concluded that our disclosure controls and procedures, as defined in Rule 13a-15(e) or 15d-15(e) under the Exchange Act, were effective as of June 30, 2018 at a reasonable level of assurance.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us.

 

Item 1A. Risk Factors.

 

As of June 30, 2018, there have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K, filed with the SEC on March 15, 2018, except for the following:

 

Recent legislation may allow us to incur additional leverage.

 

The 1940 Act generally prohibits us from incurring indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). However, recent legislation has modified the 1940 Act by allowing a BDC to increase the maximum amount of leverage it may incur from an asset coverage ratio of 200% to an asset coverage ratio of 150%, if certain requirements are met. Under the legislation, we are allowed to increase our leverage capacity if stockholders representing at least a majority of the votes cast, when a quorum is present, approve a proposal to do so. If we receive stockholder approval, we would be allowed to increase our leverage capacity on the first day after such approval. Alternatively, the legislation allows the majority of our independent directors to approve an increase in our leverage capacity, and such approval would become effective after one year. In addition, the legislation requires non-listed BDCs to offer to repurchase 25% of its securities each quarter following the calendar quarter in which the BDC obtains such approval. In either case, we would be required to make certain disclosures on our website and in SEC filings regarding, among other things, the receipt of approval to increase our leverage, our leverage capacity and usage, and risks related to leverage.

 

As a result of this legislation, we may be able to increase our leverage up to an amount that reduces our asset coverage ratio from 200% to 150%. Leverage magnifies the potential for loss on investments in our indebtedness and on invested equity capital. As we use intend to leverage to partially finance our investments, you will experience increased risks of investing in our securities. If the value of our assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more sharply than it would have had we not leveraged. Conversely, if the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged our business. Similarly, any increase in our income in excess of interest payable on the borrowed funds would cause our net investment income to increase more than it would without the leverage, while any decrease in our income would cause net investment income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to pay common stock dividends, scheduled debt payments or other payments related to our securities. Leverage is generally considered a speculative investment technique.

 

On May 30, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, assuming we comply with the requirements set forth in the SBCAA, the asset coverage ratio test applicable to us will be decreased from 200% to 150%, effective May 30, 2019. In order to comply with the requirement that we extend, within twelve months of May 30, 2018, to each of our stockholders as of May 30, 2018, the opportunity to sell the securities held by that stockholder as of that date, we filed our initial tender offer (the “Initial Tender Offer”) on June 27, 2018. On August 7, 2018 we filed our second tender offer (the “Second Tender Offer”) to each of our stockholders as of July 31, 2018, to purchase up to 315,818 shares of our common stock. The Initial Tender Offer and the Second Tender Offer represented 25% of the total issued and outstanding shares of common stock as of the relevant period. In order to comply with the provisions of the SBCAA, we intend to conduct two subsequent tender offers prior to May 30, 2019, each of which will offer to repurchase up to 25% of our issued and outstanding shares of common stock.

 

Incurring additional indebtedness could increase the risk in investing in our company.

 

The use of leverage magnifies the potential for gain or loss on amounts invested. The use of leverage is generally considered a speculative investment technique and increases the risks associated with investing in the shares of our common stock. If we comply with the disclosures and tender offer requirements set forth in the SBCAA, we will be permitted to increase our use of leverage beyond levels that were previously permitted by the 1940 Act effective May 30, 2019. If we incur such additional leverage, you will experience increased risks of investing in the shares of our common stock.

 

If the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged, thereby magnifying losses or eliminating our stake in a leveraged investment. Similarly, any decrease in our revenue or income will cause our net income to decline more sharply than it would have had we not borrowed. Such a decline would also negatively affect our ability to make distributions with respect to our shares of common stock. Our ability to service any debt depends largely on our financial performance and is subject to prevailing economic conditions and competitive pressures. In addition, our stockholders bear the burden of any increase in our expenses as a result of our use of leverage.

 

Because we may use debt to finance certain of our investments, if market interest rates were to increase, our cost of capital could increase, which could reduce our net income. In addition, if additional debt were to become unavailable, it could have a materially adverse effect on our business, financial condition and results of operations.

 

Because we may borrow money to finance certain of our investments, our net income will depend, in part, upon the difference between the rate at which we borrow funds and the rate at which we invest those funds. As a result, a significant increase in market interest rates would have a greater material adverse effect on our net income in the event we use more debt to finance our investments. In periods of rising interest rates, our cost of funds would increase, which could reduce our net income. In addition, if a credit facility were to become unavailable to us and attractive alternative financing sources were not available, it could have a materially adverse effect on our business, financial condition and results of operations.

 

 

In addition, a rise in the general level of interest rates typically leads to higher interest rates applicable to our secured loans. Accordingly, an increase in interest rates may result in an increase of our income and, as a result, an increase in the incentive fee payable to our Adviser.

 

The base management and incentive fee structure we have with our Adviser may create incentives that are not fully aligned with the interests of our stockholders.

 

In the course of our investing activities, we pay a base management fee and an incentive fee to our Adviser. The Investment Advisory Agreement that we entered into with our Adviser provides that the base management fee is based on the value of our gross assets. As a result, investors in our common stock will invest on a “gross” basis and receive distributions on a “net” basis after expenses, resulting in a lower rate of return than one might achieve through direct investments. Because these fees are based on the value of our total assets, our Adviser benefits when we incur debt or use leverage. This fee structure may encourage our Adviser to cause us to borrow money to finance additional investments. Additionally because the “hurdle” rate with respect to the portion of the incentive fee based on investment income is fixed, any increase in the use of leverage is likely to increase such portion of the incentive fee because the use of leverage could result in an increase in net income. As a result of this arrangement, our Adviser may from time to time have interests that differ from those of our stockholders, giving rise to a conflict.

 

Our incentive fee may induce our Adviser to pursue speculative investments and to use leverage when it may be unwise to do so.

 

The incentive fee payable by us to our Adviser may create an incentive for our Adviser to make investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation arrangement. The way in which the incentive fee payable to our Adviser is determined, which is calculated separately in two components as a percentage of the interest and other investment income in excess of a quarterly minimum hurdle rate and as a percentage of the realized gain on invested capital, may encourage our Adviser to use leverage or take additional risk to increase the return on our investments.

 

In addition, our Adviser receives the incentive fee based, in part, upon net capital gains realized on our investments. Unlike the portion of the incentive fee based on investment income, there is no minimum level of gain applicable to the portion of the incentive fee based on net capital gains. As a result, our Adviser may have an incentive to invest more in investments that are likely to result in capital gains as compared to income producing securities or to advance or delay realizing a gain in order to enhance its incentive fee. This practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

On January 29, 2018, the Company issued and sold 16,234 shares of its common stock at an aggregate purchase price of $325,000. The issuance of the shares of common stock was exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) and Rule 506(b) of Regulation D thereof.

 

On February 28, 2018, the Company issued and sold 2,747 shares of its common stock at an aggregate purchase price of $55,000. The issuance of the shares of common stock was exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) and Rule 506(b) of Regulation D thereof.

 

On March 29, 2018, the Company issued and sold 21,978 shares of its common stock at an aggregate purchase price of $440,000. The issuance of the shares of common stock was exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) and Rule 506(b) of Regulation D thereof.

 

On April 27, 2018, the Company issued and sold 14,728 shares of its common stock at an aggregate purchase price of $295,000. The issuance of the shares of common stock was exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) and Rule 506(b) of Regulation D thereof.

 

On May 29, 2018, the Company issued and sold 46,181 shares of its common stock at an aggregate purchase price of $925,000. The issuance of the shares of common stock was exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) and Rule 506(b) of Regulation D thereof.

 

On June 29, 2018, the Company issued and sold 72,042 shares of its common stock at an aggregate purchase price of $1,443,000. The issuance of the shares of common stock was exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) and Rule 506(b) of Regulation D thereof.

 

Item 3. Default Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures.

 

Not applicable.

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

 

The exhibits required by this item are set forth in the Exhibit Index attached hereto and are filed or incorporated as part of this Report.

 

Exhibit Index

 

3.1		Articles of Incorporation of Flat Rock Capital Corp. (Incorporated by reference to the initial filing of the Registration Statement on Form 10 (SEC File No. 000-55767) filed with the SEC on March 24, 2017.)
3.2		Amended and Restated Articles of Incorporation (Incorporated by reference to Amendment No. 2 to the Registration Statement on Form 10 (SEC File No. 000-55767) filed with the SEC on May 19, 2017.)
3.3		Bylaws (Incorporated by reference to Amendment No. 1 to the Registration Statement on Form 10 (SEC File No. 000- 55767) filed with the SEC on May 1, 2017.)
10.1		Investment Advisory Agreement (Incorporated by reference to Amendment No. 2 in the Registration Statement on Form 10 (SEC file No. 000-55767) filed with the SEC on May 19, 2017.)
10.2		Amendment No. 1 to Investment Advisory Agreement (Incorporated by reference to Amendment No. 3 to the Registration Statement on Form 10 (SEC File No. 000-55767) filed with the SEC on May 23, 2017.)
10.3		Administration Agreement (Incorporated by reference to Amendment No. 2 to the Registration Statement on Form 10 (SEC File No. 000-55767) filed with the SEC on May 19, 2017.)
10.4		Custody Agreement (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 2017, filed with the SEC on November 14, 2017.)
31.1*		Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*		Certifications of Principal Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

*       Filed herewith.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	Flat Rock Capital Corp.
Date: August 14, 2018
	/s/ Robert K. Grunewald
	Name:	Robert K. Grunewald
	Title:	President and Chief Executive Officer (Principal Executive Officer)
Date: August 14, 2018
	/s/ Richard A. Petrocelli
	Name:	Richard A. Petrocelli
	Title:	Chief Financial Officer and Chief Operating Officer (Principal Financial and Accounting Officer)

 

 

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